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 nine months ended July 31, 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
--- ---
Indicate by check mark whether the Registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
The number of shares of the Registrant's common stock, $.01 par
value, outstanding at August 31, 2005 was 41,784,442.
1
ENGINEERED SUPPORT SYSTEMS, INC.
INDEX
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of July 31, 2005 and
October 31, 2004................................................. 3
Condensed Consolidated Statements of Income for the three and
nine months ended July 31, 2005 and 2004......................... 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended July 31, 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 ........................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 29
Item 4. Controls and Procedures.................................... 29
Part II - Other Information
Item 6 ............................................................. 31
Signatures ............................................................... 32
Exhibits ................................................................. 33
2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
July 31 October 31
2005 2004
----------- ----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 12,027 $ 33,153
Accounts receivable 155,036 139,191
Contracts in process and inventories 80,271 61,009
Deferred income taxes 6,921 6,921
Other current assets 6,691 2,846
-------- --------
Total Current Assets 260,946 243,120
Property, plant and equipment, less accumulated
depreciation of $34,873 and $29,177 52,719 46,946
Goodwill 324,960 167,358
Acquired customer-related intangibles 54,699 38,314
Deferred income taxes 2,557 1,876
Other assets 12,982 13,520
-------- --------
Total Assets $708,863 $511,134
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable $ 86,000 $
Current maturities of long-term debt 313 340
Accounts payable 63,416 71,796
Other current liabilities 67,186 58,936
-------- --------
Total Current Liabilities 216,915 131,072
Long-term debt 1,946 781
Minimum pension liability 28,237 28,237
Other liabilities 14,219 14,088
Shareholders' Equity
Common stock, par value $.01 per share; 85,000
shares authorized; 41,780 and 26,642 shares issued 418 266
Additional paid-in capital 201,406 151,805
Retained earnings 263,605 202,730
Accumulated other comprehensive loss (17,883) (17,845)
-------- --------
447,546 336,956
-------- --------
Total Liabilities and Shareholders' Equity $708,863 $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 Nine Months Ended
July 31 July 31
-------------------------- ----------------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net revenues:
Products $145,754 $155,179 $425,279 $419,317
Services 112,981 66,812 330,757 207,940
-------- -------- -------- --------
258,735 221,991 756,036 627,257
-------- -------- -------- --------
Cost of revenues:
Products 98,572 107,526 284,904 288,025
Services 96,713 57,649 289,814 182,720
-------- -------- -------- --------
195,285 165,175 574,718 470,745
-------- -------- -------- --------
Gross profit 63,450 56,816 181,318 156,512
Selling, general and administrative expense 26,362 22,133 77,983 65,519
Restructuring income (expense) 5 (61)
Gain (loss) on sale of assets (6) (1,285) 14 (1,290)
-------- -------- -------- --------
Operating income from continuing
operations 37,082 33,403 103,349 89,642
Interest expense (868) (156) (1,940) (1,159)
Interest income 181 95 637 251
-------- -------- -------- --------
Income from continuing operations 36,395 33,342 102,046 88,734
Income tax provision 13,831 12,836 38,778 34,162
-------- -------- -------- --------
Net income from continuing operations 22,564 20,506 63,268 54,572
Loss on sale of
discontinued operations,
net of income tax 1,048
-------- -------- -------- --------
Net income $ 22,564 $ 20,506 $ 62,220 $ 54,572
======== ======== ======== ========
Basic earnings per share:
Continuing operations $ 0.54 $ 0.52 $ 1.54 $ 1.41
Discontinued operations (0.03)
-------- -------- -------- --------
Total $ 0.54 $ 0.52 $ 1.51 $ 1.41
======== ======== ======== ========
Diluted earnings per share:
Continuing operations $ 0.52 $ 0.49 $ 1.47 $ 1.31
Discontinued operations (0.03)
-------- -------- -------- --------
Total $ 0.52 $ 0.49 $ 1.44 $ 1.31
======== ======== ======== ========
See notes to condensed consolidated financial statements.
4
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(UNAUDITED)
Nine Months Ended
July 31
--------------------------
2005 2004
--------- --------
From operating activities:
Net income from continuing operations $ 63,268 $ 54,572
Depreciation and amortization 13,374 9,534
(Gain) loss on sale of assets (14) 1,290
--------- --------
Cash provided before changes in operating
assets and liabilities 76,628 65,396
Net increase in non-cash current assets (7,463) (42,105)
Net increase (decrease) in non-cash current liabilities (11,937) 397
Net changes in other assets and liabilities 1,935 (4,702)
--------- --------
Net cash provided by operating activities 59,163 18,986
--------- --------
From investing activities:
Purchase of Spacelink, net of cash acquired (136,480)
Purchase of PCA, net of cash acquired (37,648)
Purchase of MSI, net of cash acquired (15,746)
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, net of cash acquired (99)
Additions to property, plant and equipment (7,680) (6,228)
Proceeds from sale of property, plant and equipment 59 5,674
--------- --------
Net cash used in investing activities (197,495) (20,183)
--------- --------
From financing activities:
Net borrowings (payments) under line-of-credit agreement 86,000 (46,100)
Payments of long-term debt (263) (182)
Proceeds of long-term debt 1,405 378
Exercise of stock options 27,264 56,331
Issuance of common stock to employee stock purchase plan 4,170 3,076
Cash dividends (1,346) (932)
--------- --------
Net cash provided by financing activities 117,230 12,571
--------- --------
Effect of exchange rate changes on cash (24) 19
--------- --------
Net increase (decrease) in cash and cash equivalents (21,126) 11,393
Cash and cash equivalents at beginning of period 33,153 2,880
--------- --------
Cash and cash equivalents at end of period $ 12,027 $ 14,273
========= ========
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)
JULY 31, 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),
Prospective Computer Analysts Incorporated (PCA) and Mobilized Systems, Inc.
(MSI). 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 nine months ended July 31, 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.
6
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 nine months ended July 31, 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,
7
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 July 31, 2005 and
2004 is based on average basic common shares outstanding of 41,717 and
39,518, respectively. Diluted earnings per share for the three months ended
July 31, 2005 and 2004 is based on average diluted common shares outstanding
of 43,379 and 42,099, respectively.
Basic earnings per share for the nine months ended July 31, 2005
and 2004 is based on average basic common shares outstanding of 41,161 and
38,666, respectively. Diluted earnings per share for the nine months ended
July 31, 2005 and 2004 is based on average diluted common shares outstanding
of 43,068 and 41,729, respectively.
8
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 Nine Months Ended
July 31 July 31
------------------- -------------------
2005 2004 2005 2004
------- ------- ------- -------
Reported net income from continuing operations $22,564 $20,506 $63,268 $54,572
Total stock-based employee compensation expense
determined under the fair value method for all stock
option awards, net of income tax 3,918 1,936 4,286 2,502
------- ------- ------- -------
Pro forma net income from continuing operations $18,646 $18,570 $58,982 $52,070
======= ======= ======= =======
Earnings per share from continuing operations:
Basic - as reported $ 0.54 $ 0.52 $ 1.54 $ 1.41
======= ======= ======= =======
Basic - pro forma $ 0.45 $ 0.47 $ 1.43 $ 1.35
======= ======= ======= =======
Diluted - as reported $ 0.52 $ 0.49 $ 1.47 $ 1.31
======= ======= ======= =======
Diluted - pro forma $ 0.43 $ 0.44 $ 1.37 $ 1.25
======= ======= ======= =======
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 nine months ended July 31, 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 nine months ended
July 31, 2005 and 2004 was $5.37 and $5.03 per share, respectively.
NOTE D - ACQUISITIONS
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.
9
The purchase price was $17.5 million, net of cash acquired. $15.7 million of
the purchase price has been paid as of July 31, 2005, with an additional
$1.0 million accrued as of that date related to the final working capital
adjustment. The remaining $0.8 million of consideration is in the form of
long-term promissory notes payable to the sellers. The purchase price is
being finalized with short-term borrowings under the Company's revolving
credit facility. The fair value of assets acquired, including goodwill of
$12.7 million and customer-related intangibles of $3.2 million, was $19.1
million and liabilities totaled $1.6 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, for which equity
consideration of 342 shares of common stock valued at $13.2 million 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.
The following unaudited pro forma summary presents the combined
results for the three months ended July 31, 2004, and for the nine months
ended July 31, 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.
Nine Months Ended
Three Months July 31
Ended ----------------------------
July 31, 2004 2005 2004
------------- -------- --------
Net revenues $244,918 $777,750 $698,308
======== ======== ========
Net income from
continuing operations $ 21,359 $ 63,273 $ 55,420
======== ======== ========
Basic earnings per share
from continuing operations $ 0.54 $ 1.54 $ 1.43
======== ======== ========
Diluted earnings per share
from continuing operations $ 0.51 $ 1.47 $ 1.33
======== ======== ========
10
Pro forma net income from operations for the nine months ended July
31, 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.
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.
11
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. MSI, 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 - COMPREHENSIVE INCOME
A reconciliation of net income to comprehensive income for the
three and nine months ended July 31, 2005 and 2004 is as follows:
Three Months Ended Nine Months Ended
July 31 July 31
---------------------- ------------------------
2005 2004 2005 2004
---- ---- ---- ----
Net income $22,564 $20,506 $62,220 $54,572
Other components of
comprehensive
income, net of tax:
Currency translation adjustments 200 166 (38) (56)
------- ------- -------- -------
Comprehensive income $22,764 $20,672 $62,182 $54,516
======= ======= ======= =======
12
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
nine months ended July 31, 2005:
Support Support
Systems Services Total
-------- -------- --------
October 31, 2004 $99,774 $ 67,584 $167,358
Acquisitions 36,741 120,861 157,602
-------- -------- --------
July 31, 2005 $136,515 $188,445 $324,960
======== ======== ========
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:
July 31, 2005 9.3 years $72,660 $17,961 $54,699
October 31, 2004 11.6 years 49,263 10,949 38,314
Amortization expense related to acquired intangible assets was
$2,837 for the three months ended July 31, 2005 and $1,205 for the three
months ended July 31, 2004. Amortization expense related to acquired
intangible assets was $7,012 for the nine months ended July 31, 2005 and
$4,785 for the nine months ended July 31, 2004. (Amortization expense
related to acquired intangible assets for the nine months ended July 31,
2004 includes $2,151 related to finalization of the TAMSCO intangible asset
valuation. Total related TAMSCO amortization expense was $1,486 and $2,646
in the nine months ended July 31, 2005 and 2004, respectively.) Related
estimated amortization expense is $9,919 for the year ending October 31,
2005, $10,953 for the year ending October 31, 2006, $10,204 for the year
ending October 31, 2007, $7,001 for the year ending October 31, 2008 and
$4,879 for the year ending October 31, 2009.
13
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 may 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
the 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 July 31, 2005, the Company had $86
million in borrowings against the Amended Credit Facility, and was in
compliance with all applicable covenants.
NOTE H - CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories include accumulated contract
costs, estimated earnings thereon based upon the percentage of completion
method and contract inventories reduced by the contract value of delivered
items, as well as inventories related to contracts not accounted for using
the percentage of completion method which
14
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:
July 31, 2005 October 31, 2004
------------- ----------------
Raw materials $ 1,294 $ 1,874
Work-in-process 2,690 5,246
Finished goods 425 493
Inventories substantially applicable to
government contracts in process, less
progress payments of $49,604 and
$54,629 75,862 53,396
------- -------
$80,271 $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 July 31, 2005 by segment were $317,349 for Support
Systems and $391,514 for Support Services. Goodwill by segment as of July
31, 2005 totaled $136,515 for Support Systems and $188,445 for Support
Services.
15
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 Nine Months Ended
July 31 July 31
------------------- --------------------
2005 2004 2005 2004
---- ---- ---- ----
Net Revenues:
Support Systems $133,016 $134,907 $379,593 $376,735
Support Services 154,843 102,559 439,876 293,999
Intersegment Revenues (29,124) (15,475) (63,433) (43,477)
-------- -------- -------- --------
Total $258,735 $221,991 $756,036 $627,257
======== ======== ======== ========
Operating Income from Continuing Operations:
Support Systems $ 21,440 $ 24,317 $ 66,906 $ 71,634
Support Services 15,642 9,086 36,443 18,008
-------- -------- -------- --------
37,082 33,403 103,349 89,642
Interest expense, net 687 61 1,303 908
-------- -------- -------- --------
Income from continuing operations
before income taxes $ 36,395 $ 33,342 $102,046 $ 88,734
======== ======== ======== ========
Intersegment and intrasegment net revenues derived by ESSIbuy,
which is included in the Support Services segment, were accounted for on a
net basis prior to the quarter ended July 31, 2005. Beginning with the
quarter ended July 31, 2005, all such revenues are being accounted for on a
gross basis. Consolidated net revenues are unaffected by this change. As a
result, Support Services segment net revenues, as well as intersegment
revenues, have been restated for all prior periods.
NOTE J - SHAREHOLDERS' EQUITY
The following summary presents a reconciliation of total
shareholders' equity from October 31, 2004 to July 31, 2005:
Balance at October 31, 2004 $336,956
Comprehensive income:
Net income 62,220
Currency translation adjustments (38)
--------
Total comprehensive income 62,182
--------
Cash dividends (1,346)
Exercise of stock options 27,264
Issuance of common stock, including
$13,243 issued in conjunction
with the acquisition of Spacelink 22,490
--------
Balance at July 31, 2005 $447,546
========
16
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 nine months ended July 31, 2005 and 2004.
Three Months Ended
July 31
-----------------------------------------------
Other
Pension Benefits Postretirement Benefits
--------------------- -----------------------
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 818 $ 706 $ 54 $ 71
Interest cost 1,928 1,743 156 169
Expected return on plan assets (1,967) (1,823)
Amortization of prior service cost 178 78
Actuarial loss 1,103 641 115 110
------- ------- ---- ----
$ 2,060 $ 1,345 $325 $350
======= ======= ==== ====
Nine Months Ended
July 31
------------------------------------------------
Other
Pension Benefits Postretirement Benefits
--------------------- -----------------------
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 2,446 $ 2,119 $185 $ 212
Interest cost 5,704 5,228 470 507
Expected return on plan assets (5,694) (5,470)
Amortization of prior service cost 529 375
Actuarial loss 3,195 1,923 320 331
------- ------- ---- ------
$ 6,180 $ 4,175 $975 $1,050
======= ======= ==== ======
As of July 31, 2005, $6,250 of contributions have been made to
pension and
17
other postretirement benefit plans during 2005. The Company anticipates
contributing an additional $1,750 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 nine
months ended July 31, 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.
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 in the Company's Annual Report on Form 10-K for the year
ended October 31, 2004 for a discussion of the critical accounting policies
which we believe are most difficult, subjective or complex.
18
The following analysis should be read in this context.
RESULTS OF OPERATIONS
Consolidated net revenues increased $36.7 million, or 16.6%, to
$258.7 million in the third quarter of 2005 compared to $222.0 million in
the third quarter of 2004. $29.2 million of this $36.7 million increase was
generated by the Company's most recently acquired subsidiaries - Prospective
Computer Analysts Incorporated (PCA) which was acquired January 7, 2005,
Spacelink International, LLC (Spacelink) which was acquired February 1,
2005, and Mobilized Systems, Inc. (MSI) which was acquired May 1, 2005. The
remaining $7.5 million increase from existing operations included additional
revenues from refurbishment of M1000 Heavy Equipment Transporter ($8.5
million increase), the installation of vehicle uparmor kits ($22.6 million
increase) and the Rapid Response (R2) contract vehicle ($18.7 million
increase). These revenue increases were offset by reduced work on the 60-K
Tunner Aircraft Cargo Loader ($16.3 million decrease) as the production
phase of this long-term program ended in the quarter ended April 30, 2005,
reduced deliveries of the Manportable Surveillance and Target Acquisition
Radar (MSTAR) perimeter security program for which a large base security
subcontract with Northrup Grumman was completed in the fourth quarter of
2004 ($21.2 million decrease) and production delays on the Deployable Power
Generation and Distribution System (DPGDS), which had been encountering
performance issues on the primary power unit component of the program ($11.2
million decrease). In August 2005, the Company successfully completed
reliability testing on the primary power units. As a result, the Company's
U.S. Air Force customer has lifted a related stop work order on the 30
primary power units under the K3 portion of this contract, which had been
previously imposed on the Company. The Company's formal report on its
reliability testing will be issued to the U.S. Air Force in September 2005
and the Company expects that the evaluation of this report will result in
the removal of the stop work order on the remaining 65 primary power units
under the K4 portion of the DPGDS contract. As a result, the Company expects
that the DPGDS program will return to full rate production in the fourth
quarter of 2005. Gross profit for the quarter ended July 31, 2005 increased
$6.6 million, or 11.7%, to $63.4 million (24.5% of consolidated net
revenues) from $56.8 million (25.6% of consolidated net revenues) in the
comparable 2004 period. Substantially all of this gross profit increase
($6.2 million) was derived from the PCA, Spacelink and MSI acquisitions.
Selling, general and administrative expense increased $4.2 million, or 19.1%
in the third quarter of 2005 to $26.4 million (10.2% of consolidated net
revenues) from $22.1 million (10.0% of consolidated net revenues) in the
third quarter of 2004. Selling, general and administrative expense for PCA,
Spacelink and MSI accounted for $4.1 million of the $4.2 million increase.
As a result of the above, operating income from continuing
19
operations increased $3.7 million, or 11.0%, in the quarter ended July 31,
2005 to $37.1 million from $33.4 million in the third quarter of 2004.
Consolidated net revenues increased $128.7 million, or 20.5%, to
$756.0 million in the first nine months of 2005 compared to $627.3 million
in the first nine months of 2004. $55.6 million of this $128.7 million
increase was generated by the Company's most recently acquired subsidiaries
(PCA, Spacelink and MSI). The remaining $73.1 million increase from existing
operations included additional revenues from refurbishment of M1000 Heavy
Equipment Transporters ($24.3 million increase), the installation of vehicle
uparmor kits ($55.5 million increase) and the R2 contract vehicle ($49.3
million increase). These revenue increases were offset by reduced work on
the 60-K Tunner Aircraft Cargo Loader ($30.1 million decrease), reduced
MSTAR deliveries ($52.7 million decrease) and reduced DPGDS production
($14.2 million decrease). Gross profit for the nine months ended July 31,
2005 increased $24.8 million, or 15.8%, to $181.3 million (24.0% of
consolidated net revenues) from $156.5 million (25.0% of consolidated net
revenues) in the comparable 2004 period. Revenue growth of $128.7 million
resulted in the increase in gross profit. However, lower gross margins for
the first nine months 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 and increased estimated costs resulting from performance issues with
the primary power unit component of the DPGDS program. Selling, general and
administrative expense increased $12.5 million, or 19.0%, in the first nine
months of 2005 to $78.0 million (10.3% of consolidated net revenues) from
$65.5 million (10.4% of consolidated net revenues) in the first nine months
of 2004. Selling, general and administrative expense for PCA, Spacelink and
MSI accounted for $7.7 million of the $12.5 million increase, with the
remaining increase required to support higher operating levels. As a result
of the above, operating income from continuing operations increased $13.7
million, or 15.3%, in the first nine months of 2005 to $103.3 from $89.6
million in the first nine months of 2004.
20
SUPPORT SYSTEMS. Net revenues in the third quarter of 2005 for the
Support Systems segment totaled $133.0 million compared to $134.9 million
(prior to the elimination of intersegment revenues in each period) for the
same period in the prior year, a 1.4% decrease. The results for the quarter
ended July 31, 2005 reflect the inclusion of $9.4 million in incremental net
revenues from PCA and MSI. During the quarter the segment experienced a
$16.3 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 30, 2005, as well as a $21.2 million 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 by
an $8.5 million revenue increase from refurbishment of M1000 Heavy Equipment
Transporters and by a $20.1 million increase in intersegment work performed
for the Support Services segment. Gross profit for the segment decreased by
$3.8 million, or 9.5%, in the quarter ended July 31, 2005 to $36.1 million
(27.1% of segment revenues) from $39.9 million (29.6% of segment revenues)
in the prior year quarter as a result of the above revenue decreases, as
well as a shift to lower margin programs, in spite of a $2.8 million gross
profit contribution from PCA and MSI. Quarterly operating income for the
segment decreased to $21.4 million (16.1% of segment revenues) compared to
$24.3 million (18.0% of segment revenues) last year. Decreased revenues and
related gross profit reductions, despite a $0.9 million, or approximately
5.8%, decrease is segment selling, general and administrative expense led to
the lower results for the Support Systems segment.
Net revenues in the first nine months of 2005 for the Support
Systems segment totaled $379.6 million compared to $376.7 million (prior to
the elimination of intersegment revenues in each period) for the same period
in the prior year, a 0.8% increase. The results for the nine months ended
July 31, 2005 reflect the inclusion of $14.4 million in incremental net
revenues from PCA and MSI during the first nine months of 2005. During this
period, the segment experienced a $30.1 million revenue reduction on the
60-K Tunner Aircraft Cargo Loader and a $52.7 million revenue reduction
on the MSTAR program. These decreases were offset by a $24.3 million revenue
increase from refurbishment of M1000 Heavy Equipment Transporters and by a
$43.5 million increase in intersegment work performed for the Support
Services segment. Gross profit for the segment decreased by $2.5 million, or
2.2%, in the nine months ended July 31,
21
2005 to $111.3 million (29.3% of segment revenues) from $113.8 million
(30.2% of segment revenues) in the first nine months of the prior year, in
spite of a $4.4 million gross profit contribution from PCA and MSI. Segment
operating income for the nine months ended July 31, 2005 decreased to $66.9
million (17.6% of segment revenues) compared to $71.6 million (19.0% of
segment revenues) last year primarily as a result of gross profit reductions
and a $2.2 million increase in segment selling, general and administrative
expense.
SUPPORT SERVICES. Net revenues for the Support Services segment
increased to $154.8 million, an increase of $52.3 million, or 51.0%,
compared to $102.5 million (prior to the elimination of intersegment
revenues in each period) for the third quarter of 2005. The most significant
year-over-year revenue increases were generated by the R2 contract vehicle
($18.7 million) and the vehicle uparmor kit program ($22.6 million). In
addition, Spacelink (acquired effective February 1, 2005) added $19.8
million of incremental revenues in the third quarter of 2005. Offsetting
these increases were decreased revenues from the DPGDS program of $11.2
million. Gross profit for the segment increased by $10.7 million, or 63.2%,
in the quarter ended July 31, 2005 to $27.6 million (17.8% of segment
revenues) from $16.9 million (17.6% of segment revenues) in the prior year
quarter primarily as a result of increased revenues. Segment operating
income for the third quarter of 2005 totaled $15.6 million (10.1% of segment
revenues) compared to $9.1 million (8.9% 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 third quarter of 2005 was
constrained by a decrease of $5.2 million in DPGDS gross profit compared to
the third quarter of 2004. The Company expects that the DPGDS program will
return to full rate production in the fourth quarter of 2005.
Net revenues for the Support Services segment increased to $439.9
million, an increase of $145.9 million, or 49.6%, compared to $294.0 million
(prior to the elimination of intersegment revenues in each period) for the
first nine months of 2005. The most
22
significant year-over-year revenue increases were generated by the R2
contract vehicle ($49.3 million) and the vehicle uparmor kit program ($55.5
million). In addition, Spacelink added $41.1 million of incremental revenues
in the first nine months of 2005. Offsetting these increases were decreased
revenues from the DPGDS program of $14.2 million as previously discussed.
Gross profit for the segment increased by $27.6 million, or 64.5% in the
nine months ended July 31, 2005 to $70.3 million (16.0% of segment revenues)
from $42.7 million (15.7% of segment revenues) in the first nine months of
2004 primarily as a result of increased revenues. Segment operating income
for the first nine months of 2005 totaled $36.4 million (8.3% of segment
revenues) compared to $18.0 million (6.1% of segment revenues) in the same
period last year. The $145.9 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. Segment profitability was constrained by a decrease of
$7.5 million in DPGDS gross profit compared to the first nine months of
2004.
CONSOLIDATED RESULTS OF OPERATIONS. Net interest expense totaled
$0.7 million in the third quarter of 2005 compared to $0.1 million in the
third quarter of 2004 as a result of increased borrowing levels necessary
for the acquisitions of PCA, Spacelink and MSI in 2005. Net interest expense
totaled $1.3 million and $0.9 million for the nine months ended July 31,
2005 and 2004, respectively. The effective income tax rate was 38.0% for the
three and nine month periods ended July 31, 2005 compared to 38.5% for the
three and nine month periods ended July 31, 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 10.0% to $22.6 million (8.7% of consolidated net
revenues) in the quarter ended July 31, 2005 as compared to $20.5 million
(9.2% of consolidated net revenues) in the third quarter of 2004, and net
income from continuing operations increased 15.9% to $63.3 million (8.4% of
consolidated net revenues) in the first nine months of 2005 as compared to
$54.6 million (8.7% of consolidated net revenues) in the first nine months
of 2004.
23
Based on third 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.
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 nine months ended July 31, 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
24
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 nine months ended July 31, 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-
25
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 may 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
26
and acquisitions. As of July 31, 2005, the Company had $86.0 million in
borrowings against the Amended Credit Facility, and was in compliance with
all applicable covenants.
Effective May 1, 2005, the Company acquired all of the outstanding
stock of MSI, which designs, manufacturers and tests highly specialized
trailers, shelters and environmental control systems, primarily for the
defense industry. The purchase price was $17.5 million, net of cash
acquired. $15.7 million of the purchase price has been paid as of July 31,
2005, with an additional $1.0 million accrued as of that date related to the
final working capital adjustment. The remaining $0.8 million of
consideration is in the form of long-term promissory notes payable to the
sellers. The purchase price is being financed with short-term borrowings
under the Company's revolving credit facility. The fair value of assets
acquired, including goodwill of $12.7 million and customer-related
intangibles of $3.2 million, was $19.1 million and liabilities assumed
totaled $1.6 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.
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
27
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.
At July 31, 2005, the Company's working capital and ratio of
current assets to current liabilities were $44.0 million and 1.20 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, Spacelink and MSI acquisitions. Net
cash provided by operations totaled $59.2 million for the first nine months
of 2005 compared to net cash provided by operations of $19.0 million for the
first nine months of 2004. Investment in property, plant and equipment
totaled $7.7 million and $6.2 million for the first nine 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 nine months ended July 31, 2005 and 2004, the Company
received proceeds of $27.3 million and $56.3 million, respectively, related
to the exercise of stock options.
BUSINESS AND MARKET CONSIDERATIONS
Approximately 93% of consolidated net revenues for the nine months
ended July 31, 2005 were directly or indirectly derived from defense orders
by the U.S. government and its agencies. As of July 31, 2005, the Company's
funded backlog of orders totaled $612.8 million, with related customer
options of an additional $1,655.4 million. These amounts compare to funded
backlog of $588.1 million and related customer options of an additional
$849.2 million as of October 31, 2004.
The Company anticipates that 2006 revenues will approximate $1.20
to $1.25 billion, and that earnings per share from continuing operations
will approximate between $2.20 and $2.30.
Management continues to pursue potential acquisitions, primarily of
those companies providing strategic consolidation within the defense
industry.
28
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 July 31, 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 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.
29
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.
30
PART II
OTHER INFORMATION
Item 6 Exhibits
See Exhibit Index
31
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: September 9, 2005
------------------ By: /s/ Gerald A. Potthoff
----------------------------------
Gerald A. Potthoff
Vice Chairman and Chief Executive
Officer
Date: September 9, 2005
------------------ By: /s/ Gary C. Gerhardt
----------------------------------
Gary C. Gerhardt
Vice Chairman and Chief
Financial Officer
Date: September 9, 2005
------------------ By: /s/ Steven J. Landmann
----------------------------------
Steven J. Landmann
Senior Vice President - Controller
and Chief Accounting Officer
32
EXHIBIT INDEX
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 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.
10.3 Consulting Agreement with Ronald W. Davis dated June 1,
2005 filed as Exhibit 10.1 to the Company's Form 8-K filed
June 22, 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
33