SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the six months ended April 30, 2005 Commission file number 0-13880 ENGINEERED SUPPORT SYSTEMS, INC. (Exact name of Registrant as specified in its charter) Missouri 43-1313242 (State of Incorporation) (IRS Employer Identification Number) 201 Evans Lane, St. Louis, Missouri 63121 (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code: (314) 553-4000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the Registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). Yes X No --- --- The number of shares of the Registrant's common stock, $.01 par value, outstanding at May 31, 2005 was 41,690,252. 1 ENGINEERED SUPPORT SYSTEMS, INC. INDEX Page ---- Part I - Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets as of April 30, 2005 and October 31, 2004.................................................. 3 Condensed Consolidated Statements of Income for the three and six months ended April 30, 2005 and 2004.............................. 4 Condensed Consolidated Statements of Cash Flows for the six months ended April 30, 2005 and 2004.............................. 5 Notes to Condensed Consolidated Financial Statements ............. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................ 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk.. 31 Item 4. Controls and Procedures..................................... 32 Part II - Other Information Items 1-6 ........................................................... 33 Signatures ................................................................ 35 Exhibits .................................................................. 36 2 PART I FINANCIAL INFORMATION Item 1. Financial Statements ENGINEERED SUPPORT SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) April 30 October 31 2005 2004 ----------- ---------- (Unaudited) ASSETS Current Assets Cash and cash equivalents $ 27,726 $ 33,153 Accounts receivable 156,698 139,191 Contracts in process and inventories 83,794 61,009 Deferred income taxes 6,921 6,921 Other current assets 6,547 2,846 -------- -------- Total Current Assets 281,686 243,120 Property, plant and equipment, less accumulated depreciation of $32,883 and $29,177 51,861 46,946 Goodwill 312,275 167,358 Acquired customer-related intangibles 54,369 38,314 Deferred income taxes 2,286 1,876 Other assets 12,675 13,520 -------- -------- Total Assets $715,152 $511,134 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Notes payable $116,000 $ Current maturities of long-term debt 335 340 Accounts payable 63,748 71,796 Other current liabilities 68,290 58,936 -------- -------- Total Current Liabilities 248,373 131,072 Long-term debt 1,132 781 Additional minimum pension liability 28,237 28,237 Other liabilities 14,828 14,088 Shareholders' Equity Common stock, par value $.01 per share; 85,000 shares authorized; 41,685 and 26,642 shares issued 417 266 Additional paid-in capital 198,456 151,805 Retained earnings 241,792 202,730 Accumulated other comprehensive loss (18,083) (17,845) -------- -------- 422,582 336,956 -------- -------- Total Liabilities and Shareholders' Equity $715,152 $511,134 ======== ======== See notes to condensed consolidated financial statements. 3 ENGINEERED SUPPORT SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) (UNAUDITED) Three Months Ended Six Months Ended April 30 April 30 -------------------------- ---------------------------- 2005 2004 2005 2004 -------- -------- -------- -------- Net revenues: Products $148,144 $137,612 $289,876 $263,199 Services 115,624 72,524 207,425 142,067 -------- -------- -------- -------- 263,768 210,136 497,301 405,266 -------- -------- -------- -------- Cost of revenues: Products 102,695 91,755 196,683 179,597 Services 100,749 64,956 182,750 125,973 -------- -------- -------- -------- 203,444 156,711 379,433 305,570 -------- -------- -------- -------- Gross profit 60,324 53,425 117,868 99,696 Selling, general and administrative expense 27,068 23,389 51,621 43,386 Restructuring expense - 39 - 66 Gain (loss) on sale of assets 21 (1) 20 (5) -------- -------- -------- -------- Operating income from continuing operations 33,277 29,996 66,267 56,239 Interest expense (1,065) (305) (1,072) (1,003) Interest income 195 102 456 156 -------- -------- -------- -------- Income from continuing operations 32,407 29,793 65,651 55,392 Income tax provision 12,314 11,470 24,947 21,326 -------- -------- -------- -------- Net income from continuing operations 20,093 18,323 40,704 34,066 Loss on sale of discontinued operations, net of income tax 1,048 - 1,048 - -------- -------- -------- -------- Net income $ 19,045 $ 18,323 $ 39,656 $ 34,066 ======== ======== ======== ======== Basic earnings per share: Continuing operations $ 0.49 $ 0.47 $ 1.00 $ 0.89 Discontinued operations (0.03) - (0.03) - -------- -------- -------- -------- Total $ 0.46 $ 0.47 $ 0.97 $ 0.89 ======== ======== ======== ======== Diluted earnings per share: Continuing operations $ 0.46 $ 0.44 $ 0.95 $ 0.82 Discontinued operations (0.02) - (0.03) - -------- -------- -------- -------- Total $ 0.44 $ 0.44 $ 0.92 $ 0.82 ======== ======== ======== ======== See notes to condensed consolidated financial statements. 4 ENGINEERED SUPPORT SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (UNAUDITED) Six Months Ended April 30 -------------------------- 2005 2004 --------- -------- From operating activities: Net income from continuing operations $ 40,704 $ 34,066 Depreciation and amortization 8,340 6,701 (Gain) loss on sale of assets (20) 5 --------- -------- Cash provided before changes in operating assets and liabilities 49,024 40,772 Net increase in non-cash current assets (16,707) (31,732) Net increase (decrease) in non-cash current liabilities (8,916) 7,915 Net changes in other assets and liabilities 5,638 3,713 --------- -------- Net cash provided by operating activities 29,039 20,668 --------- -------- From investing activities: Purchase of Spacelink, net of cash acquired (136,469) - Purchase of PCA, net of cash acquired (37,638) - Purchase of TAMSCO, net of cash acquired - (7,440) Purchase of Pivotal, net of cash acquired - (10,064) Purchase of UPSI, net of cash acquired - (2,026) Purchase of EEI, not of cash acquired - (99) Additions to property, plant and equipment (5,115) (4,124) Proceeds from sale of property, plant and equipment 44 128 --------- -------- Net cash used in investing activities (179,178) (23,625) --------- -------- From financing activities: Net borrowings (payments) under line-of-credit agreement 116,000 (17,100) Payments of long-term debt (51) (103) Proceeds of long-term debt 444 381 Exercise of stock options 26,666 37,826 Issuance of common stock to employee stock purchase plan 2,242 1,282 Cash dividends (594) (453) --------- -------- Net cash provided by financing activities 144,707 21,833 --------- -------- Effect of exchange rate changes on cash 5 (11) --------- -------- Net increase (decrease) in cash and cash equivalents (5,427) 18,865 Cash and cash equivalents at beginning of period 33,153 2,880 --------- -------- Cash and cash equivalents at end of period $ 27,726 $ 21,745 ========= ======== See notes to condensed consolidated financial statements. 5 ENGINEERED SUPPORT SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (in thousands, except per share amounts) APRIL 30, 2005 NOTE A - BASIS OF PRESENTATION The accompanying condensed consolidated financial statements have been prepared by Engineered Support Systems, Inc. (the Company) without audit and include the accounts of the 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), Engineered Environments, Inc. (EEI), Pivotal Power Inc. (Pivotal Power) and Prospective Computer Analysts Incorporated (PCA). The Support Services segment includes the operations of Technical and Management Services Corporation (TAMSCO), Radian, Inc. (Radian), ESSIbuy.com, Inc. (ESSIbuy) and Spacelink International, LLC (Spacelink). In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended April 30, 2005 are not necessarily indicative of the results to be expected for the entire fiscal year. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial statements and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report to shareholders for the year ended October 31, 2004. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In October 2004, Congress passed the American Jobs Creation Act of 2004 (the Jobs Creation Act). The Jobs Creation Act includes numerous provisions that may materially affect business practices and accounting for income taxes. For companies that pay U.S. income taxes on manufacturing activities in the U.S., the Jobs Creation Act provides a phased-in deduction from taxable income equal to a stipulated percentage of qualified income from domestic production activities. In December 2004, the FASB issued two FASB Staff Positions (FSP) regarding the accounting implications of the Act related to (1) the deduction for qualified domestic production activities (FSP 109-1) and (2) the one-time tax benefit for the repatriation of foreign earnings (FSP 109-2). This guidance applies to financial statements for periods ending after the date the Act was enacted. The Jobs Creation Act also provides for a change in the period of application 6 for foreign tax credits, elimination of the 90-percent limitation of foreign tax credits against Alternative Minimum Tax, expanded disallowance of interest on convertible debt, and tax shelter disclosure penalties. The Company adopted FSP 109-1 and FSP 109-2 in the first quarter of 2005. The Company anticipates that the Jobs Creation Act and related FASB pronouncements will have a material impact on the Company's financial statements in future periods. However, the Company has determined that this impact is not material for the three and six months ended April 30, 2005 and will not be material for the year ending October 31, 2005. In November 2004, the FASB issued SFAS 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4." SFAS 151 seeks to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) in the determination of inventory carrying costs. The statement requires such costs to be treated as a current period expense. This statement is effective November 1, 2005 for the Company. The Company does not believe that the adoption of SFAS 151 will have a significant impact on the consolidated financial statements. In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment", (SFAS 123R). SFAS 123R requires companies to expense the value of employee stock options and similar awards. This statement is effective November 1, 2005 for the Company. The Company is currently evaluating its compensation policies and practices, along with the impact of SFAS 123R on its results of operations. In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error Corrections - a Replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines "restatement" as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe that the adoption of SFAS 154 will have a significant impact on the consolidated financial statements. NOTE B - EARNINGS PER SHARE Average diluted common shares outstanding include common stock equivalents, which represent common stock options as computed based on the treasury stock method. Average basic and diluted common shares outstanding have been restated to reflect a three-for-two stock split effected by the Company on April 15, 2005 in the form of a stock dividend. Basic earnings per share for the three months ended April 30, 2005 and 2004 is based on average basic common shares outstanding of 41,541 and 38,883, respectively. Diluted earnings per share for the three months ended April 30, 2005 and 2004 is based on average diluted common shares outstanding of 43,312 and 41,787, respectively. 7 Basic earnings per share for the six months ended April 30, 2005 and 2004 is based on average basic common shares outstanding of 40,878 and 38,234, respectively. Diluted earnings per share for the six months ended April 30, 2005 and 2004 is based on average diluted common shares outstanding of 42,909 and 41,556, respectively. NOTE C - 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. 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) No. 123, "Accounting for Stock-Based Compensation," to stock option awards. Three Months Ended Six Months Ended April 30 April 30 ------------------- ------------------ 2005 2004 2005 2004 ------- ------- ------- ------- Reported net income from continuing operations $20,093 $18,323 $40,704 $34,066 Total stock-based employee compensation expense determined under the fair value method for all stock option awards, net of income tax 366 517 368 558 ------- ------- ------- ------- Pro forma net income from continuing operations $19,727 $17,806 $40,336 $33,508 ======= ======= ======= ======= Earnings per share from continuing operations: Basic - as reported $ 0.49 $ 0.47 $ 1.00 $ 0.89 ======= ======= ======= ======= Basic - pro forma $ 0.47 $ 0.46 $ 0.99 $ 0.88 ======= ======= ======= ======= Diluted - as reported $ 0.46 $ 0.44 $ 0.95 $ 0.82 ======= ======= ======= ======= Diluted - pro forma $ 0.46 $ 0.43 $ 0.94 $ 0.81 ======= ======= ======= ======= Historically, options granted have been fully vested at grant date. The fair value of options at the grant date was estimated using the Black-Scholes model with the following weighted average assumptions for the three and six months ended April 30, 2005 and 2004: an expected life of 1.5 years, volatility of 26% and 36%, a dividend yield of 0.07% and 0.12% and a risk-free interest rate of 3.52% and 3.25%, respectively. The weighted average fair value of options granted in the three and six months ended April 30, 2005 and 2004 was $5.37 and $5.03 per share, respectively. NOTE D - ACQUISITIONS Effective February 1, 2005, the Company acquired all of the outstanding stock of Spacelink, which designs, integrates, operates and maintains deployed satellite and wireless networks for the U.S. Department of Defense (DOD), the U.S. intelligence community and other forward deployed federal agencies and multinational organizations worldwide. The purchase price, including transaction costs, was $149.7 million, which included consideration of 342 shares of common stock valued at $13.2 million and cash consideration financed with short-term 8 borrowings under the Company's revolving credit facility. The purchase price is net of $1.8 million of cash acquired. The purchase price is also subject to a working capital adjustment and to certain contingent cash consideration based upon Spacelink's earnings before interest, taxes, depreciation and amortization, as defined, for each of the twelve month periods ending January 31, 2006 and 2007. The fair value of assets acquired, including goodwill of $120.9 million and acquired customer-related intangibles of $13.8 million, was $159.7 million and liabilities assumed totaled $10.0 million. The following unaudited pro forma summary presents the combined results for the three months ended April 30, 2004, and for the six months ended April 30, 2005 and 2004, respectively, as adjusted to reflect the Spacelink purchase transaction assuming the acquisition had occurred at November 1, 2003. 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, 2003, nor are they necessarily indicative of the combined results that may occur in the future. Six Months Ended Three Months April 30 Ended ---------------------------- April 30, 2004 2005 2004 -------------- -------- -------- Net revenues $231,491 $519,015 $453,390 ======== ======== ======== Net income from continuing operations $ 17,666 $ 40,708 $ 34,089 ======== ======== ======== Basic earnings per share from continuing operations $ 0.45 $ 0.99 $ 0.88 ======== ======== ======== Diluted earnings per share from continuing operations $ 0.42 $ 0.94 $ 0.81 ======== ======== ======== Pro forma net income from operations for the six months ended April 30, 2005 includes $1,249, or $0.03 per basic and diluted earnings per share from continuing operations, related to the combined after-tax impact of one-time bonus expenses and transaction costs incurred by Spacelink. 9 Certain information with respect to the assets and liabilities of Spacelink as of the acquisition date is summarized below: February 1, 2005 ---------------- Accounts receivable $ 20,849 Other current assets 578 Property, plant and equipment 3,660 Goodwill 120,851 Acquired customer-related intangibles 13,810 -------- Total assets $159,748 ======== Accounts payable $ 6,710 Accrued liabilities 3,326 -------- $ 10,036 ======== On January 7, 2005, the Company acquired all of the outstanding stock of PCA, which develops and manufactures electronic test and measurement equipment provided for electronic warfare and avionics systems primarily to military customers. The purchase price, including transaction costs, was $37.6 million and is subject to a working capital adjustment. The purchase price was financed with the Company's existing cash balances. The fair value of assets acquired, including goodwill of $24.1 million and acquired customer-related intangibles of $6.4 million, was $38.1 million and liabilities assumed totaled $0.5 million. On December 5, 2003, the Company acquired all of the outstanding stock of Pivotal Power, a supplier of high-performance static power conversion equipment primarily to military customers. The purchase price, including transaction costs, was approximately $10.1 million, net of cash acquired. The purchase price was financed with short-term borrowings under the Company's revolving credit facility. The fair value of assets acquired, including goodwill of $4.4 million and acquired customer-related intangibles of $1.2 million, was $11.6 million and liabilities assumed totaled $1.5 million. Spacelink is included in the Support Services segment. PCA and Pivotal Power are included in the Support Systems segment. The operating results of each are included in consolidated operations since their respective dates of acquisition. NOTE E - OTHER COMPREHENSIVE INCOME A reconciliation of net income to other comprehensive income for the three and six months ended April 30, 2005 and 2004 is as follows: 10 Three Months Ended Six Months Ended April 30 April 30 ---------------------- ----------------------- 2005 2004 2005 2004 ---- ---- ---- ---- Net income $19,045 $18,323 $39,656 $34,066 Other components of comprehensive income, net of tax: Currency translation adjustments (108) (159) (238) (222) ------- ------- ------- ------- Total comprehensive income $18,937 $18,164 $39,418 $33,844 ======= ======= ======= ======= NOTE F - GOODWILL AND INTANGIBLE ASSETS The following table presents changes in the Company's goodwill for the Support Systems segment and for the Support Services segment for the six months ended April 30, 2005: Support Support Systems Services Total -------- -------- -------- October 31, 2004 $ 99,774 $ 67,584 $167,358 Acquisitions 24,066 120,851 144,917 -------- -------- -------- April 30, 2005 $123,840 $188,435 $312,275 ======== ======== ======== The following table presents certain information on the Company's acquired intangible assets. All acquired intangible assets are being amortized over their estimated useful lives with no estimated residual values. Weighted Average Amortization Gross Accumulated Net Period Amount Amortization Amount ------ ------ ------------ ------ Customer-related intangibles: April 30, 2005 9.5 years $69,493 $15,124 $54,369 October 31, 2004 11.6 years 49,263 10,949 38,314 Amortization expense related to acquired intangible assets was $2,745 for the three months ended April 30, 2005 and $2,870 for the three months ended April 30, 2004. Amortization expense related to acquired intangible assets was $4,175 for the six months ended April 30, 2005 and $3,580 for the six months ended April 30, 2004. 11 (Amortization expense related to acquired intangible assets for the three and six months ended April 30, 2004 includes $2,151 related to finalization of the TAMSCO intangible asset valuation. Related TAMSCO amortization expense was $445 and $990, respectively, for the three and six months ended April 30, 2005.) Related estimated amortization expense is $9,655 for the year ending October 31, 2005, $10,425 for the year ending October 31, 2006, $9,676 for the year ending October 31, 2007, $6,473 for the year ending October 31, 2008 and $4,351 for the year ending October 31, 2009. NOTE G - NOTES PAYABLE On January 27, 2005, the Company entered into an Amended and Restated Credit Agreement (Amended Credit Agreement) with its banks. The Amended Credit Agreement replaced the Company's previous credit agreement dated April 23, 2003. The Amended Credit Agreement, which expires January 27, 2010, provides for a $200 million unsecured revolving credit facility. The Company can request, subject to certain conditions, an increase of up to $100 million in the amount of the aggregate commitment under the Amended Credit Agreement. Borrowings under the Amended Credit Agreement bear interest, at the Company's option, at either the Eurodollar rate plus an applicable margin, or at the higher of the prime rate or the federal funds rate plus one-half of one percent. The margin applicable to the Eurodollar rate varies from 0.625% to 1.375% depending upon the Company's ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization (leverage ratio). The Amended Credit Agreement contains certain covenants, including maintaining net worth of at least $265 million, plus 50% of the sum, to extent positive, of the Company's consolidated net income and other comprehensive income (loss) reported after October 31, 2004, plus the net proceeds of all subsequent equity offerings. The Company must also comply with certain financial covenants, including maintenance of a leverage ratio of no greater than 2.75 to 1. The Company is also subject to various other financial and operating covenants and maintenance criteria, including restrictions on the Company's ability to incur additional indebtedness, make investments, create liens, dispose of material assets and enter into merger transactions and acquisitions. As of April 30, 2005, the Company had $116 million in borrowings against the Amended Credit Facility, and was in compliance with all related covenants. NOTE H - CONTRACTS IN PROCESS AND INVENTORIES Contracts in process and inventories of certain of the Company's operating subsidiaries (SEI, Engineered Air, Keco, Fermont, Radian, TAMSCO, Pivotal Power, PCA and Spacelink) represent accumulated contract costs, estimated earnings thereon based upon the percentage of completion method and contract inventories reduced by the contract value of delivered items. Inventories of Marlo Coil, UPSI and EEI are valued at the lower of cost or market using the first-in, first-out method. Contracts in process and inventories are comprised of the following: 12 April 30, 2005 October 31, 2004 -------------- ---------------- Raw materials $ 1,825 $ 1,874 Work-in-process 5,066 5,246 Finished goods 372 493 Inventories substantially applicable to government contracts in process, less progress payments of $36,597 and $54,629 76,531 53,396 ------- ------- $83,794 $61,009 ======= ======= NOTE I - SEGMENT INFORMATION Based on its organizational structure, 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. 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 provides certain power generation and distribution equipment and vehicle armor installation to the DoD. Total assets at April 30, 2005 by segment were $307,558 for Support Systems and $407,594 for Support Services. Goodwill by segment as of April 30, 2005 totaled $123,840 for Support Systems and $188,435 for Support Services. The differences in net revenues between the accompanying condensed consolidated statements of income and the reporting segment information as presented below are due to certain reclassifications made to categorize net revenues by their functional nature, as required, on the face of the financial statements. Three Months Ended Six Months Ended April 30 April 30 -------------------- -------------------- 2005 2004 2005 2004 ---- ---- ---- ---- Net Revenues: Support Systems $126,691 $130,034 $246,576 $241,828 Support Services 150,100 86,515 273,072 175,657 Intersegment Revenues (13,023) (6,413) (22,347) (12,219) -------- -------- -------- -------- Total $263,768 $210,136 $497,301 $405,266 ======== ======== ======== ======== Operating Income from Continuing Operations: Support Systems $ 24,197 $ 28,339 $ 45,629 $ 47,317 Support Services 9,080 1,657 20,638 8,922 -------- -------- -------- -------- 33,277 29,996 66,267 56,239 Interest expense, net (870) (203) (616) (847) -------- -------- -------- -------- Income from continuing operations before income taxes $ 32,407 $ 29,793 $ 65,651 $ 55,392 ======== ======== ======== ======== 13 NOTE J - SHAREHOLDERS' EQUITY The following summary presents a reconciliation of total shareholders' equity from October 31, 2004 to April 30, 2005: Balance at October 31, 2004 $336,956 Comprehensive income: Net income 39,656 Currency translation adjustments (238) -------- Total comprehensive income 39,418 -------- Cash dividends (594) Exercise of stock options 26,666 Issuance of common stock, including $13,243 issued in conjunction with the acquisition of Spacelink 20,136 -------- Balance at April 30, 2005 $422,582 ======== NOTE K - PENSION AND OTHER POSTRETIREMENT BENEFITS The following tables detail the amount of net periodic benefit cost recognized related to the Company's pension and other postretirement benefits for the three and six months ended April 30, 2005 and 2004. Three Months Ended April 30 --------------------------------------------------- Other Pension Benefits Postretirement Benefits -------------------- ----------------------- 2005 2004 2005 2004 ---- ---- ---- ---- Service cost $ 814 $ 706 $ 66 $ 71 Interest cost 1,887 1,743 156 169 Expected return on plan assets (1,864) (1,823) Amortization of prior service cost 193 148 Actuarial loss 1,046 641 103 110 ------- ------- ---- ---- $ 2,076 $ 1,415 $325 $350 ======= ======= ==== ==== 14 Six Months Ended April 30 --------------------------------------------------- Other Pension Benefits Postretirement Benefits -------------------- ----------------------- 2005 2004 2005 2004 ---- ---- ---- ---- Service cost $ 1,628 $ 1,412 $131 $142 Interest cost 3,776 3,486 314 337 Expected return on plan assets (3,727) (3,646) Amortization of prior service cost 351 297 Actuarial loss 2,092 1,282 205 221 ------- ------- ---- ---- $ 4,120 $ 2,831 $650 $700 ======= ======= ==== ==== As of April 30, 2005, $4,000 of contributions have been made to pension and other postretirement benefit plans. The Company anticipates contributing an additional $4,000 to fund the pension and other postretirement benefit plans in 2005 for a total of $8,000. NOTE L - DISCONTINUED OPERATIONS The Company completed the sale of Engineered Specialty Plastics, Inc. (ESP), a wholly-owned subsidiary, in the quarter ended April 30, 2003 to a private equity group (the Buyers). The Buyers subsequently alleged that the Company breached certain representations made under the related Stock Purchase Agreement (the Agreement) and sought a claim for associated damages under the binding arbitration provisions of the Agreement. During the quarter ended April 30, 2005, the Company and the Buyers reached a settlement on this claim, which included modification of the Company's $3.2 million note receivable from the Buyers to provide for suspension of interest charges and payments through July 31, 2006, extension of the note's repayment term to a balloon payment now due in April 2009, and the release of the underlying real estate collateral securing the note. Because of this settlement, the Company recorded a charge for the impairment of the note during the quarter ended April 30, 2005 equal to $1.7 million, or $1.0 million net of income tax. This amount is reflected in discontinued operations on the Condensed Consolidated Statements of Income for the three and six months ended April 30, 2005. NOTE M - STOCK SPLIT On April 15, 2005, the Company effected a three-for-two stock split in the form of a 50% stock dividend. All per share amounts in this report have been restated to reflect this split. 15 NOTE N - SUBSEQUENT EVENTS Effective May 1, 2005, the Company acquired all of the outstanding stock of Mobilized Systems, Inc. (MSI), which designs, manufactures and tests highly specialized trailers, shelters and environmental control systems, primarily for the defense industry. The purchase price was $17.0 million and is subject to a final working capital adjustment. The purchase price was financed with short-term borrowings under the Company's revolving credit facility. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. CRITICAL ACCOUNTING POLICIES Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations from the Company's 2004 Annual Report to Shareholders into the Company's Annual Report on Form 10-K for the period ended October 31, 2004 for a discussion of the critical accounting policies which we believe are most difficult, subjective or complex. The following analysis should be read in this context. RESULTS OF OPERATIONS Consolidated net revenues increased $53.7 million, or 25.5%, to $263.8 million in the second quarter of 2005 compared to $210.1 million in the second quarter of 2004. The increase was due in part to additional revenues from refurbishment of M1000 Heavy Equipment Transporters ($9.7 million increase), satellite telecommunications support activities for deployed troops abroad ($13.5 million increase) and the installation of vehicle uparmor kits ($22.1 million increase). These revenue increases were partially 17 offset by reduced work on the 60-K Tunner Aircraft Cargo Loader ($7.7 million decrease) as the production phase of this long-term program wound down in the quarater ended April 30, 2005, as well as reduced deliveries of the Manportable Surveillance and Target Acquisition Radar (MSTAR) perimeter security program for which a large base security subcontract for Northrup Grumman was completed in the fourth quarter of 2004 ($19.1 million decrease). In addition, more recently acquired subsidiaries, PCA (acquired January 7, 2005) and Spacelink (acquired effective February 1, 2005), added a combined $25.4 million of incremental revenues in the second quarter of 2005. Gross profit for the quarter ended April 30, 2005 increased $6.9 million, or 12.9%, to $60.3 million (22.9% of consolidated net revenues) from $53.4 million (25.4% of consolidated net revenues) in the comparable 2004 period. Revenue growth of $53.7 million resulted in the increase in gross profit. However, lower gross margins for the second quarter of 2005 reflect a less favorable revenue mix, primarily resulting from a greater percentage of generally lower margin Support Services segment revenues, as well as the impact of production delays combined with increased estimated costs on the Deployable Power Generation and Distribution System (DPGDS) program, a large, mobile power 18 generation system used by military forces deployed around the globe. The Company has addressed the underlying causes of performance issues with the primary power units, a key component of the DPGDS, and is in the process of implementing a remediation plan. Program revenues of approximately $26 million and related gross profit of approximately $9 million had been previously expected by the Company to be derived from the DPGDS program for the second quarter of 2005. However, the curtailment of primary power unit production during the second quarter, along with increased estimated costs required for the extensive testing and retrofit costs of fielded units, resulted in revenues and gross profit of $8.5 million and $1.4 million, respectively, on the program. Pending the timely and successful implementation of its identified solutions, the Company expects that the DPGDS program will return to full rate production early in the fourth quarter of 2005. Selling, general and administrative expense increased $3.7 million, or 15.7%, in the second quarter of 2005 to $27.1 million (10.3% of consolidated net revenues) from $23.4 million (11.1% of consolidated net revenues) in the second quarter of 2004. Selling, general and administrative expense for PCA and Spacelink accounted for $3.3 million of the $3.7 million increase, with the 19 remaining increase required to support higher operating levels. As a result of the above, operating income from continuing operations increased $3.3 million, or 10.9%, in the quarter ended April 30, 2005 to $33.3 million from $30.0 million in the second quarter of 2004. Consolidated net revenues increased $92.0 million, or 22.7%, to $497.3 million in the first six months of 2005 compared to $405.3 million in the first six months of 2004. The increase was due in part to additional revenues from refurbishment of M1000 Heavy Equipment Transporters ($15.8 million increase), satellite telecommunications support activities for deployed troops abroad ($28.3 million increase) and the installation of vehicle uparmor kits ($32.9 million increase). These revenue increases were partially offset by reduced work on the 60-K Tunner Aircraft Cargo Loader ($13.9 million decrease), as well as reduced MSTAR deliveries ($31.5 million decrease). In addition, more recently acquired subsidiaries, Pivotal Power (acquired December 5, 2003), PCA (acquired January 3, 2005) and Spacelink (acquired effective February 1, 2005), added a combined $26.8 million of incremental revenues in the first six months of 2005. Gross profit for the six months ended April 30, 2005 increased $18.2 million, or 18.2%, to $117.9 million (23.7% of consolidated net revenues) from $99.7 million (24.6% of consolidated net revenues) in the comparable 2004 period. Revenue growth of $92.0 million resulted in the increase in gross profit. However, lower gross margins for the first six months of 2005 reflect a less favorable revenue mix, primarily resulting from a greater percentage of generally lower margin Support Services segment revenues, as 20 well as the impact of production delays and increased estimated costs on the DPGDS program. The previously discussed DPGDS production delays and increased cost estimates also contributed to lower gross margins in the first six months of 2005 versus the comparable period in 2004. Selling, general and administrative expense increased $8.2 million, or 19.0%, in the first six months of 2005 to $51.6 million (10.4% of consolidated net revenues) from $43.4 million (10.7% of consolidated net revenues) in the first six months of 2004. Selling, general and administrative expense for Pivotal Power, PCA and Spacelink accounted for $4.3 million of the $8.2 million increase, with the remaining increase required to support higher operating levels. As a result of the above, operating income from continuing operations increased $10.1 million, or 17.8%, in the first six months of 2005 to $66.3 from $56.2 million in the first six months of 2004. SUPPORT SYSTEMS. Net revenues in the second quarter of 2005 for the Support Systems segment totaled $126.7 million compared to $130.0 million (prior to the elimination of intersegment revenues in each period) for the same period in the prior year, a 2.6% decrease. The results for the quarter ended April 30, 2005 reflect the inclusion of $4.1 million in incremental net revenues from PCA during the second quarter. The overall decrease was primarily due to a $7.7 million revenue reduction on the 60-K Tunner Aircraft Cargo Loader, as the production phase of this long-term program was completed in the quarter ended April 20, 2005, and to a $19.1 million 21 revenue reduction on the MSTAR program, for which a large base security subcontract for Northrup Grumman was completed in the fourth quarter of 2004. These decreases were offset in part by a $9.7 million revenue increase from refurbishment of M1000 Heavy Equipment Transporters, and by a $5.6 million increase in intersegment work performed for the Support Services segment. Gross profit for the segment decreased by $2.7 million, or 6.3%, in the quarter ended April 30, 2005 to $39.1 million (30.9% of segment revenues) from $41.8 million (32.1% of segment revenues) in the prior year quarter as a result of the above revenue decreases, as well as overall product mix change. Quarterly operating income for the segment decreased to $24.2 million (19.1% of segment revenues) compared to $28.3 million (21.8% of segment revenues) last year. Decreased revenues, related gross profit reductions and a $1.4 million, or approximately 10%, increase is segment selling, general and administrative expense led to the lower results for the Support Systems segment. Net revenues in the first six months of 2005 for the Support Systems segment totaled $246.6 million compared to $241.8 million (prior to the elimination of intersegment revenues in each period) for the same period in the prior year, a 2.0% 22 increase. The results for the six months ended April 30, 2005 reflect the inclusion of $5.4 million in incremental net revenues from Pivotal Power and PCA during the first six months of 2005. The overall decrease was primarily due to a $13.9 million revenue reduction on the 60-K Tunner Aircraft Cargo Loader and to a $31.5 million revenue reduction on the MSTAR program. These decreases were offset in part by a $15.8 million revenue increase from refurbishment of M1000 Heavy Equipment Transporters, and by a $9.5 million increase in intersegment work performed for the Support Services segment. Gross profit for the segment increased by $1.3 million, or 1.7%, in the six months ended April 30, 2005 to $75.2 million (30.5% of segment revenues) from $73.9 million (30.5% of segment revenues) in the first six months of the prior year. Segment operating income for the six months ended April 30, 2005 decreased to $45.6 million (18.5% of segment revenues) compared to $47.3 million (19.6% of segment revenues) last year primarily as a result of a $3.0 million increase in segment selling, general and administrative expense. SUPPORT SERVICES. Net revenues for the Support Services segment increased to 23 $150.1 million, an increase of $63.6 million, or 73.5%, compared to $86.5 million (prior to the elimination of intersegment revenues in each period) for the second quarter of 2005. The most significant year-over-year revenue increases were generated by satellite telecommunications support for deployed forces ($13.5 million) and the vehicle uparmor kit program ($22.1 million). In addition, Spacelink (acquired effective February 1, 2005) added $21.3 million of incremental revenues in the second quarter of 2005. Gross profit for the segment increased by $9.7 million, or 82.7%, in the quarter ended April 30, 2005 to $21.3 million (14.2% of segment revenues) from $11.6 million (13.5% of segment revenues) in the prior year quarter primarily as a result of increased revenues. Segment operating income for the second quarter of 2005 totaled $9.1 million (6.0% of segment revenues) compared to $1.7 million (1.9% of segment revenues) in the same period last year. Although incremental revenues and related gross profit contributions led to the overall improved results for the Support Services segment, the segment's operating profit for the second quarter of 2004 was abnormally low due to the inclusion of a significant amount of lower margin "pass-through" revenues on certain contracts, as well as $2.2 million in non-cash amortization charges for customer-related intangibles from 24 the May 2003 acquisition of TAMSCO. Also constraining profits for the quarter ended April 30, 2005 was the fact that the Company had anticipated DPGDS program revenues of approximately $26 million and related gross profit of approximately $9 million during the three months ended April 30, 2005. However, the curtailment of DPGDS primary power unit production during the second quarter, along with increased estimated costs required for the extensive testing and retrofit costs of fielded units, resulted in revenues and gross profit of $8.5 million and $1.4 million, respectively, on the program. Pending the timely and successful implementation of its identified solutions, the Company expects that the DPGDS program will return to full rate production early in the fourth quarter of 2005. Net revenues for the Support Services segment increased to $273.1 million, an increase of $97.4 million, or 55.5%, compared to $175.7 million (prior to the elimination of intersegment revenues in each period) for the first six months of 2005. The most significant year-over-year revenue increases were generated by satellite telecommunications support for deployed forces ($28.3 million) and the vehicle uparmor kit program ($32.9 million). In addition, Spacelink (acquired effective February 1, 2005) 25 added $21.3 million of incremental revenues in the first six months of 2005. Gross profit for the segment increased by $16.9 million, or 65.4% in the six months ended April 30, 2005 to $42.7 million (15.6% of segment revenues) from $25.8 million (14.7% of segment revenues) in the first six months of 2004 primarily as a result of increased revenues. Segment operating income for the first six months of 2005 totaled $20.6 million (7.6% of segment revenues) compared to $8.9 million (5.1% of segment revenues) in the same period last year. The $97.4 million increase in segment revenues provided significant gross profit increases as well as leveraging existing fixed overhead costs, which led to the overall improved results for the Support Services segment. CONSOLIDATED RESULTS OF OPERATIONS. Net interest expense totaled $0.9 million in the second quarter of 2005 compared to $0.2 million in the second quarter of 2004 as a result of increased borrowing levels necessary for the acquisitions of PCA and Spacelink in 2005. Net interest expense totaled $0.6 million and $0.8 million for the six months ended April 30, 2005 and 2004, respectively. The effective income tax rate was 38.0% for the three and six month periods ended April 30, 2005 compared to 38.5% for the 26 three and six month periods ended April 30, 2004. This reduction is primarily a result of the Company's ongoing state income tax reduction initiatives. As a result of the foregoing, net income from continuing operations increased 9.7% to $20.1 million (7.6% of consolidated net revenues) in the quarter ended April 30, 2005 as compared to $18.3 million (8.7% of consolidated net revenues) in the second quarter of 2004, and net income from continuing operations increased 19.5% to $40.7 million (8.2% of consolidated net revenues) in the first six months of 2005 as compared to $34.1 million (8.4% of consolidated net revenues) in the first six months of 2004. Based on second quarter results, existing backlog and anticipated orders, the Company anticipates that 2005 revenues will approximate $1.02 billion to $1.05 billion, and that earnings per share from continuing operations will approximate between $2.00 and $2.03. These estimates include the operations of Mobilized Systems, Inc. (MSI), which was acquired May 1, 2005. DISCONTINUED OPERATIONS. The Company completed the sale of Engineered Specialty Plastics, Inc. (ESP), a wholly-owned subsidiary, in the quarter ended April 30, 2003 to a private equity group (the Buyers). The Buyers subsequently alleged that the Company breached certain representations made under the related Stock Purchase 27 Agreement (the Agreement) and sought a claim for associated damages under the binding arbitration provisions of the Agreement. During the quarter ended April 30, 2005, the Company and the Buyers reached a settlement on this claim, which included modification of the Company's $3.2 million note receivable from the Buyers to provide for suspension of interest charges and payments through July 31, 2006, extension of the note's repayment term to a balloon payment now due in April 2009, and the release of the underlying real estate collateral securing the note. Because of this settlement, the Company recorded a charge for the impairment of the note during the quarter ended April 30, 2005 equal to $1.7 million, or $1.0 million net of income tax. This amount is reflected in discontinued operations on the Condensed Consolidated Statements of Income for the three and six months ended April 30, 2005. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In October 2004, Congress passed the American Jobs Creation Act of 2004 (the Jobs Creation Act). The Jobs Creation Act includes numerous provisions that may materially affect business practices and accounting for income taxes. For companies that pay U.S. income taxes on manufacturing activities in the U.S., the Jobs Creation Act provides a phased-in deduction from taxable income equal to a stipulated percentage of qualified income from domestic production activities. In December 2004, the FASB issued two FASB Staff Positions (FSP) regarding the accounting implications of the Act related to (1) the deduction for qualified domestic production activities (FSP 109-1) and (2) the one-time tax benefit for the repatriation of foreign earnings (FSP 109-2). This guidance applies to financial statements for periods ending after the date the Act was enacted. The Jobs Creation Act also provides for a change in the period of application for foreign tax credits, elimination of the 90-percent limitation of foreign tax credits against Alternative Minimum Tax, expanded disallowance of interest on convertible debt, and tax shelter disclosure penalties. The Company adopted FSP 109-1 and FSP 109-2 in the first quarter of 2005. The Company anticipates that the Jobs Creation Act and related FASB pronouncements will have a material impact on the Company's financial statements in future periods. However, the Company has determined that this impact is not material for the three and six months ended April 30, 2005 and will not be material for the year ending October 31, 2005. 28 In November 2004, the FASB issued SFAS 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4." SFAS 151 seeks to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) in the determination of inventory carrying costs. The statement requires such costs to be treated as a current period expense. This statement is effective November 1, 2005 for the Company. The Company does not believe that the adoption of SFAS 151 will have a significant impact on the consolidated financial statements. In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment", (SFAS 123R). SFAS 123R requires companies to expense the value of employee stock options and similar awards. This statement is effective November 1, 2005 for the Company. The Company is currently evaluating its compensation policies and practices, along with the impact of SFAS 123R on its results of operations. In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error Corrections - a Replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines "restatement" as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe that the adoption of SFAS 154 will have a significant impact on the consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES On January 27, 2005, the Company entered into an Amended and Restated Credit Agreement (Amended Credit Agreement) with its banks. The Amended Credit Agreement replaced the Company's previous credit agreement dated April 23, 2003. The Amended Credit Agreement, which expires January 27, 2010, provides for a $200 million unsecured revolving credit facility. The Company can request, subject to certain conditions, an increase of up to $100 million in the amount of the aggregate commitment under the Amended Credit Agreement. Borrowings under the Amended Credit Agreement bear interest, at the Company's option, at either the Eurodollar rate plus an applicable margin, or at the higher of the prime rate or the federal funds rate plus one-half of one percent. The margin applicable to the Eurodollar rate varies from 0.625% to 1.375% depending upon the Company's ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization (leverage ratio). The Amended Credit Agreement contains certain covenants, 29 including maintaining net worth of at least $265 million, plus 50% of the sum, to extent positive, of the Company's consolidated net income and other comprehensive income (loss) reported after October 31, 2004, plus the net proceeds of all subsequent equity offerings. The Company must also comply with certain financial covenants, including maintenance of a leverage ratio of no greater than 2.75 to 1. The Company is also subject to various other financial and operating covenants and maintenance criteria, including restrictions on the Company's ability to incur additional indebtedness, make investments, create liens, dispose of material assets and enter into merger transactions and acquisitions. As of April 30, 2005, the Company had $116 million in borrowings against the Amended Credit Facility, and was in compliance with all related covenants. On January 7, 2005, the Company acquired all of the outstanding stock of PCA, which develops and manufactures electronic test and measurement equipment provided for electronic warfare and avionics systems primarily to military customers. The purchase price was $37.6 million and is subject to a working capital adjustment. The purchase price was financed with the Company's existing cash balances. The fair value of assets acquired, including goodwill of $24.1 million and acquired customer-related intangibles of $6.4 million, was $38.1 million and liabilities assumed totaled $0.5 million. Effective February 1, 2005, the Company acquired all of the outstanding stock of Spacelink, which designs, integrates, operates and maintains deployed satellite and wireless networks for the U.S. Department of Defense (DOD), the U.S. intelligence community and other forward deployed federal agencies and multinational organizations worldwide. The purchase price, including transaction costs, was $149.7 million, which included consideration of $13.2 million in the common stock of the Company and cash consideration financed with short-term borrowings under the Company's revolving credit facility. The purchase price is net of $1.8 million of cash acquired. The purchase price is also subject to a working capital adjustment and to certain contingent cash consideration based upon Spacelink's earnings before interest, taxes, depreciation and amortization, as defined, for each of the twelve month periods ending January 31, 2006 and 2007. The fair value of assets acquired, including goodwill of $120.9 million and acquired customer-related intangibles of $13.8 million, was $159.7 million and liabilities assumed totaled $10.0 million. At April 30, 2005, the Company's working capital and ratio of current assets to current liabilities were $33.3 million and 1.13 to 1 as compared with $112.0 million and 1.85 to 1 at October 31, 2004. The significant changes in working capital and the ratio of current assets to current liabilities from October 31, 2004 are due to the increase in short-term borrowings against the Company's revolving credit facility, which were required as a result of the PCA and Spacelink acquisitions. Net cash provided by operations totaled $29.0 million for the first six months of 2005 compared to net cash provided by operations of $20.7 million for the first six months of 2004. Investment in property, plant and equipment totaled $5.1 million and $4.1 million for the first six months of 2005 and 2004, respectively. The Company anticipates that capital expenditures in 2005 should not exceed $15.0 million. Management believes that cash flow generated from operations, together with the available line of credit, will provide the necessary resources to meet the needs of the Company in the foreseeable future. During the six months ended April 30, 2005 and 2004, the Company received proceeds of $26.7 million and $37.8 million related to the exercise of stock options. 30 BUSINESS AND MARKET CONSIDERATIONS Approximately 93% of consolidated net revenues for the six months ended April 30, 2005 were directly or indirectly derived from defense orders by the U.S. government and its agencies. As of April 30, 2005, the Company's funded backlog of orders totaled $598.9 million, with related customer options of an additional $1,460.1 million. These amounts compare to funded backlog of $588.1 million and related customer options of an additional $849.1 million as of October 31, 2004. Management continues to pursue potential acquisitions, primarily of those companies providing strategic consolidation within the defense industry. FORWARD-LOOKING STATEMENTS In addition to historical information, this 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, which could cause the Company's actual results to differ materially from those projected in, or inferred by, the forward-looking statements, including, but not limited to 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 and other risks discussed in the Company's reports filed with the Securities and Exchange Commission from time to time. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market risks relating to the Company's operations result primarily from changes in interest rates. Given existing debt levels, significant cash flows and anticipated expenditures, Company management has not utilized interest rate swaps or other derivative contracts to hedge this risk since November 2002. Management does not believe its exposure to interest rate fluctuations has had, or will have, a significant impact on the Company's operations. ITEM 4. CONTROLS AND PROCEDURES. As of April 30, 2005, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as defined in Rules 31 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon the evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. There have been no changes in the Company's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 32 PART II OTHER INFORMATION Item 1 Legal Proceedings The Company completed the sale of Engineered Specialty Plastics, Inc. (ESP), a wholly-owned subsidiary, in the quarter ended April 30, 2003 to a private equity group (the Buyers). The Buyers subsequently alleged that the Company breached certain representations made under the related Stock Purchase Agreement (the Agreement) and sought $6.0 million in damages from the Company. Under the terms of the Agreement, this claim was subject to binding arbitration. During the quarter ended April 30, 2005, the Company and the Buyers reached a settlement on this claim, which included modification of the Company's $3.2 million note receivable from the Buyers to provide for suspension of interest charges and payments through July 31, 2006, extension of the note's repayment term to a balloon payment now due in April 2009, and the release of the underlying real estate collateral securing the note. Item 2 Unregistered Sales of Equity Securities Effective February 1, 2005, the Company acquired all of the membership interests of Spacelink International, LLC ("Spacelink"). A portion of the purchase price paid by the Company at closing consisted of the issuance by the Company of 342,438 post-split shares of its restricted common stock valued at approximately $13.2 million. The Company issued these shares of common stock to the sellers of Spacelink's membership interests, Spacelink International LTD., a Delaware corporation and SatComSolutions LLC, a Delaware limited liability company. The common stock was issued as a private placement of securities under Section 4(2) of the Securities Act of 1933. Item 3 Not Applicable Item 4 Submission of Matters to a Vote of Security Holders (a) The Company's annual shareholders' meeting was held on March 1, 2005. (b) The following individuals were nominated and elected to the Board of Directors for a term of three years (2008): Gerald A. Potthoff Gary C. Gerhardt Thomas J. Guilfoil James A. Schaefer MG George E. Friel (U.S. Army, Retired) General Charles T. Robertson, Jr. (U.S. Air Force, Retired) The following directors continued in service of their terms following the meeting: Michael F. Shanahan, Sr. Ronald W. Davis William H.T. Bush General Michael P.C. Carns (U.S. Air Force, Retired) S. Lee Kling 33 LTG Kenneth E. Lewi (U.S. Army, Retired) General Crosbie E. Saint (U.S. Army, Retired) Michael F. Shanahan, Jr. Earl W. Wims (c) The proposal for the approval of the Engineered Support Systems, Inc. 2005 Non-Executive Stock Option Plan and the allocation of 400,000 shares of Engineered Support Systems, Inc. common stock to the Plan was approved. There were 15,789,894 shares voted for the proposal, 3,945,091 shares voted against the proposal and 5,519,024 shares representing abstentions or broker non- votes. (d) Not Applicable Item 5 Not Applicable Item 6 Exhibits See Exhibit Index 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ENGINEERED SUPPORT SYSTEMS, INC. Date: June 9, 2005 ------------ By: /s/ Gerald A. Potthoff --------------------------------- Gerald A. Potthoff Vice Chairman and Chief Executive Officer Date: June 9, 2005 ------------ By: /s/ Gary C. Gerhardt --------------------------------- Gary C. Gerhardt Vice Chairman and Chief Financial Officer Date: June 9, 2005 ------------ By: /s/ Steven J. Landmann --------------------------------- Steven J. Landmann Senior Vice President - Controller and Chief Accounting Officer 35 EXHIBIT INDEX 3.1 Articles of Incorporation of Engineered Support Systems, Inc. filed July 10, 1985 on Form S-1 Registration Statement, registration number 2-98909 as amended on August 13, 1985 and August 21, 1985, and incorporated herein by reference. 3.2 Amendments of Articles of Incorporation filed January 30, 2004 on the Company's Annual Report on Form 10-K, and incorporated herein by reference. 3.3 Amended and Restated By-Laws of Engineered Support Systems, Inc. filed January 30, 2004 on the Company's Annual Report on Form 10-K, and incorporated herein by reference. 10.1 Consulting Agreement with Michael F. Shanahan, Sr. dated May 1, 2005 filed as Exhibit 10.1 to the Company's Form 8-K/A filed May 6, 2005, and incorporated herein by reference. 10.2 Form of Employment Agreement with Gerald A. Potthoff dated November 1, 2005 filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K filed January 14, 2005, as amended, and incorporated herein by reference. 10.3 Form of Employment Agreement with Gary C. Gerhardt, dated November 1, 2005 filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K filed January 14, 2005, as amended, and incorporated herein by reference. 10.4 Form of Employment Agreement with Ronald W. Davis, dated November 1, 2005 filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K filed January 14, 2005, as amended, and incorporated herein by reference. 10.5 Employment Agreement with Daniel A. Rodrigues dated April 11, 2005 filed as Exhibit 10.2 to the Company's Form 8-K/A filed May 6, 2005, and incorporated herein by reference. 10.6 Purchase Agreement by and between Engineered Support Systems, Inc. and Spacelink International LLC, Spacelink International LTD and SatComSolutions LLC dated December 9, 2004 filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K filed January 14, 2005, as amended, and incorporated herein by reference. 10.7 Closing Letter amending the Purchase Agreement by and between Engineered Support Systems, Inc. and Spacelink International LLC, Spacelink International LTD and SatComSolutions LLC dated February 7, 2005. 10.8 Stock Purchase Agreement by and between Prospective Computer Analysts Incorporated, Edward Wenger, The Lauren Wenger 2004 GRAT, The Eric Wenger 2004 GRAT, the Mitchell Wenger 2004 GRAT and Engineered Support Systems, Inc. dated January 7, 2005 filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K filed January 14, 2005, as amended, and incorporated herein by reference. 36 10.9 Amended and Restated Credit Agreement dated as of January 27, 2005 among Engineered Support Systems, Inc., as the Borrower, Bank of America, N.A. and the Other Lenders Party Hereto filed as Exhibit 99 to the Company's Current Report on Form 10-Q filed February 2, 2005 and incorporated herein by reference. 11 Statement Re: Computation of Earnings Per Share 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Section 906 of the Sarbanes-Oxley Act of 2002 37