Attached files

file filename
EX-11 - COMPUTATION OF BASIC AND DILUTED EARNINGS PER COMMON SHARE - ESTERLINE TECHNOLOGIES CORPdex11.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - ESTERLINE TECHNOLOGIES CORPdex322.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - ESTERLINE TECHNOLOGIES CORPdex311.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - ESTERLINE TECHNOLOGIES CORPdex321.htm
EX-10.1 - SHARE PURCHASE AGREEMENT - ESTERLINE TECHNOLOGIES CORPdex101.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - ESTERLINE TECHNOLOGIES CORPdex312.htm
EXCEL - IDEA: XBRL DOCUMENT - ESTERLINE TECHNOLOGIES CORPFinancial_Report.xls

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

x   

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended  

April 29, 2011

OR

 

¨   

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                                       to                                                      

Commission file number  1-6357

          ESTERLINE TECHNOLOGIES CORPORATION          

(Exact name of registrant as specified in its charter)

 

                             Delaware                                                               13-2595091                            

(State or other Jurisdiction

of incorporation or organization)

    

(I.R.S. Employer

Identification No.)

500  108th Avenue N.E., Bellevue, Washington 98004

(Address of principal executive offices)(Zip Code)

Registrant’s telephone number, including area code 425/453-9400

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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes                     X                                                 No                                      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  

x

   Accelerated filer             ¨        
Non-accelerated filer  

¨  (Do not check if a smaller reporting company)

   Smaller reporting company                ¨        

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes                                                                    No                     X            

As of May 31, 2011, 30,555,518 shares of the issuer’s common stock were outstanding.


PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of April 29, 2011 and October 29, 2010

(In thousands, except share amounts)

 

     April 29,
2011
     October 29,
2010
 
ASSETS    (Unaudited)         

Current Assets

     

Cash and cash equivalents

   $ 391,514       $ 422,120   

Cash in escrow

     5,000         0   

Accounts receivable, net of allowances

     

of $4,692 and $4,865

     308,103         309,242   

Inventories

     

Raw materials and purchased parts

     126,862         109,595   

Work in process

     124,269         99,592   

Finished goods

     64,863         53,186   
                 
     315,994         262,373   

Income tax refundable

     12,067         17,806   

Deferred income tax benefits

     38,232         37,539   

Prepaid expenses

     18,369         16,264   

Other current assets

     18,673         11,241   
                 

Total Current Assets

     1,107,952         1,076,585   

Property, Plant and Equipment

     578,266         546,004   

Accumulated depreciation

     290,324         272,234   
                 
     287,942         273,770   

Other Non-Current Assets

     

Goodwill

     835,167         739,730   

Intangibles, net

     456,648         389,017   

Debt issuance costs, net of accumulated

     

amortization of $1,780 and $4,536

     9,759         7,774   

Deferred income tax benefits

     95,048         87,622   

Other assets

     22,404         13,240   
                 
   $       2,814,920       $       2,587,738   
                 

 

2


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of April 29, 2011 and October 29, 2010

(In thousands, except share amounts)

 

     April 29,
2011
     October 29,
2010
 
LIABILITIES AND SHAREHOLDERS’ EQUITY    (Unaudited)         

Current Liabilities

     

Accounts payable

   $ 84,660       $ 82,275   

Accrued liabilities

     233,727         215,094   

Credit facilities

     110,000         1,980   

Current maturities of long-term debt

     1,782         12,646   

Deferred income tax liabilities

     10,477         7,155   

Federal and foreign income taxes

     2,451         5,227   
                 

Total Current Liabilities

     443,097         324,377   

Long-Term Liabilities

     

Long-term debt, net of current maturities

     495,719         598,972   

Deferred income tax liabilities

     153,660         127,081   

Pension and post-retirement obligations

     109,251         105,333   

Other liabilities

     27,568         16,476   

Shareholders’ Equity

     

Common stock, par value $.20 per share,

     

authorized 60,000,000 shares, issued and

outstanding 30,524,070 and 30,279,509 shares

     6,105         6,056   

Additional paid-in capital

     543,285         528,724   

Retained earnings

     950,686         874,781   

Accumulated other comprehensive income

     82,740         3,235   
                 

Total Esterline shareholders’ equity

     1,582,816         1,412,796   

Noncontrolling interests

     2,809         2,703   
                 

Total Shareholders’ Equity

     1,585,625         1,415,499   
                 
   $       2,814,920       $       2,587,738   
                 

 

3


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

For the Three and Six Month Periods Ended April 29, 2011 and April 30, 2010

(Unaudited)

(In thousands, except per share amounts)

 

     Three Months Ended     Six Months Ended  
     April 29,
2011
    April 30,
2010
    April 29,
2011
    April 30,
2010
 

Net Sales

   $       435,277      $       382,492      $       806,076      $       717,802   

Cost of Sales

     274,330        255,856        513,007        488,495   
                                
     160,947        126,636        293,069        229,307   

Expenses

        

Selling, general & administrative

     72,409        64,067        138,501        125,362   

Research, development

        

& engineering

     21,251        18,001        40,870        34,750   

Other (income) expense

     0        (38     0        3   
                                

Total Expenses

     93,660        82,030        179,371        160,115   

Operating Earnings from

        

Continuing Operations

     67,287        44,606        113,698        69,192   

Interest income

     (430     (20     (770     (403

Interest expense

     8,958        7,348        18,095        15,309   

Loss on extinguishment of debt

     831        0        831        0   
                                

Income from Continuing Operations

        

Before Income Taxes

     57,928        37,278        95,542        54,286   

Income Tax Expense

     11,848        8,144        19,502        12,713   
                                

Income from Continuing Operations

        

Including Noncontrolling Interests

     46,080        29,134        76,040        41,573   

Income Attributable to

        

Noncontrolling Interests

     (129     (24     (106     (78
                                

Income from Continuing Operations

        

Attributable to Esterline

     45,951        29,110        75,934        41,495   

Income (Loss) from Discontinued Operations

        

Attributable to Esterline, Net of Tax

     (37     538        (29     878   
                                

Net Earnings Attributable to Esterline

   $ 45,914      $ 29,648      $ 75,905      $ 42,373   
                                

Earnings Per Share Attributable to Esterline – Basic:

        

Continuing operations

   $ 1.51      $ .97      $ 2.50      $ 1.39   

Discontinued operations

     .00        .02        .00        .03   
                                

Earnings Per Share Attributable

        

to Esterline – Basic

   $ 1.51      $ .99      $ 2.50      $ 1.42   
                                

Earnings Per Share Attributable to Esterline – Diluted:

        

Continuing operations

   $ 1.47      $ .96      $ 2.44      $ 1.37   

Discontinued operations

     .00        .02        .00        .03   
                                

Earnings Per Share Attributable

        

to Esterline – Diluted

   $ 1.47      $ .98      $ 2.44      $ 1.40   
                                

 

4


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Six Month Periods Ended April 29, 2011 and April 30, 2010

(Unaudited)

(In thousands)

 

     Six Months Ended  
     April 29,
2011
    April 30,
2010
 

Cash Flows Provided (Used) by Operating Activities

    

Net earnings including noncontrolling interests

   $             76,011      $             42,451   

Adjustments to reconcile net earnings including

    

noncontrolling interests to net cash provided

(used) by operating activities:

    

Depreciation and amortization

     37,469        36,381   

Deferred income taxes

     (2,176     (8,496

Share-based compensation

     3,847        3,431   

Working capital changes, net of effect of acquisitions

    

Accounts receivable

     20,705        (7,834

Inventories

     (26,892     8,640   

Prepaid expenses

     (1,481     (1,242

Other current assets

     (2,154     (2,779

Accounts payable

     (3,396     (4,025

Accrued liabilities

     (14,497     (9,998

Federal and foreign income taxes

     (215     7,409   

Other liabilities

     2,982        5,188   

Other, net

     (758     2,578   
                
     89,445        71,704   

Cash Flows Provided (Used) by Investing Activities

    

Purchases of capital assets

     (26,315     (25,585

Proceeds from sale of capital assets

     1,343        97   

Escrow deposit

     (14,000     0   

Acquisitions, net of cash acquired

     (103,548     (768
                
     (142,520     (26,256

 

5


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Six Month Periods Ended April 29, 2011 and April 30, 2010

(Unaudited)

(In thousands)

 

     Six Months Ended  
     April 29,
2011
    April 30,
2010
 

Cash Flows Provided (Used) by Financing Activities

    

Proceeds provided by stock issuance under

    

employee stock plans

     9,357        6,413   

Excess tax benefits from stock options exercised

     1,406        1,328   

Debt and other issuance costs

     (3,504     0   

Net change in credit facilities

     110,000        (1,677

Repayment of long-term debt

     (120,826     (2,153

Proceeds from government assistance

     10,176        1,961   
                
     6,609        5,872   

Effect of Foreign Exchange Rates on Cash

     15,860        (4,449
                

Net Increase (Decrease) in Cash and Cash Equivalents

     (30,606     46,871   

Cash and Cash Equivalents – Beginning of Period

     422,120        176,794   
                

Cash and Cash Equivalents – End of Period

   $             391,514      $             223,665   
                

Supplemental Cash Flow Information

    

Cash paid for interest

   $ 17,708      $ 14,380   

Cash paid for taxes

     20,480        14,364   

Supplemental Non-cash Investing and Financing Activities

    

Capital asset and lease obligation additions

   $ 0      $ 8,137   

 

6


ESTERLINE TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Six Month Periods Ended April 29, 2011 and April 30, 2010

 

1. The consolidated balance sheet as of April 29, 2011, the consolidated statement of operations for the three and six month periods ended April 29, 2011, and April 30, 2010, and the consolidated statement of cash flows for the six month periods ended April 29, 2011, and April 30, 2010, are unaudited but, in the opinion of management, all of the necessary adjustments, consisting of normal recurring accruals, have been made to present fairly the financial statements referred to above in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the above statements do not include all of the footnotes required for complete financial statements. The results of operations and cash flows for the interim periods presented are not necessarily indicative of results that can be expected for the full year.

 

2. The notes to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended October 29, 2010, provide a summary of significant accounting policies and additional financial information that should be read in conjunction with this Form 10-Q.

 

3. The timing of the Company’s revenues is impacted by the purchasing patterns of customers and, as a result, revenues are not generated evenly throughout the year. Moreover, the Company’s first fiscal quarter, November through January, includes significant holiday periods in both Europe and North America.

 

4. Basic earnings per share is computed on the basis of the weighted average number of shares outstanding during the year. Diluted earnings per share includes the dilutive effect of stock options. Common shares issuable from stock options that are excluded from the calculation of diluted earnings per share because they were anti-dilutive were 244,100 and 712,570 in the second fiscal quarter of 2011 and 2010, respectively. Shares used for calculating earnings per share are disclosed in the following table.

 

            (In thousands)            Three Months Ended                        Six Months Ended             
     April 29,
2011
    April 30,
2010
    April 29,
2011
     April 30,
2010
 

Shares Used for Basic Earnings Per Share

     30,496        29,908        30,422         29,848   

Shares Used for Diluted Earnings Per Share

     31,160        30,406        31,086         30,312   

5.      The Company’s comprehensive income is as follows:

         

            (In thousands)    Three Months Ended     Six Months Ended  
     April 29,
2011
    April 30,
2010
    April 29,
2011
     April 30,
2010
 

Net Earnings

   $ 45,914      $ 29,648      $ 75,905       $ 42,373   

Change in Fair Value of Derivative

         

Financial Instruments, Net of Tax (1)

     6,534        3,716        5,045         1,889   

Pension and Post-retirement

         

Obligations, Net of Tax (2)

     (36     2,016        692         2,104   

Foreign Currency Translation

         

Adjustment

     73,927        (5,528     73,768         (24,800
                                 

Comprehensive Income

   $       126,339      $       29,852      $       155,410       $       21,566   
                                 

 

  (1) 

Net of tax expense of $(2,794) and $(1,526) for the second fiscal quarter of 2011 and 2010, respectively. Net of tax expense of $(2,204) and $(855) for the first six months of fiscal 2011 and 2010, respectively.

 

  (2) 

Net of tax expense of $(200) and $(1,225) for the second fiscal quarter of 2011 and 2010, respectively. Net of tax expense of $(692) and $(1,026) for the first six months of fiscal 2011 and 2010, respectively.

 

7


The Company’s accumulated other comprehensive income is comprised of the following:

 

(In thousands)    April 29,
2011
    October 29,
2010
 

Net unrealized gain on derivative contracts

   $ 15,001      $ 9,956   

Pension and post-retirement obligations

     (64,793     (65,485

Currency translation adjustment

     132,532        58,764   
                

Total accumulated other comprehensive income

   $           82,740      $           3,235   
                

 

6. On December 30, 2010, the Company acquired all of the outstanding capital stock of Eclipse Electronic Systems, Inc. (Eclipse) for approximately $120.0 million, plus the change in net assets from July 31, 2010, to the actual closing balance sheet. The $120.0 million purchase price includes cash of $14.0 million in contingent consideration, which was deposited in an escrow account and will be paid to the seller if certain performance objectives are met over the three-year period. The estimated fair value of the contingent consideration is $13.4 million. Eclipse is a designer and manufacturer of embedded communications intercept receivers for signal intelligence applications. Eclipse is included in the Avionics & Controls segment.

The following summarizes the allocation of the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition. The preliminary purchase price includes the value of future development of existing technologies, the introduction of new technologies, and the addition of new customers. These factors resulted in recording goodwill of $65.4 million. The amount allocated to goodwill is not deductible for income tax purposes.

 

(In thousands)       

As of December 30, 2010

  

Current assets

   $ 30,703   

Property, plant and equipment

     2,154   

Intangible assets subject to amortization

  

Technology (9 year weighted average useful life)

     50,100   

Tradename (3 year useful life)

     1,400   

Goodwill

     65,420   
        

Total assets acquired

     149,777   

Current liabilities assumed

     33,977   

Long-term liabilities assumed

     8,350   
        

Net assets acquired

   $           107,450   
        

 

7. On September 8, 2010, the Company sold Pressure Systems, Inc., which was included in the Sensors & Systems segment, for approximately $25.0 million, resulting in an after tax gain of $10.4 million. As a result, the consolidated income statement presents Pressure Systems, Inc. as discontinued operations. Loss from discontinued operations was $29,000 in the first six months of fiscal 2011.

The operating results of the discontinued operations for the three and six months ended April 30, 2010, consisted of the following:

 

(In thousands)    Three Months
Ended
     Six Months
Ended
 

Sales

   $ 5,128       $ 9,178   

Income from discontinued operations before income taxes

     859         1,399   

Income tax expense

     321         521   
                 

Income from discontinued operations

   $             538       $             878   
                 

 

8


8. On May 23, 2011, the Company entered into a share purchase agreement to acquire the Souriau Group (Souriau) for 483 million euros (approximately $715 million), plus certain transaction costs of the seller, which the Company expects to finance through a combination of U.S. and non-U.S. cash, a draw on the Company’s existing secured credit facility, and a new international credit facility. In accordance with the terms of the agreement, subsequent to period end, the Company deposited $350 million in escrow as security for the purchase price. Souriau is a leading global supplier of highly engineered connectors for harsh environments serving aerospace, defense & space, power generation & rail, and industrial equipment markets. The transaction is expected to close in the middle of July 2011, subject to customary regulatory conditions.

 

9. The income tax rate was 20.4% and 23.4% for the first six months of fiscal 2011 and 2010, respectively. In the first six months of fiscal 2011, the Company recognized $3.3 million of discrete tax benefits principally due to the retroactive extension of the U.S. federal research and experimentation credits and the release of a valuation allowance related to a net operating loss of an acquired subsidiary. In the first six months of fiscal 2010, the Company recognized $0.5 million of discrete tax expense mainly related to tax law changes in France. The income tax rate differed from the statutory rate in the first six months of fiscal 2011 and 2010, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next 12 months $5.9 million of tax benefits associated with research and experimentation tax credits, capital and operating losses that are currently unrecognized could be recognized as a result of settlement of examinations and/or the expiration of a statute of limitations.

 

10. As of April 29, 2011, the Company had three share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans for the first six months of fiscal 2011 and 2010 was $3.8 million and $3.4 million, respectively. During the first six months of fiscal 2011 and 2010, the Company issued 244,561 and 235,099 shares, respectively, under its employee stock plans.

Employee Stock Purchase Plan

The Company converted the ESPP to a “safe harbor” design on December 16, 2008. Under the safe harbor design, shares are purchased by participants at 95% of the market value on the purchase date and, therefore, compensation cost is not recorded under the ESPP.

Equity Incentive Plan

Under the equity incentive plan, option exercise prices are equal to the fair market value of the Company’s common stock on the date of grant. The Company granted 257,300 options and 355,800 options in the six month periods ended April 29, 2011, and April 30, 2010, respectively. The weighted-average grant date fair value of options granted during the six month periods ended April 29, 2011, and April 30, 2010, was $31.32 per share and $21.38 per share, respectively.

The fair value of each option granted by the Company was estimated using a Black-Scholes pricing model which uses the assumptions noted in the following table. The Company uses historical data to estimate volatility of the Company’s common stock and option exercise and employee termination assumptions. The risk-free rate for the contractual life of the option is based on the U.S. Treasury zero coupon issues in effect at the time of the grant.

 

     Six Months Ended  
         April 29,    
2011
         April 30,    
2010
 

Volatility

     40.8 – 42.8%         43.0 – 43.2%   

Risk-free interest rate

     2.02 – 3.64%         2.42 – 4.0%   

Expected life (years)

     4.5 – 9.5            4.5 – 9.5      

Dividends

     0            0      

Employee Sharesave Scheme

Under the employee sharesave scheme for U.K. employees, participants are allowed the option to purchase shares at 95% of the market price of the stock as of the beginning of the offering period. The term of these

 

9


options is three years. The sharesave scheme is not a “safe-harbor” design, and therefore, compensation cost is recognized on this plan. Under the sharesave scheme, option exercise prices are equal to the fair market value of the Company’s common stock on the date of grant. The Company granted 9,956 and 10,133 options in the first six month periods ended April 29, 2011, and April 30, 2010, respectively. The weighted-average grant date fair value of options granted during the six month periods ended April 29, 2011, and April 30, 2010, was $26.14 and $18.64, respectively.

The fair value of the awards under the employee share-save scheme was estimated using a Black-Scholes pricing model which uses the assumptions noted in the following table. The risk-free rate for the contractual life of the option is based on the U.S. Treasury zero coupon issues in effect at the time of grant.

 

     Six Months Ended  
         April 29,    
2011
         April 30,    
2010
 

Volatility

     51.10%         51.61%   

Risk-free interest rate

     0.98%         1.34%   

Expected life (years)

     3            3      

Dividends

     0            0      

 

11. The Company’s pension plans principally include a U.S. pension plan maintained by Esterline and a non-U.S. plan maintained by CMC. Components of periodic pension cost consisted of the following:

 

(In thousands)    Three Months Ended     Six Months Ended  
     April 29,
2011
    April 30,
2010
    April 29,
2011
    April 30,
2010
 

Components of Net Periodic Pension Cost

        

Service cost

   $ 2,313      $ 1,901      $ 4,594      $ 3,791   

Interest cost

     4,662        4,543        9,267        9,038   

Expected return on plan assets

     (5,087     (4,406     (10,111     (8,779

Amortization of prior service cost

     5        5        10        10   

Amortization of actuarial loss

     2,009        1,871        4,007        3,697   
                                

Net Periodic Cost

   $         3,902      $         3,914      $         7,767      $         7,757   
                                
The Company’s principal post-retirement plans include non-U.S. plans, which are non-contributory healthcare and life insurance plans. The components of expense of these other retirement benefits consisted of the following:    
(In thousands)    Three Months Ended     Six Months Ended  
     April 29,
2011
    April 30,
2010
    April 29,
2011
    April 30,
2010
 

Components of Net Periodic

        

Post-Retirement Plans Cost

        

Service cost

   $ 140      $ 80      $ 275      $ 158   

Interest cost

     176        176        346        350   

Amortization of actuarial gain

     (4     (19     (8     (38
                                

Net Periodic Cost

   $ 312      $ 237      $ 613      $ 470   
                                

 

12. In March 2011, the Company entered into a secured credit facility for $460 million made available through a group of banks. The credit facility is secured by substantially all of the Company’s assets and interest is based on standard inter-bank offering rates. The credit facility expires in March 2016. The spread will range from LIBOR plus 1.5% to LIBOR plus 2.25% depending on the leverage ratios at the time the funds are drawn. The Company repaid the U.S. Term Loan in March 2011 for $118.8 million. At April 29, 2011, the Company had $110.0 million outstanding under the secured credit facility at an initial interest rate of LIBOR plus 1.75% or 1.97%.

 

10


13. On March 30, 2011, the California Attorney General’s office filed a complaint against Kirkhill-TA, a subsidiary included in the Advanced Materials segment, with the Superior Court of California, Orange County, on behalf of California and the Santa Ana Regional Water Quality Control Board (Board) regarding the discharge of industrial waste water from its Brea, California, facility into Fullerton Creek and Craig Lake.

Prior to receipt of the complaint, the Company cooperated with the Board to address the discharge. Based upon the Company’s investigation, the discharge of waste water was unintentional, and was corrected as soon as the Board notified the Company of the discharge. At the request of the Board, the Company engaged an environmental engineering company to perform certain tests of the affected water. Concentrations of pollutants were below regulatory requirements. Additionally, the facility does not have a history of discharges of industrial waste. Accordingly, prior to receiving the complaint, management did not believe any significant remediation or penalties were likely.

The California water code authorizes courts to impose penalties based on the number of days in which the violation occurred and the volume of the discharge. Utilizing this statutory formula and based on management’s calculation of the days that a violation occurred and the discharge volumes, management believes that the penalty imposed could be up to $1.8 million, although the Board has alleged that violations occurred over a longer period.

Based upon the Company’s review of the complaint, established statutory penalty factors, California’s Water Quality Enforcement Policy, a review of similar cases and the facts noted above, management believes that the possible range of penalties to be paid would be from low to high six figures. The amount of the estimated liability the Company recorded in the second quarter of fiscal 2011 as a contingent liability is not material.

 

14. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy has been established that prioritizes the inputs to valuation techniques used to measure fair value. An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The hierarchy of fair value measurements is described below:

Level 1 – Valuations are based on quoted prices that the Company has the ability to obtain in actively traded markets for identical assets and liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market or exchange traded market, a valuation of these instruments does not require a significant degree of judgment.

Level 2 – Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuations are based on model-based techniques for which some or all of the assumptions are obtained from indirect market information that is significant to the overall fair value measurement and which require a significant degree of management judgment.

The following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis by level within the fair value hierarchy at April 29, 2011, and October 29, 2010.

 

11


(In thousands)    Level 2  
     April 29,
2011
     October 29,
2010
 

Assets:

     

Derivative contracts designated as hedging instruments

   $             18,877       $             11,552   

Derivative contracts not designated as hedging instruments

   $ 2,673       $ 1,256   

Embedded derivatives

   $ 20       $ 23   

Liabilities:

     

Derivative contracts designated as hedging instruments

   $ 106       $ 950   

Derivative contracts not designated as hedging instruments

   $ 443       $ 782   

Embedded derivatives

   $ 3,190       $ 1,815   
(In thousands)    Level 3  
     April 29,
2011
     October 29,
2010
 

Liabilities:

     

Contingent purchase obligation

   $ 13,350       $ 0   

The Company’s embedded derivatives are the result of entering into sales or purchase contracts that are denominated in a currency other than the Company’s functional currency or the supplier’s or customer’s functional currency. The fair value is determined by calculating the difference between quoted exchange rates at the time the contract was entered into and the period end exchange rate. These contracts are categorized as Level 2 in the fair value hierarchy.

The Company’s derivative contracts consist of foreign currency exchange contracts and interest rate swap agreements. These derivative contracts are over the counter and their fair value is determined using modeling techniques that include market inputs such as interest rates, yield curves, and currency exchange rates. These contracts are categorized as Level 2 in the fair value hierarchy.

The Company’s contingent purchase obligation consists of up to $14.0 million of additional consideration in connection with the acquisition of Eclipse. The contingent consideration will be paid to the seller if certain performance objectives are met over the three-year period. The value recorded on the balance sheet was derived from the estimated probability that the performance objective will be met by the end of the three-year period. The contingent purchase obligation is categorized as Level 3 in the fair value hierarchy.

 

15. The Company uses derivative financial instruments in the form of foreign currency forward exchange contracts and interest rate swap contracts for the purpose of minimizing exposure to changes in foreign currency exchange rates on business transactions and interest rates, respectively. The Company’s policy is to execute such instruments with banks the Company believes to be creditworthy and not to enter into derivative financial instruments for speculative purposes. These derivative financial instruments do not subject the Company to undue risk, as gains and losses on these instruments generally offset gains and losses on the underlying assets, liabilities, or anticipated transactions that are being hedged.

All derivative financial instruments are recorded at fair value in the Consolidated Balance Sheet. For a derivative that has not been designated as an accounting hedge, the change in the fair value is recognized immediately through earnings. For a derivative that has been designated as an accounting hedge of an existing asset or liability (a fair value hedge), the change in the fair value of both the derivative and underlying asset or liability is recognized immediately through earnings. For a derivative designated as an accounting hedge of an anticipated transaction (a cash flow hedge), the change in the fair value is recorded on the Consolidated Balance Sheet in Accumulated Other Comprehensive Income (AOCI) to the extent the derivative is effective in mitigating the exposure related to the anticipated transaction. The change in the fair value related to the ineffective portion of the hedge, if any, is immediately recognized in earnings. The amount recorded within AOCI is reclassified into earnings in the same period during which the underlying hedged transaction affects earnings.

 

12


The fair values of derivative instruments are presented on a gross basis, as the Company does not have any derivative contracts which are subject to master netting arrangements. The Company did not have any hedges with credit-risk-related contingent features or that required the posting of collateral as of April 29, 2011. The cash flows from derivative contracts are recorded in operating activities in the Consolidated Statement of Cash Flows.

Foreign Currency Forward Exchange Contracts

The Company transacts business in various foreign currencies which subjects the Company’s cash flows and earnings to exposure related to changes in foreign currency exchange rates. These exposures arise primarily from purchases or sales of products and services from third parties. Foreign currency forward exchange contracts provide for the purchase or sale of foreign currencies at specified future dates at specified exchange rates and are used to offset changes in the fair value of certain assets or liabilities or forecasted cash flows resulting from transactions denominated in foreign currencies. As of April 29, 2011, and October 29, 2010, the Company had outstanding foreign currency forward exchange contracts principally to sell U.S. dollars with notional amounts of $282.2 million and $245.5 million, respectively. These notional values consist primarily of contracts for the European euro, British pound sterling and Canadian dollar, and are stated in U.S. dollar equivalents at spot exchange rates at the respective dates.

Interest Rate Swaps

The Company manages its exposure to interest rate risk by maintaining an appropriate mix of fixed and variable rate debt, which over time should moderate the costs of debt financing. When considered necessary, the Company may use financial instruments in the form of interest rate swaps to help meet this objective. In November 2010, the Company entered into an interest rate swap agreement for $100.0 million on the $175.0 million Senior Notes due in 2017. The swap agreement exchanged the fixed interest rate of 6.625% for a variable interest rate on $100.0 million of the principal amount outstanding. The variable interest rate is based upon LIBOR plus 4.865% and was 5.138% at April 29, 2011. The fair value of the Company’s interest rate swap was a $4.6 million liability at April 29, 2011, and was estimated by discounting expected cash flows using market interest rates. The Company records interest receivable and interest payable on interest rate swaps on a net basis. In December 2010, the Company entered into an interest rate swap agreement for $75.0 million on the $175.0 million Senior Notes due in 2017. The swap agreement exchanged the fixed interest rate of 6.625% for a variable interest rate on $75.0 million of the principal amount outstanding. The variable interest rate is based upon LIBOR plus 4.470% and was 4.743% at April 29, 2011. The fair value of the Company’s interest rate swap was a $1.9 million liability at April 29, 2011, and was estimated by discounting expected cash flows using market interest rates. The Company recognized a net interest receivable of $0.4 million at April 29, 2011.

Embedded Derivative Instruments

The Company’s embedded derivatives are the result of entering into sales or purchase contracts that are denominated in a currency other than the Company’s functional currency or the supplier’s or customer’s functional currency.

Net Investment Hedge

In February 2006, the Company entered into a term loan for £57.0 million. The Company designated the term loan a hedge of the investment in a certain U.K. business unit. The term loan was fully repaid in June 2010. A cumulative foreign currency loss of $4.8 million resulting from the accounting of the term loan as a net investment hedge will remain in other comprehensive income in shareholders’ equity until the hedged investment is disposed of or sold.

 

13


Fair Value of Derivative Instruments

Fair values of derivative instruments in the Consolidated Balance Sheet at April 29, 2011, and October 29, 2010, consisted of:

 

(In thousands)        Fair Value  
   

Classification

   April 29,
2011
     October 29,
2010
 

Foreign currency forward

       

exchange contracts

  Other current assets    $         18,320       $         11,218   
  Other assets      3,230         1,590   
  Accrued liabilities      549         1,563   
  Other liabilities      0         169   

Embedded derivative instruments

  Other current assets    $ 20       $ 23   
  Accrued liabilities      150         189   
  Other liabilities      3,040         1,626   

Interest rate swap

  Accrued liabilities    $ 6,501       $ 0   

The effect of derivative instruments on the Consolidated Statement of Operations for the three and six month periods ended April 29, 2011, and April 30, 2010, consisted of:

 

(In thousands)         Three Months Ended     Six Months Ended  
        Location of    
Gain (Loss)
    April 29,
2011
    April 30,
2010
    April 29,
2011
    April 30,
2010
 

Fair Value Hedges:

         

Interest rate

    Interest           

swap contracts

    Expense      $ 717      $ 1,103      $ 1,196      $ 1,735   

Embedded

         

derivatives

    Sales      $         (1,350   $         (775   $         (1,143   $         (1,202

Cash Flow Hedges:

         

Foreign currency forward exchange contracts:

  

Amount of gain

         

(loss) recognized

in AOCI (effec-

tive portion)

    AOCI      $ 6,263      $ 2,904      $ 1,535      $ (1,583

Amount of gain

         

(loss) reclassified

from AOCI

into income

    Sales      $ 3,065      $ 2,338      $ 5,713      $ 4,326   

During the first six months of fiscal 2011 and 2010, the Company recorded a gain of $2.8 million and a loss of $1.2 million, respectively, on foreign currency forward exchange contracts that have not been designated as an accounting hedge. These foreign currency exchange losses are included in selling, general and administrative expense.

There was no significant impact to the Company’s earnings related to the ineffective portion of any hedging instruments during the first six months of fiscal 2011 and 2010. In addition, there was no significant impact to the Company’s earnings when a hedged firm commitment no longer qualified as a fair value hedge or when a hedged forecasted transaction no longer qualified as a cash flow hedge during the first six months of fiscal 2011 and 2010.

Amounts included in AOCI are reclassified into earnings when the hedged transaction settles. The Company expects to reclassify approximately $15.9 million of net gain into earnings over the next 12 months. The maximum duration of the Company’s foreign currency cash flow hedge contracts at April 29, 2011, is 23 months.

 

14


16. Segment information:

Business segment information for continuing operations includes the segments of Avionics & Controls, Sensors & Systems and Advanced Materials.

 

(In thousands)    Three Months Ended     Six Months Ended  
     April 29,
2011
    April 30,
2010
    April 29,
2011
    April 30,
2010
 

Sales

        

Avionics & Controls

   $     231,532      $     198,719      $     423,999      $     368,976   

Sensors & Systems

     85,181        75,218        162,236        145,910   

Advanced Materials

     118,564        108,555        219,841        202,916   
                                

Total Sales

   $ 435,277      $ 382,492      $ 806,076      $ 717,802   
                                

Income from Continuing Operations

        

Avionics & Controls

   $ 44,915      $ 28,461      $ 75,919      $ 47,893   

Sensors & Systems

     11,595        7,834        22,566        12,390   

Advanced Materials

     22,979        17,127        38,247        25,857   
                                

Segment Earnings

     79,489        53,422        136,732        86,140   

Corporate expense

     (12,202     (8,854     (23,034     (16,945

Other income (expense)

     0        38        0        (3

Interest income

     430        20        770        403   

Interest expense

     (8,958     (7,348     (18,095     (15,309

Loss on extinguishment of debt

     (831     0        (831     0   
                                
   $ 57,928      $ 37,278      $ 95,542      $ 54,286   
                                

 

17. The following schedules set forth condensed consolidating financial information as required by Rule 3-10 of Securities and Exchange Commission Regulation S-X as of April 29, 2011, and October 29, 2010, and for the applicable periods ended April 29, 2011, and April 30, 2010, for (a) Esterline Technologies Corporation (the Parent); (b) on a combined basis, the current subsidiary guarantors (Guarantor Subsidiaries) of the secured credit facility, Senior Notes due 2017, and Senior Notes due 2020; and (c) on a combined basis, the subsidiaries that are not guarantors (Non-Guarantor Subsidiaries) of the secured credit facility, Senior Notes due 2017, and Senior Notes due 2020. The Guarantor Subsidiaries previously guaranteed the Senior Subordinated Notes due 2013 that were repurchased or otherwise redeemed in August 2010. The Guarantor Subsidiaries are direct and indirect wholly-owned subsidiaries of Esterline Technologies Corporation and have fully and unconditionally, jointly and severally, guaranteed the secured credit facility, Senior Notes due 2017, Senior Notes due 2020, and Senior Subordinated Notes (until such Senior Subordinated Notes were repurchased or otherwise redeemed in August 2010).

 

15


Condensed Consolidating Balance Sheet as of April 29, 2011.

 

(In thousands)                               
     Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Assets

          

Current Assets

          

Cash and cash equivalents

   $ 100,422      $ 8,044      $ 283,048      $ 0      $ 391,514   

Escrow deposit

     5,000        0        0        0        5,000   

Accounts receivable, net

     12        140,439        167,652        0        308,103   

Inventories

     0        149,027        166,967        0        315,994   

Income tax refundable

     9,094        (2,425     5,398        0        12,067   

Deferred income tax benefits

     22,070        (1,285     17,447        0        38,232   

Prepaid expenses

     121        6,422        11,826        0        18,369   

Other current assets

     25        310        18,338        0        18,673   
   

Total Current Assets

     136,744        300,532        670,676        0        1,107,952   

Property, Plant &
Equipment, Net

     998        164,149        122,795        0        287,942   

Goodwill

     0        311,596        523,571        0        835,167   

Intangibles, Net

     0        135,352        321,296        0        456,648   

Debt Issuance Costs, Net

     9,759        0        0        0        9,759   

Deferred Income
Tax Benefits

     48,402        3,669        42,977        0        95,048   

Other Assets

     8,930        1,616        11,858        0        22,404   

Amounts Due From (To)
Subsidiaries

     130,873        298,516        0        (429,389     0   

Investment in Subsidiaries

     1,876,841        162,469        230,361        (2,269,671     0   
   

Total Assets

   $     2,212,547      $ 1,377,899      $ 1,923,534      $ (2,699,060   $     2,814,920   
   

 

16


(In thousands)                               
     Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Liabilities and Shareholders’ Equity

  

   

Current Liabilities

          

Accounts payable

   $ 2,206      $ 26,272      $ 56,182      $ 0      $ 84,660   

Accrued liabilities

     24,172        79,044        130,511        0        233,727   

Credit facilities

     110,000        0        0        0        110,000   

Current maturities of
long-term debt

     0        213        1,569        0        1,782   

Deferred income tax
liabilities

     197        259        10,021        0        10,477   

Federal and foreign
income taxes

     0        (24,348     26,799        0        2,451   
   

Total Current Liabilities

     136,575        81,440        225,082        0        443,097   

Long-Term Debt, Net

     418,499        44,339        32,881        0        495,719   

Deferred Income Tax
Liabilities

     44,720        20,973        87,967        0        153,660   

Pension and Post-
Retirement Obligations

     16,540        40,320        52,391        0        109,251   

Other Liabilities

     10,588        8,571        8,409        0        27,568   

Amounts Due To (From)
Subsidiaries

     0        0        351,267        (351,267     0   

Shareholders’ Equity

     1,585,625        1,182,256        1,165,537        (2,347,793     1,585,625   
   

Total Liabilities and
Shareholders’ Equity

   $     2,212,547      $ 1,377,899      $ 1,923,534      $ (2,699,060   $     2,814,920   
   

 

17


Condensed Consolidating Statement of Operations for the three month period ended April 29, 2011.

(In thousands)

 

    Parent     Guarantor
  Subsidiaries
    Non-
Guarantor
  Subsidiaries
      Eliminations     Total  

Net Sales

  $ 0      $ 230,031      $ 206,023      $ (777   $ 435,277   

Cost of Sales

    0        139,992        135,115        (777     274,330   
   
    0        90,039        70,908        0        160,947   

Expenses

         

Selling, general
and administrative

    0        32,901        39,508        0        72,409   

Research, development
and engineering

    0        8,283        12,968        0        21,251   

Other income

    0        0        0        0        0   
   

Total Expenses

    0        41,184        52,476        0        93,660   
   

Operating Earnings from
Continuing Operations

    0        48,855        18,432        0        67,287   

Interest Income

    (3,540     (634     (5,689     9,433        (430

Interest Expense

    7,691        5,098        5,602        (9,433     8,958   

Loss on Extinguishment of Debt

    831        0        0        0        831   
   

Income (Loss) from
Continuing Operations
Before Taxes

    (4,982     44,391        18,519        0        57,928   

Income Tax Expense
(Benefit)

    (1,204     7,124        5,928        0        11,848   
   

Income (Loss) from
Continuing Operations
Including Noncontrolling
Interests

    (3,778     37,267        12,591        0        46,080   

Income Attributable to
Noncontrolling Interests

    0        0        (129     0        (129
   

Income (Loss) from
Continuing Operations
Attributable to Esterline

    (3,778     37,267        12,462        0        45,951   

Loss from Discontinued
Operations Attributable
to Esterline, Net of Tax

    (8     (29     0        0        (37

Equity in Net Income of
Consolidated Subsidiaries

    49,700        9,003        1,320        (60,023     0   
   

Net Income (Loss)
Attributable to Esterline

  $         45,914      $ 46,241      $ 13,782      $ (60,023   $         45,914   
   

 

18


Condensed Consolidating Statement of Operations for the six month period ended April 29, 2011.

(In thousands)

 

    Parent     Guarantor
  Subsidiaries
    Non-
Guarantor
  Subsidiaries
      Eliminations     Total  

Net Sales

  $ 0      $ 425,481      $ 381,583      $ (988   $ 806,076   

Cost of Sales

    0        268,505        245,490        (988     513,007   
   
    0        156,976        136,093        0        293,069   

Expenses

         

Selling, general
and administrative

    0        64,106        74,395        0        138,501   

Research, development
and engineering

    0        17,918        22,952        0        40,870   

Other expense

    0        0        0        0        0   
   

Total Expenses

    0        82,024        97,347        0        179,371   
   

Operating Earnings from
Continuing Operations

    0        74,952        38,746        0        113,698   

Interest Income

    (7,022     (1,259     (11,099     18,610        (770

Interest Expense

    15,720        10,087        10,898        (18,610     18,095   

Loss on Extinguishment of Debt

    831        0        0        0        831   
   

Income (Loss) from
Continuing Operations
Before Taxes

    (9,529     66,124        38,947        0        95,542   

Income Tax Expense
(Benefit)

    (2,277     10,995        10,784        0        19,502   
   

Income (Loss) from
Continuing Operations
Including Noncontrolling
Interests

    (7,252     55,129        28,163        0        76,040   

Income Attributable to
Noncontrolling Interests

    0        0        (106     0        (106
   

Income (Loss) from
Continuing Operations
Attributable to Esterline

    (7,252     55,129        28,057        0        75,934   

Income from Discontinued
Operations Attributable
to Esterline, Net of Tax

    0        (29     0        0        (29

Equity in Net Income of
Consolidated Subsidiaries

    83,157        12,862        2,492        (98,511     0   
   

Net Income (Loss)
Attributable to Esterline

  $         75,905      $ 67,962      $ 30,549      $ (98,511   $         75,905   
   

 

19


Condensed Consolidating Statement of Cash Flows for the six month period ended April 29, 2011.

 

(In thousands)                              
    Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Cash Flows Provided (Used) by Operating Activities

  

   

Net earnings (loss) including
noncontrolling interests

  $         76,011      $ 67,962      $ 30,549      $ (98,511   $         76,011   

Depreciation & amortization

    0        17,957        19,512        0        37,469   

Deferred income taxes

    651        577        (3,404     0        (2,176

Share-based compensation

    0        1,523        2,324        0        3,847   

Working capital changes, net
of effect of acquisitions

         

Accounts receivable

    262        (744     21,187        0        20,705   

Inventories

    0        (13,787     (13,105     0        (26,892

Prepaid expenses

    (72     (694     (715     0        (1,481

Other current assets

    (25     (266     (1,863     0        (2,154

Accounts payable

    1,262        (2,472     (2,186     0        (3,396

Accrued liabilities

    5,510        (5,398     (14,609     0        (14,497

Federal & foreign
income taxes

    4,181        (3,767     (629     0        (215

Other liabilities

    4,266        (1,989     705        0        2,982   

Other, net

    794        1,416        (2,968     0        (758
   
    92,840        60,318        34,798        (98,511     89,445   

Cash Flows Provided (Used) by Investing Activities

  

   

Purchases of capital assets

    (15     (12,350     (13,950     0        (26,315

Proceeds from sale
of capital assets

    0        179        1,164        0        1,343   

Escrow deposit

    (14,000     0        0        0        (14,000

Acquisitions, net of
cash acquired

    0        (103,548     0        0        (103,548
   
    (14,015     (115,719     (12,786     0        (142,520

 

20


(In thousands)                              
    Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Cash Flows Provided (Used) by Financing Activities

  

   

Proceeds provided by stock
issuance under employee
stock plans

    9,357        0        0        0        9,357   

Excess tax benefits from
stock options exercised

    1,406        0        0        0        1,406   

Debt and other issuance costs

    (3,504     0        0        0        (3,504

Net change in credit facilities

    110,000        0        0        0        110,000   

Repayment of long-term debt

    (126,814     (166     6,154        0        (120,826

Proceeds from government
assistance

    0        0        10,176        0        10,176   

Net change in intercompany
financing

    (173,897     61,299        14,087        98,511        0   
   
    (183,452     61,133        30,417        98,511        6,609   

Effect of foreign exchange
rates on cash

    (1     (5     15,866        0        15,860   
   

Net increase (decrease) in
cash and cash equivalents

    (104,628     5,727        68,295        0        (30,606

Cash and cash equivalents
– beginning of year

    205,050        2,317        214,753        0        422,120   
   

Cash and cash equivalents
– end of year

  $         100,422      $ 8,044      $ 283,048      $ 0      $         391,514   
   

 

21


Condensed Consolidating Balance Sheet as of October 29, 2010.

 

(In thousands)                              
    Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
    Eliminations     Total  

Assets

         

Current Assets

         

Cash and cash equivalents

  $ 205,050      $ 2,317      $ 214,753      $ 0      $ 422,120   

Accounts receivable, net

    274        131,531        177,437        0        309,242   

Inventories

    0        118,567        143,806        0        262,373   

Income tax refundable

    12,548        0        5,258        0        17,806   

Deferred income tax benefits

    23,507        (1,627     15,659        0        37,539   

Prepaid expenses

    49        5,729        10,486        0        16,264   

Other current assets

    0        1        11,240        0        11,241   
   

Total Current Assets

    241,428        256,518        578,639        0        1,076,585   

Property, Plant &
Equipment, Net

    1,249        162,407        110,114        0        273,770   

Goodwill

    0        246,176        493,554        0        739,730   

Intangibles, Net

    0        89,812        299,205        0        389,017   

Debt Issuance Costs, Net

    7,774        0        0        0        7,774   

Deferred Income Tax
Benefits

    44,407        3,537        39,678        0        87,622   

Other Assets

    (69     2,004        11,305        0        13,240   

Amounts Due From (To)
Subsidiaries

    41,529        271,345        0        (312,874     0   

Investment in Subsidiaries

    1,710,032        149,607        227,869        (2,087,508     0   
   

Total Assets

  $     2,046,350      $     1,181,406      $     1,760,364      $     (2,400,382   $     2,587,738   
   

 

22


(In thousands)                              
    Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
    Eliminations     Total  

Liabilities and Shareholders’ Equity

  

Current Liabilities

         

Accounts payable

  $ 944      $ 28,345      $ 52,986      $ 0      $ 82,275   

Accrued liabilities

    18,662        73,870        122,562        0        215,094   

Credit facilities

    0        0        1,980        0        1,980   

Current maturities of
long-term debt

    10,938        80        1,628        0        12,646   

Deferred income tax
liabilities

    197        278        6,680        0        7,155   

Federal and foreign
income taxes

    (727     (20,522     26,476        0        5,227   
   

Total Current Liabilities

    30,014        82,051        212,312        0        324,377   

Long-Term Debt, Net

    534,375        44,525        20,072        0        598,972   

Deferred Income Tax
Liabilities

    40,300        123        86,658        0        127,081   

Pension and Post-
Retirement Obligations

    16,629        42,279        46,425        0        105,333   

Other Liabilities

    9,533        251        6,692        0        16,476   

Amounts Due To (From)
Subsidiaries

    0        0        310,115        (310,115     0   

Shareholders’ Equity

    1,415,499        1,012,177        1,078,090        (2,090,267     1,415,499   
   

Total Liabilities and
Shareholders’ Equity

  $     2,046,350      $     1,181,406      $     1,760,364      $     (2,400,382   $     2,587,738   
   

 

23


Condensed Consolidating Statement of Operations for the three month period ended April 30, 2010.

(In thousands)

 

            Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations                 Total  

Net Sales

  $ 0      $     195,231      $     187,742      $ (481   $     382,492   

Cost of Sales

    0        130,048        126,289        (481     255,856   
   
    0        65,183        61,453        0        126,636   

Expenses

         

Selling, general
and administrative

    0        28,098        35,969        0        64,067   

Research, development
and engineering

    0        7,598        10,403        0        18,001   

Other income

    0        0        (38     0        (38
   

Total Expenses

    0        35,696        46,334        0        82,030   

Operating Earnings from
Continuing Operations

    0        29,487        15,119        0        44,606   

Interest Income

    (3,899     (624     (9,857     14,360        (20

Interest Expense

    6,525        4,893        10,290        (14,360     7,348   
   

Income (Loss) from
Continuing Operations
Before Taxes

    (2,626     25,218        14,686        0        37,278   

Income Tax Expense
(Benefit)

    (532     5,382        3,294        0        8,144   
   

Income (Loss) from
Continuing Operations
Including Noncontrolling
Interests

    (2,094     19,836        11,392        0        29,134   

Income Attributable to
Noncontrolling Interests

    0        0        (24     0        (24
   

Income (Loss) from
Continuing Operations
Attributable to Esterline

    (2,094     19,836        11,368        0        29,110   

Income from Discontinued
Operations Attributable
to Esterline, Net of Tax

    0        538        0        0        538   

Equity in Net Income of
Consolidated Subsidiaries

    31,742        3,276        562        (35,580     0   
   

Net Income (Loss)
Attributable to Esterline

  $     29,648      $ 23,650      $ 11,930      $     (35,580   $ 29,648   
   

 

24


Condensed Consolidating Statement of Operations for the six month period ended April 30, 2010.

(In thousands)

 

            Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Net Sales

  $ 0      $         363,007      $         355,276      $ (481   $         717,802   

Cost of Sales

    0        244,719        244,257        (481     488,495   
   
    0        118,288        111,019        0        229,307   

Expenses

         

Selling, general and
administrative

    0        57,334        68,028        0        125,362   

Research, development
and engineering

    0        13,431        21,319        0        34,750   

Other expense

    0        0        3        0        3   
   

Total Expenses

    0        70,765        89,350        0        160,115   

Operating Earnings from
Continuing Operations

    0        47,523        21,669        0        69,192   

Interest Income

    (7,779     (1,254     (19,970     28,600        (403

Interest Expense

    13,164        9,881        20,864        (28,600     15,309   
   

Income (Loss) from
Continuing Operations
Before Taxes

    (5,385     38,896        20,775        0        54,286   

Income Tax Expense
(Benefit)

    (1,234     8,681        5,266        0        12,713   
   

Income (Loss) from
Continuing Operations
Including Noncontrolling
Interests

    (4,151     30,215        15,509        0        41,573   

Income Attributable to
Noncontrolling Interests

    0        0        (78     0        (78
   

Income (Loss) from
Continuing Operations
Attributable to Esterline

    (4,151     30,215        15,431        0        41,495   

Income from Discontinued
Operations Atributable
to Esterline, Net of Tax

    0        878        0        0        878   

Equity in Net Income of
Consolidated Subsidiaries

    46,524        6,581        304        (53,409     0   
   

Net Income (Loss)
Attributable to Esterline

  $ 42,373      $ 37,674      $ 15,735      $     (53,409   $ 42,373   
   

 

25


Condensed Consolidating Statement of Cash Flows for the six month period ended April 30, 2010.

 

(In thousands)                              
    Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Cash Flows Provided (Used) by Operating Activities

  

     

Net earnings (loss) including
noncontrolling interests

  $         42,373      $         37,674      $         15,813      $         (53,409   $         42,451   

Depreciation & amortization

    0        16,163        20,218        0        36,381   

Deferred income taxes

    (3,074     43        (5,465     0        (8,496

Share-based compensation

    0        1,573        1,858        0        3,431   

Working capital changes, net
of effect of acquisitions

         

Accounts receivable

    (31     3,048        (10,851     0        (7,834

Inventories

    0        27        8,613        0        8,640   

Prepaid expenses

    0        (1,658     416        0        (1,242

Other current assets

    0        (1     (2,778     0        (2,779

Accounts payable

    (41     3,124        (7,108     0        (4,025

Accrued liabilities

    (3,855     2,069        (8,212     0        (9,998

Federal & foreign
income taxes

    2,069        (1,930     7,270        0        7,409   

Other liabilities

    3,866        (1,074     2,396        0        5,188   

Other, net

    (1     125        2,454        0        2,578   
   
    41,306        59,183        24,624        (53,409     71,704   

Cash Flows Provided (Used) by Investing Activities

  

Purchases of capital assets

    (55     (8,652     (16,878     0        (25,585

Proceeds from sale
of capital assets

    0        92        5        0        97   

Acquisitions, net of
cash acquired

    0        (360     (408     0        (768
   
    (55     (8,920     (17,281     0        (26,256

 

26


(In thousands)                              
    Parent     Guarantor
    Subsidiaries
    Non-
Guarantor
    Subsidiaries
        Eliminations     Total  

Cash Flows Provided (Used) by Financing Activities

  

     

Proceeds provided by stock
issuance under employee
stock plans

    6,413        0        0        0        6,413   

Excess tax benefits from
stock options exercised

    1,328        0        0        0        1,328   

Net change in credit facilities

    0        0        (1,677     0        (1,677

Repayment of long-term debt

    (1,885     (200     (68     0        (2,153

Proceeds from government
assistance

    0        0        1,961        0        1,961   

Net change in intercompany
financing

    (14,452     (49,345     10,388        53,409        0   
   
    (8,596     (49,545     10,604        53,409        5,872   

Effect of foreign exchange
rates on cash

    1        (4     (4,446     0        (4,449
   

Net increase (decrease) in
cash and cash equivalents

    32,656        714        13,501        0        46,871   

Cash and cash equivalents
– beginning of year

    47,907        4,621        124,266        0        176,794   
   

Cash and cash equivalents
– end of year

  $         80,563      $ 5,335      $ 137,767      $ 0      $         223,665   
   

 

27


Item 2. Management’s Discussion and Analysis of Financial Condition and
     Results of Operations

Overview

We operate our businesses in three segments: Avionics & Controls, Sensors & Systems and Advanced Materials.

The Avionics & Controls segment includes avionics systems, control systems, interface technologies and communication systems capabilities. Avionics systems designs and develops cockpit systems integration and avionics solutions for commercial and military applications. Control systems designs and manufactures technology interface systems for military and commercial aircraft and land- and sea-based military vehicles. Interface technologies manufactures and develops custom control panels, input systems for medical, industrial, military and casino gaming industries. Communication systems designs and manufactures military audio and data products for severe battlefield environments, as well as communication control systems to enhance security and aural clarity in military applications. In addition, communication systems designs and manufactures embedded communications intercept receivers for signal intelligence applications.

The Sensors & Systems segment includes power systems and advanced sensors capabilities. Power systems develops and manufactures electrical power switching and other related systems, principally for aerospace and defense customers. Advanced sensors develops and manufactures high precision temperature and pressure sensors for aerospace and defense customers.

The Advanced Materials segment includes engineered materials and defense technologies capabilities. Engineered materials develops and manufactures thermally engineered components and high-performance elastomer products used in a wide range of commercial aerospace and military applications. Defense technologies develops and manufactures combustible ordnance components and warfare countermeasure devices for military customers. Sales in all segments include domestic, international, defense and commercial customers.

Our business and strategic plan focuses on the continued development of our products principally for aerospace and defense markets. We are concentrating our efforts to expand our capabilities in these markets and anticipate the global needs of our customers and respond to such needs with comprehensive solutions. These efforts focus on continuous research and new product development, acquisitions and strategic realignments of operations to expand our capabilities as a more comprehensive supplier to our customers across our entire product offering.

On May 23, 2011, we entered into a share purchase agreement to acquire the Souriau Group for approximately $715 million, plus certain transaction costs of the seller. Souriau is a leading global supplier of highly engineered connectors for harsh environments serving aerospace, defense & space, power generation & rail, and industrial equipment markets. The transaction is expected to close in the middle of July 2011, subject to customary closing procedures, including regulatory approval.

On December 30, 2010, we acquired all of the outstanding capital stock of Eclipse Electronic Systems, Inc. (Eclipse). Eclipse is a designer and manufacturer of embedded communications intercept receivers for signal intelligence applications. Eclipse is included in our Avionics & Controls segment.

On September 8, 2010, we sold Pressure Systems, Inc., which was included in the Sensors & Systems segment. The results of Pressure Systems, Inc. were accounted for as a discontinued operation in the consolidated financial statements.

During the first six months of fiscal 2011, our income from continuing operations was $75.9 million or $2.44 per diluted share compared to $41.5 million or $1.37 per diluted share during the prior-year period, reflecting strong sales and earnings across all our segments. During the first half of fiscal 2010, performance was weaker than the second half of the year. The strength from the second half of fiscal 2010 has continued in the first half of fiscal 2011. It is unlikely that the same year-over-year increase experienced in the first half of fiscal 2011 will continue at a comparable rate in the second half of fiscal 2011. Sales and operating earnings of Avionics & Controls increased 15% and 59%, respectively, over the prior-year period and reflected strong sales and gross margins of avionics systems and control systems. Sales and operating earnings of Sensors & Systems increased 11% and 82%, respectively, over the prior-year period reflecting robust sales of both advanced sensors and power systems and increased gross margins of advanced sensors. Sales and operating earnings of Advanced Materials increased 8%

 

28


and 48%, respectively, over the prior-year period reflecting strong sales and gross margins of engineered materials. Income from continuing operations in the first six months of fiscal 2011 reflected an income tax rate of 20.4% compared to 23.4% in the prior-year period. The decrease in the income tax rate from the prior-year period was principally due to the retroactive extension of the U.S. federal research and experimentation credits and release of a valuation allowance related to a net operating loss of an acquired subsidiary. Income from discontinued operations for the first six months of fiscal 2010 was $0.03 per diluted share.

Net income during the first six months of fiscal 2011 was $75.9 million, or $2.44 per diluted share, compared with net income of $42.4 million, or $1.40 per diluted share, in the prior-year period.

Results of Operations

Three Month Period Ended April 29, 2011, Compared with Three Month Period Ended April 30, 2010

Sales for the second fiscal quarter increased 13.8% over the prior-year period. Sales by segment were as follows:

(In thousands)

    

Incr./(Decr.)

from prior

    year period    

   Three Months Ended  
        April 29,
2011
     April 30,
2010
 

Avionics & Controls

   16.5%    $ 231,532       $ 198,719   

Sensors & Systems

   13.2%      85,181         75,218   

Advanced Materials

     9.2%      118,564         108,555   
                    

Total Net Sales

      $                 435,277       $                 382,492   
                    

The 16.5% increase in sales of Avionics & Controls was principally due to increased sales volumes of avionics systems of $18.4 million, control systems of $11.8 million, and a nominal increase of communication systems and interface technologies. The increase in avionics systems was principally due to strong cockpit integration and aviation products sales volumes. The increase in control systems reflected strong after-market sales and a $4.4 million retroactive price settlement due to product scope changes. Communication systems sales benefited from incremental sales from our Eclipse acquisition on December 30, 2010, partially offset by a $9.0 million decrease in certain communication systems sales for audio and data products for severe battlefield environments. The increase in interface technologies mainly reflected strong sales of input devices for medical and industrial commercial applications, partially offset by weaker demand for casino gaming applications.

The 13.2% increase in sales of Sensors & Systems reflected higher sales volume of advanced sensors of $4.2 million and power systems of $5.8 million. The increase in advanced sensors sales mainly reflected strong aftermarket demand for temperature sensors. The increase in power systems mainly reflected higher retrofit sales for commercial aviation. Sales in the second fiscal quarter of 2011 reflected a stronger pound sterling and euro relative to the U.S. dollar. The average exchange rate from the pound sterling to the U.S. dollar increased from 1.53 in the second fiscal quarter of 2010 to 1.61 in the second fiscal quarter of 2011. The average exchange rate from the euro to the U.S. dollar increased from 1.35 in the second fiscal quarter of 2010 to 1.40 in the second fiscal quarter of 2011.

The 9.2% increase in sales of Advanced Materials principally reflected decreased sales volumes of defense technologies of $3.7 million and increased sales volumes of engineered materials of $12.8 million. The decrease in defense technologies mainly reflected lower sales of flare countermeasures due to reduced demand and customer delaying shipments, partially offset by higher sales volumes of combustible ordnance. The increase in engineered materials primarily reflected strong demand for elastomer and insulation materials.

Overall, gross margin as a percentage of sales was 37.0%, compared to 33.1% in the same period a year ago. Gross profit was $160.9 million and $126.6 million for the second fiscal quarter of 2011 and 2010, respectively.

 

29


Avionics & Controls segment gross margin was 39.6% and 34.4% for the second fiscal quarter of 2011 and 2010, respectively. Segment gross profit was $91.6 million compared to $68.3 million in the prior-year period. Over 56% of the increase in gross profit was due to strong sales volume and improved gross margin on avionics systems reflecting increased sales volumes of cockpit integration for the T-6B military trainer as well as aviation products. Approximately 43% of the increase in gross profit was due to strong after-market sales of control systems and the $4.4 million retroactive price increase referenced above.

Sensors & Systems segment gross margin was 34.7% and 34.1% for the second fiscal quarter of 2011 and 2010, respectively. Segment gross profit was $29.5 million compared to $25.6 million in the prior-year period. The increase in gross profit was mainly due to strong power systems sales for a commercial aircraft retrofit program.

Advanced Materials segment gross margin was 33.5% compared to 30.1% for the same period one year ago. Segment gross profit was $39.8 million compared to $32.7 million in the prior-year period. Approximately 78% of the increase in gross profit was principally due to higher insulation material sales for a commercial aviation retrofit program and for petrochemical applications, as well as elastomer materials for commercial aviation applications. A $1.0 million increase in gross profit in defense technologies mainly reflected strong demand and increased prices for combustible ordnance and weakness for our non-U.S. countermeasures due to lower demand and delayed shipments. Management expects that demand for countermeasures will be at reduced levels for the remainder of fiscal 2011 compared to fiscal 2010.

Selling, general and administrative expenses (which include corporate expenses) totaled $72.4 million, or 16.6% of sales, and $64.1 million, or 16.7% of sales, for the second fiscal quarter of 2011 and 2010, respectively. The increase in selling, general and administrative expense principally reflected an increase of $3.3 million of corporate expense and a $3.7 million increase in selling, general and administrative expenses at our Avionics & Controls segment. The increase in corporate expense mainly reflected higher incentive compensation expense of $1.2 million and acquisition-related expenses of $1.4 million. The increase in selling, general and administrative expense at our Avionics & Controls segment principally reflected incremental selling, general and administrative expense from the acquisition of Eclipse.

Research, development and engineering spending was $21.3 million, or 4.9% of sales, for the second fiscal quarter of 2011 compared with $18.0 million, or 4.7% of sales, for the second fiscal quarter of 2010. The increase in research, development and engineering spending principally reflects spending on avionics systems and control systems developments. Fiscal 2011 research, development and engineering spending is expected to be approximately 5.0% of sales.

Total segment earnings (operating earnings excluding corporate expenses and other income or expense) for the second fiscal quarter of 2011 were $79.5 million, or 18.3% of sales, compared with $53.4 million, or 14.0% of sales, for the second fiscal quarter of 2010.

Avionics & Controls segment earnings were $44.9 million, or 19.4% of sales, in the second fiscal quarter of 2011 and $28.5 million, or 14.3% of sales, in the second fiscal quarter of 2010, mainly reflecting an $8.0 million increase in avionics systems, a $10.0 million increase in control systems, and a $1.6 million decrease in communication systems. Avionics systems benefited from increased gross profit, partially offset by a $3.3 million increase in research, development and engineering and a $1.9 million increase in selling, general and administrative expense. Control systems benefited from increased gross profit and a $1.1 million recovery of non-recurring engineering upon settlement with the customer. The decrease in communication systems earnings mainly reflected decreased gross profit from lower sales of certain communication systems for audio and data products for severe battlefield environments, resulting in a $3.0 million decrease in communication system earnings, partially offset by incremental income from the Eclipse acquisition.

Sensors & Systems segment earnings were $11.6 million, or 13.6% of sales, for the second fiscal quarter of 2011 compared with $7.8 million, or 10.4% of sales, for the second fiscal quarter of 2010, reflecting the increase in power systems earnings principally from increased gross profit.

Advanced Materials segment earnings were $23.0 million, or 19.4% of sales, for the second fiscal quarter of 2011 compared with $17.1 million, or 15.8% of sales, for the second fiscal quarter of 2010, primarily reflecting a

 

30


$6.6 million increase in engineered materials and a $1.2 million decrease in defense technologies. Defense technologies reflected a $2.4 million increase in combustible ordnance gross profit and a $1.3 million decrease in countermeasures gross profit, a $2.2 million increase in selling, general and administrative expenses and research, development and engineering expense. The increase in selling, general and administrative expenses reflected $1.3 million in severance costs due to a reduction in force at our non-U.S. flare countermeasure unit. The prior-year period benefited from a $0.6 million insurance recovery. The increase in engineering materials mainly reflected increased gross profit for elastomer and insulation materials.

Interest expense for the second fiscal quarter of 2011 was $9.0 million compared with $7.3 million for the second fiscal quarter of 2010, reflecting increased borrowings. During the second fiscal quarter of 2011, in connection with executing a new credit facility, the Company repaid its $118.8 million U.S. Term Loan and recorded a loss on extinguishment of debt of $0.8 million.

The income tax rate was 20.5% compared with 21.8% for the second fiscal quarter of 2011 and 2010, respectively. In the second fiscal quarter of 2011, we recognized $1.9 million of discrete tax benefits principally due to the release of a valuation allowance related to a net operating loss of an acquired subsidiary. In the second fiscal quarter of 2010, we recognized $0.2 million of discrete tax expense associated with the accrual of interest on tax reserves. The income tax rate differed from the statutory rate in the second fiscal quarter of 2011 and 2010, as both years benefited from various tax credits and certain foreign interest expense deductions.

To the extent that sales are transacted in a currency other than the functional currency of the operating unit, we are subject to foreign currency fluctuation risk. We use forward contracts to hedge our foreign currency exchange risk. To the extent that these hedges qualify under U.S. GAAP, the amount of gain or loss is deferred in Accumulated Other Comprehensive Income (AOCI) until the related sale occurs. Also, we are subject to foreign currency gains or losses from embedded derivatives on backlog denominated in a currency other than the functional currency of our operating companies or its customer. Gains and losses on forward contracts, embedded derivatives, and revaluation of assets and liabilities denominated in a currency other than the functional currency of the Company for the three month period ended April 29, 2011, and April 30, 2010, are as follows:

 

(In thousands)          Three Months Ended  
           April 29,
2011
           April 30,
2010
 

Forward foreign currency contracts – gain (loss)

     $ 2,434         $ (796

Forward foreign currency contracts – reclassified from AOCI

                           3,065                               2,338   

Embedded derivatives – (loss)

       (1,350        (775

Revaluation of monetary assets/liabilities – gain (loss)

       (3,695        534   
                       

Total

     $ 454         $ 1,301   
                       

 

Six Month Period Ended April 29, 2011, Compared with Six Month Period Ended April 30, 2010

 

Sales for the first six months increased 12.3% over the prior-year period. Sales by segment were as follows:

 

(In thousands)

  

  

  

   

Incr./(Decr.)

from prior

    year period    

         Six Months Ended  
             April 29,
2011
           April 30,
2010
 

Avionics & Controls

  14.9%      $ 423,999         $ 368,976   

Sensors & Systems

  11.2%        162,236           145,910   

Advanced Materials

    8.3%        219,841           202,916   
                       

Total Net Sales

       $                 806,076         $                 717,802   
                       

The 14.9% increase in sales of Avionics & Controls reflected increased sales volumes of avionics systems of $32.4 million, control systems of $16.2 million, and communication systems and interface technologies of

 

31


approximately $6.4 million. The increase in avionics systems was principally due to strong cockpit integration and aviation products sales volumes. The increase in communication systems mainly reflected the acquisition of Eclipse on December 30, 2010, partially offset by a $12.2 million decrease in sales of certain communication systems for audio and data products for severe battlefield environments. The increase in control systems was principally due to strong aftermarket demand for commercial aviation applications and the $4.4 million retroactive price settlement due to product scope changes as referenced above. The increase in interface technologies mainly reflected strong sales of input devices for medical and industrial commercial applications, partially offset by weaker demand for casino gaming applications.

The 11.2% increase in sales of Sensors & Systems reflected an increase sales volume of advanced sensors of $8.5 million and an increase of $7.8 million of power systems. The increase in advanced sensors sales mainly reflected higher OEM sales of pressure sensors and strong aftermarket demand. The increase in power systems mainly reflected higher retrofit sales for commercial aviation. Sales in the first three months of fiscal 2011 reflected a weaker pound sterling and euro relative to the U.S. dollar, while sales in the second three months of fiscal 2011 reflected a stronger pound sterling and euro relative to the U.S. dollar.

The 8.3% increase in sales of Advanced Materials principally reflected decreased sales volumes of defense technologies of $5.8 million and increased sales volumes of engineered materials of $21.1 million. The decrease in defense technologies mainly reflected lower sales of non-U.S. flare countermeasures due to reduced demand and customer delaying shipments, partially offset by higher sales volumes of combustible ordnance. The increase in engineered materials primarily reflected strong demand for elastomer and insulation materials.

Overall, gross margin as a percentage of sales was 36.4% and 31.9% for the first six months of fiscal 2011 and 2010, respectively. Gross profit was $293.1 million and $229.3 million for the first six months of fiscal of 2011 and 2010, respectively.

Avionics & Controls segment gross margin was 39.2% and 33.8% for the first six months of fiscal 2011 and 2010, respectively. Segment gross profit was $166.2 million compared to $124.9 million in the prior-year period. Approximately 65% of the increase in gross profit was due to strong sales volume and improved gross margin on avionics systems reflecting increased sales volumes of cockpit integrations for the T-6B military trainer, as well as aviation products. Approximately 28% of the increase in gross profit was due to strong after-market sales of control systems and the $4.4 million retroactive price increase referenced above.

Sensors & Systems segment gross margin was 35.1% and 33.0% for the first six months of fiscal 2011 and 2010, respectively. Segment gross profit was $56.9 million compared to $48.1 million in the prior-year period. Approximately 73% of the increase in gross profit reflected strong demand for advanced sensors for the aftermarket, as well as new OEM requirements. Approximately 27% of the increase in gross profit was due to strong power systems sales for a commercial aircraft retrofit program.

Advanced Materials segment gross margin was 31.8% for the first six months of fiscal 2011 compared to 27.8% for the same period one year ago. Segment gross profit was $69.9 million compared to $56.4 million in the prior-year period. Approximately 71% of the increase in gross profit was principally due to higher insulation material sales for a commercial aviation retrofit program and for petrochemical applications, as well as elastomer materials for commercial aviation applications. A $3.1 million increase in gross profit on defense technologies reflected strong demand and increased prices for combustible ordnance, which was partially offset by lower gross profit on non-U.S. flare countermeasures due to decreased demand and delayed shipments.

Selling, general and administrative expenses (which include corporate expenses) totaled $138.5 million, or 17.2% of sales, and $125.4 million, or 17.5% of sales, for the first six months of fiscal 2011 and 2010, respectively. The increase in selling, general and administrative expense principally reflected an increase of $6.1 million of corporate expense and a $6.6 million increase in selling, general and administrative expenses at our Avionics & Controls segment. The increase in corporate expense mainly reflected higher incentive compensation expense of $2.8 million and increased acquisition expenses of $1.5 million. The increase in selling, general and administrative expense at Avionics & Controls reflected $2.8 million in incremental selling, general and administrative expense from the acquisition of Eclipse and increased selling, general and administrative expenses at avionics systems.

 

32


Research, development and engineering spending was $40.9 million, or 5.1% of sales, for the first six months of fiscal 2011 compared with $34.8 million, or 4.8% of sales, for the first six months of 2010. The increase in research, development and engineering spending principally reflects spending on avionics systems, control systems, and defense technologies developments. Fiscal 2011 research, development and engineering spending is expected to be approximately 5.0% of sales.

Total segment earnings (operating earnings excluding corporate expenses and other income or expense) for the first six months of fiscal 2011 totaled $136.7 million, or 17.0% of sales, compared with $86.1 million, or 12.0% of sales, for the first six months in fiscal 2010.

Avionics & Controls segment earnings were $75.9 million, or 17.9% of sales, in the first six months of fiscal 2011 and $47.9 million, or 13.0% of sales, in the first six months of fiscal 2010, mainly reflecting an $18.7 million increase in avionics systems, a $10.2 million increase in control systems, and a nominal decrease in communication systems. Avionics systems benefited from increased gross profit, partially offset by a $4.5 million increase in research, development and engineering expense and a $3.9 million increase in selling, general and administrative expense. Control systems benefited from increased gross profit and a $1.1 million recovery of non-recurring engineering upon settlement with the customer. Additionally, the prior-year period was impacted by $1.3 million in lease termination costs resulting from a facilities move. Control systems current year earnings were impacted by increased selling, general and administrative expenses of $2.0 million and increased research, development and engineering expense of $1.8 million. The decrease in communication systems earnings mainly reflected decreased gross profit from lower sales of certain communication systems for audio and data products for severe battlefield environments, resulting in a $3.1 million decrease in communication systems earnings, partially offset by incremental income from the Eclipse acquisition.

Sensors & Systems segment earnings were $22.6 million, or 13.9% of sales, for the first six months of fiscal 2011 compared with $12.4 million, or 8.5% of sales, for the first six months of fiscal 2010, reflecting a $6.4 million increase in advanced sensors and a $3.8 million increase in power systems. Both advanced sensors and power systems benefited from increased gross profit. Power systems earnings were also enhanced by higher customer funding of non-recurring engineering expenses related to the A400M program.

Advanced Materials segment earnings were $38.2 million, or 17.4% of sales, for the first six months of fiscal 2011 compared with $25.9 million, or 12.7% of sales, for the first six months of fiscal 2010, primarily reflecting a $10.8 million increase in engineering materials and a $0.8 million increase in defense technologies. Defense technologies principally reflected a $5.7 million increase in combustible ordnance gross profit, a $2.5 million decrease in countermeasures gross profit, a $1.3 million increase in severance costs due to a reduction in force at our non-U.S. flare countermeasure unit, increased research, engineering and development of $1.5 million, and a $0.6 million insurance recovery in the prior-year period. The increase in engineering materials mainly reflected increased gross profit for elastomer and insulation materials.

On December 30, 2010, we acquired all of the outstanding capital stock of Eclipse Electronic Systems, Inc. (Eclipse). Eclipse is a designer and manufacturer of embedded communications intercept receivers for signal intelligence applications. Eclipse is included in our Avionics & Controls segment.

Interest expense for the first six months of fiscal 2011 was $18.1 million compared with $15.3 million for the first six months of fiscal 2010, reflecting higher borrowings during most of the first six months of fiscal 2011.

The income tax rate was 20.4% compared with 23.4% for the first six months of fiscal 2011 and 2010, respectively. In the first six months of fiscal 2011, we recognized $3.3 million of discrete tax benefits principally due to the retroactive extension of the U.S. federal research and experimentation credits and release of a valuation allowance related to a net operating loss of an acquired subsidiary. In the first six months of fiscal 2010, we recognized $0.5 million of discrete tax expense mainly due to tax law changes in France. The income tax rate differed from the statutory rate in the first six months of fiscal 2011 and 2010, as both years benefited from various tax credits and certain foreign interest expense deductions.

 

33


It is reasonably possible that within the next 12 months $5.9 million of benefits associated with research and experimentation tax credits, capital and operating losses that are currently unrecognized could be recognized as a result of settlement of examinations and/or the expiration of a statute of limitations.

To the extent that sales are transacted in a currency other than the functional currency of the operating unit, we are subject to foreign currency fluctuation risk. We use forward contracts to hedge our foreign currency exchange risk. To the extent that these hedges qualify under U.S. GAAP, the amount of gain or loss is deferred in Accumulated Other Comprehensive Income (AOCI) until the related sale occurs. Also, we are subject to foreign currency gains or losses from embedded derivatives on backlog denominated in a currency other than the functional currency of our operating companies or its customer. Gains and losses on forward contracts, embedded derivatives, and revaluation of assets and liabilities denominated in currency other than the functional currency of the Company for the six month period ended April 29, 2011, and April 30, 2010, are as follows:

 

(In thousands)    Six Months Ended  
     April 29,
2011
    April 30,
2010
 

Forward foreign currency contracts – gain (loss)

   $ 2,785      $ (1,197

Forward foreign currency contracts – reclassified from AOCI

     5,713        4,326   

Embedded derivatives – (loss)

     (1,143     (1,202

Revaluation of monetary assets/liabilities – (loss)

     (4,534     (256
                

Total

   $                 2,821      $                 1,671   
                

New orders for the first six months of fiscal 2011 were $862.1 million compared with $733.5 million for the same period in 2010. The increase in new orders principally reflects increased orders for Avionics & Controls of $47.5 million, including the acquired backlog of Eclipse, Sensors & Systems of $55.9 million, and Advanced Materials of $25.2 million. The increase in Avionics & Controls orders reflects a $20.2 million decrease in avionics systems, reflecting a delay in orders for cockpit integration for military transport aircraft. The increase in Advanced Materials orders reflects an increase in orders for engineered materials, partially offset by a $57.7 million decrease in orders for defense technologies, due to the timing of receiving orders. Backlog was $1.2 billion at April 29, 2011, compared to $1.1 billion at April 30, 2010, and at October 29, 2010.

Liquidity and Capital Resources

Cash and cash equivalents at April 29, 2011, totaled $391.5 million, a decrease of $30.6 million from October 29, 2010. Net working capital decreased to $664.9 million at April 29, 2011, from $752.2 million at October 29, 2010. Sources and uses of cash flows from operating activities principally consist of cash received from the sale of products and cash payments for material, labor and operating expenses. Cash flows provided by operating activities were $89.4 million and $71.7 million in the first six months of fiscal 2011 and 2010, respectively, reflecting increased income from continuing operations and increased cash receipts, partially offset by increased payments for inventory and income taxes.

Cash flows used by investing activities were $142.5 million and $26.3 million in the first six months of fiscal 2011 and 2010, respectively. Cash flows used by investing activities in the first six months of fiscal 2011 primarily reflected cash paid for acquisitions of $103.5 million and capital expenditures of $26.3 million. Cash flows used by investing activities in the first six months of fiscal 2010 primarily reflected cash paid for capital expenditures.

Cash flows provided by financing activities were $6.6 million and $5.9 million in the first six months of fiscal 2011 and 2010, respectively. Cash flows provided by financing activities in the first six months of fiscal 2011 primarily reflected proceeds from our new credit facility of $110.0 million and repayment of our U.S. Term Loan for $118.8 million.

On December 30, 2010, we acquired all of the outstanding capital stock of Eclipse for approximately $120.0 million, plus the change in net assets from July 31, 2010, to the actual closing balance sheet. The $120.0 million purchase price also includes cash of $14.0 million in contingent consideration, which was deposited in an escrow account and will be paid to the seller if certain performance objectives are met over a three-year period. The estimated fair value of the contingent consideration is $13.4 million. Eclipse is a designer and manufacturer of embedded communications intercept receivers for signal intelligence applications.

 

34


Capital expenditures, consisting of machinery, equipment and computers, are anticipated to be approximately $55 million to $65 million during fiscal 2011, compared to $53.7 million expended in fiscal 2010. Capital expenditures for fiscal 2010 included $8.1 million under capitalized lease obligations for our newly constructed avionics controls facility and facility expansion noted above.

In March 2011, we entered into a secured credit facility for $460 million made available through a group of banks. The credit facility is secured by substantially all of our assets and interest is based on standard inter-bank offering rates. The spread will range from LIBOR plus 1.5% to LIBOR plus 2.25% depending on the leverage ratios at the time the funds are drawn. At April 29, 2011, we had $110.0 million outstanding under the secured credit facility at an initial interest rate of LIBOR plus 1.75% or 1.97%.

Total debt at April 29, 2011, was $607.5 million and consisted of $168.5 million of Senior Notes due in 2017, $250.0 million of Senior Notes due in 2020, $44.4 million under capital lease obligations and $144.6 million in borrowings under our secured credit facility and various foreign currency debt agreements and other debt agreements.

On May 23, 2011, we entered into a share purchase agreement to acquire Souriau for 483.0 million euros (approximately $715 million), plus certain transaction cost of the seller, which we expect to finance through a combination of U.S. and non-U.S. cash, a draw on our existing secured credit facility, and a new international credit facility. In accordance with the terms of the agreement, subsequent to period end, we deposited $350 million in escrow as security for the purchase price. Souriau is a leading global supplier of highly engineered connectors for harsh environments serving aerospace, defense & space, power generation & rail, and industrial equipment markets. The transaction is expected to close in mid-July 2011, subject to customary closing procedures, including regulatory approvals.

Our non-U.S. subsidiaries had $283.0 million in cash and cash equivalents at April 29, 2011. Cash and cash equivalents at our U.S. parent and subsidiaries aggregated $108.5 million at April 29, 2011, and cash flow from these operations is sufficient to fund working capital, capital expenditures, acquisitions and debt repayments of our domestic operations. The earnings of our non-U.S. subsidiaries are considered to be indefinitely invested, and accordingly, no provision for federal income taxes has been made on accumulated earnings of foreign subsidiaries. The amount of unrecognized deferred income tax liability for temporary differences related to investments in foreign subsidiaries is not practical to determine because of the complexities regarding the calculation of unremitted earnings and potential for tax credits.

We believe cash on hand and funds generated from operations are adequate to service operating cash requirements and capital expenditures through the next twelve months.

Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases you can identify forward-looking statements by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risk factors set forth in “Forward-Looking Statements” and “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 29, 2010, that may cause our or the industry’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. You should not place undue reliance on these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements. Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this report are made only as of the date hereof. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments.

 

35


Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes in our exposure to market risk during the first six months of fiscal 2011. A discussion of our exposure to market risk is provided in the Company’s Annual Report on Form 10-K for the fiscal year ended October 29, 2010.

 

Item 4. Controls and Procedures

Our principal executive and financial officers evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of April 29, 2011. Based upon that evaluation, they concluded as of April 29, 2011, that our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within time periods specified in Securities and Exchange Commission rules and forms. In addition, our principal executive and financial officers concluded as of April 29, 2011, that our disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

During the time period covered by this report, there were no significant changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

On March 30, 2011, the California Attorney General’s office filed a complaint against Kirkhill-TA, a subsidiary included in our Advanced Materials segment, with the Superior Court of California, Orange County, on behalf of California and the Santa Ana Regional Water Quality Control Board (Board) regarding the discharge of industrial waste water from its Brea, California, facility into Fullerton Creek and Craig Lake.

Prior to receipt of the complaint, management cooperated with the Board to address the discharge. Based upon our investigation, the discharge of waste water was unintentional, and was corrected as soon as the Board notified the Company of the discharge. At the request of the Board, we engaged an environmental engineering company to perform certain tests of the affected water. Concentrations of pollutants were below regulatory requirements. Additionally, our facility does not have a history of discharges of industrial waste. Accordingly, prior to receiving the complaint, management did not believe any significant remediation or penalties were likely.

The California water code authorizes courts to impose penalties based on the number of days in which the violation occurred and the volume of discharge. Utilizing this statutory formula and based on our calculations of the number of days that a violation occurred and the discharge volumes, management believes that the penalty imposed could be up to $1.8 million, although the Board has alleged that violations occurred over a longer period.

Based upon our review of the complaint, established statutory penalty factors, California’s Water Quality Enforcement Policy, a review of similar cases and the facts noted above, management believes that the possible range of penalties to be paid would be from low to high six figures. The amount of the estimated liability the Company recorded in the second quarter of fiscal 2011 as a contingent liability is not material.

From time to time we are involved in legal proceedings arising in the ordinary course of business. We believe that adequate reserves for these liabilities have been made and that there is no litigation pending that could have a material adverse effect on our results of operations and financial condition.

 

36


Item 6. Exhibits

 

 10.1      Share Purchase Agreement between FCPR Sagard, FCPR Sagard Connecteurs, Individuals, The Mezzanine Sellers as Sellers and Esterline Technologies Corporation as Buyer, dated May 23, 2011.
 11      Schedule setting forth computation of basic and diluted earnings per common share for the three and six month periods ended April 29, 2011, and April 30, 2010.
 31.1      Certification of Chief Executive Officer.
 31.2      Certification of Chief Financial Officer.
 32.1      Certification (of R. Bradley Lawrence) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 32.2      Certification (of Robert D. George) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.XML      XBRL Instance Document
101.XSD      XBRL Taxonomy Extension Schema
101.CAL      XBRL Taxonomy Extension Calculation Linkbase
101.LAB      XBRL Taxonomy Extension Label Linkbase
101.PRE      XBRL Taxonomy Extension Presentation Linkbase

 

37


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 hereunto duly authorized.

 

        ESTERLINE TECHNOLOGIES CORPORATION    
   

    (Registrant)

 
Dated:  June 3, 2011     By:      

/s/ Robert D. George

 
      Robert D. George  
      Vice President, Chief Financial Officer,  
      Secretary and Treasurer  
      (Principal Financial Officer)  

 

38