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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 six months ended April 30, 2005 Commission file number 0-13880
ENGINEERED SUPPORT SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Missouri 43-1313242
(State of Incorporation) (IRS Employer Identification Number)
201 Evans Lane, St. Louis, Missouri 63121
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (314) 553-4000
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated
filer (as defined by Rule 12b-2 of the Exchange Act). Yes X No
--- ---
The number of shares of the Registrant's common stock, $.01 par
value, outstanding at May 31, 2005 was 41,690,252.
1
ENGINEERED SUPPORT SYSTEMS, INC.
INDEX
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of April 30, 2005 and
October 31, 2004.................................................. 3
Condensed Consolidated Statements of Income for the three and six
months ended April 30, 2005 and 2004.............................. 4
Condensed Consolidated Statements of Cash Flows for the six
months ended April 30, 2005 and 2004.............................. 5
Notes to Condensed Consolidated Financial Statements ............. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................ 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk.. 31
Item 4. Controls and Procedures..................................... 32
Part II - Other Information
Items 1-6 ........................................................... 33
Signatures ................................................................ 35
Exhibits .................................................................. 36
2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
April 30 October 31
2005 2004
----------- ----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 27,726 $ 33,153
Accounts receivable 156,698 139,191
Contracts in process and inventories 83,794 61,009
Deferred income taxes 6,921 6,921
Other current assets 6,547 2,846
-------- --------
Total Current Assets 281,686 243,120
Property, plant and equipment, less accumulated
depreciation of $32,883 and $29,177 51,861 46,946
Goodwill 312,275 167,358
Acquired customer-related intangibles 54,369 38,314
Deferred income taxes 2,286 1,876
Other assets 12,675 13,520
-------- --------
Total Assets $715,152 $511,134
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable $116,000 $
Current maturities of long-term debt 335 340
Accounts payable 63,748 71,796
Other current liabilities 68,290 58,936
-------- --------
Total Current Liabilities 248,373 131,072
Long-term debt 1,132 781
Additional minimum pension liability 28,237 28,237
Other liabilities 14,828 14,088
Shareholders' Equity
Common stock, par value $.01 per share; 85,000
shares authorized; 41,685 and 26,642 shares issued 417 266
Additional paid-in capital 198,456 151,805
Retained earnings 241,792 202,730
Accumulated other comprehensive loss (18,083) (17,845)
-------- --------
422,582 336,956
-------- --------
Total Liabilities and Shareholders' Equity $715,152 $511,134
======== ========
See notes to condensed consolidated financial statements.
3
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(UNAUDITED)
Three Months Ended Six Months Ended
April 30 April 30
-------------------------- ----------------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net revenues:
Products $148,144 $137,612 $289,876 $263,199
Services 115,624 72,524 207,425 142,067
-------- -------- -------- --------
263,768 210,136 497,301 405,266
-------- -------- -------- --------
Cost of revenues:
Products 102,695 91,755 196,683 179,597
Services 100,749 64,956 182,750 125,973
-------- -------- -------- --------
203,444 156,711 379,433 305,570
-------- -------- -------- --------
Gross profit 60,324 53,425 117,868 99,696
Selling, general and administrative
expense 27,068 23,389 51,621 43,386
Restructuring expense - 39 - 66
Gain (loss) on sale of assets 21 (1) 20 (5)
-------- -------- -------- --------
Operating income from continuing
operations 33,277 29,996 66,267 56,239
Interest expense (1,065) (305) (1,072) (1,003)
Interest income 195 102 456 156
-------- -------- -------- --------
Income from continuing operations 32,407 29,793 65,651 55,392
Income tax provision 12,314 11,470 24,947 21,326
-------- -------- -------- --------
Net income from continuing operations 20,093 18,323 40,704 34,066
Loss on sale of discontinued operations,
net of income tax 1,048 - 1,048 -
-------- -------- -------- --------
Net income $ 19,045 $ 18,323 $ 39,656 $ 34,066
======== ======== ======== ========
Basic earnings per share:
Continuing operations $ 0.49 $ 0.47 $ 1.00 $ 0.89
Discontinued operations (0.03) - (0.03) -
-------- -------- -------- --------
Total $ 0.46 $ 0.47 $ 0.97 $ 0.89
======== ======== ======== ========
Diluted earnings per share:
Continuing operations $ 0.46 $ 0.44 $ 0.95 $ 0.82
Discontinued operations (0.02) - (0.03) -
-------- -------- -------- --------
Total $ 0.44 $ 0.44 $ 0.92 $ 0.82
======== ======== ======== ========
See notes to condensed consolidated financial statements.
4
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(UNAUDITED)
Six Months Ended
April 30
--------------------------
2005 2004
--------- --------
From operating activities:
Net income from continuing operations $ 40,704 $ 34,066
Depreciation and amortization 8,340 6,701
(Gain) loss on sale of assets (20) 5
--------- --------
Cash provided before changes in operating
assets and liabilities 49,024 40,772
Net increase in non-cash current assets (16,707) (31,732)
Net increase (decrease) in non-cash current liabilities (8,916) 7,915
Net changes in other assets and liabilities 5,638 3,713
--------- --------
Net cash provided by operating activities 29,039 20,668
--------- --------
From investing activities:
Purchase of Spacelink, net of cash acquired (136,469) -
Purchase of PCA, net of cash acquired (37,638) -
Purchase of TAMSCO, net of cash acquired - (7,440)
Purchase of Pivotal, net of cash acquired - (10,064)
Purchase of UPSI, net of cash acquired - (2,026)
Purchase of EEI, not of cash acquired - (99)
Additions to property, plant and equipment (5,115) (4,124)
Proceeds from sale of property, plant and equipment 44 128
--------- --------
Net cash used in investing activities (179,178) (23,625)
--------- --------
From financing activities:
Net borrowings (payments) under line-of-credit agreement 116,000 (17,100)
Payments of long-term debt (51) (103)
Proceeds of long-term debt 444 381
Exercise of stock options 26,666 37,826
Issuance of common stock to employee stock purchase plan 2,242 1,282
Cash dividends (594) (453)
--------- --------
Net cash provided by financing activities 144,707 21,833
--------- --------
Effect of exchange rate changes on cash 5 (11)
--------- --------
Net increase (decrease) in cash and cash equivalents (5,427) 18,865
Cash and cash equivalents at beginning of period 33,153 2,880
--------- --------
Cash and cash equivalents at end of period $ 27,726 $ 21,745
========= ========
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)
APRIL 30, 2005
NOTE A - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have
been prepared by Engineered Support Systems, Inc. (the Company) without
audit and include the accounts of the Company and its wholly-owned
subsidiaries. These subsidiaries are organized within the Company's two
business segments: Support Systems and Support Services. The Support Systems
segment includes the operations of Systems & Electronics Inc. (SEI), Keco
Industries, Inc. (Keco), Engineered Air Systems, Inc. (Engineered Air),
Engineered Coil Company, d/b/a Marlo Coil (Marlo Coil), Engineered Electric
Company, d/b/a Fermont (Fermont), Universal Power Systems, Inc. (UPSI),
Engineered Environments, Inc. (EEI), Pivotal Power Inc. (Pivotal Power) and
Prospective Computer Analysts Incorporated (PCA). The Support Services
segment includes the operations of Technical and Management Services
Corporation (TAMSCO), Radian, Inc. (Radian), ESSIbuy.com, Inc. (ESSIbuy) and
Spacelink International, LLC (Spacelink). In the opinion of management, all
adjustments (including normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three and
six months ended April 30, 2005 are not necessarily indicative of the
results to be expected for the entire fiscal year.
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles for interim financial statements and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's annual report to shareholders
for the year ended October 31, 2004.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In October 2004, Congress passed the American Jobs Creation Act of
2004 (the Jobs Creation Act). The Jobs Creation Act includes numerous
provisions that may materially affect business practices and accounting for
income taxes. For companies that pay U.S. income taxes on manufacturing
activities in the U.S., the Jobs Creation Act provides a phased-in deduction
from taxable income equal to a stipulated percentage of qualified income
from domestic production activities. In December 2004, the FASB issued two
FASB Staff Positions (FSP) regarding the accounting implications of the Act
related to (1) the deduction for qualified domestic production activities
(FSP 109-1) and (2) the one-time tax benefit for the repatriation of foreign
earnings (FSP 109-2). This guidance applies to financial statements for
periods ending after the date the Act was enacted. The Jobs Creation Act
also provides for a change in the period of application
6
for foreign tax credits, elimination of the 90-percent limitation of foreign
tax credits against Alternative Minimum Tax, expanded disallowance of
interest on convertible debt, and tax shelter disclosure penalties. The
Company adopted FSP 109-1 and FSP 109-2 in the first quarter of 2005. The
Company anticipates that the Jobs Creation Act and related FASB
pronouncements will have a material impact on the Company's financial
statements in future periods. However, the Company has determined that this
impact is not material for the three and six months ended April 30, 2005 and
will not be material for the year ending October 31, 2005.
In November 2004, the FASB issued SFAS 151, "Inventory Costs - an
amendment of ARB No. 43, Chapter 4." SFAS 151 seeks to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material (spoilage) in the determination of inventory
carrying costs. The statement requires such costs to be treated as a current
period expense. This statement is effective November 1, 2005 for the
Company. The Company does not believe that the adoption of SFAS 151 will
have a significant impact on the consolidated financial statements.
In December 2004, the FASB issued SFAS 123 (revised 2004),
"Share-Based Payment", (SFAS 123R). SFAS 123R requires companies to expense
the value of employee stock options and similar awards. This statement is
effective November 1, 2005 for the Company. The Company is currently
evaluating its compensation policies and practices, along with the impact of
SFAS 123R on its results of operations.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and
Error Corrections - a Replacement of APB Opinion No. 20 and FASB Statement
No. 3". SFAS 154 requires retrospective application to prior period
financial statements of changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the
cumulative effect of the change. SFAS 154 also redefines "restatement" as
the revising of previously issued financial statements to reflect the
correction of an error. This statement is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005. The Company does not believe that the adoption of SFAS 154 will have a
significant impact on the consolidated financial statements.
NOTE B - EARNINGS PER SHARE
Average diluted common shares outstanding include common stock
equivalents, which represent common stock options as computed based on the
treasury stock method. Average basic and diluted common shares outstanding
have been restated to reflect a three-for-two stock split effected by the
Company on April 15, 2005 in the form of a stock dividend.
Basic earnings per share for the three months ended April 30, 2005
and 2004 is based on average basic common shares outstanding of 41,541 and
38,883, respectively. Diluted earnings per share for the three months ended
April 30, 2005 and 2004 is based on average diluted common shares
outstanding of 43,312 and 41,787, respectively.
7
Basic earnings per share for the six months ended April 30, 2005
and 2004 is based on average basic common shares outstanding of 40,878 and
38,234, respectively. Diluted earnings per share for the six months ended
April 30, 2005 and 2004 is based on average diluted common shares
outstanding of 42,909 and 41,556, 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.
Three Months Ended Six Months Ended
April 30 April 30
------------------- ------------------
2005 2004 2005 2004
------- ------- ------- -------
Reported net income from continuing operations $20,093 $18,323 $40,704 $34,066
Total stock-based employee compensation expense
determined under the fair value method for all
stock option awards, net of income tax 366 517 368 558
------- ------- ------- -------
Pro forma net income from continuing operations $19,727 $17,806 $40,336 $33,508
======= ======= ======= =======
Earnings per share from continuing operations:
Basic - as reported $ 0.49 $ 0.47 $ 1.00 $ 0.89
======= ======= ======= =======
Basic - pro forma $ 0.47 $ 0.46 $ 0.99 $ 0.88
======= ======= ======= =======
Diluted - as reported $ 0.46 $ 0.44 $ 0.95 $ 0.82
======= ======= ======= =======
Diluted - pro forma $ 0.46 $ 0.43 $ 0.94 $ 0.81
======= ======= ======= =======
Historically, options granted have been fully vested at grant date.
The fair value of options at the grant date was estimated using the
Black-Scholes model with the following weighted average assumptions for the
three and six months ended April 30, 2005 and 2004: an expected life of 1.5
years, volatility of 26% and 36%, a dividend yield of 0.07% and 0.12% and a
risk-free interest rate of 3.52% and 3.25%, respectively. The weighted
average fair value of options granted in the three and six months ended
April 30, 2005 and 2004 was $5.37 and $5.03 per share, respectively.
NOTE D - ACQUISITIONS
Effective February 1, 2005, the Company acquired all of the
outstanding stock of Spacelink, which designs, integrates, operates and
maintains deployed satellite and wireless networks for the U.S. Department
of Defense (DOD), the U.S. intelligence community and other forward deployed
federal agencies and multinational organizations worldwide. The purchase
price, including transaction costs, was $149.7 million, which included
consideration of 342 shares of common stock valued at $13.2 million and cash
consideration financed with short-term
8
borrowings under the Company's revolving credit facility. The purchase price
is net of $1.8 million of cash acquired. The purchase price is also subject
to a working capital adjustment and to certain contingent cash consideration
based upon Spacelink's earnings before interest, taxes, depreciation and
amortization, as defined, for each of the twelve month periods ending
January 31, 2006 and 2007. The fair value of assets acquired, including
goodwill of $120.9 million and acquired customer-related intangibles of
$13.8 million, was $159.7 million and liabilities assumed totaled $10.0
million.
The following unaudited pro forma summary presents the combined results
for the three months ended April 30, 2004, and for the six months ended
April 30, 2005 and 2004, respectively, as adjusted to reflect the Spacelink
purchase transaction assuming the acquisition had occurred at November 1,
2003. These pro forma results are not necessarily indicative of the combined
results that would have occurred had the acquisition actually taken place on
November 1, 2003, nor are they necessarily indicative of the combined
results that may occur in the future.
Six Months Ended
Three Months April 30
Ended ----------------------------
April 30, 2004 2005 2004
-------------- -------- --------
Net revenues $231,491 $519,015 $453,390
======== ======== ========
Net income from
continuing operations $ 17,666 $ 40,708 $ 34,089
======== ======== ========
Basic earnings per share
from continuing operations $ 0.45 $ 0.99 $ 0.88
======== ======== ========
Diluted earnings per share
from continuing operations $ 0.42 $ 0.94 $ 0.81
======== ======== ========
Pro forma net income from operations for the six months ended April
30, 2005 includes $1,249, or $0.03 per basic and diluted earnings per share
from continuing operations, related to the combined after-tax impact of
one-time bonus expenses and transaction costs incurred by Spacelink.
9
Certain information with respect to the assets and liabilities of
Spacelink as of the acquisition date is summarized below:
February 1, 2005
----------------
Accounts receivable $ 20,849
Other current assets 578
Property, plant and equipment 3,660
Goodwill 120,851
Acquired customer-related intangibles 13,810
--------
Total assets $159,748
========
Accounts payable $ 6,710
Accrued liabilities 3,326
--------
$ 10,036
========
On January 7, 2005, the Company acquired all of the outstanding stock
of PCA, which develops and manufactures electronic test and measurement
equipment provided for electronic warfare and avionics systems primarily to
military customers. The purchase price, including transaction costs, was
$37.6 million and is subject to a working capital adjustment. The purchase
price was financed with the Company's existing cash balances. The fair value
of assets acquired, including goodwill of $24.1 million and acquired
customer-related intangibles of $6.4 million, was $38.1 million and
liabilities assumed totaled $0.5 million.
On December 5, 2003, the Company acquired all of the outstanding
stock of Pivotal Power, a supplier of high-performance static power
conversion equipment primarily to military customers. The purchase price,
including transaction costs, was approximately $10.1 million, net of cash
acquired. The purchase price was financed with short-term borrowings under
the Company's revolving credit facility. The fair value of assets acquired,
including goodwill of $4.4 million and acquired customer-related intangibles
of $1.2 million, was $11.6 million and liabilities assumed totaled $1.5
million.
Spacelink is included in the Support Services segment. PCA and
Pivotal Power are included in the Support Systems segment. The operating
results of each are included in consolidated operations since their
respective dates of acquisition.
NOTE E - OTHER COMPREHENSIVE INCOME
A reconciliation of net income to other comprehensive income for
the three and six months ended April 30, 2005 and 2004 is as follows:
10
Three Months Ended Six Months Ended
April 30 April 30
---------------------- -----------------------
2005 2004 2005 2004
---- ---- ---- ----
Net income $19,045 $18,323 $39,656 $34,066
Other components of
comprehensive
income, net of tax:
Currency translation adjustments (108) (159) (238) (222)
------- ------- ------- -------
Total comprehensive income $18,937 $18,164 $39,418 $33,844
======= ======= ======= =======
NOTE F - GOODWILL AND INTANGIBLE ASSETS
The following table presents changes in the Company's goodwill for
the Support Systems segment and for the Support Services segment for the six
months ended April 30, 2005:
Support Support
Systems Services Total
-------- -------- --------
October 31, 2004 $ 99,774 $ 67,584 $167,358
Acquisitions 24,066 120,851 144,917
-------- -------- --------
April 30, 2005 $123,840 $188,435 $312,275
======== ======== ========
The following table presents certain information on the Company's
acquired intangible assets. All acquired intangible assets are being
amortized over their estimated useful lives with no estimated residual
values.
Weighted Average
Amortization Gross Accumulated Net
Period Amount Amortization Amount
------ ------ ------------ ------
Customer-related intangibles:
April 30, 2005 9.5 years $69,493 $15,124 $54,369
October 31, 2004 11.6 years 49,263 10,949 38,314
Amortization expense related to acquired intangible assets was
$2,745 for the three months ended April 30, 2005 and $2,870 for the three
months ended April 30, 2004. Amortization expense related to acquired
intangible assets was $4,175 for the six months ended April 30, 2005 and
$3,580 for the six months ended April 30, 2004.
11
(Amortization expense related to acquired intangible assets for the three
and six months ended April 30, 2004 includes $2,151 related to finalization
of the TAMSCO intangible asset valuation. Related TAMSCO amortization
expense was $445 and $990, respectively, for the three and six months ended
April 30, 2005.) Related estimated amortization expense is $9,655 for the
year ending October 31, 2005, $10,425 for the year ending October 31, 2006,
$9,676 for the year ending October 31, 2007, $6,473 for the year ending
October 31, 2008 and $4,351 for the year ending October 31, 2009.
NOTE G - NOTES PAYABLE
On January 27, 2005, the Company entered into an Amended and Restated
Credit Agreement (Amended Credit Agreement) with its banks. The Amended
Credit Agreement replaced the Company's previous credit agreement dated
April 23, 2003. The Amended Credit Agreement, which expires January 27,
2010, provides for a $200 million unsecured revolving credit facility. The
Company can request, subject to certain conditions, an increase of up to
$100 million in the amount of the aggregate commitment under the Amended
Credit Agreement.
Borrowings under the Amended Credit Agreement bear interest, at the
Company's option, at either the Eurodollar rate plus an applicable margin,
or at the higher of the prime rate or the federal funds rate plus one-half
of one percent. The margin applicable to the Eurodollar rate varies from
0.625% to 1.375% depending upon the Company's ratio of total indebtedness to
earnings before interest, taxes, depreciation and amortization (leverage
ratio). The Amended Credit Agreement contains certain covenants, including
maintaining net worth of at least $265 million, plus 50% of the sum, to
extent positive, of the Company's consolidated net income and other
comprehensive income (loss) reported after October 31, 2004, plus the net
proceeds of all subsequent equity offerings. The Company must also comply
with certain financial covenants, including maintenance of a leverage ratio
of no greater than 2.75 to 1. The Company is also subject to various other
financial and operating covenants and maintenance criteria, including
restrictions on the Company's ability to incur additional indebtedness, make
investments, create liens, dispose of material assets and enter into merger
transactions and acquisitions. As of April 30, 2005, the Company had $116
million in borrowings against the Amended Credit Facility, and was in
compliance with all related covenants.
NOTE H - CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories of certain of the Company's
operating subsidiaries (SEI, Engineered Air, Keco, Fermont, Radian, TAMSCO,
Pivotal Power, PCA and Spacelink) represent accumulated contract costs,
estimated earnings thereon based upon the percentage of completion method
and contract inventories reduced by the contract value of delivered items.
Inventories of Marlo Coil, UPSI and EEI 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:
12
April 30, 2005 October 31, 2004
-------------- ----------------
Raw materials $ 1,825 $ 1,874
Work-in-process 5,066 5,246
Finished goods 372 493
Inventories substantially applicable to
government contracts in process, less
progress payments of $36,597 and
$54,629 76,531 53,396
------- -------
$83,794 $61,009
======= =======
NOTE I - SEGMENT INFORMATION
Based on its organizational structure, the Company operates in two
business segments: Support Systems and Support Services. The Support Systems
segment designs, engineers and manufactures integrated military electronics
and other military support equipment primarily for the DoD, as well as
related heat transfer and air handling equipment for domestic commercial and
industrial users. Segment products include environmental control systems,
load management and transport systems, power generation, distribution and
conditioning systems, airborne radar systems, reconnaissance, surveillance
and target acquisition systems, chemical and biological protection systems,
petroleum and water distribution systems and other multipurpose military
support equipment. The Support Services group provides engineering services,
logistics and training services, advanced technology services, asset
protection systems and services, telecommunication systems integration and
information technology services primarily for the DoD. The Support Services
segment also provides certain power generation and distribution equipment
and vehicle armor installation to the DoD.
Total assets at April 30, 2005 by segment were $307,558 for Support
Systems and $407,594 for Support Services. Goodwill by segment as of April
30, 2005 totaled $123,840 for Support Systems and $188,435 for Support
Services.
The differences in net revenues between the accompanying condensed
consolidated statements of income and the reporting segment information as
presented below are due to certain reclassifications made to categorize net
revenues by their functional nature, as required, on the face of the
financial statements.
Three Months Ended Six Months Ended
April 30 April 30
-------------------- --------------------
2005 2004 2005 2004
---- ---- ---- ----
Net Revenues:
Support Systems $126,691 $130,034 $246,576 $241,828
Support Services 150,100 86,515 273,072 175,657
Intersegment Revenues (13,023) (6,413) (22,347) (12,219)
-------- -------- -------- --------
Total $263,768 $210,136 $497,301 $405,266
======== ======== ======== ========
Operating Income from Continuing Operations:
Support Systems $ 24,197 $ 28,339 $ 45,629 $ 47,317
Support Services 9,080 1,657 20,638 8,922
-------- -------- -------- --------
33,277 29,996 66,267 56,239
Interest expense, net (870) (203) (616) (847)
-------- -------- -------- --------
Income from continuing operations
before income taxes $ 32,407 $ 29,793 $ 65,651 $ 55,392
======== ======== ======== ========
13
NOTE J - SHAREHOLDERS' EQUITY
The following summary presents a reconciliation of total
shareholders' equity from October 31, 2004 to April 30, 2005:
Balance at October 31, 2004 $336,956
Comprehensive income:
Net income 39,656
Currency translation adjustments (238)
--------
Total comprehensive income 39,418
--------
Cash dividends (594)
Exercise of stock options 26,666
Issuance of common stock, including
$13,243 issued in conjunction
with the acquisition of Spacelink 20,136
--------
Balance at April 30, 2005 $422,582
========
NOTE K - PENSION AND OTHER POSTRETIREMENT BENEFITS
The following tables detail the amount of net periodic benefit cost
recognized related to the Company's pension and other postretirement
benefits for the three and six months ended April 30, 2005 and 2004.
Three Months Ended
April 30
---------------------------------------------------
Other
Pension Benefits Postretirement Benefits
-------------------- -----------------------
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 814 $ 706 $ 66 $ 71
Interest cost 1,887 1,743 156 169
Expected return on plan assets (1,864) (1,823)
Amortization of prior service cost 193 148
Actuarial loss 1,046 641 103 110
------- ------- ---- ----
$ 2,076 $ 1,415 $325 $350
======= ======= ==== ====
14
Six Months Ended
April 30
---------------------------------------------------
Other
Pension Benefits Postretirement Benefits
-------------------- -----------------------
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 1,628 $ 1,412 $131 $142
Interest cost 3,776 3,486 314 337
Expected return on plan assets (3,727) (3,646)
Amortization of prior service cost 351 297
Actuarial loss 2,092 1,282 205 221
------- ------- ---- ----
$ 4,120 $ 2,831 $650 $700
======= ======= ==== ====
As of April 30, 2005, $4,000 of contributions have been made to
pension and other postretirement benefit plans. The Company anticipates
contributing an additional $4,000 to fund the pension and other
postretirement benefit plans in 2005 for a total of $8,000.
NOTE L - DISCONTINUED OPERATIONS
The Company completed the sale of Engineered Specialty Plastics,
Inc. (ESP), a wholly-owned subsidiary, in the quarter ended April 30, 2003
to a private equity group (the Buyers). The Buyers subsequently alleged that
the Company breached certain representations made under the related Stock
Purchase Agreement (the Agreement) and sought a claim for associated damages
under the binding arbitration provisions of the Agreement. During the
quarter ended April 30, 2005, the Company and the Buyers reached a
settlement on this claim, which included modification of the Company's $3.2
million note receivable from the Buyers to provide for suspension of
interest charges and payments through July 31, 2006, extension of the note's
repayment term to a balloon payment now due in April 2009, and the release
of the underlying real estate collateral securing the note. Because of this
settlement, the Company recorded a charge for the impairment of the note
during the quarter ended April 30, 2005 equal to $1.7 million, or $1.0
million net of income tax. This amount is reflected in discontinued
operations on the Condensed Consolidated Statements of Income for the three
and six months ended April 30, 2005.
NOTE M - STOCK SPLIT
On April 15, 2005, the Company effected a three-for-two stock split
in the form of a 50% stock dividend. All per share amounts in this report
have been restated to reflect this split.
15
NOTE N - SUBSEQUENT EVENTS
Effective May 1, 2005, the Company acquired all of the outstanding
stock of Mobilized Systems, Inc. (MSI), which designs, manufactures and
tests highly specialized trailers, shelters and environmental control
systems, primarily for the defense industry. The purchase price was $17.0
million and is subject to a final working capital adjustment. The purchase
price was financed with short-term borrowings under the Company's revolving
credit facility.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES
Refer to Management's Discussion and Analysis of Financial Condition
and Results of Operations from the Company's 2004 Annual Report to
Shareholders into the Company's Annual Report on Form 10-K for the period
ended October 31, 2004 for a discussion of the critical accounting policies
which we believe are most difficult, subjective or complex.
The following analysis should be read in this context.
RESULTS OF OPERATIONS
Consolidated net revenues increased $53.7 million, or 25.5%, to
$263.8 million in the second quarter of 2005 compared to $210.1 million in
the second quarter of 2004. The increase was due in part to additional
revenues from refurbishment of M1000 Heavy Equipment Transporters ($9.7
million increase), satellite telecommunications support activities for
deployed troops abroad ($13.5 million increase) and the installation of
vehicle uparmor kits ($22.1 million increase). These revenue increases were
partially
17
offset by reduced work on the 60-K Tunner Aircraft Cargo Loader ($7.7
million decrease) as the production phase of this long-term program wound
down in the quarater ended April 30, 2005, as well as reduced deliveries of
the Manportable Surveillance and Target Acquisition Radar (MSTAR) perimeter
security program for which a large base security subcontract for Northrup
Grumman was completed in the fourth quarter of 2004 ($19.1 million
decrease). In addition, more recently acquired subsidiaries, PCA (acquired
January 7, 2005) and Spacelink (acquired effective February 1, 2005), added
a combined $25.4 million of incremental revenues in the second quarter of
2005. Gross profit for the quarter ended April 30, 2005 increased $6.9
million, or 12.9%, to $60.3 million (22.9% of consolidated net revenues)
from $53.4 million (25.4% of consolidated net revenues) in the comparable
2004 period. Revenue growth of $53.7 million resulted in the increase in
gross profit. However, lower gross margins for the second quarter of 2005
reflect a less favorable revenue mix, primarily resulting from a greater
percentage of generally lower margin Support Services segment revenues, as
well as the impact of production delays combined with increased estimated
costs on the Deployable Power Generation and Distribution System (DPGDS)
program, a large, mobile power
18
generation system used by military forces deployed around the globe. The
Company has addressed the underlying causes of performance issues with the
primary power units, a key component of the DPGDS, and is in the process of
implementing a remediation plan. Program revenues of approximately $26
million and related gross profit of approximately $9 million had been
previously expected by the Company to be derived from the DPGDS program for
the second quarter of 2005. However, the curtailment of primary power unit
production during the second quarter, along with increased estimated costs
required for the extensive testing and retrofit costs of fielded units,
resulted in revenues and gross profit of $8.5 million and $1.4 million,
respectively, on the program. Pending the timely and successful
implementation of its identified solutions, the Company expects that the
DPGDS program will return to full rate production early in the fourth
quarter of 2005. Selling, general and administrative expense increased $3.7
million, or 15.7%, in the second quarter of 2005 to $27.1 million (10.3% of
consolidated net revenues) from $23.4 million (11.1% of consolidated net
revenues) in the second quarter of 2004. Selling, general and administrative
expense for PCA and Spacelink accounted for $3.3 million of the $3.7 million
increase, with the
19
remaining increase required to support higher operating levels. As a result
of the above, operating income from continuing operations increased $3.3
million, or 10.9%, in the quarter ended April 30, 2005 to $33.3 million from
$30.0 million in the second quarter of 2004.
Consolidated net revenues increased $92.0 million, or 22.7%, to
$497.3 million in the first six months of 2005 compared to $405.3 million in
the first six months of 2004. The increase was due in part to additional
revenues from refurbishment of M1000 Heavy Equipment Transporters ($15.8
million increase), satellite telecommunications support activities for
deployed troops abroad ($28.3 million increase) and the installation of
vehicle uparmor kits ($32.9 million increase). These revenue increases were
partially offset by reduced work on the 60-K Tunner Aircraft Cargo Loader
($13.9 million decrease), as well as reduced MSTAR deliveries ($31.5 million
decrease). In addition, more recently acquired subsidiaries, Pivotal Power
(acquired December 5, 2003), PCA (acquired January 3, 2005) and Spacelink
(acquired effective February 1, 2005), added a combined $26.8 million of
incremental revenues in the first six months of 2005. Gross profit for the
six months ended April 30, 2005 increased $18.2 million, or 18.2%, to $117.9
million (23.7% of consolidated net revenues) from $99.7 million (24.6% of
consolidated net revenues) in the comparable 2004 period. Revenue growth of
$92.0 million resulted in the increase in gross profit. However, lower gross
margins for the first six months of 2005 reflect a less favorable revenue
mix, primarily resulting from a greater percentage of generally lower margin
Support Services segment revenues, as
20
well as the impact of production delays and increased estimated costs on the
DPGDS program. The previously discussed DPGDS production delays and
increased cost estimates also contributed to lower gross margins in the
first six months of 2005 versus the comparable period in 2004. Selling,
general and administrative expense increased $8.2 million, or 19.0%, in the
first six months of 2005 to $51.6 million (10.4% of consolidated net
revenues) from $43.4 million (10.7% of consolidated net revenues) in the
first six months of 2004. Selling, general and administrative expense for
Pivotal Power, PCA and Spacelink accounted for $4.3 million of the $8.2
million increase, with the remaining increase required to support higher
operating levels. As a result of the above, operating income from continuing
operations increased $10.1 million, or 17.8%, in the first six months of
2005 to $66.3 from $56.2 million in the first six months of 2004.
SUPPORT SYSTEMS. Net revenues in the second quarter of 2005 for the
Support Systems segment totaled $126.7 million compared to $130.0 million
(prior to the elimination of intersegment revenues in each period) for the
same period in the prior year, a 2.6% decrease. The results for the quarter
ended April 30, 2005 reflect the inclusion of $4.1 million in incremental
net revenues from PCA during the second quarter. The overall decrease was
primarily due to a $7.7 million revenue reduction on the 60-K Tunner
Aircraft Cargo Loader, as the production phase of this long-term program was
completed in the quarter ended April 20, 2005, and to a $19.1 million
21
revenue reduction on the MSTAR program, for which a large base security
subcontract for Northrup Grumman was completed in the fourth quarter of
2004. These decreases were offset in part by a $9.7 million revenue increase
from refurbishment of M1000 Heavy Equipment Transporters, and by a $5.6
million increase in intersegment work performed for the Support Services
segment. Gross profit for the segment decreased by $2.7 million, or 6.3%, in
the quarter ended April 30, 2005 to $39.1 million (30.9% of segment
revenues) from $41.8 million (32.1% of segment revenues) in the prior year
quarter as a result of the above revenue decreases, as well as overall
product mix change. Quarterly operating income for the segment decreased to
$24.2 million (19.1% of segment revenues) compared to $28.3 million (21.8%
of segment revenues) last year. Decreased revenues, related gross profit
reductions and a $1.4 million, or approximately 10%, increase is segment
selling, general and administrative expense led to the lower results for the
Support Systems segment.
Net revenues in the first six months of 2005 for the Support
Systems segment totaled $246.6 million compared to $241.8 million (prior to
the elimination of intersegment revenues in each period) for the same period
in the prior year, a 2.0%
22
increase. The results for the six months ended April 30, 2005 reflect the
inclusion of $5.4 million in incremental net revenues from Pivotal Power and
PCA during the first six months of 2005. The overall decrease was primarily
due to a $13.9 million revenue reduction on the 60-K Tunner Aircraft Cargo
Loader and to a $31.5 million revenue reduction on the MSTAR program. These
decreases were offset in part by a $15.8 million revenue increase from
refurbishment of M1000 Heavy Equipment Transporters, and by a $9.5 million
increase in intersegment work performed for the Support Services segment.
Gross profit for the segment increased by $1.3 million, or 1.7%, in the six
months ended April 30, 2005 to $75.2 million (30.5% of segment revenues)
from $73.9 million (30.5% of segment revenues) in the first six months of
the prior year. Segment operating income for the six months ended April 30,
2005 decreased to $45.6 million (18.5% of segment revenues) compared to
$47.3 million (19.6% of segment revenues) last year primarily as a result of
a $3.0 million increase in segment selling, general and administrative
expense.
SUPPORT SERVICES. Net revenues for the Support Services segment
increased to
23
$150.1 million, an increase of $63.6 million, or 73.5%, compared to $86.5
million (prior to the elimination of intersegment revenues in each period)
for the second quarter of 2005. The most significant year-over-year revenue
increases were generated by satellite telecommunications support for
deployed forces ($13.5 million) and the vehicle uparmor kit program ($22.1
million). In addition, Spacelink (acquired effective February 1, 2005) added
$21.3 million of incremental revenues in the second quarter of 2005. Gross
profit for the segment increased by $9.7 million, or 82.7%, in the quarter
ended April 30, 2005 to $21.3 million (14.2% of segment revenues) from $11.6
million (13.5% of segment revenues) in the prior year quarter primarily as a
result of increased revenues. Segment operating income for the second
quarter of 2005 totaled $9.1 million (6.0% of segment revenues) compared to
$1.7 million (1.9% of segment revenues) in the same period last year.
Although incremental revenues and related gross profit contributions led to
the overall improved results for the Support Services segment, the segment's
operating profit for the second quarter of 2004 was abnormally low due to
the inclusion of a significant amount of lower margin "pass-through"
revenues on certain contracts, as well as $2.2 million in non-cash
amortization charges for customer-related intangibles from
24
the May 2003 acquisition of TAMSCO. Also constraining profits for the
quarter ended April 30, 2005 was the fact that the Company had anticipated
DPGDS program revenues of approximately $26 million and related gross profit
of approximately $9 million during the three months ended April 30, 2005.
However, the curtailment of DPGDS primary power unit production during the
second quarter, along with increased estimated costs required for the
extensive testing and retrofit costs of fielded units, resulted in revenues
and gross profit of $8.5 million and $1.4 million, respectively, on the
program. Pending the timely and successful implementation of its identified
solutions, the Company expects that the DPGDS program will return to full
rate production early in the fourth quarter of 2005.
Net revenues for the Support Services segment increased to $273.1
million, an increase of $97.4 million, or 55.5%, compared to $175.7 million
(prior to the elimination of intersegment revenues in each period) for the
first six months of 2005. The most significant year-over-year revenue
increases were generated by satellite telecommunications support for
deployed forces ($28.3 million) and the vehicle uparmor kit program ($32.9
million). In addition, Spacelink (acquired effective February 1, 2005)
25
added $21.3 million of incremental revenues in the first six months of 2005.
Gross profit for the segment increased by $16.9 million, or 65.4% in the six
months ended April 30, 2005 to $42.7 million (15.6% of segment revenues)
from $25.8 million (14.7% of segment revenues) in the first six months of
2004 primarily as a result of increased revenues. Segment operating income
for the first six months of 2005 totaled $20.6 million (7.6% of segment
revenues) compared to $8.9 million (5.1% of segment revenues) in the same
period last year. The $97.4 million increase in segment revenues provided
significant gross profit increases as well as leveraging existing fixed
overhead costs, which led to the overall improved results for the Support
Services segment.
CONSOLIDATED RESULTS OF OPERATIONS. Net interest expense totaled $0.9
million in the second quarter of 2005 compared to $0.2 million in the second
quarter of 2004 as a result of increased borrowing levels necessary for the
acquisitions of PCA and Spacelink in 2005. Net interest expense totaled $0.6
million and $0.8 million for the six months ended April 30, 2005 and 2004,
respectively. The effective income tax rate was 38.0% for the three and six
month periods ended April 30, 2005 compared to 38.5% for the
26
three and six month periods ended April 30, 2004. This reduction is
primarily a result of the Company's ongoing state income tax reduction
initiatives. As a result of the foregoing, net income from continuing
operations increased 9.7% to $20.1 million (7.6% of consolidated net
revenues) in the quarter ended April 30, 2005 as compared to $18.3 million
(8.7% of consolidated net revenues) in the second quarter of 2004, and net
income from continuing operations increased 19.5% to $40.7 million (8.2% of
consolidated net revenues) in the first six months of 2005 as compared to
$34.1 million (8.4% of consolidated net revenues) in the first six months of
2004.
Based on second quarter results, existing backlog and anticipated
orders, the Company anticipates that 2005 revenues will approximate $1.02
billion to $1.05 billion, and that earnings per share from continuing
operations will approximate between $2.00 and $2.03. These estimates include
the operations of Mobilized Systems, Inc. (MSI), which was acquired May 1,
2005.
DISCONTINUED OPERATIONS. The Company completed the sale of
Engineered Specialty Plastics, Inc. (ESP), a wholly-owned subsidiary, in the
quarter ended April 30, 2003 to a private equity group (the Buyers). The
Buyers subsequently alleged that the Company breached certain
representations made under the related Stock Purchase
27
Agreement (the Agreement) and sought a claim for associated damages under
the binding arbitration provisions of the Agreement. During the quarter
ended April 30, 2005, the Company and the Buyers reached a settlement on
this claim, which included modification of the Company's $3.2 million note
receivable from the Buyers to provide for suspension of interest charges and
payments through July 31, 2006, extension of the note's repayment term to a
balloon payment now due in April 2009, and the release of the underlying
real estate collateral securing the note. Because of this settlement, the
Company recorded a charge for the impairment of the note during the quarter
ended April 30, 2005 equal to $1.7 million, or $1.0 million net of income
tax. This amount is reflected in discontinued operations on the Condensed
Consolidated Statements of Income for the three and six months ended April
30, 2005.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In October 2004, Congress passed the American Jobs Creation Act of
2004 (the Jobs Creation Act). The Jobs Creation Act includes numerous
provisions that may materially affect business practices and accounting for
income taxes. For companies that pay U.S. income taxes on manufacturing
activities in the U.S., the Jobs Creation Act provides a phased-in deduction
from taxable income equal to a stipulated percentage of qualified income
from domestic production activities. In December 2004, the FASB issued two
FASB Staff Positions (FSP) regarding the accounting implications of the Act
related to (1) the deduction for qualified domestic production activities
(FSP 109-1) and (2) the one-time tax benefit for the repatriation of foreign
earnings (FSP 109-2). This guidance applies to financial statements for
periods ending after the date the Act was enacted. The Jobs Creation Act
also provides for a change in the period of application for foreign tax
credits, elimination of the 90-percent limitation of foreign tax credits
against Alternative Minimum Tax, expanded disallowance of interest on
convertible debt, and tax shelter disclosure penalties. The Company adopted
FSP 109-1 and FSP 109-2 in the first quarter of 2005. The Company
anticipates that the Jobs Creation Act and related FASB pronouncements will
have a material impact on the Company's financial statements in future
periods. However, the Company has determined that this impact is not
material for the three and six months ended April 30, 2005 and will not be
material for the year ending October 31, 2005.
28
In November 2004, the FASB issued SFAS 151, "Inventory Costs - an
amendment of ARB No. 43, Chapter 4." SFAS 151 seeks to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material (spoilage) in the determination of inventory
carrying costs. The statement requires such costs to be treated as a current
period expense. This statement is effective November 1, 2005 for the
Company. The Company does not believe that the adoption of SFAS 151 will
have a significant impact on the consolidated financial statements.
In December 2004, the FASB issued SFAS 123 (revised 2004),
"Share-Based Payment", (SFAS 123R). SFAS 123R requires companies to expense
the value of employee stock options and similar awards. This statement is
effective November 1, 2005 for the Company. The Company is currently
evaluating its compensation policies and practices, along with the impact of
SFAS 123R on its results of operations.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and
Error Corrections - a Replacement of APB Opinion No. 20 and FASB Statement
No. 3". SFAS 154 requires retrospective application to prior period
financial statements of changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the
cumulative effect of the change. SFAS 154 also redefines "restatement" as
the revising of previously issued financial statements to reflect the
correction of an error. This statement is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005. The Company does not believe that the adoption of SFAS 154 will have a
significant impact on the consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
On January 27, 2005, the Company entered into an Amended and Restated
Credit Agreement (Amended Credit Agreement) with its banks. The Amended
Credit Agreement replaced the Company's previous credit agreement dated
April 23, 2003. The Amended Credit Agreement, which expires January 27,
2010, provides for a $200 million unsecured revolving credit facility. The
Company can request, subject to certain conditions, an increase of up to
$100 million in the amount of the aggregate commitment under the Amended
Credit Agreement.
Borrowings under the Amended Credit Agreement bear interest, at the
Company's option, at either the Eurodollar rate plus an applicable margin,
or at the higher of the prime rate or the federal funds rate plus one-half
of one percent. The margin applicable to the Eurodollar rate varies from
0.625% to 1.375% depending upon the Company's ratio of total indebtedness to
earnings before interest, taxes, depreciation and amortization (leverage
ratio). The Amended Credit Agreement contains certain covenants,
29
including maintaining net worth of at least $265 million, plus 50% of the
sum, to extent positive, of the Company's consolidated net income and other
comprehensive income (loss) reported after October 31, 2004, plus the net
proceeds of all subsequent equity offerings. The Company must also comply
with certain financial covenants, including maintenance of a leverage ratio
of no greater than 2.75 to 1. The Company is also subject to various other
financial and operating covenants and maintenance criteria, including
restrictions on the Company's ability to incur additional indebtedness, make
investments, create liens, dispose of material assets and enter into merger
transactions and acquisitions. As of April 30, 2005, the Company had $116
million in borrowings against the Amended Credit Facility, and was in
compliance with all related covenants.
On January 7, 2005, the Company acquired all of the outstanding stock
of PCA, which develops and manufactures electronic test and measurement
equipment provided for electronic warfare and avionics systems primarily to
military customers. The purchase price was $37.6 million and is subject to a
working capital adjustment. The purchase price was financed with the
Company's existing cash balances. The fair value of assets acquired,
including goodwill of $24.1 million and acquired customer-related
intangibles of $6.4 million, was $38.1 million and liabilities assumed
totaled $0.5 million.
Effective February 1, 2005, the Company acquired all of the
outstanding stock of Spacelink, which designs, integrates, operates and
maintains deployed satellite and wireless networks for the U.S. Department
of Defense (DOD), the U.S. intelligence community and other forward deployed
federal agencies and multinational organizations worldwide. The purchase
price, including transaction costs, was $149.7 million, which included
consideration of $13.2 million in the common stock of the Company and cash
consideration financed with short-term borrowings under the Company's
revolving credit facility. The purchase price is net of $1.8 million of cash
acquired. The purchase price is also subject to a working capital adjustment
and to certain contingent cash consideration based upon Spacelink's earnings
before interest, taxes, depreciation and amortization, as defined, for each
of the twelve month periods ending January 31, 2006 and 2007. The fair value
of assets acquired, including goodwill of $120.9 million and acquired
customer-related intangibles of $13.8 million, was $159.7 million and
liabilities assumed totaled $10.0 million.
At April 30, 2005, the Company's working capital and ratio of
current assets to current liabilities were $33.3 million and 1.13 to 1 as
compared with $112.0 million and 1.85 to 1 at October 31, 2004. The
significant changes in working capital and the ratio of current assets to
current liabilities from October 31, 2004 are due to the increase in
short-term borrowings against the Company's revolving credit facility, which
were required as a result of the PCA and Spacelink acquisitions. Net cash
provided by operations totaled $29.0 million for the first six months of
2005 compared to net cash provided by operations of $20.7 million for the
first six months of 2004. Investment in property, plant and equipment
totaled $5.1 million and $4.1 million for the first six months of 2005 and
2004, respectively. The Company anticipates that capital expenditures in
2005 should not exceed $15.0 million. Management believes that cash flow
generated from operations, together with the available line of credit, will
provide the necessary resources to meet the needs of the Company in the
foreseeable future.
During the six months ended April 30, 2005 and 2004, the Company
received proceeds of $26.7 million and $37.8 million related to the exercise
of stock options.
30
BUSINESS AND MARKET CONSIDERATIONS
Approximately 93% of consolidated net revenues for the six months
ended April 30, 2005 were directly or indirectly derived from defense orders
by the U.S. government and its agencies. As of April 30, 2005, the Company's
funded backlog of orders totaled $598.9 million, with related customer
options of an additional $1,460.1 million. These amounts compare to funded
backlog of $588.1 million and related customer options of an additional
$849.1 million as of October 31, 2004.
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, which could cause the Company's actual results to
differ materially from those projected in, or inferred by, the
forward-looking statements, including, but not limited to acquisitions,
additional financing requirements, the decision of any of the Company's key
customers (including the U.S. government) to reduce or terminate orders with
the Company, cutbacks in defense spending by the U.S. government and
increased competition in the Company's markets and other risks discussed in
the Company's reports filed with the Securities and Exchange Commission from
time to time.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risks relating to the Company's operations result primarily
from changes in interest rates. Given existing debt levels, significant cash
flows and anticipated expenditures, Company management has not utilized
interest rate swaps or other derivative contracts to hedge this risk since
November 2002. Management does not believe its exposure to interest rate
fluctuations has had, or will have, a significant impact on the Company's
operations.
ITEM 4. CONTROLS AND PROCEDURES.
As of April 30, 2005, the Company carried out an evaluation, under
the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures as defined in Rules
31
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Based upon the evaluation, the Company's Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective.
There have been no changes in the Company's internal control over
financial reporting during the period covered by this report that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
32
PART II
OTHER INFORMATION
Item 1 Legal Proceedings
The Company completed the sale of Engineered Specialty Plastics, Inc. (ESP),
a wholly-owned subsidiary, in the quarter ended April 30, 2003 to a private
equity group (the Buyers). The Buyers subsequently alleged that the Company
breached certain representations made under the related Stock Purchase
Agreement (the Agreement) and sought $6.0 million in damages from the
Company. Under the terms of the Agreement, this claim was subject to binding
arbitration. During the quarter ended April 30, 2005, the Company and the
Buyers reached a settlement on this claim, which included modification of
the Company's $3.2 million note receivable from the Buyers to provide for
suspension of interest charges and payments through July 31, 2006, extension
of the note's repayment term to a balloon payment now due in April 2009, and
the release of the underlying real estate collateral securing the note.
Item 2 Unregistered Sales of Equity Securities
Effective February 1, 2005, the Company acquired all of the membership
interests of Spacelink International, LLC ("Spacelink"). A portion of the
purchase price paid by the Company at closing consisted of the issuance by
the Company of 342,438 post-split shares of its restricted common stock
valued at approximately $13.2 million. The Company issued these shares of
common stock to the sellers of Spacelink's membership interests, Spacelink
International LTD., a Delaware corporation and SatComSolutions LLC, a
Delaware limited liability company. The common stock was issued as a private
placement of securities under Section 4(2) of the Securities Act of 1933.
Item 3 Not Applicable
Item 4 Submission of Matters to a Vote of Security Holders
(a) The Company's annual shareholders' meeting was held on March
1, 2005.
(b) The following individuals were nominated and elected to the
Board of Directors for a term of three years (2008):
Gerald A. Potthoff
Gary C. Gerhardt
Thomas J. Guilfoil
James A. Schaefer
MG George E. Friel (U.S. Army, Retired)
General Charles T. Robertson, Jr. (U.S. Air Force, Retired)
The following directors continued in service of their terms
following the meeting:
Michael F. Shanahan, Sr.
Ronald W. Davis
William H.T. Bush
General Michael P.C. Carns (U.S. Air Force, Retired)
S. Lee Kling
33
LTG Kenneth E. Lewi (U.S. Army, Retired)
General Crosbie E. Saint (U.S. Army, Retired)
Michael F. Shanahan, Jr.
Earl W. Wims
(c) The proposal for the approval of the Engineered Support
Systems, Inc. 2005 Non-Executive Stock Option Plan and the
allocation of 400,000 shares of Engineered Support Systems,
Inc. common stock to the Plan was approved. There were
15,789,894 shares voted for the proposal, 3,945,091 shares
voted against the proposal and 5,519,024 shares representing
abstentions or broker non- votes.
(d) Not Applicable
Item 5 Not Applicable
Item 6 Exhibits
See Exhibit Index
34
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: June 9, 2005
------------
By: /s/ Gerald A. Potthoff
---------------------------------
Gerald A. Potthoff
Vice Chairman and Chief Executive
Officer
Date: June 9, 2005
------------
By: /s/ Gary C. Gerhardt
---------------------------------
Gary C. Gerhardt
Vice Chairman and Chief
Financial Officer
Date: June 9, 2005
------------
By: /s/ Steven J. Landmann
---------------------------------
Steven J. Landmann
Senior Vice President - Controller
and Chief Accounting Officer
35
EXHIBIT INDEX
3.1 Articles of Incorporation of Engineered Support Systems,
Inc. filed July 10, 1985 on Form S-1 Registration
Statement, registration number 2-98909 as amended on
August 13, 1985 and August 21, 1985, and incorporated
herein by reference.
3.2 Amendments of Articles of Incorporation filed January 30,
2004 on the Company's Annual Report on Form 10-K, and
incorporated herein by reference.
3.3 Amended and Restated By-Laws of Engineered Support
Systems, Inc. filed January 30, 2004 on the Company's
Annual Report on Form 10-K, and incorporated herein by
reference.
10.1 Consulting Agreement with Michael F. Shanahan, Sr. dated
May 1, 2005 filed as Exhibit 10.1 to the Company's Form
8-K/A filed May 6, 2005, and incorporated herein by
reference.
10.2 Form of Employment Agreement with Gerald A. Potthoff dated
November 1, 2005 filed as Exhibit 10.2 to the Company's
Annual Report on Form 10-K filed January 14, 2005, as
amended, and incorporated herein by reference.
10.3 Form of Employment Agreement with Gary C. Gerhardt, dated
November 1, 2005 filed as Exhibit 10.3 to the Company's
Annual Report on Form 10-K filed January 14, 2005, as
amended, and incorporated herein by reference.
10.4 Form of Employment Agreement with Ronald W. Davis, dated
November 1, 2005 filed as Exhibit 10.4 to the Company's
Annual Report on Form 10-K filed January 14, 2005, as
amended, and incorporated herein by reference.
10.5 Employment Agreement with Daniel A. Rodrigues dated April
11, 2005 filed as Exhibit 10.2 to the Company's Form 8-K/A
filed May 6, 2005, and incorporated herein by reference.
10.6 Purchase Agreement by and between Engineered Support
Systems, Inc. and Spacelink International LLC, Spacelink
International LTD and SatComSolutions LLC dated December
9, 2004 filed as Exhibit 10.7 to the Company's Annual
Report on Form 10-K filed January 14, 2005, as amended,
and incorporated herein by reference.
10.7 Closing Letter amending the Purchase Agreement by and
between Engineered Support Systems, Inc. and Spacelink
International LLC, Spacelink International LTD and
SatComSolutions LLC dated February 7, 2005.
10.8 Stock Purchase Agreement by and between Prospective
Computer Analysts Incorporated, Edward Wenger, The Lauren
Wenger 2004 GRAT, The Eric Wenger 2004 GRAT, the Mitchell
Wenger 2004 GRAT and Engineered Support Systems, Inc.
dated January 7, 2005 filed as Exhibit 10.8 to the
Company's Annual Report on Form 10-K filed January 14,
2005, as amended, and incorporated herein by reference.
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10.9 Amended and Restated Credit Agreement dated as of January
27, 2005 among Engineered Support Systems, Inc., as the
Borrower, Bank of America, N.A. and the Other Lenders
Party Hereto filed as Exhibit 99 to the Company's Current
Report on Form 10-Q filed February 2, 2005 and
incorporated herein by reference.
11 Statement Re: Computation of Earnings Per Share
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to
Section 906 of the Section 906 of the Sarbanes-Oxley Act
of 2002
37