(1) UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements have been
prepared in accordance with instructions to Form 10-Q and, therefore, do not
include all information and footnotes normally included in consolidated
financial statements prepared in conformity with accounting principles generally
accepted in the United States. They should be read in conjunction with the
consolidated financial statements and notes thereto of EDO Corporation and
Subsidiaries (the "Company") for the year ended December 31, 2006 filed by the
Company on Form 10-K with the Securities and Exchange Commission.
The accompanying consolidated financial statements include all adjustments
(consisting of normal recurring adjustments) that management considers necessary
for a fair presentation of its consolidated financial position and results of
operations for the interim periods presented. The results of operations for the
interim periods are not necessarily indicative of the results that may be
expected for the entire year.
Certain reclassifications have been made to prior year's presentations to
conform to current year's presentations.
(2) PROPOSED SALE OF THE COMPANY
On September 16, 2007, the Company entered into a definitive Agreement and
Plan of Merger (the "Merger Agreement") with ITT Corporation, an Indiana
corporation ("ITT"), and Donatello Acquisition Corp., a New York corporation and
a wholly-owned subsidiary of ITT ("Merger Sub"). The Merger Agreement provides
that, upon the terms and subject to the conditions set forth in the Merger
Agreement, Merger Sub will merge with and into the Company (the "Merger"), with
the Company continuing as a surviving corporation and a wholly-owned subsidiary
of ITT. Pursuant to the Merger Agreement, each common share of the Company
issued and outstanding immediately prior to the effective time of the Merger
will be converted into the right to receive $56.00 in cash, without interest, on
the terms set forth in the Merger Agreement. The Merger is expected to close in
early 2008. Consummation of the Merger is subject to customary conditions,
including approval by the shareholders of the Company, expiration or termination
of the applicable Hart-Scott-Rodino waiting period and receipt of certain other
regulatory approvals, the absence of any Material Adverse Effect (as defined in
the Merger Agreement) with respect to the Company's business, and certain other
customary closing conditions. The Merger Agreement also contains certain
termination rights for both the Company and ITT upon termination of the Merger
Agreement under specified circumstances, a termination initiated by EDO could
require the Company to pay ITT a termination fee of $47.0 million and reimburse
ITT for up to $3.0 million in transaction-related expenses.
(3) ACQUISITIONS
On September 15, 2006, the Company acquired all of the stock of Impact
Science and Technology Inc., (IST) for $123.7 million, consisting of a cash
payment of $106.4 million and a $17.3 million promissory note to be paid over
three years. In addition, certain key IST employees received retention payments
in the form of 405,103 restricted EDO Common Shares valued at $9 million. We
also incurred $0.6 million of transaction costs. Also, there was a subsequent
determination of the final purchase price, resulting in a $9.2 million accrual
at December 31, 2006 and payment in January 2007. IST is a privately-held
company providing signals intelligence (SIGINT) systems and analysis support to
the intelligence community, and advanced countermeasures and electronic-attack
systems to the U.S. Department of Defense (DoD) and other government agencies.
The acquisition strengthened our position in specialized communication products
and expanded the Company's business in the intelligence community. The acquired
company became part of the Company's Electronic Systems and Communications
segment. The excess of the purchase price over the net assets acquired related
to IST is not deductible for income tax purposes. During the first quarter of
2007, the Company finalized its valuation for the allocation of the purchase
price and acquired intangible assets. The final allocation did not change
amortization expense materially from the amounts reported as of December 31,
2006.
On September 6, 2006, the Company acquired all of the stock of CAS Inc.,
(CAS) for $178.1 million, consisting of a cash payment of $173.2 million and
214,574 EDO common shares valued at $4.9 million. We also incurred $1.6 million
in transaction costs. In addition, there was a subsequent determination of the
final purchase price, resulting in a $0.1 million payment in the first quarter
of 2007. During the three months ended June 30, 2007, the Company recorded an
adjustment to increase goodwill by $0.2 million related to the resolution of
contingencies at the acquisition date. CAS is a privately-held company providing
engineering services, logistics support, and weapon-systems analysis to the DoD.
This acquisition has strengthened and expanded our range of professional and
engineering services. The acquired company became part of the Company's
Engineered Systems and Services segment. The excess of the purchase price over
the net assets acquired recorded as goodwill and other intangible assets in the
amount of $168.5 million are deductible for income tax purposes over 15 years.
During the first quarter of 2007, the Company finalized its valuation for the
allocation of the purchase price and acquired intangible assets. The final
allocation did not change amortization expense materially from the amounts
reported as of December 31, 2006.
7
(4) STOCK-BASED COMPENSATION
The Company has granted non-qualified stock options and restricted shares
under the 2002 Long-Term Incentive Plan (LTIP), the 2002 Non-Employee Director
Stock Option Plan (NEDSOP) and in connection with the CAS and IST acquisitions.
These plans are described in Note 12 to the consolidated financial statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2006.
The Company records stock-based compensation in accordance with the
provisions of Statement of Financial Accounting Standards No. 123 (Revised
10/04), "Share-Based Payment" ("FAS 123R"). The Company did not grant any
options during the three months ended September 29, 2007. During the nine months
ended September 29, 2007, the Company granted 65,000 options to its Board of
Directors that were fully vested upon grant. The stock-based compensation
expense related to stock option plans included in operating expenses for the
three months ended September 29, 2007 and September 30, 2006 were $0 and $37
thousand, respectively, and $1.0 million and $0.8 million for the nine months
ended September 29, 2007 and September 30, 2006, respectively. Tax benefits
related to this expense for the three months ended September 29, 2007 and
September 30, 2006 were $0 and $15 thousand, respectively. Tax benefits related
to this expense for the nine months ended September 29, 2007 and September 30,
2006 were $0.4 million and $0.3 million, respectively. The net effect of stock
based compensation expense related to stock option plans resulted in a reduction
in net income of $0 and $22 thousand for the three months ended September 29,
2007 and September 30, 2006, respectively. The net effect of stock based
compensation expense related to stock option plans resulted in a reduction in
net income of $0.6 million and $0.5 million for the nine months ended September
29, 2007 and September 30, 2006, respectively.
The significant weighted average assumptions used for the valuation of the
Company's stock options using the Black-Scholes option pricing model for the
nine months ended September 29, 2007 were as follows: expected dividend yield of
1%, risk free interest rate of 5.09%, expected volatility of 33.91% and an
expected option life of 7 years.
As of September 29, 2007, there was no future compensation expense related
to non-vested stock options.
The Company did not issue any stock-settled appreciation right options
(SSAR) for the three months ended September 29, 2007. During the nine months
ended September 29, 2007, the Company issued 243,775 SSAR to select employees.
Stock based compensation expense recognized for stock-settled appreciation
rights awards for the three and nine months ended September 29, 2007 was $0.2
million and $0.5 million, respectively. There were no SSARs granted during the
three and nine months ended September 30, 2006.
The significant weighted average assumptions relating to the valuation of
the Company's SSARs using the Black-Scholes option pricing model for the nine
months ended September 29, 2007: expected dividend yield of 1%, risk free
interest rate of 4.60%, expected volatility of 34.79% and an expected option
life of 5 years.
As of September 29, 2007, there was $2.1 million of unrecognized future
compensation expense related to non-vested SSARs not yet recognized in the
consolidated statement of earnings.
Stock-based compensation expense recognized for restricted/performance
share awards for the three and nine months ended September 29, 2007 was $1.3
million and $4.6 million, respectively, compared to $0.7 million and $2.3
million for the three and nine months ended September 30, 2006, respectively.
The unrecognized compensation cost related to the unvested
restricted/performance shares at September 29, 2007 was approximately $9.9
million and will be recognized over a weighted-average period of 1.8 years.
(5) BUSINESS COMBINATIONS AND GOODWILL AND OTHER INTANGIBLE ASSETS
Statement of Financial Accounting Standard ("SFAS") No. 141, "Business
Combinations," requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. SFAS No. 141 also includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets arising from business combinations completed after June 30,
2001. SFAS No. 142, "Goodwill and Other Intangible Assets," prohibits the
amortization of goodwill and other intangible assets with indefinite useful
lives and requires that those assets be reviewed for impairment at least
annually. Other intangible assets with definite lives are amortized over their
estimated useful lives.
8
In accordance with SFAS No. 142, goodwill must be tested at least annually
for impairment at the reporting unit level. If an indication of impairment
exists, the Company is required to determine if such goodwill's implied fair
value is less than the carrying value in order to determine the amount, if any,
of the impairment loss required to be recorded. Impairment indicators include,
among other conditions, cash flow deficits, an historic or anticipated decline
in revenue or operating profits, adverse legal or regulatory developments,
accumulation of costs significantly in excess of amounts originally expected to
acquire the asset and/or a material decrease in the fair value of some or all of
the assets. The Company performs the required impairment tests of goodwill as of
October 1, each year. The changes in the carrying amount of goodwill by segment
during the nine months ended September 29, 2007 were as follows:
ENGINEERED ELECTRONIC
SYSTEMS SYSTEMS AND
AND COMMUNICATIONS
SERVICES TOTAL
--------------- ---------------- ----------------
(IN THOUSANDS)
Balance as of January 1, 2007 $ 186,460 $ 199,466 $ 385,926
Purchase price adjustments 333 2 335
Reclassification from other intangibles based on
final purchase price allocation 7,410 1,208 8,618
--------------- ---------------- ----------------
Balance as of September 29, 2007 $ 194,203 $ 200,676 $ 394,879
=============== ================ ================
Summarized below are other intangible assets:
SEPTEMBER 29, DECEMBER 31, LIFE
2007 2006
---------------- ---------------- ---------------
(IN THOUSANDS)
Other intangible assets subject to amortization:
Capitalized non-compete agreements related to
acquisitions $ 2,738 $ 2,738 1-5 years
Purchased technologies related to acquisitions 27,213 28,083 8-25 years
Customer contracts and relationships related to
acquisitions 81,422 87,186 6-20 years
Trade name related to acquisitions 5,498 8,464 3-10 years
---------------- ----------------
116,871 126,471
Less accumulated amortization (30,808) (23,095)
---------------- ----------------
$ 86,063 $ 103,376
Other intangible assets not subject to
amortization:
Trade name related to acquisitions 400 400
---------------- ----------------
$ 86,463 $ 103,776
================ ================
|
The amortization expense for the three months ended September 29, 2007 and
September 30, 2006 amounted to $2.6 million and $1.7 million, respectively. The
amortization expense for the nine months ended September 29, 2007 and September
30, 2006 amounted to $7.7 million and $5.1 million, respectively. Total
remaining amortization expense for 2007, 2008, 2009, 2010, 2011 and thereafter
related to these other intangible assets is estimated to be $2.6 million, $9.6
million, $9.4 million, $8.7 million, $7.0 million and $48.8 million,
respectively.
For the three and nine months ended September 30, 2006, the Company
incurred an impairment charge of approximately $1.5 million related to certain
other intangible assets associated with the Company's rugged computer product
line. As sales and orders were not materializing to expected levels, the Company
tested for impairment and it was determined that the future undiscounted cash
flows associated with these assets were insufficient to recover their carrying
values. These assets were written down to zero, which was determined on the
basis of future discounted cash flows.
(6) INVENTORIES
Inventories are summarized by major classification as follows:
SEPTEMBER 29, DECEMBER 31,
2007 2006
------------- -------------
(IN THOUSANDS)
Raw material and supplies $ 34,890 $ 14,881
Work-in-process 47,804 52,742
Finished goods 39,143 15,045
Less: Unliquidated progress payments (3,113) (26,413)
------------- -------------
$ 118,724 $ 56,255
============= =============
|
9
(7) INCOME TAXES
The Company adopted FASB Interpretation 48 ("FIN 48"), Accounting for
Uncertainty in Income Taxes, at the beginning of fiscal year 2007. FIN 48
creates a single model to address accounting for uncertainty in tax positions.
FIN 48 clarifies the accounting for income taxes, by prescribing a minimum
recognition threshold a tax position is required to meet before being recognized
in the financial statements. FIN 48 also provides guidance on de-recognition,
measurement, classification, interest and penalties, accounting in interim
periods, disclosure and transition. As a result of the implementation, the
Company recognized a $2.5 million net increase to reserves for uncertain tax
positions. This increase was accounted for as an adjustment to the beginning
balance of retained earnings on the balance sheet.
As of September 29, 2007, the Company had approximately $12.5 million of
total gross unrecognized tax benefits. Of this total, approximately $5.1 million
represents the amount of net unrecognized tax benefits that, if recognized,
would favorably affect the effective income tax rate in any future periods. For
the three months ended September 29, 2007, the gross unrecognized tax benefit
decreased by $2.5 million. This decrease resulted from favorable settlements
with taxing authorities and the expiration of the statute of limitations net of
increases related to unrecognized tax benefits resulting from tax positions
taken during the current period. The net favorable effect to the effective
income tax rate was $2.3 million. For the nine months ended September 29, 2007,
the gross unrecognized tax benefit decreased by $3.0 million. The net favorable
effect to the effective income tax rate was $2.6 million.
The Company is subject to U.S. federal income tax as well as income tax of
multiple state jurisdictions. The Company has substantially concluded all U.S.
federal income tax matters for years through 2003, except as it relates to the
Company's amended return for 2002 claiming a federal research and development
credit which is currently under audit. Substantially all material state and
local matters have been concluded for years through 2003. In addition, the
Company is subject to income tax in various foreign jurisdictions. The Company
has substantially concluded all material tax matters in foreign jurisdictions
for years through 2004.
While it is reasonably possible that a reduction in the unrecognized tax
benefit may occur, based on audit process protocol from the various taxing
authorities, it is not possible to estimate the impact of any amount of such
changes that may occur within the next twelve months.
The Company's continuing practice is to recognize interest and/or penalties
related to income tax matters in income tax expense. The Company had $4.0
million accrued for interest and penalties as of September 29, 2007. For the
three months ended September 29, 2007, the gross interest and penalties
decreased by $2.2 million as a result of favorable settlements with taxing
authorities and the expiration of the statue of limitations net of additional
accrued interest and penalties. For the three months ended September 29, 2007,
the net favorable effect to the effective income tax rate was $1.5 million. For
the nine months ended September 29, 2007, the gross interest and penalties
decreased by $1.6 million. For the nine months ended September 29, 2007, the net
favorable effect to the effective income tax rate was $1.1 million.
(8) EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
---------------------------------------------------------------------------
SEPTEMBER 29, SEPTEMBER 30, SEPTEMBER 29, SEPTEMBER 30,
2007 2006 2007 2006
--------------- ---------------- ---------------- ----------------
(IN THOUSANDS)
Numerator:
Earnings for basic calculation $ 11,198 $ 2,065 $ 22,898 $ 7,397
Effect of dilutive securities:
Convertible Notes 1,187 -- 3,562 --
--------------- ---------------- ---------------- ----------------
Numerator for diluted calculation $ 12,385 $ 2,065 $ 26,460 $ 7,397
=============== ================ ================ ================
Denominator:
Denominator for basic calculation 18,771 18,205 18,657 18,105
Effect of dilutive securities:
Stock based awards 781 393 635 458
Convertible Notes 5,886 -- 5,886 --
--------------- ---------------- ---------------- ----------------
Denominator for diluted calculation 25,438 18,598 25,178 18,563
=============== ================ ================ ================
|
10
The assumed conversion of the Convertible Notes was dilutive for the three
and nine months ended September 29, 2007 and anti-dilutive for the three months
and nine months ended September 30, 2006.
The following table summarizes, for each year presented, the number of
shares excluded from the computation of diluted earnings per share, as their
effect upon potential issuance was anti-dilutive:
FOR THE NINE MONTHS ENDED
SEPTEMBER 29, SEPTEMBER 30,
2007 2006
------------- -------------
(IN THOUSANDS)
Convertible Subordinated Notes -- 5,886
Unexercised stock options -- 399
------------- -------------
-- 6,285
============= =============
|
(9) DEFINED BENEFIT PLAN
The Company maintains a qualified noncontributory defined benefit pension
plan covering approximately twenty five percent of its employees. In November
2002, the plan was amended whereby benefits accrued under the plan were frozen
as of December 31, 2002. The Company's funding policy is to make annual
contributions to the extent such contributions are actuarially determined and
tax deductible. For the three and nine months ended September 29, 2007, the
Company contributed $9.2 million to the plan. For the three and nine months
ended September 30, 2006, the Company contributed $6.0 million to the plan.
For the three months ended September 29, 2007 and September 30, 2006, the
Company recorded pension expense of $0.6 million and $1.2 million, respectively.
For the nine months ended September 29, 2007 and September 30, 2006, the Company
recorded pension expense of $2.2 million and $3.6 million, respectively.
Summarized below are the components of the expense for each period presented:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
------------------------------ -----------------------------
SEPTEMBER 29, SEPTEMBER 30, SEPTEMBER 29, SEPTEMBER 30,
2007 2006 2007 2006
------------- ------------- -----------------------------
(IN THOUSANDS)
Interest cost $ 3,078 $ 3,038 $ 9,234 $ 9,115
Expected return on plan assets (3,544) (3,209) (10,230) (9,628)
Amortization of unrecognized net loss 1,076 1,365 3,229 4,095
------------- ------------- ------------- -------------
$ 610 $ 1,194 $ 2,233 $ 3,582
============= ============= ============= =============
|
(10) EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
The Company sponsors an employee stock ownership plan (ESOP) which provides
retirement benefits to substantially all employees. The cost basis of the
unearned/unallocated shares was initially recorded as a reduction to
shareholders' equity. Compensation expense is recorded based on the market value
of the Company's common shares as they are committed-to-be-released quarterly,
as payments are made under the related indirect loan. The difference between the
market value and the cost basis of the shares was recorded as additional paid-in
capital. Dividends on unallocated shares are recorded as compensation expense.
(11) COMPREHENSIVE INCOME
As of September 29, 2007, accumulated other comprehensive loss included in
shareholders' equity in the accompanying consolidated balance sheets primarily
represents additional minimum liabilities on benefit plans and the effect of
adopting FASB Statement No. 158 (SFAS 158), Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans, on December 31, 2006.
Comprehensive income for the three months ended September 29, 2007 was $11.3
million compared to comprehensive income for the three months ended September
30, 2006 of $2.1 million. Comprehensive income for the nine months ended
September 29, 2007 was $23.0 million compared to comprehensive income for the
nine months ended September 30, 2006 of $7.8 million.
11
(12) BUSINESS SEGMENTS
The Company determines its operating segments based upon an analysis of its
products and services, production processes, types of customers, economic
characteristics and the related regulatory environment, which is consistent with
how management operates the Company. The Company's operations are reflected in
two business segments: Engineered Systems and Services and Electronic Systems
and Communications. The Engineered Systems and Services segment addresses the
Integrated Systems and Structures, Undersea Warfare, and Professional Services
markets. Primary products include aircraft armament systems, integrated
composite structures, mine countermeasure systems, sonar systems and components,
and flight line products. This segment also includes a wide range of
professional and engineering services. The Electronic Systems and Communications
segment includes products that serve the Electronic Warfare, C4 (Command,
Control, Communications and Computers) products and systems, and Intelligence
and Information Warfare markets. Primary products include electronic force
protection systems, interference cancellation technology, airborne electronic
warfare systems, electronic intelligence (ELINT) and electronic support measure
(ESM) systems, intelligence and information warfare systems, C4 products and
services, and antenna products.
The following table sets forth net sales, operating earnings, and
earnings before income taxes for each period presented.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
------------------------------ -----------------------------
SEPTEMBER 29, SEPTEMBER 30, SEPTEMBER 29, SEPTEMBER 30,
2007 2006 2007 2006
------------- ------------- ------------- -------------
(IN THOUSANDS)
Net Sales:
Engineered Systems & Services..........$ 117,974 $ 79,409 $ 353,954 $ 204,462
Electronic Systems & Communications.... 138,808 104,984 404,264 252,038
------------- ------------- ------------- -------------
$ 256,782 $ 184,393 $ 758,218 $ 456,500
------------- ------------- ------------- -------------
Operating earnings:
Engineered Systems & Services.......... 7,335 646 25,902 4,069
Electronic Systems & Communications.... 8,779 1,758 21,168 4,068
------------- ------------- ------------- -------------
16,114 2,404 47,070 8,137
Net interest expense................... (4,837) (2,528) (16,262) (5,067)
Other, net............................. (37) 113 (49) (144)
------------- ------------- ------------- -------------
Earnings (loss) before income taxes....$ 11,240 $ (11) $ 30,759 $ 2,926
============= ============= ============= =============
|
(13) RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement No. 157, "Fair Value Measurements" (SFAS 157). SFAS 157 defines fair
value, establishes a framework for using fair value to measure assets and
liabilities, and expands disclosure requirements about fair value measurements.
SFAS 157 is effective for fiscal years beginning after November 15, 2007, and
early application is permitted. SFAS 157 becomes effective for the Company on
January 1, 2008. The Company does not believe SFAS 157 will have a material
impact on our results from operations or financial position.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an Amendment of FASB
Statement No. 115." SFAS No. 159 permits entities to choose to measure eligible
items at fair value at specified election dates and report unrealized gains and
losses on items for which the fair value option has been elected in earnings at
each subsequent reporting date. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007. The Company is currently evaluating the
impact of adopting this Statement; however, the adoption is not expected to have
an effect on EDO's consolidated results of operations or financial position.
(14) GUARANTOR AND NON-GUARANTOR SUBSIDIARIES
The Company may, from time to time, issue indebtedness, a condition of
which would be the guarantee of this indebtedness by certain of its
subsidiaries. Presented below is condensed consolidating financial information
for the Company and the contemplated subsidiary guarantors and non-guarantors at
September 29, 2007 and December 31, 2006 and for the three and nine month
periods ended September 29, 2007 and September 30, 2006. Each contemplated
subsidiary guarantor is 100% owned, directly or indirectly, by the Company. Any
guarantees that may be issued will be full and unconditional, as well as joint
and several. In connection with the Company's credit facility, the Company
cannot declare or pay any dividend on its outstanding common stock in an amount
that exceeds fifty percent of its consolidated net income for the immediately
preceding four quarters.
12
EDO CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
SEPTEMBER 29, 2007
(IN THOUSANDS)
(UNAUDITED)
EDO
Corporation
Parent Subsidiary
Company Only Guarantors Non-Guarantors Eliminations Consolidated
----------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,409 $ (3641) $ 5,650 $ -- $ 3,418
Accounts receivable, net 48,747 179,886 4,483 -- 233,116
Inventories 12,203 102,367 4,154 -- 118,724
Deferred income tax asset, net 12,159 -- -- -- 12,159
Prepayments and other 5,100 4,020 322 -- 9,442
----------------------------------------------------------------------------
Total current assets 79,618 282,632 14,609 -- 376,859
Investment in subsidiaries 658,009 -- -- (658,009) --
Property, plant and equipment, net 29,298 27,814 3,387 -- 60,499
Goodwill -- 386,169 8,710 -- 394,879
Other intangible assets, net -- 77,854 8,609 -- 86,463
Deferred income tax asset, net 16,295 -- -- -- 16,295
Other assets 16,209 2,326 -- -- 18,535
----------------------------------------------------------------------------
$ 799,429 776,795 35,315 (658,009) 953,530
----------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 22,203 $ 118,477 $ 6,142 $ -- $ 146,822
Contract advances and deposits 20,398 28,608 -- -- 49,006
Postretirement benefits obligation,
short-term 2,512 -- -- -- 2,512
Short-term borrowing under revolver 144,000 -- -- -- 144,000
Notes payable 7,766 -- -- -- 7,766
----------------------------------------------------------------------------
Total current liabilities 196,879 147,085 6,142 -- 350,106
Income taxes payable 14,333 -- -- -- 14,333
Notes payable, long-term 8,766 -- -- -- 8,766
Deferred income taxes (438) -- 438 -- --
Long-term debt 201,250 -- -- -- 201,250
Postretirement benefits obligation,
long-term 67,232 -- -- -- 67,232
Environmental obligation 1,187 -- -- -- 1,187
Other long-term liabilities 29 -- -- -- 29
Intercompany accounts -- 464,808 20,667 (485,475) --
Shareholders' equity:
Preferred shares -- -- -- -- --
Common shares 21,452 98 -- (98) 21,452
Additional paid-in capital 191,134 60,152 6,418 (66,570) 191,134
Retained earnings 148,131 108,703 1,214 (109,917) 148,131
Accumulated other comprehensive (loss)
income, net of income tax benefit (35,524) -- 436 -- (35,088)
Treasury shares (2,444) (4,051) -- 4,051 (2,444)
Unearned ESOP shares (12,558) -- -- -- (12,558)
----------------------------------------------------------------------------
Total shareholders' equity 310,191 164,902 8,068 (172,534) 310,627
----------------------------------------------------------------------------
$ 799,429 $ 776,795 $ 35,315 $ (658,009) $ 953,530
============================================================================
|
13
EDO CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF
EARNINGS FOR THE THREE MONTHS ENDED
SEPTEMBER 29, 2007
(IN THOUSANDS)
(UNAUDITED)
EDO
Corporation
Parent
Company Subsidiary
Only Guarantors Non-Guarantors Eliminations Consolidated
-----------------------------------------------------------------------
Net Sales $ 55,284 $ 198,059 $ 8,676 $ (5,237) $ 256,782
-----------------------------------------------------------------------
Costs and expenses:
Cost of sales 44,220 155,648 5,378 (5,237) 200,009
Selling, general and administrative 4,833 28,910 1,998 -- 35,741
Research and development 932 1,922 53 -- 2,907
Acquisition-related costs -- 2,011 -- -- 2,011
-----------------------------------------------------------------------
49,985 188,491 7,429 (5,237) 240,668
Operating earnings 5,299 9,568 1,247 -- 16,114
Non-operating income (expense):
Interest income 54 60 66 -- 180
Interest expense (5,010) -- (7) -- (5,017)
Other, net (82) 45 -- -- (37)
-----------------------------------------------------------------------
(5,038) 105 59 -- (4,874)
Earnings before income taxes 261 9,673 1,306 -- 11,240
Income tax benefit (expense) 5,160 (4,785) (417) -- (42)
-----------------------------------------------------------------------
Earnings after income taxes 5,421 4,888 889 -- 11,198
Equity in undistributed earnings of
subsidiaries 5,777 -- -- (5,777) --
-----------------------------------------------------------------------
Net earnings $ 11,198 $ 4,888 $ 889 $ (5,777) $ 11,198
=======================================================================
EDO CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF
EARNINGS FOR THE NINE MONTHS ENDED
SEPTEMBER 29, 2007
(IN THOUSANDS)
(UNAUDITED)
EDO
Corporation
Parent Subsidiary
Company Only Guarantors Non-Guarantors Eliminations Consolidated
------------------------------------------------------------------------
Net Sales $ 166,772 $ 576,227 $ 24,651 $ (9,432) $ 758,218
------------------------------------------------------------------------
Costs and expenses:
Cost of sales 132,874 452,412 16,475 (9,432) 592,329
Selling, general and administrative 13,619 85,948 5,501 -- 105,068
Research and development 2,231 5,032 174 -- 7,437
Acquisition-related costs -- 6,314 -- -- 6,314
------------------------------------------------------------------------
148,724 549,706 22,150 (9,432) 711,148
Operating earnings 18,048 26,521 2,501 -- 47,070
Non-operating income (expense):
Interest income 173 184 174 -- 531
Interest expense (16,748) (38) (7) -- (16,793)
Other, net (245) 126 70 -- (49)
------------------------------------------------------------------------
(16,820) 272 237 -- (16,311)
Earnings before income taxes 1,228 26,793 2,738 -- 30,759
Income tax benefit (expense) 5,549 (12,392) (1,018) -- (7,861)
------------------------------------------------------------------------
Earnings after income taxes 6,777 14,401 1,720 -- 22,898
Equity in undistributed earnings of
subsidiaries 16,121 -- -- (16,121) --
------------------------------------------------------------------------
Net earnings $ 22,898 $ 14,401 $ 1,720 $ (16,121) $ 22,898
========================================================================
|
14
EDO CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED
SEPTEMBER 29, 2007
(IN THOUSANDS)
(UNAUDITED)
EDO
Corporation
Parent Subsidiary
Company Only Guarantors Non-GuarantorsEliminations Consolidated
----------------------------------------------------------------------
OPERATING ACTIVITIES:
Earnings from operations $ 22,898 $ 14,401 $ 1,720 $ (16,121) $ 22,898
Adjustments to earnings to arrive at cash (used)
provided by operations:
Depreciation 3,915 6,153 626 -- 10,694
Amortization -- 7,140 573 -- 7,713
Bad debt expense 7 47 -- -- 54
Deferred tax provision 880 -- -- -- 880
Loss on sale of property, plant and equipment 8 154 -- -- 162
Long-term Incentive Plan compensation expense 5,184 -- -- -- 5,184
Stock option compensation expense 970 -- -- -- 970
Employee Stock Ownership Plan compensation expense 4,209 -- -- -- 4,209
Dividends on unallocated Employee Stock Ownership
Plan shares 156 -- -- -- 156
Common shares issued for directors' fees 159 -- -- -- 159
Changes in operating assets and liabilities,
excluding effects of acquisitions:
Equity in earnings of subsidiaries (16,121) -- -- 16,121 --
Intercompany 39,402 (38,818) (584) -- --
Accounts receivable (513) 32,258 383 -- 32,128
Inventories (1,387) (60,347) (735) -- (62,469)
Prepayments and other assets 13,400 1,060 (16) -- 14,444
Accounts payable, accrued liabilities and other (30,369) 35,006 1,606 -- 6,243
Contribution to defined benefit pension plan (9,200) -- -- -- (9,200)
Contract advances and deposits 6,817 (2,134) -- -- 4,683
----------------------------------------------------------------------
Cash (used) provided by operations 40,415 (5,080) 3,573 -- 38,908
----------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchase of property, plant and equipment (5,745) (6,149) (352) -- (12,246)
Cash paid for acquisitions, net of cash acquired (9,327) -- -- -- (9,327)
----------------------------------------------------------------------
Cash used by investing activities (15,072) (6,149) (352) -- (21,573)
----------------------------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from exercise of stock options 3,029 -- -- -- 3,029
Excess income tax benefit from stock options and
Long-term Incentive Plan 1,408 -- -- -- 1,408
Short-term borrowings under revolver 80,000 -- -- -- 80,000
Repayment of revolving debt (116,000) -- -- -- (116,000)
Payment of short-term notes (5,767) -- -- -- (5,767)
Payment of common share cash dividends (1,909) -- -- -- (1,909)
----------------------------------------------------------------------
Cash used by financing activities (39,239) -- -- -- (39,239)
----------------------------------------------------------------------
Net (decrease) increase in cash and cash
equivalents (13,896) (11,229) 3,221 -- (21,904)
Cash and cash equivalents at beginning of period 15,305 7,588 2,429 -- 25,322
----------------------------------------------------------------------
Cash and cash equivalents at end of period $ 1,409 $ (3,641) $ 5,650 $ -- $ 3,418
======================================================================
|
15
EDO CORPORATION
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2006
(IN THOUSANDS)
EDO
Corporation
Parent Subsidiary
Company Only Guarantors Non-Guarantors Eliminations Consolidated
----------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,305 $ 7,588 $ 2,429 -- $ 25,322
Accounts receivable, net 48,241 212,191 4,866 -- 265,298
Inventories 10,816 42,020 3,419 -- 56,255
Deferred income tax asset, net 12,160 -- -- -- 12,160
Prepayments and other 10,312 3,064 306 -- 13,682
----------------------------------------------------------------------------
Total current assets 96,834 264,863 11,020 -- 372,717
Investment in subsidiaries 678,997 -- -- (678,997) --
Property, plant and equipment, net 27,476 27,974 3,659 -- 59,109
Goodwill -- 377,216 8,710 -- 385,926
Other intangible assets, net -- 94,594 9,182 -- 103,776
Deferred income tax asset, net 8,291 -- -- -- 8,291
Other assets 17,387 2,616 -- -- 20,003
----------------------------------------------------------------------------
$ 828,985 $ 767,263 $ 32,571 $ (678,997) $ 949,822
----------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 52,769 $ 84,685 $ 4,660 -- $ 142,114
Contract advances and deposits 13,581 30,742 -- -- 44,323
Postretirement benefits obligation, short-term 1,794 -- -- -- 1,794
Short-term borrowing under revolver 180,000 -- -- -- 180,000
Notes payable 7,766 -- -- -- 7,766
----------------------------------------------------------------------------
Total current liabilities 255,910 115,427 4,660 -- 375,997
Income taxes payable 4,154 -- -- -- 4,154
Notes payable 14,533 -- -- -- 14,533
Deferred income tax (427) -- 427 -- --
Long-term debt 201,250 -- -- -- 201,250
Postretirement benefits obligation 77,734 -- -- -- 77,734
Environmental obligation 1,198 -- -- -- 1,198
Other long-term liabilities 40 -- -- -- 40
Inter-company accounts -- 501,335 21,249 (522,584) --
Shareholders' equity:
Preferred shares -- -- -- -- --
Common shares 21,177 98 -- (98) 21,177
Additional paid-in capital 177,117 60,403 6,418 (66,821) 177,117
Retained earnings 129,444 94,052 (506) (93,546) 129,444
Accumulated other comprehensive loss, net of
income tax benefit (37,642) -- 323 -- (37,319)
Treasury shares (1,966) (4,052) -- 4,052 (1,966)
Unearned Employee Stock Ownership Plan shares (13,537) -- -- -- (13,537)
----------------------------------------------------------------------------
Total shareholders' equity 274,593 150,501 6,235 (156,413) 274,916
----------------------------------------------------------------------------
$ 828,985 $ 767,263 $ 32,571 $ (678,997) $ 949,822
============================================================================
|
16
EDO CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF
EARNINGS FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2006
(IN THOUSANDS)
(UNAUDITED)
EDO
Corporation
Parent
Company Subsidiary
Only Guarantors Non-Guarantors Eliminations Consolidated
-----------------------------------------------------------------------
Net Sales $ 53,878 $ 126,808 $ 6,687 $ (2,980) $ 184,393
-----------------------------------------------------------------------
Costs and expenses:
Cost of sales 43,901 99,740 3,925 (2,980) 144,586
Selling, general and administrative 7,513 20,658 2,036 -- 30,207
Research and development 1,076 3,446 179 -- 4,701
Acquisition-related costs -- 1,008 -- -- 1,008
Impairment loss on other intangible assets -- -- 1,487 -- 1,487
-----------------------------------------------------------------------
52,490 124,852 7,627 (2,980) 181,989
Operating earnings (loss) 1,388 1,956 (940) -- 2,404
Non-operating income (expense):
Interest income 918 103 75 -- 1,096
Interest expense (3,590) (34) -- -- (3,624)
Other, net (1) 167 (53) -- 113
-----------------------------------------------------------------------
(2,673) 236 22 -- (2,415)
(Loss) earnings before income taxes (1,285) 2,192 (918) -- (11)
Income tax benefit (expense) 4,066 (1,723) (267) -- 2,076
-----------------------------------------------------------------------
Earnings (loss) after income taxes 2,781 469 (1,185) -- 2,065
Equity in undistributed earnings of subsidiaries (716) -- -- 716 --
-----------------------------------------------------------------------
Net earnings (loss) $ 2,065 $ 469 $ (1,185) $ 716 $ 2,065
=======================================================================
EDO
Corporation
Parent Subsidiary
Company Only Guarantors Non-Guarantors Eliminations Consolidated
-------------------------------------------------------------------------
Net Sales $ 151,218 $ 294,779 $ 19,098 $ (8,595) $ 456,500
-------------------------------------------------------------------------
Costs and expenses:
Cost of sales 125,091 226,766 12,225 (8,595) 355,487
Selling, general and administrative 17,206 55,169 6,646 -- 79,021
Research and development 2,891 7,565 457 -- 10,913
Acquisition-related costs -- 1,455 -- -- 1,455
Impairment loss on other intangible assets -- -- 1,487 -- 1,487
-------------------------------------------------------------------------
145,188 290,955 20,815 (8,595) 448,363
Operating earnings (loss) 6,030 3,824 (1,717) -- 8,137
Non-operating income (expense):
Interest income 2,933 103 182 -- 3,218
Interest expense (8,285) -- -- -- (8,285)
Other, net (23) 15 (136) -- (144)
-------------------------------------------------------------------------
(5,375) 118 46 -- (5,211)
Earnings (loss) before income taxes 655 3,942 (1,671) -- 2,926
Income tax benefit (expense) 8,610 (3,940) (199) -- 4,471
-------------------------------------------------------------------------
Earnings (loss) after income taxes 9,265 2 (1,870) -- 7,397
Equity in undistributed earnings of
subsidiaries (1,868) -- -- 1,868 --
-------------------------------------------------------------------------
Net earnings (loss) $ 7,397 $ 2 $ (1,870) $ 1,868 $ 7,397
=========================================================================
|
17
EDO CORPORATION
CONDENSED CONSOLIDATING STATEMENT OF
EARNINGS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2006
(IN THOUSANDS)
(UNAUDITED)
EDO
Corporation
Parent Subsidiary
Company Only Guarantors Non-Guarantors Eliminations Consolidated
-------------------------------------------------------------------------
OPERATING ACTIVITIES:
Earnings (loss) from operations $ 7,397 $ 2 $ (1,870) $ 1,868 $ 7,397
Adjustments to earnings (loss) to arrive at
cash (used) provided by operations:
Depreciation 3,722 4,454 689 -- 8,865
Amortization -- 4,370 751 -- 5,121
Impairment loss on other intangible assets -- -- 1,487 -- 1,487
Bad (recovery) debt expense (75) 69 -- -- (6)
Deferred tax provision (2,591) 2,606 -- -- 15
Loss (gain) on sale of property, plant and
equipment 15 (74) -- -- (59)
Long-term Incentive Plan compensation expense 2,261 -- -- -- 2,261
Stock option compensation expense 838 -- -- -- 838
Employee Stock Ownership Plan compensation
expense 3,310 -- -- -- 3,310
Dividends on unallocated Employee Stock
Ownership Plan shares 172 -- -- -- 172
Common shares issued for directors' fees 162 -- -- -- 162
Changes in operating assets and liabilities,
excluding effects of acquisitions:
Equity in earnings of subsidiaries 1,868 -- -- (1,868) --
Intercompany (36,188) 36,053 135 -- --
Accounts receivable 16,110 7,079 (124) -- 23,065
Inventories 6,300 (17,744) (892) -- (12,336)
Prepayments and other assets 8,454 (6,831) 7 -- 1,630
Accounts payable, accrued liabilities and
other (18,561) (6,285) 1,015 -- (23,831)
Contribution to defined benefit pension plan (6,000) -- -- -- (6,000)
Contract advances and deposits 9,885 (8,691) -- -- 1,194
-------------------------------------------------------------------------
Cash (used) provided by operations (2,921) 15,008 1,198 -- 13,285
-------------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchase of property, plant and equipment (5,221) (8,048) (947) -- (14,216)
Payments received on notes receivable 100 -- -- -- 100
Proceeds from sale of property, plant and
equipment -- 633 -- -- 633
Cash paid for acquisitions, net of cash
acquired (265,318) -- -- -- (265,318)
-------------------------------------------------------------------------
Cash used by investing activities (270,439) (7,415) (947) -- (278,801)
-------------------------------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from exercise of stock options 842 10 -- -- 852
Excess income tax benefit from stock options
and Long-term Incentive Plan 429 -- -- -- 429
Proceeds from management group receivables 140 -- -- -- 140
Short-term borrowings under revolver 200,000 -- -- -- 200,000
Payment of common share cash dividends (1,830) -- -- -- (1,830)
-------------------------------------------------------------------------
Cash provided by financing activities 199,581 10 -- -- 199,591
-------------------------------------------------------------------------
Net (decrease) increase in cash and cash
equivalents (73,779) 7,603 251 -- (65,925)
Cash and cash equivalents at beginning of
period 99,067 4,232 5,432 -- 108,731
-------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 25,288 $ 11,835 $ 5,683 $ -- $ 42,806
=========================================================================
|
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
EDO Corporation (the "Company") designs and manufactures a diverse range of
products with core competencies in critical defense areas. We are a leading
supplier of sophisticated, highly engineered products and systems for defense,
aerospace and intelligence applications. We believe our advanced systems are
mission-critical on a wide range of military programs and are at the core of
transforming defense capabilities. We have two reporting segments: Engineered
Systems and Services and Electronic Systems and Communications. Our Engineered
Systems and Services segment comprises of aircraft armament systems, integrated
composite structures, undersea warfare sonar systems, and professional
engineering services. Our Electronic Systems and Communications segment provides
highly-engineered electronic systems and equipment including electronic warfare
systems, reconnaissance and surveillance systems, and command, control,
communications, and computers (C4) products and systems. The Company has a
disciplined acquisition program which is diversifying its base of major
platforms and customers.
The Company's Annual Report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and all amendments to those reports, and the Proxy
Statement for its Annual Meeting of Shareholders are made available, free of
charge, on its Web site www.edocorp.com, as soon as reasonably practicable after
such reports have been filed with or furnished to the Securities and Exchange
Commission.
Additional Information and Where to Find It
On September 17, EDO announced that it has entered into a definitive merger
agreement with ITT Corporation, pursuant to which ITT will acquire all of the
outstanding shares of EDO for $56.00 per share in cash.
In connection with the proposed merger, EDO filed with the SEC a definitive
proxy statement and other relevant materials on November 5, 2007. The definitive
proxy statement will be mailed to EDO's shareholders of record at the close of
business on November 2, 2007, the record date for the special meeting of our
shareholders to consider and vote on a proposal to approve and adopt the merger
agreement. EDO's shareholders are urged to read the definitive proxy statement
and other relevant materials carefully because they will contain important
information about EDO and the merger.
Shareholders, investors and other interested parties may obtain a free copy
of the definitive proxy statement and any other relevant documents (when they
become available) that EDO files with the SEC at the SEC's web site at
www.sec.gov. The definitive proxy statement and any other relevant documents may
also be accessed at www.edocorp.com or obtained free from the Company by
directing a request to EDO Corporation, 60 East 42nd Street, 42nd Floor, New
York, NY 10165, Attn: Investor Relations.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
We make estimates and assumptions in the preparation of our consolidated
financial statements in conformity with accounting principles generally accepted
in the United States. Actual results could differ significantly from those
estimates under different assumptions and conditions. We believe that the
following discussion addresses our critical accounting policies, which are those
that are most important to the portrayal of our consolidated financial condition
and results of operations and which require our most difficult and subjective
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. Except for the treatment of tax
contingency accruals, there have been no material changes from the methodology
applied by management for critical estimates previously disclosed in the
Company's most recent Annual Report on Form 10-K. Effective January 1, 2007, the
company began to measure and record tax contingency accruals in accordance with
FIN 48 - Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109. The expanded disclosure requirements of FIN 48 are presented
in Note 6 of this report. FIN 48 prescribes a threshold for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. Only tax positions meeting the more-likely-than-not
recognition threshold at the effective date may be recognized or continue to be
recognized upon adoption of this Interpretation. FIN 48 also provides guidance
on accounting for de-recognition, interest and penalties, and classification and
disclosure of matters related to uncertainty in income taxes. The following is a
brief discussion of the critical accounting policies employed by us:
REVENUE RECOGNITION
Sales under long-term, fixed-price contracts, including pro-rata profits,
are generally recorded based on the relationship of costs incurred to date to
total projected final costs or, alternatively, as deliveries and other
milestones are achieved or services are provided. These projections are revised
throughout the lives of the contracts. Adjustments to profits resulting from
such revisions are made cumulative to the date of change and may affect current
period earnings. Sales on other than long-term contract orders (principally
commercial products) are recorded as shipments are made. Our gross profit is
affected by a variety of factors, including the mix of products, systems and
services sold production efficiencies, price competition and general economic
conditions. Estimated losses on long-term contracts are recorded when
identified.
19
INVENTORIES
Inventories under long-term contracts and programs reflect all accumulated
production costs, including factory overhead, initial tooling and other related
costs (including general and administrative expenses relating to certain of our
defense contracts), less the portion of such costs charged to cost of sales. All
other inventories are stated at the lower of cost (principally first-in,
first-out method) or market. Inventory costs in excess of amounts recoverable
under contracts and which relate to a specific technology or application and
which may not have alternative uses are charged to cost of sales when such
circumstances are identified.
From time to time, we manufacture certain products prior to receiving firm
contracts in anticipation of future demand. Such costs are inventoried and are
incurred to help maintain stable and efficient production schedules.
Several factors may influence the sale and use of our inventories,
including our decision to exit a product line, technological change, new product
development and/or revised estimates of future product demand. If inventory is
determined to be overvalued due to one or more of the above factors, we would be
required to recognize such loss in value at the time of such determination.
Under the contractual arrangements by which progress payments are received,
the United States Government has a title to or a security interest in the
inventories identified with related contracts.
PROPERTY, PLANT AND EQUIPMENT AND OTHER LONG-LIVED ASSETS
Property, plant and equipment is recorded at cost and is depreciated on a
straight-line basis over the estimated useful lives of such assets. Leasehold
improvements are amortized over the shorter of their estimated useful lives or
their respective lease periods.
In those cases where we determine that the useful life of property, plant
and equipment should be shortened, we depreciate the net book value in excess of
salvage value over its revised remaining useful life thereby increasing
depreciation expense. Factors such as technological advances, changes to our
business model, changes in our capital strategy, changes in the planned use of
equipment, fixtures, software or changes in the planned use of facilities could
result in shortened useful lives. Long-lived assets, other than goodwill, are
reviewed by us for impairment whenever events or changes in circumstances
indicate that the carrying amount of any such asset may not be recoverable. The
estimate of cash flow, which is used to determine recoverability, is based upon,
among other things, certain assumptions about future operating performance.
Our estimates of undiscounted cash flow may differ from actual cash flow
due to such factors including technological advances, changes to our business
model, or changes in our capital strategy or planned use of long-lived assets.
If the sum of the undiscounted cash flows, excluding interest, is less than the
carrying value, we would recognize an impairment loss, measured as the amount by
which the carrying value exceeds the fair value of the asset.
In accordance with SFAS No. 142, goodwill must be tested at least annually
for impairment at the reporting unit level. If an indication of impairment
exists, we are required to determine if such goodwill's implied fair value is
less than the unit carrying value in order to determine the amount, if any, of
the impairment loss required to be recorded. Impairment indicators include,
among other conditions, cash flow deficits, an historic or anticipated decline
in revenue or operating profits, adverse legal or regulatory developments,
accumulation of costs significantly in excess of amounts originally expected to
acquire the asset and/or a material decrease in the fair value of some or all of
the assets.
To determine the fair value of our reporting units, we generally use a
present value technique (discounted cash flow) corroborated by market multiples
when available and as appropriate, for all of the reporting units. The
discounted cash flow method measures intrinsic value by reference to an
enterprise's or an asset's expected annual free cash flows. We applied what we
believe to be the most appropriate valuation methodology for each of the
reporting units. If we had established different reporting units or utilized
different valuation methodologies, the impairment test results could differ.
PENSION AND POST-RETIREMENT BENEFITS OBLIGATIONS
We sponsor defined benefit pension and other retirement plans in various
forms covering all eligible employees. Several statistical and other factors
which attempt to anticipate future events are used in calculating the expense
and liability related to the plans. These factors include assumptions about the
discount rate and expected return on plan assets within certain guidelines and
in conjunction with our actuarial consultants. In addition, our actuarial
consultants also use subjective factors such as withdrawal and mortality rates
to estimate the expense and liability related to these plans. The actuarial
assumptions used by us may differ significantly, either favorably or
unfavorably, from actual results due to changing market, economic or regulatory
conditions, higher or lower withdrawal rates or longer or shorter life spans of
participants.
20
We used the building block approach to the estimation of the long-term rate
of return on assets. Under this approach, we reviewed the publicly available
common source data for the range of returns on basic types of equity and fixed
income instruments and the differential to those rates provided by active
investment management. In consultation with our actuarial and active asset
management consultants and taking into account the funds' actual performance and
expected asset allocation going forward, we selected an overall return rate
within the resulting range.
RESULTS OF OPERATIONS
The following information should be read in conjunction with the
Consolidated Financial Statements as of September 29, 2007.
THREE MONTHS ENDED SEPTEMBER 29, 2007 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 2006
Net sales by segment were as follows:
THREE MONTHS ENDED INCREASE/
------------------------------ (DECREASE)
SEPTEMBER 29, SEPTEMBER 30, FROM
SEGMENT 2007 2006 PRIOR PERIOD
------- -----------------------------------------------
(IN THOUSANDS)
Engineered Systems & Services $ 117,974 $ 79,409 48.6%
Electronic Systems & Communications 138,808 104,984 32.2%
-----------------------------------------------
Total $ 256,782 $ 184,393 39.3%
===============================================
|
In the Engineered Systems and Services segment, the increase in sales is
attributable primarily to the contribution of sales of CAS which was acquired on
September 6, 2006, and higher sales on aircraft armament products. This increase
was partially offset by lower sales in our flight-line test systems product and
various undersea warfare programs.
In the Electronic Systems and Communications segment, the increase in sales
is attributable to deliveries associated with the Transition Switch Module (TSM)
program, sales contributed by IST which was acquired on September 15, 2006,
increased sales on our force protection systems as well as spares related to ESM
systems.
Operating earnings by segment were as follows:
THREE MONTHS ENDED
SEPTEMBER 29, SEPTEMBER 30,
SEGMENT 2007 2006
------------------------------
(IN THOUSANDS)
Engineered Systems & Services $ 7,335 $ 646
Electronic Systems & Communications 8,779 1,758
------------------------------
Total $ 16,114 $ 2,404
==============================
|
Operating earnings for the three months ended September 29, 2007 were $16.1
million or 6.3% of net sales. This compares to operating earnings for the three
months ended September 30, 2006 of $2.4 million or 1.3% of net sales.
Items of note affecting operating earnings are summarized here to help
clarify the comparison of results.
THREE MONTHS ENDED
SEPTEMBER 29, SEPTEMBER 30,
2007 2006
--------------------------------
(IN THOUSANDS)
Pension $ 610 $ 1,194
ESOP Compensation expense $ 1,725 $ 975
Other intangible asset amortization $ 2,562 $ 1,707
------------------------------
$ 4,897 $ 3,876
==============================
|
21
The decrease in pension expense in 2007 compared to 2006 is attributable to
changes in actuarial assumptions such as discount rate and return on plan assets
as well as the contributions made by the Company in 2007 for the 2006 plan year.
The higher ESOP compensation expense for the three months ended September 29,
2007 is attributable to our higher average stock price compared to the three
months ended September 30, 2006. The increase in other intangible asset
amortization expense is attributable to the acquisitions of CAS and IST in the
third quarter of 2006.
The Engineered Systems and Services segment's operating earnings for the
three months ended September 29, 2007 were $7.3 million or 6.2% of this
segment's net sales compared to operating earnings of $0.6 million or 0.8% of
this segment's net sales for the three months ended September 30, 2006. The
increase is attributable the increased sales on aircraft armament programs, the
mix of programs in our services division, and the contributions of CAS, which
was acquired on September 6, 2006. These increases were partially offset by a
$3.2 million cost growth on the ALOFTS sonar program and the aforementioned
lower sales on flight line test systems.
For the three months ended September 30, 2006, operating earnings in the
Engineering Systems and Services segment were negatively impacted by a $2.2
million cost growth on an aircraft armament systems program and a $0.4 million
cost growth on an undersea warfare program as well as lower margins due to lower
sales volume of composite structures, primarily the Joint Air to Surface
Standoff Missile units (JASSM) and the attendant higher absorption of overhead
costs. In addition, operating earnings for Engineered Systems and Services were
impacted by a write-down of unamortized other intangible assets of $1.5 million
related to the Company's rugged computer product line.
The Electronic Systems and Communications segment's operating earnings for
the three months ended September 29, 2007 were $8.8 million or 6.3% of this
segment's net sales compared to operating earnings of $1.8 million or 1.7% of
this segment's net sales for the three months ended September 30, 2006. This
increase is mainly attributable to sales on our TSM program, increased sale of
our Antenna Products, and higher sales of ESM systems. This increase is
partially offset by unabsorbed overhead costs at two of our facilities as we
prepare for increased production of force protection systems.
For the three months ended September 30, 2006, operating earnings in the
Electronic Systems and Communications segment were negatively impacted by the
significantly lower sales volume of electronic force protection systems. In
addition, earnings were negatively impacted by a charge of approximately $2.1
million related to the settlement of a contract dispute during the third quarter
of 2006.
Selling, general and administrative expenses for the three months ended
September 29, 2007 were $35.7 million or 13.9% of net sales compared to $30.2
million or 16.4% of net sales for the three months ended September 30, 2006. The
increase is primarily attributable to the acquisitions of CAS and IST made in
the third quarter of 2006 and includes the other intangible assets amortization
expense associated with these acquisitions.
During the three months ended September 29, 2007, the Company recorded
acquisition-related costs of $2.0 million for "stay-pay" related to the
acquisitions in 2005 and 2006 compared to $1.0 million for the three months
ended September 30, 2006. We expect to incur similar amounts related primarily
to the CAS and IST acquisitions over the next 2 years.
Research and development expense for the three months ended September 29,
2007 decreased to $2.9 million or 1.1% of net sales from $4.7 million or 2.5% of
net sales for the three months ended September 30, 2006, during which time there
was higher than usual spending on electronic force protection and ESM Systems.
Interest expense, net of interest income, for the three months ended
September 29, 2007 increased to $4.8 million from $2.5 million for the three
months ended September 30, 2006, primarily due to interest on borrowings under
our credit facility. Also included in interest expense is interest on our 4.0%
Convertible Subordinated Notes ("Notes") which were issued in November 2005 and
due in 2025, interest on the promissory note associated with the IST acquisition
made in September 2006 and due in 2009, interest on the promissory note
associated with the NexGen acquisition made in 2005 and due in 2008, and the
amortization of deferred debt issuance costs associated with the offering of the
Notes and amortization of deferred financing costs associated with our credit
facility.
For the three months ended September 29, 2007 we recorded a discrete net
income tax benefit of $4.7 million primarily related to changes in tax
contingencies and the claim for the federal research and development credit for
2003 not previously claimed This compares to a $2.3 million discrete net income
tax benefit recorded for the three months ended September 30, 2006 related
primarily to claims for the federal research and development credit and
extraterritorial income (ETI) exclusion tax benefits not previously claimed.
22
For the three months ended September 29, 2007, net earnings were $11.2
million or $0.49 per diluted common share on 25.4 million diluted shares
compared to net earnings of $2.1 million or $0.11 per diluted common share on
18.6 million diluted shares for the three months ended September 30, 2006. The
convertible Notes were dilutive for the third quarter of 2007 and anti-dilutive
in the third quarter of 2006.
NINE MONTHS ENDED SEPTEMBER 29, 2007 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 2006
Net sales by segment were as follows:
NINE MONTHS ENDED INCREASE/
------------------------------ (DECREASE)
SEPTEMBER 29, SEPTEMBER 30, FROM
SEGMENT 2007 2006 PRIOR PERIOD
------------------------------------------------
(IN THOUSANDS)
Engineered Systems & Services $ 353,954 $ 204,462 73.1%
Electronic Systems & Communications 404,264 252,038 60.4%
------------------------------------------------
Total $ 758,218 $ 456,500 66.1%
================================================
|
In the Engineered Systems and Services segment, the increase in sales is
attributable primarily to the contribution of sales of CAS which was acquired on
September 6, 2006, increased sales of our flight line test systems products and
higher sales in undersea warfare products.
In the Electronic Systems and Communications segment, the increase in sales
is attributable to deliveries associated with the Transition Switch Module (TSM)
program, deliveries of force protection systems and the sales contributed by IST
which was acquired on September 15, 2006.
Operating earnings by segment were as follows:
NINE MONTHS ENDED
SEPTEMBER 29, SEPTEMBER 30,
SEGMENT 2007 2006
------------------------------
(IN THOUSANDS)
Engineered Systems & Services...................$ 25,902 $ 4,069
Electronic Systems & Communications............. 21,168 4,068
------------------------------
Total...........................................$ 47,070 $ 8,137
==============================
|
Operating earnings for the nine months ended September 29, 2007 were $47.1
million or 6.2% of net sales. This compares to operating earnings for the nine
months ended September 30, 2006 of $8.1 million or 1.8% of net sales.
Items of note affecting operating earnings are summarized here to help
clarify the comparison of results.
NINE MONTHS ENDED
SEPTEMBER 29, SEPTEMBER 30,
2007 2006
--------------------------------
(IN THOUSANDS)
Pension.........................................$ 2,233 $ 3,582
ESOP Compensation expense.......................$ 4,209 $ 3,310
Other intangible asset amortization.............$ 7,713 $ 5,121
Stock-based compensation expense re: options....$ 970 $ 838
--------------------------------
$ 15,125 $ 12,851
================================
|
The decrease in pension expense in 2007 compared to 2006 is attributable to
changes in actuarial assumptions such as discount rate and return on plan assets
as well as the contributions made by the Company in 2007 for the 2006 plan year.
The higher ESOP compensation expense for the first nine months of 2007 is
attributable to our higher average stock price compared to the first nine months
of 2006. The increase in other intangible asset amortization expense is
attributable to the acquisitions of CAS and IST in the third quarter of 2006.
The increase in stock-based compensation expense relates to the higher share
price on the dates of grant compared to 2006.
23
The Engineered Systems and Services segment's operating earnings for the
nine months ended September 29, 2007 were $25.9 million or 7.3% of this
segment's net sales compared to operating earnings of $4.1 million or 2.0% of
this segment's net sales for the nine months ended September 30, 2006. This
increase is attributable to cost reductions on an aircraft armament program,
increased sales on flight line test equipment, the contribution of CAS, which
was acquired on September 6, 2006 and the mix of sales in our services business.
These increases were partially offset by cost growth on the ALOFTS sonar program
and an aircraft armament program.
For the nine months ended September 30, 2006, operating earnings in the
Engineered Systems Services segment were negatively impacted by a $2.5 million
cost growth on ALOFTS, $1.4 million and $2.2 million on two aircraft armament
systems programs, $1.2 million related to the conclusion of a legal action as
well as a write-off of unamortized other intangible assets of $1.5 million
related to the Company's rugged computer product line.
In the Electronic Systems and Communications segment, operating earnings
for the nine months ended September 29, 2007 were $21.2 million or 5.2% of this
segment's net sales compared to operating earnings of $4.1 million or 1.6% of
this segment's net sales for the nine months ended September 30, 2006. The
increase is attributable to increased sales on our TSM program, electronic
warfare products, and antenna products. This was partially offset by unabsorbed
overhead costs at two of our facilities as we prepare for increased production
of force protection systems, as well as cost growth on a close-out of an open
contract issue on a long standing contract that is now complete.
For the nine months ended September 30, 2006, operating earnings were
negatively impacted by less recovery of overhead expenses due to lower sales
volume of electronic force protection systems, cost growth of $2.5 million on an
interference cancellation program, lower milestone achievements of
reconnaissance and surveillance systems, and approximately $5.0 million in legal
costs and provisions for liabilities in respect of concluded legal matters.
Selling, general and administrative expenses for the nine months ended
September 29, 2007 were $105.1 million or 13.9% of net sales compared to $79.0
million or 17.3% for the nine months ended September 30, 2006. The increase is
primarily attributable to the acquisitions of CAS and IST made in 2006 including
the other intangible assets amortization expense associated with these
acquisitions.
During the nine months ended September 29, 2007, the Company recorded
acquisition-related costs of $6.3 million for "stay-pay" related to the
acquisitions made in 2005 and 2006, compared to $1.5 million for the nine months
ended September 30, 2006. We expect to incur similar amounts related primarily
to the CAS and IST acquisitions over the next 2 years.
Research and development expense for the nine months ended September 29,
2007 decreased to $7.4 million or 1.0% of net sales from $10.9 million or 2.4%
of net sales for the nine months ended September 30, 2006, during which time
there was higher spending on electronic force protection and aircraft armament
systems.
Interest expense, net of interest income, for the nine months ended
September 29, 2007 increased to $16.3 million from $5.1 million for the nine
months ended September 30, 2006 primarily due to interest on borrowings under
our credit facility. Also included in interest expense is interest on our 4.0%
Convertible Subordinated Notes ("Notes") which were issued in November 2005 and
due in 2025, interest on the promissory note associated with the IST acquisition
made in September 2006 and due in 2009, interest on the promissory note
associated with the NexGen acquisition made in 2005 and due in 2008, and the
amortization of deferred debt issuance costs associated with the offering of the
Notes and amortization of deferred financing costs associated with our credit
facility.
For the nine months ended September 29, 2007, we recorded a discrete net
income tax benefit of $4.7 million primarily related to changes in tax
contingencies and the claim for the federal research and development credit for
2003 not previously claimed, compared to a $6.0 million discrete net income tax
benefit recorded for the nine months ended September 30, 2006 related primarily
to claims for the federal research and development credit and extraterritorial
income (ETI) exclusion tax benefits not previously claimed and changes in tax
contingencies.
For the nine months ended September 29, 2007, net earnings were $22.9
million or $1.05 per diluted common share on 25.2 million diluted shares
compared to net earnings of $7.4 million or $0.40 per diluted common share on
18.6 million diluted shares for the nine months ended September 30, 2006. The
Convertible Notes were dilutive for the nine months ended September 29, 2007 and
anti-dilutive for the nine months ended September 30.
24
LIQUIDITY AND CAPITAL RESOURCES
Balance sheet
Cash and cash equivalents decreased 86.5% to $3.4 million at September 29,
2007 from $25.3 million at December 31, 2006. For the nine months ended
September 29, 2007, cash provided by operations was $38.9 million, reflecting
earnings from operations and collections of billed receivables which were
partially offset by increases in inventories and contributions to the defined
benefit pension plan. During the nine months ended September 29, 2007, we
reduced our borrowings under the credit facility by a net $36.0 million.
Furthermore, $9.3 million was used to settle the final purchase prices of CAS
and IST, $12.2 million was used for the purchase of plant and equipment, $5.8
million for a scheduled principal payment on our IST promissory note and $1.9
million for the payment of common share dividends.
Accounts receivable decreased 12.1% to $233.1 million at September 29, 2007
from $265.3 million at December 31, 2006 due to collections of billed
receivables. At September 29, 2007 approximately 90% of billed receivables were
in the under-60 days aging category compared with 89% at December 31, 2006.
Inventories increased to $118.7 million at September 29, 2007 from $56.3
million at December 31, 2006 due primarily to the efforts expended on
work-in-process on major programs such as TSM and Crew 2.1.
FINANCING ACTIVITIES
Credit Facility
We have a five-year credit facility with a consortium of banks, led by
Citibank, N.A., as the administrative agent, Bank of America, N.A, as the
documentation agent and Wachovia Bank, N.A. as syndication agent. The facility
expires in November 2010.
The credit agreement provides for a revolving credit facility in an
aggregate amount equal to $300 million with sub-limits of $20 million for
short-term swing loans and $100 million for letters of credit. The potential
cash borrowing under the facility is reduced by the amount of outstanding
letters of credit. The Company has the option to select Base Rate or Eurodollar
Rate loans under the terms of the Credit Agreement. Any borrowings under the
facility would be priced initially at LIBOR plus a predetermined amount
depending on our consolidated leverage ratio at the time of the borrowing. At
September 29, 2007, LIBOR was approximately 5.13% and the applicable adjustment
to LIBOR was 2.00%. The facility requires us to pay each lender in the
consortium a commitment fee on the average daily unused portion of their
respective commitment at a rate equal to 0.25%. In addition, the agreement
provides for potential incremental credit extensions in the form of term loans
or revolving credit commitment increases of up to $100 million.
At September 29, 2007 there were $21.9 million of letters of credit
outstanding and $144.0 million of direct borrowings outstanding under the credit
facility, resulting in $134.1 million available for additional borrowings. At
December 31, 2006, there were $180.0 million of direct borrowings outstanding
under the credit facility. Accrued interest payable related to the credit
facility was $0.3 million and $0.8 million at September 29, 2007 and December
31, 2006, respectively.
In connection with the credit facility, the Company is required to maintain
both financial and non-financial covenants and ratios, including, but not
limited to, leverage ratio, fixed charge coverage ratio, and senior secured
leverage ratio. As of September 29, 2007, the Company was in compliance with its
covenants. The credit facility is secured by the Company's accounts receivable,
inventory and machinery and equipment.
4.0% Convertible Subordinated Notes due 2025 ("4.0% Notes")
In November 2005, we completed the offering of $201.2 million principal of
4.0% Notes and received proceeds of $195.7 million, net of $5.5 million of
commissions. Interest payments are due May 15 and November 15 of each year
commencing on May 15, 2006. The Company made its scheduled interest payment of
$4.0 million on the 4.0% Notes during the second quarter of 2007. Accrued
interest payable, included in accrued liabilities, was $3.1 million and $1.0
million at September 29, 2007 and December 31, 2006, respectively. The Notes are
convertible, unless previously redeemed or repurchased by the Company, at the
option of the holder at any time prior to maturity, into the Company's common
stock at an initial conversion price of $34.19 per share, subject to adjustment
in certain events. As of September 29, 2007, there had been no such conversions.
25
Shelf Registration
At September 29, 2007, our remaining capacity under the universal shelf
registration statement that became effective in January 2004 was approximately
$298.8 million. We believe that, for the foreseeable future, we have adequate
liquidity and sufficient capital to fund our currently anticipated requirements
for working capital, capital expenditures, including acquisitions, research and
development expenditures, interest payments and funding of our pension and
post-retirement benefit obligations. We continue to focus on positioning
ourselves to be a significant player in the consolidation of first-tier defense
suppliers and, to that end, actively seek candidates for strategic acquisitions.
Future acquisitions may be funded from any of the following sources: cash on
hand; borrowings under our credit facility; issuance of our common stock or
other equity securities; and/or convertible or other debt offerings.
COMMITMENT AND CONTINGENCIES
We are obligated under building and equipment leases expiring between 2007
and 2019. The aggregate future minimum lease commitments under those obligations
with non-cancellable terms in excess of one year are shown below. Our
commitments under letters of credit and advance payment and performance bonds
relate primarily to advances received on foreign contracts should we fail to
perform in accordance with the contract terms. We do not expect to have to make
payments under these letters of credit or bonds since these obligations are
removed as we perform under the related contracts. The amounts for letters of
credit and performance bonds represent the amount of commitment expiration per
period.
In order to aggregate all commitments and contractual obligations as of
September 29, 2007, we have included the following table:
PAYMENTS DUE IN (IN MILLIONS):
----------------------------------------------------------------------
COMMITMENTS AND CONTRACTUAL OBLIGATIONS: 2012 AND
TOTAL 2007 2008 2009 2010 2011 BEYOND
------------------------------------------------------------------------------------------------------------------------
Borrowings Under Revolver $ 144.0 $ 144.0 $ -- $ -- $ -- $ -- $ --
Notes payable 16.5 2.0 8.8 5.7 -- -- --
4.0% Convertible Subordinated Notes due 2025 (1) 201.2 -- -- -- -- -- 201.2
Operating leases 145.2 5.7 22.4 20.6 19.3 18.1 59.1
Letters of credit 21.9 2.5 7.0 11.8 -- -- 0.6
Projected pension contributions (2) 33.6 -- 14.7 8.5 8.3 2.1 --
Advance payment and performance bonds 1.7 -- -- 1.7 -- -- --
----------------------------------------------------------------------
Total $ 564.1 $ 154.2 $ 52.9 $ 48.3 $ 27.6 $ 20.2 $ 260.9
======================================================================
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(1) Excludes interest of approximately $8 million annually.
(2) Actual pension contributions may differ from amounts presented above
and are contingent on cash flow, liquidity, and actuarial assumptions.
Additionally, we are subject to certain legal actions that arise out of the
normal course of business. It is our belief that the ultimate outcome of these
actions is unlikely to have a material adverse effect on our consolidated
financial position, results of operations or liquidity
CONCENTRATION OF SALES
We conduct a significant amount of our business with the United States
Government. Although there are currently no indications of a significant change
in the status of government funding of certain programs, should this occur, our
results of operations, financial position and liquidity could be materially
affected. Such a change could have a significant impact on our profitability and
our stock price. This could also affect our ability to acquire funds from our
credit facility due to covenant restrictions or from other sources.
For the three and nine months ended September 29, 2007, sales of TSM
represented 12.7% and 15.1% of net sales, respectively. For the three and nine
months ended September 30, 2006, sales of TSM represented 13.9% and 7.3% of net
sales, respectively.
26
The funded backlog of unfilled orders at September 29, 2007 increased to
$1,362.3 million from $804.4 million at December 31, 2006. Our backlog consists
primarily of current orders under long-lived, mission-critical programs of key
defense platforms.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
The statements in this Quarterly report and in oral statements that may be
made by representatives of the Company relating to plans, strategies, economic
performance and trends and other statements that are not descriptions of
historical facts may be forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, Section 27(a) of the
Securities Act of 1933 and Section 21(e) of the Securities Exchange Act of 1934.
Forward looking statements are inherently subject to risks and uncertainties,
and actual results could differ materially from those currently anticipated due
to a number of factors, which include, but are not limited to the following for
each of the types of information noted below.
U.S. and international military program sales, follow-on procurement,
contract continuance, and future program awards, upgrades and spares support are
subject to: U.S. and international military budget constraints and
determinations; U.S. congressional and international legislative body
discretion; U.S. and international government administration policies and
priorities; changing world military threats, strategies and missions;
competition from foreign manufacturers of platforms and equipment; NATO country
determinations regarding participation in common programs; changes in U.S. and
international government procurement timing, strategies and practices, the
general state of world military readiness and deployment; and the ability to
obtain export licenses.
Commercial product sales are subject to: success of product development
programs currently underway or planned; competitiveness of current and future
production costs and prices and market and consumer base development of new
product programs.
Achievement of margins on sales, earnings and cash flow can be affected by:
unanticipated technical problems; government termination of contracts for
convenience; decline in expected levels of sales; underestimation of anticipated
costs on specific programs; the ability to effect acquisitions; and risks
inherent in integrating recent acquisitions into our overall structure.
Expectations of future income tax rates can be affected by a variety of
factors, including statutory changes in Federal and state tax rates, tax
treatment of acquisitions, results of tax audits, the amount of the
non-deductible portion of our non-cash ESOP compensation expense and other
factors detailed under "Special Note Regarding Forward-Looking Statements" in
the definitive proxy statement filed by the Company on November 5, 2007 in
connection with the proposed sale of the company described in Note 2.
The Company has no obligation to update any forward-looking statements.