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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the three months ended January 31, 2003 Commission file number 0-13880
ENGINEERED SUPPORT SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Missouri 43-1313242
(State of Incorporation) (IRS Employer Identification Number)
201 Evans Lane, St. Louis, Missouri 63121
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (314) 553-4000
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares of the Registrant's common stock, $.01 par value,
outstanding at February 28, 2003 was 16,056,115.
1
ENGINEERED SUPPORT SYSTEMS, INC.
INDEX
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of January 31, 2003 and
October 31, 2002.................................................. 3
Condensed Consolidated Statements of Income for the three
months ended January 31, 2003 and 2002............................ 4
Condensed Consolidated Statements of Cash Flows for the three
months ended January 31, 2003 and 2002............................ 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................ 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.. 17
Item 4. Controls and Procedures..................................... 17
Part II - Other Information
Items 1-6 ........................................................... 18
Signatures ................................................................ 19
Exhibits .................................................................. 22
2
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
January 31 October 31
2003 2002
---------- ----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 1,071 $ 4,793
Accounts receivable 48,422 47,407
Contracts in process and inventories 40,909 42,182
Deferred income taxes 6,660 6,660
Other current assets 8,015 5,010
Current assets of discontinued operations 8,194 10,079
--------- ---------
Total Current Assets 113,271 116,131
Property, plant and equipment, less accumulated
depreciation of $26,712 and $25,464 44,659 43,105
Goodwill 108,452 103,444
Deferred income taxes 6,772 6,885
Other assets 18,485 19,274
Long-term assets of discontinued operations 1,308 1,308
--------- ---------
Total Assets $ 292,947 $ 290,147
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable $ $ 13,000
Current maturities of long-term debt 21,000 21,000
Accounts payable 31,324 28,439
Other current liabilities 36,956 32,323
Current liabilities of discontinued operations 2,297 3,793
--------- ---------
Total Current Liabilities 91,577 98,555
Long-term debt 15,750 21,000
Additional minimum pension liability 20,334 20,334
Other liabilities 14,919 15,401
Shareholders' Equity
Common stock, par value $.01 per share; 30,000
shares authorized; 17,022 and 16,991 shares issued 170 170
Additional paid-in capital 100,248 95,569
Retained earnings 93,250 84,961
Accumulated other comprehensive loss (14,098) (14,275)
--------- ---------
179,570 166,425
Less treasury stock at cost, 967 and 1,171 shares 29,203 31,568
--------- ---------
150,367 134,857
--------- ---------
Total Liabilities and Shareholders' Equity $ 292,947 $ 290,147
========= =========
See notes to condensed consolidated financial statements.
3
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
Three Months Ended
January 31
--------------------------
2003 2002
--------- --------
Net revenues $ 121,663 $ 91,286
Cost of revenues 94,517 71,373
--------- --------
Gross profit 27,146 19,913
Selling, general and administrative expense 12,907 9,396
--------- --------
Operating income from continuing operations 14,239 10,517
Interest expense (456) (859)
Interest income 49 22
Gain on sale of assets 6 3
--------- --------
Income from continuing operations 13,838 9,683
Income tax provision 5,397 3,777
--------- --------
Net income from continuing operations 8,441 5,906
Income (loss) from discontinued operations,
net of income tax 137 (382)
--------- --------
Net income $ 8,578 $ 5,524
========= ========
Basic earnings per share:
Continuing operations $ 0.53 $ 0.38
Discontinued operations 0.01 (0.02)
--------- --------
Total $ 0.54 $ 0.36
========= ========
Diluted earnings per share:
Continuing operations $ 0.50 $ 0.37
Discontinued operations 0.01 (0.02)
--------- --------
Total $ 0.51 $ 0.35
========= ========
See notes to condensed consolidated financial statements.
4
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(UNAUDITED)
Three Months Ended
January 31
---------------------------
2003 2002
--------- ---------
From operating activities:
Net income from continuing operations $ 8,441 $ 5,906
Depreciation and amortization 2,177 1,340
Gain on sale of assets (6) (3)
--------- ---------
Cash provided before changes in operating
assets and liabilities 10,612 7,243
Net (increase) decrease in non-cash current assets (4,655) 13,765
Net increase (decrease) in non-cash current liabilities 4,371 (7,989)
Decrease in other assets 1,913 1,559
--------- ---------
Net cash provided by continuing operations 12,241 14,578
Net cash provided by discontinued operations 525 490
--------- ---------
Net cash provided by operating activities 12,766 15,068
--------- ---------
From investing activities:
Additions to property, plant and equipment (2,831) (773)
Proceeds from sale of property, plant and equipment 10 3
--------- ---------
Net cash used in continuing operations (2,821) (770)
Net cash used in discontinued operations
--------- ---------
Net cash used in investing activities (2,821) (770)
--------- ---------
From financing activities:
Net payments under line-of-credit agreement (13,000) (700)
Payments of long-term debt (5,250) (5,260)
Purchase of treasury stock (266)
Exercise of stock options 5,137 121
Cash dividends (288) (185)
--------- ---------
Net cash used in continuing operations (13,667) (6,024)
Net cash used in discontinued operations
--------- ---------
Net cash used in financing activities (13,667) (6,024)
--------- ---------
Net increase (decrease) in cash and cash equivalents (3,722) 8,274
Cash and cash equivalents at beginning of period 4,793 1,015
--------- ---------
Cash and cash equivalents at end of period $ 1,071 $ 9,289
========= =========
See notes to condensed consolidated financial statements.
5
ENGINEERED SUPPORT SYSTEMS, INC
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(in thousands, except per share amounts)
JANUARY 31, 2003
NOTE A - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared by the Company without audit. In the opinion of management, all
adjustments (including normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three month
period ended January 31, 2003 are not necessarily indicative of the results to
be expected for the entire fiscal year.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial statements and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report to shareholders for the year ended October 31, 2002.
NOTE B - EARNINGS PER SHARE
Average diluted common shares outstanding include common stock
equivalents, which represent common stock options as computed based on the
treasury stock method.
Basic earnings per share for the three months ended January 31, 2003
and 2002 is based on average basic common shares outstanding of 15,915 and
15,342, respectively. Diluted earnings per share for the three months ended
January 31, 2003 and 2002 is based on average diluted common shares outstanding
of 16,845 and 15,929, respectively.
NOTE C - STOCK-BASED COMPENSATION
The Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for all stock option plans. Accordingly, no compensation expense has
been recognized for stock option awards. The following table illustrates the
effect on net income from continuing operations and earnings per share had the
Company applied the fair value recognition provisions of Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
to stock option awards.
6
Three Months Ended
January 31
----------------------
2003 2002
------ ------
Reported net income from continuing operations $8,441 $5,906
Total stock-based employee compensation expense
determined under the fair value method for all stock
option awards, net of income tax 5
------ ------
Pro forma net income from continuing operations $8,436 $5,906
====== ======
Earnings per share from continuing operations:
Basic - as reported $ 0.53 $ 0.38
====== ======
Basic - pro forma $ 0.53 $ 0.38
====== ======
Diluted - as reported $ 0.50 $ 0.37
====== ======
Diluted - pro forma $ 0.50 $ 0.37
====== ======
The fair value of options at the grant date was estimated using the
Black-Scholes model with the following weighted average assumptions for the
three months ended January 31, 2003: an expected life of 1.5 years, volatility
of 51%, a dividend yield of 0.16% and a risk-free interest rate of 3.74%. The
weighted average fair value of options granted in the three months ended January
31, 2003 was $7.66. There were no stock option awards in the three months ended
January 31, 2002.
NOTE D - ACQUISITIONS
On May 10, 2002, the Company acquired all of the outstanding common
stock of Radian, Inc., a supplier of engineering, logistics support and systems
integration services to the U.S. Department of Defense. 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. (Acquired customer-related
intangibles, less $2.1 million of amortization to date, are included on the
January 31, 2003 Condensed Consolidated Balance Sheet in Other Assets.) The cash
portion of the purchase price was financed with available cash resources and
short-term borrowings under the Company's revolving credit facility.
On 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 for the U.S. Department of Defense, 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 two measurement dates, December 31, 2002 and October 31, 2003. Based
upon UPSI's net revenue through the December 31, 2002 measurement date, $5.0
million of cash consideration was added to the purchase price and is included on
the January 31, 2003 Condensed Consolidated Balance Sheet in Other Current
Liabilities. (The Company estimates the maximum amount of contingent cash
consideration related to the October 31, 2003 measurement date to be $0.6
million). The fair value of the
7
assets acquired, including goodwill of $10.4 million, was $11.6 million and
liabilities assumed totaled $1.2 million. The purchased 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.
NOTE E - OTHER COMPREHENSIVE INCOME (LOSS)
The Company's other comprehensive income (loss) for the three months
ended January 31, 2003 and 2002 was $177 and $150, respectively. The components
of other comprehensive income (loss) include a minimum pension liability
adjustment and an adjustment to the fair value of derivatives.
NOTE F - GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141 (SFAS 141), "Business
Combinations," and No. 142 (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 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., 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.
As a result of the adoption of SFAS 142 effective November 1, 2001, the
Company recorded no goodwill amortization in the three month periods ended
January 31, 2003 and 2002, respectively.
The following disclosure presents certain information on the Company's
acquired intangible assets as of January 31, 2003 and October 31, 2002. All
acquired intangible assets are being amortized over their estimated useful lives
with no estimated residual values. These amounts are included in Other Assets in
the Condensed Consolidated Balance Sheets.
8
Weighted Average
Amortization Gross Accumulated Net
Period Amount Amortization Amount
---------------- ------ ------------ ------
Customer-related intangibles:
January 31, 2003 5.4 years $ 15,300 $ 2,130 $ 13,170
October 31, 2002 5.4 years 15,300 1,420 13,880
The amortization expense related to acquired intangible assets was $710
for the three months ended January 31, 2003. 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 for the three months ended January 31, 2002.
NOTE G - 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) No. 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, none of which had been terminated as of January 31, 2003.
During the three months ended January 31, 2003, the Company recorded the
following costs in connection with the restructuring plan.
Accrued at Accrued at
October 31, Expensed Utilized January 31,
2002 2003
----------- -------- -------- -----------
Severance and related benefits $ 789 $ 789
Other cash restructuring costs 153 153
------ -------- -------- ------
Restructuring costs, excluding non-cash items $ 942 $ 942
====== ======== ======== ======
9
NOTE H - DISCONTINUED OPERATIONS
During the second quarter of 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 business segment.
The Company expects that the disposition through sale of ESP will be completed
by April 30, 2003. In conjunction with this plan, the Company has recorded an
estimated loss on disposal of discontinued operations of $4.2 million as of
January 31, 2003 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
three months ended January 31, 2003 and 2002 in the Condensed Consolidated
Statements of Income. All assets and liabilities associated with ESP have been
reclassified as assets and liabilities of discontinued operations on the January
31, 2003 and October 31, 2002 Condensed Consolidated Balance Sheets. Certain
information with respect to the discontinued operations of ESP for the three
month periods ended January 31, 2003 and 2002 is as follows:
Three Months Ended
January 31
---------------------
2003 2002
------- -------
Net revenues $ 5,125 $ 2,830
======= =======
Income (loss) from operations, net of income tax $ 137 $ (382)
Estimated loss on disposal, net of income tax
------- -------
Income (loss) on discontinued operations, net of income tax $ 137 $ (382)
======= =======
Certain information with respect to the assets and liabilities of ESP is
summarized as follows:
January 31 October 31
2003 2002
---------- ----------
Accounts receivable $ 3,325 $ 4,750
Inventories 4,869 5,329
Property, plant and equipment 1,308 1,308
------- -------
Assets of Discontinued Operations $ 9,502 $11,387
======= =======
Accounts payable $ 1,801 $ 3,354
Accrued expenses and other liabilities 496 439
------- -------
Liabilities of Discontinued Operations $ 2,297 $ 3,793
======= =======
NOTE I - CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories of certain of the Company's
operating subsidiaries (Systems & Electronics Inc., Engineered Air Systems,
Inc., Keco Industries, Inc., Engineered Electric Company and Radian, Inc.)
represent accumulated contract costs, estimated earnings
10
thereon based upon the percentage of completion method and contract inventories
reduced by the contract value of delivered items. Inventories of Engineered Coil
Company and Universal Power Systems, Inc. are valued at the lower of cost or
market using the first-in, first-out method. Contracts in process and
inventories are comprised of the following:
January 31, 2003 October 31, 2002
---------------- ----------------
Raw materials $ 2,599 $ 3,662
Work-in-process 1,827 2,368
Finished goods 115 178
Inventories substantially applicable to
government contracts in process, less
Progress payments of $51,308 and $55,809 36,368 35,974
-------- --------
$ 40,909 $ 42,182
======== ========
NOTE J - 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. Inter-segment
revenues for the three months ended January 31, 2003 and 2002, respectively,
were not significant. Total assets by segment as disclosed in the Company's
annual report for the year ended October 31, 2002 have not changed materially
since that date. Goodwill by segment as of October 31, 2002 totaled $53,725 for
Light Military Support Equipment, $23,086 for Heavy Military Support Equipment
and $26,633 for Electronics and Automation Systems. Goodwill by segment as of
January 31, 2003 totaled $58,733 for Light Military Support Equipment, $23,086
for Heavy Military Support Equipment and $26,633 for Electronics and Automation
Systems. In addition, there have been no changes in either the basis of
segmentation or the measurement of segment income since October 31, 2002.
Information by segment is as follows:
11
Three Months Ended
January 31
-------------------------
2003 2002
-------- --------
Net revenues:
Light military support equipment $ 68,937 $ 39,583
Heavy military support equipment 31,149 31,024
Electronics and automation systems 21,577 20,679
-------- --------
Total $121,663 $ 91,286
======== ========
Operating income from continuing operations:
Light military support equipment $ 6,118 $ 5,352
Heavy military support equipment 5,337 3,287
Electronics and automation systems 2,784 1,878
-------- --------
14,239 10,517
Interest expense (456) (859)
Interest income 49 22
Gain on sale of assets 6 3
-------- --------
Income from continuing operations
before income taxes $ 13,838 $ 9,683
======== ========
NOTE K - SUBSEQUENT EVENT
On March 4, 2003, the Company announced that it had entered into a
non-binding letter of intent to acquire all of the outstanding stock of
Technical and Management Services Corporation (TAMSCO), a provider of
information technology logistics and digitization services and a designer and
integrator of telecommunications systems primarily for the DoD, in exchange for
approximately $66.5 million in cash. TAMSCO's revenues for the year ended
December 31, 2002 were approximately $116 million.
Neither the Company or TAMSCO in obligated to complete the transaction
under the non-binding letter of intent. The proposed transaction is subject to
the completion of satisfactory due diligence and the negotiation and execution
of a definitive agreement.
12
ITEM 2. 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 second quarter of 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 business segment.
In conjunction with this plan, the Company recorded an estimated loss on
disposal 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 three months
ended January 31, 2003 and 2002 in the Condensed Consolidated Statements of
Income. Additionally, all depreciation on the property, plant and equipment of
ESP was suspended as of the end of the second quarter of 2002.
During the third quarter of 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) No. 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 following analysis should be read in this context.
13
RESULTS OF OPERATIONS
Consolidated net revenues from continuing operations increased
$30.4 million, or 33.3%, to $121.7 million in the first quarter of 2003
compared to $91.3 million in the first quarter of 2002. The increase was
primarily the result of $28.9 million of net revenues from Radian, Inc.
(Radian), which was acquired May 10, 2002, and from Universal Power Systems,
Inc. (UPSI), which was acquired June 27, 2002. Radian's most significant
contract, the Deployable Power Generation and Distribution System (DPGDS)
for the U.S. Air Force and U.S. Army contributed $15.8 million in revenues
during the quarter ended January 31, 2003. Gross profit from continuing
operations for the three months ended January 31, 2003 increased $7.2
million, or 36.3%, to $27.1 million (22.3% of consolidated net revenues)
from $19.9 million (21.8% of consolidated net revenues) in the comparable
2002 period. The increase in gross profit was a result of a significant
increase in revenues, offset by a lower margin contract mix, in the Light
Military Support Equipment segment and improved operating performance in the
other two business segments. Selling, general and administrative expense
from continuing operations increased $3.5 million, or 37.4%, in the first
quarter of 2003 to $12.9 million (10.6% of consolidated net revenues) from
$9.4 million (10.3% of consolidated net revenues) in the first quarter of
2002. As a result of the above, income from continuing operations increased
$4.1 million, or 42.9%, in the quarter ended January 31, 2003 to $13.8
million from $9.7 million in the first quarter of 2002.
LIGHT MILITARY SUPPORT EQUIPMENT. Net revenues for the Light Military
Support Equipment segment increased by $29.4 million, or 74.2%, to $68.9 million
in the first quarter of 2003 from $39.5 million in the first quarter of 2002 due
to the addition of Radian and UPSI to the segment. Gross profit for the segment
increased by $4.7 million, or 51.5%, in the first quarter of 2003 to $13.9
million (20.1% of segment net revenues) from $9.2 million (23.1% of segment net
revenues) in the first quarter of 2002. The significant increase in revenues,
offset by a lower margin contract mix, resulted in the gross profit increase.
Income from operations increased by $0.8 million, or 14.3%, in the first quarter
of 2003 to $6.1 million from $5.3 million in the first quarter of 2002 as a
result of the additions of Radian and UPSI.
HEAVY MILITARY SUPPORT EQUIPMENT. Net revenues for the Heavy Military
Support Equipment segment increased by $0.1 million, or 0.4%, to $31.1 million
in the first quarter of 2003 from $31.0 million in the first quarter of 2002.
Gross profit for the segment increased by $1.8 million, or 26.9%, in the first
quarter of 2003 to $8.4 million (27.1% of segment net revenues) from $6.6
million (21.5% of segment net revenues) in the first quarter of 2002. The
significant gross profit increase was due to improved margins on the M1000 Heavy
Equipment Transporter and other segment programs, stemming from production
efficiencies and resultant cost reductions. Income from operations increased by
$2.0 million, or 62.4%, in the first quarter of 2003 to $5.3 million from $3.3
million in the first quarter of 2002, as a result of the gross profit gains
noted above.
ELECTRONICS AND AUTOMATION SYSTEMS. Net revenues for the Electronics
and Automation Systems segment increased by $0.9 million, or 4.3%, to $21.6
million in the first quarter of 2003 from $20.7 million in the first quarter of
2002. The Knight (formerly Striker) and MSTAR programs remained the most
significant contributors to segment net revenues, along
14
with several aircraft-based radar programs. Gross profit for the segment
increased by $0.7 million, or 17.9%, in the first quarter of 2003 to $4.8
million (22.4% of segment net revenues) from $4.1 million (19.9% of segment net
revenues) in the first quarter of 2002. Income from operations increased by $0.9
million, or 48.2%, in the first quarter of 2003 to $2.8 million from $1.9
million in the first quarter of 2002 as a result of the above.
Net interest expense decreased by $0.4 million to $0.4 million in the
first quarter of 2003. This decrease was a result of lower outstanding
borrowings on the Company's revolving and term-debt credit facilities, as well
as the impact of lower interest rates. The effective income tax rate was 39.0%
for the three months ended January 31, 2003 and 2002. As a result of the
foregoing, net income from continuing operations increased 42.9% to $8.4 million
(6.9% of consolidated net revenues) in the quarter ended January 31, 2003 as
compared to $5.9 million (6.5% of consolidated net revenues) in the first
quarter of 2002.
During the second quarter of 2002, the Company formally adopted a plan
to dispose of ESP. In conjunction with this plan, the Company has recorded an
estimated loss, net of income tax, of $4.2 million as of January 31, 2003
related to the disposal of ESP. In addition, the Company realized income (loss)
from ESP operations, net of income tax, of $0.1 million and $(0.4) million in
the first quarter of 2003 and 2002, respectively.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 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.
The Company has accounted for the planned disposition through sale of ESP as
discontinued operations in accordance with SFAS 144.
In June 2002, the FASB issued SFAS No. 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 adopted these disclosure requirements for the
year ended October 31, 2002 and will apply them to its interim financial
statements in 2003.
15
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 clarifies disclosures regarding
certain guarantees to be made by a guarantor in its interim and annual financial
statements. FIN 45 also clarifies that a guarantor is required to recognize, at
the inception of certain guarantees, a liability for the fair value of the
obligation undertaken in issuing the guarantee, but does not prescribe a
specific approach for subsequently measuring the liability over its life.
Recognition provisions of FIN 45 are to be applied prospectively for guarantees
issued or modified after December 31, 2002. The related disclosure requirements
are effective for periods ending after December 15, 2002. The Company adopted
FIN 45 as of the current quarter, which did not have a material effect on its
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
In conjunction with the acquisition of SEI in September 1999, the
Company entered into a credit agreement which provided for 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 January 31,
2003, the Company had no borrowings against the revolving line of credit,
remaining availability under the line of credit of $52.8 million and a cash
balance of $1.1 million.
At January 31, 2003, the Company's working capital and ratio of
current assets to current liabilities were $21.7 million and 1.24 to 1 as
compared with $17.6 million and 1.18 to 1 at October 31, 2002. The Company
generated cash flow from continuing operations of $12.2 million in the three
months ended January 31, 2003 as compared to $14.6 million in the first three
months of 2002. Investment in property, plant and equipment totaled $2.8 million
and $0.8 million for the first three months of 2003 and 2002, respectively. $1.9
million of total capital expenditures for the three months ended January 31,
2003 were incurred at the Company's Keco Industries, Inc. subsidiary and relate
to the Company's previously discussed restructuring plan. The Company
anticipates that capital expenditures in 2003 should not exceed $7.0 million.
Management believes that cash flow generated from operations, together with the
available line of credit, will provide the necessary resources to meet the needs
of the Company in the foreseeable future.
There have been no material changes in the total contractual and
contingent obligations included in the Company's annual report to shareholders
for the year ended October 31, 2002.
BUSINESS AND MARKET CONSIDERATIONS
Approximately 95% of consolidated net revenues from continuing
operations for the three months ended January 31, 2003 were directly or
indirectly derived from defense orders by the U.S. government and its agencies.
As of January 31, 2003, the Company's funded backlog of orders totaled
$340.5 million, with related customer options of an additional $727.4 million.
16
Management continues to pursue potential acquisitions, primarily of
those companies providing strategic consolidation within the defense industry.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this report includes certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which are intended to be covered by the safe harbors created
thereby. The forward-looking statements involve certain risks and uncertainties,
including, but not limited to acquisitions, additional financing requirements,
the decision of any of the Company's key customers (including the U.S.
government) to reduce or terminate orders with the Company, cutbacks in defense
spending by the U.S. government and increased competition in the Company's
markets, which could cause the Company's actual results to differ materially
from those projected in, or inferred by, the forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
At 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. These contracts expired in November 2002. At
January 31, 2003, the Company had no derivative contracts.
ITEM 4. 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 the 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.
17
PART II
OTHER INFORMATION
Items 1-5 Not applicable.
Item 6 Exhibits and Reports on Form 8-K.
(a) Exhibits
11. Statement Re: Computation of Earnings Per Share
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) No reports on Form 8-K were filed during the three months
ended January 31, 2003.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENGINEERED SUPPORT SYSTEMS, INC.
Date: March 17, 2003 By: /s/ Michael F. Shanahan, Sr.
--------------------- ------------------------------
Michael F. Shanahan, Sr.
Chairman of the Board and
Chief Executive Officer
Date: March 17, 2003 By: /s/ Gary C. Gerhardt
--------------------- ------------------------------
Gary C. Gerhardt
Vice Chairman - Administration
and Chief Financial Officer
19
CERTIFICATIONS
I, Michael F. Shanahan, Sr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Engineered Support
Systems, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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 quarterly
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
quarterly report (the "Evaluation Date"); and,
c. Presented in this quarterly 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
quarterly 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: March 17, 2003
/s/ Michael F. Shanahan, Sr.
- ------------------------------------
Michael F. Shanahan, Sr.
Chairman and Chief Executive Officer
20
CERTIFICATIONS
I, Gary C. Gerhardt, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Engineered Support
Systems, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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 quarterly
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
quarterly report (the "Evaluation Date"); and,
c. Presented in this quarterly 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
quarterly 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: March 17, 2003
/s/ Gary C. Gerhardt
- ----------------------------------
Gary C. Gerhardt
Vice Chairman - Administration and
Chief Executive Officer
21