Exhibit 13
On Active Duty
ENGINEERED SUPPORT SYSTEMS IS
TEAMING WITH AMERICA'S MILITARY
IN THE DEFENSE OF FREEDOM
[ESSI LOGO]
Engineered Support Systems, Inc.
2003 Annual Report
RESULTS
BUILDING ON THE MOMENTUM OF OUR FINANCIAL STRENGTH
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Year Ended October 31 2003 2002 2001 2000 1999
(in thousands, except per share amounts)
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SELECTED FINANCIAL DATA
RESULTS OF OPERATIONS
Net revenues $ 572,701 $ 407,945 $365,198 $335,342 $ 146,526
Operating income from continuing operations $ 72,469 $ 48,592 $ 35,847 $ 30,171 $ 14,080
Depreciation and amortization 8,961 7,038 9,001 9,398 3,465
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EBITDA (Earnings before interest, taxes,
depreciation and amortization) $ 81,430 $ 55,630 $ 44,848 $ 39,569 $ 17,545
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Net income from continuing operations $ 43,283 $ 27,666 $ 18,269 $ 12,711 $ 6,962
Net income $ 43,408 $ 23,533 $ 18,576 $ 13,040 $ 7,309
Diluted shares outstanding 25,838 24,314 22,824 20,433 17,105
Diluted earnings per share
Continuing operations $ 1.68 $ 1.14 $ 0.80 $ 0.62 $ 0.41
Total $ 1.68 $ 0.97 $ 0.81 $ 0.64 $ 0.43
Cash dividends per share $ 0.04 $ 0.04 $ 0.04 $ 0.04 $ 0.04
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FINANCIAL POSITION
Total assets $ 419,301 $ 290,147 $240,435 $238,352 $ 239,396
Bank debt 73,190 55,000 63,738 96,797 114,591
Shareholders' equity 197,167 134,857 109,392 78,500 63,422
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Funded backlog $ 533,439 $ 350,063 $291,745 $307,274 $ 286,789
Total backlog 1,456,174 1,218,706 973,552 905,421 1,137,268
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NET REVENUES
(in millions)
[GRAPH]
99 $146.5
00 $335.3
01 $365.2
02 $407.9
03 $572.7
EBITDA
(in millions)
[GRAPH]
99 $17.5
00 $39.6
01 $44.8
02 $55.6
03 $81.4
OPERATING INCOME
FROM CONTINUING
OPERATIONS
(in millions)
[GRAPH]
99 $14.1
00 $30.2
01 $35.8
02 $48.6
03 $72.5
NET INCOME
(in millions)
[GRAPH]
99 $7.3
00 $13.0
01 $18.6
02 $23.5
03 $43.4
DILUTED EARNINGS
PER SHARE
[GRAPH]
99 $0.43
00 $0.64
01 $0.81
02 $0.97
03 $1.68
FORCES
ESSI'S OPERATING UNITS ARE READY FOR ACTION
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COMPANY BUSINESS
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ENGINEERED AIR SYSTEMS, INC. Established in 1982, EAS designs a wide range of military
support equipment including nuclear/biological/chemical
defense systems, environmental control systems, water
storage, purification and distribution equipment, petroleum
testing labs, containers and general support equipment.
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ENGINEERED COIL/MARLO COIL Acquired in 1998, Marlo is a leading designer and
manufacturer of custom engineering coils and
refrigeration and air-handling equipment, and ranks as
the largest supplier of marine coils, air-handling units,
product coolers and refrigeration plants to the U.S. Navy.
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KECO INDUSTRIES, INC. Acquired in 1998, Keco is a major producer of military
support equipment including environmental control systems,
water purification systems, refrigeration equipment,
containers and general military support equipment.
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ENGINEERED ELECTRIC/FERMONT Acquired in 1999, Fermont is a leading supplier of
military generator sets and power systems.
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SYSTEMS & ELECTRONICS INC. Acquired in 1999, SEI is a leading designer and
manufacturer of military support equipment including
aircraft loading systems, heavy transport systems,
fire-control support systems, radar systems, specialized
avionics testing equipment and materials handling equipment.
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ESSIBUY.COM, INC. Launched in 2001, ESSIbuy.com is the company's product
and logistics support division, providing one-stop shopping
for comprehensive logistic services including online access
to training, operating and maintenance manuals, spare and
replacement parts, warranty services and other technical
support.
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RADIAN, INC. Acquired in 2002, Radian is a key supplier of engineering,
logistics and training services, asset protection systems,
advanced technology and systems integration services. Radian
also provides certain power generation and distribution
equipment.
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UNIVERSAL POWER SYSTEMS, INC. Acquired in 2002, UPSI is a recognized leader in the
design, development, manufacture and distribution of
transportable and fixed-site uninterruptible power supply
systems, with more than 15,000 units successfully
deployed throughout the world.
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TECHNICAL AND MANAGEMENT Acquired in 2003, TAMSCO is a provider of telecommunications
SERVICES CORPORATION and information technology services, integrated logistics
support, systems integration and electronics manufacturing.
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ENGINEERED ENVIRONMENTS, INC. Acquired in 2003, EEi is a designer and manufacturer of
specialized environmental control units, air handling and
heat transfer systems.
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PIVOTAL POWER INC. Acquired in December 2003, Pivotal Power is a supplier of
ruggedized and full MIL-SPEC high-performance static power
conversion equipment and other power management systems
for ground-based, shipboard and airborne communications
and weapons platforms.
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BUSINESS SEGMENT FACILITIES MARKETS
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Support Systems Manufacturing, engineering and U.S. military and prime defense
administrative facilities in St. Louis, Mo., contractors.
with a workforce of 45.
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Support Systems Manufacturing, engineering, testing and U.S. military and prime defense
administrative facilities in High Ridge, contractors, healthcare,
Mo., with a workforce of 200. semiconductor and
pharmaceutical industries.
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Support Systems Manufacturing, engineering and U.S. military and prime defense
administrative facilities in Florence, Ky., contractors.
with a workforce of 330.
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Support Systems Manufacturing, engineering, testing and U.S. military and prime defense
administrative facilities in Bridgeport, Conn., contractors.
with a workforce of 135.
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Support Systems Manufacturing, engineering, testing and U.S. and foreign militaries and
administrative facilities in St. Louis and prime defense contractors and
West Plains, Mo., with a workforce of 950. U.S. Postal Service.
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Support Services Located in administrative facilities in U.S. military.
St. Louis, Mo., with a workforce of 20.
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Support Services Based in Alexandria, Va., with facilities in U.S. military, intelligence
several states located adjacent to key U.S. agencies, commercial clients.
military installations including on-site at
the Pentagon, with a workforce of 375.
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Support Systems Manufacturing, engineering, testing and U.S. military and prime defense
administrative facilities in Chantilly, Va., contractors, diplomatic community,
with a workforce of 20. intelligence agencies.
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Support Services Based in Calverton, Md., with manufacturing U.S. military and prime defense
facilities in Polson, Mont., and a significant contractors.
presence at numerous key military locations
nationwide and abroad, with a workforce of 700.
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Support Systems Manufacturing and administrative facilities U.S. military and commercial
in Cincinnati, Ohio, with a workforce of 75. clients.
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Support Systems Manufacturing and administrative facilities U.S., UK and Canadian
in Halifax, Nova Scotia, Canada, with a militaries and prime defense
workforce of 80. contractors.
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Fueled by a steady steam of strategic acquisitions, Engineered Support
Systems has emerged as a leading designer, manufacturer and supplier of
integrated military electronics, support equipment and technical and
logistics services for all branches of America's armed forces and certain
foreign militaries, homeland security forces and selected government and
intelligence agencies. The company also produces specialized equipment and
systems for commercial and industrial applications.
LEADERSHIP [PHOTO]
[PHOTO] SUPPORT
SERVICES
SUPPORT [PHOTO]
SYSTEMS
Update
A LETTER TO OUR SHAREHOLDERS
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[PHOTO]
Michael F. Shanahan, Sr.
Chairman of the Board
With eight consecutive years of record results, Engineered Support Systems,
Inc. is rapidly approaching revenues of $1 billion and beyond. In pursuit of
that goal, we continue to deliver exceptional performance with our proven
strategy of solid internal growth, selective acquisitions, differentiated
technology, and quality products and services that meet the needs of our
nation's military, homeland security and intelligence organizations.
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For the fiscal year ended October 31, 2003, company revenues reached $572.7
million, an increase of 40 percent, and net income climbed to $43.4 million,
or $1.68 per share, increases of 85 percent and 73 percent, respectively.
Other key measurements also reflect our continued strong financial
performance. Free cash flow generation was a robust $55 million, 1.3 times
net income. This drove our year-end debt-to-equity ratio down to just 0.37,
and we posted an industry-leading return on shareholders' equity of 26.4
percent in 2003.
Against the backdrop of combat operations in Iraq and Afghanistan,
the global war on terrorism and homeland security initiatives, the company's
revenues continued strong throughout fiscal 2003. For the year, entered
orders for our products and services totaled $659 million yielding a solid
book-to-bill ratio of 1.15 times, pushing total contract backlog, including
unfunded options on existing long-term contracts, to a record of nearly $1.5
billion.
Based on the company's steady financial progress, we announced a
year-end 3-for-2 stock split in the form of a 50 percent stock dividend,
increasing the number of shares outstanding to approximately 25 million.
This stock split, the third split in the past two and a half years, will
enhance long-term shareholder value and provide additional liquidity and
share float.
STRATEGIC ACQUISITIONS
Although not dependent on acquisitions to achieve sustained growth, we view
acquisitions as a fundamental component of our long-term business strategy.
That said, we do not seek acquisitions simply for the sake of getting
bigger. We look for defense-oriented companies with similar products,
customer bases and related technologies; accretive to earnings; with
compatible organizational chemistry.
Carefully following these criteria, we have successfully concluded
11 acquisitions since 1998, including three during calendar 2003. These
acquisitions have significantly reinforced our existing product lines, added
new service areas and technologies, expanded our markets and customer base
and brought strong, capable management to our organization.
We finalized the acquisition of Technical and Management Services
Corporation (TAMSCO) in May 2003 for $67.5 million in cash plus the payoff
of primarily working capital indebtedness subject to certain post-closing
adjustments. TAMSCO's revenues have historically grown at
2 | Engineered Support Systems, Inc.
a double-digit rate, reaching approximately $116 million for the 2002
calendar year. The addition of TAMSCO has been highly accretive, accounting
for revenues of $70.6 million and contributing incremental operating
earnings of $6.1 million in the first six months post-closing.
As a provider of information technology logistics and digitization
services, and a designer and integrator of telecommunications systems
primarily for the U.S. Department of Defense, TAMSCO is clearly a great fit
for Engineered Support Systems. Their business complements the company's
logistics and electronics manufacturing operations, with opportunities to
leverage business development initiatives and fortify our growth prospects
with existing U.S. Air Force and Army customers.
In September 2003, we completed the acquisition of Engineered
Environments, Inc. (EEi) for $15.5 million in cash, plus the payoff of
mortgages and working capital-related indebtedness. EEi's revenues for
calendar 2002 reached approximately $14 million, generating solid operating
margins. The acquisition has been immediately accretive to earnings, as
well.
As a designer and manufacturer of specialized environmental control
units and heat transfer systems for defense and industrial markets, this
Cincinnati, Ohio-based firm clearly complements our nearby Keco Industries
operation in northern Kentucky. EEi brings us proven technical expertise in
providing environmental control solutions and long-standing working
relationships with major defense prime contractors.
Subsequent to fiscal year-end, we completed our first international
defense acquisition with the purchase of Pivotal Power Inc. of Halifax, Nova
Scotia, Canada. Pivotal Power is a rapidly growing supplier of ruggedized
and full MIL-SPEC high-performance static power conversion equipment to the
worldwide defense market. We paid total consideration of $10.0 million in
cash plus the assumption of certain interest-free loans with a Canadian
development agency.
For its most recent year ended September 30, 2003, Pivotal Power
posted revenues of approximately $7.5 million, generating EBITDA (earnings
before interest, taxes, depreciation and amortization) of approximately $1.5
million. These results are supported by a multi-year contract backlog
totaling approximately $25 million comprised of several key programs with
major defense primes. Pivotal represents a highly synergistic addition to
our existing resources in the power generation and conditioning areas.
ESSI RANKED We have successfully
No. 9 concluded 11
ON FORBES MAGAZINE'S acquisitions since
"200 BEST SMALL 1998, including
COMPANIES IN AMERICA," three within
RISING FROM NO. 28 the past year.
A YEAR AGO.
MARKET SEGMENTS
97% Military/Government 3% Commercial
[GRAPH]
OPERATIONAL IMPROVEMENTS
We continue to make progress in our efforts to better serve our shareholders
by focusing on our core defense businesses. In April 2003, we sold our
injection-molded plastics operation to a private equity group for
approximately $6.6 million, plus contingent consideration, with the cash
proceeds
2003 Annual Report | 3
used to reduce outstanding bank indebtedness. Since announcing our
intentions a year earlier, this business unit had been treated as a
discontinued operation within our financial statements.
Our ongoing facility rationalization plan continues to deliver
improved operating efficiencies and utilization of our internal
capabilities, helping retain a competitive cost structure within the defense
industry as we pursue future business growth both directly with the
Department of Defense and the prime contractor community.
By fiscal year-end, we curtailed operations at Systems &
Electronics' Sanford, Fla. electronics plant and relocated the electronics
assembly work to alternate company facilities. Earlier in the year,
operations at the Blue Ash, Ohio plant were consolidated into our recently
expanded Florence, Ky. facility, and the production activities of Engineered
Air Systems were relocated to other facilities as well. We anticipate
selling the Sanford, Blue Ash and Engineered Air facilities within the next
two years.
This consolidation will improve overall utilization of the
company's existing production capacity and provide substantial cost savings.
Beginning in fiscal 2004, we expect to realize estimated recurring annual
after-tax cost savings of $3 million to $4 million as a direct result of our
facility rationalization initiatives. Remaining manufacturing capacity is
quite flexible and ample to sustain the growth of our core Support Systems
business.
At mid year, we reached a new labor agreement covering
approximately 300 union workers at our West Plains, Mo. manufacturing
facility. This five-year agreement provides stability for our labor force
and key military customers; and as we expand our business, we plan to
further utilize the plant's strong capabilities and capacity to support
future production programs.
RECOGNITION FOR OUR ACHIEVEMENTS
Our momentum in the marketplace continues to attract widespread recognition.
For the fifth consecutive year, the company was named to Forbes magazine's
"200 Best Small Companies in America," rising to No. 9 from No. 28 a year
ago. We also ranked highly on Fortune magazine's list of the "100 Fastest
Growing Companies" for the second year running.
ORGANIZATIONAL AND MANAGEMENT CHANGES
As announced at the annual shareholders' meeting last spring, we have
separated the Chairman and CEO roles by appointing Gerald E. Daniels to the
position of Vice
REVENUE BY BUSINESS SEGMENT
67% Support Systems 33% Support Services
[GRAPH]
In 2003 we reorganized OUR NEW STRUCTURE
the company into two broad MATCHES HOW WE
operational and reporting ALLOCATE
segments - Support Services RESOURCES
and Support Systems. AND MANAGE OUR
BUSINESS.
4 | Engineered Support Systems, Inc.
Chairman and CEO. A graduate of the U.S. Naval Academy and a former naval
officer, Jerry brings the knowledge and experience gained in a 23-year
career with The Boeing Company and its predecessor, McDonnell Douglas
Corporation, most recently as President and CEO of Boeing Military Aircraft
and Missile Systems.
As we have defined these roles, Mike Shanahan as Chairman will
continue to provide leadership in areas of overall business strategy and
direction, and ongoing development and initiatives of the Board of
Directors. Jerry Daniels as Vice Chairman and CEO will assume responsibility
for day-to-day leadership and all functional areas of the company, with
emphasis on new avenues of business development, expansion of product and
service offerings, and pursuit of synergistic acquisitions.
With this appointment, the Office of the Chairman, our senior
leadership and policy-making team, now consists of the Chairman, Vice
Chairman and CEO, President and COO, Vice Chairman - Administration and CFO,
and President - Business Development.
We also reorganized our corporate structure into two major business
segments, Support Systems and Support Services, to reflect the increasing
scope of our service-related businesses. Daniel A. Rodrigues, Corporate
Group President, will oversee the Support Systems segment; Nicholas R.
Innerbichler, one of the founders of TAMSCO, has been named Corporate Group
President responsible for the Support Services segment.
Other notable senior management changes include the appointment of
Karen A. Bedell to the new position of Senior Vice President - Marketing and
Strategic Planning, the promotion of Lawrence R. Brewer to President -
Washington D.C. Operations and the promotion of Frank A. Tricomi to the
position of President - ESSIbuy.com, our online logistics business.
ON ACTIVE DUTY
As we have always said, rapid deployment of our armed forces drives our
business. That has never been more true than today with our military
personnel actively engaged in Iraq and Afghanistan and stationed in dozens
of countries around the globe. The men and women of Engineered Support
Systems are on active duty producing products and delivering services to
support and safeguard America's warfighters. We are up to the challenge.
OFFICE OF THE CHAIRMAN
/s/ Michael F. Shanahan, Sr.
Michael F. Shanahan, Sr.
Chairman of the Board
/s/ Gerald E. Daniels
Gerald E. Daniels
Vice Chairman and
Chief Executive Officer
/s/ Gerald A. Potthoff
Gerald A. Potthoff
President and Chief Operating Officer
/s/ Gary C. Gerhardt
Gary C. Gerhardt
Vice Chairman and
Chief Financial Officer
/s/ Ronald W. Davis
Ronald W. Davis
President - Business Development
2003 Annual Report | 5
Leadership
CANDID CONVERSATIONS WITH SENIOR MANAGEMENT
[PHOTO] Jerry Daniels
Vice Chairman and
Chief Executive
Officer
Q. What knowledge and experience gained as a military officer has carried
over to the business sector?
A. Initially, there are certain management skills that you learn, then
there are certain leadership skills that you learn. In both realms,
clearly, experience is the best teacher and you quickly realize that
having good people is the key - both in finding the right people and
then trusting them to do their jobs. I did learn a lot about teamwork
from my days in the submarine force. You had to rely on your shipmates
and I've carried that with me throughout my business career.
Q. What first attracted you to Engineered Support Systems?
A. As a long-time executive in the defense industry, I'd been watching the
growth of the company for some time and was impressed by its
entrepreneurial run of successes. From the outside, I saw a company
that was thriving in a cost-competitive market, winning program after
program, growing its business and was very innovative. Already having
decided to leave Boeing's defense business, I welcomed the opportunity
to help take this organization to the next level when asked by Mike
Shanahan and the Board to join Engineered Support as CEO.
Q. What impressions have you formed about the company, its management and
employees?
A. It's just an outstanding company ... great business instincts, moves
quickly, understands and respects the customer, and the people are
great. For me, the real change was going from a large, centralized
operating unit to this decentralized holding company environment. I had
already reached the conclusion that a rapidly growing company needs to
be fairly decentralized so you don't stifle that entrepreneurial
spirit. You give a tremendous amount of autonomy to the operating
units, and your job becomes helping them get the barriers to
performance out of their way.
Q. What niche does the company fill in the defense industry?
A. We stick to what we know best, which is primarily the world of
sustainment - that part of the defense business that allows the
military to sustain their presence in a remote environment, to sustain
the battle - that's what we do. We provide the equipment that gets them
the fuel, water, heat, power, air conditioning, ammunition, cargo,
communications - that's all part of the sustainment process for the
military ... and that's our core.
We're really in a sweet spot within the defense market. Today, our armed
forces are increasingly being pushed out of large, permanent overseas
bases, forced to conduct military operations both from the continental
United States and from alternate temporary bases around the world. In
addition, the military is outsourcing more and more of its
non-warfighting services to civilian contractors like Engineered
Support. Both of these trends are working to our advantage.
The movement away from these large bases means the military has to
transform itself into a far more mobile, deployable force - and we
provide many of the products and services that allow them to be more
agile and self-sufficient. On the services side, via TAMSCO, Radian and
ESSIbuy, we have the opportunity to capitalize on this outsourcing
initiative. By leveraging our extensive capabilities in these critical
areas, we expect to experience faster growth in our part of the market
6 | Engineered Support Systems, Inc.
- sustainment and support - than will other parts of the overall defense
industry.
Q. How do you define your role and responsibilities as CEO?
A. show up every day with four things in mind - to meet the commitments
we've made to our customers and shareholders, to grow the business, to
constantly improve our processes, and to continually strengthen the
team. The team includes both our employees and our suppliers. That's
how I define my job and how I measure myself and our operating units.
If we're going to do this right, you have to be doing all of them
simultaneously and continuously.
Q. What do you see as the greatest opportunities for continued growth?
A. We will continue to grow via smart acquisitions and winning new
opportunities in our current market areas. And, we can open new
markets. First, partnering with the larger prime defense contractors
and, secondly, capitalizing on emerging homeland security initiatives
are two customer sets and market areas that offer some great
opportunities. I also believe that we can continue to grow the markets
we already occupy by continually redefining our roles in those areas.
For instance, clearly, we're the leading supplier of mobile electrical
power generation equipment on the battlefield. But, going forward, if
we define ourselves as simply as that, we might ignore other
complementary growth opportunities that may be natural extensions of
our current capabilities. We must challenge ourselves to branch out
into related fields where we can bring both our customer knowledge and
technical knowledge to bear.
Q. Where do you see the company in five or 10 years?
A. Our near-term goal is to be a billion-dollar-a-year revenue producer.
We don't have a specific time frame in mind, and we're only going to do
it if we can do it profitably. If we stay focused, stick with what
works and what we know best, and develop the right people to execute
it, there's no reason why this company can't be a multi-billion-dollar
company within the next decade.
[PHOTO] Jerry Potthoff
President and Chief
Operating Officer
Q. What key messages do you want investors to understand?
A. Our core business hasn't changed - the military doesn't leave home
without us - today more so than ever. That said, our long-term success
doesn't necessarily depend on America being at war or being engaged in
large-scale operations such as those currently under way in Iraq and
Afghanistan. Our nation's military is deployed in over 130 countries,
so our products and personnel are deployed, as well. As long as America
remains the world's policeman, our products and services will help them
complete their missions.
Another constant for our company is that we're serious about technology.
As we grow, we take on new roles and responsibilities, competing with
increasing levels of technical sophistication. We now require that each
of our operating divisions have a formal R&D project that is linked to
significant market opportunities. In most cases, these initiatives
involve upgrading our existing products to their next generational
level, improvements that fit today's ongoing military transformation.
2003 Annual Report | 7
Q. Describe your approach to integrating newly acquired companies.
A. We seek to acquire good companies and give them as much operating
autonomy as we can. Generally, acquisition targets are private
companies whose owners don't want to believe that you're going to come
in and alter their culture and perhaps destroy the identity they've
created over the years. Our integration approach matches those
expectations.
Once on board, we attempt to understand their strengths and weaknesses in
terms of operating costs, capacities and capabilities to put ourselves
in a position to improve their bottom line and to enhance efficiencies.
For instance, we just launched the third phase of our facility
utilization program, upgrading the database to include our newest
acquisitions - UPSI, Radian, TAMSCO and EEi - to look at opportunities
to leverage capabilities and streamline operations.
Q. What about merging managements and cultures?
A. Our integration strategy is not to simply combine a group of
organizations together and do away with one sector of management. At
Engineered Support, the fundamental intent of our integration plan is
to get people to work with each other. So we ask new acquisitions to be
part of our peer group process, which allows the senior staff of all
our companies to know one another better, to learn from each other and
to find ways to proactively address common business issues.
We currently have more than 10 peer groups reflecting different functional
disciplines. In addition, we recently formed a peer group focusing on
the power area that includes the numerous divisions involved with power
technology working together, exchanging knowledge and developing
collaborative approaches to grow that area of the business. Similar
market-focused peer groups are also being formed throughout the company
to foster growth. While as a stand-alone company, a particular
division's resources may be limited, we try to get our team to realize
that our combined knowledge is staggering and that together we can do
great things.
Q. How important is growing the Support Services segment to the company?
A. Historically an adjunct to our manufactured products, logistics
services within ESSI are really going through a breakthrough -
transforming from a cost center to a profit center, generating revenue
from new business. With the recent acquisitions of Radian and TAMSCO,
we're now evolving into a full-service corporation with much greater
capabilities than we possessed just a couple of years ago. It's a
natural evolution of our business and it fits perfectly with the
transformation of the military - military personnel handling the
warfighting while outsourcing the administrative roles and
non-tactical assignments to civilian contractors.
[PHOTO] Gary Gerhardt
Vice Chairman and
Chief Financial Officer
Q. What attracts investors to the company?
A. Investors are willing to put their hard-earned money with us because
they trust the management team. That is a key for us because in today's
environment, no one wants to believe in the management of a company.
But throughout our history, we've built solid credibility with our
customers, shareholders and employees that will endure for the long
haul.
Performance-wise, we've done what we said we were going to do,
oftentimes better than expected. And, investors realize that we're not
8 | Engineered Support Systems, Inc.
going to do anything contrary to the creation of shareholder value. We
will grow our business profitably and we will not grow revenues merely for
the sake of top-line growth - we are bottom-line focused. We're going
to stick to our core business of serving military and homeland security
customers in various capacities.
Q. What are Engineered Support's immediate and long-term growth
expectations?
A. After another record year in 2003, we're forecasting a 30 percent
increase in annual revenues for 2004 as we approach the $750 million
mark, which is expected to drive earnings per share more than 40
percent higher. Fueled by solid internal growth and synergistic
acquisitions, on a longer-term basis, we are committed to delivering
annual net income gains of 20 percent or more to our stockholders. Our
track record of meeting or exceeding shareholder expectations speaks
for itself.
Q. How much of that business growth will be organic versus through
acquisitions?
A. Looking back at our business over the years, we've seen annual internal
revenue growth of 5-7 percent on average. With the current heightened
level of military operations around the globe creating lasting customer
demand, we can expect to exceed this growth level in most of our major
product and service categories for some time. In addition, the various
cost savings initiatives we've undertaken, including the institution of
lean manufacturing programs and our facility rationalization project,
have been highly successful in improving production efficiency and
significantly reducing operating expenses throughout the company. That
being said, the addition of accretive acquisitions, such as the three
transactions completed during calendar 2003, will continue to be a key
part of our growth strategy going forward, comprising the remainder of
our targeted earnings growth.
Q. What challenges does the company face in addressing the increasingly
stringent corporate governance regulations?
A. Certainly the well-publicized corporate scandals and the regulators'
responses to them, including Sarbanes-Oxley legislation and
strengthened stock exchange listing requirements, have impacted every
public company in America to some degree. Here at Engineered Support
Systems, we've been actively addressing these enhanced requirements to
ensure our compliance in the areas of corporate governance, internal
controls and accounting procedures. To accomplish this task, we've
established a seasoned internal audit staff, strengthened our corporate
compliance committees and are continuing our internal assessment of the
impact of these rule changes on the company. We believe that we will
easily meet all such requirements by the various effective dates of the
Sarbanes-Oxley legislation and that our internal control structure is
solid and functioning well.
[PHOTO] Ron Davis
President - Business
Development
Q. Describe the company's strategic initiatives in business development.
A. Actually there are several, but of increasing importance is our level
of involvement in logistics services. In recent years, we have seen a
trend of the military away from having uniformed personnel performing
logistic services toward having subcontractors pick up that work.
Mindful of this, three years ago we launched ESSIbuy.com, our online
logistics support storefront, to meet these emerging needs.
2003 Annual Report | 9
Later, we acquired service companies like Radian and TAMSCO to further
position ourselves to take advantage of this initiative. And indeed,
the logistics support opportunities continue to emerge.
Q. What sort of opportunities?
A. We've recently received our first significant contract for depot-level
support wherein we will provide an electronic storefront to enable the
Army to buy spare, replacement and repair parts for all of the
petroleum and water systems required at that depot. Our Support Systems
group originally supplied much of that hardware, and now we're
providing quick-turnaround logistics capabilities as part of full
life-cycle support.
Of importance, this initial $14.4 million contract was won assembling a
team that included TAMSCO, Radian, ESSIbuy and Keco, successfully
leveraging our combined capabilities to capture that business. We're
anticipating similar opportunities as well, including a subcontract
calling for the repair and refurbishment of a number of M1000 tank
transport trailers which we originally built that have been extensively
deployed in combat missions in Iraq.
Q. Has homeland security developed into a major market?
A. Initially after 9-11, we consciously did not put a lot of business
development effort into pursuing the homeland security market. While a
significant amount of funds have been earmarked for this vital
initiative, to date most of these resources have been directed toward
reorganization and training of the various agencies and personnel. The
material that has been procured ranges from providing first responders
with chemical suits and gas masks or supplying airports with bomb
detection equipment - markets that we don't serve. We believe that our
best approach to addressing homeland security needs is through offering
products and services that are proven and available through established
procurement channels. The successes we've seen in the perimeter
security and base access areas illustrate this.
In addition, local governments will likely be unable to position
themselves and to fund their needs for homeland security equipment, so
we expect these functions to be provided either at the federal level or
through state National Guard units as the situation matures. A great
deal of our existing support equipment would then be used for emergency
response should this occur.
Q. How is the Business Development group adapting to address these new
opportunities?
A. With nearly 3,000 employees, 11 operating units and $750 million in
annual revenues, the company is becoming much too complex to
effectively manage all business development activities from a
centralized location. Accordingly, we're in the process of redeploying
our corporate Business Development team to move toward more of a
strategic support role versus a tactical focus. Each operating unit
will house its own sales group reporting to that unit's president.
Business Development will continue to be supported by a more robust
Washington, D.C.-based marketing office, as well as by
soon-to-be-established field offices at major customer sites.
These senior executives of the Office of the Chairman, together with the
corporate officers and subsidiary presidents pictured throughout this
report, will provide the leadership to drive exceptional performance,
continued growth and superior shareholder value going forward.
10 | Engineered Support Systems, Inc.
[PHOTO] [PHOTO] ENGINEERED [PHOTO]
SUPPORT'S NEARLY
3,000
EMPLOYEES ARE "ON
ACTIVE DUTY" AT 11
OPERATING UNITS.
[PHOTO]
Climate
OVERVIEW OF THE DEFENSE INDUSTRY MARKETPLACE
- ------------------------------------------------------------------------------
Fueled by a steady stream of strategic acquisitions, Engineered Support
Systems has emerged as a diversified supplier of high-tech, integrated
military electronics, support equipment and logistics services for all
branches of America's armed forces and certain foreign militaries, homeland
security forces, and selected government and intelligence agencies.
- ------------------------------------------------------------------------------
For fiscal 2003, sales to these customers, directly or through subcontracts,
accounted for 97 percent of company revenues. The company also produces
specialized equipment and systems for commercial and industrial
applications.
Our products and services - designed to support America and its
allies' armed forces on the ground, at sea and in the air - increasingly
meet the military's shift toward lighter, faster, more rapidly deployable
and more easily sustainable forces.
TRANSFORMING THE U.S. MILITARY
Two years ago, the Pentagon and the Bush Administration began to transform
the size and configuration of the nation's military from a force focused on
fighting two major wars simultaneously to a smaller, more flexible force
capable of meeting the global challenges of the 21st century. This new
perspective involves a deliberate shift from threat-based to
capabilities-based defense planning, with significant changes in how the
U.S. Department of Defense (DoD) defines, structures and supports major
defense missions.
As detailed in the 2003 Annual Defense Report from Secretary of
Defense Rumsfeld, winning the global war on terror demands that U.S. forces
be flexible, light and agile, and able to respond quickly to sudden changes.
Among the critical operational goals guiding the military's transformation
are these - defend the U.S. homeland and bases of operations overseas,
protect and sustain forces in distant theaters, and deny enemies sanctuary.
Each of these priorities links directly to our core competencies
and proven capabilities. While threats and terrain may change, we believe
the defense of our country and our freedoms will always require a
well-equipped, well-sustained fighting force on the ground, at sea and in
the air. That's who we serve ... that's our ultimate customer. And the men
and women of Engineered Support Systems are on active duty to meet that
commitment.
To combat the uncertainty of future threats, the armed forces are
becoming lighter, faster and more flexible. In response, we continue to
transform our support equipment to make it lighter, more reliable and
increasingly efficient. Further, the modern military requires
technologically advanced weapons systems and platforms, communications and
logistics support. We are aggressively expanding our capabilities in these
critical areas both internally and through strategic acquisitions.
STRATEGIC ACQUISITIONS
In recent months, Engineered Support Systems significantly enhanced its
roster of action-ready operating units through several key acquisitions. In
May 2003, we acquired Technical and Management Services Corporation
(TAMSCO), a provider of information technology logistics and
telecommunications systems to the DoD which accounts for more than 98
percent of the firm's revenues, with the U.S. Army and U.S. Air Force
ranking as its two largest customers.
Founded in 1982, TAMSCO is based in Calverton, Md. and operates an
electronics manufacturing facility in Polson, Mont. that also supports its
information technology services
[PHOTO]
Corporate Officers: (left to right) David D. Mattern, Daniel E. Kreher,
Dan D. Jura, Karen A. Bedell, Allan K. Kaste, Robert L. Klautzer, Steven J.
Landmann, Larry K. Brewer, Ronald W. Hauser and John R. Wootton.
12 | Engineered Support Systems, Inc.
[PHOTO] [PHOTO]
Radian - Camouflage net application TAMSCO - Satcom hardware
[PHOTO] [PHOTO]
Pivotal - Power supply Radian - Pump maintenance
as both a manufacturer and authorized reseller of technology products. The
firm maintains a significant presence at a number of key military locations
including the Warner Robins Air Logistics Center in Warner Robins, Ga. and
the U.S. Army's Communications-Electronics Command at Ft. Monmouth, N.J.
TAMSCO's workforce numbers approximately 700, more than half holding
security clearances, thus providing qualifications to work on highly
specialized, mission-critical assignments for federal defense and
intelligence agencies. It is led by Maj. Gen. David R. Gust, U.S. Army
(ret.).
TAMSCO's primary business categories include:
o Telecommunications and information technology services - satcom life
cycle support, telemedicine
o Integrated logistics services - integrated logistics support, automated
maintenance management, electronic publishing and technical
publications
o Systems integration - systems engineering, software development and
maintenance, test program set development
We are pursuing opportunities to leverage several of TAMSCO's
business development initiatives, in particular, the digitization of
technical manuals, the repair and return of electronics sub-systems, and the
rapid deployment of mobile satellite-based communications systems to remote
areas worldwide. In addition, with the DoD planning to spend $6.8 billion in
2004 on information technology to improve logistics, TAMSCO's logistics
expertise should augment our existing capabilities.
In September 2003, we acquired Engineered Environments, Inc. (EEi),
a proven provider of engineered solutions for applications involving air
handling, heat transfer and climate control, as well as lightweight
environmental units. Founded over 10 years ago, EEi operates a
31,000-square-foot office and manufacturing facility in Cincinnati, Ohio
with a workforce of approximately 75 employees. The DoD accounts for more
than 80 percent of the firm's revenues, directly or through contracts with
prime defense contractors.
EEi provides engineering and manufacturing of customized air
conditioners, heat exchangers, liquid chillers, air filtration systems,
environmental control units and aircraft ground support equipment for
military and commercial customers. While enhancing our existing portfolio of
military support equipment, EEi is solidly positioned to capitalize on the
growing market for mobile military shelters and systems that increasingly
require customized environmental control solutions for personnel comfort and
sophisticated electronics. It will continue to be managed by its founder,
Gerald W. Solomon.
In December 2003, we completed our first international acquisition
with the purchase of Pivotal Power Inc., of Halifax, Nova Scotia, Canada, a
provider of static power conversion equipment directly to military and prime
defense contractors. As a supplier of full MIL-SPEC power conversion
equipment, inverters, battery chargers and other power management systems
for shipboard, ground-based and airborne communications and weapons
platforms, Pivotal Power boasts a multi-year contact backlog of some $25
million.
Under the leadership of its President, Carlo M. Shimoon, Pivotal
Power has grown rapidly over the past few years, posting revenues of
approximately $7.5 million for its most recent fiscal year with solid
profitability. Pivotal Power directly complements our Universal Power
Systems, Inc. business acquired in 2002 with more robust product offerings
and extensive manufacturing and design capabilities that will benefit our
growing presence in providing power solutions on the battlefield.
As a result of the expanding scope and increasing importance of the
logistic services sector to our core military equipment manufacturing
business, we have reorganized the company into two broad operational and
reporting segments - Support Services and Support Systems.
2003 Annual Report | 13
Support Services
MEETING THE CHANGING NEEDS OF MODERN WARFARE
- ------------------------------------------------------------------------------
Engineered Support Systems' fast-growing Support Services segment accounted
for approximately one-third of consolidated revenues for fiscal 2003,
producing net revenues of $188.3 million and operating income of $18.4
million. With recent acquisitions in the Services sector and internal
growth, we expect this segment to account for an estimated 35 to 40 percent
of company revenues going forward.
- ------------------------------------------------------------------------------
The increasingly important Support Services segment features the quick
turnaround of task orders resulting in a relatively short-term funded
contract backlog, robust top-line revenue growth rates and operating profit
margins typically in the high single digits. Entered orders for this segment
totaled $229.3 million in 2003 and year-end contract backlog was $563.7
million.
Basic categories within the Support Services segment include
engineering, logistics and training services; advanced technology services;
asset protection systems and services; telecommunications and information
technology services; integrated logistics services; and systems integration.
Key capabilities offered by the Services segment include the following:
RADIAN MILITARY PARTS REINVENTION NETWORK (MILPARTS)
Service: With military aircraft, ships and vehicles increasingly being kept
in service beyond their originally intended life spans, key parts or
subsystem components are often unavailable as manufactured spare parts.
Using proprietary technology, Radian MILPARTS has the unique ability to
reverse engineer and manufacture critical components or replacement parts
for aging military equipment platforms. The original part design is
translated into a three-dimensional model, rapidly prototyped and tested;
Radian's network of manufacturing partners then provide perfect quality
parts, identical to the originals.
Status: During 2003, MILPARTS received a $2.1 million order to produce 18
Night Vision System Forward Looking Infrared (FLIR) kits for use on the U.S.
Marine Corps' CH-53E heavy lift helicopter which is carried aboard most U.S.
Navy amphibious class ships. Since formed in 2000, Radian MILPARTS has
recreated various replacement parts and components for several helicopter
and ship platforms used by the U.S. Navy, Marine Corps and Coast Guard. It
is well positioned to capitalize on growing opportunities in this market.
ESSIBUY.COM ONLINE LOGISTICS SUPPORT (ESSIBUY)
Service: ESSIbuy, the company's online product and logistic support
operation, provides spare parts and sustainment support for virtually all
company-designed and -manufactured systems used extensively by the U.S.
military. It continues to emerge as the Warfighters' One Stop Logistics
Shop.(R)
Status: ESSIbuy advanced significantly this year, achieving several notable
milestones. Near year-end, ESSIbuy received a firm, fixed price contract
valued at $14.2 million from the U.S. military's Sierra Army Depot to
provide logistics support services and equipment for the Inland Petroleum
[PHOTO]
Support Services Group: (left to right) David R. Gust, Frank A. Tricomi,
Richard P. Dacey and Nicholas R. Innerbichler.
14 | Engineered Support Systems, Inc.
WITH RECENT ACQUISITIONS,
SUPPORT SERVICES
HAS BECOME AN
INCREASINGLY IMPORTANT
PART OF THE COMPANY'S
GROWTH
[PHOTO] STRATEGY. [PHOTO] [PHOTO]
TAMSCO - Satellite dish Radian - Security camera ESSIbuy - Order entry
Distribution System. This was easily the most significant contract award to
ESSIbuy during its three years of existence and it signifies an emerging
market opportunity that is expected to flourish in coming years. For 2003,
ESSIbuy posted increased revenues and delivered positive cash flow while
building a capable team of logistics support personnel. Frank A. Tricomi was
promoted to President of the business unit in recognition of the dedication
and leadership displayed during ESSIbuy's developmental phase.
INTERACTIVE ELECTRONIC TECHNICAL MANUALS (IETM)
Service: Traditional printed military technical manuals are cumbersome and
frequently outdated. Converting to an electronic format, manuals can be
continually updated, are easily accessible on the Internet or CD-ROM, and
can improve military deployment by freeing up needed cargo space and
increasing the efficiency of maintenance operations.
Status: The company continues in the forefront of this effort, using its
proprietary WebTM(TM) conversion process to convert military technical and
repair parts manuals into fully hyperlinked, web-based IETMs. In 2003,
ESSIbuy performed manual conversion in support of the U.S. Army's Family of
Medium Tactical Vehicles. Under several contracts with the U.S. Air Force,
TAMSCO has also provided a wide range of IETM digital conversion services
for sustainment of technical order documents.
TIME DIVISION MULTIPLE ACCESS (TDMA) SATELLITE COMMUNICATIONS NETWORKS
Service: TDMA is advanced digital transmission technology that allows
multiple users to access a single radio frequency channel without
interference.
Status: Under a $165 million ceiling task order from the U.S. Army, during
2003 TAMSCO implemented a satellite communications network linking 27 remote
transmitting and receiving stations to a central control facility in Germany
that connects forward-deployed logistics personnel in Southwest Asia with
the Army's logistics network in the United States. TAMSCO also created an
identical communications network to support military telemedicine operations
abroad. Currently, TAMSCO is manning 110 of these and similar
satellite-based communications networks with nearly 90 experienced personnel
deployed in remote locations around the globe. (See sidebar feature, page 16.)
INFORMATION TRANSFER VEHICLE (ITV)
Service: The ITV is designed to be deployed in the event of a chemical or
biological terrorist attack within the United States and to establish a
centralized information link between first responders and various government
and civilian agencies.
Status: Awarded a contract by the U.S. Army to develop, configure and
deliver an ITV, our TAMSCO subsidiary is currently participating in the
initial development phase of the project by providing a satellite-based
communications system for this critical homeland security need.
ASSET PROTECTION SERVICES
Service: Radian has developed substantial expertise in the site assessment,
design and implementation of leading-edge security systems for U.S. military
and allied government installations.
Status: Radian has seen continued growth of its security projects under
long-term contracts with the U.S. Army
2003 Annual Report | 15
and at the Pentagon for asset protection systems at key domestic military
bases. Last year, we received an initial $2.1 million contract to design and
install an access control and perimeter security system in United Arab
Emirates for key UAE government facilities. Radian has also developed an
advanced secured-entry system called the Radian Access Point Screening
System (RAPSS) that is currently undergoing customer evaluation.
FLEXIBLE, MULTI-YEAR SERVICES CONTRACTS
Service: The key to success for any government services firm is obtaining
awards of well-funded, multi-year contract vehicles. Over the past two
years, Radian and TAMSCO both have strengthened their growth opportunities
with key contract awards.
Status: In 2003, Radian was awarded a five-year, $75 million ceiling
services contract through the U.S. Army Tank-automotive and Armaments
Command to provide a variety of technical services in support of military
vehicle and equipment acquisition. TAMSCO was named a prime contractor on
the U.S. Army's Rapid Response (R2) contract, an eight-year, $2.9 billion
ceiling contract vehicle under which any federal agency can procure
engineering, logistics services or equipment through an accelerated
procurement cycle. Since the award, TAMSCO has received over $55 million in
orders under the R2 contract. TAMSCO is one of only two prime defense
contractors included under both the R2 and Flexible Acquisition and
Sustainment Tool (FAST) contract, a seven-year, $7.4 billion ceiling
contract with the U.S. Air Force.
OTHER SERVICES PROGRAMS
TAMSCO has developed an efficient repair-and-return logistics program to
receive, assess, repair and return damaged or poorly functioning F-15
aircraft systems resulting in substantial cost savings. Through the U.S. Air
Force, TAMSCO supports the Royal Saudi Air Force's fleet of F-15 fighter
aircraft under a seven-year, $162 million subcontract partnered with a
Native American-owned firm.
In addition, TAMSCO is supporting the U.S. Air Force's technical
order sustainment and production program, providing technical data
integration, technical data alignment, digitization, tracking, quality
control, configuration control and production for all managed C-130 aircraft
technical orders. Radian is providing engineering services and support for
the U.S. Army's entire tactical power generation and environmental control
families of equipment managed by the Project Manager, Mobile, Electric
Power. Leveraging its significant domain expertise, Radian is also
supporting fueling operations for the U.S. Air Force and Army customer
community.
SATCOM FOR THE SOLDIER
Military satellite communications is a bandwidth-limited resource, with
command and control communications and intelligence use claiming top
priority. Logistics traffic is well down the priority list. Since 1992, our
TAMSCO subsidiary has been putting on-demand satellite communications
capabilities in the hands of military logistics personnel.
Today, a TAMSCO-designed satellite communications network with 27
remote terminals linked to a central control facility in Germany is
connecting forward-deployed logistics personnel in Southwest Asia to the
U.S. Army's stateside logistics network. Maintenance and supply updates,
equipment requisitions and more are all traveling over the Multi Media
Communications Systems (MMCS) supplied and supported by TAMSCO - freeing
personnel to handle logistics work rather than support communications. The
MMCS package combines satellite connection, voice/phone capabilities, secure
and non-secure Internet, plus video telecommunications. MMCS provides
superior capabilities at less cost and with roughly three times the
bandwidth of the military's own system.
With each MMCS package, TAMSCO provides two operators - satellite
and data specialists who work 12 hours a day, seven days a week during an
11-month tour. Currently, 90 TAMSCO employees including four women - more
than 10 percent of its workforce - are deployed with these systems. Most
gained their technical training and certification in the military, all hold
secret security clearances and many have been previously deployed by TAMSCO
in Bosnia, Kosovo and Afghanistan.
TAMSCO's MMCS technology is also being used in military
telemedicine applications - linking medical clinics in Kuwait and Iraq with
the U.S. Army regional hospital in Germany for consulting and distance
learning.
16 | Engineered Support Systems, Inc.
SUPPORT
SERVICES
[PHOTOS] Radian - Security equipment
TAMSCO - F-15 systems logistics
TAMSCO - Montieth Technical Control, Kosovo
TAMSCO - Camp Able Sentry Operations Center, Kosovo
Radian - Fuel cell APU
[PHOTOS]
TAMSCO - AMRAAM interface panel
Essibuy - Customer service
Milparts - CH-53 helicopter
Radian - DPGDS
TAMSCO - MMCS
[PHOTOS] Radian - Fuel nozzle repair
TAMSCO - CFLCC system transit
case and antenna
ESSIbuy - Interactive Electronic
Technical Manuals (IETM)
Radian - Water distribution
[PHOTOS] TAMSCO - Hybrid circuit card
TAMSCO - Trek satellite
TAMSCO - Ft. Monmouth
Radian - Fuel Pump Operation
TAMSCO - Flyaway MMCS
2003 Annual Report | 17
Support Systems
PROVIDING MILITARY SUPPORT AT HOME AND OVERSEAS
- ------------------------------------------------------------------------------
Engineered Support Systems' core Support Systems segment includes the design
and manufacture of both heavy and lightweight military support equipment,
power generation equipment, and defense electronics and automation systems.
- ------------------------------------------------------------------------------
Accounting for two-thirds of consolidated revenues, this segment produced
net revenues of $389.3 million and operating income of $54.1 million for
fiscal 2003. Entered orders for this segment totaled $431.6 million in 2003
and year-end contract backlog including unfunded production options was
$892.5 million.
Within the Support Systems segment, basic military support
equipment product categories include nuclear/biological/chemical defense
systems, environmental control systems, petroleum and water distribution
systems, water purification systems, aircraft cargo-handling equipment,
transport systems and general military support equipment.
Various products in the power category include lightweight military
generator sets, trailer-based power generation and distribution systems, and
uninterruptible power supply systems and power conditioning equipment.
Electronics product categories include fire-control support systems,
airborne and ground-based radar systems, and automatic testing equipment.
THE COMPANY'S KEY MILITARY SUPPORT EQUIPMENT PRODUCTS INCLUDE:
Field Deployable Environmental Control Unit (FDECU) System: A field
deployable heat pump, the FDECU is used to cool, heat, dehumidify, filter
and circulate air to meet electrical and personnel climate control
requirements. This ruggedized unit has become a staple for most military
units in remote areas requiring controlled air temperatures including
protection against chemical and biological agents for portable shelters,
field hospitals, tents and fixed sites.
Status: During 2003, the U.S. Air Force ordered several thousand FDECUs
valued at $40.7 million under an existing, multi-year contract, bringing the
cumulative funded value to nearly $170 million as of year-end; plus the U.S.
Army ordered over 600 units via a contract valued at $6.7 million. To date,
more than 12,500 FDECUs had been ordered, and these units are being used
extensively in Southwest Asia to support heightened military operations and
forward-deployed units. We are also supplying FDECUs equipped with
nuclear/biological/chemical kits to the U.S. Navy for its fleet hospital
operations in support of Navy and Marine forces overseas.
CBPS IS BATTLE-TESTED UNDER IRAQ'S HARSH CONDITIONS
The self-contained Chemical Biological Protected Shelter (CBPS) system is an
environmentally controlled and contamination-free work area designed for use
in chemically or biologically contaminated areas. Today, it's proving itself
in the harsh climate of Iraq.
Since beginning full-scale production in fiscal 2000, the company
has produced approximately 160 CBPS units - with some 60 units deployed in
the field for the first time during Operation Iraqi Freedom. Beyond its
chemical/biological protection capabilities, the shelter provides a
controlled environment where medics and surgeons can treat patients in
forward-deployed field hospitals and aid stations. This capability is
proving critically important in Iraq's harsh desert climate marked by
blowing sand and extreme temperature swings.
One of the first reports from the battlefield detailed how the life
of a badly burned Marine was saved. Injured at night, the desert cold had
dangerously lowered his temperature. Treated within the clean, sterile CBPS
facility, his temperature was quickly stabilized in the heated environment
so he could be safely evacuated to an American military hospital in Germany.
18 | Engineered Support Systems, Inc.
YEAR-END
CONTRACT BACKLOG
INCLUDING UNFUNDED
PRODUCTION OPTIONS WAS
$892.5
MILLION.
[PHOTOS]
Chemical Biological Protected Shelter (CBPS)
System: The CBPS is a self-contained, environmentally controlled and
contamination-free work area designed to serve as a mobile medical aid
station, field command post or emergency facility in chemically or
biologically contaminated areas. The highly mobile CBPS can be deployed and
fully operational in less than 20 minutes.
Status: During the year, the U.S. Army ordered 52 CBPS systems, bringing the
cumulative number under contract to 204 units. The current CBPS contract
backlog totals $53.7 million including unfunded production options for
another 104 units. In the harsh conditions of warfare, the CBPS is proving
critically essential as a sterile, environmentally controlled shelter for
medical aid. (See sidebar feature, page 18.)
Tunner 60-K Aircraft Cargo Loader/Transporter
System: With a load capacity of 30 tons, the Tunner has dramatically
decreased the time required to load or unload military transports such as
the C-17 or C-5 to just a few hours. Considered the backbone of U.S.
military airlift operations, this versatile, reliable vehicle supports the
military's rapid deployment of forces and equipment on a global scale.
Status: Over its contractual life, the Tunner has represented the company's
largest single defense program, with a total contract value exceeding $500
million. To date, the U.S. Air Force has ordered the contract's maximum
requirement of 318 vehicles, including the final $67 million delivery
contract received this year. Including logistics support-related work,
entered orders under the Tunner program approximated $84 million for 2003.
Now deployed at more than 60 airbases worldwide, the Tunner is being used
daily to support the war on terrorism and to aid in humanitarian relief
efforts.
Minuteman Environmental Control System (ECS)
Replacement Program
System: Environmental control systems that provide air conditioning, heating
and ventilation in over 550 Minuteman launch and missile alert facilities
are being upgraded with modern, more-efficient equipment.
Status: Beginning in the early 1960s, our Engineered Air Systems subsidiary
previously designed, manufactured and installed the ECS equipment. The
company was awarded a contract for the first phase of the three-phase ECS
program with an estimated total value exceeding $200 million once production
work commences in 2005. (See sidebar feature below.)
Heavy Expanded Mobility Ammunition Trailer (HEMAT)
System: The highly mobile HEMAT trailer, with a payload capacity of 11 tons,
is designed to transport multiple-launch rocket pods,
palletized/unpalletized conventional
MINUTEMAN MEETS SPACE COWBOYS
In the early 1960s, at the height of the Cuban Missile Crisis, the nation's
Minuteman ICBM weapons program began. As part of the program, the
predecessor of our Engineered Air Systems subsidiary installed the original
environmental control systems in launch facilities and underground missile
silos. In the 1980s, we performed an upgrade to the systems, and in fiscal
2003, we began another upgrade with an initial trade study phase, to be
followed by the prototype phase and moving into production by 2005. This
upgrade program, worth in excess of $200 million in total revenues and
including over 550 Minuteman silos and control facilities, is expected to
run through 2011.
Mirroring the premise of the Space Cowboys motion picture, many of
the company engineers who originally developed these environmental control
systems had since retired. But a half dozen retirees who started the program
in the 1960s as young engineers have eagerly returned. Now ranging from 65
to 78 years of age and warmly referred to as "The Minuteman Cowboys" around
our offices, these seasoned veterans are serving as mentors to our younger
engineers and freely sharing their first-hand knowledge of the legacy
system.
[PHOTO]
20 | Engineered Support Systems, Inc.
Support Systems Group: (left to right) Carlo M. Shimoon, Thomas G. Cornwell,
Gerald W. Solomon, Gerald A. Nicholson, Thomas C. Santoro, Frederic D.
Knight, Daniel A. Rodrigues, Joseph H. Creaghead and James T. Myrick.
[PHOTO]
ammunition and fuel bladders and pods over paved, secondary or cross-country
roads.
System: During the year, the company received production orders totaling
$8.7 million under a long-term contract with the U.S. Army. Including an
additional $6.2 million order received subsequent to year-end, a total of
nearly 500 HEMATs are currently under contract with a total contract value
of approximately $35 million to be completed in 2005.
Fuel System Supply Point (FSSP)
System: Air, sea and ground transportable, the FSSP system consists of
multiple, lightweight collapsible storage units housing equipment that
interconnects into a portable fuel receipt, storage and distribution system.
The FSSP delivers a tenfold increase in storage capacity over the fuel
supply system currently used by the U.S. Army, to 1.2 million gallons of
fuel and a 600 gallon-per-minute dispensing rate.
Status: Under a $9.4 million subcontract received during the year, the
company will provide design, engineering and logistics support, plus initial
manufacturing and testing of various components. Full-rate production could
bring the potential contract value to as much as $110 million extending
through 2010. Through Radian, we are also providing lifecycle logistics
support for the FSSP program.
OTHER SUPPORT EQUIPMENT PROGRAMS:
Under a $24 million U.S. Air Force contract, the company is producing metal
revetment kits for use as protective barriers to safeguard aircraft,
equipment and personnel from small arms fire and shrapnel in forward
deployed areas. Under a joint contract, the company is supplying the U.S.
Marine Corps with water purification equipment, base camp materiel and
chemical/biological decontamination equipment including Multi-Purpose
Decontamination Systems. We also received manufacturing orders for various
shipboard systems for the U.S. Navy's LHD-8 Wasp Class Amphibious Assault
Ship and LPD-17 San Antonio Class Amphibious Transport Ship programs under
separate contracts totaling $14.7 million during the year.
AMONG THE COMPANY'S KEY POWER PRODUCTS ARE THE FOLLOWING:
Deployable Power Generation and Distribution System (DPGDS)
System: The air-transportable DPGDS provides electrical power for military
operations and humanitarian missions ranging from small, isolated outposts
to fully operational, forward-deployed airbases. The high power density of
these units translates into a 25 percent weight reduction and 15 percent
fuel efficiency increase compared to existing sets, as well as improved
reliability and maintainability.
Status: To date, DPGDS orders have exceeded $140 million through the first
five years of the U.S. Air Force contract estimated to be worth well in
excess of $300 million through 2008. DPGDS equipment has been deployed as
part of ongoing U.S. Air Force and Army activities in Southwest Asia during
Operations Iraqi and Enduring Freedom. Production work for the prime power
units and certain distribution equipment under the DPGDS successfully
migrated to various company facilities during 2003 with additional in-house
production efforts anticipated. (Note: DPGDS-related revenues and profit
contribution are reported within our Support Services business segment.)
Tactical Quiet Generator (TQG)
System: Rugged TQG sets combine reliable performance with lightweight,
low-noise capabilities to provide electrical power in remote field
locations. TQGs meet the military's requirement for high-tech, durable,
lightweight support equipment in conjunction with its objective to create a
more mobile, rapidly deployable force.
Status: The company produces six of the 10 variants in use by the military -
3, 5, 10, 15, 100 and 200-kilowatt
2003 Annual Report | 21
versions. During the year, the company received orders totaling nearly $50
million for the production of TQG sets. Demand for generator sets has been
on the rise with their extensive deployment in current U.S. Military
operations.
Intelligence Facility Upgrades
System: Sensitive military intelligence facilities are being upgraded to
accommodate additional reserve personnel mobilized in support of
counter-terrorism operations. These upgrades entail the acquisition and
installation of emergency back-up generators, matching uninterruptible power
supply systems and HVAC facility buildouts to support fully functional
24-hour, seven-day-a-week operability.
Status: Our UPSI subsidiary is providing project management for the upgrade
of 12 U.S. Army Reserve Command sites under a contract valued at $7.3
million. UPSI previously oversaw the upgrade of nine Naval Intelligence
Command facilities under a separate contract completed earlier this year.
THE COMPANY'S KEY DEFENSE ELECTRONICS PRODUCTS INCLUDE:
Manportable Surveillance and Target Acquisition Radar (MSTAR)
System: The MSTAR provides wide-area surveillance to a maximum range of 25
miles, day or night in all weather conditions. Highly reliable and easily
transportable, the radar system detects, locates and distinguishes moving
targets as ground personnel, tracked or wheeled vehicles, and low-flying
helicopters. The MSTAR is ideally suited for perimeter security applications
or as part of an integrated security system for force protection, border
surveillance and asset protection.
Status: The MSTAR has performed in service with U.S. and allied forces in
Iraq, Afghanistan, the Balkans and other areas of conflict. During 2003, we
were awarded an $11.2 million contract from the Canadian military for the
upgrade of MSTAR systems for integration into its Coyote Reconnaissance
vehicle. Later, the U.S. Air Force placed several smaller orders for the
production of MSTARs for use as part of military base perimeter security
systems.
Based upon its mission performance in this emerging market area, we
recently received a $58 million subcontract to provide 350 MSTAR systems for
military base perimeter security missions. (See sidebar feature below.)
Combat Talon II Radar (CTII)
System: The CTII is a dual-band, multi-mode radar system used aboard U.S.
Air Force C-130 aircraft to provide highly advanced terrain-following and
terrain-avoidance navigation even under adverse weather conditions.
Status: During 2003, the company received an eight-year contract valued at
$44.2 million to provide depot-level repairs, engineering support and spare
and replacement
MSTAR TAKES ON SECOND MISSION
Since the mid-1990s, the company has produced the Manportable Surveillance
and Target Acquisition Radar (MSTAR) under a license agreement with a
British partner. Extremely reliable, lightweight and easily transportable,
the MSTAR provides wide-area surveillance coverage in all weather
conditions, day or night, to detect and identify moving people, vehicles and
low-flying helicopters.
Originally developed as a stand-alone sensor for tactical ground
forces, the MSTAR is proving its worth in an increasingly vital role -
perimeter security. The company is currently supplying more than 350 MSTAR
radars under multiple contracts in support of the U.S. Air Force's
Integrated Base Defense Security System. They will be used for rapid
deployment as a wide-area ground surveillance sensor and as the core
component of integrated security solutions for base defense applications in
highly sensitive areas.
The versatile MSTAR can also be utilized in a variety of homeland
security missions including intrusion detection, border surveillance and
perimeter security - providing protection for critical infrastructure assets
such as power generation facilities, airports and testing ranges.
[PHOTO]
22 | Engineered Support Systems, Inc.
SUPPORT
SYSTEMS
[PHOTOS]
[PHOTOS]
SEI - Adverse Weather Aerial
Delivery System (AWADS)
SEI - High Power Offload
to CASS (HPOC)
Keco - FDECU production
UPSI - Power supply
SEI - M1000 HET in Iraq
[PHOTOS]
SEI - RADTS in lab
EEi - Custom cooling
Keco - Paint line
Marlo - Coil manufacture
SEI West Plains - Tunner
[PHOTOS]
SEI - HEMAT
SEI West Plains - selecting
Tunner parts
SEI - Combat Talon II Radar
SEI - Design engineer
[PHOTOS]
Fermont - Tactical Quiet
Generator (TQG)
SEI - Tunner
Keco - FDECU line
Marlo - Coil testing
SEI - Knight Precision Targeting
System
2003 Annual Report | 23
parts for CTII systems currently used aboard U.S. Air Force aircraft. The
CTII has contributed to the successful deployment of special operations
personnel and equipment in remote locations around the globe - including
extensive use during military operations in Afghanistan and Iraq.
F-5 Aircraft Fire Control Radar System
System: First built by the company in 1973 for Northrop's F-5 fighter
aircraft, the F-5 Aircraft Fire Control Radar System has evolved into its
current configuration since that time. F-5 aircraft are flown extensively,
particularly by foreign militaries, and radar system upgrades and repairs
are routinely needed to extend their utility.
Status: More than 1,000 of these radar systems have been manufactured and
sold by the company's SEI subsidiary for use by several of our military
allies. During 2003, we received a $13 million contract for system upgrades
for the Republic of China Air Force which will extend the serviceable life
of the F-5 radar system through 2015.
Knight Precision Targeting System
System: Knight is an advanced, digital command control and communications
system that provides precision target location and laser target designation
for both artillery and air-delivered general purpose and precision-guided
munitions.
Status: During the year, the company received orders of approximately $20
million for Knight systems configured for the U.S. Army's HMMWV, Bradley and
Stryker fire support vehicles. Vehicle mounted systems are currently
deployed with the fire support elements of several U.S. Army units engaged
in combat operations in Iraq and Afghanistan.
Automatic Test Equipment
System: Engineered Support has a long history of providing sophisticated
automatic testing equipment for maintenance support of avionics and various
weapons platforms.
Status: In 2003, the company received an $8.1 million subcontract from a
major defense prime contractor for the Reconfigurable Transportable
Consolidated Automated Support System (RTCASS), a rapidly deployable
automatic test station for maintenance support of aircraft avionics
equipment. The multi-year RTCASS production program has a potential value of
up to $59 million and will be used to support several aircraft weapons
platforms for the U.S. Air Force and Marine Corps. The company is also
designing, developing, testing and producing a Synthetic Instrument
Measurement Unit (SIMU) that combines the functionality of six classical
instruments into one package to perform complex electronic measurements.
FOREIGN MILITARIES AND GOVERNMENTS
Engineered Support continues to market its products and services
internationally to selected foreign militaries and governments. In addition
to various service and systems projects mentioned previously, Engineered
Support derives a significant amount of business from international defense
customers. For example, under a $26.1 million task order from the Royal
Saudi Air Force, TAMSCO is supplying continued support to the print plant
operation at Riyadh and operation of a forward supply/repair and return
point at Dhahran, plus program support personnel. The recent acquisition of
Pivotal Power will aid our international sales relationships particularly in
Canada and the United Kingdom.
COMMERCIAL AND INDUSTRIAL PRODUCTS
During 2003, our Marlo Coil operation generated nearly $11 million in
revenues from the design and manufacture of heating, ventilating and air
condition (HVAC) systems and industrial cooling coils used in aerospace,
food processing, healthcare, pharmaceutical and other applications.
Historically, we have produced a variety of automation systems for
the U.S. Postal Service (USPS). Currently, we are developing and testing the
Residue Collection Module which is designed to detect biohazard materials in
the mail sorting process. Further development on the program will occur in
2004.
24 | Engineered Support Systems, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Revenues on long-term contracts, substantially all of which are directly or
indirectly with the U.S. Government, are recognized under the percentage of
completion method and include a proportion of the earnings that are expected
to be realized on the contract in the ratio that production measures,
primarily labor, incurred bear to the estimated production measures for the
contract. Earnings expectations are based upon estimates of contract values
and costs at completion. Contracts in process are reviewed on a periodic
basis. Adjustments to revenues and earnings are made in the current
accounting period based upon revisions in contract values and estimated
costs at completion. Amounts representing contract change orders, claims and
other items are included in revenues, as recognized under the percentage of
completion method, only when these amounts can be reliably estimated and
realization is probable. Provisions for estimated losses on contracts are
recorded when identified. Substantially all other revenues are recognized
when title passes to the customer.
During 2002, the Company formally adopted a plan to dispose of
Engineered Specialty Plastics, Inc. (ESP), a wholly-owned subsidiary. In
conjunction with this plan, the Company recorded an after-tax estimated loss
on disposal of $4.2 million to reduce the carrying value of ESP's net assets
to their estimated fair value less estimated selling costs. Accordingly, the
Company has reported the results of operations of ESP as discontinued
operations for 2003, 2002 and 2001 in the Consolidated Statements of Income.
Additionally, all depreciation on the property, plant and equipment of ESP
was suspended upon its classification as a discontinued operation. The
Company completed the sale of ESP to a private equity group during 2003. See
Note E in the Consolidated Financial Statements.
During 2002, the Company announced a restructuring plan to improve
both plant utilization and long-term profitability. Under the plan, the
Company's Blue Ash, Ohio and Olivette, Missouri manufacturing locations were
closed during 2003 with related production efforts relocated to other
existing Company facilities. In conjunction with this restructuring plan,
the Company recorded a pre-tax restructuring expense of $1.4 million in 2002
related to certain severance costs and asset write-downs at these
facilities. The restructuring provision was reduced by $0.3 million during
2003 as a result of the Company having previously accrued estimated
severance costs in excess of actual severance costs. The Company anticipates
annual savings, net of income tax, from the restructuring plan of $1.5
million to $2.0 million beginning in 2004. See Note D in the Consolidated
Financial Statements. Emerging Issues Task Force (EITF) 94-3 provides
specific requirements as to the appropriate recognition of restructuring
costs associated with employee termination benefits and other exit costs.
Employee termination costs are recognized when benefit arrangements are
communicated to affected employees in sufficient detail to enable the
employees to determine the amount of benefits to be received upon
termination. Other costs resulting from the restructuring plan that are not
associated with or that do not benefit activities that will be continued are
recognized at the date of commitment to the plan subject to certain
conditions. For the cost to be accrued, the cost must not be associated with
or incurred to generate revenues after the commitment date, and it must be
either incremental to other costs incurred prior to the commitment date, or
represent amounts under a contractual obligation that existed prior to the
commitment date that will either continue after the plan is completed with
no economic benefit or which will result in a penalty to cancel the
obligation. Other costs directly related to the restructuring plan which are
not eligible for recognition at the commitment date, such as relocation and
other integration costs, are expensed as incurred.
During 2003, the Company announced an additional restructuring plan
under which the electronics assembly work performed at the Company's
Sanford, Florida facility of its Systems & Electronics Inc. (SEI) subsidiary
was to be relocated to alternate SEI facilities. In conjunction with this
restructuring plan, the Company recorded a pre-tax restructuring expense of
$2.1 million in 2003 related to certain severance costs and asset
write-downs at this facility. The Company anticipates annual savings, net of
income tax, from this restructuring plan of $1.5 million to $2.0 million
beginning in 2004. The Sanford facility was vacated during 2003. See Note D
in the Consolidated Financial Statements for additional information.
Statement of Financial Accounting Standards No. 146 (SFAS 146), "Accounting
for Costs Associated with Exit or Disposal Activities," applies to all
disposal activities initiated after December 31, 2002 and prospectively
nullifies EITF 94-3. SFAS 146 requires that a liability for employee
termination costs associated with an exit or disposal activity be recognized
when the liability is incurred. (EITF 94-3 had previously required that a
liability for such costs be recognized at the date of the Company's
commitment to an exit or disposal plan.)
The determination of the Company's obligation and expense for
pension and other postretirement benefits is dependent on certain
assumptions developed by the Company and used by actuaries in calculating
such amounts. Assumptions include, among others, the discount rate and the
expected long-term rate of return on plan assets. Actual results that differ
from assumptions made
2003 Annual Report | 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
are accumulated and amortized over future periods and, therefore, generally
affect the Company's recognized expense and recorded obligation in such
future periods. Significant differences in actual experience or significant
changes in assumptions may materially affect pension and other
postretirement obligations.
The following analysis should be read in this context.
RECENT DEVELOPMENTS
Over the past three years, the Company's net revenues and net income have
increased substantially as a result of both internal growth and several
significant acquisitions. During 2003, the Company acquired two companies
operating in the defense industry. Effective May 1, 2003, the Company
acquired all the capital stock of Technical and Management Services
Corporation (TAMSCO), a provider of information technology logistics and
digitization services, and a designer and integrator of telecommunications
systems primarily for the U.S. Department of Defense (DoD), for
approximately $69.4 million in cash plus the payoff of primarily working
capital-related indebtedness. TAMSCO is included in the Company's Support
Services business segment. Effective September 24, 2003, the Company
acquired all of the capital stock of Engineered Environments, Inc. (EEi), a
designer and manufacturer of specialized environmental control units and
heat transfer systems for defense and industrial markets, for approximately
$15.5 million in cash plus the payoff of certain mortgages and working
capital-related indebtedness. EEi is included in the Company's Support
Systems business segment. After allocating the respective purchase prices to
the fair value of all identifiable tangible and intangible assets, goodwill
of $75.8 million was recorded.
During 2002, the Company also acquired two companies operating in
the defense industry. Effective May 10, 2002, the Company acquired all the
capital stock of Radian, Inc. (Radian), a provider of engineering services,
asset protection/security systems and power generation equipment to the DoD,
for approximately $42.0 million in cash and Company common stock, plus the
payoff of certain working capital-related indebtedness. In conjunction with
the Radian acquisition, the Company recorded $15.3 million in
customer-related intangibles, which are being amortized over the weighted
average of the related customer contracts' estimated useful lives of 5.4
years. Radian is included within the Company's Support Services business
segment. Effective June 27, 2002, the Company acquired all of the capital
stock of Universal Power Systems, Inc. (UPSI), a provider of uninterruptible
power supply systems to the DoD, intelligence agencies and commercial
customers. The final purchase price, including contingent cash consideration
paid based upon UPSI's net revenue levels through October 31, 2003, totaled
approximately $12.5 million. UPSI is included within the Company's Support
Systems business segment. After allocating the respective purchase prices to
the fair value of all identifiable tangible and intangible assets, goodwill
of $39.1 million was recorded.
In accordance with the Company's adoption of Statement of Financial
Accounting Standards (SFAS) 142, "Goodwill and Other Intangible Assets,"
effective November 1, 2001, recorded goodwill balances are no longer being
amortized. Goodwill amortization totaled $3.2 million, or $1.9 million after
income tax, in 2001.
RESULTS OF CONTINUING OPERATIONS
The following discussion is with regard to the Company's results of
continuing operations. (The discontinued operations of the Company's ESP
subsidiary are discussed later.) The following table provides a comparative
margin analysis for continuing operations for the years ended October 31,
2003, 2002 and 2001.
- -------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- -------------------------------------------------------------------------
Net revenues 100.0% 100.0% 100.0%
- -------------------------------------------------------------------------
Cost of revenues 75.9 76.7 79.3
- -------------------------------------------------------------------------
Gross profit 24.1 23.3 20.7
Selling, general and
administrative expense 11.1 11.1 10.9
Restructuring expense 0.3 0.3
- -------------------------------------------------------------------------
Income from operations 12.7 11.9 9.8
Interest expense, net 0.3 0.8 1.6
=========================================================================
Income before income taxes 12.4 11.1 8.2
Income tax provision 4.8 4.3 3.2
- -------------------------------------------------------------------------
Net income 7.6% 6.8% 5.0%
- -------------------------------------------------------------------------
- -------------------------------------------------------------------------
BUSINESS SEGMENTS WITHIN CONTINUING OPERATIONS
The Company operates in two business segments: Support Systems and Support
Services. The Support Systems segment engineers and manufactures a broad
range of military support equipment and electronics systems primarily for
the DoD, as well as related air handling and heat transfer equipment for
commercial and industrial users, and material handling equipment for the
U.S. Postal Service. The segment's defense-related products include
environmental control systems, generator sets and power conditioning
equipment, chemical and biological protection systems, petroleum and water
systems, aircraft load management and transport systems, airborne radar
systems, target acquisition systems, avionics test equipment and other
multipurpose military support equipment. The Support Services segment
provides engineering, logistics and training services, advanced technology
services, asset protection systems and services, telecommunication systems
integration and information technology services primarily for the DoD. The
Support Services
26 | Engineered Support Systems, Inc.
segment also provides certain power generation and distribution equipment to
the DoD.
The Company previously defined its business segments as Light
Military Support Equipment, Heavy Military Support Equipment and Electronics
and Automation Systems. With the Company's entry into the services area
through the acquisitions of Radian on May 10, 2002 and TAMSCO on May 1,
2003, the growth of the Company's logistics support capabilities and the
continuing rationalization of its operations, the Company has reorganized
into the Support Systems and Support Services segments from the previous
three segments. The new reporting structure reflects how the Company manages
operations, reports results and allocates resources.
The Company's business segments were formally changed in the fourth
quarter of 2003. All prior periods presented have been restated to reflect
this change.
The following table sets forth net revenues and income from
operations for the years ended October 31, 2003, 2002 and 2001 for each of
the Company's business segments:
- -----------------------------------------------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------
NET REVENUES
Support Systems $389.3 68.0% $374.4 91.8% $365.2 100.0%
Support Services 188.3 32.9 33.7 8.3
Intersegment Revenues (4.9) (0.9) (0.2) (0.1)
- -----------------------------------------------------------------------------------------------------------------
Total $572.7 100.0% $407.9 100.0% $365.2 100.0%
- -----------------------------------------------------------------------------------------------------------------
INCOME FROM OPERATIONS
Support Systems $ 54.1 74.6% $ 48.0 98.8% $ 36.8 102.5%
Support Services 18.4 25.4 0.6 1.2 (0.9) (2.5)
- -----------------------------------------------------------------------------------------------------------------
Total $ 72.5 100.0% $ 48.6 100.0% $ 35.9 100.0%
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
2003 COMPARED TO 2002
Consolidated net revenues increased $164.8 million, or 40%, in 2003 to
$572.7 million from $407.9 million in 2002. The increase is primarily
attributable to the inclusion of $70.6 million in net revenues of TAMSCO
since its acquisition date in 2003 combined with incremental revenues of
$82.9 million and $9.3 million, respectively, generated by Radian and UPSI
in 2003 over their levels for a partial year during 2002. Gross profit for
2003 increased $42.9 million, or 45%, to $138.1 million (24.1% of
consolidated net revenues) from $95.2 million (23.3% of consolidated net
revenues) in 2002. The increase was primarily due to the incremental
contributions from TAMSCO, Radian and UPSI in 2003 of $9.9 million, $18.7
million and $3.5 million, respectively, combined with higher profit levels
on certain existing programs for the current year as discussed below.
Selling, general and administrative expense increased $18.7 million, or 41%,
in 2003 to $63.8 million (or 11.1% of consolidated net revenues) from $45.1
million (11.1% of consolidated net revenues) in 2002. This increase was
primarily the result of the recent acquisitions of TAMSCO, Radian and UPSI
which incurred incremental selling, general and administrative expense of a
combined $13.5 million during 2003, including an additional $1.4 million in
amortization of acquired customer-related intangibles. Under its facility
rationalization plans, the Company incurred restructuring expense of $1.8
million and $1.4 million, respectively, in 2003 and 2002 related to the
write-down of fixed assets at the affected facilities and to accrue for
expected employee benefits costs. Both restructuring plans were largely
completed during 2003. As a result of the above, operating income from
continuing operations increased by $23.9 million, or 49%, in 2003 to $72.5
million from $48.6 million in 2002.
Support Systems: Net revenues (prior to the elimination of
intersegment revenues) for the Support Systems segment increased by $14.9
million, or 4%, to $389.3 million in 2003 from $374.4 million in 2002. The
current year increase was primarily attributable to the incremental net
revenues of UPSI and EEi of $9.3 million and $1.5 million, respectively,
during the current year. Excluding the impact of acquisitions, net revenues
for the segment increased by a net of $4.1 million during 2003. Higher
production levels related to heightened military operations in Iraq and
Afghanistan, principally for the Field Deployable Environmental Control Unit
(FDECU), the Knight Precision Targeting System (Knight) and other support
equipment, led to solid revenue gains on these defense programs during 2003.
However, the completion of the M1000 Heavy Equipment Transport trailer
(M1000) production program during mid-2003, and reduced contract work on the
Tunner 60-K Cargo Loader (Tunner) and High Power Offload to CASS (HPOC)
program in 2003 largely offset these advances. Gross profit for the segment
increased by $12.9 million, or 15%, to $101.5 million in 2003 (26.1% of
segment net revenues) from $88.6 million (23.7% of segment net revenues) in
2002. The increase in gross profit was the result of the incremental
contribution from UPSI and EEi in 2003
2003 Annual Report | 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS continued
of a combined $3.9 million coupled with higher profits on FDECU, Knight and
other support equipment programs due to increased revenues and production
levels as noted above. Income from operations for the segment increased by
$6.1 million, or 13%, in 2003 to $54.1 million from $48.0 million in 2002.
The increase was the result of higher gross profit partially offset by
additional selling, general and administrative expense in 2003.
Support Services: Net revenues (prior to the elimination of
intersegment revenues) for the Support Services segment increased by $154.6
million, or 459%, in 2003 to $188.3 million from $33.7 million in 2002. The
significant growth in net revenues was attributable to the inclusion of
TAMSCO which reported $70.6 million in net revenues since its 2003
acquisition date, combined with $82.9 million in incremental net revenues
reported by Radian in 2003. Radian's rapid revenue growth resulted from the
inclusion of its operations for a full year in 2003 as well as a significant
year-over-year increase in revenues on the Deployable Power Generation and
Distribution System (DPGDS) program with the U.S. Air Force and Army. Gross
profit for the segment increased by $30.0 million, or 460%, in 2003 to $36.6
million (19.4% of segment net revenues) from $6.5 million (19.3% of segment
net revenues) in 2002. The increase in gross profit was attributable to the
higher level of net revenues in 2003 as discussed above. Income from
operations for the segment increased by $17.8 million in 2003 to $18.4
million from $0.6 million in 2002 as a result of the significant increases
in net revenues and gross profit as compared to the prior year.
Net interest expense decreased by $1.5 million to $1.7 million in
2003 compared to $3.2 million in 2002 as a result of lower interest rates on
outstanding borrowings throughout 2003. The Company's effective borrowing
rate decreased from 4.94% at October 31, 2002 to 2.34% at October 31, 2003.
The Company's reported effective income tax rate for both 2003 and
2002 was 39% resulting in total income tax expense of $27.7 million in 2003
and $17.7 million in 2002.
As a result of the foregoing, net income from continuing operations
increased 69% to $43.3 million (7.6% of consolidated net revenues) in 2003
compared to $27.7 million (6.8% of consolidated net revenues) in 2002.
Discontinued Operations: As discussed above, in conjunction with
the Company's 2002 decision to divest of ESP, its financial results have
been reclassified as a discontinued operation in the Consolidated Financial
Statements for all periods presented. Income from discontinued operations
totaled $0.3 million, net of income tax, in 2003 compared to $49,000, net of
income tax, in 2002. In conjunction with the planned disposition of ESP, the
Company recorded after-tax losses of $0.2 million and $4.2 million,
respectively, during 2003 and 2002 to reduce the carrying value of ESP's
assets to their estimated net realizable values less estimated selling
costs. ESP was sold to a private equity group in 2003. See Note E in the
Consolidated Financial Statements.
2002 COMPARED TO 2001
Consolidated net revenues increased $42.7 million, or 12%, in 2002 to $407.9
million from $365.2 million in 2001. The increase is primarily attributable
to the inclusion of revenues from Radian of $33.1 million and UPSI of $3.7
million since their respective acquisition dates in 2002. Gross profit for
2002 increased $19.6 million, or 26%, to $95.2 million (23.3% of
consolidated net revenues) from $75.6 million (20.7% of consolidated net
revenues) in 2001. The inclusion of the Radian and UPSI operations since
their respective acquisition dates contributed combined gross profit of $7.1
million in 2002. Higher gross profit on certain existing long-term contracts
as discussed below also contributed to the advancement in 2002. Selling,
general and administrative expense increased $5.4 million, or 14%, in 2002
to $45.1 million (11.1% of consolidated net revenues) from $39.8 million
(10.9% of consolidated net revenues) in 2001. This increase was primarily
the result of the acquisitions of Radian and UPSI which incurred combined
selling, general and administrative expense totaling $5.6 million, including
$1.4 million in amortization of acquired customer-related intangibles, since
their respective acquisition dates during 2002. As discussed above, the
Company no longer amortized goodwill effective November 1, 2001 in
accordance with SFAS 142. Goodwill amortization of $3.2 million was included
in selling, general and administrative expense in 2001. In conjunction with
the Company's restructuring plan announced during 2002, restructuring
expense of $1.4 million was recorded to write down fixed assets at the
affected facilities and to accrue for expected employee benefits costs. The
restructuring plan was completed during 2003. As a result of the above,
income from continuing operations increased by $12.7 million, or 36%, in
2002 to $48.6 million from $35.9 million in 2001.
Support Systems: Net revenues (prior to the elimination of
intersegment revenues) for the Support Systems segment increased by $9.2
million, or 3%, to $374.4 million in 2002 from $365.2 million in 2001. The
increase was primarily attributable to the incremental net revenues of UPSI
of $3.7 million since its acquisition date in 2002, combined with higher
revenues on several long-term manufacturing programs including Tunner,
Knight and various radar programs partially offset by reduced revenues from
the U.S. Postal Service as well as lower production work on HPOC and the
Chemical Biological Protected Shelter (CBPS) programs as compared to the
prior year. Gross profit for the segment
28 | Engineered Support Systems, Inc.
increased by $13.0 million, or 17%, in 2002 to $88.6 million (23.7% of
segment net revenues) from $75.6 million (20.7% of segment net revenues) in
2001. The increase in gross profit was the result of the contribution from
UPSI in 2002 coupled with higher profits on several long-term manufacturing
programs. Income from operations for the segment increased by $11.2 million,
or 31%, in 2002 to $48.0 million from $36.8 million in 2001. The increase
was the result of higher gross profit partially offset by additional
selling, general and administrative expense in 2002.
Support Services: Net revenues (prior to the elimination of
intersegment revenues) for the Support Services segment increased by $33.7
million in 2002 almost entirely due to the acquisition of Radian during the
year. Gross profit for the segment totaled $6.5 million (19.3% of segment
net revenues) for 2002 compared to zero for the prior year. Income from
operations for the segment increased by $1.5 million in 2002 to $0.6 million
compared to an operating loss of $0.9 million in 2001 as a result of the
Radian acquisition during the year.
Net interest expense decreased by $2.7 million to $3.2 million in
2002 compared to $5.9 million in 2001 primarily as a result of lower
outstanding borrowings on the Company's revolving and term debt credit
facilities combined with a decline in interest rates throughout 2002. The
Company's effective borrowing rate decreased from 5.61% at October 31, 2001
to 4.94% at October 31, 2002.
The Company's reported effective income tax rate for both 2002 and
2001 was 39% resulting in total income tax expense of $17.7 million in 2002
and $11.7 million in 2001.
As a result of the foregoing, net income from continuing operations
increased 51% to $27.7 million (6.8% of consolidated net revenues) in 2002
compared to $18.3 million (5.0% of consolidated net revenues) in 2001.
Discontinued Operations: Income from discontinued operations
totaled $49,000, net of income tax, in 2002 compared to $0.3 million, net of
income tax, in 2001. In conjunction with the planned disposition of ESP, the
Company recorded an after-tax loss of $4.2 million during 2002 to reduce the
carrying value of ESP's assets to their estimated net realizable values less
estimated selling costs.
OUTLOOK FOR 2004 AND FUTURE YEARS
For 2004, the Company is forecasting approximately a 30% increase in
consolidated net revenues to between $740 and $750 million for the year,
without consideration for any potential future acquisitions. The Company
anticipates that the inclusion of the operations of TAMSCO, EEi and Pivotal
Power Inc. (Pivotal Power), which was acquired subsequent to year-end, as
well as significant internal revenue growth will contribute to this
increase. The Company anticipates that cash flows generated from operating
earnings growth will be used to continue to pay down existing bank debt in
2004. Reflecting the above forecasted assumptions, the Company expects
diluted earnings per share to increase to between $2.40 and $2.45 in 2004.
The Company continues to believe that significant growth
opportunities exist within the military support equipment, electronics and
logistics support segments of the defense industry in response to (i) the
current fragmentation within the industry; (ii) the DoD's emphasis on
awarding contracts on the basis of "best value;" (iii) the DoD's increasing
outsourcing of engineering, design and logistics services to contractors;
(iv) heightened military operations around the globe; and, (v) overall
increases in defense spending by the DoD. The Company's focus for 2004
includes the continued rationalization of its existing defense operations in
order to leverage its infrastructure and achieve additional operational
synergies, as well as the continued integration of its recently acquired
TAMSCO, EEi and Pivotal Power operations. The Company continues to review
potential defense acquisitions in both the Support Systems and Support
Services business areas. Any such transaction must be accretive to earnings,
must bring significant increases in revenues and backlog, and must provide
long-term value to the Company's shareholders.
LIQUIDITY AND CAPITAL RESOURCES
Effective April 23, 2003, the Company retired all borrowings under its
existing credit facility and entered into a new bank agreement which
provided a $125 million unsecured, revolving credit facility. Borrowings
under the new agreement, which expires April 23, 2007, are subject to
interest, at the Company's option, at either the Eurodollar rate plus an
applicable margin or at the prime rate plus an applicable margin. The margin
applicable to the Eurodollar rate varies from 0.875% to 1.625% and the
margin applicable to the prime rate varies from 0.0% to 0.25% depending upon
the Company's ratio of total indebtedness to earnings before interest,
taxes, depreciation and amortization (leverage ratio). As of October 31,
2003, the Company had borrowings of $73.1 million outstanding against the
new revolving credit facility, remaining availability under the credit
facility of $49.1 million and a cash balance of $2.9 million.
The Company's working capital needs are generally funded through
cash flow from operations and the revolving line of credit. At October 31,
2003, the Company's working capital and ratio of current assets to current
liabilities (excluding its revolving credit facility) were $43.8 million and
1.39 to 1, respectively, compared with $30.6 million and 1.36 to 1 a year
ago. During 2003, the Company generated operating cash flows from continuing
operations of $64.8 million compared to $55.2 million in 2002. The
2003 Annual Report | 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS continued
improvement in operating cash flows reflects higher net income and continued
prudent management of working capital levels.
During 2003, the Company expended cash totaling $99.1 million in
conjunction with the acquisitions of TAMSO, EEi and UPSI (contingent
consideration), including the payoff of certain loans and working
capital-related indebtedness associated therewith. The Company financed
these transactions with short-term borrowings under its new revolving credit
facility.
Investment in property, plant and equipment totaled $9.7 million
and $3.5 million, respectively, in 2003 and 2002. The increase was primarily
the result of additional facility expenditures at the Company's SEI and Keco
subsidiaries due in large part to its restructuring initiatives. The Company
anticipates that capital expenditures in 2004 should not exceed $7.5
million. Management believes that cash flow generated from operations,
together with its available revolving credit facility, will provide the
necessary resources to meet the capital needs of the Company for the
foreseeable future.
COMMITTED AMOUNTS
Total contractual and contingent obligations as of October 31, 2003 are as
follows:
- -----------------------------------------------------------------------------------------------------------------------------
Payments / Expiration
-----------------------------------------------------------------------------
Year Ended October 31 2004 2005 2006 2007 2008 Total
- -----------------------------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS:
Short-term borrowings $ 73,100 $ $ $ $ $ 73,100
Long-term debt 90 90
Operating leases 4,004 2,639 1,957 1,333 242 10,175
Unconditional purchase obligations 167,788 860 71 168,719
- -----------------------------------------------------------------------------------------------------------------------------
244,982 3,499 2,028 1,333 242 252,084
CONTINGENT OBLIGATIONS:
Letters of credit 2,757 2,757
- -----------------------------------------------------------------------------------------------------------------------------
Total Obligations $247,739 $3,499 $2,028 $1,333 $242 $254,841
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
While contingent obligations are included in the table above, the Company
does not expect to fund the full amounts indicated for letters of credit.
INFLATION
Since a significant portion of the Company's contracts with the DoD are at
fixed prices, inflation can affect the ultimate profit to be realized on
them. Some contracts have price adjustment provisions that limit the impact
of inflation on profits. In addition, the Company's volume purchasing and
forward purchasing policies serve to limit the effects of inflation. The
Company considers potential inflation in preparation of contract proposals
and bids. In addition, the Company's commercial and industrial products are
predominantly custom-made. Therefore, the impact of inflation on operating
results is typically not significant. The Company attempts to alleviate
inflationary pressures on commercial and industrial products by increasing
selling prices to help offset rising costs (subject to competitive
conditions), increasing productivity and improving manufacturing techniques.
Because of these factors, management does not believe that inflation has
had, or that anticipated inflation will have, a significant effect on the
Company's operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS 146 provides direction for
accounting and disclosure regarding specific costs related to an exit or
disposal activity. These include, but are not limited to, costs to terminate
a contract that is not a capital lease, costs to consolidate facilities or
relocate employees, and certain termination benefits provided to employees
who are involuntarily terminated under the terms of a one-time benefit
arrangement. The Company adopted SFAS 146 for all disposal activities
initiated after December 31, 2002.
In December 2002, the FASB issued SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an Amendement of SFAS
123." SFAS 148 provides additional transition guidance for those entities
that elect to voluntarily adopt the provisions of SFAS 123, "Accounting for
Stock-Based Compensation." Furthermore, SFAS 148 mandates new disclosures in
both interim and year-end financial statements within the Company's
30 | Engineered Support Systems, Inc.
Significant Accounting Policies footnote. The Company adopted these
disclosure requirements beginning with the year ended October 31, 2002.
The Company adopted FASB Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," in fiscal 2003. The adoption did not
have a material impact on the financial statements and all guarantees have
been appropriately disclosed. The FASB issued a revised version of FIN 46,
"Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin (ARB) No. 51, Consolidated Financial
Statements," in December 2003. The adoption of FIN 46 will not have a
material impact on the Company's financial statements as it does not
maintain any of the interests governed by this pronouncement.
In April 2003, the Financial Accounting Standards Board (FASB)
issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities." SFAS 149 amends and clarifies financial reporting
for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and
for hedging activities under SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The provisions of this Statement that relate
to Statement 133 implementation issues that have been effective for fiscal
quarters that began prior to June 15, 2003, should continue to be applied in
accordance with their respective effective dates. The adoption of SFAS 149
will not have a material impact on the Company's Consolidated Financial
Statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
This statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity and requires the classification of such financial instruments as a
liability (or an asset in certain circumstances). Many of those instruments
were previously permitted to be classified as equity. SFAS 150 is effective
for financial instruments entered into or modified after May 31, 2003 and is
otherwise effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS 150 will not have a material
impact on the Company's Consolidated Financial Statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB
Statement No. 132" (FAS 132 (revised 2003)). This Statement revises
employers' disclosures about pension plans and other postretirement benefit
plans. It does not change the measurement or recognition of those plans
required by FASB Statements No. 87, "Employers' Accounting for Pensions,"
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits" and No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions." The new rules
require additional disclosures about the assets, obligations, cash flows and
net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. The required information will be provided
separately for pension plans and for other postretirement benefit plans.
This includes expanded disclosure on an interim basis as well. The new
disclosures are required for years ending after December 15, 2003 and thus
will be effective for the Company in fiscal 2004.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report includes certain
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which are intended to be covered by the
safe harbors created thereby. The forward-looking statements involve certain
risks and uncertainties, including but not limited to 2004 forecasted
results, acquisitions, additional financing requirements, the decision of
any of the Company's key customers (including the U.S. Government) to reduce
or terminate orders with the Company, cutbacks in defense spending by the
U.S. Government and increased competition in the Company's markets, which
could cause the Company's actual results to differ materially from those
projected in, or inferred by, the forward-looking statements.
2003 Annual Report | 31
CONSOLIDATED BALANCE SHEETS
In thousands, except per share amounts
- --------------------------------------------------------------------------------------
October 31 2003 2002
- --------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,880 $ 4,793
Accounts receivable, net 90,805 47,407
Contracts in process and inventories, net 50,959 42,182
Refundable income taxes 2,709
Deferred income taxes 5,939 6,660
Prepaid expenses and other assets 4,668 2,301
Current assets of discontinued operations 10,079
- --------------------------------------------------------------------------------------
Total Current Assets 155,251 116,131
PROPERTY, PLANT AND EQUIPMENT
Land 5,541 4,785
Buildings and improvements 41,955 34,739
Machinery and equipment 26,672 25,621
Furniture and fixtures 4,998 3,424
- --------------------------------------------------------------------------------------
79,166 68,569
Less accumulated depreciation 28,800 25,464
- --------------------------------------------------------------------------------------
50,366 43,105
Goodwill 191,332 103,444
Acquired customer-related intangibles 11,049 13,880
Deferred income taxes 6,885
Other assets 11,303 5,394
Long-term assets of discontinued operations 1,308
- --------------------------------------------------------------------------------------
Total Assets $419,301 $290,147
- --------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 73,100 $ 13,000
Current maturities of long-term debt 90 21,000
Accounts payable 48,609 28,439
Income taxes payable 2,493
Accrued employee compensation 27,933 20,117
Other liabilities 32,336 12,206
Current liabilities of discontinued operations 3,793
- --------------------------------------------------------------------------------------
Total Current Liabilities 184,561 98,555
Long-term debt 21,000
Deferred income taxes 325
Additional minimum pension liability 25,751 20,334
Other liabilities 11,497 15,401
Commitments and contingencies (Note N)
SHAREHOLDERS' EQUITY
Common stock, par value $.01 per share; 30,000 shares
authorized; 25,263 and 16,991 shares issued 253 170
Additional paid-in capital 106,512 95,569
Retained earnings 127,753 84,961
Accumulated other comprehensive loss (16,142) (14,275)
- --------------------------------------------------------------------------------------
218,376 166,425
Less treasury stock at cost, 561 and 1,171 shares 21,209 31,568
- --------------------------------------------------------------------------------------
Total Shareholders' Equity 197,167 134,857
- --------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $419,301 $290,147
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
32 | Engineered Support Systems, Inc.
CONSOLIDATED STATEMENTS OF INCOME
In thousands, except per share amounts
- ----------------------------------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- ----------------------------------------------------------------------------------------------------
Net revenues:
Products $461,490 $389,324 $365,171
Services 111,211 18,621 27
- ----------------------------------------------------------------------------------------------------
572,701 407,945 365,198
- ----------------------------------------------------------------------------------------------------
Cost of revenues:
Products 340,380 297,286 289,581
Services 94,262 15,481 3
- ----------------------------------------------------------------------------------------------------
434,642 312,767 289,584
- ----------------------------------------------------------------------------------------------------
Gross profit 138,059 95,178 75,614
Selling, general and administrative expense 63,832 45,145 39,767
Restructuring expense 1,758 1,441
- ----------------------------------------------------------------------------------------------------
Operating income from continuing operations 72,469 48,592 35,847
Interest expense (1,881) (3,367) (6,118)
Interest income 221 128 214
Gain on sale of assets 147 7 6
- ----------------------------------------------------------------------------------------------------
Income from continuing operations 70,956 45,360 29,949
Income tax provision 27,673 17,694 11,680
- ----------------------------------------------------------------------------------------------------
Net income from continuing operations 43,283 27,666 18,269
Discontinued operations:
Income from discontinued operations, net of income tax 294 49 307
Loss on disposal, net of income tax (169) (4,182)
- ----------------------------------------------------------------------------------------------------
Net income $ 43,408 $ 23,533 $ 18,576
- ----------------------------------------------------------------------------------------------------
Basic earnings per share:
Continuing operations $ 1.79 $ 1.18 $ 0.87
Discontinued operations:
Income 0.01 0.01
Loss on disposal (0.01) (0.17)
- ----------------------------------------------------------------------------------------------------
Total $ 1.79 $ 1.01 $ 0.88
- ----------------------------------------------------------------------------------------------------
Diluted earnings per share:
Continuing operations $ 1.68 $ 1.14 $ 0.80
Discontinued operations:
Income 0.01 0.01
Loss on disposal (0.01) (0.17)
- ----------------------------------------------------------------------------------------------------
Total $ 1.68 $ 0.97 $ 0.81
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
2003 Annual Report | 33
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
In thousands
- ---------------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Other ESOP
Common Paid-in Retained Comprehensive Guaranteed Treasury
Stock Capital Earnings Loss Bank Loan Stock Total
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 2000 $83 $49,365 $43,571 $(431) $(14,088) $ 78,500
Comprehensive income:
Net income 18,576 18,576
Other components of
comprehensive
income, net of tax:
Minimum pension
liability adjustment (4,670) (4,670)
Adjustment to fair value
of derivatives (884) (884)
----------
Total comprehensive income 13,022
----------
Cash dividends (324) (324)
Exercise of stock options 15 35,866 35,881
Reduction of ESOP guaranteed
bank loan 431 431
Purchase of treasury stock (18,675) (18,675)
Issuance of treasury stock 470 87 557
Five-for-four stock split 19 (19)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 2001 117 85,682 61,823 (5,554) (32,676) 109,392
Comprehensive income:
Net income 23,533 23,533
Other components of
comprehensive
income, net of tax:
Minimum pension liability
adjustment (9,428) (9,428)
Adjustment to fair value
of derivatives 707 707
----------
Total comprehensive income 14,812
----------
Cash dividends (395) (395)
Issuance of common stock 1 1,354 1,355
Exercise of stock options 5,235 792 6,027
Issuance of treasury stock 3,350 316 3,666
Three-for-two stock split 52 (52)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 2002 170 95,569 84,961 (14,275) (31,568) 134,857
Comprehensive income:
Net income 43,408 43,408
Other components of
comprehensive
income, net of tax:
Minimum pension liability
adjustment (2,044) (2,044)
Adjustment to fair value
of derivatives 177 177
----------
Total comprehensive income 41,541
----------
Cash dividends (616) (616)
Issuance of common stock 1 1,727 1,728
Exercise of stock options 8,682 9,705 18,387
Purchase of treasury stock (557) (557)
Issuance of treasury stock 983 844 1,827
Three-for-two stock split 82 (449) 367
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 2003 $253 $106,512 $127,753 $(16,142) $ $(21,209) $197,167
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
34 | Engineered Support Systems, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
- -----------------------------------------------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 43,283 $ 27,666 $ 18,269
Adjustments to reconcile net income from continuing
operations to net cash provided by continuing operations:
Depreciation and amortization 8,961 7,038 9,001
Deferred income taxes 5,768 (1,082) 3,539
Gain on sale of assets (147) (10) (6)
- -----------------------------------------------------------------------------------------------------------------
Cash provided by continuing operations before changes
in operating assets and liabilities, excluding the effects
of acquisitions 57,865 33,612 30,803
Changes in operating assets and liabilities:
Accounts receivable (13,639) (8,725) (2,192)
Contracts in process and inventories 3,065 12,723 2,282
Accounts payable 5,539 4,911 (3,681)
Current income taxes 4,996 3,347 3,063
Net changes in other assets and liabilities 7,017 9,343 (15,991)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 64,843 55,211 14,284
Net cash provided by (used in) discontinued operations 1,612 (670) 3,528
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 66,455 54,541 17,812
- -----------------------------------------------------------------------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of TAMSCO, net of cash acquired (77,415)
Purchase of EEI, net of cash acquired (16,630)
Purchase of Radian, net of cash acquired (39,997)
Purchase of UPSI, net of cash acquired (5,008) (5,500)
Additions to property, plant and equipment (9,681) (3,515) (1,624)
Proceeds from sale of property, plant and equipment 316 11 12
- -----------------------------------------------------------------------------------------------------------------
Net cash used in continuing operations (108,418) (49,001) (1,612)
Net cash provided by (used in) discontinued operations 2,918 (11) (158)
- -----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (105,500) (49,012) (1,770)
- -----------------------------------------------------------------------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES:
Net borrowings (payments) under line-of-credit agreement 60,100 12,300 (15,600)
Payments of long-term debt (41,910) (21,038) (17,028)
Exercise of stock options 18,387 6,027 35,881
Purchase of treasury stock (557) (18,675)
Cash dividends (616) (395) (324)
Issuance of common stock to employee stock purchase plan 1,728 1,355
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) continuing operations 37,132 (1,751) (15,746)
Net cash provided by (used in) discontinued operations
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 37,132 (1,751) (15,746)
- -----------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (1,913) 3,778 296
Cash and cash equivalents at beginning of year 4,793 1,015 719
- -----------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 2,880 $ 4,793 $ 1,015
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
2003 Annual Report | 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In thousands, except per share amounts
NOTE A SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation: The Consolidated
Financial Statements include the accounts of Engineered Support Systems,
Inc. (Company) and its wholly owned subsidiaries. These subsidiaries are
organized within the Company's two business segments: Support Systems and
Support Services. The Support Systems segment includes the operations of
Systems & Electronics Inc. (SEI), Keco Industries, Inc. (Keco), Engineered
Air Systems, Inc. (Engineered Air), Engineered Coil Company, d/b/a Marlo
Coil (Marlo Coil), Engineered Electric Company d/b/a Fermont (Fermont),
Universal Power Systems, Inc. (UPSI) and Engineered Environments, Inc.
(EEi). The Support Services segment includes the operations of Technical and
Management Services Corporation (TAMSCO), Radian, Inc. (Radian) and
ESSIbuy.com, Inc. (ESSIbuy). All material intercompany accounts and
transactions have been eliminated in consolidation.
Industry Information: The Company's Support Systems segment
designs, engineers and manufactures integrated military electronics and
other support equipment. The Company's Support Services segment provides
engineering, logistics support and systems integration services.
Substantially all revenues are directly or indirectly derived from contracts
with the U.S. Government.
Use of Estimates: In preparing these financial statements,
management makes estimates and uses assumptions that affect some of the
reported amounts and disclosures. Actual results could differ from these
estimates and assumptions.
Cash and Cash Equivalents: Cash equivalents include temporary
investments with original maturities of three months or less.
Revenue Recognition: Revenues on long-term contracts, substantially
all of which are directly or indirectly with the U.S. Government, are
recognized under the percentage of completion method and include a
proportion of the earnings that are expected to be realized on the contract
in the ratio that production measures, primarily labor, incurred bear to the
estimated production measures for the contract. Earnings expectations are
based upon estimates of contract values and costs at completion. Contracts
in process are reviewed on a periodic basis. Adjustments to revenues and
earnings are made in the current accounting period based upon revisions in
contract values and estimated costs at completion. Amounts representing
contract change orders, claims and other items are included in revenues, as
recognized under the percentage of completion method, only when these
amounts can be reliably estimated and realization is probable. Provisions
for estimated losses on contracts are recorded when identified.
Substantially all other revenues are recognized when title passes to the
customer.
Stock-Based Compensation: The Company applies Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations in accounting for all stock option plans. (See Note
K for a further description of these plans.) Accordingly, no compensation
expense has been recognized for stock option awards. The following table
illustrates the effect on net income from continuing operations and earnings
per share had the Company applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) 123, "Accounting for
Stock-Based Compensation," to stock option awards.
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- ------------------------------------------------------------------------
Reported net income from
continuing operations $43,283 $27,666 $18,269
Total stock-based employee
compensation expense
determined under the fair
value method for all stock
option awards, net of
income tax 3,521 11,105 3,925
- ------------------------------------------------------------------------
Pro forma net income $39,762 $16,561 $14,344
========================================================================
Earnings per share:
Basic - as reported $ 1.79 $ 1.18 $ 0.87
========================================================================
Basic - pro forma $ 1.64 $ 0.71 $ 0.68
========================================================================
Diluted - as reported $ 1.68 $ 1.14 $ 0.80
========================================================================
Diluted - pro forma $ 1.54 $ 0.68 $ 0.63
========================================================================
- ------------------------------------------------------------------------
The fair value of options at the grant date was estimated using the
Black-Scholes model with the following weighted average assumptions for
2003, 2002 and 2001, respectively: an expected life of 1.5 years; volatility
of 36%, 51% and 58%; a dividend yield of 0.12%, 0.16% and 0.16%; and a
risk-free interest rate of 3.25%, 3.74% and 4.27%.
The weighted average fair value of options granted in 2003, 2002
and 2001 was $7.55, $5.11 and $2.35, respectively.
Fair Value of Financial Instruments: For purposes of financial
reporting, the Company has determined that the fair value of the Company's
financial instruments, including cash and cash equivalents, accounts
receivable, accounts payable, accrued liabilities and long-term debt,
approximates book value at October 31, 2003 and 2002, based on either their
short-term nature or on terms currently available to the Company in
financial markets.
Credit Risk: Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents, and accounts
36 | Engineered Support Systems, Inc.
receivable. At October 31, 2003 and 2002, the Company's cash and cash
equivalents were primarily invested in money market accounts at a financial
institution. Management believes the credit risk is limited due to the
short-term nature of these funds. Management believes the credit risk
related to accounts receivable is limited due to the fact that 72% and 68%
of accounts receivable at October 31, 2003 and 2002, respectively, are due
from the U.S. Government and its agencies. Allowances for anticipated
doubtful accounts are provided based on historical experience and evaluation
of specific accounts. The allowance for doubtful accounts was $211 and $281
at October 31, 2003 and 2002, respectively.
Interest Rate Risk: Interest rate risk is managed through a
portfolio of variable- and fixed-rate debt that management deems
appropriate. Furthermore, the Company will periodically convert its
variable-rate debt to fixed rates via interest rate swaps. Given the
Company's outstanding debt position and anticipated cash flows, management
does not believe its exposure to interest rate fluctuations has had, or will
have, a significant impact on the Company's operations.
Contracts in Process and Inventories: Contracts in process and
inventories represent accumulated contract costs, estimated earnings thereon
based upon the percentage of completion method and contract inventories
reduced by the contract value of delivered items. Accumulated contract costs
and inventories are stated at actual costs incurred and consist of direct
engineering, production, tooling, applicable overhead and other costs
(excluding selling, general and administrative costs which are charged
against income as incurred). Title to or a security interest in certain
items included in contracts in process and inventories is vested in the U.S.
Government by reason of the progress payment provisions of related
contracts. In accordance with industry standards, contracts in process and
inventories related to long-term contracts are classified as current assets
although a portion may not be realized within one year.
Substantially all inventories related to contracts not accounted
for under the percentage of completion method are valued at the lower of
cost or market using the first-in, first-out method.
Property, Plant and Equipment: Property, plant and equipment are
stated at cost and are depreciated using the straight-line method over their
estimated useful lives of 15 to 40 years for buildings and improvements,
five to 15 years for machinery and equipment, and three to 10 years for
furniture and fixtures. Depreciation expense totaled $5,387 in 2003, $4,934
in 2002 and $5,073 in 2001.
Income Taxes: The income tax provision is based on earnings
reported in the financial statements. Deferred income taxes are provided for
the tax effects of temporary differences between financial and income tax
reporting using current statutory tax rates.
Impairment of Long-lived Assets: Long-lived assets, including
goodwill, are reviewed for impairment annually or whenever events or changes
in circumstances indicate that the carrying amount may not be recoverable.
If the sum of the expected future undiscounted cash flows is less than the
carrying amount of the asset, a loss is recognized for the difference
between the fair value and the carrying value of the asset.
Earnings Per Share: Basic earnings per share is based on average
basic common shares outstanding, after the effect of the stock split
described in Note O, of 24,203 in 2003, 23,373 in 2002 and 21,054 in 2001.
Diluted earnings per share is based on average diluted common shares
outstanding, after the effect of the stock split described in Note O, of
25,838 in 2003, 24,314 in 2002 and 22,824 in 2001. Average diluted common
shares outstanding include common stock equivalents, which represent common
stock options as computed using the treasury stock method.
Treasury Stock: Shares of treasury stock are valued at cost using
the first-in, first-out method.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS 146 provides direction for
accounting and disclosure regarding specific costs related to an exit or
disposal activity. These include, but are not limited to, costs to terminate
a contract that is not a capital lease, costs to consolidate facilities or
relocate employees, and certain termination benefits provided to employees
who are involuntarily terminated under the terms of a one-time benefit
arrangement. The Company adopted SFAS 146 for all disposal activities
initiated after December 31, 2002.
In December 2002, the FASB issued SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an Amendement of SFAS
123." SFAS 148 provides additional transition guidance for those entities
that elect to voluntarily adopt the provisions of SFAS 123, "Accounting for
Stock-Based Compensation." Furthermore, SFAS 148 mandates new disclosures in
both interim and year-end financial statements within the Company's
Significant Accounting Policies footnote. The Company adopted these
disclosure requirements beginning with the year ended October 31, 2002.
The Company adopted FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of
2003 Annual Report | 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
in thousands, except per share amounts
Indebtedness of Others," in fiscal 2003. The adoption did not have a
material impact on the financial statements and all guarantees have been
appropriately disclosed. The FASB issued a revised version of FIN 46,
"Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin (ARB) No. 51, Consolidated Financial
Statements," in December 2003. The adoption of FIN 46 will not have a
material impact on the Company's financial statements as it does not
maintain any of the interests governed by this pronouncement.
In April 2003, the Financial Accounting Standards Board (FASB)
issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities." SFAS 149 amends and clarifies financial reporting
for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and
for hedging activities under SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The provisions of this Statement that relate
to Statement 133 implementation issues that have been effective for fiscal
quarters that began prior to June 15, 2003, should continue to be applied in
accordance with their respective effective dates. The adoption of SFAS 149
will not have a material impact on the Company's Consolidated Financial
Statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
This statement establishes standards for the classification and measurement
of certain financial instruments with characteristics of both liabilities
and equity and requires the classification of such financial instruments as
a liability (or an asset in certain circumstances). Many of those
instruments were previously permitted to be classified as equity. SFAS 150
is effective for financial instruments entered into or modified after May
31, 2003 and is otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS 150 will not have
a material impact on the Company's Consolidated Financial Statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB
Statement No. 132" (FAS 132 (revised 2003)). This Statement revises
employers' disclosures about pension plans and other postretirement benefit
plans. It does not change the measurement or recognition of those plans
required by FASB Statements No. 87, "Employers' Accounting for Pensions,"
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits" and No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions." The new rules
require additional disclosures about the assets, obligations, cash flows and
net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. The required information will be provided
separately for pension plans and for other postretirement benefit plans.
This includes expanded disclosure on an interim basis as well. The new
disclosures are required for years ending after December 15, 2003 and thus
will be effective for the Company in fiscal 2004.
NOTE B ACQUISITIONS
On May 1, 2003, the Company acquired all of the outstanding common stock of
TAMSCO, a provider of information technology logistics and digitization
services and a designer and integrator of telecommunication systems
primarily for the U.S. Department of Defense (DoD). The purchase price was
approximately $69.4 million, which is net of $0.1 million of cash acquired.
The transaction has been treated as an asset purchase for tax purposes
pursuant to Section 338(h)(10) of the Internal Revenue Code. Approximately
$6.9 million of the purchase price has not yet been paid subject to final
determination of tax adjustments and collection of accounts receivable. In
connection with this transaction, the Company also assumed and paid $14.9
million of TAMSCO indebtedness. The purchase of TAMSCO, net of cash
acquired, totals $77.4 million in the Consolidated Statements of Cash Flows,
which represents the $69.4 million purchase price plus assumed indebtedness
of $14.9 million less $6.9 million of purchase price not yet paid. The fair
value of assets acquired, including goodwill of $63.9 million, was $102.2
million and liabilities assumed totaled $32.8 million. The purchase price
was financed with short-term borrowings under the Company's revolving credit
facility.
The following unaudited pro forma summary presents the combined
historical results of operations for the years ended October 31, 2003 and
2002 as adjusted to reflect the TAMSCO purchase transaction assuming the
acquisition had occurred on November 1, 2001. These pro forma results are
not necessarily indicative of the combined results that would have occurred
had the acquisition actually taken place on November 1, 2001, nor are they
necessarily indicative of the combined results that may occur in the future.
38 | Engineered Support Systems, Inc.
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002
- ------------------------------------------------------------------------
Net revenues $652,655 $523,874
========================================================================
Net income from
continuing operations $ 46,144 $ 30,853
========================================================================
Basic earnings per share
from continuing operations $ 1.91 $ 1.32
========================================================================
Diluted earnings per share
from continuing operations $ 1.79 $ 1.27
========================================================================
- ------------------------------------------------------------------------
Certain information with respect to the assets and liabilities of
TAMSCO as of acquisition date is summarized as follows:
- ------------------------------------------------------------------------
May 1, 2003
- ------------------------------------------------------------------------
Accounts recievable $ 27,837
Contracts in process and inventories 6,907
Property, plant and equipment 2,906
Goodwill 63,889
Other assets 676
- ------------------------------------------------------------------------
Total assets $102,215
========================================================================
Notes payable $ 14,038
Current maturities of long-term debt 813
Accounts payable 13,856
Accrued expenses and other liabilities 4,102
- ------------------------------------------------------------------------
Total liabilities $ 32,809
========================================================================
- ------------------------------------------------------------------------
On September 24, 2003, the Company acquired all of the outstanding
common stock of EEi, a designer and manufacturer of specialized
environmental control units and heat transfer systems for defense and
industrial markets. The purchase price was approximately $15.5 million. The
purchase of EEi, net of cash acquired, totals $16.6 million in the
Consolidated Statements of Cash Flows, which represents the $15.5 million
purchase price plus assumed indebtedness of $1.1 million. The fair value of
assets acquired, including goodwill of $11.9 million, was $19.8 million and
liabilities assumed totaled $4.3 million. The purchase price was financed
with short-term borrowings under the Company's revolving credit facility.
On June 27, 2002, the Company acquired all of the outstanding
common stock of UPSI, a provider of uninterruptible power supply systems for
the DoD, intelligence agencies and commercial customers. The purchase price
was approximately $5.5 million plus certain contingent cash consideration
based upon UPSI's net revenue levels through two measurement dates, December
31, 2002 and October 31, 2003. Based upon UPSI's net revenue through the
December 31, 2002 measurement date, $5.0 million of cash consideration was
added to the purchase price and paid during the year ended October 31, 2003.
Based upon UPSI's net revenue through the October 31, 2003 measurement date,
$2.0 million of cash consideration was added to the purchase price and paid
subsequent to and accrued as of October 31, 2003. The fair value of the
assets acquired, including goodwill of $12.5 million, was $13.6 million and
liabilities assumed totaled $1.1 million. The purchase price was financed
with short-term borrowings under the Company's revolving credit facility.
On May 10, 2002, the Company acquired all of the outstanding common
stock of Radian, a supplier of engineering, logistics support and systems
integration services to the DoD. The purchase price was approximately $42.0
million, which included consideration of $2.0 million in the common stock of
the Company. The purchase price is net of $0.4 million of cash acquired. The
fair value of the assets acquired, including goodwill of $26.6 million and
customer-related intangibles of $15.3 million, was $58.3 million and
liabilities assumed totaled $16.3 million. The cash portion of the purchase
price was financed with available cash resources and short-term borrowings
under the Company's revolving credit facility.
TAMSCO and Radian are included in the Support Services segment. EEi
and UPSI are included in the Support Systems segment. The operating results
of each are included in consolidated operations since their respective dates
of acquisition.
NOTE C GOODWILL AND INTANGIBLE ASSETS
In June 2001, the FASB issued SFAS 141, "Business Combinations," and SFAS
142, "Goodwill and Other Intangible Assets." Under SFAS 142, goodwill and
other acquired intangible assets deemed to have indefinite lives are no
longer amortized but are subject to periodic impairment tests. All other
acquired intangible assets are amortized over their useful lives. In
addition, SFAS 141 eliminated the pooling-of-interests method of accounting
for business combinations.
The Company adopted SFAS 141 and SFAS 142 effective November 1,
2001. The Company has identified its reporting units to be its operating
subsidiaries. The carrying value of each reporting unit as of November 1,
2001 was determined by assigning assets and liabilities, including existing
goodwill and acquired intangible assets, to the reporting units. Upon
adoption of SFAS 142, amortization of goodwill ceased. The Company performed
a transitional goodwill impairment assessment as of November 1, 2001 and
goodwill impairment assessments as of October 31, 2002 and 2003. None of
these assessments resulted in an indication of potential impairment of
goodwill. The Company
2003 Annual Report | 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
In thousands, except per share amounts
plans to continue its annual impairment test as of October 31 in the future.
The following pro forma information reconciles reported net income
from continuing operations to adjusted net income from continuing
operations, which reflect the adoption of SFAS 142:
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- ------------------------------------------------------------------------
Reported net income from
continuing operations $43,283 $27,666 $18,269
Goodwill amortization, net
of tax benefit 1,922
- ------------------------------------------------------------------------
Adjusted net income from
continuing operations $43,283 $27,666 $20,191
========================================================================
Basic earnings per share:
Reported net income from
continuing operations $ 1.79 $ 1.18 $ 0.87
Goodwill amortization, net
of tax benefit 0.09
- ------------------------------------------------------------------------
Adjusted net income from
continuing operations $ 1.79 $ 1.18 $ 0.96
========================================================================
Diluted earnings per share:
Reported net income from
continuing operations $ 1.68 $ 1.14 $ 0.80
Goodwill amortization, net
of tax benefit 0.08
- ------------------------------------------------------------------------
Adjusted net income from
continuing operations $ 1.68 $ 1.14 $ 0.88
========================================================================
- ------------------------------------------------------------------------
Discontinued operations had no goodwill amortization in 2003, 2002
or 2001. Goodwill as of October 31, 2003 totaled $95,719 for the Support
Systems segment and $95,613 for the Support Services segment.
The following disclosure presents certain information on the
Company's acquired identifiable intangible assets as of October 31, 2003 and
2002. There were no acquired identifiable intangible assets as of October
31, 2001. All acquired identifiable intangible assets are being amortized
over their estimated useful lives, as indicated below, with no estimated
residual values.
- --------------------------------------------------------------------------------------
Weighted Average
Amortization Gross Accumulated Net
Period Amount Amortization Amount
- --------------------------------------------------------------------------------------
Customer-related
intangibles:
October 31, 2003 5.4 years $15,300 $4,251 $11,049
October 31, 2002 5.4 years $15,300 $1,420 $13,880
- --------------------------------------------------------------------------------------
The amortization expense related to acquired intangible assets was
$2,831 for the year ended October 31, 2003 and $1,420 for the year ended
October 31, 2002. Related estimated amortization expense is $2,831 annually
through the year ending October 31, 2006, and $2,556 for the year ending
October 31, 2007. There was no amortization expense related to acquired
intangible assets in 2001.
NOTE D OPERATIONAL RESTRUCTURING
During the quarter ended July 31, 2002, the Company announced a
restructuring plan to improve both plant utilization and long-term
profitability. Under the plan, the Company's Blue Ash, Ohio and Olivette,
Missouri manufacturing locations were closed during the year ended October
31, 2003 with related production efforts being relocated to other existing
Company facilities. Emerging Issues Task Force No. 94-3 (EITF 94-3), which
was effective through December 31, 2002, provided specific requirements as
to the appropriate recognition of restructuring costs associated with
employee termination benefits and other exit costs. Employee termination
costs are recognized when benefit arrangements are communicated to affected
employees in sufficient detail to enable the employees to determine the
amount of benefits to be received upon termination. Other costs resulting
from the restructuring plan that are not associated with or that do not
benefit activities that will be continued are recognized at the date of
commitment to the plan subject to certain conditions. For the cost to be
accrued, it must not be associated with or incurred to generate revenues
after the commitment date, and must be either incremental to other costs
incurred prior to the commitment date or represent amounts under a
contractual obligation that existed prior to the commitment date that will
either continue after the plan is completed with no economic benefit or
which will result in a penalty to cancel the obligation. Other costs
directly related to the restructuring plan which are not eligible for
recognition at the commitment date, such as relocation and other integration
costs, are expensed as incurred. The plan involved the termination of 113
employees by October 31, 2003.
During the year ended October 31, 2003, the Company recorded the
following costs in connection with this restructuring plan. The
restructuring provision was $(0.3) million in 2003 as a result of the
Company having previously accrued estimated severance costs in excess of
actual costs.
40 | Engineered Support Systems, Inc.
- --------------------------------------------------------------------------------------
Accrued at Accrued at
October 31, Expense October 31,
2002 (Income) Utilized 2003
- --------------------------------------------------------------------------------------
Severance and
related benefits $789 $(183) $606 $
Other cash
restructuring costs 153 (153)
- --------------------------------------------------------------------------------------
Restructuring costs,
excluding non-cash items $942 $(336) $606 $
======================================================================================
- --------------------------------------------------------------------------------------
During the quarter ended April 30, 2003, the Company announced an
additional restructuring plan under which electronics assembly work
performed at the Company's Sanford, Florida facility of its Systems &
Electronics Inc. (SEI) subsidiary would be relocated to alternate SEI
facilities. Statement of Financial Accounting Standards No. 146 (SFAS 146),
"Accounting for Costs Associated with Exit or Disposal Activities," applies
to all disposal activities initiated after December 31, 2002 and
prospectively nullifies EITF 94-3. SFAS 146 requires that a liability for
employee termination costs associated with an exit or disposal activity be
recognized when the liability is incurred. (EITF 94-3 had previously
required that a liability for such costs be recognized at the date of the
Company's commitment to an exit or disposal plan.) In accordance with SFAS
146, the Company recorded restructuring expense of $2.1 million in the year
ended October 31, 2003. The Company anticipates that it will record an
additional $0.1 million of restructuring expense related to this plan during
the first quarter of 2004. The plan involves terminating 107 employees, 101
of which had been terminated as of October 31, 2003. Substantially all
amounts accrued at October 31, 2003 will be paid by April 30, 2004.
During the year ended October 31, 2003, the Company recorded the
following costs in connection with this restructuring plan:
- ------------------------------------------------------------------------
Accrued at
October 31,
Expense Utilized 2003
- ------------------------------------------------------------------------
Severance and related benefits $1,169 $186 $983
========================
Estimated loss on asset disposal 890
Other non-cash costs 35
- --------------------------------------------
Total Restructuring Costs $2,094
============================================
- ------------------------------------------------------------------------
NOTE E DISCONTINUED OPERATIONS
As a result of management's decision to focus on defense markets, during the
second quarter of 2002 the Company formally adopted a plan to dispose of
Engineered Specialty Plastics, Inc. (ESP), a wholly-owned subsidiary. The
Company completed the sale of ESP in the quarter ended April 30, 2003 to a
private equity group. Consideration received by the Company included $4.1
million of cash, a $3.3 million two-year note from the buyers secured by the
real property of ESP, and contingent consideration based upon ESP's future
revenues, net of a $0.8 million working capital adjustment paid by the
Company. In conjunction with the disposition of ESP, the Company had
recorded an estimated loss on disposal of discontinued operations of $4.2
million during the year ended October 31, 2002 to reduce the carrying value
of ESP's net assets to their estimated fair value less estimated selling
costs. The completion of the sale resulted in an additional $0.2 million
loss on disposal during the year ended October 31, 2003. The Company has
reported the results of operations of ESP as discontinued operations for the
years ended October 31, 2003, 2002 and 2001 in the Consolidated Statements
of Income. All assets and liabilities associated with ESP are presented as
assets and liabilities of discontinued operations on the October 31, 2002
Consolidated Balance Sheet. Certain information with respect to the
discontinued operations of ESP is as follows:
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- ------------------------------------------------------------------------
Net revenues $9,136 $17,619 $25,270
- ------------------------------------------------------------------------
Income from discontinued
operations, net of income tax $ 294 $ 49 $ 307
Loss on disposal, net of income tax (169) (4,182)
- ------------------------------------------------------------------------
Income (loss) on discontinued
operations $ 125 $(4,133) $ 307
- ------------------------------------------------------------------------
Certain information with respect to the assets and liabilities of ESP is
summarized as follows:
- ------------------------------------------------------------------------
October 31, 2002
- ------------------------------------------------------------------------
Accounts receivable $ 4,750
Inventories 5,329
Property, plant and equipment 1,308
- ------------------------------------------------------------------------
Assets of Discontinued Operations $11,387
========================================================================
Accounts payable $ 3,354
Accrued expenses and other liabilities 439
- ------------------------------------------------------------------------
Liabilities of Discontinued Operations $ 3,793
========================================================================
- ------------------------------------------------------------------------
NOTE F ACCOUNTS RECEIVABLE
Accounts receivable includes amounts due from the U.S. Government and its
agencies of $65,441 and $32,442 at October 31, 2003 and 2002, respectively.
2003 Annual Report | 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
In thousands, except per share amounts
NOTE G CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories are comprised of the following:
- ------------------------------------------------------------------------
October 31 2003 2002
- ------------------------------------------------------------------------
Raw materials $ 2,669 $ 3,662
Work-in-process 2,332 2,368
Finished goods 185 178
Inventories substantially applicable
to government contracts in process,
reduced by progress payments of
$55,010 and $55,809 45,773 35,974
- ------------------------------------------------------------------------
$50,959 $42,182
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
Contracts in process and inventories at October 31, 2003 and 2002
include estimated revenue of $87,992 and $82,669, respectively, representing
accumulated contract costs and related estimated earnings on uncompleted
government contracts.
NOTE H NOTES PAYABLE AND LONG-TERM DEBT
Effective April 23, 2003, the Company retired all borrowings under the
existing credit facility and entered into a new bank agreement which
provided a $125 million unsecured revolving credit facility. Borrowings
under the new agreement, which expires April 23, 2007, are subject to
interest, at the Company's option, at either the Eurodollar rate plus an
applicable margin or at the prime rate plus an applicable margin. The margin
applicable to the Eurodollar rate varies from 0.875% to 1.625% and the
margin applicable to the prime rate varies from 0.0% to 0.25% depending upon
the Company's ratio of total indebtedness to earnings before interest,
taxes, depreciation and amortization (leverage ratio). At October 31, 2003,
the average effective variable interest rate under the credit agreement was
2.34% and the Company had $49.1 million of availability under the revolving
credit facility, which carries an unused commitment fee of 0.2% to 0.35%
depending on the Company's leverage ratio.
The credit agreement contains certain covenants, including
maintaining net worth of at least $135 million plus 50% of the sum, to
extent positive, of net income and other comprehensive income (loss) after
January 31, 2003 plus the net proceeds of all equity offerings. The Company
must also maintain a leverage ratio no greater than 2.75 to 1 through
October 31, 2004 and 2.50 to 1 subsequent to that date. Pursuant to the
terms of the credit agreement, the Company is subject to various other
financial and operating covenants and maintenance criteria, including
restrictions on the Company's ability to incur additional indebtedness, make
capital expenditures, create liens, dispose of material assets and enter
into merger transactions and lease agreements. At October 31, 2003, the
Company was in compliance with all covenants of its credit agreement. No
compensating balance is required or maintained related to the agreement.
Long-term debt consists of:
- ------------------------------------------------------------------------
October 31 2003 2002
- ------------------------------------------------------------------------
Term loan, variable rate equal to the
lesser of LIBOR plus applicable margin
or prime rate plus applicable margin,
payable in quarterly installments $42,000
Other $90
- ------------------------------------------------------------------------
90 42,000
Less current maturities 90 21,000
- ------------------------------------------------------------------------
$ $21,000
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
Borrowings under the revolving credit facility totaled $73.1
million as of October 31, 2003 and averaged $42.5 million for the year ended
October 31, 2003. Borrowings under the revolving credit facility are
unsecured and guaranteed by the Company.
Interest paid was $2,215 in 2003, $3,124 in 2002 and $5,906 in
2001.
NOTE I DERIVATIVES AND HEDGING ACTIVITY
Effective November 1, 2000, the Company adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 137 and
SFAS 138. The effect of adopting SFAS 133 was immaterial based on the fair
value of the Company's derivative instruments at the date of adoption.
In accordance with SFAS 133, derivative financial instruments are
recognized on the balance sheet at fair value. Changes in the fair value of
a derivative instruments designated as "fair value" hedges, along with the
corresponding change in fair value of the hedged asset or liability, are
recorded in current period earnings. Changes in the fair value of derivative
instruments designated as "cash flow" hedges, to the extent the hedges are
highly effective, are recorded in other comprehensive income, net of related
tax effects. The ineffective portion of the cash flow hedge,
42 | Engineered Support Systems, Inc.
if any, is recognized in current period earnings. Other comprehensive income
is relieved when current earnings are affected by the variability of cash
flows.
The Company formally designates derivatives as hedging instruments
on the date it enters into the derivative contract. This process includes
linking derivative instruments designated as hedges to specific assets,
liabilities, firm commitments or specific forecasted transactions. The
Company evaluates, both at the inception of the hedge and on an ongoing
basis, whether derivatives used as hedging instruments are highly effective
in offsetting changes in the fair value of cash flows of the hedged items.
If it is determined that a derivative is not highly effective as a hedge or
ceases to be highly effective, the Company discontinues hedge accounting
prospectively.
During the year ended October 31, 2003, the Company's derivative
contracts, which matured in November 2002, consisted only of interest rate
swaps used by the Company to convert a portion of its variable rate
long-term debt to fixed rates.
NOTE J INCOME TAXES
The income tax provision is comprised of the following:
- -----------------------------------------------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------
Continuing Continuing Continuing
Operations Combined Operations Combined Operations Combined
- -----------------------------------------------------------------------------------------------------------------
Current:
Federal $20,091 $20,187 $14,967 $14,117 $ 6,743 $ 6,669
State 1,798 1,798 2,017 2,017 1,669 1,669
- -----------------------------------------------------------------------------------------------------------------
21,889 21,985 16,984 16,134 8,412 8,338
- -----------------------------------------------------------------------------------------------------------------
Deferred:
Federal 5,191 5,176 637 (974) 2,941 3,175
State 593 592 73 (108) 327 364
- -----------------------------------------------------------------------------------------------------------------
5,784 5,768 710 (1,082) 3,268 3,539
- -----------------------------------------------------------------------------------------------------------------
$27,673 $27,753 $17,694 $15,052 $11,680 $11,877
=================================================================================================================
- -----------------------------------------------------------------------------------------------------------------
The deferred income tax provision (benefit) results from the
following temporary differences:
- -----------------------------------------------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------
Continuing Continuing Continuing
Operations Combined Operations Combined Operations Combined
- -----------------------------------------------------------------------------------------------------------------
Uncompleted contracts $ 541 $ 541 $ 143 $ 143 $(1,033) $(1,033)
Depreciation 289 343 (504) (539) 1,713 1,873
Goodwill amortization 3,589 3,589 1,485 1,485 759 759
Contributions to employee
benefits plans (57) (57) 348 354 182 185
Loss on disposal of
discontinued operations (60) (1,823)
Other 1,422 1,412 (762) (702) 1,647 1,755
- -----------------------------------------------------------------------------------------------------------------
$5,784 $5,768 $710 $(1,082) $ 3,268 $ 3,539
=================================================================================================================
- -----------------------------------------------------------------------------------------------------------------
2003 Annual Report | 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
In thousands, except per share amounts
Deferred income tax liabilities (assets) are comprised of the
following:
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002
- ------------------------------------------------------------------------
Depreciation $ 2,769 $ 2,480
Uncompleted contracts (1,212) (1,753)
Employee benefits (4,124) (4,067)
Goodwill 7,028 3,440
Asset reserves (1,633) (286)
Stock options (2,723)
Other comprehensive loss (10,321) (9,127)
Other 1,879 (1,509)
- ------------------------------------------------------------------------
$ (5,614) $(13,545)
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
The change in the stock option component of deferred income tax
liabilities (assets) indicated above is recorded directly to shareholders'
equity.
Deferred income tax liabilities (assets) are presented on the
Consolidated Balance Sheets as follows:
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002
- ------------------------------------------------------------------------
Current assets $(5,939) $ (6,660)
Non-current assets (6,885)
Non-current liabilities 325
- ------------------------------------------------------------------------
$(5,614) $(13,545)
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
A reconciliation between the income tax provision and the annual
amount computed by applying the statutory federal income tax rate to income
before income taxes is as follows:
- ------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- ------------------------------------------------------------------------
Income tax provision at
statutory federal rate $24,835 $15,876 $10,482
State income taxes and
other, net 2,838 1,818 1,198
- ------------------------------------------------------------------------
$27,673 $17,694 $11,680
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
Income taxes paid were $13,923 in 2003, $2,713 in 2002 and $4,587
in 2001.
NOTE K STOCK OPTIONS
The Company has established plans whereby options may be granted to
employees and directors of the Company to purchase shares of the Company's
common stock. Options granted are at an option price equal to the market
value on the date the option is granted. Subject to continuation of
employment, all options must be exercised within five years from the date of
grant and are exercisable at any time during this period. As of October 31,
2003, 4,432 shares of unissued common stock were authorized and reserved for
outstanding options, which had a weighted average remaining contractual life
of 3.6 years at that date. Transactions involving the stock option plans are
as follows:
- ----------------------------------------------------------------------
Shares Price per share
- ----------------------------------------------------------------------
Outstanding at October 31, 2000 2,192 $ 1.45 to $ 5.95
Options granted 2,741 $ 7.60 to $13.29
Options exercised (3,512) $ 1.45 to $13.29
Options forfeited (3) $ 3.85
- ----------------------------------------------------------------------
Outstanding at October 31, 2001 1,418 $ 2.93 to $13.29
Options granted 3,564 $18.95 to $20.13
Options exercised (480) $ 2.93 to $13.29
- ----------------------------------------------------------------------
Outstanding at October 31, 2002 4,502 $ 3.72 to $20.13
Options granted 765 $23.87 to $44.19
Options exercised (834) $ 3.72 to $24.92
Options forfeited (1) $20.13
- ----------------------------------------------------------------------
Outstanding at October 31, 2003 4,432 $3.85 to $44.19
- ----------------------------------------------------------------------
- ----------------------------------------------------------------------
The following table summarizes information for stock options
outstanding at October 31, 2003:
- ------------------------------------------------------------------------
Weighted Weighted
Average Average
Options Remaining Exercise
Range of Exercise Prices Outstanding Life Price
- ------------------------------------------------------------------------
$ 3.85 to $13.29 755 1.9 years $ 6.36
$18.95 to $20.13 2,920 3.8 years $19.19
$23.87 to $44.19 757 4.8 years $39.28
- ----------------------------------------------------------------------
- ------------------------------------------------------------------------
The following table provides information as of October 31, 2003
with respect to the shares of common stock that may be issued under the
Company's existing equity compensation plans:
- -----------------------------------------------------------------------------------------------------------------
Number of shares
Number of shares Weighted-average remaining available
to be issued exercise price for future issuance
upon exercise of of outstanding under equity
outstanding options options compensation plans
- -----------------------------------------------------------------------------------------------------------------
Equity compensation
approved by shareholders 4,042 $20.18 754
Equity compensation plans
not approved by
shareholders 390 $23.12
- -----------------------------------------------------------------------------------------------------------------
Total 4,432 $20.44 754
=================================================================================================================
- -----------------------------------------------------------------------------------------------------------------
44 | Engineered Support Systems, Inc.
NOTE L PENSION AND OTHER POSTRETIREMENT BENEFITS
Effective September 30, 1999, the Company acquired SEI and assumed the
pension and other postretirement benefit plans related to SEI's employees
and non-employee participants. Substantially all employees of SEI are
covered by defined benefit or defined contribution pension plans. In
addition, certain retirees of SEI are eligible for postretirement health and
life insurance benefits. To qualify for postretirement health and life
insurance benefits, an SEI 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 SEI employees.
All former full-time employees of Engineered Air who were covered
by a collective bargaining agreement are also covered by a defined benefit
pension plan. These SEI and Engineered Air benefits are provided under
defined benefit pay-related and flat-dollar plans, which are primarily
non-contributory. Annual Company contributions to retirement plans equal or
exceed the minimum funding requirements of the Employee Retirement Income
Security Act or other applicable regulations.
The components of pension and other postretirement benefit costs
are presented below for 2003, 2002 and 2001:
- ------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------
Pension Benefits
Service cost $ 2,859 $ 2,444 $ 2,215
Interest cost 7,018 6,287 6,155
Expected return on plan assets (6,994) (7,421) (7,579)
Amortization of prior service cost 556 126 102
Recognized actuarial loss (gain) 1,526 300 (120)
Other 36
- ------------------------------------------------------------------------
Net pension costs $ 5,001 $ 1,736 $ 773
- ------------------------------------------------------------------------
Other Postretirement Benefits
Service cost $273 $ 199 $ 184
Interest cost 713 651 596
Actuarial loss (gain) 343 123 (43)
========================================================================
Net other benefit costs $ 1,329 $ 973 $ 737
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
A reconciliation of the changes in the plans' benefit obligations
and fair values of assets over the two-year period ending October 31, 2003
and a statement of the funded status at October 31, 2003 and 2002 follows.
- --------------------------------------------------------------------------------------
2003 2002
- --------------------------------------------------------------------------------------
Pension Benefits
Reconciliation of benefit obligation:
Benefit obligation at beginning of year $ 97,987 $ 89,222
Service cost 2,859 2,444
Interest cost 7,018 6,287
Plan amendments 1,525 67
Actuarial loss 10,481 3,661
Benefit payments (3,989) (3,654)
Other (39) (40)
- --------------------------------------------------------------------------------------
Benefit obligation at October 31 $115,842 $ 97,987
- --------------------------------------------------------------------------------------
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year $ 58,742 $ 66,074
Actual return on plan assets 9,411 (6,623)
Employer contributions 5,108 2,945
Benefit payments (3,989) (3,654)
- --------------------------------------------------------------------------------------
Fair value of plan assets at October 31 $ 69,272 $ 58,742
- --------------------------------------------------------------------------------------
Funded status:
Funded status at October 31 $(46,570) $(39,245)
Unrecognized prior service cost 3,358 4,388
Unrecognized actuarial loss 41,844 34,077
- --------------------------------------------------------------------------------------
Accrued benefit cost $ (1,368) $ (780)
- --------------------------------------------------------------------------------------
Other Postretirement Benefits
Reconciliation of benefit obligation:
Benefit obligation at beginning of year $ 9,441 $ 7,933
Service cost 273 199
Interest cost 713 651
Actuarial loss 2,557 2,342
Benefit payments (1,600) (1,684)
- --------------------------------------------------------------------------------------
Benefit obligation at October 31 $ 11,384 $ 9,441
- --------------------------------------------------------------------------------------
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year $ $
Employer contributions 1,600 1,684
Benefit payments (1,600) (1,684)
- --------------------------------------------------------------------------------------
Fair value of plan assets at October 31 $ $
- --------------------------------------------------------------------------------------
Funded status:
Funded status at October 31 $(11,384) $ (9,441)
Unrecognized actuarial loss 4,680 2,467
- --------------------------------------------------------------------------------------
Accrued benefit cost $ (6,704) $ (6,974)
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
2003 Annual Report | 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
The amounts recognized in the Company's Consolidated Balance Sheets
as of October 31 are as follows:
- ------------------------------------------------------------------------
2003 2002
- ------------------------------------------------------------------------
Pension Benefits
Prepaid benefit cost $ 3,527 $ 4,797
Accrued benefit cost (8,832) (9,160)
Intangible asset 3,225 805
Additional minimum liability (25,751) (20,334)
Other comprehensive loss 26,463 23,112
- ------------------------------------------------------------------------
Net amount recognized $ (1,368) $ (780)
- ------------------------------------------------------------------------
Other Postretirement Benefits
Prepaid benefit cost $516 $199
Accrued benefit cost (7,220) (7,173)
- ------------------------------------------------------------------------
Net amount recognized $ (6,704) $ (6,974)
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
Assumptions used in accounting for the defined benefit plans in
2003, 2002 and 2001 were a discount rate of 6.00%, 6.75% and 7.25%,
respectively, and an expected long-term rate of return on assets of 8.75%,
9.5% and 10.0%, respectively. A 1% increase in the discount rate would
decrease net pension costs for 2003 and the accrued benefit cost at October
31, 2003 by $1,726 and a 1% decrease in the discount rate would increase net
pension benefit costs for 2003 and the accrued benefit cost at October 31,
2003 by $1,919. A 1% increase in the expected long-term rate of return on
assets would decrease net pension costs for 2003 and the accrued benefit
cost at October 31, 2003 by $773 and a 1% decrease in the expected long-term
rate of return on assets would increase net pension benefit costs for 2003
and the accrued benefit cost at October 31, 2003 by $755.
Assumptions used in accounting for other postretirement benefits in
2003, 2002 and 2001 were a discount rate of 6.00%, 6.75% and 7.25%,
respectively, and a healthcare cost trend of 10.0%, 10.5% and 10.5%,
respectively, decreasing 0.5% annually to an ultimate rate of 5.5%. A 1%
increase in the discount rate would decrease net other benefit costs for
2003 and the accrued benefit cost at October 31, 2003 by $100 and a 1%
decrease in the discount rate would increase net other benefit costs for
2003 and the accrued benefit cost at October 31, 2003 by $100. A 1% increase
in the healthcare cost trend rate for each year would increase the October
31, 2003 net benefit obligation by approximately $32, while a 1% decrease in
the healthcare cost trend rate for each year would decrease the October 31,
2003 net benefit obligation by approximately $35.
The Company has an Employee Stock Ownership Plan (ESOP) covering
all employees of Engineered Air, Marlo Coil, Keco, Fermont, ESSIbuy, UPSI
and Radian. The ESOP provides for a matching contribution by the Company of
no less than 25% of each employee's contributions up to a maximum of 6% of
the employee's earnings. The Company also makes discretionary annual
contributions. All employee and employer contributions to the ESOP are 100%
vested. In addition, the Company sponsors the SEI Employee Savings
Investment Plan, the TAMSCO Tax Deferred Retirement Plan and the Engineered
Environments, Inc. 401(k) Plan. The Company has recorded expense based on
contributions to the ESOP and the SEI, TAMSCO and EEi plans for the years
ended October 31, 2003, 2002 and 2001 of $1,989, $1,895 and 1,721,
respectively.
NOTE M BUSINESS SEGMENT INFORMATION
The Company operates in two business segments: Support Systems and Support
Services. The Support Systems segment designs, engineers and manufactures
integrated military electronics and other military support equipment
primarily for the DoD, as well as related heat transfer and air handling
equipment for domestic commercial and industrial users, and material
handling equipment primarily for the U.S. Postal Service. Segment products
include environmental control systems, load management and transport
systems, power generation, distribution and conditioning systems, airborne
radar systems, reconnaissance, surveillance and target acquisition systems,
chemical and biological protection systems, petroleum and water distribution
systems and other multipurpose military support equipment. The Support
Services group provides engineering services, logistics and training
services, advanced technology services, asset protection systems and
services, telecommunication systems integration and information technology
services primarily for the DoD. The Support Services segment also
46 | Engineered Support Systems, Inc.
provides certain power generation and distribution equipment to the DoD.
The Company previously defined its business segments as Light
Military Support Equipment, Heavy Military Support Equipment and Electronics
and Automation Systems. With the Company's entry into the services area
through the acquisitions of Radian on May 10, 2002 and TAMSCO on May 1,
2003, the growth of the Company's logistics support capabilities and the
continuing rationalization of its operations, the Company has reorganized
into the Support Systems and Support Services segments from the previous
three segments. The new reporting structure reflects how the Company manages
operations, reports results and allocates resources.
Management utilizes more than one measurement and multiple views of
data to measure business segment performance and to allocate resources to
the segments. However, the dominant measurements are consistent with the
Company's Consolidated Financial Statements and, accordingly, are reported
on the same basis herein. Management evaluates the performance of its
business segments and allocates resources to them primarily based on income
from operations, along with cash flows and overall economic returns. The
Company's export net revenues are not significant. All corporate expenses
and assets have been allocated to the segments. In 2003, 2002 and 2001,
approximately, 95%, 91% and 91% of consolidated net revenues were derived
directly or indirectly from the U.S. Government.
Information by segment is summarized as follows:
- --------------------------------------------------------------------------
Year Ended October 31 2003 2002 2001
- --------------------------------------------------------------------------
Net Revenues:
Support Systems $389,301 $374,428 $365,171
Support Services 188,322 33,742 27
Intersegment Revenues (4,922) (225)
- --------------------------------------------------------------------------
$572,701 $407,945 $365,198
==========================================================================
Income from Continuing Operations:
Support Systems $ 54,053 $ 48,015 $ 36,790
Suppport Services 18,416 577 (943)
- --------------------------------------------------------------------------
$ 72,469 $ 48,592 $ 35,847
- --------------------------------------------------------------------------
Identifiable Assets:
Support Systems $224,599 $213,685 $224,631
Support Services 194,702 65,075 20
- --------------------------------------------------------------------------
419,301 278,760 224,651
Discontinued operations 11,387 15,784
- --------------------------------------------------------------------------
$419,301 $290,147 $240,435
- --------------------------------------------------------------------------
Depreciation and Amortization:
Support Systems $ 5,529 $ 5,467 $ 9,001
Support Services 3,432 1,571
- --------------------------------------------------------------------------
$ 8,961 $ 7,038 $ 9,001
- --------------------------------------------------------------------------
Capital Expenditures:
Support Systems $ 8,782 $ 3,487 $ 1,624
Support Services 899 28
- --------------------------------------------------------------------------
Total $ 9,681 $ 3,515 $ 1,624
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
NOTE N COMMITMENTS AND CONTINGENCIES
As a government contractor, the Company is continually subject to audit by
various agencies of the U.S. Government to determine compliance with various
procurement laws and regulations. As a result of such audits and as part of
normal business operations of the Company, various claims and charges are
asserted against the Company. It is not possible at this time to predict the
outcome of all such actions. However, management is of the opinion that it
has good defenses against such actions and believes that none of these
matters will have a material effect on the consolidated financial position,
results of operations or cash flows of the Company.
2003 Annual Report | 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
In thousands, except per share amounts
Total contractual and contingent obligations as of October 31, 2003 are as
follows:
- -------------------------------------------------------------------------------------------------------------------------------
Payments / Expiration
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended October 31 2004 2005 2006 2007 2008 Total
- -------------------------------------------------------------------------------------------------------------------------------
Contractual Obligations:
Short-term borrowings $ 73,100 $ $ $ $ $ 73,100
Long-term debt 90 90
Operating leases 4,004 2,639 1,957 1,333 242 10,175
Unconditional purchase obligations 167,788 860 71 168,719
- -------------------------------------------------------------------------------------------------------------------------------
244,982 3,499 2,028 1,333 242 252,084
Contingent Obligations:
Letters of credit 2,757 2,757
- -------------------------------------------------------------------------------------------------------------------------------
Total Obligations $247,739 $3,499 $2,028 $1,333 $242 $254,841
===============================================================================================================================
- -------------------------------------------------------------------------------------------------------------------------------
While contingent obligations are included in the table above, the
Company does not expect to fund the full amounts indicated for letters of
credit.
NOTE O STOCK SPLIT
On October 31, 2003, the Company effected a three-for-two stock split in the
form of a 50% stock dividend. All per share amounts, as well as all share
amounts related to the Company's stock option plans, in this report have
been restated to reflect this stock split.
NOTE P SUBSEQUENT EVENT
Effective December 5, 2003, the Company acquired all of the outstanding
stock of Pivotal Power Inc. (Pivotal Power), a supplier of high-performance
static power conversion equipment primarily to military customers. The
purchase price was $10.7 million, consisting of $10.0 million in cash and
the assumption of $0.7 million of indebtedness. The cash portion of the
purchase price was financed with short-term borrowings under the Company's
revolving credit facility.
48 | Engineered Support Systems, Inc.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Engineered Support Systems, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of
Engineered Support Systems, Inc. and its subsidiaries at October 31, 2003
and 2002, and the results of their operations and their cash flows for each
of the three years in the period ended October 31, 2003 in conformity with
accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements
in accordance with auditing standards generally accepted in the United
States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note C to the Consolidated Financial Statements, on November
1, 2001 the Company changed its method of accounting for goodwill and
intangible assets to conform to Statement of Financial Accounting Standards
No. 142.
/S/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
St. Louis, Missouri
December 9, 2003
REPORT OF MANAGEMENT RESPONSIBILITIES
The Company's management is responsible for the fair presentation and
consistency of all financial data included in the Annual Report. Where
appropriate, the data reflects management estimates. The Company's Audit
Committee consists of four non-employee directors. This Committee meets with
financial officers and PricewaterhouseCoopers LLP meets with the Audit
Committee, with and without management present, to discuss their
examinations, the adequacy of internal controls and the quality of financial
reporting.
2003 Annual Report | 49
SUPPLEMENTAL INFORMATION
The table below presents unaudited quarterly financial information in
thousands, except for per share amounts, for the years ended October 31,
2003 and 2002.
- -----------------------------------------------------------------------------------------------------------------------------------
Quarter Ended January 31 April 30 July 31 October 31 Fiscal Year
- -----------------------------------------------------------------------------------------------------------------------------------
2003 2002 2003 2002 2003 2002 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues $121,663 $91,286 $125,057 $91,780 $155,669 $106,599 $170,312 $118,280 $572,701 $407,945
Gross profit 27,146 19,913 29,783 21,762 38,161 25,791 42,969 27,712 138,059 95,178
Net income from
continuing operations 8,441 5,906 8,479 6,564 12,416 6,933 13,947 8,263 43,283 27,666
Net income 8,578 5,524 8,636 3,276 12,416 6,678 13,778 8,055 43,408 23,533
Diluted earnings per share:
Continuing operations $0.33 $0.25 $0.33 $0.27 $0.48 $0.29 $0.52 $0.33 $1.68 $1.14
Total $0.34 $0.23 $0.34 $0.14 $0.48 $0.27 $0.51 $0.32 $1.68 $0.97
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings per share calculations are based on diluted common shares
outstanding for each quarter and, therefore, the sum of the quarters may not
necessarily be equal to the full year diluted earnings per share amounts.
MARKET DATA
The Company's common stock trades on the NASDAQ Stock Market under the
symbol EASI. As of December 31, 2003, the approximate number of common
shareholders was 14,700. The following table sets forth the high and low
stock prices for each quarter as provided by the NASDAQ Stock Market.
- --------------------------------------------------------------------------------------
2003 2002
- --------------------------------------------------------------------------------------
High Low High Low
- --------------------------------------------------------------------------------------
QUARTER ENDED
January 31 $26.60 $21.00 $23.78 $12.93
April 30 27.25 20.90 22.77 15.35
July 31 31.20 22.47 23.97 18.51
October 31 46.13 26.80 27.49 20.00
- --------------------------------------------------------------------------------------
DIVIDENDS
The company pays a semi-annual dividend. The most recently declared dividend
was in the amount of $.018 per share payable January 30, 2004 to
shareholders of record on December 31, 2003.
CORPORATE INFORMATION
Transfer Agent and Registrar
Mellon Investor Services LLC
85 Challenger Road
Ridgefield Park, NJ 07660
www.melloninvestor.com
Independent Accountants
PricewaterhouseCoopers LLP
800 Market Street
St. Louis, MO 63101
Legal Counsel
David Douglass Mattern
201 Evans Lane
St. Louis, MO 63121
Annual Meeting
March 2, 2004
Engineered Support Systems, Inc.
201 Evans Lane
St. Louis, MO 63121
Investor Information
You may contact the Company at:
Investor Relations
Engineered Support Systems, Inc.
201 Evans Lane
St. Louis, MO 63121
You may view online and request additional copies of the Company's Annual
Report and Form 10-K on the Company's website at www.engineeredsupport.com.
50 | Engineered Support Systems, Inc.
DIRECTORS AND OFFICERS
DIRECTORS
[PHOTO] MICHAEL F. SHANAHAN, SR.
Chairman of the Board
Engineered Support Systems, Inc.
[PHOTO] GERALD E. DANIELS
Vice Chairman and
Chief Executive Officer
Engineered Support Systems, Inc.
[PHOTO] GERALD A. POTTHOFF
President and
Chief Operating Officer
Engineered Support Systems, Inc.
[PHOTO] GARY C. GERHARDT
Vice Chairman and
Chief Financial Officer
Engineered Support Systems, Inc.
[PHOTO] RONALD W. DAVIS
President - Business Development
Engineered Support Systems, Inc.
[PHOTO] WILLIAM H. T. BUSH
Chairman of the Board
Bush-O'Donnell & Co., Inc.
[PHOTO] GEN. MICHAEL P. C. CARNS
United States Air Force, Retired
[PHOTO] MAJ. GEN. GEORGE E. FRIEL
United States Army, Retired
[PHOTO] THOMAS J. GUILFOIL
Partner
Guilfoil, Petzall & Shoemake
[PHOTO] S. LEE KLING Chairman
The Kling Company
[PHOTO] LT. GEN. KENNETH E. LEWI
United States Army, Retired
[PHOTO] GEN. CHARLES T. ROBERTSON, JR.
United States Air Force, Retired
Vice President, Business Development
Aerospace Support
The Boeing Company
[PHOTO] GEN. CROSBIE E. SAINT
United States Army, Retired
[PHOTO] MICHAEL F. SHANAHAN, JR.
[PHOTO] EARL W. WIMS
Chairman
Marketing Horizons, Inc.
OFFICERS
MICHAEL F. SHANAHAN, SR.
Chairman of the Board
GERALD E. DANIELS
Vice Chairman and
Chief Executive Officer
GERALD A. POTTHOFF
President and
Chief Operating Officer
GARY C. GERHARDT
Vice Chairman and
Chief Financial Officer
RONALD W. DAVIS
President - Business Development
NICHOLAS R. INNERBICHLER
Group President - Support Services
DANIEL A. RODRIGUES
Group President - Support Systems
LARRY K. BREWER
President - Washington D.C. Operations
KAREN A. BEDELL
Senior Vice President - Marketing
and Strategic Planning
DAN D. JURA
Senior Vice President - Sales
RONALD W. HAUSER
Vice President - Strategy, Plans
and Market Research
ALLAN K. KASTE
Vice President -
Human Resources
ROBERT L. KLAUTZER
Vice President - Management
Information Systems
DANIEL E. KREHER
Vice President - Acquisitions
and Investor Relations
STEVEN J. LANDMANN
Vice President - Finance
and Controller
DAVID D. MATTERN
Secretary and General Counsel
JOHN R. WOOTTON
Vice President - Advanced
Development and Technology
THOMAS G. CORNWELL
President - Engineered Air
Systems, Inc.
JOSEPH H. CREAGHEAD
President - Keco Industries, Inc.
RICHARD P. DACEY
President - Radian, Inc.
DAVID R. GUST
President - Technical and
Management Services
Corporation
FREDERIC D. KNIGHT
President - Universal Power
Systems, Inc.
JAMES T. MYRICK
President - Systems &
Electronics Inc.
GERALD A. NICHOLSON
President - Engineered Coil
Company d/b/a Marlo Coil
THOMAS C. SANTORO
President - Engineered Electric
Company d/b/a Fermont
CARLO M. SHIMOON
President - Pivitol Power Inc.
GERALD W. SOLOMON
President - Engineered
Environments, Inc.
FRANK A. TRICOMI
President - ESSIbuy.com, Inc.
Up to the Challenge
[PHOTO]
ENGINEERED SUPPORT SYSTEMS REMAINS TOTALLY COMMITTED TO DELIVERING
EXCEPTIONAL PERFORMANCE, ACHIEVING PROFITABLE GROWTH, ENHANCING SHAREHOLDER
VALUE ... AND PROVIDING QUALITY PRODUCTS AND SERVICES TO SUPPORT AND
SAFEGUARD AMERICA'S ARMED FORCES STATIONED AT HOME OR DEPLOYED AROUND THE
GLOBE.
[ESSI LOGO]
Engineered Support Systems, Inc.
201 Evans Lane
St. Louis, MO 63121-1126
www.engineeredsupport.com
APPENDIX
The inside front cover of the Annual Report contains graphs showing
Results. The information in the graphs are presented in a tabular format
immediately following the graphs.