<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the nine months ended July 31, 1998 Commission file number 0-13880
ENGINEERED SUPPORT SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Missouri 43-1313242
(State of Incorporation) (IRS Employer Identification Number)
1270 North Price Road, St. Louis, Missouri 63132
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (314) 993-5880
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
----- -----
The number of shares of the Registrant's common stock, $.01 par value,
outstanding at August 31, 1998 was 4,856,082.
<PAGE> 2
<TABLE>
ENGINEERED SUPPORT SYSTEMS, INC.
INDEX
<CAPTION>
Page
----
<S> <C>
Part I - Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of July 31, 1998 and
October 31, 1997 3
Condensed Consolidated Statements of Income for the three and nine months
ended July 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows for the three and nine
months ended July 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Part II - Other Information
Items 1-6 12
Signatures 13
Exhibits 14
</TABLE>
2
<PAGE> 3
<TABLE>
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<CAPTION>
July 31 October 31
1998 1997
----------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 4,742,551 $ 8,313,160
Accounts receivable 9,558,881 3,398,973
Contracts in process and inventories 19,244,765 7,072,377
Other current assets 1,864,454 1,423,620
----------- -----------
Total Current Assets 35,410,651 20,208,130
Property, plant and equipment, less accumulated
depreciation of $15,381,658 and $14,767,236 27,172,391 14,490,049
Intangible assets 25,396,787 825,406
Other assets 941,292 1,560,469
----------- -----------
Total Assets $88,921,121 $37,084,054
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 6,454,174 $ 73,273
Accounts payable 4,801,088 5,596,760
Other current liabilities 7,850,664 2,978,407
----------- -----------
Total Current Liabilities 19,105,926 8,648,440
Long-term debt 38,705,201 1,194,433
Deferred income taxes 2,642,295 2,642,295
ESOP guaranteed bank loan 762,600 873,300
Shareholders' Equity
Common stock, par value $.01 per share; 10,000,000
shares authorized; 5,422,104 and 3,772,573 shares issued 54,221 37,726
Additional paid-in capital 10,466,227 9,698,665
Retained earnings 21,583,781 18,026,195
----------- -----------
32,104,229 27,762,586
Less ESOP guaranteed bank loan 762,600 873,300
Less treasury stock at cost, 621,772 and 598,858 shares 3,636,530 3,163,700
----------- -----------
27,705,099 23,725,586
----------- -----------
Total Liabilities and Shareholders' Equity $88,921,121 $37,084,054
=========== ===========
See notes to condensed consolidated financial statements.
</TABLE>
3
<PAGE> 4
<TABLE>
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<CAPTION>
Three Months Ended Nine Months Ended
July 31 July 31
-------------------------- ---------------------------
1998 1997 1998 1997
-------------------------- ---------------------------
<S> <C> <C> <C> <C>
Net revenues $24,927,269 $23,926,087 $64,177,114 $67,508,389
Cost of revenues 19,047,032 19,852,518 49,344,649 56,640,821
----------- ----------- ----------- -----------
Gross profit 5,880,237 4,073,569 14,832,465 10,867,568
Selling, general and administrative
expense 3,035,326 1,935,323 7,943,372 5,534,028
----------- ----------- ----------- -----------
Income from operations 2,844,911 2,138,246 6,889,093 5,333,540
Interest expense (income) 434,919 (23,411) 742,861 5,747
----------- ----------- ----------- -----------
Income before income taxes 2,409,992 2,161,657 6,146,232 5,327,793
Income tax provision 963,000 864,000 2,456,000 2,129,000
----------- ----------- ----------- -----------
Net income $ 1,446,992 $ 1,297,657 $ 3,690,232 $ 3,198,793
=========== =========== =========== ===========
Basic earnings per share $.30 $.27 $.77 $.67
=========== =========== =========== ===========
Diluted earnings per share $.29 $.26 $.74 $.65
=========== =========== =========== ===========
See notes to condensed consolidated financial statements.
</TABLE>
4
<PAGE> 5
<TABLE>
ENGINEERED SUPPORT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<CAPTION>
Nine Months Ended
July 31
-------------------------------
1998 1997
----------- ----------
<S> <C> <C>
From operating activities:
Net income $3,690,232 $3,198,793
Depreciation and amortization 1,906,899 1,421,428
Gain on sale of assets (151,125)
----------- ----------
Cash provided (used) before changes in operating
assets and liabilities 5,446,006 4,620,221
Net (increase) decrease in non-cash current assets (100,823) 4,407,801
Net increase (decrease) in non-cash current liabilities (2,242,549) (760,981)
(Increase) decrease in other assets 988,767 180,856
----------- ----------
Net cash provided by (used in) operating activities 4,091,401 8,447,897
----------- ----------
From investing activities:
Purchase of Marlo Coil, net of cash acquired (25,314,467)
Purchase of Keco Industries, net of cash acquired (22,731,913)
Purchase of manufacturing and distribution rights for
McIntyre Engineering products (1,367,192)
Additions to property, plant and equipment (1,116,706) (1,497,893)
Proceeds from sale of property, plant and equipment 151,125
----------- ----------
Net cash provided by (used in) investing activities (50,379,153) (1,497,893)
----------- ----------
From financing activities:
Net payments under line-of-credit agreement (1,075,961)
Payments of long-term debt (1,267,706) (1,439,691)
Proceeds of long-term debt 45,000,000
Purchase of treasury stock (495,652) (957,091)
Exercise of stock options 689,108 516,228
Cash dividends (132,646) (78,911)
----------- ----------
Net cash provided by (used in) financing activities 42,717,143 (1,959,465)
----------- ----------
Net increase (decrease) in cash and cash equivalents (3,570,609) 4,990,539
Cash and cash equivalents at beginning of period 8,313,160 1,415,773
----------- ----------
Cash and cash equivalents at end of period $4,742,551 $6,406,312
=========== ==========
See notes to condensed consolidated financial statements.
</TABLE>
5
<PAGE> 6
ENGINEERED SUPPORT SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
JULY 31, 1998
NOTE A - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared by the Company without audit. In the opinion of management, all
adjustments (including normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three and
nine month periods ended July 31, 1998 are not necessarily indicative of the
results to be expected for the entire fiscal year.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial statements and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. For further information, refer
to the consolidated financial statements and footnotes thereto included in
the Company's annual report to shareholders for the year ended October 31,
1997.
NOTE B - EARNINGS PER SHARE
All earnings per share amounts have been computed after giving effect
to the stock split described in Note E. Average diluted common shares
outstanding include common stock equivalents, which represent common stock
options as computed based on the treasury stock method.
Basic earnings per share for the three months ended July 31, 1998 and
1997 is based on average basic common shares outstanding of 4,790,372 and
4,726,484, respectively. Diluted earnings per share for the three months
ended July 31, 1998 and 1997 is based on average diluted common shares
outstanding of 5,019,260 and 4,929,858, respectively.
Basic earnings per share for the nine months ended July 31, 1998 and
1997 is based on average basic common shares outstanding of 4,766,985 and
4,755,138, respectively. Diluted earnings per share for the nine months
ended July 31, 1998 and 1997 is based on average diluted common shares
outstanding of 4,985,906 and 4,945,067, respectively.
NOTE C - CONTRACTS IN PROCESS AND INVENTORIES
Contracts in process and inventories of Engineered Air Systems, Inc.
and Keco Industries, Inc. represent accumulated contract costs, estimated
earnings thereon based upon the percentage of completion method and contract
inventories reduced by the contract value of delivered items. Inventories of
Engineered Specialty Plastics, Inc. and Engineered Coil Company are valued at
the
6
<PAGE> 7
lower of cost or market using the first-in, first-out method. Contracts
in process and inventories are comprised of the following:
<TABLE>
<CAPTION>
July 31, 1998 October 31, 1997
------------- ----------------
<S> <C> <C>
Raw materials $4,208,511 $1,535,860
Work-in-process 1,362,890 167,043
Finished goods 575,754 804,956
Inventories substantially applicable to
government contracts in process, less
progress payments of $13,145,417 and
$9,333,930, respectively 13,097,610 4,564,518
----------- ----------
$19,244,765 $7,072,377
=========== ==========
</TABLE>
NOTE D - ACQUISITIONS
On February 1, 1998, Engineered Coil Company, a wholly-owned subsidiary
of the Company, acquired substantially all of the net assets of Nuclear
Cooling, Inc., d/b/a Marlo Coil, a manufacturer of heat transfer and air
movement equipment, for approximately $25.4 million, including acquisition
costs. The fair value of assets acquired, including goodwill of $17.0
million, was $31.0 million and liabilities assumed totaled $5.6 million. The
purchase price was financed with approximately $2.9 million of available cash
resources and bank term debt of $22.5 million.
On June 24, 1998, the Company acquired all of the outstanding stock of
Keco Industries, Inc., a manufacturer of military ground support equipment,
for $25.6 million, including acquisition costs. (The purchase agreement also
provides for an additional payment if the Company elects treatment of the
transaction pursuant to Section 338(h)(10) of the Internal Revenue Code. The
Company will make this election if it determines that the resulting income
tax benefits exceed the additional purchase price. No consideration for this
election is included in the purchase price above). The fair value of the
assets acquired, including goodwill of $6.9 million, was $28.0 million and
liabilities assumed totaled $2.4 million. The purchase price was financed
with approximately $3.1 million of available cash resources and bank term
debt of $22.5 million.
The following unaudited pro forma summary presents the combined
historical results of operations for the nine months ended July 31, 1998 and
1997 as adjusted to reflect the purchase transactions assuming the
acquisitions had occurred at November 1, 1996. These pro forma results are
not necessarily indicative of the combined results that would have occurred
had the acquisitions actually taken place on November 1, 1996, nor are they
necessarily indicative of the combined results that may occur in the future.
7
<PAGE> 8
<TABLE>
<CAPTION>
Nine Months Ended
July 31
-------
1998 1997
----------- ------------
<S> <C> <C>
Net revenues $97,281,453 $120,903,665
=========== ============
Net income $3,843,809 $3,760,693
=========== ============
Basic earnings per share $.81 $.79
=========== ============
Diluted earnings per share $.77 $.76
=========== ============
</TABLE>
NOTE E - STOCK SPLIT
On June 26, 1998, the Company effected a 3-for-2 stock split in the
form of a 50% stock dividend. All earnings per share amounts in this Form
10-Q have been restated to reflect this stock split.
8
<PAGE> 9
ENGINEERED SUPPORT SYSTEMS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net Revenues. Net revenues increased 4.2% in the third quarter of 1998
to $24.9 million from $23.9 million in the third quarter of 1997, and
decreased 4.9% to $64.2 million in the first nine months of 1998 from $67.5
million in the comparable 1997 period.
Net revenues from DoD contracts and sales of commercial air handling
equipment decreased by $0.6 million to $17.5 million for the third quarter of
1998 from $18.1 million for the prior year period. This was despite an
additional $7.4 million of net revenues generated by Marlo Coil, which was
acquired February 1, 1998, and an additional $3.2 million of net revenues
generated by Keco Industries, Inc. (Keco), which was acquired June 24, 1998.
Net revenues from sales of injection molded plastic products increased $1.6
million to $7.4 million for the third quarter of 1998 from $5.8 million in
the prior year.
Net revenues for the nine months ended July 31, 1998 decreased by 4.9%
to $64.2 million from $67.5 million for the comparable period in 1997. This
decrease was due primarily to the fact that several significant DoD contracts
completed, or were nearing completion of, their production cycles, including
those for Aviation Ground Power Units, C-5/MA-3D Flight Line Air
Conditioners, Harvest Falcon Water Distribution Systems and Revetment Kits.
Net revenues from DoD contracts and sales of commercial air handling
equipment decreased by $4.1 million to $44.4 million for the first nine
months of 1998 from $48.5 million for the prior year period. This was
despite an additional $14.6 million of net revenues generated by Marlo Coil
and an additional $3.2 million generated by Keco subsequent to their
respective acquisitions. Although several major contracts, primarily the
Chemical/Biological Protected Shelter System (CBPSS), the
Chemically/Biologically Hardened Air Management Plant (CHAMP), and the Field
Deployable Environmental Control Units (FDECU), underwent significant
engineering and development efforts during the nine months ended July 31,
1998, substantial revenues derived from the production phases of these
contracts are not expected to begin until fiscal 1999. Net revenues from
sales of injection molded plastic products increased $0.8 million to $19.8
million for the first nine months of 1998 from $19.0 million in the
comparable 1997 period.
Gross Profit. Gross profit for the third quarter of 1998 increased
44.4% to $5.9 million (23.6% of net revenues) from $4.1 million (17.0% of net
revenues) in the prior year. Gross profit for the first nine months of 1998
increased 36.5% to $14.8 million (23.1% of net revenues) from $10.9 million
(16.1% of net revenues) for the comparable period in 1997. These increases
were primarily the result of higher margins within the Company's historical
operations due to a more profitable mix of contracts and products, as well as
the addition of Marlo Coil which generated gross margins above those provided
by the Company's historical operations.
9
<PAGE> 10
Selling, General and Administrative Expense. Selling, general and
administrative expense increased by $1.1 million to $3.0 million (12.2% of
net revenues) for the quarter ended July 31, 1998 from $1.9 million (8.1% of
net revenues) for the third quarter of 1997, and increased by $2.4 million to
$7.9 million (12.4% of net revenues) for the nine months ended July 31, 1998
from $5.5 million (8.2% of net revenues) for the comparable period in 1997.
These increases were due to the addition of selling, general and
administrative expense generated by the two businesses acquired.
Net Interest Expense. Net interest expense increased by $0.5 million
to $0.4 million for the quarter ended July 31, 1998 and by $0.7 million to
$0.7 million for the nine months ended July 31, 1998 as compared to the
respective prior year periods. These increases were a result of debt
incurred in conjunction with the Marlo Coil and Keco acquisitions.
Income Tax Provision. The effective income tax rate for the three and
nine month periods ended July 31, 1998 and 1997 was 40.0%.
Net Income. As a result of the forgoing, the net income of the Company
increased by 11.5% to $1.4 million (5.8% of net revenues) for the quarter
ended July 31, 1998 from $1.3 million (5.4% of net revenues) for the third
quarter of 1997, and increased by 15.4% to $3.7 million (5.8% of net
revenues) for the nine months ended July 31, 1998 from $3.2 million (4.7% of
net revenues) for the comparable period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
In March 1998, the Company restated and amended its credit facility to
provide a $45.0 million term loan to finance the Marlo Coil and Keco
acquisitions and to provide a $10.0 million revolving credit facility.
Principal payments on the term loan are scheduled to begin September 1, 1998,
with the final payment due May 1, 2003. The Company may choose an interest
rate calculated at either LIBOR plus an applicable margin or at the prime
rate less 0.5%. The margin applicable to LIBOR varies from 0.5% to 1.5%
depending upon the Company's ratio of total indebtedness to earnings before
interest, taxes, depreciation and amortization (leverage ratio).Pursuant to
the terms of the related and amended credit facility, the Company is subject
to various financial and operating covenants. Although the Company is
currently in compliance with all such covenants, the failure of the Company
to comply with any of these covenants would constitute a default which, if
not timely corrected or waived, could result in an acceleration of the
maturity of certain of the debt obligations of the Company.
The Company's primary sources of short-term financing are from cost
reimbursements under contracts with the U.S. government via receipt of
progress payments, billings for delivered products and bank borrowings under
its $10.0 million revolving line of credit. On July 31, 1998, the Company's
working capital and ratio of current assets to current liabilities were $16.3
million and 1.85 to 1. The Company generated $4.1 million and $8.4 million
in cash flow from operations in the nine months ended July 31, 1998 and 1997,
respectively, which was used, in part, to finance investment in property,
plant and equipment of $1.1 million and $1.5 million, respectively, in such
periods. During the first nine months of 1998, the Company also acquired
substantially all of the net assets of Marlo Coil for $25.4 million and all
of the capital stock of Keco for $25.6 million. These acquisitions were
financed
10
<PAGE> 11
with term loan borrowings under the restated and amended credit facility and
available cash resources. See Note D of the July 31, 1998 condensed
consolidated financial statements for further discussion.
BUSINESS AND MARKET CONSIDERATIONS
Approximately 56% of consolidated net revenues for the nine months
ended July 31, 1998 were derived from defense orders by the U.S. government
and its agencies. (This percentage will increase as a result of the Keco
acquisition.) As of July 31, 1998, the Company's combined backlog of defense
orders at Engineered Air, Marlo Coil and Keco totaled $74.9 million, with
related government options of an additional $359.2 million.
Management continues to pursue potential acquisitions, primarily of
those companies providing strategic consolidation within the defense
industry.
11
<PAGE> 12
PART II
OTHER INFORMATION
Items 1-5 Not applicable.
Item 6(a) Exhibits
4. (i) Registration Statement Number 33-14504 on Form S-8
dated May 22, 1987 for the registration of 340,000
shares of Engineered Support Systems, Inc. common
stock, $.01 par value, pursuant to the Amended and
Restated Engineered Air Systems, Inc. Employee
Equity Plan, is incorporated herein by reference.
(ii) Registration Statement Number 33-77338 on Form S-8
dated March 25, 1994 for the registration of
150,000 shares of Engineered Support Systems, Inc.
common stock, $.01 par value, pursuant to the
Engineered Support Systems, Inc. Inc. 1993 Stock
Option Plan, is incorporated herein by reference.
(iii) Registration Statement Number 333-27695 on Form S-8
dated May 23, 1997 for the registration of 50,000
shares of Engineered Support Systems, Inc. common
stock, $.01 par value, pursuant to the Engineered
Support Systems, Inc. 1997 Stock Option Plan for
Non-employee Directors, is incorporated herein by
reference.
(iv) Registration Statement Number 333-52753 on Form S-8
dated May 15, 1998 for the registration of 400,000
shares of Engineered Support Systems, Inc. common
stock, $.01 par value, pursuant to the Engineered
Support Systems, Inc. 1998 Stock Option Plan, is
incorporated herein by reference.
(v) Restated and Amended Credit Agreement dated as of
March 17, 1998 and between the Several Lenders From
Time to Time Party Hereto and Nations Bank N.A., as
agent, and Engineered Support Systems, Inc. and its
subsidiaries.
11. Statement Re: Computation of Earnings Per Share.
27. Statement Re: Summary Financial Information
(b) Form 8-K/A, amendments 1 and 2, were filed on July 2 and August
13, 1998 related to the acquisition of Keco Industries, Inc.
12
<PAGE> 13
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENGINEERED SUPPORT SYSTEMS, INC.
Date: September 4, 1998 By: /s/ Michael F. Shanahan Sr.
----------------------------- ------------------------------------
Michael F. Shanahan Sr.
Chairman of the Board, President
and Chief Executive Officer
Date: September 4, 1998 By: /s/ Gary C. Gerhardt
----------------------------- ------------------------------------
Gary C. Gerhardt
Executive Vice President and
Chief Financial Officer
13
<PAGE> 1
<TABLE>
Exhibit 11
ENGINEERED SUPPORT SYSTEMS, INC.
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
<CAPTION>
Three Months Ended Nine Months Ended
July 31 July 31
------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
NET INCOME $1,446,992 $1,297,657 $3,690,232 $3,198,793
========== ========== ========== ==========
BASIC EARNINGS PER SHARE
Average shares outstanding 4,790,372 4,726,484 4,766,985 4,755,138
========== ========== ========== ==========
$.30 $.27 $.77 $.67
========== ========== ========== ==========
DILUTED EARNINGS PER SHARE
Average shares outstanding 4,790,372 4,726,484 4,766,985 4,755,138
Net effect of dilutive stock options<F1> 228,888 203,374 218,921 189,929
---------- ---------- ---------- ----------
5,019,260 4,929,858 4,985,906 4,945,067
========== ========== ========== ==========
$.29 $.26 $.74 $.65
========== ========== ========== ==========
<FN>
<F1> Based on the treasury stock method.
</TABLE>
14
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM
10-Q FOR THE NINE MONTHS ENDED JULY 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-01-1997
<PERIOD-END> JUL-31-1998
<CASH> 4,742,551
<SECURITIES> 0
<RECEIVABLES> 9,758,381
<ALLOWANCES> 199,500
<INVENTORY> 19,244,765
<CURRENT-ASSETS> 35,410,651
<PP&E> 42,554,049
<DEPRECIATION> 15,381,658
<TOTAL-ASSETS> 88,921,121
<CURRENT-LIABILITIES> 19,105,926
<BONDS> 39,467,801
<COMMON> 54,221
0
0
<OTHER-SE> 27,650,878
<TOTAL-LIABILITY-AND-EQUITY> 88,921,121
<SALES> 64,177,114
<TOTAL-REVENUES> 64,177,114
<CGS> 49,344,649
<TOTAL-COSTS> 49,344,649
<OTHER-EXPENSES> 7,952,872
<LOSS-PROVISION> (9,500)
<INTEREST-EXPENSE> 742,861
<INCOME-PRETAX> 6,146,232
<INCOME-TAX> 2,456,000
<INCOME-CONTINUING> 3,690,232
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,690,232
<EPS-PRIMARY> .77
<EPS-DILUTED> .74
</TABLE>
