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 three months ended January 31, 1999 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)
1270 North Price Road, St. Louis, Missouri 63132
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (314) 993-5880
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
--- ---
The number of shares of the Registrant's common stock, $.01 par
value, outstanding at February 26, 1999 was 4,867,670.
ENGINEERED SUPPORT SYSTEMS, INC.
INDEX
Page
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Part I - Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of January 31, 1999 and
October 31, 1998 3
Condensed Consolidated Statements of Income for the three months
ended January 31, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows for the three months
ended January 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Part II - Other Information
Items 1-6 13
Signatures 14
Exhibits 15
2
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
January 31 October 31
1999 1998
----------- -----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 3,778,646 $ 5,773,529
Accounts receivable 11,938,409 14,036,184
Contracts in process and inventories 20,755,607 18,686,810
Other current assets 1,343,484 1,542,973
----------- -----------
Total Current Assets 37,816,146 40,039,496
Property, plant and equipment, less accumulated
depreciation of $14,580,148 and $13,895,326 24,863,737 25,064,982
Cost in excess of net assets acquired, less accumulated
amortization of $1,345,994 and $1,073,176 25,563,074 25,835,892
Other assets 1,168,524 1,219,852
----------- -----------
Total Assets $89,411,481 $92,160,222
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 7,454,168 $ 7,204,172
Accounts payable 6,080,543 7,285,396
Other current liabilities 6,121,827 7,340,394
----------- -----------
Total Current Liabilities 19,656,538 21,829,962
Long-term debt 34,769,787 36,779,160
Deferred income taxes 2,659,699 2,659,699
ESOP guaranteed bank loan 688,800 725,700
Shareholders' Equity
Common stock, par value $.01 per share; 10,000,000
shares authorized; 5,490,604 shares issued 54,906 54,906
Additional paid-in capital 11,230,443 11,082,278
Retained earnings 24,983,931 23,682,931
----------- -----------
36,269,280 34,820,115
Less ESOP guaranteed bank loan 688,800 725,700
Less treasury stock at cost, 629,684 and 638,702
shares 3,943,823 3,928,714
----------- -----------
31,636,657 30,165,701
----------- -----------
Total Liabilities and Shareholders' Equity $89,411,481 $92,160,222
=========== ===========
See notes to condensed consolidated financial statements.
3
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended
January 31
-----------------------------------
1999 1998
----------- -----------
Net revenues $28,236,975 $16,238,139
Cost of revenues 21,655,628 12,934,370
----------- -----------
Gross profit 6,581,347 3,303,769
Selling, general and administrative expense 3,633,948 1,844,460
----------- -----------
Income from operations 2,947,399 1,459,309
Interest expense (693,762) (23,396)
Interest income 56,766 96,248
----------- -----------
Income before income taxes 2,310,403 1,532,161
Income tax provision 922,000 613,000
----------- -----------
Net income $ 1,388,403 $ 919,161
=========== ===========
Basic earnings per share $.29 $.19
=========== ===========
Diluted earnings per share $.28 $.19
=========== ===========
See notes to condensed consolidated financial statements.
4
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
January 31
-----------------------------------
1999 1998
----------- -----------
From operating activities:
Net income $ 1,388,403 $ 919,161
Depreciation and amortization 890,179 464,417
----------- -----------
Cash provided (used) before changes in operating
assets and liabilities 2,278,582 1,383,578
Net (increase) decrease in non-cash current assets 228,467 (1,347,010)
Net increase (decrease) in non-cash current
liabilities (2,384,024) (2,445,336)
(Increase) decrease in other assets 193,002 219,295
----------- -----------
Net cash provided by (used in) operating
activities 316,027 (2,189,473)
----------- -----------
From investing activities:
Additions to property, plant and equipment (399,079) (73,122)
----------- -----------
Net cash provided by (used in) investing
activities (399,079) (73,122)
----------- -----------
From financing activities:
Payments of long-term debt (1,759,377) (1,267,706)
Purchase of treasury stock (65,052) (339,758)
Exercise of stock options 86,407
Cash dividends (87,402) (43,115)
----------- -----------
Net cash provided by (used in) financing
activities (1,911,831) (1,564,172)
----------- -----------
Net increase (decrease) in cash and cash equivalents (1,994,883) (3,826,767)
Cash and cash equivalents at beginning of period 5,773,529 8,313,160
----------- -----------
Cash and cash equivalents at end of period $ 3,778,646 $ 4,486,393
=========== ===========
See notes to condensed consolidated financial statements.
5
ENGINEERED SUPPORT SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
JANUARY 31, 1999
NOTE A - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have
been prepared by the Company without audit. 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 month period ended January 31, 1999 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 information 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,
1998.
NOTE B - EARNINGS PER SHARE
All earnings per share amounts have been computed after giving
effect to the stock split described in Note E. Average diluted common
shares outstanding include common stock equivalents, which represent
common stock options as computed based on the treasury stock method.
Basic earnings per share for the three months ended January 31,
1999 and 1998 is based on average basic common shares outstanding of
4,852,342 and 4,762,133, respectively. Diluted earnings per share for
the three months ended January 31, 1999 and 1998 is based on average
diluted common shares outstanding of 5,032,339 and 4,967,366,
respectively.
NOTE C - CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories of Engineered Air Systems,
Inc. and Keco Industries, Inc. represent accumulated contract costs,
estimated earnings thereon based upon the percentage of completion
method and contract inventories reduced by the contract value of
delivered items. Inventories of Engineered Specialty Plastics, Inc. and
Engineered Coil Company 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:
6
January 31, 1999 October 31, 1998
---------------- ----------------
Raw materials $ 4,449,814 $ 4,578,766
Work-in-process 1,385,119 1,397,593
Finished goods 549,350 845,607
Inventories substantially applicable to
government contracts in process, less
progress payments of $14,719,950 and
$15,932,239 14,371,324 11,864,844
----------- -----------
$20,755,607 $18,686,810
=========== ===========
NOTE D - 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, for approximately $25.4
million. The fair value of 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 acquired all of the outstanding
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 included in Other Current Liabilities on the
January 31, 1999 and October 31, 1998 Condensed Consolidated Balance
Sheets.) 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.
7
If these acquisitions had occurred on November 1, 1997, net
revenues would have been $33,759,015 resulting in net income of
$648,081, or $.14 per basic common share and $.13 per diluted common
share, on an unaudited pro forma basis for the three months ended
January 31, 1998. 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, 1997, nor are they
necessarily indicative of the combined results that may occur in the
future.
NOTE E - STOCK SPLIT
On June 26, 1998, the Company effected a 3-for-2 stock split in
the form of a 50% stock dividend. All earnings per share amounts in
this Form 10-Q have been restated to reflect this stock split.
NOTE F - SUBSEQUENT EVENT
On February 22, 1999, Engineered Electric Company, a wholly-owned
subsidiary of the Company, acquired substantially all of the net assets
of the Fermont division of Dynamics Corp. of America, a wholly-owned
subsidiary of CTS Corporation, in a purchase transaction for
approximately $10 million subject to certain post-closing adjustments.
Fermont is a manufacturer of electrical generators sold primarily to the
Department of Defense. Further details of the transaction will be
provided in Form 8-K to be filed with the Securities and Exchange
Commission.
8
ENGINEERED SUPPORT SYSTEMS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net Revenues. Net revenues increased 73.9% in the first quarter
of 1999 to $28.2 million from $16.2 million in the first quarter of
1998. Net revenues from military support and related industrial/
commercial equipment increased by $10.9 million to $22.3 million
in the first quarter of 1999 from $11.4 million in the first quarter
of 1998. This increase was due to an additional $14.8 million of net
revenues generated by businesses acquired in 1998. (See Note D of the
January 31, 1999 condensed consolidated financial statements for
further discussion). This increase was partially offset by a decrease
of $3.9 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
Aviation Ground Power Units (AGPU) and C-5/MA-3D Flight Line Air
Conditioners. Net revenues from sales of custom molded plastic products
through Engineered Specialty Plastics, Inc. (ESP) increased $1.1 million
to $5.9 million in the first quarter of 1999 from $4.8 million in the
first quarter of 1998.
Gross Profit. Gross profit for the first quarter of 1999
increased 99.2% to $6.6 million (23.3% of net revenues) from $3.3
million (20.3% of net revenues) in the prior year. The increase in
gross profit was a result of the businesses acquired in 1998, net of a
decrease in gross profit in our historical military support operations
resulting from a significant decrease in net revenues. The increase in
gross margins was a result of higher margins in our historical military
support operations due to a more profitable mix of contracts 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. Selling, general and
administrative expense increased by $1.8 million to $3.6 million (12.9%
of net revenues) for the quarter ended January 31, 1999 from $1.8
million (11.4% of net revenues) for the first quarter of 1998. These
increases were due to the addition of selling, general and
administrative expense generated by the two businesses acquired,
including additional goodwill amortization of $0.3 million.
Interest Expense and Interest Income. Interest expense increased
by $0.7 million to $0.7 million for the quarter ended January 31, 1999
as compared to the prior year period as a result of debt incurred in
conjunction with the 1998 acquisitions. Interest income was $0.1
million in the first quarter of both 1999 and 1998.
9
Income Tax Provision. The effective income tax rate was 39.9% for
the quarter ended January 31, 1999 and 40.0% for the quarter ended
January 31, 1998.
Net Income. As a result of the forgoing, the net income of the
Company increased by 51.1% to $1.4 million (4.9% of net revenues) for
the quarter ended January 31, 1999 from $0.9 million (5.7% of net
revenues) for the first quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
In March 1998, the Company restated and amended its credit
facility to provide a $45.0 million term loan to finance the Marlo Coil
and Keco acquisitions and to provide a $10.0 million revolving credit
facility. Principal payments on the term loan began September 1, 1998,
with the final payment due May 1, 2003. The Company may choose an
interest rate calculated at either 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). Pursuant to the terms of the restated and amended credit
facility, the Company is subject to various financial and operating
covenants. Although the Company is currently in compliance with all
such covenants, the failure of the Company to comply with any of these
covenants would constitute a default which, if not timely corrected or
waived, could result in an acceleration of the maturity of certain of
the debt obligations of the Company.
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 bank
borrowings under its $10.0 million revolving line of credit. On January
31, 1999, the Company's working capital and ratio of current assets to
current liabilities were $18.2 million and 1.92 to 1 as compared to
$18.2 million and 1.83 to 1, respectively, at October 31, 1998. During
1998, the Company purchased Marlo Coil, net of cash acquired, for $25.3
million and purchased Keco, net of cash acquired, for $24.1 million.
These acquisitions were financed with term loan borrowings under the
restated and amended credit facility and with available cash resources.
See Note D of the January 31, 1999 condensed consolidated financial
statements for further discussion.
On February 22, 1999, Engineered Electric Company, a wholly-owned
subsidiary of the Company, acquired substantially all of the net assets
of the Fermont division of Dynamics Corp. of America, a wholly-owned
subsidiary of CTS Corporation, in a purchase transaction for
approximately $10 million subject to certain post-closing adjustments.
Approximately $5.7 million of the Fermont purchase price was initially
financed under the revolving credit facility, which borrowing we
anticipate will be reduced with cash flow generated from operations.
10
The Company invested $0.4 million in property, plant and equipment
during the three months ended January 31, 1999 and anticipates that
capital expenditures will not exceed $2.0 million for the year ended
October 31, 1999. Management believes that cash flow generated by
existing operations, together with the available line of credit, will
provide the necessary resources to meet the existing needs of the
Company in the foreseeable future.
BUSINESS AND MARKET CONSIDERATIONS
Approximately 66% of consolidated net revenues for the quarter
ended January 31, 1999 were directly or indirectly derived from defense
orders by the U.S. government and its agencies. As of January 31, 1999,
the Company's combined backlog of defense orders at Engineered Air,
Marlo Coil and Keco totaled $99.3 million, with related government
options of an additional $286.2 million.
Management continues to pursue potential acquisitions, primarily
of those companies providing strategic consolidation within the defense
industry.
YEAR 2000 READINESS DISCLOSURE
We are dependent upon computer hardware and software for internal
operations and for processing product orders with our customers and
suppliers. We rely on computerized systems for nearly every component
of our business operations including: production scheduling and control;
purchasing and receiving; inventory control; sales orders and invoicing;
accounting (including accounts payable, accounts receivable, general
ledger and payroll); engineering; quality control and inspection; word
processing; and, in some cases, product testing.
We have developed and are implementing a plan to address Year 2000
issues which may impact our business. This plan includes: (a) surveys
of information technology systems, non-information technology or non-IT
systems and product categories; (b) assessment of required replacement
or other Year 2000 remediation; (c) implementation and subsequent
testing of systems for Year 2000 compliance; and (d) review of material
suppliers' and customers' Year 2000 status or impact on our ability to
avoid business interruption.
We have completed Year 2000 compliance testing on substantially
all of our information technology systems and expect to have such
testing completed by September 30, 1999. Such testing to date has not
revealed any material noncompliance. We are in the process of upgrading
or replacing those systems we believe may be noncompliant and expect to
have such work completed by September 30, 1999.
11
With respect to non-IT systems such as security/alarm, fire
control and telephone systems, we have surveyed and evaluated these
systems for Year 2000 problems. In some instances, this evaluation has
included communications with the original manufacturers or suppliers for
representations regarding the equipment. We believe that the majority
of these non-IT systems do not function on date-sensitive software or
hardware. We therefore do not anticipate that Year 2000 poses a
significant risk to non-IT systems.
We do not generally manufacture products which contain date-
sensitive computerized components other than control units for some air
handling units manufactured by Marlo. We obtain these control units
from third-party suppliers and test them for Year 2000 compliance at the
time of installation. Accordingly, we do not anticipate significant
Year 2000 risks associated with our products.
We may be affected by the Year 2000 readiness of our major
suppliers and customers, over which we have no direct control. We
believe that there is no single supplier which is critical to our
business as a whole or which could cause a significant disruption in our
production, although some of our business could be affected if a
particular supplier on a particular contract were to fail to perform due
to a Year 2000 failure within that supplier's business at a critical
time. We have contacted some of our significant suppliers with Year
2000 surveys designed to assess supplier Year 2000 readiness and may contact
other significant suppliers we conclude present a material Year 2000 risk.
Of the suppliers responding, a significant number have indicated that they
consider themselves Year 2000 compliant. We anticipate Year 2000 compliance
of our significant suppliers by September 30, 1999 and may replace any such
suppliers who have failed to respond to surveys or who cannot provide
reasonable Year 2000 assurances.
Approximately 75% of our revenues come directly or indirectly from the
Department of Defense. Year 2000 compliance by government agencies is
difficult to assess. However, according to published reports, which we have
not verified, the government may not be fully Year 2000 compliant on a
timely basis. A disruption in the day-to-day functions of the
Department of Defense or other government agencies (and more
particularly, a disruption in the ability to pay accounts payable) could
have a material adverse impact on our business.
We expect to expend a total of approximately $0.3 million on Year 2000
compliance, of which approximately $0.1 million had been expended through
January 31, 1999.
In addition to the risks identified in the foregoing discussion,
we face material risks that (i) automated business functions could
falter due to undetected or unaddressed Year 2000 issues which, for
instance, could increase the cost of operations and cause delays in product
shipment, and (ii) interruption in utilities could cause plant
shutdowns. Any one of these scenarios could have a material adverse
impact on our operations, liquidity and financial condition.
To date, we have not developed a formal Year 2000 contingency
plan. During the first half of calendar 1999, we will continue our Year
2000 compliance efforts as described above and, in conjunction
therewith, intend to research and develop alternative plans designed to
mitigate the potential adverse consequences of either an internal or
external Year 2000 problem. These plans will include, for instance: (i)
securing funding sources to cover our cash needs in the event we suffer
payment delays from a major customer, and (ii) identifying alternative
supply sources in the event significant suppliers are unable to deliver
products on a timely basis.
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, 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.
12
PART II
OTHER INFORMATION
Items 1-5 Not applicable.
Item 6 (a) Exhibits
11. Statement Re: Computation of Earnings Per Share.
27. Statement Re: Financial Data Schedule
(b) No reports on Form 8-K were filed during the three months
ended January 31, 1999.
13
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: March 8, 1999 By: /s/ Michael F. Shanahan Sr.
------------------- ---------------------------------
Michael F. Shanahan Sr.
Chairman of the Board, President
and Chief Executive Officer
Date: March 8, 1999 By: /s/ Gary C. Gerhardt
------------------- ---------------------------------
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
14