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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the year ended October 31, 2002 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 No.)
201 EVANS LANE, ST. LOUIS, MISSOURI 63121
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number including area code: (314) 553-4000
Securities registered pursuant to Section 12(b) of the
Securities Exchange Act of 1934:
Title of each class Name of each exchange on which registered
----------------------- -----------------------
Common stock, $.01 par value Over the counter
National Market System
National Association of Security Dealers
No securities are registered pursuant to Section 12(g) of the
Securities Exchange Act of 1934.
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 requirement for the past 90 days. Yes |X| No | |
Based on the closing price on January 17, 2003, the aggregate market
value of the voting stock held by non-affiliates of the Registrant was
approximately $572,279,000.
The number of shares of the Registrant's common stock, $.01 par value,
outstanding at January 17, 2003 was 16,007,011.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I and II incorporate by reference portions of the Engineered Support
Systems, Inc. Annual Report to Shareholders (the Annual Report) for the year
ended October 31, 2002. Part III incorporates by reference portions of the
Engineered Support Systems, Inc. Proxy Statement for the Annual Shareholders
Meeting to be held on March 4, 2003 (the Definitive Proxy Statement) to be
filed within 120 days after the close of the year ended October 31, 2002.
PART I
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ITEM 1. BUSINESS
Engineered Support Systems, Inc. is a holding company for nine wholly owned
subsidiaries: Systems & Electronics Inc. (SEI), Engineered Air Systems, Inc.
(Engineered Air), Keco Industries, Inc. (Keco), Radian Inc. (Radian),
Engineered Coil Company, d/b/a Marlo Coil (Marlo Coil), Engineered Electric
Company, d/b/a Fermont (Fermont), Universal Power Systems, Inc. (UPSI),
ESSIbuy.com (ESSIbuy) and Engineered Specialty Plastics, Inc. (ESP).
Engineered Support Systems, Inc. and its subsidiaries (Company) are a
diversified supplier of high-tech integrated military electronics, support
equipment and logistics services to the United States armed forces and
certain foreign militaries. The Company also engineers and manufactures
air-handling and heat-transfer equipment, material-handling equipment and
custom-molded plastic products for commercial and industrial users.
Engineered Air was incorporated under the laws of the State of
Missouri on December 24, 1981 and acquired the assets of the Defense Systems
Division of Allis-Chalmers Corporation on March 30, 1982. The Company was
incorporated under the laws of the State of Missouri in December 1983, and
exchanged all of its outstanding common stock for two-thirds of the common
stock of Engineered Air held by the Company's founders. The Company
purchased the remaining one-third of the common stock of Engineered Air in
January 1984, effective as of November 1, 1983. The Company became a
publicly owned corporation on August 21, 1985. On March 9, 1993, the Company
purchased all of the outstanding stock of Associated Products, Inc.
(subsequently changed to Engineered Specialty Plastics, Inc.). Effective
February 1, 1998, Engineered Coil Company acquired substantially all of the
net assets of Nuclear Cooling, Inc., d/b/a Marlo Coil. On June 24, 1998, the
Company acquired all of the outstanding common stock of Keco. On February
22, 1999, Engineered Electric Company acquired substantially all of the net
assets of the Fermont Division of Dynamics Corporation of America, d/b/a
Fermont. On September 30, 1999, the Company acquired all of the outstanding
common stock of SEI. On May 10, 2002, the Company acquired all the
outstanding capital stock of Radian. On June 27, 2002, the Company acquired
all the outstanding stock of UPSI.
PRODUCTS
Products are manufactured by the Company within three operating segments:
Light Military Support Equipment, Heavy Military Support Equipment and
Electronics and Automation Systems. The Light Military Support Equipment
segment engineers and manufactures a broad range of military support
equipment primarily for the U.S. Department of Defense (DoD), as well as
related heat-transfer and air-handling equipment for domestic commercial and
industrial users. Segment products include environmental control systems,
generator sets, power generation and distribution equipment, petroleum and
water systems, uninterruptible power supplies, chemical and biological
protection systems and other multipurpose military support equipment. The
Light Military Support Equipment segment also provides logistics support and
engineering services to the DoD and security system solutions to the DoD and
other governmental agencies. The Heavy Military Support Equipment segment
engineers and manufactures load management and transport systems primarily
for the DoD. Segment products include aircraft load management equipment and
equipment transport systems. The Electronics and Automation Systems segment
engineers and manufactures radar and electronic warfare systems, fire
support systems and avionics test equipment primarily for the DoD. The
segment also engineers and manufactures material-handling equipment
primarily for the U.S. Postal Service and for the pharmaceutical industry
throughout the United States. The Company's Plastic Products segment, which
manufactures injection-molded resin products, as well as a proprietary line
of plastic faucets, primarily for commercial customers in the south-central
United States, is being held for sale as of October 31, 2002 and has been
classified as discontinued operations in the Company's Consolidated
Financial Statements for all periods presented.
See pages 4 through 24 of the 2002 Annual Report which are
incorporated herein by reference.
2
ENGINEERING AND DESIGN
The Company employs 666 people engaged in engineering activities that
include, among other tasks, the design and development of new products and
the improvement of existing products. The majority of these development
activities are conducted pursuant to, and funded by, DoD contracts in
response to designated performance specifications. The Company's
expenditures on research and development were approximately $1.8 million,
$1.1 million and $0.8 million for the years ended October 31, 2002, 2001 and
2000. The Company anticipates that unfunded internal research and
development will approximate $3 million in fiscal year 2003. The Company
believes that its engineering expertise gives it a significant competitive
advantage.
The Company's engineering capabilities are in the areas of systems,
electro-mechanics, electro-chemical, mechanics, electrical systems and
electronics, and acoustics, as well as expertise in thermodynamics, air
flow, liquid pumping, stress analysis, liquid fuel combustion, dynamic and
climactic environmental engineering, biological and chemical
decontamination, non-pyrotechnic smoke generation, and filtration of
chemically and biologically contaminated air.
The Company's design and development of support equipment is
enhanced by computer-aided design and manufacturing (CAD/CAM) systems used
by engineers and draftsmen to design complex products and component parts in
three-dimensional view. The Company's engineering technologies and expertise
provide it with the ability to adapt its production process to new product
needs on a timely basis. The Company also has the capability to provide
complete technical data support for the products it manufactures. This
includes integrated logistics support, spare parts provisioning and
preparation of technical manuals.
MARKETING
The Company's marketing of military equipment and services focuses, in part,
on determining the current and future needs of the DoD. To identify those
needs, the Company gathers information from primary sources such as the DoD
budget and its supporting documents, and military requirement documents such
as the Air Force's Statement of Need, the Navy's Operational Requirements
and the Army's Required Operational Capability, along with direct interface
with its customers. The Company analyzes this data through an established
new business opportunity procedure and then determines whether or not to bid
on specific projects based upon determinations of potential profitability
and the likelihood of being awarded the contract.
For its defense products, the Company maintains a domestic field
marketing/sales network with offices located in the Washington, D.C. area
and at several major U.S. Government defense procurement centers. The
Washington, D.C. office carries out legislative activities, and conducts
customer liaison activities with all branches of the U.S. armed services and
with foreign government offices in the Washington, D.C. area. The primary
responsibility for individual products or programs is handled within the
product line organizations, with the field organization providing closely
coordinated assistance.
In addition, the Company supplies electronic sorting and material
handling equipment to the U.S. Postal Service and other customers. Sales of
custom commercial, industrial and marine air-handling units and coils are
effected both directly and through sales representatives located primarily
in the United States, parts of Canada, and Puerto Rico, with the
pharmaceutical, telecommunications and healthcare industries representing a
significant portion of current sales volume.
PURCHASED COMPONENTS AND RAW MATERIALS
The Company's products require a wide variety of components and materials.
Although the Company has multiple sources of supply for most of its material
requirements, sole-source vendors supply certain components, and the
Company's ability to perform certain contracts depends on their performance.
In the past, these required raw materials and various purchased components
generally have been available in sufficient quantities.
3
GOVERNMENT CONTRACTING
The Company's government contracts are obtained through the DoD procurement
process as governed by the Federal Acquisition Regulations and related
agency supplements, and are typically fixed-price contracts. This means that
the price is agreed upon before the contract is awarded and the Company
assumes complete responsibility for any difference between estimated and
actual costs.
Under the Truth in Negotiations Act of 1962 (Negotiations Act), the
U.S. Government has the right for three years after final payment on certain
negotiated contracts, subcontracts and modifications thereto, to determine
whether the Company furnished the U.S. Government with complete, accurate
and current cost or pricing data as defined by the Negotiations Act. In the
event the Company fails to satisfy this requirement, the U.S. Government has
the right to adjust a contract or subcontract price by the amount of any
overstatement as defined by the Negotiations Act.
U.S. Government contracts typically contain terms permitting the
contract to be terminated at the convenience of the U.S. Government. In the
event of such termination, the Company is entitled to reimbursement for
certain expenditures and overhead as provided for in applicable U.S.
Government procurement regulations. Generally, this results in the
contractor being reasonably compensated for work actually done, but not for
anticipated profits. The U.S. Government may also terminate contracts for
cause if the Company fails to perform in strict accordance with contract
terms. The Company has never had a contract terminated by the U.S.
Government for failure to perform in accordance with contract terms.
Termination of, or elimination of appropriation for, a significant
government contract could have a material adverse effect on the Company's
business, financial condition and results of operations in subsequent
periods. Similarly, U.S. Government contracts typically permit the U.S.
Government to change, alter or modify the contract at its discretion. If the
U.S. Government were to exercise this right, the Company would be entitled
to reimbursement of all allowable and allocable costs incurred in making the
change plus a reasonable profit.
For manufactured items, the U.S. Government typically finances a
substantial portion of the Company's contract costs through progress
payments. As such, the Company receives progress payments in accordance with
DoD contract terms which provide progress payments at 75% to 90% of costs
incurred.
INTELLECTUAL PROPERTY
The Company owns various patents and other forms of intellectual property.
From time to time, the Company develops proprietary information and trade
secrets regarding the design and manufacture of various products. The
Company considers its proprietary information and intellectual property to
be valuable assets. However, the Company's business is not materially
dependent on their protection.
COMPETITION
The markets for all of the Company's products are highly competitive. In
order to obtain U.S. Government contracts, the Company must comply with
detailed and complex procurement procedures adopted by the DoD pursuant to
regulations promulgated by the U.S. Government. The regulations and
procurement procedures are adopted to promote competitive bidding. In
addition, the Company competes with a number of businesses with plastic
injection-molding capabilities and competes with a large number of suppliers
to commercial and industrial air-handling customers. In all phases of its
operations, the Company competes in both performance and price with
companies, some of which are considerably larger, more diversified and have
greater financial resources than the Company.
4
BACKLOG
The Company records its backlog as either funded or unfunded backlog. The
Company's funded backlog as of October 31, 2002 was approximately $350.1
million. The Company's funded backlog is subject to fluctuations and is not
necessarily indicative of future revenues. Funded backlog represents
products or services that the customer has committed by contract to purchase
from the Company. Unfunded backlog includes products or services that the
customer has the option to purchase under contract with the Company,
including, with respect to contracts which include a maximum amount
of products or services purchasable by the customer thereunder, such maximum
amount, and with respect to contracts without a specified maximum amount,
the Company's estimate of the amount of products or services it expects the
customer to purchase using the Best Estimated Quantity (BEQ) as a guide
where a BEQ is specified or another suitable method where a BEQ is not
specified. There are no commitments by the customer to purchase products or
services included in unfunded backlog and there can be no assurance that any
or all amounts included therein will generate revenue for the Company.
Moreover, cancellations of purchase orders or reductions of product
quantities or levels of service to be provided in existing contracts could
substantially reduce the Company's funded backlog and, consequently, future
net revenues. Failure of the Company to replace canceled or reduced backlog,
whether funded or unfunded, could have a material adverse effect on the
Company's business, financial condition and results of operations in
subsequent periods.
The following table summarizes funded and unfunded defense backlog
(in millions) as of the indicated dates:
Funded Unfunded
Defense Backlog Defense Backlog
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October 31, 2002 $350.1 $868.6
October 31, 2001 291.7 681.8
October 31, 2000 307.3 598.1
October 31, 1999 286.8 850.5
October 31, 1998 85.8 319.6
EMPLOYEES
As of October 31, 2002, the Company employed 2,412 persons, of which 1,046
were engaged in manufacturing activities, 666 in engineering activities and
700 in office administration and management functions. District No. 9 of the
International Association of Machinists and Aerospace Workers (AFL-CIO)
represents approximately 315 employees under a collective bargaining
agreement, which expires March 18, 2003. The Company believes it will be
able to negotiate a new collective bargaining agreement with this union.
Lodge 1012 of the International Brotherhood of Boilermakers, Iron Ship
Builders, Blacksmiths, Forgers and Helpers (AFL-CIO) represents
approximately 90 employees under a collective bargaining agreement, which
expires April 30, 2003. During 2002, the Company announced a facility
consolidation plan under which the Engineered Air manufacturing operations
will be curtailed effective in the spring of 2003. As a result, Lodge 1012
members' jobs will be eliminated. Severance arrangements and terms of
separation for these union members were negotiated under this collective
bargaining agreement.
The Company considers its overall employee relations to be
satisfactory.
5
ITEM 2. PROPERTIES
The Company conducts its business from 16 principal manufacturing and office
facilities. All owned facilities are owned by the Company and are subject to
deeds of trust in favor of the Company's lender.
Location Description Square Footage
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St. Louis County, Missouri (1) Manufacturing/Office 171,000
St. Louis County, Missouri (1) Manufacturing 25,000
Hot Springs, Arkansas (1) Manufacturing/Office 110,000
Bossier City, Louisiana (1) Manufacturing 80,000
High Ridge, Missouri (1) Manufacturing/Office 185,000
Florence, Kentucky (1) Manufacturing/Office 174,000
Blue Ash, Ohio (1) Manufacturing 132,000
West Plains, Missouri (1) Manufacturing/Office 445,000
St. Louis County, Missouri (1) Office 260,000
Sanford, Florida (1) Manufacturing/Office 177,000
Bridgeport, Connecticut (1) Manufacturing/Office 109,000
Bridgeport, Connecticut (2) Manufacturing 26,000
Alexandria, Virginia (2) Office 34,000
Troy, Michigan (2) Office 20,000
Chantilly, Virginia (2) Office 16,000
Newington, Virginia (2) Office 10,200
(1) Owned
(2) Leased
The Company also leases certain small product support and service
facilities located throughout the United States and abroad.
The Company believes that its current facilities are sufficient for
the conduct of its current level of operations.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are from time to time parties to various
legal proceedings arising out of their business. Management believes that
there are no such proceedings pending or threatened against them which, if
determined adversely, would have a material adverse effect on the business
or financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
There were no matters submitted to a vote of shareholders during the fourth
quarter of the year ended October 31, 2002.
6
PART II
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ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED SHAREHOLDER MATTERS
Information concerning the Company's common stock, as included under the
captions "Dividends" and "Market Data" in the 2002 Annual Report, is
incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
Financial data required as listed under the caption "Financial Status:
Affirmative" on the inside front cover of the 2002 Annual Report, is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Revenues on long-term contracts performed within the Company's Light
Military Support Equipment, Heavy Military Support Equipment and Electronics
and Automation Systems segments, 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 measures, primarily labor,
incurred bear to the estimated production measures for the contract.
Earnings expectations are based upon estimates of contract values and costs
at completion. Contracts in process are reviewed on a periodic basis.
Adjustments to revenues and earnings are made in the current accounting
period based upon revisions in contract values and estimated costs at
completion. Provisions for estimated losses on contracts are recorded when
identified.
During the year ended October 31, 2002, the Company formally
adopted a plan to dispose of Engineered Specialty Plastics, Inc. (ESP), a
wholly owned subsidiary representing the entirety of the Plastic Products
segment. The Company expects that disposition through the sale of ESP will
be completed during the first six months of 2003. In conjunction with this
plan, the Company recorded an after-tax estimated loss on disposal of $4.2
million to reduce the carrying value of ESP's net assets to their estimated
fair value less estimated selling costs. Accordingly, the Company has
reported the results of operations of ESP as discontinued operations for the
years ended October 31, 2002, 2001 and 2000 in the Consolidated Statements
of Income. Additionally, all depreciation on the property, plant and
equipment of ESP was suspended upon classification as discontinued
operations.
During the year ended October 31, 2002, the Company announced a
restructuring plan to improve both plant utilization and long-term
profitability. Under the plan, the Company's Blue Ash, Ohio and Olivette,
Missouri manufacturing locations will be closed during the year ending
October 31, 2003 with related production efforts being relocated to other
existing Company facilities. In conjunction with this restructuring plan,
the Company recorded a pre-tax restructuring expense of $1.4 million in 2002
related to certain severance costs and asset write-downs at these
facilities. The Company anticipates annual savings, net of income tax, from
the restructuring plan of $1.5 million to $2.0 million beginning in 2004.
See Note D in the Consolidated Financial Statements. Emerging Issues Task
Force (EITF) 94-3 provides specific requirements as to the appropriate
recognition of restructuring costs associated with employee termination
benefits and other exit costs. Employee termination costs are recognized
when benefit arrangements are communicated to affected employees in
sufficient detail to enable the employees to determine the amount of
benefits to be received upon termination. Other costs resulting from the
restructuring plan that are not associated with or that do not benefit
activities that will be continued are recognized at the date of commitment
to the plan subject to certain conditions. For the cost to be accrued, the
cost must not be associated with or incurred to generate
7
revenues after the commitment date, and it must be either incremental to
other costs incurred prior to the commitment date, or represent amounts
under a contractual obligation that existed prior to the commitment date
that will either continue after the plan is completed with no economic
benefit or which will result in a penalty to cancel the obligation. Other
costs directly related to the restructuring plan which are not eligible for
recognition at the commitment date, such as relocation and other integration
costs, are expensed as incurred.
The following analysis should be read in this context.
RECENT DEVELOPMENTS
Over the past three years, the Company's net revenues and net income have
increased substantially as a result of both internal growth and several
significant acquisitions. During 2002, the Company acquired two companies
operating in the defense industry. Effective May 10, 2002, the Company
acquired substantially all the capital stock of Radian Inc. (Radian), a
provider of engineering services, asset protection/security systems and
power generation equipment to the U.S. Department of Defense (DoD), for
approximately $42.0 million in cash and Company common stock. In conjunction
with the Radian acquisition, the Company recorded $15.3 million in
customer-related intangibles, which are being amortized over the weighted
average of the related customer contracts' estimated useful lives of 5.4
years. Effective June 27, 2002, the Company acquired all of the outstanding
common stock of Universal Power Systems, Inc. (UPSI), a provider of
uninterruptible power supply systems to the DoD, intelligence agencies and
commercial customers. The purchase price was approximately $5.5 million plus
certain contingent cash consideration based upon UPSI's net revenue levels
through October 31, 2003. Each of these acquisitions was accounted for as a
purchase and is included in the Light Military Support Equipment segment.
After allocating the respective purchase prices to the fair value of all
identifiable tangible and intangible assets, goodwill of $31.7 million was
recorded. In accordance with the Company's adoption of Statement of
Financial Accounting Standards (SFAS) 142, "Goodwill and Other Intangible
Assets," effective November 1, 2001, recorded goodwill balances are no
longer being amortized. Goodwill amortization totaled $3.2 million, or $1.9
million after income tax, in 2001.
Year Ended October 31 2002 2001 2000
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RESULTS OF CONTINUING OPERATIONS
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 76.7 79.3 80.3
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Gross profit 23.3 20.7 19.7
Selling, general and administrative expense 11.1 10.9 10.7
Restructuring expense 0.3
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Income from operations 11.9 9.8 9.0
Interest expense, net 0.8 1.6 2.7
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Income before income taxes 11.1 8.2 6.3
Income tax provision 4.3 3.2 2.5
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Net income 6.8% 5.0% 3.8%
===============================================================================
The Company operates in three business segments: Light Military
Support Equipment, Heavy Military Support Equipment, and Electronics and
Automation Systems. The Light Military Support Equipment segment engineers
and manufactures a broad range of military support equipment primarily for
the DoD, as well as related air-handling equipment for domestic commercial
and industrial users. The segment also provides engineering services and
asset protection/security systems to the DoD and other U.S. Government
customers. Segment products include environmental control systems, generator
sets and related power generation and distribution equipment, chemical and
biological protection systems, petroleum and water systems and other
multipurpose military support equipment. The Heavy Military Support
Equipment segment engineers and manufactures aircraft load management and
transport systems primarily for the DoD. The Electronics and Automation
Systems
8
segment engineers and manufactures airborne radar systems, reconnaissance,
surveillance and target acquisition systems and avionics test equipment
primarily for the DoD. The segment also manufactures material-handling
equipment for the U.S. Postal Service.
The following table sets forth net revenues and income from
operations for the years ended October 31, 2002, 2001 and 2000 for each of
the Company's business segments (dollars in millions):
Year Ended October 31 2002 2001 2000
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NET REVENUES
Light Military Support Equipment $187.0 45.8% $155.6 42.6% $160.3 47.8%
Heavy Military Support Equipment 133.3 32.7 124.6 34.1 114.7 34.2
Electronics and Automation Systems 87.6 21.5 85.0 23.3 60.3 18.0
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Total $407.9 100.0% $365.2 100.0% $335.3 100.0%
==========================================================================================================
INCOME FROM OPERATIONS
Light Military Support Equipment $ 15.9 32.8% $ 15.2 42.3% $ 16.6 55.1%
Heavy Military Support Equipment 22.9 47.2 12.6 35.1 7.2 24.0
Electronics and Automation Systems 9.8 20.0 8.1 22.6 6.4 20.9
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Total $ 48.6 100.0% $ 35.9 100.0% $ 30.2 100.0%
==========================================================================================================
2002 COMPARED TO 2001
Consolidated net revenues increased $42.7 million, or 11.7%, in 2002 to
$407.9 million from $365.2 million in 2001. The increase is primarily
attributable to higher net revenues in the Light Military Support Equipment
segment from the inclusion of the net revenues of Radian of $33.1 million
and UPSI of $3.7 million since their respective acquisition dates. Gross
profit for 2002 increased $19.6 million, or 25.9%, to $95.2 million (23.3%
of consolidated net revenues) from $75.6 million (20.7% of consolidated net
revenues) in 2001. The increase was due to the inclusion of the Radian and
UPSI operations since their respective acquisition dates during 2002 which
contributed total gross profit of $7.1 million in 2002. In addition, the
Heavy Military Equipment segment generated $10.6 million of additional gross
profit during 2002 resulting from higher segment revenues and improved
profitability on its long-term defense contracts, as discussed below.
Selling, general and administrative expenses increased $5.4 million, or
13.5%, in 2002 to $45.2 million (or 11.1% of consolidated net revenues) from
$39.8 million (10.9% of consolidated net revenues) in 2001. This increase
was primarily the result of the acquisitions of Radian and UPSI which
incurred combined selling, general and administrative expenses totaling $5.6
million, including $1.4 million in amortization of acquired customer-related
intangibles, since their respective acquisition dates during 2002. As
discussed above, the Company no longer amortized goodwill effective November
1, 2001 in accordance with SFAS 142. Goodwill amortization of $3.2 million
was included in selling, general and administrative expense in 2001. In
conjunction with the Company's restructuring plan announced during 2002,
restructuring expense of $1.4 million was recorded to write down fixed
assets at the affected facilities and to accrue for expected employee
benefits costs. The restructuring plan is expected to be completed by
mid-2003. As a result of the above, income from continuing operations
increased by $12.7 million, or 35.6%, in 2002 to $48.6 million from $35.9
million in 2001.
LIGHT MILITARY SUPPORT EQUIPMENT. Net revenues for the Light Military
Support Equipment segment increased by $31.4 million, or 20.2%, to $187.0
million in 2002 from $155.6 million in 2001. The current year increase was
primarily attributable to the inclusion of the net revenues of Radian of
$33.1 million and UPSI of $3.7 million since their respective acquisition
dates. Excluding the impact of acquisitions, net revenues for the segment
declined by $5.4 million. This reduction was due to lower production
activity on several long-term contracts in the segment, principally the
Tactical Quiet Generators (TQG) and the Chemical Biological Protected
Shelter (CBPS) programs, as compared to the prior year. Gross profit for the
segment increased by $7.7 million, or 25.1%, to $38.3 million (20.5% of
segment net revenues) from $30.6 million (19.7% of segment net revenues) in
2001. The
9
increase in gross profit was the result of the contribution from Radian and
UPSI since their respective acquisition dates of a combined $7.1 million in
2002. Income from operations increased by $0.7 million, or 5.1%, in 2002 to
$15.9 million from $15.2 million in 2001. The increase was the result of
higher gross profit partially offset by additional selling, general and
administrative expenses associated with the operations of Radian and UPSI
since their respective acquisition dates.
HEAVY MILITARY SUPPORT EQUIPMENT. Net revenues for the Heavy Military
Support Equipment segment increased by $8.7 million, or 7.0%, in 2002 to
$133.3 million from $124.6 million in 2001. The increase was principally due
to higher net revenues on the Tunner 60-K Cargo Loader (Tunner) program
during 2002. Gross profit for the segment increased by $10.6 million, or
39.0%, in 2002 to $37.6 million (28.2% of segment net revenues) from $27.1
million (21.7% of segment net revenues) in 2001. Increased revenues on the
Tunner contract, reductions in estimated production costs on the program and
favorable overhead absorption rates at the segment's manufacturing facility
led to the advancement in gross profit during 2002. Income from operations
increased by $10.3 million, or 81.7%, in 2002 to $22.9 million from $12.6
million in 2001. The significant increase was primarily due to higher net
revenue and gross profit levels in 2002 as mentioned above.
ELECTRONICS AND AUTOMATION SYSTEMS. Net revenues for the Electronics and
Automation Systems segment increased by $2.6 million, or 3.1%, in 2002 to
$87.6 million from $85.0 million in 2001. The growth in net revenues was
related to additional production work on the Knight Fire Support (Knight)
contract and various radar programs partially offset by reduced revenues
from the United States Postal Service and lower production levels on the
High Power Offload to CASS (HPOC) contract during 2002. Gross profit for the
segment increased by $1.3 million, or 7.3%, in 2002 to $19.3 million (22.0%
of segment net revenues) from $17.9 million (21.1% of segment net revenues)
in 2001. The increase in gross profit is attributable to the higher level of
net revenues in 2002 as discussed above. Income from operations increased by
$1.7 million, or 20.5%, in 2002 to $9.8 million from $8.1 million in 2001 as
a result of the increases in net revenues and gross profit as compared to
the prior year.
Net interest expense decreased by $2.7 million to $3.2 million in
2002 compared to $5.9 million in 2001 primarily as a result of lower
outstanding borrowings on the Company's revolving and term debt credit
facilities combined with a decline in interest rates throughout 2002. The
Company's effective borrowing rate decreased from 5.61% at October 31, 2001
to 4.94% at October 31, 2002.
The Company's reported effective income tax rate for both 2002 and
2001 was 39% resulting in total income tax expense of $17.7 million in 2002
and $11.7 million in 2001.
As a result of the foregoing, net income from continuing operations
increased 51.4% to $27.7 million (6.8% of consolidated net revenues) in 2002
compared to $18.3 million (5.0% of consolidated net revenues) in 2001.
DISCONTINUED OPERATIONS. As discussed above, in conjunction with the
Company's 2002 decision to divest of ESP, the Plastic Products segment's
financial results have been reclassified as a discontinued operation in the
Consolidated Financial Statements for all periods presented. Income from
discontinued operations totaled $49,000, net of income tax, in 2002 compared
to $0.3 million, net of income tax, in 2001. The change was principally the
result of a $1.1 million reduction in gross profit related to a $7.7
million, or 30.3%, decline in segment revenues during 2002 as compared to
the prior year. This was partially offset by reduced operating expenses as
compared to the prior year primarily related to the suspension of
depreciation expense for the second half of 2002. In conjunction with the
planned disposition of ESP, the Company recorded an after-tax loss of $4.2
million during 2002 to reduce the carrying value of ESP's assets to their
estimated fair value less estimated selling costs.
10
2001 COMPARED TO 2000
Consolidated net revenues increased $29.9 million, or 8.9%, in 2001 to
$365.2 million from $335.3 million in 2000. The increase was primarily a
result of higher production levels in the Electronics and Automation Systems
and the Heavy Military Support Equipment segments. Gross profit for 2001
increased $9.5 million, or 14.4%, in 2001 to $75.6 million (20.7% of
consolidated net revenues) from $66.1 million (19.7% of consolidated net
revenues) in 2000. The increase in gross profit was a result of higher net
revenues and improved performance on several key programs, as discussed
below. Selling, general and administrative expense increased $3.8 million,
or 10.7%, in 2001 to $39.8 million (10.9% of consolidated net revenues) from
$35.9 million (10.7% of consolidated net revenues) in 2000. As a result of
the above income from operations increased by $5.7 million, or 18.8%, in
2001 to $35.9 million from $30.2 million in 2000.
LIGHT MILITARY SUPPORT EQUIPMENT. Net revenues for the Light Military
Support Equipment segment decreased by $4.7 million, or 2.9%, to $155.6
million in 2001 from $160.3 million in 2000. The decrease in 2001 revenues
related to the completion of certain long-term contracts during the year.
This decrease was partially offset by higher production levels on some key
continuing programs. Gross profit for the segment increased by $1.7 million,
or 6.0%, in 2001 to $30.6 million (19.7% of segment net revenues) from $28.9
million (18.0% of segment net revenues) in 2000. The increase in gross
profit and gross margin can be attributed to improved contract performance
on certain key programs, including Tactical Quiet Generator (TQG) and
Chemical Biological Protected Shelter (CBPS). Income from operations
decreased by $1.4 million, or 8.8%, in 2001 to $15.2 million from $16.6
million in 2000. The decrease was primarily a result of the increased
selling, general and administrative expense partially offset by improved
contract performance as mentioned above.
HEAVY MILITARY SUPPORT EQUIPMENT. Net revenues for the Heavy Military
Support Equipment segment increased by $9.9 million, or 8.6%, in 2001 to
$124.6 million from $114.7 million in 2000. A labor stoppage occurring at
this segment's manufacturing facilities early in 2000 negatively impacted
segment revenues by approximately $6.0 million to $7.0 million. Gross profit
for the segment increased by $4.3 million, or 18.7%, in 2001 to $27.1
million (21.7% of segment net revenues) from $22.8 million (19.9% of segment
net revenues) in 2000. The increase in gross profit can be attributed to
increased revenues as previously mentioned and improved gross margins on
existing contracts. Income from operations increased by $5.4 million, or
74.4%, in 2001 to $12.6 million from $7.2 million in 2000. The increase was
primarily a result of the increase in net revenues over 2000 and the
improved gross margins as previously mentioned.
ELECTRONICS AND AUTOMATION SYSTEMS. Net revenues for the Electronics and
Automation Systems segment increased by $24.7 million, or 40.9%, in 2001 to
$85.0 million from $60.3 million in 2000. The increase in 2001 revenues was
due to additional work performed on several major programs, including the
HPOC and Knight systems. Gross profit for the segment increased by $3.5
million, or 24.4%, in 2001 to $17.9 million (21.1% of segment net revenues)
from $14.4 million (23.9% of segment net revenues) in 2000. The increase in
gross profit can be attributed to increased revenues as previously
mentioned, while the decrease in margin was a result of a less favorable
contract mix than in 2000. Income from operations increased by $1.8 million,
or 27.7%, in 2001 to $8.1 million from $6.3 million in 2000 as a result of
the increased revenues, partially offset by an increase in higher operating
costs.
11
DISCONTINUED OPERATIONS. Income from discontinued operations totaled $0.3
million, net of income taxes, in both 2001 and 2000. Annual fluctuations in
segment net revenues, gross profit and operating expenses were not
significant.
Net interest expense decreased by $3.1 million to $5.9 million in
2001 as a result of lower outstanding borrowings on the Company's revolving
and term debt credit facilities compared to 2000 and due to a decrease in
interest rates throughout 2001. The Company's effective borrowing rate
decreased from 8.12% at October 31, 2000 to 5.61% at October 31, 2001.
The effective income tax rates for 2001 and 2000 were 39% and 40%,
respectively, resulting in total income tax expense of $11.7 million in 2001
and $8.5 million in 2000. The reduction in the Company's effective income
tax rate resulted from the implementation of various tax planning strategies
during the year. As a result of the foregoing, net income increased 42.5% to
$18.6 million (5.1% of consolidated net revenues) in 2001 as compared to
$13.0 million (3.9% of consolidated net revenues) in 2000.
OUTLOOK FOR 2003 AND FUTURE YEARS
For 2003, the Company is forecasting a 12% to 13% increase in consolidated
net revenues to approximately $460 million for the year, without
consideration for any potential future acquisitions. The Company anticipates
that the inclusion for an entire year of the operations of Radian and UPSI,
both acquired during 2002, will contribute most significantly to this
increase in net revenues. The Company anticipates that cash flows generated
from operating earnings growth will be used to continue to pay down existing
bank debt in 2003, reducing interest costs to approximately $1.0 million for
the year. Reflecting the above forecasted assumptions, the Company expects
net income from continuing operations to increase approximately 20% in 2003.
In June 2001, the Financial Accounting Standards Board (FASB)
issued SFAS 141, "Business Combinations," and SFAS 142, "Goodwill and Other
Intangible Assets." Under SFAS 142, goodwill and other intangible assets
deemed to have indefinite lives will no longer be amortized but will be
subject to periodic impairment tests. All other intangible assets will be
amortized over their useful lives. In addition, SFAS 141 eliminates the
pooling-of-interests method of accounting for business combinations.
The Company adopted SFAS 141 and SFAS 142 as of November 1, 2001.
The Company has identified its reporting units to be its operating
subsidiaries with the exception of Systems & Electronics Inc. (SEI), which
comprises two reporting units: the Heavy Military Support Equipment and the
Electronics and Automation Systems segments of the Company. The carrying
value of each reporting unit as of November 1, 2001 was determined by
assigning assets and liabilities, including existing goodwill and intangible
assets, to the reporting units. Upon adoption of SFAS 142, amortization of
goodwill ceased. The Company has performed a transitional goodwill
impairment assessment as of November 1, 2001 and a goodwill impairment
assessment as of October 31, 2002. Neither assessment resulted in impairment
of goodwill. An annual impairment test will be performed in the fourth
quarter of each year. Under SFAS 142, the Company also capitalized and is
amortizing acquired identifiable intangible assets. In conjunction with its
acquisition of Radian, the Company capitalized acquired identifiable
intangible assets related to Radian's existing long-term government
contracts at a value of approximately $15.3 million and recorded related
amortization expense of $1.4 million, or $0.9 million, net of income tax.
The Company expects to record $2.8 million annually in intangible asset
amortization expense over the weighted average duration of the related
customer contracts of 5.4 years.
The Company continues to believe that significant growth
opportunities exist within the military support equipment, electronics and
services-related segments of the defense industry in response to (i) the
current fragmentation within the industry; (ii) the DoD's emphasis on
awarding contracts on the basis of "best value"; (iii) the DoD's increasing
reliance on the engineering and design capabilities of contractors; (iv)
heightened military operations around the globe; and, (v) overall increases
in defense spending by the DoD. The Company's focus for 2003 includes the
continued rationalization of its
12
existing defense operations in order to leverage its infrastructure and
achieve additional operational synergies, as well as the continued
integration of its recently acquired Radian and UPSI operations. The Company
continues to review potential defense acquisitions in both the manufacturing
and services areas. Any such transaction must be accretive to earnings, must
bring significant increases in revenues and backlog, and must provide
long-term value to the Company's shareholders.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital needs are generally funded through cash flow
from operations and the revolving line of credit. At October 31, 2002, the
Company's working capital and ratio of current assets to current liabilities
were $17.6 million and 1.18 to 1, respectively, compared with $41.3 million
and 1.59 to 1 a year ago. The reductions in working capital and in the
current ratio in 2002 are a result of the use of existing cash balances and
the revolving line of credit to fund the Radian and UPSI acquisitions
(combined cash purchase price of $45.5 million) during the year, offset by
significant operating cash flows. The Company generated operating cash flows
of $54.5 million in 2002 compared to $17.8 million in 2001. The significant
improvement in cash flow generation reflects increased net income, the
income tax benefit of non-qualified stock options deducted in the current
year and improved working capital management. Investment in property, plant
and equipment totaled $3.5 million and $1.6 million, respectively, in 2002
and 2001. The Company anticipates that capital expenditures in 2002 should
not exceed $6.0 million and will primarily be used for expansion of the Keco
manufacturing facility, as well as certain improvements at other facilities.
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 for the foreseeable future.
In conjunction with the acquisition of SEI in September 1999, the
Company entered into a credit agreement which provided a $90 million term
loan and a $55 million revolving credit facility. 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, 2002, the Company had $13 million outstanding against the
revolving line of credit, remaining availability under the revolving line of
credit of $39.7 million and a cash balance of $4.8 million.
COMMITTED AMOUNTS
Total contractual and contingent obligations as of October 31, 2002 are as
follows (in millions):
Payments / Expiration
- ---------------------------------------------------------------------------------------------
Less than One to Four to Over
One Year Three Years Five Years Five Years Total
- ---------------------------------------------------------------------------------------------
Contractual Obligations:
Short-term borrowings $ 13.0 $ 13.0
Long-term debt 21.0 21.0 42.0
Operating leases 3.4 4.4 2.4 0.3 10.5
Unconditional purchase
obligations 97.7 0.3 0.1 98.1
- ---------------------------------------------------------------------------------------------
135.1 25.7 2.5 0.3 163.6
- ---------------------------------------------------------------------------------------------
Contingent Obligations:
Letters of credit 2.2 2.2
Additional consideration
related to UPSI acquisition 5.2 0.4 5.6
- ---------------------------------------------------------------------------------------------
7.4 0.4 7.8
- ---------------------------------------------------------------------------------------------
Total Obligations $142.5 $26.1 $2.5 $0.3 $171.4
=============================================================================================
13
While contingent obligations are included in the table above, the
Company does not expect to fund the full amounts indicated for letters of
credit. In addition, $5.6 million represents the Company's estimate of the
maximum amount of additional consideration related to the UPSI acquisition.
On November 1, 2000, the Company adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 137 and
SFAS 138. The effect of adopting SFAS 133 was immaterial based on the fair
value of the Company's derivative instruments at the date of adoption.
During the year ended October 31, 2002, the Company's derivative contracts
consisted only of interest rate swaps used by the Company to convert a
portion of its variable rate long-term debt to fixed rates. At October 31,
2002, the Company recorded a liability of $0.3 million related to the fair
value of those interest rate swap agreements, which are designated as and
considered highly effective cash flow hedges of the Company's forecasted
variable rate interest payments. The entire corresponding loss, net of
income tax, is recorded in shareholders' equity as accumulated other
comprehensive loss. The Company does not expect to reclassify any of the
loss to current earnings in 2003.
INFLATION
Since a significant portion of the Company's contracts with the DoD are at
fixed prices, inflation can affect the ultimate profit to be realized on
them. Some contracts have price adjustment provisions that limit the impact
of inflation on profits. In addition, the Company's volume purchasing and
forward purchasing policies serve to limit the effects of inflation. The
Company considers potential inflation in preparation of contract proposals
and bids. In addition, the Company's commercial and industrial products are
predominantly custom-made. Therefore, the impact of inflation on operating
results is typically not significant. The Company attempts to alleviate
inflationary pressures on commercial and industrial products by increasing
selling prices to help offset rising costs (subject to competitive
conditions), increasing productivity and improving manufacturing techniques.
Because of these factors, management does not believe that inflation has
had, or that anticipated inflation will have, a significant effect on the
Company's operations.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 addresses the financial accounting
and reporting for the impairment or disposal of long-lived assets and
supersedes SFAS 121. The Company adopted SFAS 144 effective November 1,
2001. In the year ended October 31, 2002, the Company accounted for the
planned disposition through sale of ESP as discontinued operations in
accordance with SFAS 144.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 provides direction
for accounting and disclosure regarding specific costs related to an exit or
disposal activity. These include, but are not limited to, costs to terminate
a contract that is not a capital lease, costs to consolidate facilities or
relocate employees, and certain termination benefits provided to employees
that are involuntarily terminated under the terms of a one-time benefit
arrangement. The Company is required to adopt SFAS 146 for any disposal
activities initiated after December 31, 2002. The Company is currently
reviewing the impact of the adoption of SFAS 146 on its financial
statements.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock
Based Compensation - Transition and Disclosure - an Amendment of SFAS 123."
SFAS 148 provides additional transition guidance for those entities that
elect to voluntarily adopt the provisions of SFAS 123, "Accounting for Stock
Based Compensation." Furthermore, SFAS 148 mandates new disclosures in both
interim and year-end financial statements within the Company's Significant
Accounting Policies footnote. The Company has adopted these disclosure
requirements for the year ended October 31, 2002 and will apply them to its
interim financial statements in 2003.
14
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report on Form 10-K
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 2003
forecasted results, acquisitions, additional financing requirements, the
decision of any of the Company's key customers (including the U.S.
Government) to reduce or terminate orders with the Company, cutbacks in
defense spending by the U.S. Government and increased competition in the
Company's markets, which could cause the Company's actual results to differ
materially from those projected in, or inferred by, the forward-looking
statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page Reference
- ----------------------------------------------------------------------------
Consolidated Balance Sheets at October 31, 2002 and 2001 16
Consolidated Statements of Income for the years ended
October 31, 2002, 2001 and 2000 17
Consolidated Statements of Shareholders' Equity
for the years ended October 31, 2002, 2001 and 2000 18
Consolidated Statements of Cash Flows for the years ended
October 31, 2002, 2001 and 2000 19
Notes to Consolidated Financial Statements 20
Report of Independent Accountants 35
All other schedules are omitted because they are not applicable or
the required information is included in the Consolidated Financial
Statements or the notes thereto.
15
CONSOLIDATED BALANCE SHEETS
- -----------------------------------------------------------------------------------------
In thousands, except per share amounts
October 31 2002 2001
- -----------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 4,793 $ 1,015
Accounts receivable, net 47,407 31,430
Contracts in process and inventories, net 42,182 49,391
Refundable income taxes 2,709
Deferred income taxes 6,660 19,901
Prepaid expenses and other assets 2,301 2,316
Current assets of discontinued operations 10,079 7,184
- -----------------------------------------------------------------------------------------
Total Current Assets 116,131 111,237
PROPERTY, PLANT AND EQUIPMENT
Land 4,785 4,785
Buildings and improvements 34,739 32,174
Machinery and equipment 25,621 25,107
Furniture and fixtures 3,424 3,013
- -----------------------------------------------------------------------------------------
68,569 65,079
Less accumulated depreciation 25,464 21,007
- -----------------------------------------------------------------------------------------
43,105 44,072
Goodwill 103,444 71,427
Acquired customer-related intangibles 13,880
Deferred income taxes 6,885
Other assets 5,394 5,099
Long-term assets of discontinued operations 1,308 8,600
- -----------------------------------------------------------------------------------------
TOTAL ASSETS $290,147 $240,435
=========================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 13,000 $ 700
Current maturities of long-term debt 21,000 21,038
Accounts payable 28,439 20,396
Income taxes payable 638
Accrued employee compensation 20,117 15,952
Other liabilities 12,206 9,188
Current liabilities of discontinued operations 3,793 2,060
- -----------------------------------------------------------------------------------------
Total Current Liabilities 98,555 69,972
Long-term debt 21,000 42,000
Deferred income taxes 1,142
Additional minimum pension liability 20,334 8,591
Other liabilities 15,401 9,338
Commitments and contingencies (Note N)
SHAREHOLDERS' EQUITY
Common stock, par value $.01 per share; 30,000 shares
authorized; 16,991 and 11,672 shares issued 170 117
Additional paid-in capital 95,569 85,682
Retained earnings 84,961 61,823
Accumulated other comprehensive loss (14,275) (5,554)
- -----------------------------------------------------------------------------------------
166,425 142,068
Less treasury stock at cost, 1,171 and 1,467 shares 31,568 32,676
- -----------------------------------------------------------------------------------------
Total Shareholders' Equity 134,857 109,392
- -----------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $290,147 $240,435
=========================================================================================
See Notes to Consolidated Financial Statements.
16
CONSOLIDATED STATEMENTS OF INCOME
- -----------------------------------------------------------------------------------------------------------
In thousands, except per share amounts
Year Ended October 31 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Net revenues $407,945 $365,198 $335,342
Cost of revenues 312,767 289,584 269,251
- -----------------------------------------------------------------------------------------------------------
Gross profit 95,178 75,614 66,091
Selling, general and administrative expense 45,145 39,767 35,920
Restructuring expense 1,441
- -----------------------------------------------------------------------------------------------------------
Operating income from continuing operations 48,592 35,847 30,171
Interest expense 3,367 6,118 9,119
Interest income 128 214 140
Gain (loss) on sale of assets 7 6 (6)
- -----------------------------------------------------------------------------------------------------------
Income from continuing operations 45,360 29,949 21,186
Income tax provision 17,694 11,680 8,475
- -----------------------------------------------------------------------------------------------------------
Net income from continuing operations 27,666 18,269 12,711
Discontinued operations:
Income from discontinued operations, net of income tax 49 307 329
Estimated loss on disposal, net of income tax (4,182)
- -----------------------------------------------------------------------------------------------------------
NET INCOME $ 23,533 $ 18,576 $ 13,040
===========================================================================================================
Basic earnings per share:
Continuing operations $ 1.78 $ 1.30 $ 0.96
Discontinued operations:
Income 0.02 0.03
Estimated loss on disposal (0.27)
- -----------------------------------------------------------------------------------------------------------
Total $ 1.51 $ 1.32 $ 0.99
===========================================================================================================
Diluted earnings per share:
Continuing operations $ 1.71 $ 1.20 $ 0.93
Discontinued operations:
Income 0.02 0.03
Estimated loss on disposal (0.26)
- -----------------------------------------------------------------------------------------------------------
Total $ 1.45 $ 1.22 $ 0.96
===========================================================================================================
See Notes to Consolidated Financial Statements.
17
CONSOLIDATED STATEMENTS OF
SHAREHOLDERS' EQUITY
- ----------------------------------------------------------------------------------------------------------------------------
In thousands
Accum.
Additional Other ESOP
Common Paid-in Retained Comp. Guaranteed Treasury
Stock Capital Earnings Loss Bank Loan Stock Total
- ----------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 1999 $ 75 $37,032 $30,781 $(578) $ (3,888) $ 63,422
Net income 13,040 13,040
Cash dividends (250) (250)
Exercise of stock options 8 11,449 11,457
Reduction of ESOP
guaranteed bank loan 147 147
Purchase of treasury stock (10,576) (10,576)
Issuance of treasury stock 884 376 1,260
- ----------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 2000 83 49,365 43,571 (431) (14,088) 78,500
Comprehensive income:
Net income 18,576 18,576
Other components of
comprehensive income,
net of tax:
Minimum pension
liability adjustment (4,670) (4,670)
Adjustment to fair
value of derivatives (884) (884)
--------
Total comprehensive income 13,022
--------
Cash dividends (324) (324)
Exercise of stock options 15 35,866 35,881
Reduction of ESOP
guaranteed bank loan 431 431
Purchase of treasury stock (18,675) (18,675)
Issuance of treasury stock 470 87 557
Five-for-four stock split 19 (19)
- ----------------------------------------------------------------------------------------------------------------------------
Balance at October 31, 2001 117 85,682 61,823 (5,554) (32,676) 109,392
Comprehensive income:
Net income 23,533 23,533
Other components of
comprehensive income,
net of tax:
Minimum pension
liability adjustment (9,428) (9,428)
Adjustment to fair
value of derivatives 707 707
--------
Total comprehensive income 14,812
--------
Cash dividends (395) (395)
Issuance of common stock 1 1,354 1,355
Exercise of stock options 5,235 792 6,027
Issuance of treasury stock 3,350 316 3,666
Three-for-two stock split 52 (52)
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE AT OCTOBER 31, 2002 $170 $95,569 $84,961 $(14,275) $(31,568) $134,857
============================================================================================================================
See Notes to Consolidated Financial Statements.
18
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------
In thousands
Year Ended October 31 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 27,666 $ 18,269 $ 12,711
Adjustments to reconcile net income from continuing
operations to net cash provided by continuing operations:
Depreciation and amortization 7,038 9,001 9,398
Deferred income taxes 1,592 3,539 2,521
Loss (gain) on sale of assets (10) (6) 6
- ------------------------------------------------------------------------------------------------------------
Cash provided by continuing operations before changes
in operating assets and liabilities, excluding the effects
of acquisitions 36,286 30,803 24,636
Changes in operating assets and liabilities:
Accounts receivable (8,725) (2,192) (7,797)
Contracts in process and inventories 12,723 2,282 9,344
Accounts payable 4,911 (3,681) (2,171)
Current income taxes 3,347 3,063 (3,490)
Net changes in other assets and liabilities 6,669 (15,991) 2,370
- ------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 55,211 14,284 22,892
Net cash provided by (used in) discontinued operations (670) 3,528 (1,923)
- ------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 54,541 17,812 20,969
- ------------------------------------------------------------------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of Radian, net of cash acquired (39,997)
Purchase of UPSI, net of cash acquired (5,500)
Additions to property, plant and equipment (3,515) (1,624) (3,573)
Proceeds from sale of property, plant and equipment 11 12 307
- ------------------------------------------------------------------------------------------------------------
Net cash used in continuing operations (49,001) (1,612) (3,266)
Net cash used in discontinued operations (11) (158) (278)
- ------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (49,012) (1,770) (3,544)
- ------------------------------------------------------------------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES:
Net borrowings (payments) under line-of-credit agreement 12,300 (15,600) (7,600)
Payments of long-term debt (21,038) (17,028) (10,047)
Exercise of stock options 6,027 35,881 11,457
Purchase of treasury stock (18,675) (10,576)
Cash dividends (395) (324) (250)
Issuance of common stock to employee stock purchase plan 1,355
- ------------------------------------------------------------------------------------------------------------
Net cash used in continuing operations (1,751) (15,746) (17,016)
Net cash used in discontinued operations
- ------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,751) (15,746) (17,016)
- ------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 3,778 296 409
Cash and cash equivalents at beginning of year 1,015 719 310
- ------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 4,793 $ 1,015 $ 719
============================================================================================================
See Notes to Consolidated Financial Statements.
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------------------------------
In thousands, except per share amounts
NOTE A: SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION: The Consolidated
Financial Statements include the accounts of Engineered Support Systems,
Inc. (Company) and its wholly owned subsidiaries, which include Systems &
Electronics Inc. (SEI), Engineered Air Systems, Inc. (Engineered Air), Keco
Industries, Inc. (Keco), Engineered Coil Company, d/b/a Marlo Coil (Marlo
Coil), Engineered Electric Company, d/b/a Fermont (Fermont), ESSIbuy.com
(ESSIbuy), Radian Inc. (Radian), Universal Power Systems, Inc. (UPSI) and
Engineered Specialty Plastics, Inc. (ESP). All material intercompany
accounts and transactions have been eliminated in consolidation.
INDUSTRY INFORMATION: SEI, Engineered Air, Keco, Fermont, ESSIbuy,
Radian and UPSI provide integrated military electronics, support equipment
and logistics services. Substantially all revenues for these subsidiaries
are related to contracts with the U.S. Government. Marlo Coil manufactures
and sells heat-transfer and air-handling equipment primarily to defense
contractors, mechanical contractors and industrial users. ESP manufactures
and sells injection-molded plastic products, and manufactures and
distributes a proprietary line of faucets.
USE OF ESTIMATES: In preparing these financial statements,
management makes estimates and uses assumptions that affect some of the
reported amounts and disclosures. Actual results could differ from these
estimates and assumptions.
CASH AND CASH EQUIVALENTS: Cash equivalents include temporary
investments with original maturities of three months or less.
REVENUE RECOGNITION: Revenues on long-term contracts performed by
SEI, Engineered Air, Keco, Fermont and Radian, 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 measures,
primarily labor, incurred bear to the estimated production measures for the
contract. Earnings expectations are based upon estimates of contract values
and costs at completion. Contracts in process are reviewed on a periodic
basis. Adjustments to revenues and earnings are made in the current
accounting period based upon revisions in contract values and estimated
costs at completion. Provisions for estimated losses on contracts are
recorded when identified. On substantially all sales, Marlo Coil, ESSIbuy,
UPSI and ESP recognize revenue when title passes to the customer.
STOCK-BASED COMPENSATION: The Company applies Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations in accounting for all stock option plans. (See Note
K for a further description of these plans.) Accordingly, no compensation
expense has been recognized for stock option awards. The following table
illustrates the effect on net income from continuing operations and earnings
per share had the Company applied the fair value recognition provisions of
Statement of Financial Accounting Standards (SFAS) 123, "Accounting for
Stock-Based Compensation," to stock option awards.
20
Year Ended October 31 2002 2001 2000
- ----------------------------------------------------------------------------------------------
Reported net income from continuing operations $27,666 $18,269 $12,711
Total stock-based employee compensation expense
determined under the fair value method for all stock
option awards, net of income tax 11,105 3,925 1,554
- ----------------------------------------------------------------------------------------------
Pro forma net income $16,561 $14,344 $11,157
==============================================================================================
Earnings per share:
Basic - as reported $ 1.78 $ 1.30 $ 0.96
==============================================================================================
Basic - pro forma $ 1.06 $ 1.02 $ 0.85
==============================================================================================
Diluted - as reported $ 1.71 $ 1.20 $ 0.93
==============================================================================================
Diluted - pro forma $ 1.02 $ 0.94 $ 0.82
==============================================================================================
The fair value of options at the grant date was estimated using the
Black-Scholes model with the following weighted average assumptions for
2002, 2001 and 2000, respectively: an expected life of 1.5 years, 1.5 years
and 1.9 years; volatility of 51%, 58% and 48%; a dividend yield of 0.16%,
0.16% and 0.25%; and a risk-free interest rate of 3.74%, 4.27% and 6.55%.
The weighted average fair value of options granted in 2002, 2001
and 2000 was $7.66, $3.52 and $2.20, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS: For purposes of financial
reporting, the Company has determined that the fair value of the Company's
financial instruments, including cash and cash equivalents, accounts
receivable, accounts payable, accrued liabilities and long-term debt,
approximates book value at October 31, 2002 and 2001, based on either their
short-term nature or on terms currently available to the Company in
financial markets.
CREDIT RISK: Financial instruments which potentially subject the
Company to concentrations of credit risk consist principally of cash and
cash equivalents, and accounts receivable. At October 31, 2002 and 2001, 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
68% and 77%, respectively, of accounts receivable at October 31, 2002 and
2001 are due from the U.S. Government and its agencies. Allowances for
anticipated doubtful accounts are provided based on historical experience
and evaluation of specific accounts. The allowance for doubtful accounts was
$281 and $147 at October 31, 2002 and 2001, respectively.
INTEREST RATE RISK: Interest rate risk is managed through a
portfolio of variable- and fixed-rate debt composed of short- and long-term
instruments. The objective is to maintain a cost-effective mix that
management deems appropriate. Furthermore, the Company will periodically
convert its variable-rate term debt to fixed rates via interest rate swaps.
Given the Company's outstanding debt position, management does not believe
its exposure to interest rate fluctuations has had, or will have, a
significant impact on the Company's operations.
CONTRACTS IN PROCESS AND INVENTORIES: Contracts in process and
inventories represent accumulated contract costs, estimated earnings thereon
based upon the percentage of completion method and contract inventories
reduced by the contract value of delivered items of SEI, Engineered Air,
Keco, Fermont and Radian. 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.
Inventories of Marlo Coil, ESSIbuy, UPSI and ESP are valued at the
lower of cost or market using the first-in, first-out method.
21
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are
stated at cost and are depreciated using the straight-line method over their
estimated useful lives of 15 to 40 years for buildings and improvements,
five to 15 years for machinery and equipment, and three to 10 years for
furniture and fixtures. Depreciation expense totaled $4,934 in 2002, $5,073
in 2001 and $5,445 in 2000.
INCOME TAXES: The income tax provision is based on earnings
reported in the financial statements. Deferred income taxes are provided for
the tax effects of temporary differences between financial and income tax
reporting using current statutory tax rates.
IMPAIRMENT OF LONG-LIVED ASSETS: Long-lived assets, including
goodwill, are reviewed for impairment annually or whenever events or changes
in circumstances indicate that the carrying amount may not be recoverable.
If the sum of the expected future undiscounted cash flows is less than the
carrying amount of the asset, a loss is recognized for the difference
between the fair value and the carrying value of the asset.
EARNINGS PER SHARE: Basic earnings per share is based on average
basic common shares outstanding, after the effect of the stock split
described in Note O, of 15,582 in 2002, 14,036 in 2001 and 13,161 in 2000.
Diluted earnings per share is based on average diluted common shares
outstanding, after the effect of the stock split described in Note O, of
16,209 in 2002, 15,216 in 2001 and 13,622 in 2000. Average diluted common
shares outstanding include common stock equivalents, which are comprised
entirely of common stock options as computed using the treasury stock
method.
TREASURY STOCK: Shares of treasury stock are valued at cost using
the first-in, first-out method.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS: In August 2001, the
Financial Accounting Standards Board (FASB) issued SFAS 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses the
financial accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS 121. The Company adopted SFAS 144
effective November 1, 2001. In the year ended October 31, 2002, the Company
accounted for the planned disposition through sale of ESP as discontinued
operations in accordance with SFAS 144.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 provides direction
for accounting and disclosure regarding specific costs related to an exit or
disposal activity. These include, but are not limited to, costs to terminate
a contract that is not a capital lease, costs to consolidate facilities or
relocate employees, and certain termination benefits provided to employees
that are involuntarily terminated under the terms of a one-time benefit
arrangement. The Company is required to adopt SFAS 146 for any disposal
activities initiated after December 31, 2002. The Company is currently
reviewing the impact of the adoption of SFAS 146 on its financial
statements.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock
Based Compensation - Transition and Disclosure - an Amendment of SFAS 123."
SFAS 148 provides additional transition guidance for those entities that
elect to voluntarily adopt the provisions of SFAS 123, "Accounting for Stock
Based Compensation." Furthermore, SFAS 148 mandates new disclosures in both
interim and year-end financial statements within the Company's Significant
Accounting Policies footnote. The Company has adopted these disclosure
requirements for the year ended October 31, 2002 and will apply them to its
interim financial statements in 2003.
NOTE B: ACQUISITIONS
On May 10, 2002, the Company acquired all of the outstanding capital stock
of Radian, a supplier of engineering, logistics support and systems
integration services to the U.S. Department of Defense (DoD). The purchase
price was approximately $42.0 million, which included consideration of $2.0
million in the common stock of the Company. The purchase price is net of
$0.4 million of cash acquired. The fair value of the assets acquired,
including goodwill of $26.6 million and customer-related intangibles of
$15.3 million, was $58.3 million and liabilities assumed totaled $16.3
million. The cash portion of the purchase price was financed with available
cash resources and short-term borrowings under the Company's revolving
credit facility.
22
On June 27, 2002, the Company acquired all of the outstanding
common stock of UPSI, a provider of uninterruptible power supply systems for
the DoD, intelligence agencies and commercial customers. The purchase price
was approximately $5.5 million plus certain contingent cash consideration
based upon UPSI's net revenue levels through October 31, 2003. (The Company
estimates the maximum amount of contingent cash consideration to be $5.6
million.) The fair value of the assets acquired, including goodwill of $5.4
million, was $6.6 million and liabilities assumed totaled $1.1 million. The
purchase price was financed with short-term borrowings under the Company's
revolving credit facility.
Both companies are included in the Light Military Support Equipment
segment and their operating results are included in consolidated operations
since the date of acquisition.
NOTE C: GOODWILL AND INTANGIBLE ASSETS
In June 2001, the FASB issued SFAS 141, "Business Combinations," and SFAS
142, "Goodwill and Other Intangible Assets." Under SFAS 142, goodwill and
other acquired intangible assets deemed to have indefinite lives are no
longer amortized but are subject to periodic impairment tests. All other
acquired intangible assets are amortized over their useful lives. In
addition, SFAS 141 eliminated the pooling-of-interests method of accounting
for business combinations.
The Company adopted SFAS 141 and SFAS 142 effective November 1,
2001. The Company has identified its reporting units to be its operating
subsidiaries with the exception of SEI, which comprises two reporting units:
the Heavy Military Support Equipment and the Electronics and Automation
Systems segments of the Company. The carrying value of each reporting unit
as of November 1, 2001 was determined by assigning assets and liabilities,
including existing goodwill and acquired intangible assets, to the reporting
units. Upon adoption of SFAS 142, amortization of goodwill ceased. The
Company performed a transitional goodwill impairment assessment as of
November 1, 2001 and a goodwill impairment assessment as of October 31,
2002. Neither assessment resulted in impairment of goodwill.
The following pro forma information reconciles reported net income
from continuing operations to adjusted net income from continuing
operations, which reflect the adoption of SFAS 142:
Year Ended October 31 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
Reported net income from continuing operations $27,666 $18,269 $12,711
Goodwill amortization, net of tax benefit 1,922 1,928
- ----------------------------------------------------------------------------------------------------
Adjusted net income from continuing operations $27,666 $20,191 $14,639
====================================================================================================
Basic earnings per share:
Reported net income from continuing operations $ 1.78 $ 1.30 $ 0.96
Goodwill amortization, net of tax benefit 0.14 0.15
- ----------------------------------------------------------------------------------------------------
Adjusted net income from continuing operations $ 1.78 $ 1.44 $ 1.11
====================================================================================================
Diluted earnings per share:
Reported net income from continuing operations $ 1.71 $ 1.20 $ 0.93
Goodwill amortization, net of tax benefit 0.13 0.14
- ----------------------------------------------------------------------------------------------------
Adjusted net income from continuing operations $ 1.71 $ 1.33 $ 1.07
====================================================================================================
Discontinued operations had goodwill amortization of $0 in 2002, $0
in 2001 and $116 in 2000. Goodwill as of October 31, 2002 totaled $53,725
for the Light Military Support Equipment segment, $23,086 for the Heavy
Military Support Equipment segment and $26,633 for the Electronics and
Automation segment.
23
The following disclosure presents certain information on the
Company's acquired identifiable intangible assets as of October 31, 2002.
There were no acquired identifiable intangible assets as of October 31, 2001
and 2000. All acquired identifiable intangible assets are being amortized
over their estimated useful lives, as indicated below, with no estimated
residual values. These amounts are included in Other Assets in the
Consolidated Balance Sheets.
Weighted Average
Amortization Gross Accumulated Net
Period Amount Amortization Amount
- ---------------------------------------------------------------------------------------------
Customer-related intangibles:
October 31, 2002 5.4 years $15,300 $1,420 $13,880
The amortization expense related to acquired intangible assets was
$1,420 for the year ended October 31, 2002. Related estimated amortization
expense is $2,840 annually through the year ended October 31, 2006, and
$2,520 for the year ended October 31, 2007. There was no amortization
expense related to acquired intangible assets in 2001 and 2000.
NOTE D: OPERATIONAL RESTRUCTURING
During the year ended October 31, 2002, the Company announced a
restructuring plan to improve both plant utilization and long-term
profitability. Under the plan, the Company's Blue Ash, Ohio and Olivette,
Missouri manufacturing locations will be closed during the year ending
October 31, 2003 with related production efforts being relocated to other
existing Company facilities. Emerging Issues Task Force (EITF) 94-3 provides
specific requirements as to the appropriate recognition of restructuring
costs associated with employee termination benefits and other exit costs.
Employee termination costs are recognized when benefit arrangements are
communicated to affected employees in sufficient detail to enable the
employees to determine the amount of benefits to be received upon
termination. Other costs resulting from the restructuring plan that are not
associated with or that do not benefit activities that will be continued are
recognized at the date of commitment to the plan subject to certain
conditions. For the cost to be accrued, it must not be associated with or
incurred to generate revenues after the commitment date, and must be either
incremental to other costs incurred prior to the commitment date or
represent amounts under a contractual obligation that existed prior to the
commitment date that will either continue after the plan is completed with
no economic benefit or which will result in a penalty to cancel the
obligation. Other costs directly related to the restructuring plan which are
not eligible for recognition at the commitment date, such as relocation and
other integration costs, are expensed as incurred.
The plan will involve terminating 113 employees. During the year
ended October 31, 2002, the Company recorded the following costs in
connection with the restructuring plan.
Accrued at
Expensed Utilized October 31,
in 2002 in 2002 2002
- ---------------------------------------------------------------------------------------------
Severance and related benefits $ 789 $789
Other cash restructuring costs 153 153
- ---------------------------------------------------------------------------------------------
Restructuring costs, excluding non-cash items 942 $942
==========================
Pension curtailment costs 310
Estimated loss on asset disposal 189
- -------------------------------------------------------------
Total restructuring costs $1,441
=============================================================
24
NOTE E: DISCONTINUED OPERATIONS
During the year ended October 31, 2002, the Company formally adopted a plan
to dispose of ESP, a wholly owned subsidiary representing the entirety of
the Plastic Products segment. The Company expects that disposition through
the sale of ESP will be completed during the first six months of 2003. In
conjunction with this plan, the Company has recorded an estimated loss on
disposal of discontinued operations of $4.2 million, net of income tax of
$2.7 million, as of October 31, 2002 to reduce the carrying value of ESP's
net assets to their estimated fair value less estimated selling costs.
Accordingly, the Company has reported the results of operations of ESP as
discontinued operations for the years ended October 31, 2002, 2001 and 2000
in the Consolidated Statements of Income. Additionally, all depreciation on
the property, plant and equipment of ESP was suspended upon classification
as discontinued operations. All assets and liabilities associated with ESP
have been reclassified as assets and liabilities of discontinued operations
on the October 31, 2002 and 2001 Consolidated Balance Sheets. Certain
information with respect to the discontinued operations of ESP is as
follows:
Year Ended October 31 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
Net revenues $17,619 $25,270 $26,147
- ----------------------------------------------------------------------------------------------------
Income from discontinued operations, net of income tax $ 49 $ 307 $ 329
Estimated loss on disposal, net of income tax (4,182)
- ----------------------------------------------------------------------------------------------------
Income (loss) on discontinued operations, net of income tax $(4,133) $ 307 $ 329
====================================================================================================
Certain information with respect to the assets and liabilities of
ESP is summarized as follows:
October 31 2002 2001
- ----------------------------------------------------------------------------------------------------
Accounts receivable $ 4,750 $ 2,598
Inventories 5,329 4,586
Property, plant and equipment 1,308 8,600
- ----------------------------------------------------------------------------------------------------
Assets of Discontinued Operations $11,387 $15,784
====================================================================================================
Accounts payable $ 3,354 $ 1,544
Accrued expenses and other liabilities 439 516
- ----------------------------------------------------------------------------------------------------
Liabilities of Discontinued Operations $ 3,793 $ 2,060
====================================================================================================
NOTE F: ACCOUNTS RECEIVABLE
Accounts receivable includes amounts due from the U.S. Government
and its agencies of $32,442 and $24,114 at October 31, 2002 and 2001,
respectively.
NOTE G: CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories are comprised of the following:
October 31 2002 2001
- ----------------------------------------------------------------------------------------------------
Raw materials $ 3,662 $ 3,137
Work-in-process 2,368 1,448
Finished goods 178
Inventories substantially applicable to government contracts in process,
reduced by progress payments of $55,809 and $59,069 35,974 44,806
- ----------------------------------------------------------------------------------------------------
$42,182 $49,391
====================================================================================================
Contracts in process and inventories at October 31, 2002 and 2001
include estimated revenue of $82,669 and $83,341, respectively, representing
accumulated contract costs and related estimated earnings on uncompleted
government contracts.
25
NOTE H: NOTES PAYABLE AND LONG-TERM DEBT
Effective September 30, 1999, the Company entered into a bank credit
agreement which provided a $90 million term loan and a $55 million revolving
credit facility. Quarterly principal payments on the term loan began on
December 31, 1999, with final payment due in September 2004. Borrowings
under the term loan and the 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 plus an
applicable margin. The margin applicable to LIBOR varies from 1.0% to 2.25%
and the margin applicable to the prime rate varies from 0.0% to 1.0%
depending upon the Company's ratio of total indebtedness to earnings before
interest, taxes, depreciation and amortization (leverage ratio). At October
31, 2002, the average variable interest rate under the credit agreement was
3.03% and the Company had $39.7 million of availability under the revolving
credit facility, which carries an unused commitment fee of 0.3% to 0.5%
depending on the Company's leverage ratio. As of October 31, 2002, the
Company had converted $23.6 million of variable rate term debt to fixed
rates via interest rate swaps with three financial institutions. The
notional amounts of the swaps are reduced over time to reflect scheduled
principal payments and the fixed rate is capped at 6.545% to 6.60%, plus the
Company's borrowing margin applicable to LIBOR. Including the impact of
interest rate swaps, the Company's effective interest rate at October 31,
2002 was 4.94%.
The credit agreement, as amended, contains certain covenants,
including maintaining net worth of at least $74 million plus the net
proceeds of all equity offerings after October 31, 2001 plus 50% of
quarterly net income after October 31, 2001, and maintaining a leverage
ratio no greater than 2.50 to 1 subsequent to October 31, 2001. Pursuant to
the terms of the credit agreement, the Company is subject to various other
financial and operating covenants and maintenance criteria, including
restrictions on the Company's ability to incur additional indebtedness, make
capital expenditures, create liens, dispose of material assets and enter
into merger transactions and lease agreements. At October 31, 2002, the
Company was in compliance with all covenants of its credit agreement. No
compensating balance is required or maintained related to the agreement.
Long-term debt consists of:
October 31 2002 2001
- ------------------------------------------------------------------------------------
Term loan, variable rate equal to the lesser of LIBOR plus
applicable margin or prime rate plus applicable margin,
payable in quarterly installments $42,000 $63,000
Other 38
- ------------------------------------------------------------------------------------
42,000 63,038
Less current maturities 21,000 21,038
- ------------------------------------------------------------------------------------
$21,000 $42,000
====================================================================================
Borrowings under the revolving credit facility totaled $13.0
million as of October 31, 2002 and averaged $10.2 million for the year ended
October 31, 2002. Borrowings under the revolving credit facility and the
bank term 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 as follows:
Year Ended October 31
- ------------------------------------------------------------------------------------
2003 $21,000
2004 21,000
- ------------------------------------------------------------------------------------
$42,000
====================================================================================
Interest paid was $3,124 in 2002, $5,906 in 2001 and $9,865 in 2000.
26
NOTE I: DERIVATIVES AND HEDGING ACTIVITY
Effective November 1, 2000, the Company adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 137 and
SFAS 138. The effect of adopting SFAS 133 was immaterial based on the fair
value of the Company's derivative instruments at the date of adoption.
In accordance with SFAS 133, derivative financial instruments are
recognized on the balance sheet at fair value. Changes in the fair value of
a derivative instruments designated as "fair value" hedges, along with the
corresponding change in fair value of the hedged asset or liability, are
recorded in current period earnings. Changes in the fair value of derivative
instruments designated as "cash flow" hedges, to the extent the hedges are
highly effective, are recorded in other comprehensive income, net of related
tax effects. The ineffective portion of the cash flow hedge, if any, is
recognized in current period earnings. Other comprehensive income is
relieved when current earnings are affected by the variability of cash
flows.
The Company formally designates derivatives as hedging instruments
on the date it enters into the derivative contract. This process includes
linking derivative instruments designated as hedges to specific assets,
liabilities, firm commitments or specific forecasted transactions. The
Company evaluates, both at the inception of the hedge and on an ongoing
basis, whether derivatives used as hedging instruments are highly effective
in offsetting changes in the fair value of cash flows of the hedged items.
If it is determined that a derivative is not highly effective as a hedge or
ceases to be highly effective, the Company discontinues hedge accounting
prospectively.
During the period ended October 31, 2002, the Company's derivative
contracts consisted only of interest rate swaps used by the Company to
convert a portion of its variable rate long-term debt to fixed rates. At
October 31, 2002, the Company recorded a liability of $290 related to the
fair value of those interest rate swap agreements which are designated as
and considered highly effective cash flow hedges of the Company's forecasted
variable rate interest payments. The entire corresponding loss, net of
income tax, is recorded in shareholders' equity as accumulated other
comprehensive loss. The Company does not expect to reclassify any of this
loss to current earnings in 2003.
NOTE J: INCOME TAXES
The income tax provision is comprised of the following:
Year Ended October 31 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
Continuing Continuing Continuing
Operations Combined Operations Combined Operations Combined
- -------------------------------------------------------------------------------------------------------------
Current:
Federal $14,967 $14,117 $ 6,743 $ 6,669 $5,286 $5,321
State 2,017 2,017 1,669 1,669 897 853
- -------------------------------------------------------------------------------------------------------------
16,984 16,134 8,412 8,338 6,183 6,174
=============================================================================================================
Deferred:
Federal 637 1,429 2,941 3,175 2,006 2,206
State 73 163 327 364 286 315
- -------------------------------------------------------------------------------------------------------------
710 1,592 3,268 3,539 2,292 2,521
- -------------------------------------------------------------------------------------------------------------
$17,694 $17,726 $11,680 $11,877 $8,475 $8,695
=============================================================================================================
27
The deferred income tax provision (benefit) results from the
following temporary differences:
Year Ended October 31 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------------
Continuing Continuing Continuing
Operations Combined Operations Combined Operations Combined
- -------------------------------------------------------------------------------------------------------------------------
Uncompleted contracts $ 143 $ 143 $(1,033) $(1,033) $ 732 $ 732
Depreciation (504) (539) 1,713 1,873 526 632
Goodwill amortization 1,485 1,485 759 759 746 746
Contributions to employee
benefits plans 348 354 182 185 481 475
Estimated loss on disposal
of discontinued operations (1,823)
Other, net (762) 149 1,647 1,755 (193) (64)
- -------------------------------------------------------------------------------------------------------------------------
$ 710 $ (231) $ 3,268 $ 3,539 $2,292 $2,521
=========================================================================================================================
Deferred income tax liabilities (assets) are comprised of the
following:
Year Ended October 31 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Depreciation $ 2,480 $ 5,116
Uncompleted contracts (1,753) (1,896)
Employee benefits (4,067) (4,520)
Goodwill 3,440 1,955
Asset reserves (286) (1,012)
Stock options (2,723) (15,156)
Other comprehensive loss (9,127) (3,551)
Other (1,509) 305
- -------------------------------------------------------------------------------------------------------------------------
$(13,545) $(18,759)
=========================================================================================================================
The change in the stock option component of deferred income tax
liabilities (assets) indicated above is recorded directly to shareholders'
equity.
Deferred income tax liabilities (assets) are presented on the
Consolidated Balance Sheets as follows:
Year Ended October 31 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Current assets $ (6,660) $(19,901)
Non-current assets (6,885)
Non-current liabilities 1,142
- -------------------------------------------------------------------------------------------------------------------------
$(13,545) $(18,759)
=========================================================================================================================
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 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------------
Income tax provision at statutory federal rate $15,876 $10,482 $7,415
State income taxes and other, net 1,818 1,198 1,060
- -------------------------------------------------------------------------------------------------------------------------
$17,694 $11,680 $8,475
=========================================================================================================================
Income taxes paid were $2,713 in 2002, $4,587 in 2001 and $9,110 in
2000.
28
NOTE K: 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,
2002, 3,001 shares of unissued common stock were authorized and reserved for
outstanding options, which had a weighted average remaining contractual life
of 4.35 years at that date.
Transactions involving the stock option plans are as follows:
Shares Price per Share
- ----------------------------------------------------------------------------------------------------
Outstanding at October 31, 2000 1,461 $ 2.18 to $ 8.93
Options granted 1,827 $11.40 to $19.93
Options forfeited (2) $ 5.77
Options exercised (2,341) $ 2.18 to $19.93
- ----------------------------------------------------------------------------------------------------
Outstanding at October 31, 2001 945 $ 4.40 to $19.93
Options granted 2,376 $28.42 to $30.19
Options exercised (320) $ 4.40 to $19.93
- ----------------------------------------------------------------------------------------------------
Outstanding at October 31, 2002 3,001 $ 5.58 to $30.19
====================================================================================================
The following table summarizes information for stock options outstanding at
October 31, 2002:
Weighted Weighted
Average Average
Options Remaining Exercise
Range of Exercise Prices Outstanding Life Price
- ----------------------------------------------------------------------------------------------------
$ 5.58 to $ 8.00 291 2.0 years $ 6.05
$11.67 to $19.93 334 3.4 years $12.18
$28.42 to $30.19 2,376 4.8 years $28.88
The following table provides information as of October 31, 2002
with respect to the shares of common stock that may be issued under the
Company's existing equity compensation plans:
Number of shares
remaining available
for future issuance
Number of shares Weighted-average under equity
to be issued exercise price compensation plans
upon exercise of of outstanding (excluding securities
outstanding options options reflected in column (a))
Plan category (a) (b) (c)
- ----------------------------------------------------------------------------------------------------
Equity compensation plans
approved by shareholders 2,585 $23.94 279
Equity compensation plans not
approved by shareholders 416 $30.19 34
- ---------------------------------------------------------------- ------------------------
Total 3,001 $24.80 313
================================================================ ========================
29
NOTE L: PENSION AND OTHER POSTRETIREMENT BENEFITS
Effective September 30, 1999, the Company acquired SEI and assumed the
pension and other postretirement benefit plans related to SEI's employees
and non-employee participants. Substantially all employees of SEI are
covered by defined benefit or defined contribution pension plans. In
addition, certain retirees of SEI are eligible for postretirement health and
life insurance benefits. As a result, a net pension liability of $4,860 was
assumed as of the acquisition date, representing a $68,822 benefit
obligation net of $63,962 in the fair value of related plan assets. The
Company also assumed an unfunded postretirement benefit liability of $9,077
as of the acquisition date. To qualify for postretirement health and life
insurance benefits, an SEI employee must retire at age 55 or later and the
employee's age plus service must equal or exceed 75. Retiree contributions
are defined as a percentage of medical premiums. Consequently, retiree
contributions increase with increases in the medical premiums. The life
insurance plans are noncontributory and provide coverage of a flat dollar
amount for qualifying retired SEI employees.
All full-time employees of Engineered Air who are covered by a
collective bargaining agreement are also covered by a defined benefit
pension plan. These SEI and Engineered Air benefits are provided under
defined benefit pay-related and flat-dollar plans, which are primarily
non-contributory. Annual Company contributions to retirement plans equal or
exceed the minimum funding requirements of the Employee Retirement Income
Security Act or other applicable regulations.
The components of pension and other postretirement benefit costs
are presented below for 2002, 2001 and 2000.
2002 2001 2000
- ---------------------------------------------------------------------------------------------------
PENSION BENEFITS
Service cost $ 2,444 $ 2,215 $ 2,257
Interest cost 6,287 6,155 5,745
Expected return on plan assets (7,421) (7,579) (7,116)
Amortization of prior service cost 126 102 46
Recognized actuarial loss (gain) 300 (120) 52
- ---------------------------------------------------------------------------------------------------
Net pension benefit costs $ 1,736 $ 773 $ 984
===================================================================================================
OTHER POSTRETIREMENT BENEFITS
Service cost $ 199 $ 184 $ 165
Interest cost 651 596 638
Actuarial loss (gain) 123 (43) (7)
- ---------------------------------------------------------------------------------------------------
Net other postretirement benefit costs $ 973 $ 737 $ 796
===================================================================================================
30
A reconciliation of the changes in the plans' benefit obligations
and fair values of assets over the two-year period ending October 31, 2002
and a statement of the funded status at October 31, 2002 and 2001 follows:
2002 2001
- ---------------------------------------------------------------------------------------------------
PENSION BENEFITS
RECONCILIATION OF BENEFIT OBLIGATION:
Benefit obligation at beginning of year $ 89,222 $ 79,327
Service cost 2,444 2,215
Interest cost 6,287 6,155
Plan amendments 67
Actuarial loss 3,661 4,839
Benefit payments (3,654) (3,274)
Other (40) (40)
- ---------------------------------------------------------------------------------------------------
Benefit obligation at October 31 $ 97,987 $ 89,222
===================================================================================================
RECONCILIATION OF FAIR VALUE OF PLAN ASSETS:
Fair value of plan assets at beginning of year $ 66,074 $ 77,379
Actual return on plan assets (6,623) (8,354)
Employer contributions 2,945 323
Benefit payments (3,654) (3,274)
- ---------------------------------------------------------------------------------------------------
Fair value of plan assets at October 31 $ 58,742 $ 66,074
===================================================================================================
FUNDED STATUS:
Funded status at October 31 $(39,245) $(23,148)
Unrecognized prior service cost 4,388 936
Unrecognized actuarial loss 34,077 20,455
- ---------------------------------------------------------------------------------------------------
Accrued benefit cost $ (780) $ (1,757)
===================================================================================================
OTHER POSTRETIREMENT BENEFITS
RECONCILIATION OF BENEFIT OBLIGATION:
Benefit obligation at beginning of year $ 7,933 $ 8,332
Service cost 199 184
Interest cost 651 596
Actuarial loss 2,342 592
Benefit payments (1,684) (1,771)
- ---------------------------------------------------------------------------------------------------
Benefit obligation at October 31 $ 9,441 $ 7,933
===================================================================================================
RECONCILIATION OF FAIR VALUE OF PLAN ASSETS:
Fair value of plan assets at beginning of year
Employer contributions 1,684 1,771
Benefit payments (1,684) (1,771)
- ---------------------------------------------------------------------------------------------------
Fair value of plan assets at October 31
===================================================================================================
FUNDED STATUS:
Funded status at October 31 $ (9,441) $ (7,933)
Unrecognized actuarial loss 2,467 254
- ---------------------------------------------------------------------------------------------------
Accrued benefit cost $ (6,974) $ (7,679)
===================================================================================================
31
The amounts recognized in the Company's Consolidated Balance Sheets
as of October 31 are as follows:
2002 2001
- ---------------------------------------------------------------------------------------------------
PENSION BENEFITS
Prepaid benefit cost $ 4,797 $ 4,739
Accrued benefit cost (9,160) (6,496)
Intangible asset 805 936
Additional minimum liability (20,334) (8,591)
Other comprehensive loss 23,112 7,655
- ---------------------------------------------------------------------------------------------------
Net amount recognized $ (780) $(1,757)
===================================================================================================
OTHER POSTRETIREMENT BENEFITS
Prepaid benefit cost $ 199
Accrued benefit cost (7,173) (7,679)
- ---------------------------------------------------------------------------------------------------
Net amount recognized $ (6,974) $(7,679)
===================================================================================================
Assumptions used in accounting for the defined benefit plans in
2002, 2001 and 2000 were a discount rate of 6.75%, 7.25% and 7.75%,
respectively, and an expected long-term rate of return on assets of 9.5%,
10.0% and 10.0%, respectively.
Assumptions used in accounting for other postretirement benefits in
2002, 2001 and 2000 were a discount rate of 6.75%, 7.25% and 7.75%,
respectively, and a healthcare cost trend of 10.5% decreasing 0.5% annually
to 5.5%, 5.5% and 6.0%, respectively. A 1% increase in the healthcare cost
trend rate for each year would increase the October 31, 2002 net benefit
obligation by approximately $16, while a 1% decrease in the healthcare cost
trend rate for each year would decrease the October 31, 2002 net benefit
obligation by approximately $24.
The Company has an Employee Stock Ownership Plan (ESOP) covering
all salaried employees of Engineered Air, and all employees of ESP, Marlo
Coil, Keco, Fermont and ESSIbuy. The ESOP provides for a matching
contribution by the Company of no less than 25% of each employee's
contributions up to a maximum of 6% of the employee's earnings. The Company
also makes discretionary annual contributions. All employee and employer
contributions to the ESOP are 100% vested. In addition, the Company sponsors
the Radian Inc. 401(k) Employment Retirement Plan and the Universal Power
Systems, Inc. 401(k) Plan which cover all employees of Radian and UPSI,
respectively. The Company has recorded expense based on contributions to the
ESOP, the Radian plan and the UPSI plan for the years ended October 31,
2002, 2001 and 2000 of $1,895, $1,721 and $1,459, respectively.
NOTE M: BUSINESS SEGMENT INFORMATION
The Company operates in three business segments: Light Military Support
Equipment, Heavy Military Support Equipment and Electronics and Automation
Systems. The Light Military Support Equipment segment engineers and
manufactures a broad range of military support equipment primarily for the
DoD, as well as related heat-transfer and air-handling equipment for
domestic commercial and industrial users. The segment also provides
engineering services and asset protection/security systems to the DoD and
other government customers. Segment products include environmental control
systems, generator sets and related power generation and distribution
systems, chemical and biological protection systems, petroleum and water
systems and other multipurpose military support equipment. The Heavy
Military Support Equipment segment engineers and manufactures load
management and transport systems primarily for the DoD. The Electronics and
Automation Systems segment engineers and manufactures airborne radar
systems, reconnaissance, surveillance and target acquisition systems and
avionics test equipment primarily for the DoD. The segment also engineers
and manufactures material-handling equipment primarily for the U.S. Postal
Service.
32
Management utilizes more than one measurement and multiple views of
data to measure business segment performance and to allocate resources to
the segments. However, the dominant measurements are consistent with the
Company's Consolidated Financial Statements and, accordingly, are reported
on the same basis herein. Management evaluates the performance of its
business segments and allocates resources to them primarily based on income
from operations, along with cash flows and overall economic returns. The
Company's export net revenues and intersegment net revenues are not
significant. All corporate expenses and assets have been allocated to the
segments. In 2002, 2001 and 2000, approximately 91%, 91% and 93% of
consolidated net revenues were from the U.S. Government.
Information by segment is summarized as follows:
Year Ended October 31 2002 2001 2000
- -----------------------------------------------------------------------------------------------
NET REVENUES:
Light Military Support Equipment $187,005 $155,603 $160,277
Heavy Military Support Equipment 133,292 124,584 114,742
Electronics and Automation Systems 87,648 85,011 60,323
- -----------------------------------------------------------------------------------------------
$407,945 $365,198 $335,342
===============================================================================================
INCOME FROM OPERATIONS:
Light Military Support Equipment $ 15,939 $ 15,160 $ 16,614
Heavy Military Support Equipment 22,908 12,601 7,226
Electronics and Automation Systems 9,745 8,086 6,331
- -----------------------------------------------------------------------------------------------
$ 48,592 $ 35,847 $ 30,171
===============================================================================================
IDENTIFIABLE ASSETS:
Light Military Support Equipment $171,160 $ 95,627 $ 89,575
Heavy Military Support Equipment 59,346 62,398 74,496
Electronics and Automation Systems 48,254 66,626 53,301
- -----------------------------------------------------------------------------------------------
278,760 224,651 217,372
Discontinued operations 11,387 15,784 20,980
- -----------------------------------------------------------------------------------------------
$290,147 $240,435 $238,352
===============================================================================================
DEPRECIATION AND AMORTIZATION:
Light Military Support Equipment $ 3,599 $ 3,055 $ 3,077
Heavy Military Support Equipment 2,035 3,354 3,971
Electronics and Automation Systems 1,404 2,592 2,350
- -----------------------------------------------------------------------------------------------
$ 7,038 $ 9,001 $ 9,398
===============================================================================================
CAPITAL EXPENDITURES:
Light Military Support Equipment $ 1,611 $ 667 $ 1,578
Heavy Military Support Equipment 1,148 714 1,180
Electronics and Automation Systems 756 243 815
- -----------------------------------------------------------------------------------------------
$ 3,515 $ 1,624 $ 3,573
===============================================================================================
NOTE N: COMMITMENTS AND CONTINGENCIES
As a government contractor, the Company is continually subject to audit by
various agencies of the U.S. Government to determine compliance with various
procurement laws and regulations. As a result of such audits and as part of
normal business operations of the Company, various claims and charges are
asserted against the Company. It is not possible at this time to predict the
outcome of all such actions. However, management is of the opinion that it
has good defenses against such actions and believes that none of these
matters will have a material effect on the consolidated financial position
or the results of operations of the Company.
33
Total contractual and contingent obligations as of October 31, 2002
are as follows:
Payments / Expiration
- --------------------------------------------------------------------------------------------------------
Less than One to Four to Over
One Year Three Years Five Years Five Years Total
- --------------------------------------------------------------------------------------------------------
Contractual Obligations:
Short-term borrowings $ 13,000 $ 13,000
Long-term debt 21,000 21,000 42,000
Operating leases 3,367 4,418 2,414 338 10,537
Unconditional purchase
obligations 97,681 324 56 98,061
- --------------------------------------------------------------------------------------------------------
135,048 25,742 2,470 338 163,598
- --------------------------------------------------------------------------------------------------------
Contingent Obligations:
Letters of credit 2,282 2,282
Additional consideration
related to UPSI acquisition 5,174 426 5,600
- --------------------------------------------------------------------------------------------------------
7,456 426 7,882
- --------------------------------------------------------------------------------------------------------
Total Obligations $142,504 $26,168 $2,470 $338 $171,480
========================================================================================================
While contingent obligations are included in the table above, the
Company does not expect to fund the full amounts indicated for letters of
credit. In addition, the Company estimates the maximum amount of additional
consideration related to the UPSI acquisition to be $5.6 million.
NOTE O: STOCK SPLIT
On October 31, 2002, the Company effected a three-for-two stock split in the
form of a 50% stock dividend. All per share amounts, as well as all share
amounts related to the Company's stock option plans, in this report have
been restated to reflect this stock split.
34
REPORT OF INDEPENDENT ACCOUNTANTS
- -------------------------------------------------------------------------------
To the Board of Directors and Shareholders of Engineered Support Systems, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of
Engineered Support Systems, Inc. and its subsidiaries at October 31, 2002
and 2001, and the results of their operations and their cash flows for each
of the three years in the period ended October 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements
in accordance with auditing standards generally accepted in the United
States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note C to the Consolidated Financial Statements, on
November 1, 2001 the Company changed its method of accounting for goodwill
and intangible assets to conform to Statement of Financial Accounting
Standards No. 142.
/s/ PricewaterhouseCoopers LLP
- -----------------------------------
PricewaterhouseCoopers LLP
December 10, 2002
35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
- ----------------------------------------------------------------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the captions "Election of Directors" in the
registrant's Definitive Proxy Statement (to be filed within 120 days after
the close of its fiscal year ended October 31, 2002) is incorporated herein
by reference. Executive officers and key employees of the Company as of
January 17, 2003 are as follows:
Name Age Position
- --------------------------------------------------------------------------------------------------
Michael F. Shanahan, Sr. 63 Chairman, Chief Executive Officer
Gerald A. Potthoff 62 President, Chief Operating Officer
Gary C. Gerhardt 57 Vice Chairman-Administration, Chief Financial Officer
Ronald W. Davis 56 President, Business Development
Timothy B. Fleischer 43 Corporate Group President
Daniel A. Rodrigues 47 Corporate Group President
Larry K. Brewer 60 Senior Vice President - Business Development
Matt D. Hay 34 Vice President - Washington Operations
Dan D. Jura 50 Senior Vice President - Sales
Allan K. Kaste 56 Vice President - Human Resources
Robert L. Klautzer 58 Vice President - Management Information Systems
Steven J. Landmann 43 Vice President - Finance & Controller
John R. Wootton 55 Vice President - Technology
Thomas G. Cornwell 47 President (Engineered Air)
Joseph H. Creaghead 59 President (Keco)
Richard P. Dacey 61 President (Radian)
Frederic D. Knight 46 President (UPSI)
James T. Myrick 57 President (SEI)
Gerald A. Nicholson 56 President (Marlo Coil)
Thomas C. Santoro 49 President (Fermont)
EXECUTIVE OFFICERS
The officers serve at the discretion of the Board of Directors, subject to
the terms and conditions of their employment agreements.
Michael F. Shanahan, Sr. has been a senior executive of the Company
since its formation in 1982. He has served as Chief Executive Officer of the
Company since 1985 and as its Chairman since 1987.
Gerald A. Potthoff has been President and Chief Operating Officer
of the Company since 1999. Prior thereto, he served as President of SEI from
1991 until 2000.
Gary C. Gerhardt has been Vice Chairman - Administration of the
Company since 1999. Prior thereto, he served as Executive Vice President of
the Company since 1994 and has been its Chief Financial Officer since 1993.
Ronald W. Davis was named President, Business Development of the
Company in 2002. Prior thereto, he served as Vice President - Planning and
Development and, briefly, as Vice President - Marketing of the Company since
1999 and as Vice President - Marketing for Engineered Air since 1990.
36
Timothy B. Fleischer was named Corporate Group President of the
Company in 2002. Prior thereto, he served as President of Radian since its
acquisition in May of 2002 and previously as its President and Chief
Executive Officer since 1994.
Daniel A. Rodrigues was named Corporate Group President of the
Company in 2002. Prior thereto, he served as President of SEI since 2000 and
as Senior Vice President and General Manager of SEI since 1999 and as its
Vice President of Program Administration since 1995.
Larry K. Brewer has been Senior Vice President - Business
Development of the Company since February 2000. Prior thereto, he served SEI
as Vice President - Business Development since 1998, Vice President - Corp.
Marketing & Washington DC Operations since 1997 and as Vice President -
Government Relations since 1995.
Matt D. Hay has been Vice President - Washington Operations of the
Company since 1999, and for SEI since 1998.
Dan D. Jura was named Senior Vice President - Sales of the Company
in 2002. Prior thereto, he served as Vice President - Sales for the Company
since 1999 and for Engineered Air since 1993.
Allan K. Kaste has been Vice President - Human Resources of the
Company since 2000. He has served as Vice President - Human Resources for
SEI since 1994.
Robert L. Klautzer has been Vice President - Management Information
Systems of the Company since 2000. He has served as Vice President -
Management Information Systems for SEI since 1997 and, prior thereto, as its
Director - Management Information Systems since 1988.
Steven J. Landmann has been Vice President - Finance & Controller
of the Company since 1999. Prior thereto, he served as Controller for the
Company since 1998 and for Engineered Air since 1994.
John R. Wootton has been Vice President - Technology of the Company
since 2000. He has served as Vice President - Technology for SEI since 1997
and, prior thereto, as its Director - Technology since 1994.
Thomas G. Cornwell has been President of Engineered Air since 2000.
Prior thereto, he served as Director - Program Management for SEI since
1992.
Joseph H. Creaghead was named President of Keco in 2002. Prior
thereto, he was General Manager - Managing Director of Husco International
Ltd. since 1997.
Richard P. Dacey was named President of Radian in 2002. Prior
thereto, he served as its Executive Vice President and Chief Operating
Officer since 1995 after a distinguished career with the U.S. Army.
Frederic D. Knight was named President of UPSI upon its acquisition
by the Company in June 2002. He has served as its Chief Technology Officer
since 2000 and, prior thereto, as its President and Chief Executive Officer
since 1989.
James T. Myrick was named President of SEI in 2002. Prior thereto,
he served as its Executive Vice President since 2001 and as its Vice
President - Finance since 1997.
Gerald A. Nicholson has been President of Marlo Coil since 2001.
Prior thereto, he was Executive Vice President for the Tweco/Arcair and
Coyne Cylinder divisions of Thermadyne Industries from 1995 to 1998.
Thomas C. Santoro has been President of Fermont since 1995.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning the Company's executive compensation as shown in the
Definitive Proxy Statement (to be filed within 120 days after the close of
the fiscal year ended October 31, 2002) is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
Information relating to the ownership of the Company's securities by certain
beneficial owners and management as shown in the Definitive Proxy Statement
(to be filed within 120 days after the close of the year ended October 31,
2002) is incorporated herein by reference.
37
The following table provides information as of October 31, 2002
with respect to the shares of common stock that may be issued under the
Company's existing equity compensation plans:
Number of shares
remaining available
for future issuance
Number of shares Weighted-average under equity
to be issued exercise price compensation plans
upon exercise of of outstanding (excluding securities
outstanding options options reflected in column (a))
Plan category (a) (b) (c)
- -----------------------------------------------------------------------------------------------------
Equity compensation plans
approved by shareholders 2,585,122 $23.94 278,436
Equity compensation plans not
approved by shareholders 415,628 $30.19 34,373
- ----------------------------------------------------------------- ------------------------
Total 3,000,750 $24.80 312,909
================================================================= ========================
All shares and per share amounts have been restated to reflect a
three-for-two stock split effected by the Company on October 31, 2002.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information on certain relationships, related transactions and affiliation
of directors as shown in the Definitive Proxy Statement (to be filed within
120 days after the close of the year ended October 31, 2002) is incorporated
herein by reference.
38
PART IV
- ----------------------------------------------------------------------------
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, the Company
carried out an evaluation, under the supervision and with the participation
of the Company's management, including the Company's Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Based upon that evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective. Disclosure
controls and procedures are controls and procedures that are designed to
ensure that information required to be disclosed in Company reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect those controls
subsequent to the date this evaluation was carried out, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS,
SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
See Item 8 above.
(2) The following financial statement schedule and accountants'
report are included as Exhibit 99.3.
Schedule II - Valuation and Qualifying Accounts - years ended
October 31, 2002, 2001 and 2000
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
are not required under the related instructions or are
inapplicable, and therefore have been omitted.
(3) Exhibits
Lists of Exhibits (listed by numbers corresponding to exhibit table of Item
601 in regulation S-K)
3.1 Articles of Incorporation of Engineered Support Systems, Inc.(1)
3.2 Amendment of Articles of Incorporation(2)
3.3 Amended and Restated By-Laws of Engineered Support Systems, Inc.(2)
4.1 Credit Agreement dated as of September 30, 1999 among Engineered
Support Systems, Inc., Bank of America, National Association, as
Agent and as Swing Line Lender, and the Other Financial
Institutions Party Hereto(5)
4.2 Engineered Air Systems, Inc. Employee Stock Ownership Plan,
subsequently renamed the Engineered Support Systems, Inc. Employee
Stock Ownership Plan(4)
4.3 Trust Agreement for the Engineered Air Systems, Inc. Employee Stock
Ownership Trust(4)
4.4 Engineered Support Systems, Inc. 2000 Stock Option Plan(6)
4.5 Engineered Support Systems, Inc. 2000 Stock Option Plan for
Non-Employee Directors(7)
4.6 Engineered Support Systems, Inc. Employee Stock Purchase Plan(8)
4.7 Engineered Support Systems, Inc. Stock Purchase Plan for
Non-Employee Directors(9)
4.8 Engineered Support Systems, Inc. 2002 Stock Option Plan(10)
4.9 Engineered Support Systems, Inc. 2002 Stock Option Plan for
Non-Employee Directors(11)
4.10 Engineered Support Systems, Inc. 2002 Non-Executive Stock Option
Plan(12)
39
10.1 Employment Agreement with Michael F. Shanahan, Sr.
10.2 Employment Agreement with Gerald A. Potthoff
10.3 Employment Agreement with Gary C. Gerhardt
10.4 Employment Agreement with Ronald W. Davis
10.5 Employment Agreement with Larry K. Brewer
10.6 Form of Indemnification Agreement with Directors(2)
11 Statement Re: Computation of Earnings Per Share
13 Engineered Support Systems, Inc. Annual Report for the year ended
October 31, 2002 (the Annual Report). Except for the portions
incorporated herein by reference as evidenced in the Form 10-K, the
Annual Report is furnished for the information of the Securities
and Exchange Commission and is not deemed filed as part of this 10-K.
21 Subsidiaries of Registrant(1)
23 Consent of PricewaterhouseCoopers LLP, Independent Accountants
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
99.3 Valuation and Qualifying Accounts (Schedule II)
(1) This information is incorporated herein by reference from Form S-1
Registration Statement filed on July 10, 1985, registration number
2-98909 as amended on August 13, 1985 and August 21, 1985.
(2) This information is incorporated herein by reference from Form 10-K
Annual Report filed on January 30, 1989.
(3) Not used.
(4) This information is incorporated herein by reference from Form S-8
registration statement, effective June 11, 1987, registration
number 33-14504.
(5) This information is incorporated herein by reference from Form
8-K/A filed on December 14, 1999.
(6) This information is incorporated by reference from Form S-8
registration statement, effective September 1, 2000, registration
number 333-45022.
(7) This information is incorporated by reference from Form S-8
registration statement, effective September 1, 2000, registration
number 333-45020.
(8) This information is incorporated by reference from Form S-8
registration statement, effective June 29, 2001, registration
number 333-64126.
(9) This information is incorporated by reference from Form S-8
registration statement, effective July 20, 2001, registration
number 333-65490.
(10) This information is incorporated by reference from Form S-8
registration statement, effective August 9, 2002, registration
number 333-97859.
(11) This information is incorporated by reference from Form S-8
registration statement, effective August 9, 2002, registration
number 333-97861.
(12) This information is incorporated by reference from Form S-8
registration statement, effective November 12, 2002, registration
number 333-101161.
(b) Reports on Form 8-K
During the fourth quarter of 2002, the Company filed no reports on
Form 8-K.
(c) Exhibits
See list of Exhibits in this Part IV, Item 15(a)3 above.
(d) Financial Statement Schedules
See Part IV, Item 15(a)2 above.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned thereunto duly
authorized.
ENGINEERED SUPPORT SYSTEMS, INC.
Dated: January 29, 2003 By: /s/ Gary C. Gerhardt
---------------- ----------------------------------
GARY C. GERHARDT
Vice Chairman - Administration and
Chief Financial Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
Signature Title Date
- ----------------------------------------------------------------------------------------------------
/s/ Michael F. Shanahan, Sr. Chairman of the Board of Directors January 29, 2003
- ------------------------------ and Chief Executive Officer ----------------
MICHAEL F. SHANAHAN, SR.
/s/ Gary C. Gerhardt Vice Chairman - Administration January 29, 2003
- ------------------------------ and Chief Financial Officer ----------------
GARY C. GERHARDT
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
DIRECTORS
/s/ Michael F. Shanahan, Sr. January 29, 2003 /s/ Thomas J. Guilfoil January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
MICHAEL F. SHANAHAN, SR. THOMAS J. GUILFOIL
/s/ Gerald A. Potthoff January 29, 2003 /s/ S. Lee Kling January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
GERALD A. POTTHOFF S. LEE KLING
/s/ Gary C. Gerhardt January 29, 2003 /s/ Kenneth E. Lewi January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
GARY C. GERHARDT KENNETH E. LEWI
/s/ Timothy B. Fleischer January 29, 2003 /s/ Charles T. Robertson, Jr. January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
TIMOTHY B. FLEISCHER CHARLES T. ROBERTSON, JR.
/s/ William H.T. Bush January 29, 2003 /s/ Crosbie E. Saint January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
WILLIAM H.T. BUSH CROSBIE E. SAINT
/s/ Michael P. C. Carns January 29, 2003 /s/ Michael F. Shanahan, Jr. January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
MICHAEL P. C. CARNS MICHAEL F. SHANAHAN, JR.
/s/ George E. Friel January 29, 2003 /s/ Earl W. Wims January 29, 2003
- ------------------------------ ---------------- ------------------------------- ----------------
GEORGE E. FRIEL EARL W. WIMS
42
CERTIFICATIONS
I, Michael F. Shanahan, Sr., certify that:
1. I have reviewed this Annual Report on Form 10-K of Engineered Support
Systems, Inc.
2. Based on my knowledge, this Annual Report does not contain any untrue
statements of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this Annual Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Annual Report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
Annual Report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
Annual Report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this Annual Report (the "Evaluation Date"); and
c. Presented in this Annual Report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
and finance committee of the registrant's board of directors (or persons
performing the equivalent functions):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
Annual Report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: January 29, 2003
/s/ Michael F. Shanahan, Sr.
- --------------------------------------
MICHAEL F. SHANAHAN, SR.
Chairman and Chief Executive Officer
43
CERTIFICATIONS
I, Gary C. Gerhardt, certify that:
1. I have reviewed this Annual Report on Form 10-K of Engineered Support
Systems, Inc.
2. Based on my knowledge, this Annual Report does not contain any untrue
statements of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this Annual Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Annual Report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
Annual Report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
Annual Report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this Annual Report (the "Evaluation Date"); and
c. Presented in this Annual Report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
and finance committee of the registrant's board of directors (or persons
performing the equivalent functions):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
Annual Report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: January 29, 2003
/s/ Gary C. Gerhardt
- -------------------------------------
GARY C. GERHARDT
Vice Chairman - Administration and Chief Financial Officer
44
ENGINEERED SUPPORT SYSTEMS, INC.
EXHIBIT INDEX
Page No.
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11. Statement Re: Computation of Earnings Per Share 46
13. Engineered Support Systems, Inc. Annual Report for year ended
October 31, 2002 (the Annual Report). Except for the portions
incorporated herein by reference as evidenced in the Form 10-K,
the Annual Report is furnished for the information of the
Securities and Exchange Commission and is not deemed filed as
part of this Form 10-K.
23. Consent of PricewaterhouseCoopers LLP, Independent Accountants 47
99.1 Certification of Chief Executive Officer 48
99.2 Certification of Chief Financial Officer 49
99.3 Valuation and Qualifying Accounts (Schedule II) 51
45