/ /CONTENTS
Letter to the Shareholders.................1
Management's Discussion
and Analysis...............................3
Consolidated Financial
Statements.................................6
Supplemental Information..................16
Directors and
Officers...................INSIDE BACK COVER
SUMMARY OF SELECTED FINANCIAL DATA In thousands, except for per share data
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Year Ended October 31 1998 1997 1996 1995 1994
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RESULTS OF OPERATIONS:
Net revenues $96,973 $88,571 $81,507 $65,533 $56,619
Gross profit 22,630 14,755 12,414 10,745 8,145
Income from operations 10,242 7,668 5,936 5,016 2,085
Net interest expense (income) 1,474 (64) 434 895 828
Income before income taxes 9,647 7,732 5,522 4,121 1,257
Income tax provision 3,858 3,093 2,208 1,648 502
Net income 5,789 4,639 3,314 2,473 755
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FINANCIAL POSITION:
Working capital $18,210 $11,560 $ 8,354 $ 4,700 $ 3,120
Property, plant and equipment, net 25,065 14,490 14,097 14,601 15,290
Total assets 92,160 37,084 34,092 33,792 34,386
Long-term debt and ESOP bank loan 37,505 2,068 2,959 3,924 5,152
Shareholders' equity 30,166 23,726 19,251 15,217 13,330
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PER SHARE DATA:
Earnings (basic) $1.21 $.98 $ .72 $ .54 $ .15
Earnings (diluted) 1.16 .94 .68 .51 .14
Dividends .03 .02 .01 .01 .00
Shareholders' equity 6.22 4.98 4.06 3.40 2.81
Net revenues 19.43 17.88 16.70 13.39 10.68
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BACKLOG OF DEFENSE ORDERS:
Funded backlog $80,801 $44,114 $90,722 $90,385 $77,856
Government options on funded backlog 319,575 155,039 153,795 100,172 153,668
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/ /LETTER TO THE SHAREHOLDERS
Dear Shareholder:
1998 was an exciting year for Engineered Support Systems, Inc. The Company's
long-standing defense subsidiary substantially completed development on two
major contracts. A strategic acquisition secured the talents and facilities of
this subsidiary's heretofore most significant competitor. A second acquisition
allowed the Company to broaden its product offerings to the U.S. Navy, a
military branch not previously served by either the existing or acquired
defense operations. And finally, the Company's commercial plastics subsidiary
turned in another outstanding performance. As in each of the prior two years,
the Company's net revenues, net income and earnings per share increased to
record levels. However, the most exciting part of our 1998 results lies in the
fact that the Company enters 1999 in a stronger financial, operating and
strategic position than at any point in our history.
SUMMARY OF 1998
The Company reported net income of $5,789,000, or $1.16 per diluted common
share, on revenues of $97.0 million. This compares with net income of
$4,639,000, or $.94 per diluted common share, on revenues of $88.6 million in
1997. (All per share amounts give effect to a 3-for-2 stock split completed by
the Company on June 26, 1998).
Net revenues and operating income from military support and related
industrial/commercial equipment increased 9% and 26%, respectively, from the
prior year. These results represent the operations of three of the Company's
four subsidiaries: Engineered Air Systems, Inc. (Engineered Air), Keco
Industries, Inc. (Keco) and Engineered Coil Company, d/b/a Marlo Coil (Marlo
Coil). Much of Engineered Air's efforts in 1998 were focused on the development
of two key contracts: the Chemical and Biological Protected Shelter System
(CBPSS) and the Chemically/Biologically Hardened Air Management Plant (CHAMP).
These two programs represent $116 million, or 29%, of the Company's total
funded and unfunded backlog of defense orders at October 31, 1998. Both
contracts enter full-scale production in 1999. In addition, we believe that
significant market potential exists for chemical and biological defense
systems and related products, such as the CBPSS and CHAMP, because of the
growing awareness of the threat of chemical and biological warfare and
terrorism.
In February 1998, Engineered Coil Company, a wholly-owned subsidiary of the
Company, acquired substantially all of the net assets of Nuclear Cooling, Inc.,
d/b/a Marlo Coil, a manufacturer of heat transfer and air movement equipment
used by the U.S. Navy, as well as industrial and commercial customers. Acquired
for $25.4 million, Marlo Coil generated net revenues of $21.7 million for the
nine months of 1998 during which it was owned by the Company. Marlo Coil
provides not only solid and consistent operating results, but also the
opportunity for the Company to broaden its product offerings to the U.S. Navy,
Military Sealift Command and Coast Guard, customers not currently served by the
Company's other subsidiaries.
Keco was acquired for $26.7 million in June 1998, thereby enhancing the
Company's position as a significant supplier of ground support equipment to the
Department of Defense (DoD). Keco's net revenues totaled $14.8 million for the
four-month period of 1998 during which it was owned by the Company. In addition
to significant operational synergies, the Keco acquisition also brings with it
the largest contract in the Company's history. The contract for Field
Deployable Environmental Control Units (FDECU) entered production in the fourth
quarter of 1998 and represents $147 million, or 37%, of the Company's total
funded and unfunded backlog of defense orders at October 31, 1998.
While the acquisitions of Marlo Coil and of Keco have been immediately
accretive to earnings per share, we believe that both transactions add
significant long-term value to our shareholders. Because of the DoD's
continuing emphasis on "best value buying", whereby production quality and
engineering/design capabilities are emphasized, we believe the Company will
continue to be recognized as a preferred supplier during contract procurement
particularly in light of the added capabilities and streamlined cost structures
resulting from the two acquisitions.
Net revenues and operating income from the custom molded plastic products
operations of Engineered Specialty Plastics, Inc. (ESP) increased 12% and 53%,
respectively, to record levels in 1998. The significant earnings gain is
primarily a result of increased capacity utilization. During the year, ESP
invested $1.0 million in new equipment, primarily for two molding machines with
1200 and 610 tons of clamp pressure, respectively. The additional machines were
added to handle strong customer demand, which the Company anticipates will
continue through 1999 and beyond.
BALANCE SHEET RESHAPED
In order to finance the Marlo Coil and Keco acquisitions, the Company amended
its existing bank credit agreement in March 1998 to provide a $45.0 million
term loan and a $10.0 million revolving credit facility. The amended agreement
provides for a more favorable interest rate and for a five-year repayment
schedule on the term loan. As of October 31, 1998, the Company had a term loan
balance of $44.0 million after initiating principal payments in September, no
borrowings under the revolving credit facility and a cash balance of $5.8
million. Although total debt, including the ESOP guaranteed bank loan,
represented 48.5% of total assets at October 31, 1998 versus 5.8% in the prior
year, the Company believes that operational cash flows will be more than
sufficient to service the existing debt. In this regard, the Company generated
free cash flow (net income plus non-cash items less capital expenditures) of
$7.4 million in 1998 compared to $4.2 million in 1997. Free cash flow is
expected to increase significantly in future years as operational results for
Marlo Coil and Keco are included for the entire period, and as defense
production levels increase primarily as a result of the FDECU, CBPSS and CHAMP
contracts.
Working capital increased to $18.2 million at October 31, 1998 from $11.6
million in the prior year and the current ratio remained strong at 1.83 to 1 at
October 31, 1998. A portion of the working capital increase was due to $2.6
million of proceeds generated from the sale of property, plant and equipment,
primarily a facility previously leased to an unrelated third party. (An
after-tax gain on the sale of these assets totaling $0.5 million, or $.11 per
share, is included in 1998 net income). Total shareholders' equity increased to
$30.2 million, or $6.22 per share, at October 31, 1998 compared to $23.7
million, or $4.98 per share, at October 31, 1997.
ACQUISITION STRATEGY
We continue to believe that significant opportunities exist for consolidation
within the defense industry. The acquisitions of Marlo Coil and Keco have
allowed the Company to broaden our product lines and diversify our existing
customer base, while realizing cost savings from process improvements, greater
purchasing power and the elimination of duplicative costs. We will continue to
pursue strategic acquisitions within the defense industry. However, any
acquisition consummated by the Company must provide both accretion to earnings
per share and long-term shareholder value.
I would like to congratulate all of our employees and directors for another
outstanding performance in 1998. Your efforts have rewarded our shareholders
with an average annual return of 50.9% for the seven-year period ended December
31, 1998. I look forward to the challenge of continuing to provide significant
shareholder value in the years to come.
Sincerely,
/s/ Michael F. Shanahan Sr.
Michael F. Shanahan, Sr.
Chairman of the Board, President
and Chief Executive Officer
1 / /
/ /THE COMPANY
Engineered Support Systems, Inc. is a leading designer and manufacturer of
military support equipment and related products for the United States armed
forces. The Company also manufactures specialized commercial and industrial air
handling equipment, as well as injection molded plastic products. Existing
subsidiaries include Engineered Air Systems, Inc. (Engineered Air), Keco
Industries, Inc. (Keco), Engineered Coil Company, d/b/a Marlo Coil (Marlo Coil)
and Engineered Specialty Plastics, Inc. (ESP). Engineered Air, a manufacturer
of military support equipment based in St. Louis, Missouri, was formed on
December 24, 1981 and on March 30, 1982 acquired certain assets and liabilities
of the Defense Systems Division of Allis-Chalmers Corporation. ESP was acquired
on March 9, 1993. This subsidiary, located in Hot Springs, Arkansas,
manufactures injection molded plastic products and manufactures and distributes
a proprietary line of plastic faucets. On February 1, 1998, Engineered Coil
Company acquired substantially all of the net assets of Nuclear Cooling, Inc.,
d/b/a Marlo Coil, a manufacturer of heat transfer and air movement equipment
located in High Ridge, Missouri. Marlo Coil's products are sold to the U.S.
Navy through prime contractors, as well as to commercial and industrial
customers. On June 24, 1998, the Company acquired all of the outstanding stock
of Keco, which has operations in Florence, Kentucky and Blue Ash, Ohio. Like
Engineered Air, Keco designs and manufactures military support equipment.
MILITARY PRODUCTS
The Company's military support equipment is designed for rapid deployment to
remote locations and to meet stringent requirements with respect to durability,
reliability and portability that generally exceed standards for equipment
manufactured for commercial applications. While at any time the Company's
revenues depend upon several major contracts, over the last five years the
Company has provided over 40 distinct products to the Department of Defense
(DoD). The Company classifies its military products into five general
categories:
/ / Chemical and biological defense systems, which include the Chemical and
Biological Protected Shelter System (CBPSS), a contamination-free,
environmentally-controlled mobile field medical facility; the Micro-
Climatic Conditioning System (MCS), an on-board air filtration system for
Paladin tanks; and the Sanator/M-17, a lightweight chemical and biological
decontamination system.
/ / Environmental control systems, which include the Chemically/Biologically
Hardened Air Management Plant (CHAMP), initially designed for use by the
U.S. Air Force in chemically and biologically hardened air transportable
hospitals; the B-1B/B-2 and the C-5/MA-3D Flight Line Air Conditioners,
which are used to cool aircraft avionics and electronics systems during
pre-flight and post-flight checkouts and repairs; Field Deployable
Environmental Control Units (FDECU), which is a field deployable heat pump
for use in cooling, heating, dehumidifying, filtering and circulating air
for portable shelters, tents and vans; and fan coil units and assemblies,
air handling units, coils, product coolers and refrigeration plants for use
aboard U.S. Navy ships and military sealift and Coast Guard vessels.
/ / Petroleum and water systems, which include petroleum storage, distribution
and refueling equipment; water storage and distribution equipment; Airmobile
and Semi-trailer Mounted Petroleum Test Laboratories; and Reverse Osmosis
Water Purification Units (ROWPU), durable, mobile water purification systems
which provide safe drinking water, primarily to forces in the field.
/ / Containerized systems, which include Quadcon containers, transportable and
connectable containers for multi-use storage or transportation of bulk
products and a number of refrigerated container products.
/ / General support equipment, which include the Aviation and Ground Power Unit
(AGPU), a mobile self-contained, turbine driven ground power unit that
provides electrical, hydraulic and pneumatic power to aircraft on the flight
line; portable field latrines, laundry, shower and shave facilities for use
by forward deployed combat units; and deployable fire protection systems.
COMMERCIAL AND INDUSTRIAL PRODUCTS
Marlo Coil has been able to capitalize on its naval contracting experience to
design and manufacture a broad range of air handling and heat transfer
equipment for commercial and industrial applications. Such applications include
commercial and institutional buildings, civilian marine applications, and
pharmaceutical, semiconductor and telecommunications clean rooms.
ESP engineers and manufactures injection molded custom and specialty plastic
products for consumer and industrial markets. These products include housewares,
food handling totes, storage containers, medical devices, automotive equipment,
plastic components for computer terminals and telecommunications equipment and
a proprietary line of nonmetallic faucets. The Company's plastics manufacturing
operations are vertically integrated, with the facilities to both mold and
finish plastic to high quality specifications. The Company operates 33 injection
molding machines ranging in size from 45 to 2,200 tons of clamp pressure.
/ / 2
/ /MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
The Company has grown substantially in recent years as a result of both
internal growth and of two significant acquisitions in 1998. Effective February
1, 1998, the Company acquired substantially all of the net assets of Nuclear
Cooling, Inc., d/b/a Marlo Coil (Marlo Coil), a manufacturer of heat transfer
and air movement equipment, from an investor group for approximately $25.4
million. On June 24, 1998, the Company purchased all of the outstanding common
stock of Keco Industries, Inc. (Keco), a manufacturer of military ground
support equipment, from an investor group for approximately $26.7 million.
These two acquisitions were accounted for as purchase transactions. After
allocating the respective purchase price to the fair value of all identifiable
tangible and intangible assets, goodwill of $24.5 million was recognized and is
being amortized over an estimated life of 25 years. On a pro forma basis, the
Company's net revenues and net income for 1998 were $130.4 million and $6.1
million, respectively, compared to actual net revenues and net income for 1998
of $97.0 million and $5.8 million, respectively. Pro forma 1998 net revenues
and net income represent compound annual increases of 26.5% and 35.2%,
respectively, from actual 1996 net revenues of $81.5 million and net income of
$3.3 million.
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Year Ended October 31 1998 1997 1996
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RESULTS OF OPERATIONS
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 76.7 83.3 84.8
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Gross profit 23.3 16.7 15.2
Selling, general and administrative expense 12.8 8.0 7.9
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Income from operations 10.5 8.7 7.3
Interest expense (1.8) (0.3) (0.6)
Interest income 0.3 0.3 0.1
Gain on sale of assets 0.9 0.0 0.0
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Income before income taxes 9.9 8.7 6.8
Income tax provision 3.9 3.5 2.7
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Net income 6.0% 5.2% 4.1%
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The discussion set forth below analyzes certain factors and trends related to
the financial results for each of the three years ended October 31, 1998, 1997
and 1996. This discussion should be read in conjunction with the Consolidated
Financial Statements and Notes to the Consolidated Financial Statements.
1998 COMPARED TO 1997
Net revenues increased 9.5% in 1998 to $97.0 million from $88.6 million in
1997. Net revenues from military support and related industrial/commercial
equipment increased by $5.5 million in 1998 to $69.9 million from $64.4 million
in 1997. This increase was due to an additional $21.7 million of net revenues
generated by Marlo Coil during nine months of operations subsequent to its
acquisition and an additional $14.8 million of net revenues generated by Keco
during four months of operations subsequent to its acquisition. Engineered Air
Systems, Inc. (Engineered Air) experienced a decrease of $31.0 million in net
revenues due primarily to the fact that several significant Department of
Defense (DoD) contracts completed, or were nearing completion of, their
production cycles, including those for C-5/MA-3D Flight Line Air Conditioners,
Aviation Ground Power Units (AGPU), Revetment Kits and Harvest Falcon Water
Distribution Systems. Although several major contracts, primarily the
Chemical/Biological Protected Shelter System (CBPSS), the
Chemically/Biologically Hardened Air Management Plant (CHAMP) and the Field
Deployable Environmental Control Units (FDECU), underwent significant
development efforts during 1998, substantial revenues derived from the
production phase of the contracts will not begin until 1999. Net revenues from
sales of custom molded plastic products increased $2.9 million to $27.1 million
in 1998 from $24.2 million in 1997.
Gross profit for 1998 increased 53.4% to $22.6 million (23.3% of net
revenues) from $14.8 million (16.7% of net revenues) in 1997. The increase in
gross profit was a result of higher net revenues and gross margins at
Engineered Specialty Plastics, Inc. (ESP) and of the additions of Keco and
Marlo Coil, net of a decrease in gross profit at Engineered Air resulting from
a significant decrease in net revenues. The increase in gross margins was a
result of higher margins within the Company's historical operations (Engineered
Air and ESP) due to a more profitable mix of contracts and products, and of the
addition of Marlo Coil which generated gross margins above those provided by
the Company's historical operations.
Selling, general and administrative expense increased by $5.3 million to
$12.4 million (12.8% of net revenues) in 1998 from $7.1 million (8.0% of net
revenues) in 1997. This increase was due to the addition of selling, general
and administrative expense generated by Marlo Coil and Keco, including
additional goodwill amortization of $0.6 million.
Interest expense increased by $1.5 million to $1.8 million in 1998 as a
result of term debt incurred in conjunction with the Marlo Coil and Keco
acquisitions. Interest income was $0.3 million in both 1998 and 1997.
In 1998, the Company realized a $0.9 million gain primarily related to the
sale of a facility previously leased to an unrelated third party. Proceeds from
the sale of all property, plant and equipment totaled $2.6 million.
The effective income tax rate for 1998 and 1997 was 40.0% resulting in total
tax expense of $3.9 million in 1998 and $3.1 million in 1997. As a result of
the foregoing, the net income of the Company increased 24.8% to $5.8 million
(6.0% of net revenues) in 1998
3 / /
from $4.6 million (5.2% of net revenues) in 1997.
1997 COMPARED TO 1996
Net revenues in 1997 increased by 8.7% to $88.6 million from $81.5 million in
1996. Net revenues from military support equipment increased by $5.2 million to
$64.4 million in 1997 from $59.2 million in 1996, primarily as a result of
higher revenues generated from the AGPU contract. Net revenues from sales of
custom molded plastic products increased by $1.9 million to $24.2 million in
1997 from $22.3 million for 1996. The increase from sales of custom molded
plastic products was achieved in spite of reduced shipments of houseware
products in the fourth quarter of 1997 resulting from reduced orders from the
Company's largest custom molded plastics customer.
Gross profit in 1997 increased by 18.9% to $14.8 million (16.7% of net
revenues) from $12.4 million (15.2% of net revenues) in 1996. These increases
are primarily due to significantly higher margins from sales of custom molded
plastic products resulting primarily from increased capacity utilization.
Selling, general and administrative expense increased by $0.6 million to $7.1
million (8.0% of net revenues) in 1997 from $6.5 million (7.9% of net revenues)
in 1996. This increase was consistent with the growth in the Company's net
revenues.
Because of strong operational cash flow in 1997, the Company was able to
reduce total debt (excluding the ESOP guaranteed bank loan) from $2.7 million
at October 31, 1996 to $1.3 million at October 31, 1997 and to increase cash
and cash equivalents from $1.4 million at October 31, 1996 to $8.3 million at
October 31, 1998. As a result, interest expense decreased $0.3 million and
interest income increased $0.2 million in 1997.
The effective income tax rate for 1997 and 1996 was 40.0% resulting in total
tax expense of $3.1 million in 1997 and $2.2 million in 1996. As a result of
the foregoing, the net income of the Company increased by 40.0% to $4.6 million
(5.2% of net revenues) for 1997 from $3.3 million (4.1% of net revenues) in
1996.
OUTLOOK FOR 1999 AND FUTURE YEARS
Primarily due to the acquisitions of Keco and Marlo Coil, the Company's
funded backlog of defense orders increased to $80.8 million at October 31, 1998
from $44.1 million at October 31, 1997. In addition, government options on
existing defense contracts (unfunded backlog) increased to $319.6 million at
October 31, 1998 from $155.0 million at October 31, 1997. The Company expects
the majority of these options to be converted into funded backlog.
The Company anticipates that revenues and net income will increase in 1999.
These increases will be a result of the inclusion of Keco and Marlo Coil
operating results for the entire period, as well as the transition of several
major contracts from development to the production phase. The Company will
derive the most significant portion of its 1999 defense revenues from contracts
for the FDECU, B-1B Air Conditioners, the CHAMP, Army Space Heaters and the
CBPSS. The FDECU, CBPSS and CHAMP contracts represent $262.2 million, or 65%,
of the Company's total funded and unfunded backlog of defense orders at October
31, 1998 and, therefore, provide a significant base of revenues through their
respective contract lives.
ESP once again generated record levels of net revenues and earnings in 1998.
The Company anticipates that ESP's 1999 results will equal or exceed those
posted in 1998, and believes that significant growth potential remains within
both current and untapped markets.
The Company believes that significant opportunities continue to exist for
acquisitions within the defense industry. Although the Company believes an
acquisition may occur in 1999, any such transaction must be accretive to
earnings and must provide long-term value to our shareholders.
LIQUIDITY AND CAPITAL RESOURCES
In March 1998, the Company restated and amended its credit agreement to
provide a $45.0 million term loan to finance the acquisitions of Marlo Coil
and Keco and to provide a $10.0 million revolving credit facility. The Company
purchased Marlo Coil, net of cash acquired, for $25.3 million and purchased
Keco, net of cash acquired, for $24.1 million. The Company's primary sources
of short-term financing are from cost reimbursements under contracts with the
U.S. government via receipt of progress payments, billings for delivered
products and borrowings under the revolving line of credit. As of October 31,
1998, the Company had no borrowings against the revolving line of credit and
had a cash balance of $5.8 million.
The Company's working capital needs are generally funded through cash flow
from operations and the revolving line of credit. On October 31, 1998, the
Company's working capital and ratio of current assets to current liabilities
were $18.2 million and 1.83 to 1 as compared with $11.6 million and 2.34 to 1 a
year ago. The Company generated $5.4 million and $10.7 million in cash flow
from operations in 1998 and 1997, respectively, which was used, in part, to
finance investment in property, plant and equipment of $1.3 million and $2.0
million, respectively, and treasury stock purchases of $0.8 million and $1.0
million, respectively. In addition, $2.6 million of proceeds were generated in
1998 from the sales of a facility previously leased to an unrelated third party
and of machinery and equipment. (Related income taxes on these sales
approximated $0.3 million). $1.3 million of cash was also provided in 1998 from
the exercise of stock options.
The Company anticipates that capital expenditures in 1999 should not exceed
$2.0 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.
INFLATION
Since substantially all of the Company's contracts with the DoD are at fixed
prices, inflation can affect the ultimate profit to be realized on them. Some
contracts have price adjustment provisions that limit the impact of inflation
on profits. In addition, the Company's volume purchasing and forward purchasing
policies serve to limit the effects of inflation. The Company considers
potential inflation in preparation of contract proposals and bids. The
Company's commercial and industrial products as manufactured and sold by Marlo
Coil and ESP are predominantly custom-made. Therefore the impact of inflation
on operating results is typically not significant. The Company attempts to
alleviate inflationary pressures on commercial and industrial products by
increasing selling prices to help offset rising costs (subject to competitive
conditions), increasing productivity and improving manufacturing techniques.
Because of these factors, management does not believe that inflation has had,
or that anticipated inflation will have, a significant effect on the Company's
operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130), and
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" (SFAS 131), in June 1997,
and Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pension and Other Postretirement Benefits" (SFAS 132), in
February 1998. SFAS 130 establishes standards for the reporting and display of
the Company's components of comprehensive income in the financial statements.
SFAS 131 defines segments in terms of the Company's internal organization
structure. SFAS 132 revises employers' disclosures about pension and other
postretirement benefit
/ / 4
plans. The Company will adopt these statements for fiscal year 1999. The
adoption of these statements will have no impact on the Company's operating
results, statement of financial position or cash flows, as SFAS 130, 131
and 132 provide standards on financial statement disclosure only.
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS 133), was issued in June
1998. SFAS 133 provides standards on accounting and disclosure for derivative
instruments and requires that all derivatives be measured at fair value and
reported as either assets or liabilities in the statement of financial
position. The Company is required to adopt this statement no later than the
beginning of fiscal year 2000. The adoption of this statement will have no
impact on the Company's operating results, statement of financial position or
cash flows, as the Company does not invest in derivative instruments.
YEAR 2000 READINESS DISCLOSURE
The Company is dependent upon its software programs and operating systems for
internal operations and for processing product orders with its customers and
suppliers. The Company has completed its assessment of the potential impact of
the Year 2000 on the Company's programs and systems. The Company manages its
information systems on a decentralized basis with stand-alone systems located
at each of its operating subsidiaries. The Company expects to complete the
remediation and testing of its information systems by September 30, 1999. Such
remediation efforts primarily relate to the repair of, as opposed to the
replacement of, affected systems. The Company expects to incur costs no greater
than $0.3 million, of which approximately $0.1 million has been incurred
through October 31, 1998, in order to make the Company's software programs and
operating systems Year 2000 compliant.
The Company currently is unable to ascertain the magnitude of any Year 2000
problems that may exist in the software programs and operating systems of its
customers and suppliers, or the impact that any such problems could have on the
sales made and services provided by the Company to such customers or suppliers.
However, the Company's customer base is limited to a relatively small number of
customers with a relatively small number of purchase and sales transactions.
Also, the Company is not highly dependent upon electronic data interchange with
its vendors or suppliers. In the case of Year 2000 related failures, the
Company believes it can sustain manufacturing operations through manual
processes. The occurrence of Year 2000 related failures in the software
programs and operating systems of any of the Company's significant customers,
primarily the DoD and other U.S. government agencies, or suppliers could have a
material adverse effect on the Company's business, results of operations or
financial condition in subsequent periods, especially if it results in delays
in payments due the Company. The Company is diligently quantifying issues and
developing contingency sources to mitigate the risks associated with
interruptions in its business due to Year 2000 problems. Such contingencies
include obtaining necessary financing in the event the U.S. government is
unable to meet its scheduled payments.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report includes certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended, which are intended to be covered by the safe harbors created
thereby. The forward-looking statements involve certain risks and
uncertainties, including, but not limited to 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, increased competition in the Company's
markets and the impact of any Year 2000 problems, which could cause the
Company's actual results to differ materially from those projected in, or
inferred by, the forward-looking statements.
REVENUES BY PRODUCT CLASSIFICATION (in millions)
The following table sets forth net revenues for the years ended October 31,
1998, 1997 and 1996 from each of the Company's product classifications:
- ---------------------------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
Military Support and Related Industrial/
Commercial Equipment:
Environmental Control Systems $43.4 44.7% $22.8 25.7% $27.4 33.6%
Petroleum and Water Systems 4.5 4.6 8.2 9.3 15.0 18.4
Chemical and Biological Defense Systems 4.8 4.9 5.0 5.6 -- --
General Support Equipment 17.2 17.9 28.4 32.1 16.8 20.6
- ---------------------------------------------------------------------------------------------------------------------------------
69.9 72.1 64.4 72.7 59.2 72.6
Custom Molded Plastic Products 27.1 27.9 24.2 27.3 22.3 27.4
- ---------------------------------------------------------------------------------------------------------------------------------
Total $97.0 100.0% $88.6 100.0% $81.5 100.0%
- ---------------------------------------------------------------------------------------------------------------------------------
Fluctuations in 1998 revenues by product classification are due, in part,
to the acquisitions of Keco and Marlo Coil. Other fluctuations between
periods result primarily from changes in DoD requirements. As a result,
year-to-year comparisons of revenue by product may not be meaningful.
5 / /
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------------------
October 31 1998 1997
- --------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 5,773,529 $ 8,313,160
Accounts receivable, net 14,036,184 3,398,973
Contracts in process and inventories, net 18,686,810 7,072,377
Refundable income taxes 971,925 175,989
Deferred income taxes 112,685 1,062,281
Prepaid expenses and other assets 458,363 185,350
- --------------------------------------------------------------------------------------------
Total Current Assets 40,039,496 20,208,130
PROPERTY, PLANT AND EQUIPMENT
Land 1,833,320 769,798
Buildings and improvements 15,330,883 10,389,127
Machinery and equipment 20,580,343 17,474,282
Furniture and fixtures 1,215,762 624,078
- --------------------------------------------------------------------------------------------
38,960,308 29,257,285
Less accumulated depreciation 13,895,326 14,767,236
- --------------------------------------------------------------------------------------------
25,064,982 14,490,049
OTHER ASSETS
Cost in excess of net assets acquired, less accumulated
amortization of $1,073,176 and $410,396 25,835,892 648,370
Other assets 1,219,852 1,737,505
- --------------------------------------------------------------------------------------------
27,055,744 2,385,875
- --------------------------------------------------------------------------------------------
TOTAL ASSETS $92,160,222 $37,084,054
- --------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 7,204,172 $ 73,273
Accounts payable 7,285,396 5,596,760
Accrued employee compensation 2,503,745 1,342,054
Other liabilities 3,642,852 1,636,353
Due to related party (Note B) 1,193,797
- --------------------------------------------------------------------------------------------
Total Current Liabilities 21,829,962 8,648,440
LONG-TERM DEBT 36,779,160 1,194,433
DEFERRED INCOME TAXES 2,659,699 2,642,295
ESOP GUARANTEED BANK LOAN 725,700 873,300
Commitments and contingencies (Note J)
SHAREHOLDERS' EQUITY
Common stock, par value $.01 per share; 10,000,000 shares
authorized; 5,490,604 and 3,772,573 shares issued 54,906 37,726
Additional paid-in capital 11,082,278 9,698,665
Retained earnings 23,682,931 18,026,195
- --------------------------------------------------------------------------------------------
34,820,115 27,762,586
Less ESOP guaranteed bank loan 725,700 873,300
Less treasury stock at cost, 638,702 and 598,858 shares 3,928,714 3,163,700
- --------------------------------------------------------------------------------------------
Total Shareholders' Equity 30,165,701 23,725,586
- --------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $92,160,222 $37,084,054
- --------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
/ / 6
CONSOLIDATED STATEMENTS OF INCOME
- ----------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Net revenues $96,972,886 $88,570,970 $81,506,943
Cost of revenues 74,343,103 73,816,030 69,093,075
- ----------------------------------------------------------------------------------------------------------------
Gross profit 22,629,783 14,754,940 12,413,868
Selling, general and administrative expense 12,387,419 7,087,026 6,477,851
- ----------------------------------------------------------------------------------------------------------------
Income from operations 10,242,364 7,667,914 5,936,017
Interest expense (1,767,640) (221,987) (472,258)
Interest income 293,379 286,019 38,110
Gain on sale of assets 879,278 20,339
- ----------------------------------------------------------------------------------------------------------------
Income before income taxes 9,647,381 7,731,946 5,522,208
Income tax provision 3,858,000 3,093,000 2,208,000
- ----------------------------------------------------------------------------------------------------------------
Net income $ 5,789,381 $ 4,638,946 $ 3,314,208
- ----------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic $1.21 $.98 $.72
Diluted $1.16 $.94 $.68
- ----------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------------
Additional ESOP
Common Paid-In Retained Guaranteed Treasury
Stock Capital Earnings Bank Loan Stock Total
- -----------------------------------------------------------------------------------------------------------------------
Balance at October 31, 1995 $34,570 $ 7,917,844 $10,217,090 $(1,168,500) $(1,784,380) $15,216,624
Net income 3,314,208 3,314,208
Cash dividends (65,604) (65,604)
Exercise of stock options 2,303 1,051,464 1,053,767
Reduction of ESOP guaranteed
bank loan 147,600 147,600
Purchase of treasury stock (471,382) (471,382)
Issuance of treasury stock to ESOP 29,181 26,822 56,003
- -----------------------------------------------------------------------------------------------------------------------
Balance at October 31, 1996 36,873 8,998,489 13,465,694 (1,020,900) (2,228,940) 19,251,216
Net income 4,638,946 4,638,946
Cash dividends (78,445) (78,445)
Exercise of stock options 853 628,581 629,434
Reduction of ESOP guaranteed
bank loan 147,600 147,600
Purchase of treasury stock (957,091) (957,091)
Issuance of treasury stock to ESOP 71,595 22,331 93,926
- -----------------------------------------------------------------------------------------------------------------------
Balance at October 31, 1997 37,726 9,698,665 18,026,195 (873,300) (3,163,700) 23,725,586
Net income 5,789,381 5,789,381
Cash dividends (132,645) (132,645)
Exercise of stock options 1,198 1,263,526 1,264,724
Reduction of ESOP guaranteed
bank loan 147,600 147,600
Three-for-two stock split 15,982 (15,982)
Purchase of treasury stock (802,349) (802,349)
Issuance of treasury stock to ESOP 136,069 37,335 173,404
- -----------------------------------------------------------------------------------------------------------------------
Balance at October 31, 1998 $54,906 $11,082,278 $23,682,931 $ (725,700) $(3,928,714) $30,165,701
- -----------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
7 / /
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 5,789,381 $ 4,638,946 $ 3,314,208
Adjustments to reconcile net income to net cash provided
by operations:
Depreciation and amortization 2,812,585 1,897,832 1,849,807
Deferred income taxes 967,000 (385,000) (385,000)
Gain on sale of assets (879,278) (20,339)
- --------------------------------------------------------------------------------------------------------------------
Cash provided before changes in operating assets and
liabilities, excluding the effects of acquisitions 8,689,688 6,151,778 4,758,676
Changes in operating assets and liabilities:
Accounts receivable (1,543,761) 1,456,357 (1,344,734)
Contracts in process and inventories (1,169,062) 2,942,250 2,102,852
Accounts payable (698,894) (237,694) (1,868,487)
Current income taxes (795,936) (87,503) (166,635)
Net changes in other assets and liabilities 870,462 522,524 55,647
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operations 5,352,497 10,747,712 3,537,319
- --------------------------------------------------------------------------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of Marlo Coil, net of cash acquired (25,344,103)
Purchase of Keco Industries, net of cash acquired (24,092,537)
Purchase of McIntyre Engineering (1,512,388)
Additions to property, plant and equipment (1,331,147) (1,987,322) (1,145,395)
Proceeds from sale of property, plant and equipment 2,578,027 102,421
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (49,702,148) (1,987,322) (1,042,974)
- --------------------------------------------------------------------------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES
Payments under line-of-credit agreement (1,075,961) (1,124,041)
Proceeds of long-term debt 45,000,000
Payments of long-term debt (2,443,749) (1,456,901) (857,921)
Exercise of stock options 1,264,724 629,434 1,053,767
Purchase of treasury stock (802,349) (957,091) (471,382)
Cash dividends (132,645) (78,445) (65,604)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 41,810,020 (1,863,003) (1,465,181)
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (2,539,631) 6,897,387 1,029,164
Cash and cash equivalents at beginning of year 8,313,160 1,415,773 386,609
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 5,773,529 $ 8,313,160 $ 1,415,773
- --------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
/ / 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation: The consolidated
financial statements include the accounts of Engineered Support Systems, Inc.
(Company) and its wholly owned subsidiaries, Engineered Air Systems, Inc.
(Engineered Air), Keco Industries, Inc. (Keco), Engineered Coil Company, d/b/a
Marlo Coil (Marlo Coil), and Engineered Specialty Plastics, Inc. (ESP). All
material intercompany accounts and transactions have been eliminated in
consolidation.
Use of Estimates: In preparing these financial statements, management makes
estimates and uses assumptions that effect some of the reported amounts and
disclosures. Actual results could differ from these estimates and assumptions.
Revenue Recognition: Revenues on long-term contracts performed by Engineered
Air and Keco, substantially all of which are with the U.S. government, are
recognized under the percentage of completion method and include a proportion
of the earnings that are expected to be realized on the contract in the ratio
that production costs incurred bear to total estimated production costs.
Earnings expectations are based upon estimates of contract values and costs at
completion. Contracts in process are reviewed on a periodic basis. Adjustments
to revenues and earnings are made in the current accounting period based upon
revisions in contract values and estimated costs at completion. Provisions for
estimated losses on contracts are recorded when identified. Marlo Coil and ESP
recognize revenue when products are shipped. Allowances for anticipated
doubtful accounts are provided based on historical experience and evaluation of
specific accounts. The allowance for doubtful accounts was $273,000 and
$283,000 at October 31, 1998 and 1997, respectively.
Fair Value of Financial Instruments: For purposes of financial reporting, the
Company has determined that the fair value of the Company's financial
instruments, including cash and cash equivalents, accounts receivable and
long-term debt, approximates book value at October 31, 1998 and 1997, based on
terms currently available to the Company in financial markets.
Credit Risk: Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents,
and accounts receivable. At October 31, 1998 and 1997, the Company's cash and
cash equivalents were primarily invested in money market accounts at a
financial institution. Management believes the credit risk is limited due to
the short-term nature of these funds. Management believes the credit risk
related to accounts receivable is limited due to the fact that 52% and 42%,
respectively, of accounts receivable at October 31, 1998 and 1997 are due from
the U.S. government and its agencies, and due to the adequacy of the Company's
allowance for doubtful accounts.
Contracts in Process and Inventories: Contracts in process and inventories
represent accumulated contract costs, estimated earnings thereon based upon the
percentage of completion method and contract inventories reduced by the
contract value of delivered items of Engineered Air and Keco. Inventories of
Marlo Coil and ESP are valued at the lower of cost or market using the
first-in, first-out method.
Accumulated contract costs and inventories are stated at actual costs incurred
and consist of direct engineering, production, tooling, applicable overhead and
other costs (excluding selling, general and administrative costs which are
charged against income as incurred). Title to or a security interest in certain
items included in contracts in process and inventories is vested in the U.S.
government by reason of the progress payment provisions of related contracts.
In accordance with industry standards, contracts in process and inventories
related to long-term contracts are classified as current assets although a
portion may not be realized within one year.
Property, Plant and Equipment: Property, plant and equipment are stated at cost
and are depreciated using the straight-line method over their estimated useful
lives of 15 to 40 years for buildings and improvements, 5 to 15 years for
machinery and equipment and 3 to 10 years for furniture and fixtures.
Income Taxes: The income tax provision is based on earnings reported in the
financial statements. Deferred income taxes are provided for the tax effects of
temporary differences between financial and income tax reporting using current
statutory tax rates.
Cost in Excess of Net Assets Acquired: The excess of cost over net assets
acquired in purchase transactions is being amortized on a straight-line basis
over approximately 25 years.
Cash and Cash Equivalents: Cash equivalents include temporary investments with
original maturities of three months or less.
Earnings Per Share: Basic earnings per share for 1998, 1997 and 1996 is based
on average basic common shares outstanding, after the effect of the stock split
described in Note K, of 4,785,335, 4,753,265 and 4,592,858, respectively.
Diluted earnings per share for 1998, 1997 and 1996 is based on average diluted
common shares outstanding, after the effect of the stock split described in
Note K, of 4,991,453, 4,954,787 and 4,879,944, respectively. Average diluted
common shares outstanding include common stock equivalents, which represent
common stock options as computed based on the treasury stock method.
Treasury Stock: Shares of treasury stock are valued at cost using the first-in,
first-out method.
Impairment of Long-Lived Assets: Long-lived assets, including goodwill, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. If the sum of the expected
future undiscounted cash flows is less than the carrying amount of the asset, a
loss is recognized for the difference between the fair value and the carrying
value of the asset.
Industry Information: Engineered Air and Keco operate predominately in one
segment--military ground support equipment--and substantially all revenues for
these subsidiaries are related to contracts with the U.S. government. Marlo
Coil manufactures and sells heat transfer and air movement equipment primarily
to defense contractors, mechanical contractors and industrial users. ESP
manufactures and sells made-to-order injection molded plastic products, and
manufactures and distributes a proprietary line of kitchen and bathroom
faucets.
Recently Issued Accounting Pronouncements: The Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS 130), and Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" (SFAS 131), in June 1997, and Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pension and Other
Postretirement Benefits" (SFAS 132), in February 1998. SFAS 130 establishes
standards for the reporting and display of the
9 / /
Company's components of comprehensive income in the financial statements. SFAS
131 defines segments in terms of the Company's internal organization structure.
SFAS 132 revises employers' disclosures about pension and other postretirement
benefit plans. The Company will adopt these statements for fiscal year 1999.
The adoption of these statements will have no impact on the Company's operating
results, statement of financial position or cash flows, as SFAS 130, 131 and
132 provide standards on financial statement disclosure only. Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133) was issued in June 1998. SFAS 133 provides
standards on accounting and disclosure for derivative instruments, and requires
that all derivatives be measured at fair value and reported as either assets or
liabilities in the statement of financial position. The Company is required to
adopt this statement no later than the beginning of fiscal year 2000. The
adoption of this statement will have no impact on the Company's operating
results, statement of financial position or cash flows, as the Company does not
invest in derivative instruments.
NOTE B -- ACQUISITIONS
Effective February 1, 1998, Engineered Coil Company, a wholly-owned subsidiary
of the Company, acquired substantially all of the net assets of Nuclear
Cooling, Inc., d/b/a Marlo Coil, a manufacturer of heat transfer and air
movement equipment, from an investor group for approximately $25.4 million. The
fair value of the assets acquired, including goodwill of $17.1 million, was
$31.0 million and liabilities assumed totaled $5.6 million. The purchase price
was financed with approximately $2.9 million of available cash resources and
bank term debt of $22.5 million. The operating results of Engineered Coil
Company (Marlo Coil) are included in the Company's consolidated results of
operations from the date of acquisition.
On May 29, 1998, Marlo Coil purchased the exclusive rights to manufacture and
distribute the U.S. Navy/Marine products of Edge Electronics Corporation, d/b/a
McIntyre Engineering, for approximately $1.5 million. The fair value of the
assets acquired was $1.5 million, including goodwill of $1.4 million and a
seven-year covenant not to compete of $0.1 million. The purchase price was
financed with available cash resources.
On June 24, 1998, the Company purchased all of the outstanding common stock of
Keco Industries, Inc. (Keco), a manufacturer of military ground support
equipment, from an investor group for approximately $26.7 million. ($1.2
million of this amount relates to consideration to be paid to Keco's previous
shareholders in order for the Company to elect treatment of the transaction as
an asset purchase pursuant to Section 338(h)(10) of the Internal Revenue Code.
This election allows the Company to generate deductions for goodwill
amortization and additional depreciation for federal income tax purposes.
Section 338(h)(10) consideration to be paid is reflected on the October 31,
1998 Consolidated Balance Sheet as Due to Related Party.) The fair value of the
assets acquired, including goodwill of $7.4 million, was $29.6 million and
liabilities assumed totaled $2.9 million. The purchase price was financed with
approximately $4.2 million of available cash resources and bank term debt of
$22.5 million. The operating results of Keco are included in the Company's
consolidated results of operations from the date of acquisition.
The following unaudited pro forma summary presents the combined historical
results of operations for the years ended October 31, 1998 and 1997 as adjusted
to reflect the purchase transactions assuming the acquisitions had occurred at
November 1, 1996. These pro forma results are not necessarily indicative of the
combined results that would have occurred had the acquisitions actually taken
place on November 1, 1996, nor are they necessarily indicative of the combined
results that may occur in the future.
- ------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997
- ------------------------------------------------------------------------------------------------------------
Net revenues $130,422,267 $156,659,400
- ------------------------------------------------------------------------------------------------------------
Net income $ 6,063,501 $ 6,183,958
- ------------------------------------------------------------------------------------------------------------
Basic earnings per share $1.27 $1.30
- ------------------------------------------------------------------------------------------------------------
Diluted earnings per share $1.21 $1.25
- ------------------------------------------------------------------------------------------------------------
NOTE C -- ACCOUNTS RECEIVABLE
Accounts receivable includes amounts due from the U.S. government of $7,388,364
and $1,561,696 at October 31, 1998 and 1997, respectively.
NOTE D -- CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories are comprised of the following:
- ----------------------------------------------------------------------------------------------------------
October 31 1998 1997
- ----------------------------------------------------------------------------------------------------------
Raw materials $ 4,578,766 $1,535,860
Work-in-process 1,397,593 167,043
Finished goods 845,607 804,956
Inventories substantially applicable to government contracts
in process,reduced by progress payments of $15,932,239 and
$9,333,930 11,864,844 4,564,518
- ----------------------------------------------------------------------------------------------------------
$18,686,810 $7,072,377
- ----------------------------------------------------------------------------------------------------------
Contracts in process and inventories at October 31, 1998 and 1997 include
estimated revenue of $18,256,000 and $12,204,000, respectively, representing
accumulated contract costs and related estimated earnings on uncompleted
government contracts.
NOTE E -- NOTES PAYABLE AND LONG-TERM DEBT
In March 1998, the Company amended its bank credit agreement to provide a $45.0
million term loan and a $10.0 million revolving credit facility. Monthly
principal payments on the term loan began in September 1998 with final payment
due in May 2003. Borrowings under the term loan and the
/ / 10
revolving credit facility are subject to interest, at the Company's option, at
either the London Interbank Offered Rate (LIBOR) plus an applicable margin or
at the prime rate less 0.5%. The margin applicable to LIBOR varies from 0.5% to
1.5% depending upon the Company's ratio of total indebtedness to earnings
before interest, taxes, depreciation and amortization (leverage ratio). At
October 31, 1998, the effective interest rate under the credit agreement was
6.47%, and the Company had $10.0 million of availability under the revolving
credit facility, which carries an unused commitment fee of 0.125%. The credit
agreement contains certain covenants, including maintaining tangible net worth
of at least $23.7 million plus 50% of quarterly net income after April 30,
1998, and maintaining a leverage ratio no greater than 3.5 to 1 through October
31, 1999, no greater than 3.0 to 1 from October 31, 1999 to October 31, 2000
and no greater than 2.5 to 1 subsequent to October 31, 2000. Pursuant to the
terms of the credit agreement, the Company is subject to various other
financial and operating covenants and maintenance criteria, including
restrictions on the Company's ability to incur additional indebtedness, make
capital expenditures, create liens, dispose of material assets and enter into
merger transactions and lease agreements, and requirements to maintain certain
levels of consolidated cash flows, fixed charge coverage and consolidated
current ratios. At October 31, 1998, the Company was in compliance with all
restrictive covenants of its amended credit agreement. No compensating balance
is required or maintained related to the agreement.
Industrial revenue bonds in the amount of $750,000 were issued in September
1982 for construction of Keco's office building and primary manufacturing
facility. The bonds require the Company to make quarterly payments of principal
and interest through 2002 at a variable interest rate (5.695% at October 31,
1998). The bonds provide the Company with the option to purchase the facility
for a nominal amount when fully paid.
Long-term debt consists of:
- ---------------------------------------------------------------------------------------------------------
October 31 1998 1997
- ---------------------------------------------------------------------------------------------------------
Term loan, variable rate equal to the lesser of LIBOR plus
applicable margin or prime rate less 0.5%, payable in
monthly installments of principal plus interest, with a
final payment of $1,333,328 in 2003 $43,833,332
Industrial revenue bonds, variable rate, payable in
quarterly installments of $9,375 plus interest, due 2002 150,000
Installment note, 8.0%, payable in monthly installments of
$14,335 including interest $1,267,706
- ---------------------------------------------------------------------------------------------------------
43,983,332 1,267,706
Less current maturities 7,204,172 73,273
- ---------------------------------------------------------------------------------------------------------
$36,779,160 $1,194,433
- ---------------------------------------------------------------------------------------------------------
The Company has guaranteed a bank term loan for the Engineered Support Systems,
Inc. Employee Stock Ownership Plan (ESOP). As loan payments are made, shares,
which had been purchased with proceeds from the loan, are released and
allocated to participant accounts. The bank holds the unallocated shares as
collateral for the loan. The loan, which matures in August 2003, bears interest
at the bank's prime rate and is payable in monthly installments of $12,300 plus
interest. Under the terms of the loan agreement, the Company is required to
make contributions to the ESOP in an amount no less than the amount sufficient
to fund the monthly installments.
Borrowings under the revolving credit facility, the bank term loan and the ESOP
loan are secured by substantially all assets of the Company and its
subsidiaries and are guaranteed by the Company. Annual principal payments of
long-term debt are $7,204,172 in 1999, $8,204,160 in 2000, $9,037,500 in 2001,
$10,204,168 in 2002 and $9,333,332 in 2003. Interest paid was $1,828,000,
$158,000 and $531,000 in 1998, 1997 and 1996, respectively.
NOTE F -- INCOME TAXES
The income tax provision is comprised of the following:
- -----------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
Current:
Federal $2,526,000 $3,170,000 $2,380,000
State 365,000 308,000 213,000
- -----------------------------------------------------------------------------------------------------------------
2,891,000 3,478,000 2,593,000
- -----------------------------------------------------------------------------------------------------------------
Deferred:
Federal 874,000 (327,000) (327,000)
State 93,000 (58,000) (58,000)
- -----------------------------------------------------------------------------------------------------------------
967,000 (385,000) (385,000)
- -----------------------------------------------------------------------------------------------------------------
$3,858,000 $3,093,000 $2,208,000
- -----------------------------------------------------------------------------------------------------------------
The deferred income tax provision (benefit) results from the following
temporary differences:
- -----------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------
Uncompleted contracts $ 813,000 $ (23,000) $ (332,000)
Depreciation (328,000) (229,000) 18,000
Contributions to employee benefit plans 222,000 (60,000) (56,000)
Other, net 260,000 (73,000) (15,000)
- -----------------------------------------------------------------------------------------------------------------
$ 967,000 $ (385,000) $ (385,000)
- -----------------------------------------------------------------------------------------------------------------
11 / /
Deferred tax liabilities (assets) are comprised of the following:
- ----------------------------------------------------------------------------------------------
October 31 1998 1997
- ----------------------------------------------------------------------------------------------
Depreciation $2,740,000 $3,040,000
Contract revenue 393,000 (460,000)
Employee benefits (124,000) (354,000)
Asset reserves (182,000) (268,000)
Net operating loss and tax credit carryforwards (195,000) (273,000)
Other (85,000) (105,000)
- ----------------------------------------------------------------------------------------------
$2,547,000 $1,580,000
- ----------------------------------------------------------------------------------------------
A reconciliation between the income tax provision and the annual amount
computed by applying the statutory federal income tax rate to income before
income taxes is as follows:
- ----------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Income tax provision at statutory federal rate $3,280,000 $2,629,000 $1,878,000
State income taxes and other, net 578,000 464,000 330,000
- ----------------------------------------------------------------------------------------------------------------
$3,858,000 $3,093,000 $2,208,000
- ----------------------------------------------------------------------------------------------------------------
Income taxes paid were $3,081,000, $3,228,000 and $2,239,000 in 1998, 1997 and
1996, respectively.
As of October 31, 1998, the Company had net operating loss carryforwards of
approximately $13,000 available to offset future taxable income, and investment
and targeted jobs tax credit carryforwards of approximately $190,000 available
to offset future federal income taxes which would otherwise be payable. These
carryforwards, which relate to ESP, expire in 2003. The Company expects the
carryforwards to be fully utilized and, accordingly, has recorded a deferred
tax asset relating to the carryforwards.
NOTE G -- SHAREHOLDERS' EQUITY
The Company has established plans whereby options may be granted to employees
and directors of the Company to purchase shares of the Company's common stock.
Options granted are at an option price equal to the market value on the date
the option is granted. Subject to continuation of employment, all options must
be exercised within five years from the date of grant and are exercisable at
any time during this period. As of October 31, 1998, 869,038 shares of unissued
common stock were authorized and reserved for outstanding options, which had a
weighted average remaining contractual life of 3.7 years at that date.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations in accounting for the
stock option plans. Accordingly, no compensation expense has been recognized
for stock option awards. Had compensation expense for the Company's stock
option awards been determined based upon their grant date fair value consistent
with the methodology prescribed under Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), the
Company's net income would have been reduced by $825,000, or $.17 per average
diluted common share outstanding, in 1998 and $219,000, or $.04 per average
diluted common share outstanding, in 1997. The fair value of options at the
grant date was estimated using the Black-Scholes model with the following
weighted average assumptions for 1998 and 1997, respectively: an expected life
of 3.2 years and 3.6 years, volatility of 50% and 42%, a dividend yield of
0.30% and 0.17%, and a risk-free interest rate of 4.67% and 6.06%. The weighted
average fair value of options granted in 1998 and 1997 was $5.13 and $2.53,
respectively. Transactions involving the stock option plans are as follows:
- ----------------------------------------------------------------------------------------------------
Shares Price per share
- ----------------------------------------------------------------------------------------------------
Outstanding at October 31, 1996 320,250 $1.25 to $6.42
Options granted 144,000 $6.50 to $8.25
Options exercised (127,950) $1.00 to $8.25
- ----------------------------------------------------------------------------------------------------
Outstanding at October 31, 1997 336,300 $1.25 to $8.25
Options granted 268,000 $10.46 to $15.00
Options exercised (143,500) $1.25 to $15.00
Options canceled (1,500) $15.00
- ----------------------------------------------------------------------------------------------------
Outstanding at October 31, 1998 459,300 $2.37 to $15.00
- ----------------------------------------------------------------------------------------------------
/ / 12
The following table summarizes information for stock options outstanding at
October 31, 1998:
- -----------------------------------------------------------------------------------------------------------------------------
Options Weighted Average Weighted Average
Range of Exercise Prices Outstanding Remaining Life Exercise Price
- -----------------------------------------------------------------------------------------------------------------------------
$2.37 to $3.83 18,000 1.13 years $ 2.80
$4.08 to $5.75 71,050 2.15 years $ 4.22
$6.42 to $8.25 126,250 3.09 years $ 6.58
$10.46 to $15.00 244,000 4.69 years $13.33
- -----------------------------------------------------------------------------------------------------------------------------
NOTE H -- RETIREMENT PLANS
Engineered Air has a non-contributory defined benefit plan covering
substantially all full-time employees covered by a collective bargaining
agreement. The Company's funding policy is to make annual contributions to the
plan sufficient to fund the normal cost, including amortization of prior
service cost, over a period of 15 years. A summary of the components of net
periodic pension cost for the defined benefit plan is as follows:
- --------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------
Service cost $ 131,000 $ 140,000 $ 133,600
Interest cost on projected benefit obligation 335,000 306,000 261,300
Actual return on plan assets (425,000) (365,000) (288,200)
Net amortization and deferral 47,000 53,800 28,300
- --------------------------------------------------------------------------------------------------------------
Total pension expense $ 88,000 $ 134,800 $ 135,000
- --------------------------------------------------------------------------------------------------------------
Assumptions used in accounting for the defined benefit plan in 1998, 1997 and
1996 were a weighted average discount rate of 6.75 percent, 7.5 percent and
7.75 percent, respectively, and an expected long-term rate of return on assets
of 9.0 percent. The decrease in the discount rate assumption resulted in an
increase of $421,000 in the accumulated and projected benefit obligation as of
October 31, 1998. The following table sets forth funded status and amounts
recognized in the consolidated balance sheets for the defined benefit pension
plan:
- ----------------------------------------------------------------------------------------------
October 31 1998 1997
- ----------------------------------------------------------------------------------------------
Actuarial present value of benefit obligation:
Vested benefit obligation $5,087,000 $4,415,000
Non-vested benefit obligation 112,000 186,000
- ----------------------------------------------------------------------------------------------
Accumulated benefit obligation $5,199,000 $4,601,000
- ----------------------------------------------------------------------------------------------
Plan assets at fair value--primarily listed common stocks,
bonds and U.S. government secur $5,366,000 $4,893,000
Projected benefit obligation 5,199,000 4,601,000
- ----------------------------------------------------------------------------------------------
Plan assets in excess of projected benefit obligation 167,000 292,000
Unrecognized net (gain) loss 793,000 (192,000)
Unrecognized prior service cost 234,000 274,000
Unrecognized net obligation at November 1, 1986, net of
amortization 8,000
- ----------------------------------------------------------------------------------------------
Net pension asset recognized in consolidated balance sheets $1,194,000 $ 382,000
- ----------------------------------------------------------------------------------------------
The Company has an Employee Stock Ownership Plan (ESOP) covering all salaried
employees of Engineered Air, and all employees of ESP, Marlo Coil (effective
July 1, 1998) and Keco (effective January 1, 1999). The ESOP provides for a
matching contribution by the Company of no less than 25% of each employee's
contributions up to a maximum of 6% of the employee's earnings. The Company
also makes discretionary annual contributions in an amount no less than the
amount sufficient to pay the monthly installments of the ESOP bank loan. All
employee and employer contributions to the ESOP are 100 percent vested. The
Company has recorded expenses based on contributions to the ESOP for the years-
ended October 31, 1998, 1997 and 1996 of $481,000, $377,000 and $293,000,
respectively. Interest payments on the ESOP bank loan were $62,000, $81,000 and
$93,000 in 1998, 1997 and 1996, respectively. The Company accounts for ESOP
shares under the cash payment method. All ESOP shares are considered
outstanding for purposes of computing net income per share.
Prior to July 1, 1998, the Marlo Coil Employee Retirement Plan (Marlo Plan)
covered all full-time employees of Marlo Coil. The Marlo Plan provided for a
matching contribution by the Company of 50% of each employee's contributions up
to a maximum of 4% of the employee's earnings. The Company also made
discretionary contributions to the Marlo Plan. The Company has recorded
expenses based on contributions to the Marlo Plan for the year ended October
31, 1998 of $86,000. The Marlo Plan was terminated effective June 30, 1998 and
all assets were transferred to the ESOP.
Prior to January 1, 1999, all full-time employees of Keco were covered by the
Keco Industries 401(k) Profit Sharing Plan (Keco Plan). The Keco Plan provided
for a matching contribution by the Company of 100% of each employee's
contributions up to a maximum of 3% of the employee's earnings. The Company
also made additional contributions in an amount equal to 2% of the employee's
earnings to the Keco Plan. The Company has recorded expenses based on
contributions to the Keco Plan for the year ended October 31, 1998 of $128,000.
The Keco Plan will be terminated effective February 28, 1999 and all assets
will be transferred to the ESOP.
13 / /
NOTE I -- SEGMENT INFORMATION
The Company operates in two industry segments: the military support and related
industrial/commercial equipment segment and the custom molded plastic products
segment. The military support and related industrial/commercial equipment
operations involve the engineering, fabrication and assembly of a broad range
of military support equipment designed for rapid deployment around the world,
as well as related heat transfer and air handling equipment sold to commercial
and industrial users. The custom molded plastic products operations involve the
manufacture and sale of a broad range of injection molded resin products, as
well as the manufacture and sale of a proprietary line of plastic faucets. All
corporate expenses and assets have been allocated to the business segments.
Approximately 55%, 82% and 79%, respectively, of 1998, 1997 and 1996
consolidated revenues were from two customers--45%, 71% and 73%, respectively,
from the U.S. government and 10%, 11% and 6%, respectively, from another
customer. The Company's export net sales and intersegment net sales are not
significant. Information by industry segment is summarized as follows:
- -------------------------------------------------------------------------------------------------------------
Year Ended October 31 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
Net Revenues:
Military Support and Related Industrial/Commercial
Equipment $69,912,976 $64,397,161 $59,179,141
Custom Molded Plastic Products 27,059,910 24,173,809 22,327,802
- -------------------------------------------------------------------------------------------------------------
Total $96,972,886 $88,570,970 $81,506,943
- -------------------------------------------------------------------------------------------------------------
Income from Operations:
Military Support and Related Industrial/Commercial
Equipment $ 7,051,192 $ 5,577,402 $ 5,087,705
Custom Molded Plastic Products 3,191,172 2,090,512 848,312
- -------------------------------------------------------------------------------------------------------------
Total $10,242,364 $ 7,667,914 $ 5,936,017
- -------------------------------------------------------------------------------------------------------------
Identifiable Assets:
Military Support and Related Industrial/Commercial
Equipment $76,871,245 $24,255,029 $21,033,652
Custom Molded Plastic Products 15,288,977 12,829,025 13,058,479
- -------------------------------------------------------------------------------------------------------------
Total $92,160,222 $37,084,054 $34,092,131
- -------------------------------------------------------------------------------------------------------------
Depreciation and Amortization Expense:
Military Support and Related Industrial/Commercial
Equipment $ 1,905,378 $ 833,008 $ 746,581
Custom Molded Plastic Products 907,207 1,064,824 1,103,226
- -------------------------------------------------------------------------------------------------------------
Total $ 2,812,585 $ 1,897,832 $ 1,849,807
- -------------------------------------------------------------------------------------------------------------
Capital Expenditures:
Military Support and Related Industrial/Commercial
Equipment $ 332,030 $ 583,561 $ 1,035,240
Custom Molded Plastic Products 999,117 1,403,761 110,155
- -------------------------------------------------------------------------------------------------------------
Total $ 1,331,147 $ 1,987,322 $ 1,145,395
- -------------------------------------------------------------------------------------------------------------
NOTE J -- CONTINGENCIES
As a government contractor, the Company is continually subject to audit by
various agencies of the U.S. government to determine compliance with various
procurement laws and regulations. As a result of such audits and as part of
normal business operations of the Company, various claims and charges are
asserted against the Company. It is not possible at this time to predict the
outcome of all such actions. However, management is of the opinion that it has
good defenses against such actions and believes that none of these matters will
have a material effect on the consolidated financial position or the results of
operations of the Company.
NOTE K -- STOCK SPLIT
On June 26, 1998, the Company effected a 3-for-2 stock split in the form of a
50% stock dividend. All per share amounts, as well as all share amounts related
to the Company's stock option plans, in this report have been restated to
reflect this stock split.
/ / 14
/ /REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Engineered Support Systems,
Inc.
In our opinion, the accompanying consolidated balance sheets and related
consolidated statements of income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Engineered
Support Systems, Inc. and its subsidiaries at October 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the three
years in the period ended October 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these statements based on our audits. We conducted our audits of
these statements in accordance with generally accepted auditing standards,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
St. Louis, Missouri
December 4, 1998
/ /REPORT OF MANAGEMENT RESPONSIBILITIES
The Company's management is responsible for the fair presentation and
consistency of all financial data included in the Annual Report. Where
necessary, the data reflects management estimates. The Company's Audit
Committee consists of three non-employee directors. This Committee meets with
financial officers and PricewaterhouseCoopers LLP personnel to review internal
controls, financial reporting and accounting practices. PricewaterhouseCoopers
LLP meets with the Audit Committee, with and without management present, to
discuss their examinations, the adequacy of internal controls and the quality
of financial reporting.
15 / /
/ /SUPPLEMENTAL INFORMATION
The table below presents unaudited quarterly financial information in
thousands, except for per share data, for the years ended October 31, 1998 and
1997:
Quarter Ended
- ----------------------------------------------------------------------------------------------------------------------------
January 31 April 30 July 31 October 31
- ----------------------------------------------------------------------------------------------------------------------------
1998 1997 1998 1997 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------
Net revenues $16,238 $20,731 $23,012 $22,851 $24,927 $23,926 $32,796 $21,063
- ----------------------------------------------------------------------------------------------------------------------------
Gross profit 3,304 3,115 5,648 3,679 5,880 4,074 7,798 3,887
- ----------------------------------------------------------------------------------------------------------------------------
Net income 919 803 1,324 1,098 1,447 1,298 2,099 1,440
- ----------------------------------------------------------------------------------------------------------------------------
Basic earnings per share .19 .17 .28 .23 .30 .27 .43 .30
Diluted earnings per share .19 .16 .27 .22 .29 .26 .42 .29
- ----------------------------------------------------------------------------------------------------------------------------
Earnings per share calculations for each of the quarters is based on the
average basic and diluted common shares outstanding for each period and,
therefore, the sum of the quarters may not necessarily be equal to the full
year basic and diluted earnings per share amounts. All per share amounts
reflect a 3-for-2 stock split effected by the Company on June 26, 1998.
MARKET DATA
The Company's common stock trades on the NASDAQ Stock Market under the symbol
EASI. As of December 31, 1998, the approximate number of common shareholders
was 2,000. The following table sets forth the high and low stock prices for
each quarter as provided by the NASDAQ Stock Market.
- --------------------------------------------------------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
HIGH LOW High Low
- --------------------------------------------------------------------------------------------------------------------------------
Quarter Ended:
January 31 $16.00 $ 9.67 $10.33 $ 6.42
April 30 16.75 10.46 9.83 7.09
July 31 20.83 15.83 13.33 7.33
October 31 18.50 13.25 19.33 11.33
- --------------------------------------------------------------------------------------------------------------------------------
DIVIDENDS
The Board of Directors initiated a semi-annual dividend program in 1995. The
most recently declared dividend was in the amount of $.018 per share payable
January 29, 1999 to shareholders of record on December 31, 1998.
/ /CORPORATE INFORMATION
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services
200 North Broadway
St. Louis, MO 63102
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
800 Market Street
St. Louis, MO 63101
LEGAL COUNSEL
David Douglas Mattern
1034 S. Brentwood Boulevard
Suite 1250
St. Louis, MO 63117
ANNUAL MEETING
March 8, 1999
10:00 A.M.
Ritz-Carlton
100 Carondelet Plaza
Clayton, MO 63105
FORM 10-K
A copy of the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission is available upon written request to:
Investor Relations
Engineered Support Systems, Inc.
1270 North Price Road
St. Louis, MO 63132
/ / 16
/ /DIRECTORS AND OFFICERS
DIRECTORS
ENGINEERED SUPPORT SYSTEMS, INC.
Michael F. Shanahan, Sr.
Chairman, President and
Chief Executive Officer
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
R. Bruce Earls
President and Chief Executive Officer
Engineered Coil Company
John J. Wichlenski
President and Chief Executive Officer
Engineered Air Systems, Inc.
Alexander M. Cornwell, Jr.
President
Cornwell Consulting
MG George E. Friel
U.S. Army, Retired
Thomas J. Guilfoil
Partner
Guilfoil, Petzall & Shoemake
LTG Kenneth E. Lewi
U.S. Army, Retired
Michael F. Shanahan, Jr.
Lockton Companies
Earl E. Walker
President
Carr Lane Company
Earl W. Wims
President
Marketing Horizons, Inc.
MANAGEMENT
ENGINEERED SUPPORT SYSTEMS, INC.
Michael F. Shanahan, Sr.
Chairman, President and
Chief Executive Officer
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
MANAGEMENT
ENGINEERED AIR SYSTEMS, INC.
Michael F. Shanahan, Sr.
Chairman
John J. Wichlenski
President and
Chief Executive Officer
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
Ronald W. Davis
Vice President-Marketing
Michael W. Donnelly
Vice President-Manufacturing
Dan D. Jura
Vice President-Sales
Terrence E. Lyles
Vice President-Purchasing
E. Allen Springer
Vice President-Engineering
David P. Walsh
Vice President-Quality Assurance
MANAGEMENT
ENGINEERED SPECIALTY PLASTICS, INC.
Michael F. Shanahan, Sr.
Chairman
John E. Capeless
Vice President and
General Manager
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
MANAGEMENT
ENGINEERED COIL COMPANY
Michael F. Shanahan, Sr.
Chairman
R. Bruce Earls
President and
Chief Executive Officer
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
Douglas B. Sease
Vice President-Operations
MANAGEMENT
KECO INDUSTRIES, INC.
Michael F. Shanahan, Sr.
Chairman
George W. Andrews
President and
Chief Executive Officer
Marvin L. Smith
Executive Vice President
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
Thomas W. Andrews
Vice President-Engineering