SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the nine months ended July 31, 2002 Commission file number 0-13880
ENGINEERED SUPPORT SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Missouri 43-1313242
(State of Incorporation) (IRS Employer Identification Number)
201 Evans Lane, St. Louis, Missouri 63121
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (314) 553-4000
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
The number of shares of the Registrant's common stock, $.01 par
value, outstanding at August 31, 2002 was 10,526,677.
1
ENGINEERED SUPPORT SYSTEMS, INC.
INDEX
Page
----
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of July 31, 2002 and
October 31, 2001.......................................................................... 3
Condensed Consolidated Statements of Income for the three and nine
months ended July 31, 2002 and 2001....................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended July 31, 2002 and 2001.............................................................. 5
Notes to Condensed Consolidated Financial Statements...................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 17
Part II - Other Information
Items 1-6.................................................................................... 18
Signatures......................................................................................... 19
Exhibits........................................................................................... 21
2
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
July 31 October 31
2002 2001
----------- ----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 2,015 $ 1,015
Accounts receivable 40,007 31,430
Contracts in process and inventories 46,680 49,391
Deferred income taxes 14,248 19,901
Other current assets 2,790 2,316
Current assets of discontinued operations 8,274 7,184
--------- ---------
Total Current Assets 114,014 111,237
Property, plant and equipment, less accumulated
depreciation of $24,533 and $21,007 42,966 44,072
Goodwill 103,447 71,427
Other assets 20,516 5,099
Long-term assets of discontinued operations 2,417 8,600
--------- ---------
Total Assets $ 283,360 $ 240,435
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable $ 22,000 $ 700
Current maturities of long-term debt 21,009 21,038
Accounts payable 20,700 20,396
Other current liabilities 31,263 25,778
Current liabilities of discontinued operations 3,092 2,060
--------- ---------
Total Current Liabilities 98,064 69,972
Long-term debt 26,251 42,000
Deferred income taxes 1,142
Other liabilities 24,241 17,929
Shareholders' Equity
Common stock, par value $.01 per share; 30,000
shares authorized; 11,721 and 11,672 shares issued 117 117
Additional paid-in capital 94,515 85,682
Retained earnings 76,922 61,823
Accumulated other comprehensive loss (5,035) (5,554)
--------- ---------
166,519 142,068
Treasury stock at cost, 1,210 and 1,467 shares (31,715) (32,676)
--------- ---------
134,804 109,392
--------- ---------
Total Liabilities and Shareholders' Equity $ 283,360 $ 240,435
========= =========
See notes to condensed consolidated financial statements.
3
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
Three Months Ended Nine Months Ended
July 31 July 31
----------------------------- --------------------------
2002 2001 2002 2001
------------ ---------- ---------- ----------
Net revenues $ 106,599 $ 91,332 $ 289,665 $ 272,012
Cost of revenues (80,808) (72,509) (222,200) (217,128)
----------- ---------- ---------- ----------
Gross profit 25,791 18,823 67,465 54,884
Selling, general and administrative expense (12,142) (9,796) (31,841) (28,600)
Restructuring expense (1,441) (1,441)
----------- ---------- ---------- ----------
Operating income from continuing operations 12,208 9,027 34,183 26,284
Interest expense (867) (1,337) (2,489) (5,110)
Interest income 21 48 106 173
Gain on sale of assets 1 5 4 9
----------- ---------- ---------- ----------
Income from continuing operations 11,363 7,743 31,804 21,356
Income tax provision (4,430) (3,097) (12,405) (8,542)
----------- ---------- ---------- ----------
Net income from continuing operations 6,933 4,646 19,399 12,814
Discontinued operations:
Income (loss) from discontinued operations,
net of income tax 97 166 (427) 283
Estimated loss on disposal,
net of income tax (352) (3,497)
----------- ---------- ---------- ----------
Net income $ 6,678 $ 4,812 $ 15,475 $ 13,097
=========== ========== ========== ==========
Basic earnings per share:
Continuing operations $ 0.66 $ 0.50 $ 1.88 $ 1.39
Discontinued operations:
Income (loss) 0.01 0.02 (0.04) 0.03
Estimated loss on disposal (0.03) (0.34)
----------- ---------- ---------- ----------
Total $ 0.64 $ 0.52 $ 1.50 $ 1.42
=========== ========== ========== ==========
Diluted earnings per share:
Continuing operations $ 0.64 $ 0.44 $ 1.81 $ 1.28
Discontinued operations:
Income (loss) 0.01 0.02 (0.04) 0.03
Estimated loss on disposal (0.03) (0.33)
----------- ---------- ---------- ----------
Total $ 0.62 $ 0.46 $ 1.44 $ 1.31
=========== ========== ========== ==========
See notes to condensed consolidated financial statements.
4
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(UNAUDITED)
Nine Months Ended
July 31
----------------------------
2002 2001
---------- ----------
From operating activities:
Net income from continuing operations $ 19,399 $ 12,814
Depreciation and amortization 4,758 7,211
Gain on sale of assets (4) (9)
---------- ----------
Cash provided before changes in operating
assets and liabilities 24,153 20,016
Net decrease in non-cash current assets 17,032 7,668
Net decrease in non-cash current liabilities (3,507) (3,340)
(Increase) decrease in other assets 796 (577)
---------- ----------
Net cash provided by continuing operations 38,474 23,767
Net cash provided by (used in) discontinued operations (37) 2,734
---------- ----------
Net cash provided by operating activities 38,437 26,501
---------- ----------
From investing activities:
Purchase of Radian, net of cash acquired (39,992)
Purchase of UPSI, net of cash acquired (5,497)
Additions to property, plant and equipment (1,976) (1,381)
Proceeds from sale of property, plant and equipment 4 11
---------- ----------
Net cash used in continuing operations (47,461) (1,370)
Net cash provided by (used in) discontinued operations 1 (162)
---------- ----------
Net cash used in investing activities (47,460) (1,532)
---------- ----------
From financing activities:
Net payments under line-of-credit agreement 21,300 (16,300)
Payments of long-term debt (15,779) (12,770)
Purchase of treasury stock (92)
Exercise of stock options 4,875 6,041
Cash dividends (373) (324)
---------- ----------
Net cash provided by (used in) continuing operations 10,023 (23,445)
Net cash used in discontinued operations
---------- ----------
Net cash provided by (used in) financing activities 10,023 (23,445)
---------- ----------
Net increase in cash and cash equivalents 1,000 1,524
Cash and cash equivalents at beginning of period 1,015 719
---------- ----------
Cash and cash equivalents at end of period $ 2,015 $ 2,243
========== ==========
See notes to condensed consolidated financial statements.
5
ENGINEERED SUPPORT SYSTEMS, INC
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(in thousands, except per share amounts)
JULY 31, 2002
NOTE A - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have
been prepared by the Company without audit. In the opinion of management,
all adjustments (including normal recurring accruals) considered necessary
for a fair presentation have been included. Operating results for the three
and nine month periods ended July 31, 2002 are not necessarily indicative of
the results to be expected for the entire fiscal year.
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles for interim financial statements and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's annual report to shareholders
for the year ended October 31, 2001.
NOTE B - EARNINGS PER SHARE
Average diluted common shares outstanding include common stock
equivalents, which represent common stock options as computed based on the
treasury stock method.
Basic earnings per share for the three months ended July 31, 2002
and 2001 is based on average basic common shares outstanding of 10,472 and
9,360, respectively. Diluted earnings per share for the three months ended
July 31, 2002 and 2001 is based on average diluted common shares outstanding
of 10,810 and 10,500, respectively.
Basic earnings per share for the nine months ended July 31, 2002
and 2001 is based on average basic common shares outstanding of 10,340 and
9,226, respectively. Diluted earnings per share for the nine months ended
July 31, 2002 and 2001 is based on average diluted common shares outstanding
of 10,710 and 9,991, respectively.
NOTE C - ACQUISITIONS
On May 10, 2002, the Company acquired all of the outstanding common
stock of Radian, Inc., a supplier of engineering, logistics support and
systems integration services to the U.S. Department of Defense. The purchase
price was approximately $42 million, which included consideration of $2.0
million in the common stock of the Company. The purchase price is net of
$0.4 million of cash acquired. The fair value of the assets acquired,
including goodwill of $26.6 million and customer-related intangibles of
$15.3 million, was $58.3 million and liabilities assumed totaled $16.3
million. (Acquired customer-related intangibles, net of
6
$0.7 million of amortization to date, are included on the July 31, 2002
Condensed Consolidated Balance Sheet as Other Assets.) The cash portion of
the purchase price was financed with available cash resources and short-term
borrowings under the Company's revolving credit facility.
On June 27, 2002, the Company acquired all of the outstanding
common stock of Universal Power Systems, Inc. (UPSI), a provider of
uninterruptible power supply systems for the U.S. Department of Defense,
intelligence agencies and commercial customers. The purchase price was
approximately $5.5 million plus certain contingent cash consideration based
upon UPSI's net revenue levels through October 31, 2003. The fair value of
the assets acquired, including goodwill of $5.4 million, was $6.6 million
and liabilities assumed totaled $1.1 million. The purchased price was
financed with short-term borrowings under the Company's revolving credit
facility.
Both companies will be included in the Light Military Support
Equipment segment.
NOTE D - OTHER COMPREHENSIVE INCOME (LOSS)
The Company's other comprehensive income (loss) for the three
months ended July 31, 2002 and 2001 was $181 and $(102), respectively, and
for the nine months ended July 31, 2002 and 2001 was $519 and $(718),
respectively. The components of other comprehensive income (loss) include a
minimum pension liability adjustment and an adjustment to the fair value of
derivatives.
NOTE E - DISCONTINUED OPERATIONS
During the second quarter of 2002, the Company formally adopted a
plan to dispose of Engineered Specialty Plastics, Inc. (ESP), a wholly-owned
subsidiary representing the entirety of the Plastic Products business
segment. The Company expects that the disposition through sale of ESP will
be completed by the end of fiscal 2002. In conjunction with this plan, the
Company has recorded an estimated loss on disposal of discontinued
operations of $3.5 million as of July 31, 2002 to reduce the carrying value
of ESP's net assets to their estimated fair value less estimated selling
costs. Accordingly, the Company has reported the results of operations of
ESP as discontinued operations for the three and nine months ended July 31,
2002 and 2001 in the Condensed Consolidated Statements of Income. All assets
and liabilities associated with ESP have been reclassified as assets and
liabilities of discontinued operations on the July 31, 2002 and October 31,
2001 Condensed Consolidated Balance Sheets. Certain information with respect
to the discontinued operations of ESP for the three and nine month periods
ended July 31, 2002 and 2001 is as follows:
Three Months Ended Nine Months Ended
July 31 July 31
--------------------- --------------------
2002 2001 2002 2001
------- ------- -------- --------
Net revenues $ 4,904 $ 7,876 $ 11,001 $ 18,356
======= ======= ======== ========
Income (loss) from operations, net of income tax $ 97 $ 166 $ (427) $ 283
Estimated loss on disposal, net of income tax (352) (3,497)
------- ------- -------- --------
Income (loss) on discontinued operations, net of income tax $ (255) $ 166 $ (3,924) $ 283
======= ======= ======== ========
7
Certain information with respect to the assets and liabilities of ESP is
summarized as follows:
July 31 October 31
2002 2001
------- ----------
Accounts receivable $ 3,362 $ 2,598
Inventories 4,854 4,586
Other assets 58
Property, plant and equipment 2,417 8,600
------- ----------
Assets of Discontinued Operations $10,691 $ 15,784
======= ==========
Accounts payable $ 2,575 $ 1,544
Accrued expenses and other liabilities 517 516
------- ----------
Liabilities of Discontinued Operations $ 3,092 $ 2,060
======= ==========
NOTE F - OPERATIONAL RESTRUCTURING
During the quarter ended July 31, 2002, the Company announced a
restructuring plan to improve both plant utilization and long-term
profitability. Under the plan, the Company's Blue Ash, Ohio and Olivette,
Missouri manufacturing locations will be closed during the year ending
October 31, 2003 with related production efforts being relocated to other
existing Company facilities. EITF No. 94-3 provides specific requirements as
to the appropriate recognition of restructuring costs associated with
employee termination benefits and other exit costs. Employee termination
costs are recognized when benefit arrangements are communicated to affected
employees in sufficient detail to enable the employees to determine the
amount of benefits to be received upon termination. Other costs resulting
from the restructuring plan that are not associated with or that do not
benefit activities that will be continued are recognized at the date of
commitment to the plan subject to certain conditions. For the cost to be
accrued, the cost must not be associated with or incurred to generate
revenues after the commitment date, and it must be either incremental to
other costs incurred prior to the commitment date, or represent amounts
under a contractual obligation that existed prior to the commitment date
that will either continue after the plan is completed with no economic
benefit or which will result in a penalty to cancel the obligation. Other
costs directly related to the restructuring plan which are not eligible for
recognition at the commitment date, such as relocation and other integration
costs, are expensed as incurred.
The plan will involve terminating 113 employees. During the quarter
ended July 31, 2002, the Company recorded the following amounts in the
income statement in connection with the restructuring plan.
Severance and related benefits $ 789
Pension curtailment costs 310
Loss on asset disposal 189
Other 153
--------
Total $ 1,441
========
8
NOTE G - CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories of certain of the Company's
operating subsidiaries (Systems & Electronics Inc., Engineered Air Systems,
Inc., Keco Industries, Inc. and Engineered Electric Company and Radian,
Inc.) represent accumulated contract costs, estimated earnings thereon based
upon the percentage of completion method and contract inventories reduced by
the contract value of delivered items. Inventories of Engineered Coil
Company and Universal Power Systems, Inc. are valued at the lower of cost or
market using the first-in, first-out method. Contracts in process and
inventories are comprised of the following:
July 31, 2002 October 31, 2001
--------------- ------------------
Raw materials $ 4,222 $ 3,137
Work-in-process 1,942 1,448
Inventories substantially applicable to
government contracts in process, less
Progress payments of $47,779 and
$59,069 40,516 44,806
----------- -----------
$ 46,680 $ 49,391
=========== ===========
NOTE H - GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board (FASB)
issued Statements of Financial Accounting Standards No. 141 (SFAS 141),
"Business Combinations," and No. 142 (SFAS 142), "Goodwill and Other
Intangible Assets." Under SFAS 142, goodwill and other intangible assets
deemed to have indefinite lives will no longer be amortized but will be
subject to periodic impairment tests. All other intangible assets will be
amortized over their useful lives. In addition, SFAS 141 eliminates the
pooling-of-interests method of accounting for business combinations.
The Company adopted SFAS 141 and SFAS 142 as of November 1, 2001.
The Company has identified its reporting units to be its operating
subsidiaries with the exception of Systems & Electronics Inc., which
comprises two reporting units: the Heavy Military Support Equipment and the
Electronics and Automation Systems operating segments of the Company. The
carrying value of each reporting unit as of November 1, 2001 was determined
by assigning assets and liabilities, including existing goodwill and
intangible assets, to the reporting units. Upon adoption of SFAS 142,
amortization of goodwill ceased. The Company has performed a transitional
goodwill impairment assessment which resulted in no impairment of goodwill.
An annual impairment test will be performed in the fourth quarter of each
fiscal year.
The following pro forma information reconciles reported net income
from continuing operations for the three and nine months ended July 31, 2001
to adjusted net income from continuing operations, which reflects the
adoption of SFAS 142:
9
Three Months Ended Nine Months Ended
July 31 July 31
-------------------- ----------------------
2002 2001 2002 2001
------- ------- -------- -------
Reported net income from continuing operations $ 6,933 $ 4,646 $ 19,399 $12,814
Goodwill amortization, net of tax benefit 478 1,412
------- ------- -------- -------
Adjusted net income from continuing operations $ 6,933 $ 5,124 $ 19,399 $14,226
======= ======= ======== =======
Basic earnings per share:
Reported net income from continuing operations $ 0.66 $ 0.50 $ 1.88 $ 1.39
Goodwill amortization, net of tax benefit 0.05 0.15
------- ------- -------- -------
Adjusted net income from continuing operations $ 0.66 $ 0.55 $ 1.88 $ 1.54
======= ======= ======== =======
Diluted earnings per share:
Reported net income from continuing operations $ 0.64 $ 0.44 $ 1.81 $ 1.28
Goodwill amortization, net of tax benefit 0.05 0.14
------- ------- -------- -------
Adjusted net income from continuing operations $ 0.64 $ 0.49 $ 1.81 $ 1.42
======= ======= ======== =======
Discontinued operations had no goodwill amortization in the three and nine
month periods ended July 31, 2001.
The following disclosure presents certain information on the
Company's acquired intangible assets as of July 31, 2002 and October 31,
2001. All acquired intangible assets are being amortized over their
estimated useful lives, as indicated below, with no estimated residual
values. These amounts are included in Other Assets in the Condensed
Consolidated Balance Sheets.
Weighted Average
Amortization Gross Accumulated Net
Period Amount Amortization Amount
---------------- ------- ------------ -------
Customer-related intangibles:
July 31, 2002 5.4 years $15,300 $ 710 $14,590
October 31, 2001 0 0 0
The amortization expense related to acquired intangible assets was
$710 for the three and nine month periods ended July 31, 2002. There was no
amortization expense related to acquired intangible assets for the three and
nine month periods ended July 31, 2001.
NOTE I - DERIVATIVES AND HEDGING ACTIVITY
During the nine months ended July 31, 2002, the Company's
derivative contracts consisted only of interest rate swaps used by the
Company to convert a portion of its variable rate long-term debt to fixed
rates. At July 31, 2002, the Company recorded a liability of $599 related to
the fair value of those interest rate swap agreements, which are designated
as and
10
considered highly effective cash flow hedges of the Company's forecasted
variable rate interest payments. The entire corresponding loss, net of
income tax, is recorded in shareholders' equity as accumulated other
comprehensive loss.
NOTE J - SEGMENT INFORMATION
The Company operates in three segments: Light Military Support
Equipment, Heavy Military Support Equipment, and Electronics and Automation
Systems. Inter-segment revenues for the three and nine months ended July 31,
2002 and 2001, respectively, were not significant. Total assets by segment
as disclosed in the Company's annual report for the year ended October 31,
2001 have not changed materially since that date. Goodwill by segment as of
October 31, 2001 totaled $21,708 for Light Military Support Equipment,
$25,650 for Heavy Military Support Equipment and $24,069 for Electronics and
Automation Systems. Goodwill by segment as of July 31, 2002 totaled $53,728
for Light Military Support Equipment, $25,650 for Heavy Military Support
Equipment and $24,069 for Electronics and Automation Systems. In addition,
there have been no changes in either the basis of segmentation or the
measurement of segment income since October 31, 2001. Information by segment
is as follows:
Three Months Ended Nine Months Ended
July 31 July 31
------------------------ -------------------------
2002 2001 2002 2001
--------- ------- --------- ---------
Net revenues:
Light military support equipment $ 47,871 $38,900 $ 124,833 $ 114,022
Heavy military support equipment 32,790 31,762 98,235 95,417
Electronics and automation systems 25,938 20,670 66,597 62,573
--------- ------- --------- ---------
Total $ 106,599 $91,332 $ 289,665 $ 272,012
========= ======= ========= =========
Operating income from continuing operations:
Light military support equipment $ 2,079 $ 2,573 $ 11,779 $ 9,759
Heavy military support equipment 5,380 3,863 14,331 10,703
Electronics and automation systems 4,749 2,591 8,073 5,822
--------- ------- --------- ---------
12,208 9,027 34,183 26,284
Interest expense (867) (1,337) (2,489) (5,110)
Interest income 21 48 106 173
Gain on sale of assets 1 5 4 9
--------- ------- --------- ---------
Income from continuing operations
before income taxes $ 11,363 $ 7,743 $ 31,804 $ 21,356
========= ======= ========= =========
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES
Revenues on long-term contracts performed within the Company's
Light Military Support Equipment, Heavy Military Support Equipment and
Electronics and Automation Systems segments, substantially all of which are
with the U.S. Government, are recognized under the percentage of completion
method and include a proportion of the earnings that are expected to be
realized on the contract in the ratio that production measures, primarily
labor, incurred bear to the estimated production measures for the contract.
Earnings expectations are based upon estimates of contract values and costs
at completion. Contracts in process are reviewed on a periodic basis.
Adjustments to revenues and earnings are made in the current accounting
period based upon revisions in contract values and estimated costs at
completion. Provisions for estimated losses on contracts are recorded when
identified.
During the second quarter of 2002, the Company formally adopted a
plan to dispose of Engineered Specialty Plastics, Inc. (ESP), a wholly-owned
subsidiary representing the entirety of the Plastic Products business
segment. In conjunction with this plan, the Company recorded an estimated
loss on disposal to reduce the carrying value of ESP's net assets to their
estimated fair value less estimated selling costs. Accordingly, the Company
has reported the results of operations of ESP as discontinued operations for
the three and nine months ended July 31, 2002 and 2001 in the Condensed
Consolidated Statements of Income. Additionally, all depreciation on the
property, plant and equipment of ESP was suspended as of the end of the
second quarter of 2002.
During the third quarter of 2002, the Company announced a
restructuring plan to improve both plant utilization and long-term
profitability. Under the plan, the Company's Blue Ash, Ohio and Olivette,
Missouri manufacturing locations will be closed during the year ending
October 31, 2003 with related production efforts being relocated to other
existing Company facilities. EITF No. 94-3 provides specific requirements as
to the appropriate recognition of restructuring costs associated with
employee termination benefits and other exit costs. Employee termination
costs are recognized when benefit arrangements are communicated to affected
employees in sufficient detail to enable the employees to determine the
amount of benefits to be received upon termination. Other costs resulting
from the restructuring plan that are not associated with or that do not
benefit activities that will be continued are recognized at the date of
commitment to the plan subject to certain conditions. For the cost to be
accrued, the cost must not be associated with or incurred to generate
revenues after the commitment date, and it must be either incremental to
other costs incurred prior to the commitment date, or represent amounts
under a contractual obligation that existed prior to the commitment date
that will either continue after the plan is completed with no economic
benefit or which will result in a penalty to cancel the obligation. Other
costs directly related to the restructuring plan which are not eligible for
recognition at the commitment date, such as relocation and other integration
costs, are expensed as incurred.
12
The following analysis should be read in this context.
RESULTS OF OPERATIONS
Consolidated net revenues from continuing operations increased
$15.3 million, or 16.7%, to $106.6 million in the third quarter of 2002
compared to $91.3 million in the third quarter of 2001. The increase was
primarily the result of $13.7 million of net revenues from Radian, Inc.,
which was acquired May 10, 2002, and from Universal Power Systems, Inc.,
which was acquired June 27, 2002. Gross profit from continuing operations
for the three months ended July 31, 2002 increased $7.0 million, or 37.0%,
to $25.8 million (24.2% of consolidated net revenues) from $18.8 million
(20.6% of consolidated net revenues) in the comparable 2001 period. The
increase in gross profit was primarily a result of improved operating
performance in all three business segments. Selling, general and
administrative expense from continuing operations increased $2.3 million, or
23.9%, in the third quarter of 2002 to $12.1 million (11.4% of consolidated
net revenues) from $9.8 million (10.7% of consolidated net revenues) in the
third quarter of 2001. In addition, the Company recorded a restructuring
expense of $1.4 million in the third quarter of 2002 in conjunction with the
Company's adoption of a restructuring plan to close its Blue Ash, Ohio and
Olivette, Missouri manufacturing locations and to move related production
efforts to other existing Company facilities. As a result of the above,
operating income from continuing operations increased $3.2 million, or
35.2%, in the quarter ended July 31, 2002 to $12.2 million from $9.0 million
in the third quarter of 2001.
Consolidated net revenues from continuing operations increased
$17.7 million, or 6.5%, to $289.7 million in the nine months ended July 31,
2002 compared to $272.0 million in the first three quarters of 2001. As with
the third quarter results, the increase was primarily the result of $13.7
million of net revenues generated by the acquisitions of Radian, Inc. and
Universal Power Systems, Inc. Marginal increases in the Heavy Military
Support Equipment and Electronics and Automation Systems segments accounted
for the remainder of the increase in net revenues. Gross profit from
continuing operations for the nine months ended July 31, 2002 increased
$12.6 million, or 22.9%, to $67.5 million (23.3% of consolidated net
revenues) from $54.9 million (20.2% of consolidated net revenues) in the
comparable 2001 period. Selling, general and administrative expense from
continuing operations increased $3.2 million, or 11.3%, in the first three
quarters of 2002 to $31.8 million (11.0% of consolidated net revenues) from
$28.6 million (10.5% of consolidated net revenues) in the prior year. In
addition, the Company recorded a restructuring expense of $1.4 million, as
previously discussed. As a result of the above, operating income from
continuing operations increased $7.9 million, or 30.1%, in the nine months
ended July 31, 2002 to $34.2 million from $26.3 million in the first three
quarters of 2001.
LIGHT MILITARY SUPPORT EQUIPMENT. Net revenues for the Light
Military Support Equipment segment increased by $9.0 million, or 23.1%, to
$47.9 million in the third quarter of 2002 from $38.9 million in the third
quarter of 2001 due to the addition of Radian, Inc. and Universal Power
Systems, Inc. to the segment. For the nine months ended July 31, 2002, net
revenues for the segment increased by $10.8 million, or 9.5%%, to $124.8
million from $114.0 million in 2001. Gross profit for the segment increased
by $3.2 million, or 49.9%, in the third
13
quarter of 2002 to $9.6 million (20.1% of segment net revenues) from $6.4
million (16.5% of segment net revenues) in the third quarter of 2001.
Likewise, gross profit for the segment increased by $5.9 million, or 27.8%,
in the nine months ended July 31, 2002 to $27.1 million (21.7% of segment
net revenues) from $21.2 million (18.6% of segment net revenues) in 2001.
Significant gross margin improvements resulted from certain key Light
Military Support Equipment programs, including Tactical Quiet Generators,
and from acquisitions made in the quarter. Because of the $1.4 million
restructuring expense, income from operations decreased by $0.5 million, or
20.7%, in the third quarter of 2002 to $2.1 million from $2.6 million in the
third quarter of 2001, and increased by $1.9 million, or 19.6%, in the first
nine months of 2002 to $11.8 million from $9.8 million in 2001, as a result
of the gross profit gains noted above and due to the elimination of goodwill
amortization, which totaled $0.3 million in the third quarter of 2001 and
$0.8 million in the first nine months of 2001, in accordance with the
adoption of SFAS 142.
HEAVY MILITARY SUPPORT EQUIPMENT. Net revenues for the Heavy
Military Support Equipment segment increased by $1.0 million, or 3.2%, to
$32.8 million in the third quarter of 2002 from $31.8 million in the third
quarter of 2001. For the nine months ended July 31, 2002, net revenues for
the segment increased by $2.8 million, or 3.0%, to $98.2 million from $95.4
million in 2001. Gross profit for the segment increased by $1.3 million, or
17.3%, in the third quarter of 2002 to $8.8 million (26.7% of segment net
revenues) from $7.5 million (23.5% of segment net revenues) in the third
quarter of 2001. For the nine months ended July 31, 2002, gross profit for
the segment increased by $4.0 million, or 19.0%, to $25.1 million (25.6% of
segment net revenues) from $21.1 million (22.1% of segment net revenues) in
the first nine months of 2001. Significant gross margin improvements for the
three and nine month periods ended July 31, 2002 were realized on the Tunner
60-K Aircraft Cargo Loader/Transporter and on the M1000 Heavy Equipment
Transporter. Income from operations increased by $1.5 million, or 39.3%, in
the third quarter of 2002 to $5.4 million from $3.9 million in the third
quarter of 2001, and increased by $3.6 million, or 33.9%, in the first nine
months of 2002 to $14.3 million from $10.7 million in 2001, as a result of
the gross profit gains noted above and due to the elimination of goodwill
amortization, which totaled $0.3 million in the third quarter of 2001 and
$1.0 million in the first nine months of 2001, in accordance with the
adoption of SFAS 142.
ELECTRONICS AND AUTOMATION SYSTEMS. Net revenues for the
Electronics and Automation Systems segment increased by $5.3 million, or
25.5%, to $25.9 million in the third quarter of 2002 from $20.7 million in
the third quarter of 2001. For the nine months ended July 31, 2002, net
revenues for the segment increased by $4.0 million, or 6.4%, to $66.6
million from $62.6 million in the first nine months of 2001. Net revenues
were higher for the segment primarily due to additional work performed on
the Striker RSTA program for the U.S. Army and on certain ground-based and
airborne radar systems programs, partially offset by reduced HPOC and U.S.
Postal Service revenues. Gross profit for the segment increased by $2.5
million, or 50.2%, in the third quarter of 2002 to $7.4 million (28.5% of
segment net revenues) from $4.9 million (23.8% of segment net revenues) in
the third quarter of 2001. For the nine months ended July 31, 2002, gross
profit for the segment increased by $2.7 million, or 21.2%, to $15.3 million
(22.9% of segment net revenues) from $12.6 million (20.1% of segment net
revenues) in the first nine months of 2001. Income from operations increased
by $2.2 million,
14
or 83.3%, in the third quarter of 2002 to $4.7 million from $2.6 million in
the third quarter of 2001, and increased by $2.3 million, or 38.7%, in the
nine months ended July 31, 2002 to $8.1 million from $5.8 million in the
first nine months of 2001, as a result of the above and due to the
elimination of goodwill amortization, which totaled $0.2 million in the
third quarter of 2001 and $0.6 million in the first nine months of 2001, in
accordance with the adoption of SFAS 142.
Net interest expense decreased by $0.4 million to $0.8 million in
the third quarter of 2002 and by $2.6 million to $2.4 million in the nine
months ended July 31, 2002. These decreases were primarily a result of lower
outstanding borrowings on the Company's revolving and term-debt credit
facilities, as well as the impact of lower interest rates. The effective
income tax rate was 39.0% for the three and nine months ended July 31, 2002
as compared to 40.0% for the three and nine months ended July 31, 2001. The
reduction in the Company's effective income tax rate resulted from the
implementation of various tax planning strategies in fiscal 2001. As a
result of the foregoing, net income from continuing operations increased
49.2% to $6.9 million (6.5% of consolidated net revenues) in the quarter
ended July 31, 2002 as compared to $4.6 million (5.1% of consolidated net
revenues) in the third quarter of 2001. For the nine months ended July 31,
2002, net income from continuing operations increased 51.4% to $19.4 million
(6.7% of consolidated net revenues) from $12.8 million (4.7% of consolidated
net revenues) for the first nine months of 2001.
During the second quarter of 2002, the Company formally adopted a
plan to dispose of ESP. In conjunction with this plan, the Company has
recorded an estimated loss, net of income tax, of $3.5 million as of July
31, 2002 related to the disposal of ESP. In addition, the Company realized
income (loss) from ESP operations, net of income tax, of $0.1 million and
$0.2 million in the third quarter of 2002 and 2001, respectively, and of
$(0.4) million and $0.3 million in the nine months ended July 31, 2002 and
2001, respectively.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB)
issued Statements of Financial Accounting Standards No. 141 (SFAS 141),
"Business Combinations", and No. 142 (SFAS 142), "Goodwill and Other
Intangible Assets". Under SFAS 142, goodwill and other intangible assets
deemed to have indefinite lives will no longer be amortized, but will be
subject to periodic impairment tests. All other intangible assets will be
amortized over their useful lives. In addition, SFAS 141 eliminates the
pooling-of-interests method of accounting for business combinations. The
Company adopted SFAS 141 and SFAS 142 as of November 1, 2001 and had no
impairment of goodwill as a result of its transitional assessment.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS 144 addresses the
financial accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS 121. The Company adopted SFAS 144
effective November 1, 2001. In the quarter ended April 30, 2002, the Company
accounted for the planned disposition through sale of ESP as discontinued
operations in accordance with SFAS 144.
In June 2002, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS 146 provides direction for
accounting and disclosure regarding specific costs related to an exit or
disposal activity. These include, but are not limited to, costs to terminate
a contract that is not a capital lease, costs to consolidate facilities or
relocate employees, and certain termination benefits provided to employees
that are involuntarily terminated under the terms of a one-time benefit
arrangement. The Company is required to adopt SFAS 146 for any disposal
activities initiated after December 31, 2002. The Company is currently
reviewing the impact of the adoption of SFAS 146 on its financial
statements.
15
LIQUIDITY AND CAPITAL RESOURCES
In conjunction with the acquisition of SEI in September 1999, the
Company entered into a new credit agreement to provide a $90.0 million term
loan and a $55.0 million revolving credit facility. The Company's primary
sources of short-term financing are from cost reimbursements under contracts
with the U.S. government via receipt of progress payments, billings for
delivered products and borrowings under the revolving line of credit. As of
July 31, 2002, the Company had $22.0 million in borrowings against the
revolving line of credit, remaining availability under the line of credit
of $30.7 million and a cash balance of $2.0 million.
At July 31, 2002, the Company's working capital and ratio of
current assets to current liabilities were $16.0 million and 1.16 to 1 as
compared with $41.3 million and 1.59 to 1 at October 31, 2001. This decrease
is a result of the use of available cash resources and short-term borrowings
in the execution of the acquisitions of Radian, Inc. and Universal Power
Systems, Inc. The Company generated cash flow from continuing operations of
$38.5 million in the nine months ended July 31, 2002 as compared to $23.8
million in the first nine months of 2001. Investment in property, plant and
equipment totaled $2.0 million and $1.4 million for the first nine months of
2002 and 2001, respectively. The Company anticipates that capital
expenditures in 2002 should not exceed $5.0 million. Management believes
that cash flow generated from operations, together with the available line
of credit, will provide the necessary resources to meet the needs of the
Company in the foreseeable future.
BUSINESS AND MARKET CONSIDERATIONS
Approximately 95% of consolidated net revenues from continuing
operations for the nine months ended July 31, 2002 were directly or
indirectly derived from defense orders by the U.S. government and its
agencies. As of July 31, 2002, the Company's funded backlog of orders
totaled $365.4 million, with related customer options of an additional
$883.5 million.
Management continues to pursue potential acquisitions, primarily of
those companies providing strategic consolidation within the defense
industry.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this report includes certain
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which are intended to be covered by the
safe harbors created thereby. The forward-looking statements involve certain
risks and uncertainties, including, but not limited to acquisitions,
additional financing requirements, the decision of any of the Company's key
customers (including the U.S. government) to reduce or terminate orders with
the Company, cutbacks in defense spending by the U.S. government and
increased competition in the Company's markets, which could cause the
Company's actual results to differ materially from those projected in, or
inferred by, the forward-looking statements.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
During the period ended July 31, 2002, the Company's derivative
contracts consisted only of interest rate swaps used by the Company to
convert a portion of its variable rate long-term debt to fixed rates. At
July 31, 2002, the Company recorded a liability of $0.6 million related to
the fair value of those interest rate swap agreements, which are designated
as and considered highly effective cash flow hedges of the Company's
forecasted variable rate interest payments. The entire corresponding loss,
net of income tax, is recorded in shareholder's equity as accumulated other
comprehensive loss.
17
PART II
OTHER INFORMATION
Items 1-5 Not applicable.
Item 6 Exhibits and Reports on Form 8-K.
(a) Exhibits
11. Statement Re: Computation of Earnings Per Share
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Form 8-K was filed on May 29, 2002 related to the
acquisition by the Company on May 10, 2002 of Radian, Inc.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENGINEERED SUPPORT SYSTEMS, INC.
Date: September 16, 2002 By: /s/ Michael F. Shanahan, Sr.
---------------------- ----------------------------
Michael F. Shanahan, Sr.
Chairman of the Board and
Chief Executive Officer
Date: September 16, 2002 By: /s/ Gary C. Gerhardt
---------------------- ----------------------------
Gary C. Gerhardt
Vice Chairman - Administration
and Chief Financial Officer
19
CHIEF EXECUTIVE OFFICER CERTIFICATION
I, Michael F. Shanahan, Sr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Engineered
Support Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
Date: September 16, 2002
--------------------
By: /s/ Michael F. Shanahan, Sr.
----------------------------
Michael F. Shanahan, Sr.
Chairman of the Board and
Chief Executive Officer
CHIEF FINANCIAL OFFICER CERTIFICATION
I, Gary C. Gerhardt, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Engineered
Support Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
Date: September 16, 2002
--------------------
By: /s/ Gary C. Gerhardt
-----------------------------
Gary C. Gerhardt
Vice Chairman - Administration
and Chief Financial Officer
20