UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM -------- TO--------
COMMISSION FILE NUMBER 1-10596
ESCO TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
MISSOURI 43-1554045
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9900A CLAYTON ROAD
ST. LOUIS, MISSOURI 63124-1186
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (314) 213-7200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ----
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer X Accelerated filer Non-accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.
Class Outstanding at July 31, 2006
---------------------------------------- ------------------------------
[Common stock, $.01 par value per share] 25,821,770 shares
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended
June 30,
-------------
2006 2005
---- ----
Net sales $ 123,626 108,800
Costs and expenses:
Cost of sales (excluding amortization) 77,152 71,732
Asset impairment - 790
Amortization of intangible assets 2,554 475
Selling, general and administrative expenses 28,385 21,662
Interest income (195) (534)
Other income, net (513) (38)
----- -------
Total costs and expenses 107,383 94,087
Earnings before income taxes 16,243 14,713
Income tax expense 5,080 2,312
-------- --------
Net earnings $ 11,163 12,401
====== ======
Earnings per share:
Basic $ 0.43 0.49
==== ====
Diluted $ 0.42 0.47
==== ====
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
Nine Months Ended
June 30,
-------------
2006 2005
---- ----
Net sales $ 337,096 319,335
Costs and expenses:
Cost of sales (excluding amortization) 221,654 209,070
Asset impairment - 790
Amortization of intangible assets 4,603 1,463
Selling, general and administrative
expenses 78,574 62,395
Interest income (1,012) (1,317)
Other income, net (2,440) (1,207)
------- -----
Total costs and expenses 301,379 271,194
Earnings before income taxes 35,717 48,141
Income tax expense 15,006 14,790
------ ------
Net earnings $ 20,711 33,351
====== ======
Earnings per share:
Basic $ 0.81 1.31
==== ====
Diluted $ 0.78 1.27
==== ====
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, September 30,
2006 2005
------ ------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 35,258 104,484
Accounts receivable, net 82,744 68,819
Costs and estimated earnings on
long-term contracts less progress,
billings of $5,618 and $7,033,
respectively 2,321 4,392
Inventories 50,208 48,645
Current portion of deferred tax
assets 26,616 30,219
Other current assets 11,487 8,394
-------- -------
Total current assets 208,634 264,953
Property, plant and equipment, net 69,363 67,190
Goodwill 143,677 68,880
Other assets 63,783 27,697
-------- --------
$ 485,457 428,720
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current
maturities of long-term debt $ - -
Accounts payable 46,918 29,299
Advance payments on long-term
contracts, less costs
incurred of $13,544 and $10,949, 5,471 6,773
respectively
Accrued salaries 11,715 12,024
Accrued other expenses 21,845 14,661
-------- --------
Total current liabilities 85,949 62,757
Deferred income 6,452 3,134
Pension obligations 17,474 17,481
Other liabilities 16,761 14,324
Long-term debt - -
--------- --------
Total liabilities 126,636 97,696
Shareholders' equity:
Preferred stock, par value $.01 per
share, authorized 10,000,000 shares - -
Common stock, par value $.01 per
share, authorized 50,000,000
shares, issued 28,986,800 and
28,738,958 shares, respectively 290 287
Additional paid-in capital 233,865 228,317
Retained earnings 180,074 159,363
Accumulated other comprehensive
loss (4,147) (5,566)
------- --------
410,082 382,401
Less treasury stock, at cost:
3,168,426 and 3,175,626 common
shares, respectively (51,261) (51,377)
------- --------
Total shareholders' equity 358,821 331,024
$ 485,457 428,720
======= =======
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Nine Months Ended
June 30,
---------
2006 2005
------- ------
Cash flows from operating activities:
Net earnings $ 20,711 33,351
Adjustments to reconcile net
earnings to net cash provided by
operating activities:
Depreciation and amortization 12,407 9,263
Stock compensation expense 3,660 2,064
Changes in operating working
capital 13,005 (3,020)
Effect of deferred taxes 444 3,526
Other (2,831) 198
-------- -----
Net cash provided by operating
activities 47,396 45,382
Cash flows from investing activities:
Acquisition of businesses, less cash
acquired (91,468) -
Capital expenditures (6,753) (6,580)
Additions to capitalized software (24,413) (4,951)
--------- -------
Net cash used by investing
activities (122,634) (11,531)
Cash flows from financing activities:
Borrowings from long-term debt 52,000 -
Principal payments on long-term debt
(52,000) (122)
Purchases of common stock into
treasury - (24,928)
Excess tax benefit from stock
options exercised 1,112 -
Proceeds from exercise of stock
options 2,031 2,538
Other 2,869 2,145
------- -------
Net cash provided (used) by
financing activities 6,012 (20,367)
------- ---------
Net (decrease) increase in cash and cash
equivalents (69,226) 13,484
Cash and cash equivalents, beginning of
period 104,484 72,281
---------- --------
Cash and cash equivalents, end of period
$ 35,258 85,765
====== ======
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements, in the opinion of
management, include all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the results for the interim
periods presented. The consolidated financial statements are presented in
accordance with the requirements of Form 10-Q and consequently do not
include all the disclosures required by accounting principles generally
accepted in the United States of America (GAAP). For further information
refer to the consolidated financial statements and related notes included
in the Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 2005. During 2005, the Company issued a 2-for-1 stock split
which was effected as a 100 percent stock dividend and was paid on
September 23, 2005. The prior years common stock and per share amounts have
been adjusted to reflect the stock split.
The Company's business is typically not impacted by seasonality, however,
the results for the three and nine-month periods ended June 30, 2006 are
not necessarily indicative of the results for the entire 2006 fiscal year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This Summary of Significant Accounting Policies supplements the summary in
the Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 2005.
(a) Revenue Recognition
Filtration / Fluid Flow Operating Unit: Within the Filtration / Fluid Flow
operating unit, approximately 75% of operating unit revenues (30% of
consolidated revenues) are recognized when products are delivered (when
title and risk of ownership transfers) or when services are performed for
unaffiliated customers.
Approximately 25% of operating unit revenues (10% of consolidated revenues)
are recorded under the percentage-of-completion provisions of SOP 81-1,
"Accounting for Performance of Construction-Type and Certain
Production-Type Contracts." Products accounted for under SOP 81-1 include
the design, development and manufacture of complex fluid control products,
quiet valves, manifolds and systems primarily for the aerospace and
military markets. For arrangements that are accounted for under SOP 81-1,
the Company estimates profit as the difference between total estimated
revenue and total estimated cost of a contract and recognizes these
revenues and costs based on units delivered. The percentage-of-completion
method of accounting involves the use of various techniques to estimate
expected costs at completion.
Communications Segment: Within the Communications segment, approximately
95% of the segment's revenue arrangements (30% of consolidated revenues)
contain software components. Revenue under these arrangements is recognized
in accordance with Statement of Position 97-2 (SOP 97-2), "Software Revenue
Recognition," as amended by SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions." The segment's
software revenue arrangements generally include multiple products and
services, or "elements" consisting of meter and substation hardware, meter
reading system software, program management support during the deployment
period and software support (post-contract customer support, "PCS"). These
arrangements typically require the Company to deliver software at the
inception of the arrangement while the hardware, and program management
support are delivered over the contractual deployment period. Software
support is provided during deployment and subsequent thereto. The software
element included in such arrangements is essential to the functionality of
the hardware and, therefore, the hardware is considered to be
software-related. Hardware is considered a specified element in the
software arrangement and vendor-specific objective evidence of fair value
("VSOE") has been established for this element. VSOE for the hardware
element is determined based on the price when sold separately to customers.
These revenue arrangements are divided into separate units of accounting if
the delivered item(s) has value to the customer on a stand-alone basis,
there is objective and reliable evidence of the fair value of the
undelivered item(s) and delivery/performance of the undelivered item(s) is
probable. For multiple element arrangements, revenue is allocated to the
individual elements based on VSOE of the individual elements.
The application of these principles requires judgment, including the
determination of whether a software arrangement includes multiple elements
and estimates of the fair value of the elements. The VSOE of the
undelivered elements is determined based on the historical evidence of
stand-alone sales of these elements to customers. Hardware revenues are
generally recognized at the time of shipment or receipt by customer
depending upon contract terms. VSOE generally does not exist for the
software element, therefore, the Company uses the residual method to
recognize revenue when VSOE exists for all other undelivered elements.
Under the residual method, the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is recognized as
revenue.
SOP 97-2 requires the seller of software that includes post-contract
customer support (PCS) to establish VSOE of the undelivered element of the
contract in order to account separately for the PCS revenue. The Company
determines VSOE by a consistent pricing of PCS and PCS renewals as a
percentage of the software license fees and by reference to contractual
renewals, when the renewal terms are substantive. Revenues for PCS are
recognized ratably over the maintenance term specified in the contract
(generally in 12 monthly increments). Revenues for program management
support are recognized when services have been provided. The Company
determines VSOE for program management support based on hourly rates when
services are performed separately.
Deferred revenue is recorded for products or services that have not been
provided but have been invoiced under contractual agreements or paid for by
a customer, or when products or services have been provided but the
criteria for revenue recognition have not been met. If there is a customer
acceptance provision or there is uncertainty about customer acceptance,
revenue is deferred until the customer has accepted the product or service.
Approximately 5% of segment revenues (1% of consolidated revenues) are
recognized when products are delivered (when title and risk of ownership
transfers) or when services are performed for unaffiliated customers.
Products include the SecurVision digital video surveillance systems.
Test Segment: Within the Test segment, approximately 60% of revenues (20%
of consolidated revenues) are recognized when products are delivered (when
title and risk of ownership transfers) or when services are performed for
unaffiliated customers. Certain arrangements contain multiple elements
which are accounted for under the provisions of EITF 00-21, "Revenue
Arrangements with Multiple Deliverables." The multiple elements generally
consist of materials and installation services used in the construction and
installation of standard shielded enclosures to measure and contain
magnetic and electromagnetic energy. The installation process does not
involve changes to the features or capabilities of the equipment and does
not require proprietary information about the equipment in order for the
installed equipment to perform to specifications. There is objective and
reliable evidence of fair value for each of the units of accounting, as a
result, the arrangement revenue is allocated to the separate units of
accounting based on their relative fair values. Typically, fair value is
the price of the deliverable when it is regularly sold on a stand-alone
basis.
Approximately 40% of the segment's revenues (9% of consolidated revenues)
are recorded under the percentage-of-completion provisions of SOP 81-1,
"Accounting for the Performance of Construction-Type and Certain
Production-Type Contracts" due to the complex nature of the enclosures that
are designed and produced under these contracts. Products accounted for
under SOP 81-1 include the construction and installation of complex test
chambers to a buyer's specifications that provide its customers with the
ability to measure and contain magnetic, electromagnetic and acoustic
energy. As discussed above, for arrangements that are accounted for under
SOP 81-1, the Company estimates profit as the difference between total
estimated revenue and total estimated cost of a contract and recognizes
these revenues and costs based on either (a) units delivered or (b)
contract milestones.
If a reliable measure of output cannot be established (which applies in
less than 8% of Test segment revenues or 2% of consolidated revenues),
input measures (e.g., costs incurred) are used to recognize revenue. Given
the nature of the Company's operations related to these contracts, costs
incurred represent an appropriate measure of progress towards completion.
The percentage-of-completion method of accounting involves the use of
various techniques to estimate expected costs at completion. These
estimates are based on Management's judgment and the Company's substantial
experience in developing these types of estimates.
(b) Capitalized Software
The costs incurred for the development of computer software that will be
sold, leased, or otherwise marketed are charged to expense when incurred as
research and development until technological feasibility has been
established for the product. Technological feasibility is typically
established upon completion of a detailed program design. Costs incurred
after this point are capitalized on a project-by-project basis in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed." Costs that are capitalized
primarily consist of external development costs. Upon general release of
the product to customers, the Company ceases capitalization and begins
amortization, which is calculated on a project-by-project basis as the
greater of (1) the ratio of current gross revenues for a product to the
total of current and anticipated future gross revenues for the product or
(2) the straight-line method over the estimated economic life of the
product. The Company generally amortizes the software development costs
over a three to seven year period based upon the estimated future economic
life of the product. Factors considered in determining the estimated future
economic life of the product include anticipated future revenues, and
changes in software and hardware technologies. The carrying values of
capitalized costs are evaluated for impairment on an annual basis to
determine if circumstances exist which indicate the carrying value of the
asset may not be recoverable. If expected cash flows are insufficient to
recover the carrying amount of the asset, then an impairment loss is
recognized to state the asset at its net realizable value.
3. EARNINGS PER SHARE (EPS)
Basic EPS is calculated using the weighted average number of common shares
outstanding during the period. Diluted EPS is calculated using the weighted
average number of common shares outstanding during the period plus shares
issuable upon the assumed exercise of dilutive common share options and
vesting of performance-accelerated restricted shares (restricted shares) by
using the treasury stock method. The number of shares used in the
calculation of earnings per share for each period presented is as follows
(in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
----------- ----------
2006 2005 2006 2005
------ ------ ------ ------
Weighted Average
Shares Outstanding -
Basic
25,790 25,424 25,678 25,442
Dilutive Options and
Restricted Shares
651 764 740 784
----- ----- ----- -----
Adjusted Shares- 26,441 26,188 26,418 26,226
Diluted ====== ====== ====== ======
Options to purchase 32,000 shares of common stock at a price of $54.88 and
options to purchase 8,000 shares of common stock at prices ranging from
$39.86 - $50.26 were outstanding during the three month periods ended June
30, 2006 and 2005, respectively, but were not included in the computation
of diluted EPS because the options' exercise prices were greater than the
average market price of the common shares. The options expire at various
periods through 2013. Approximately 12,000 and 38,000 restricted shares
were excluded from the respective computation of diluted EPS based upon the
application of the treasury stock method for the three month periods ended
June 30, 2006 and 2005, respectively.
4. SHARE-BASED COMPENSATION
Prior to October 1, 2005, the Company accounted for its stock option plans
using the intrinsic value method of accounting provided under APB Opinion
No. 25, "Accounting for Stock Issued to Employees," (APB 25) and related
interpretations, as permitted by FASB Statement No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) under which no compensation expense
was recognized for stock option grants. Accordingly, share-based
compensation for stock options was included as a pro forma disclosure in
the financial statement footnotes and continues to be provided for periods
prior to fiscal 2006.
Effective October 1, 2005, the Company adopted the fair value recognition
provisions of FASB Statement No. 123 (R), "Share-Based Payment," (SFAS
123(R)) using the modified-prospective transition method. Under this
transition method, compensation cost recognized in the first nine months of
fiscal 2006 includes:
a) compensation cost for all share-based payments granted through September
30, 2005, for which the requisite service period had not been completed as
of September 30, 2005, based on the grant date fair value estimated in
accordance with the original provisions of SFAS 123, and
b) compensation cost for all share-based payments granted subsequent to
September 30, 2005, based on the grant date fair value estimated in
accordance with the provisions of SFAS 123(R). Results for prior periods
have not been restated.
As a result of adopting SFAS 123(R) on October 1, 2005, the Company's net
earnings for the three and nine-month periods ended June 30, 2006 are $0.6
million and $1.7 million lower respectively, than if it had continued to
account for share-based compensation under APB 25.
The Company provides compensation benefits to certain key employees under
several share-based plans providing for employee stock options and/or
performance-accelerated restricted shares (restricted shares), and to
non-employee directors under a non-employee directors compensation plan.
Stock Option Plans
The Company has various stock option plans that permit the Company to grant
key Management employees (1) options to purchase shares of the Company's
common stock or (2) stock appreciation rights with respect to all or any
part of the number of shares covered by the options. All outstanding
options were granted at prices equal to fair market value at the date of
grant. The options granted prior to September 30, 2003 have a ten-year
contractual life from date of issuance, expiring in various periods through
2013. Beginning in fiscal 2004, the options granted have a five-year
contractual life from date of issuance. No stock appreciation rights have
been awarded to date. The Company's stock option awards are subject to
graded vesting over a three year service period. Beginning with fiscal 2006
awards, the Company recognizes compensation cost on a straight-line basis
over the requisite service period for the entire award. Prior to fiscal
2006, the Company calculated the pro forma compensation cost using the
graded vesting method (FIN 28 approach).
The fair value of each option award is estimated as of the date of grant
using a Black-Scholes option pricing model. The weighted average
assumptions for the periods indicated are noted below. Expected volatility
is based on historical volatility of ESCO's stock calculated over the
expected term of the option. The expected term was calculated in accordance
with Staff Accounting Bulletin No. 107 using the simplified method for
"plain-vanilla" options. The risk-free rate for the expected term of the
option is based on the U.S. Treasury yield curve in effect at the date of
grant.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the three month period ended June 30, 2006
and 2005, respectively: expected dividend yield of 0% in both periods;
expected volatility of 28.2% and 27.6%; risk-free interest rate of 5.0% and
3.7%; and expected term of 3.5 years and 4.17 years. Pre-tax compensation
expense related to the stock option awards was $0.6 million and $1.7
million for the third quarter of 2006 and the first nine months of 2006,
respectively.
The following summary presents information regarding outstanding stock
options as of June 30, 2006 and changes during the nine months then ended
with regard to options under the option plans:
Aggregate Weighted-Average
Intrinsic Remaining
Weighted Value (in Contractual
Shares Avg. Price millions) Life
------- ---------- --------- ----
Outstanding at
October 1, 2005 1,324,548 $20.48
Granted 320,380 $44.46
Exercised (185,561) $16.09 $6.1
Cancelled (25,740) $35.97
---------- --------
Outstanding at
June 30, 2006 1,433,627 $26.14 $38.9 4 years
-----------
Exercisable at
June 30, 2006 797,726 $16.23 $29.5
==========
The weighted-average grant-date fair value of options granted during the
first nine months of fiscal 2006 was $12.11.
During fiscal 2004, the Board of Directors authorized and the shareholders
approved, the 2004 Incentive Compensation Plan, which states, in part, that
on February 5, 2004, there shall be added to the authorized shares
allocated 2,000,000 shares for the grant of stock options, stock
appreciation rights, performance-accelerated restricted stock, or other
full value awards. Of these, shares up to 600,000 may be utilized for
performance-accelerated restricted stock or other full value awards.
Restricted Share Awards
At June 30, 2006, the maximum number of restricted shares available for
issue under the 2004 Incentive Compensation Plan and the 2001 Stock
Incentive Plan was 600,000 and 361,162 shares, respectively. These shares
vest over five years with accelerated vesting over three years if certain
performance targets are achieved. In these cases, if it is probable that
the performance condition will be met, the Company recognizes compensation
cost on a straight-line basis over the shorter performance period;
otherwise, it will recognize compensation cost over the longer service
period. Compensation cost for all outstanding restricted share awards is
being recognized over the shorter performance period as it is probable the
performance condition will be met. The restricted share award grants were
valued at the stock price on the date of grant. Pre-tax compensation
expense related to the restricted share awards was $0.2 million and $1.3
million for the three and nine-month periods ended June 30, 2006,
respectively, and $0.3 million and $1.6 million for the respective prior
year periods.
The following summary presents information regarding outstanding restricted
share awards as of June 30, 2006 and changes during the nine-month period
then ended:
Weighted
Shares Avg. Price
--------- -------------
Nonvested at October 1, 2005 238,436 $23.78
Granted 64,130 $43.02
Vested (118,736) $17.41
Cancelled (10,500) $32.78
--------- --------
Nonvested at June 30, 2006 173,330 $34.72
======
Non-Employee Directors Plan
The non-employee directors compensation plan includes a retainer of 800
common shares per quarter. Compensation expense related to the non-employee
directors was $0.2 million and $0.7 million for the three and nine-month
periods ended June 30, 2006, respectively, and $0.2 million and $0.5
million for the respective prior year periods.
The total share-based compensation cost that has been recognized in results
of operations and included within SG&A was $1.0 million and $3.7 million
for the three and nine-month periods ended June 30, 2006, respectively, and
$0.5 million and $2.1 million for the three and nine-month periods ended
June 30, 2005, respectively. The total income tax benefit recognized in
results of operations for share-based compensation arrangements was $0.3
million and $1.0 million for the three and nine-month periods ended June
30, 2006, respectively and $0.2 million and $0.7 million for the three and
nine-month periods ended June 30, 2005, respectively. As of June 30, 2006,
there was $9.0 million of total unrecognized compensation cost related to
share-based compensation arrangements. That cost is expected to be
recognized over a weighted-average period of 3.75 years.
Pro Forma Net Earnings
The following table provides pro forma net earnings and earnings per share
had the Company applied the fair value method of SFAS
123 for the three and nine-month periods ended June 30, 2005:
(Unaudited)
(Dollars in thousands,
except per share amounts)
Three Months Ended Nine Months Ended
June 30, June 30,
------------- ----------
2005 2005
------ ------
Net earnings, as reported $ 12,401 $ 33,351
Add: stock-based employee
compensation expense
included in reported
net earnings, net of tax
202 952
Less: total stock-based
employee compensation
expense determined
under fair value based
methods, net of tax
(704) (2,549)
------ --------
Pro forma net earnings $ 11,899 $ 31,754
====== =======
Net earnings per share:
Basic - as reported $ 0.49 $ 1.31
==== ===
Basic - pro forma 0.47 1.25
==== ====
Diluted - as reported $ 0.47 $ 1.27
==== ====
Diluted - pro forma 0.45 1.21
==== ====
5. ACQUISITIONS
Effective February 1, 2006, the Company acquired the capital stock of
Hexagram, Inc. (Hexagram) for a purchase price of $67.5 million subject to
a potential working capital adjustment. The acquisition agreement also
provides for contingent consideration of up to $6.25 million over the five
year period following the acquisition if Hexagram exceeds certain sales
targets. Hexagram is a RF fixed network automatic meter reading (AMR)
company headquartered in Cleveland, Ohio. Hexagram's annual revenue over
the past three years has been in the range of $20 million to $35 million.
The operating results for Hexagram, since the date of acquisition, are
included within the Communications segment. The Company recorded
approximately $55 million of goodwill and trademarks as a result of the
transaction, subject to post-closing adjustments including finalization of
purchase accounting. The Company also recorded $6.6 million of identifiable
intangible assets consisting primarily of patents and proprietary know-how,
customer contracts, and order backlog which will be amortized on a
straight-line basis over periods ranging from six months to seven years.
The post-closing purchase accounting items are expected to be completed
prior to September 30, 2006.
Effective November 29, 2005, the Company acquired Nexus Energy Software,
Inc. (Nexus) through an all cash for shares merger transaction for
approximately $29 million in cash plus contingent cash consideration over
the four year period following the merger if Nexus exceeds certain sales
targets. Nexus is a software company headquartered in Wellesley,
Massachusetts with annual revenues in the past in excess of $10 million.
The operating results for Nexus, since the date of acquisition, are
included within the Communications segment. The Company recorded
approximately $24 million of goodwill as a result of the transaction,
subject to post-closing adjustments including finalization of purchase
accounting. The Company also recorded $2.7 million of identifiable
intangible assets consisting primarily of customer contracts and order
backlog which will be amortized on a straight-line basis over periods
ranging from one year to three years. The post-closing purchase accounting
items are expected to be completed prior to September 30, 2006.
6. INVENTORIES
Inventories consist of the following (in thousands):
June 30, September 30,
2006 2005
---- ----
Finished goods $ 13,444 14,361
Work in process, including long- term
contracts 13,246 12,512
Raw materials 23,518 21,772
------ ------
Total inventories $ 50,208 48,645
====== ======
7. COMPREHENSIVE INCOME
Comprehensive income for the three-month periods ended June 30, 2006 and
2005 was $12.2 million and $11.2 million, respectively. Comprehensive
income for the nine-month periods ended June 30, 2006 and 2005 was $22.1
million and $34.0 million, respectively. For the three and nine-month
periods ended June 30, 2006, the Company's comprehensive income was
positively impacted by foreign currency translation adjustments of $1.1
million and $1.4 million, respectively. For the three and nine-month
periods ended June 30, 2005, the Company's comprehensive income was
negatively impacted by foreign currency translation adjustments of $1.2
million and positively impacted by foreign currency translation adjustments
of $0.7 million, respectively.
8. BUSINESS SEGMENT INFORMATION
The Company is organized based on the products and services that it offers.
Under this organizational structure, the Company operates in three
segments: Filtration/Fluid Flow, Communications and Test. The components of
the Filtration/Fluid Flow segment are presented separately due to differing
long-term economics.
Management evaluates and measures the performance of its operating segments
based on "Net Sales" and "EBIT", which are detailed in the table below.
EBIT is defined as earnings from continuing operations before interest and
taxes. During the second quarter of fiscal 2006, the Company changed its
reporting of goodwill and acquired intangible assets (including related
amortization) from operating segments to Corporate as they are excluded by
management in assessing the segment's operating performance. There was no
impact on EBIT in the prior periods.
($ in thousands) Three Months ended Nine Months ended
June 30, June 30,
---------- ----------
NET SALES 2006 2005 2006 2005
--------- ---- ---- ---- ----
PTI $ 11,379 10,262 $ 33,787 30,621
VACCO 6,551 9,616 22,930 28,787
Filtertek 24,628 24,774 72,335 70,223
-------- ------- ------- -------
Filtration/Fluid
Flow 42,558 44,652 129,052 129,631
Communications 49,251 31,141 111,623 100,759
Test 31,817 33,007 96,421 88,945
-------- --------- --------- ---------
Consolidated
totals $123,626 108,800 $337,096 319,335
======= ======= ======= =======
EBIT
----
PTI 1,479 585 4,261 2,821
VACCO 1,388 2,717 4,720 8,473
Filtertek 2,330 2,585 5,026 6,693
------- ------- ------- --------
Filtration/Fluid
Flow 5,197 5,887 14,007 17,987
Communications 11,369 8,192 20,138 28,446
Test 4,034 3,274 11,288 8,694
Corporate (4,552) (3,174) (10,728) (8,303)
-------- -------- --------- --------
Consolidated EBIT 16,048 14,179 34,705 46,824
Add: Interest income 195 534 1,012 1,317
---- ----- ------- -------
Earnings before
income taxes $ 16,243 14,713 $ 35,717 48,141
====== ====== ====== ======
9. ASSET IMPAIRMENT
In June 2005, the Company abandoned its plans to commercialize certain
sensor products within the Filtration/Fluid Flow segment. This action
resulted in an asset impairment charge of $0.8 million to write-off certain
patents and a related licensing agreement to their respective fair market
values. The Company ended its development efforts on this program after it
determined that the market was not developing as quickly as anticipated and
the expected costs and timeframe to fully commercialize the products were
not acceptable.
10. RETIREMENT AND OTHER BENEFIT PLANS
A summary of net periodic benefit expense for the Company's defined benefit
plans and postretirement healthcare and other benefits for the three and
nine-month periods ended June 30, 2006 and 2005 are shown in the following
tables. Net periodic benefit cost for each period presented is comprised of
the following:
Three Months Ended Nine Months Ended
June 30, June 30,
---------- ----------
(Dollars in thousands) 2006 2005 2006 2005
------- ------- ------- -------
Defined benefit plans
Interest cost $ 635 663 $ 1,935 1,988
Expected return on
assets (696) (713) (2,046) (2,138)
Amortization of:
Prior service cost 6 - 6 -
Actuarial loss 55 125 305 375
---- ----- ----- -----
Net periodic benefit cost $ - 75 $ 200 225
==== === === ===
Net periodic postretirement (retiree medical) benefit cost for each period
presented is comprised of the following:
Three Months Ended Nine Months Ended
June 30, June 30,
----------- -----------
(Dollars in thousands) 2006 2005 2006 2005
------ ------ ------ -------
Service cost $ 9 8 $ 26 23
Interest cost 10 10 30 30
Prior service cost (1) - (3) -
Amortization of (9) (5) (15) (14)
actuarial gain ---- ---- ---- ----
Net periodic
postretirement
benefit cost $ 9 13 $ 38 39
==== ==== ==== ====
11. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued FASB Staff Position FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004 (FSP 109-2)." The
American Jobs Creation Act of 2004, (the "Act") provides for a special
one-time deduction of 85 percent of certain foreign earnings repatriated
into the U.S. from non-U.S. subsidiaries through September 30, 2006. During
the second quarter ended March 31, 2006, the Company repatriated $28.7
million of foreign earnings which qualify for the special one-time
deduction. Tax expense of $1.7 million was recorded in the second quarter
of fiscal 2006 as a result of this repatriation.
The Company is currently evaluating the merits of repatriating additional
funds under the Act. At June 30, 2006, the range of reasonably possible
amounts of unremitted earnings that are being considered for repatriation
is between zero and $10.5 million, which would require the Company to pay
income taxes in the range of zero to $1.0 million. Federal income taxes on
the repatriated amounts would be based on the 5.25% effective statutory
rate as provided in the Act, plus applicable withholding taxes. To date,
the Company has not provided for income taxes on these unremitted earnings
generated by non-U.S. subsidiaries. As a result, additional taxes may be
required to be recorded for any funds repatriated under the Act. The
Company expects to complete its evaluation of these additional funds by
September 30, 2006.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109."
This Interpretation is effective for ESCO beginning October 1, 2007. This
Interpretation prescribes a recognition threshold and measurement process
for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. The Company is currently
evaluating the adoption of this Interpretation and does not currently have
an estimate of the impact on the consolidated financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following discussion refers to the Company's results from continuing
operations, except where noted. References to the third quarters of 2006 and
2005 represent the fiscal quarters ended June 30, 2006 and 2005, respectively.
NET SALES
Net sales increased $14.8 million, or 13.6%, to $123.6 million for the third
quarter of 2006 from $108.8 million for the third quarter of 2005 including $9.5
million from acquisitions. Net sales increased $17.8 million, or 5.6% to $337.1
million for the first nine months of fiscal 2006 from $319.3 for the first nine
months of fiscal 2005 including $17.2 million from acquisitions. Favorable
foreign currency values increased sales by approximately $1.1 million in the
third quarter of 2006 and unfavorable foreign currency values decreased sales by
approximately $0.6 million in the first nine months of fiscal 2006.
-Filtration/Fluid Flow
Net sales decreased $2.1 million, or 4.7%, to $42.6 million for the third
quarter of 2006 from $44.7 million for the third quarter of 2005. Net sales
decreased $0.5 million, or 0.4%, to $129.1 million for the first nine months of
fiscal 2006 from $129.6 million for the first nine months of fiscal 2005. The
sales decrease during the fiscal quarter ended June 30, 2006 as compared to the
prior year quarter is mainly due to the following: a decrease in defense spares
and T-700 shipments at VACCO of $3.0 million; a net sales decrease at Filtertek
of $0.2 million; partially offset by higher commercial aerospace shipments at
PTI of $1.1 million. The sales decrease for the first nine months of fiscal 2006
as compared to the prior year period is mainly due to the following: a decrease
in defense spares and T-700 shipments at VACCO of $5.9 million; partially offset
by higher commercial aerospace shipments at PTI of $3.2 million and a net sales
increase at Filtertek of $2.1 million driven by higher commercial shipments.
-Communications
Net sales increased $18.1 million, or 58.2%, to $49.2 million for the third
quarter of 2006 from $31.1 million for the third quarter of 2005. Net sales
increased $10.8 million, or 10.7%, to $111.6 million for the first nine months
of fiscal 2006 from $100.8 million in the prior year period. The sales increase
in the third quarter of 2006 as compared to the prior year quarter was due to
the following: $9.4 million of higher shipments of DCSI's automatic meter
reading (AMR) products; contributions by the Hexagram and Nexus acquisitions of
$7.0 million and $2.5 million, respectively; partially offset by $0.7 million of
lower shipments of Comtrak's SecurVision video security products.
The sales increase in the first nine months of fiscal 2006 as compared to the
prior year period was due to the following: $2.2 million of higher shipments of
DCSI's AMR products; $10.9 million in sales from Hexagram and $6.3 million in
sales from Nexus; partially offset by $8.5 million of lower shipments of
Comtrak's video security products.
The increase in sales of DCSI's AMR products of $2.2 million for the first nine
months of fiscal 2006 as compared to the prior year period was due to the
following items: an increase in sales to TXU Electric Delivery Company (TXU) of
$22.8 million in the first nine months of fiscal 2006; partially offset by $14.4
million of lower AMR product sales to the COOP market due to the decrease in
orders entered during the latter half of fiscal 2005 and $6.2 million of lower
sales to Puerto Rico Power Authority (PREPA).
Sales of SecurVision products were $1.5 million for the third quarter of 2006 as
compared to $2.3 million for the prior year third quarter and $4.4 million for
the first nine months of fiscal 2006 as compared to $12.9 million in the prior
year nine-month period. The decrease in sales in the third quarter and first
nine months of fiscal 2006 was due to an acceleration of shipments in the prior
year periods.
In June 2006, Hexagram announced it had appointed the Neptune Technology Group
as its exclusive distributor for the Hexagram STAR Wireless Fixed Network System
for the Water Utility, Water Sub-Metering and Government Markets in the
U.S.A., Canada, Mexico and Caribbean.
-Test
For the third quarter of 2006, net sales of $31.8 million were $1.2 million, or
3.6%, lower than the $33.0 million of net sales recorded in the third quarter of
fiscal 2005. Net sales increased $7.5 million, or 8.4%, to $96.4 million for the
first nine months of fiscal 2006 from $88.9 million for the first nine months of
fiscal 2005. The sales decrease in the third quarter of 2006 as compared to the
prior year quarter was mainly due to a decrease in government shielding projects
and the timing of large chamber projects in Japan.
The sales increase for the first nine months of fiscal 2006 compared to the
prior year period was primarily due to the following: a $9.8 million increase in
net sales from the Company's U.S. operations driven by sales of additional test
chambers and higher component sales; partially offset by a $1.1 million decrease
in net sales from the Company's European operations due to the prior year
completion of several large test chamber projects and a $1.2 million decrease in
net sales from the Company's Asian operations due to the timing of orders in
Japan.
ORDERS AND BACKLOG
Backlog was $260.0 million at June 30, 2006 compared with $233.1 million at
September 30, 2005. The Company received new orders totaling $109.1 million in
the third quarter of 2006. New orders of $49.6 million were received in the
third quarter of 2006 related to Filtration/Fluid Flow products, $29.7 million
related to Communications products and $29.8 million related to Test products.
The Company received new orders totaling $363.9 million in the first nine months
of 2006 compared to $321.6 million in the prior year period. New orders of
$134.0 million were received in the first nine months of 2006 related to
Filtration/Fluid flow products, $144.4 million related to Communications
products (including $9.4 million of new orders and $6.0 million of acquired
backlog from Hexagram and $14.6 million of new orders and $9.0 million of
acquired backlog from Nexus) and $85.6 million related to Test products. New
orders of $138.9 million were received in the first nine months of 2005 related
to Filtration/Fluid flow products, $100.1 million related to Communications
products and $82.6 million related to Test products.
In addition, in November 2005, DCSI signed an agreement with Pacific Gas &
Electric (PG&E) with an anticipated contract value of approximately $300 million
covering five million endpoints over a five year deployment period currently
scheduled to begin in fiscal 2007. The Company received orders totaling $2.4
million from PG&E under this agreement during the first nine months of 2006. On
November 3, 2005, Hexagram entered into a contract to provide equipment,
software and services to PG&E in support of the gas utility portion of PG&E's
AMI project. The total anticipated contract revenue from commencement through
the five-year full deployment for this Hexagram contract is expected to be
approximately $225 million. See "Pacific Gas & Electric."
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets was $2.6 million and $4.6 million for the
three and nine-month periods ended June 30, 2006, respectively, compared to $0.5
million and $1.5 million for the respective prior year periods. Amortization of
intangible assets in the third quarter of 2006 and first nine months of fiscal
2006 includes $1.0 million and $1.9 million, respectively, of amortization of
acquired intangible assets related to the Nexus and Hexagram acquisitions, as
described in Note 5 to the consolidated financial statements. The amortization
of acquired intangible assets related to Nexus and Hexagram are included in
Corporate's operating results. The remaining amortization expenses consist of
other identifiable intangible assets (primarily software, patents and licenses).
During the three and nine-month periods ended June 30, 2006, the Company
recorded $0.9 million and $1.2 million, respectively, of amortization related to
DCSI's TNG capitalized software.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative (SG&A) expenses for the third quarter of
2006 were $28.4 million (23.0% of net sales), compared with $21.7 million (19.9%
of net sales) for the prior year quarter. For the first nine months of 2006,
SG&A expenses were $78.6 million (23.3% of net sales) compared with $62.4
million (19.5% of net sales) for the prior year period. The increase in SG&A
spending in the fiscal quarter ended June 30, 2006 as compared to the prior year
quarter was primarily due to the following items: $2.7 million of SG&A expenses
related to Hexagram; $2.3 million of SG&A expenses related to Nexus; and $0.6
million of stock option expense. The increase in SG&A spending in the first nine
months of 2006 as compared to the prior year period was primarily due to the
following items: $5.1 million of SG&A expenses related to Nexus; $4.2 million of
SG&A expenses related to Hexagram; and $1.7 million of stock option expense.
OTHER (INCOME) EXPENSES, NET
Other income, net, was $0.5 million for the third quarter of 2006 compared to
$0.1 million for the prior year quarter. Other income, net, was $2.4 million for
the first nine months of fiscal 2006 compared to $1.2 million for the prior year
period. Principal components of other income, net, for the first nine months of
2006 included the following items: $1.8 million non-cash gain in the second
quarter representing the release of a reserve related to an indemnification
obligation with respect to a previously divested subsidiary; $1.6 million of
royalty income; partially offset by a $0.2 million write off of assets related
to a terminated subcontract manufacturer. The principal components of other
income, net, for the first nine months of fiscal 2005 included the following
items: $1.5 million of royalty income; and a $0.5 million write down of fixed
assets related to the termination of a supply agreement with a medical device
customer.
EBIT
The Company evaluates the performance of its operating segments based on EBIT,
defined below. EBIT was $16.0 million (13.0% of net sales) for the third quarter
of 2006 and $14.2 million (13.0% of net sales) for the third quarter of 2005.
For the first nine months of fiscal 2006, EBIT was $34.7 million (10.3% of net
sales) and $46.8 million (14.7% of net sales) for the first nine months of
fiscal 2005. The decrease in EBIT for the first nine months of 2006 as compared
to the prior year period is primarily due to the decrease in margins in the
Communications segment described below.
This Form 10-Q contains the financial measure "EBIT", which is not calculated in
accordance with generally accepted accounting principles in the United States of
America (GAAP). EBIT provides investors and Management with an alternative
method for assessing the Company's operating results. The Company defines "EBIT"
as earnings from continuing operations before interest and taxes. Management
evaluates the performance of its operating segments based on EBIT and believes
that EBIT is useful to investors to demonstrate the operational profitability of
the Company's business segments by excluding interest and taxes, which are
generally accounted for across the entire Company on a consolidated basis. EBIT
is also one of the measures Management uses to determine resource allocations
within the Company and incentive compensation. The following table represents a
reconciliation of EBIT to net earnings.
Three Months ended Nine Months ended
June 30, June 30,
($ in thousands) ----------- -----------
2006 2005 2006 2005
---- ---- ---- ----
EBIT $16,048 14,179 $34,705 46,824
Interest income 195 534 1,012 1,317
Less: Income taxes 5,080 2,312 15,006 14,790
------- ------- --------- --------
Net earnings $11,163 12,401 $20,711 33,351
====== ====== ======= ======
-Filtration/Fluid Flow
EBIT was $5.2 million (12.2% of net sales) and $5.9 million (13.2% of net sales)
in the third quarters of 2006 and 2005, respectively, and $14.0 million (10.9%
of net sales) and $18.0 million (13.9% of net sales) in the first nine months of
fiscal 2006 and 2005, respectively. For the third quarter of 2006 as compared to
the prior year quarter, EBIT decreased $0.7 million due to the following: a $1.3
million decrease at VACCO due to lower defense spares shipments; a $0.3 million
decrease at Filtertek; partially offset by a $0.9 million increase at PTI due to
continued strengthening of the commercial aerospace market. For the first nine
months of fiscal 2006 as compared to the prior year period, EBIT decreased $4.0
million due to the following: a $3.8 million decrease at VACCO due to lower
defense spares shipments; a $1.7 million decrease at Filtertek; partially offset
by a $1.4 million increase at PTI. Filtertek's third quarter and first nine
months of fiscal 2005 included $1.0 million and $1.9 million, respectively, of
cost reimbursement related to a supply agreement with a medical device customer
which was terminated in fiscal 2005. In the third quarter of fiscal 2005, PTI
recorded an asset impairment charge of $0.8 million. See Note 9 to the
consolidated financial statements for further discussion.
-Communications
EBIT in the third quarter of 2006 was $11.4 million (23.2% of net sales)
compared to EBIT of $8.2 million (26.4% of net sales) in the prior year quarter.
For the first nine months of fiscal 2006, EBIT was $20.1 million (18.0% of net
sales) compared to $28.4 million (28.2% of net sales) in the prior year period.
The increase in EBIT in the third quarter of 2006 was due to the following
items: a $3.6 million increase at DCSI resulting from increased sales; a $0.6
million increase related to Hexagram; partially offset by a $0.6 million EBIT
loss at Nexus due to customer delays and a $0.4 million decrease at Comtrak due
to lower shipments of its video security products. The decrease in EBIT for the
first nine months of fiscal 2006 compared to the prior year period was mainly
due to the following items: a $4.5 million decrease at DCSI due to product mix,
charges related to subcontractor and warranty issues recorded in the first
quarter of 2006 and amortization of TNG software; a $3.6 million decrease at
Comtrak due to lower shipments of its video security products; a $0.7 million
EBIT loss at Nexus due to customer delays and additional SG&A spending related
to marketing and new product development initiatives; partially offset by a $0.6
million increase related to Hexagram.
-Test
EBIT in the third quarter of 2006 was $4.0 million (12.6% of net sales) as
compared to $3.3 million (10.0% of net sales) in the prior year quarter. For the
first nine months of fiscal 2006, EBIT was $11.3 million (11.7% of net sales) as
compared to $8.7 million (9.8% of net sales) in the prior year period. EBIT
increased $0.7 million and $2.6 million over the prior year quarter and nine
month period, respectively, due to the favorable changes in sales mix resulting
from additional sales of test chambers, antennas and other components. In
addition, EBIT in the first nine months of fiscal 2005 was adversely affected by
installation cost overruns incurred on certain government shielding projects in
foreign locations, as well as increased material costs (steel and copper).
-Corporate
Corporate costs included in EBIT were $4.6 million and $10.7 million for the
three and nine-month periods ended June 30, 2006, respectively, compared to $3.2
million and $8.3 million for the respective prior year periods. In the third
quarter of 2006, Corporate costs included the following: $1.0 million of pre-tax
amortization of acquired intangible assets related to Nexus and Hexagram; and
$0.6 million of pre-tax stock option expense. In the first nine months of 2006,
Corporate costs included the following: $1.9 million of pre-tax amortization of
acquired intangible assets related to Nexus and Hexagram; $1.7 million of
pre-tax stock option expense; partially offset by a $1.8 million non-cash gain
representing the release of a reserve related to an indemnification obligation
with respect to a previously divested subsidiary.
INTEREST INCOME, NET
Interest income, net, was $0.2 million and $1.0 million for the three and
nine-month periods ended June 30, 2006, respectively, compared to interest
income, net, of $0.5 million and $1.3 million for the respective prior year
periods. The decrease in interest income in the third quarter of 2006 as
compared to the prior year quarter was due to lower average cash balances on
hand.
INCOME TAX EXPENSE
The third quarter 2006 effective income tax rate was 31.3% compared to 15.7% in
the third quarter of 2005. The effective income tax rate in the first nine
months of fiscal 2006 was 42.0% compared to 30.7% in the prior year period. The
third quarter 2006 income tax expense was favorably impacted by a $1.0 million
research tax credit. The effect of the research tax credit impacted the third
quarter 2006 rate by 6.0%. The increase in the effective income tax rate in the
first nine months of fiscal 2006 as compared to the prior year period was also
affected by the impact of repatriating $28.7 million of cash held by foreign
subsidiaries into the United States under the tax provisions of the American
Jobs Creation Act of 2004. The effect of the repatriation impacted the fiscal
2006 second quarter effective income tax expense by $1.7 million and the
effective rate by 10.9%. In addition, lower volume of profit contributions of
the Company's foreign operations (primarily Puerto Rico due to the lower sales
to PREPA) impacted the tax rate. The third quarter 2005 income tax rate was
impacted by an adjustment to income tax expense due to the Company finalizing
certain foreign tax returns in June; an adjustment to the 2005 tax provision
resulting from higher foreign sourced pretax income; and a favorable state tax
rate adjustment. The third quarter 2005 effective tax rate, absent the
adjustments mentioned above, would have been approximately 33%. The Company
estimates the annual effective tax rate for fiscal 2006 to be approximately 41%.
During the third quarter of 2006, the Company began an analysis of available
research tax credits and filed its 2005 U.S. tax return which included a $1.0
million research credit. Under current law, the research tax credit expired for
research expenditures incurred after December 31, 2005. The Company expects that
a research credit of $0.2 million will be reflected in its 2006 U.S. income tax
return. The Company will continue to evaluate the amount of research credit that
is available for years prior to 2005 and expects that this evaluation will be
completed by September 30, 2006.
CAPITAL RESOURCES AND LIQUIDITY
Working capital (current assets less current liabilities) decreased to $122.7
million at June 30, 2006 from $202.2 million at September 30, 2005. During the
first nine months of 2006, cash decreased $69.2 million, primarily due to the
approximately $91 million, net, paid for the Nexus and Hexagram acquisitions
offset by cash generated by operations. Accounts receivable increased by $13.9
million in the first nine months of 2006, of which $5.9 million related to the
acquisitions of Nexus and Hexagram; $3.5 million related to the Filtration
segment due to timing and volume of sales; and $3.5 million related to DCSI due
to timing of sales. Accounts payable increased by $17.6 million in the first
nine months of 2006, of which $1.7 million related to the acquisitions of Nexus
and Hexagram and $10.0 million related to DCSI due to timing of vendor payments.
Net cash provided by operating activities was $47.4 million and $45.4 million
for the nine-month periods ended June 30, 2006 and 2005, respectively.
Capital expenditures were $6.8 million and $6.6 million in the first nine months
of fiscal 2006 and 2005, respectively. Major expenditures in the current period
included manufacturing equipment used in the Filtration/Fluid Flow businesses.
At June 30, 2006, other assets (non-current) of $63.8 million included $39.5
million of capitalized software. Approximately $34.9 million of the capitalized
software balance represents external development costs on software development
called "TNG" within the Communications segment to further penetrate the investor
owned utility (IOU) market. TNG is being developed in conjunction with a third
party software contractor. TNG is being deployed to efficiently handle the
additional levels of communications dictated by the size of the service
territories and the frequency of reads that are required under time-of-use or
critical peak pricing scenarios needed to meet the requirements of large IOUs.
At June 30, 2006, the Company had approximately $4 million of commitments
related to TNG version 1.6 which is expected to be spent over the next three
months. The Company expects to spend up to $7 million in fiscal 2007 on TNG.
Amortization of TNG is on a straight-line basis over seven years and began in
March 2006. The Company has recorded $1.2 million in amortization expense
related to TNG in the first nine months of fiscal 2006.
The closure and relocation of the Filtertek Puerto Rico facility was completed
in March 2004. The Puerto Rico facility is included in other current assets with
a carrying value of $3.6 million at June 30, 2006. The facility is being
marketed for sale.
In October 2004, the Company entered into a $100 million five-year revolving
bank credit facility with a $50 million increase option that has a final
maturity and expiration date of October 6, 2009. At June 30, 2006, the Company
had approximately $99.2 million available to borrow under the credit facility in
addition to $35.3 million cash on hand. At June 30, 2006, the Company had no
borrowings, and outstanding letters of credit of $1.7 million ($0.8 million
outstanding under the credit facility). On February 1, 2006, the Company
borrowed $47 million to partially fund the acquisition of Hexagram which was
subsequently repaid from the foreign cash repatriation by March 31, 2006. The
interest rate on this debt was approximately 5.3%. During April 2006, the
Company borrowed $5 million which was subsequently repaid prior to April 30,
2006. The interest rate on this debt was 7.75%. Cash flow from operations and
borrowings under the Company's bank credit facility are expected to meet the
Company's capital requirements and operational needs for the foreseeable future.
Acquisitions
Effective February 1, 2006, the Company acquired the capital stock of Hexagram,
Inc. (Hexagram) for a purchase price of $67.5 million subject to a potential
working capital adjustment. The acquisition agreement also provides for
contingent consideration of up to $6.25 million over the five year period
following the acquisition if Hexagram exceeds certain sales targets. Hexagram is
a RF fixed network AMR company headquartered in Cleveland, Ohio. Hexagram's
annual revenue over the past three years has been in the range of $20 million to
$35 million. The operating results for Hexagram, since the date of acquisition,
are included within the Communications segment. The Company recorded
approximately $55 million of goodwill and trademarks as a result of the
transaction, subject to post-closing adjustments including finalization of
purchase accounting. The Company also recorded $6.6 million of identifiable
intangible assets consisting primarily of patents and proprietary know-how,
customer contracts, and order backlog which will be amortized on a straight-line
basis over periods ranging from six months to seven years. The post-closing
purchase accounting items are expected to be completed prior to September 30,
2006.
Effective November 29, 2005, the Company acquired Nexus Energy Software, Inc.
(Nexus) through an all cash for shares merger transaction for approximately $29
million in cash plus contingent cash consideration over the four year period
following the merger if Nexus exceeds certain sales targets. Nexus is a software
company headquartered in Wellesley, Massachusetts with annual revenues in the
past in excess of $10 million. The operating results for Nexus, since the date
of acquisition, are included within the Communications segment. The Company
recorded approximately $24 million of goodwill as a result of the transaction,
subject to post-closing adjustments including finalization of purchase
accounting. The Company also recorded $2.7 million of identifiable intangible
assets consisting of customer contracts and backlog value which will be
amortized on a straight-line basis over periods ranging from one year to three
years. The post-closing purchase accounting items are expected to be completed
prior to September 30, 2006.
Pacific Gas & Electric
On November 7, 2005, the Company announced that DCSI had entered into a contract
to provide equipment, software and services to Pacific Gas & Electric (PG&E) in
support of the electric portion of PG&E's Advanced Metering Infrastructure (AMI)
project. PG&E's current AMI project plan calls for the purchase of TWACS
communication equipment for approximately five million electric customers over a
five-year period after the commencement of full deployment. The total
anticipated contract value from commencement through the five-year full
deployment period is expected to be approximately $300 million. PG&E has the
right to purchase additional equipment and services to support existing and new
customers through the twenty to twenty-five year term of the contract. Equipment
will be purchased by PG&E only upon issuance of purchase orders and release
authorizations. PG&E will continue to have the right to purchase products or
services from other suppliers for the electric portion of the AMI project. Full
deployment is contingent upon satisfactory system testing, and final PG&E
management approval, all of which are currently expected to be concluded during
fiscal 2007. On July 20, 2006, the California Public Utilities Commission
approved PG&E's AMI project. DCSI has agreed to deliver to PG&E versions of its
newly developed TNG software as they become available and are tested. Acceptance
of the final version for which DCSI has committed is currently anticipated in
the latter portion of fiscal 2007. Until such acceptance is obtained, the
Company will be required under U.S. financial accounting standards to defer
revenue recognition. The contract provides for liquidated damages in the event
of DCSI's late development or delivery of hardware and software, and includes
indemnification and other customary provisions. The contract may be terminated
by PG&E for default, for its convenience and in the event of a force majeure
lasting beyond certain prescribed periods. The Company has guaranteed the
obligations of DCSI under the contract. If PG&E terminates the contract for its
convenience, DCSI will be entitled to recover certain costs.
On November 3, 2005, Hexagram entered into a contract to provide equipment,
software and services to PG&E in support of the gas utility portion of PG&E's
AMI project. The total anticipated contract revenue from commencement through
the five-year full deployment is expected to be approximately $225 million. As
with DCSI's contract with PG&E, discussed above, equipment will be purchased
only upon issuance of purchase orders and release authorizations, and PG&E will
continue to have the right to purchase products or services from other suppliers
for the gas utility portion of the AMI project. Full deployment is contingent
upon satisfactory system testing, and final PG&E management approval, which are
expected to be concluded during fiscal 2006. On July 20, 2006, the California
Public Utilities Commission approved PG&E's AMI project. The contract provides
for liquidated damages in the event of late deliveries, includes indemnification
and other customary provisions, and may be terminated by PG&E for default, for
its convenience and in the event of a force majeure lasting beyond certain
prescribed periods. The Company has guaranteed the performance of the contract
by Hexagram.
CRITICAL ACCOUNTING POLICIES
Management has evaluated the accounting policies used in the preparation of the
Company's financial statements and related notes and believes those policies to
be reasonable and appropriate. Certain of these accounting policies require the
application of significant judgment by Management in selecting appropriate
assumptions for calculating financial estimates. By their nature, these
judgments are subject to an inherent degree of uncertainty. These judgments are
based on historical experience, trends in the industry, information provided by
customers and information available from other outside sources, as appropriate.
The most significant areas involving Management judgments and estimates may be
found in the Critical Accounting Policies section of Management's Discussion and
Analysis and in Note 1 to the Consolidated Financial Statements contained in the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2005 at Exhibit 13, as supplemented by Note 2 to the Consolidated Financial
Statements in Item 1 hereof.
OTHER MATTERS
Contingencies
As a normal incident of the businesses in which the Company is engaged, various
claims, charges and litigation are asserted or commenced against the Company. In
the opinion of Management, final judgments, if any, which might be rendered
against the Company in current litigation are adequately reserved, covered by
insurance, or would not have a material adverse effect on its financial
statements.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued FASB Staff Position FAS 109-2, "Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004 (FSP 109-2)." The American Jobs Creation Act
of 2004, (the "Act") provides for a special one-time deduction of 85 percent of
certain foreign earnings repatriated into the U.S. from non-U.S. subsidiaries
through September 30, 2006. During the second quarter ended March 31, 2006, the
Company repatriated $28.7 million of foreign earnings which qualify for the
special one-time deduction. Tax expense of $1.7 million was recorded in the
second quarter of fiscal 2006 as a result of this repatriation.
The Company is currently evaluating the merits of repatriating additional funds
under the Act. At June 30, 2006, the range of reasonably possible amounts of
unremitted earnings that are being considered for repatriation is between zero
and $10.5 million, which would require the Company to pay income taxes in the
range of zero to $1.0 million. Federal income taxes on the repatriated amounts
would be based on the 5.25% effective statutory rate as provided in the Act,
plus applicable withholding taxes. To date, the Company has not provided for
income taxes on these unremitted earnings generated by non-U.S. subsidiaries. As
a result, additional taxes may be required to be recorded for any funds
repatriated under the Act. The Company expects to complete its evaluation of the
repatriation of these additional funds by September 30, 2006.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109." This
Interpretation is effective for ESCO beginning October 1, 2007. This
Interpretation prescribes a recognition threshold and measurement process for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. The Company is currently evaluating the
adoption of this Interpretation and does not currently have an estimate of the
impact on the consolidated financial statements.
FORWARD LOOKING STATEMENTS
Statements in this report that are not strictly historical are "forward looking"
statements within the meaning of the safe harbor provisions of the federal
securities laws. Forward looking statements include those relating to the
estimates or projections made in connection with the Company's accounting
policies, annual effective tax rate, research tax credits, timing of
Communications segment commitments and expenditures, outcome of current claims
and litigation, future cash flow, capital requirements and operational needs for
the foreseeable future, the ultimate values and timing of revenues under the
DCSI / PG&E contract and the Hexagram / PG&E contract, the start of deployment
under the Company's PG&E contracts, the future delivery and acceptance of the
TNG software by PG&E, timing of spending for TNG commitments, completion of
Hexagram and Nexus post-closing purchase accounting items, the amounts, if any,
and timing of additional foreign earnings repatriated into the U.S. and the
additional taxes resulting from such repatriation. Investors are cautioned that
such statements are only predictions, and speak only as of the date of this
report. The Company's actual results in the future may differ materially from
those projected in the forward-looking statements due to risks and uncertainties
that exist in the Company's operations and business environment including, but
not limited to: PG&E's Board of Directors and PG&E's management impacting PG&E's
AMI projects; the timing and success of DCSI's software development efforts; the
timing and content of purchase order releases under PG&E's contracts; the
Company's successful performance under the PG&E contracts; weakening of economic
conditions in served markets; changes in customer demands or customer
insolvencies; competition; intellectual property rights; successful execution of
the planned sale of the Company's Puerto Rico facility; material changes in the
costs of certain raw materials including steel, copper and petroleum based
resins; delivery delays or defaults by customers; termination for convenience of
customer contracts; timing and magnitude of future contract awards; performance
issues with key suppliers, customers and subcontractors; collective bargaining
and labor disputes; changes in laws and regulations including changes in
accounting standards and taxation requirements; changes in foreign or U.S.
business conditions affecting the distribution of foreign earnings; costs
relating to environmental matters; litigation uncertainty; and the Company's
successful execution of internal operating plans.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to the Company's operations result primarily from changes
in interest rates and changes in foreign currency exchange rates. There has been
no material change to the Company's risks since September 30, 2005. Refer to the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2005 for further discussion about market risk.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of Management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based upon that evaluation, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were effective as of that date. Disclosure controls and
procedures are controls and procedures that are designed to ensure that
information required to be disclosed in Company reports filed or submitted under
the Securities Exchange Act of 1934 (the "Exchange Act") is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. There has been no change in the Company's
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) during the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In August 2004, the Company's Board of Directors approved the extension of the
previously authorized (February 2001) open market common stock repurchase
program originally authorizing up to 2.6 million shares, which is subject to
market conditions and other factors and covers the period through September 30,
2006. At June 30, 2006, the Company had 1,152,966 shares remaining for
repurchase under this program. There were no stock repurchases during the first
nine months of fiscal 2006.
ITEM 6. EXHIBITS
a) Exhibits
Exhibit
Number
3.1 Restated Articles of Incorporated by reference
Incorporation to Form 10-K for the
fiscal year ended
September 30, 1999, at
Exhibit 3(a)
3.2 Amended Certificate of Incorporated by reference
Designation Preferences to Form 10-Q for the
and Rights of Series A fiscal quarter ended March
Participating Cumulative 31, 2000, at Exhibit 4(e)
Preferred Stock of the
Registrant
3.3 Articles of Merger Incorporated by reference
effective July 10, 2000 to Form 10-Q for the
fiscal quarter ended June
30, 2000, at Exhibit 3(c)
3.4 Bylaws, as amended and Incorporated by reference
restated. to Form 10-K for the
fiscal year ended
September 30, 2003, at
Exhibit 3.4
4.1 Specimen Common Stock Incorporated by reference
Certificate to Form 10-Q for the
fiscal quarter ended June
30, 2000, at Exhibit 4(a)
4.2 Specimen Rights Incorporated by reference
Certificate to Current Report on Form
8-K dated February 3,
2000, at Exhibit B to
Exhibit 4.1
4.3 Rights Agreement dated Incorporated by reference
as of September 24, 1990 to Current Report on Form
(as amended and Restated 8-K dated February 3,
as of February 3, 2000) 2000, at Exhibit 4.1
between the Registrant
and Registrar and
Transfer Company, as
successor Rights Agent
4.4 Credit Agreement dated Incorporated by reference to
as of October 6, 2004 Form10-K for the fiscal year
among the Registrant, ended September 30, 2004, at
Wells Fargo Bank, Exhibit 4.4
N.A., as agent, and
the lenders listed
therein
4.5 Consent and waiver to Incorporated by reference to
Credit Agreement Current Report on Form 8-K
(listed as 4.4, above) dated February 2, 2006 at
dated as of January Exhibit 4.1
20, 2006
31.1 Certification of Chief
Executive Officer
relating to Form 10-Q
for period ended June
30, 2006
31.2 Certification of Chief
Financial Officer
relating to Form 10-Q
for period ended June
30, 2006
32 Certification of Chief
Executive Officer and
Chief Financial
Officer relating to
Form 10-Q for period
ended June 30, 2006
SIGNATURE
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.
ESCO TECHNOLOGIES INC.
/s/ Gary E. Muenster
Gary E. Muenster
Senior Vice President and Chief Financial Officer
(As duly authorized officer and principal accounting
officer of the registrant)
Dated: August 9, 2006