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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period _________ to _________
Commission file number: 1-10596
ESCO Electronics Corporation
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Missouri 43-1554045
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
8888 Ladue Road, Ste. 200
St. Louis, Missouri 63124-2090
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(314) 213-7200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each
Exchange on
Title of Each Class Which Registered
------------------- ----------------
Common Stock Trust Receipts New York Stock
Exchange, Inc.
Common Stock, par value $0.01 per New York Stock
share Exchange, Inc.
Preferred Stock Purchase Rights New York Stock
Exchange, Inc.
(Cover page 1 of 2 pages)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
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 filing requirements
for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form l0-K or any amendment to
this Form l0-K. [X]
Aggregate market value of the Common Stock Trust Receipts held by non-affiliates
of the registrant as of close of business on December 18, 1998:
$104,266,488.*
* For purpose of this calculation only, without
determining whether the following are affiliates of the
registrant, the registrant has assumed that (i) its
directors and executive officers are affiliates, and (ii)
no party who has filed a Schedule 13D or 13G is an affiliate.
Number of Common Stock Trust Receipts outstanding at December 18, 1998:
12,267,321 Receipts.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the registrant's Annual Report to Stockholders for fiscal year
ended September 30, 1998 (the "1998 Annual Report") (Parts I and II).
2. Portions of the registrant's Proxy Statement dated December 4, 1998 (Part
III).
(Cover page 2 of 2 pages)
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ESCO ELECTRONICS CORPORATION
INDEX TO ANNUAL REPORT ON FORM 10-K
Item Description Page
--------------------------------------------------------------- ----
Part I
1. Business .............................................. 1
The Company .......................................... 1
Products ............................................. 1
Marketing and Sales .................................. 4
Government Defense Contracts ......................... 5
Intellectual Property ................................ 6
Backlog .............................................. 7
Purchased Components and Raw Materials ............... 7
Competition .......................................... 7
Research and Development ............................. 8
Environmental Matters ................................ 8
Employees ............................................ 9
Financing ............................................ 9
History of the Business .............................. 9
Forward-Looking Information .......................... 10
2. Properties ............................................ 11
3. Legal Proceedings ..................................... 12
4. Submission of Matters to a Vote of Security Holders ... 13
Executive Officers of the Registrant .......................... 13
Part II
5. Market for the Registrant's Common Equity and Related
Stockholder Matters ................................... 13
6. Selected Financial Data ............................... 14
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................... 14
7A. Quantitative and Qualitative Disclosures About
Market Risk ........................................... 14
8. Financial Statements and Supplementary Data ........... 14
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................... 14
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Item Description Page
- ---- ----------- ----
Part III
10. Directors and Executive Officers of the Registrant .... 14
11. Executive Compensation ................................ 14
12. Security Ownership of Certain Beneficial Owners and
Management ............................................ 15
13. Certain Relationships and Related Transactions ........ 15
Part IV
14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K ........................................... 15
SIGNATURES ...................................................... 20
INDEX TO EXHIBITS ............................................... 21
II
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PART I
ITEM 1. BUSINESS
THE COMPANY
ESCO Electronics Corporation ("ESCO") is a holding company for the
following-listed operating subsidiaries: Distribution Control Systems, Inc.
("DCSI"), EMC Test Systems, L.P. ("ETS"), Euroshield OY, Filtertek Inc.
("Filtertek"), Filtertek BV, Filtertek de Puerto Rico, Inc., Filtertek SA, PTI
Technologies Inc. ("PTI"), PTI Advanced Filtration Inc. ("PTI Advanced"), PTI
Technologies Limited ("PTI Limited"), Rantec Microwave & Electronics, Inc.
("Rantec"), Systems & Electronics Inc. ("SEI"), and VACCO Industries ("VACCO").
These operating subsidiaries are subsidiaries of Defense Holding Corp.
("DHC"), a wholly-owned direct subsidiary of ESCO. ESCO and its direct and
indirect subsidiaries are hereinafter referred to collectively as the
"Company".
The above-listed operating subsidiaries are engaged in the research,
development, manufacture, sale and support of a wide variety of commercial and
defense systems and products. Commercial items are supplied to a variety of
customers worldwide. Defense items principally are supplied to the United States
Government under prime contracts with the Army, Navy and Air Force and under
subcontracts with their prime contractors, and are also sold to foreign
customers. The Company's businesses are subject to a number of risks and
uncertainties, including without limitation those discussed below. See Item 3.
"Legal Proceedings" and "Management's Discussion and Analysis" appearing in the
1998 Annual Report.
On December 31, 1997, ESCO acquired Euroshield OY, a company located in
Eura, Finland. On July 1, 1998, ESCO acquired Advanced Membrane Technology,
Inc., based in San Diego, California, and renamed that company "PTI Advanced
Filtration Inc."
PRODUCTS
The Company operates in two principal industry segments: commercial and
defense. See Note 11 of the Notes to Consolidated Financial Statements in the
1998 Annual Report, which Note is herein incorporated by reference.
COMMERCIAL PRODUCTS
-------------------
The Company's commercial products are described below.
FILTRATION/FLUID FLOW
---------------------
PTI, PTI Advanced and PTI Limited develop and manufacture a wide range of
filtration products. PTI is a leading supplier of filters to the commercial
aerospace market. PTI's industrial business includes the supply of filtration
solutions to the industrial and mobile fluid power markets and petrochemical
processing industry. PTI also manufactures microfiltration products used in a
variety of commercial markets and applications. The filtration membranes for
many of these applications are, or will be, produced by PTI Advanced, which also
supplies filtration systems for use in the dairy industry and in industrial
paint operations. PTI Limited manufactures and distributes filter products
primarily in the European industrial marketplace. In fiscal year 1998, PTI
formed a joint venture in India, known as "SANMAR-PTI Filters Limited," with
SANMAR Engineering Corporation to manufacture and sell filtration products for
the Indian and other international markets. VACCO and PTI jointly develop and
manufacture industrial filtration elements and systems primarily
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used within the petrochemical and nuclear industries, where a premium is placed
on superior performance in a harsh environment. VACCO supplies latch valves,
check valves and filters to the aerospace industry, primarily for use in
satellite propulsion systems. VACCO also uses its etched disk technology to
produce quiet valves and manifolds for U.S. Navy applications.
Filtertek develops and manufactures a broad range of high-volume, original
equipment manufacturer ("OEM") filtration products at its facilities in North
America, South America and Europe. Filtertek's products, which are centered
around its insert injection-molding technology wherein a filter medium is
inserted into the tooling prior to injection-molding of the filter housing, have
widespread applications in the medical and health care markets, automotive fluid
systems, and other commercial and industrial markets. A typical application can
require daily production of many thousands of units, at very high levels of
quality, and is generally produced in highly-automated manufacturing cells. Many
of Filtertek's products are patented or incorporate proprietary product or
process design, or both. In fiscal year 1998, Filtertek introduced a number of
new products, including an automotive transmission sump filter and products for
medical intravenous ("I.V.") application. Products with applications in water
filtration, blood filtration and fuel filtration are nearing completion of
development, with market introduction planned in fiscal year 1999.
COMMUNICATIONS/TEST
-------------------
ETS designs and manufactures electromagnetic compatibility ("EMC") test
equipment. It also supplies controlled radio frequency testing environments
(anechoic chambers), shielded rooms for high security data processing and secure
communication, and electromagnetic absorption materials. ETS's products include
antennas, antenna masts, turntables, current probes, field probes, TEM
(transverse electromagnetic) cells, GTEM (gigahertz transverse electromagnetic)
cells, shielded rooms and boxes, microwave absorber, calibration equipment and
other test accessories required to do EMC testing. ETS also provides all the
design, program management and integration services required to supply customers
with turnkey EMC solutions. Euroshield OY designs and manufactures a broad range
of modular shielding systems and shielded doors, some of which are proprietary,
for the world market. It also provides the design, program management and
integration services to supply the European market with turnkey EMC solutions.
DCSI is a leading manufacturer of two-way power line communication systems
for the utility industry. These systems provide the electric utilities with a
patented communication technology for demand-side management, distribution
automation, and automatic meter reading capabilities, thus improving the
efficiency of power delivery to the consumer of electric energy. In fiscal year
1998, DCSI, through its Puerto Rican subsidiary, received orders in excess of
$50 million from Puerto Rico Electric Power Authority for the first phase of an
automatic meter reading system. Although there is no guaranty of additional
orders, future island-wide implementation of this system is expected to result
in a total project value in excess of $100 million extending over a 5-8 year
time period.
Rantec designs and manufactures antennas and antenna feeds for wireless
communications applications, including an electronically-scanned antenna used
for control and navigation of air traffic. Rantec has developed and produced a
commercial satellite cross-link antenna for use on the IRIDIUM1 system, a
fully-operational global telephone system. Rantec also produces satellite
antenna systems for use on commercial aircraft for in-flight entertainment, both
audio and video. In addition, Rantec has developed and is currently supplying
antennas for local multi-point distribution system ("LMDS") communications.
Rantec is currently developing power supplies for use in the
telecommunications market.
___________________________
1IRIDIUM is a registered trademark and service mark of IRIDIUM LLC.
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OTHER INDUSTRIAL /GOVERNMENT PRODUCTS
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SEI supplies electronic sorting and material handling equipment to the
United States Postal Service and other customers.
Rantec designs and manufactures various power supplies, principally for
high resolution computer and avionics displays and other industrial and medical
equipment. In fiscal year 1998, Rantec began deliveries of a miniaturized, high
voltage power supply for the emerging field emissive display market.
Filtertek, through its Tek Packaging Division, produces special thermoform
packaging for the medical, electronics, commercial and retail markets.
The Comtrak Division of SEI has applied its expertise in image processing
and target recognition to develop a proprietary video security monitoring system
which should have applications in commercial and industrial security systems.
Currently, Comtrak is working jointly with ADT Security Services, Inc. to field
test this sytem, and initial sales are expected in fiscal year 1999. Comtrak
also has extensive experience in the design and manufacture of location systems.
Comtrak used this technological expertise to develop a vehicle location,
tracking and communications system which will have applications in theft
deterrence, fleet management and messaging communications.
DEFENSE PRODUCTS
----------------
The Company's defense products are described below. Current activity
includes the development of new products as well as production of existing
products and support in the form of spare parts and service.
DEFENSE ELECTRONICS
-------------------
Defense electronics equipment is designed and manufactured by SEI and
Rantec. These subsidiaries primarily produce a diverse mix of military equipment
which includes, but is not limited to, the following product lines:
* SEI designs and manufactures launching and guidance systems (fire
support systems) utilizing electro-optic technology for anti-armor
missiles. These systems are manufactured in differing configurations
for installation on a variety of helicopters, armored vehicles and
light wheeled vehicles. SEI has also developed the Mission Equipment
Package ("MEP") for the Bradley Fire Support Team Vehicle ("BFIST"),
which is used to direct artillery fire, locate enemy targets and
provide vehicle self-location. In fiscal year 1997, SEI was awarded a
contract for the Army's new "STRIKER" system, a program that
integrates the BFIST MEP and an advanced surveillance sensor package
on the High-mobility Multi-purpose Wheeled Vehicle ("HUMVEE"). In May
1998, SEI delivered the first STRIKER system to the U.S. Army.
STRIKER is expected to have a number of applications in the ground
forces of the U.S. and its allies.
* SEI produces airborne radar systems for ground mapping, weather
imaging, terrain following and fire control applications. All of these
products have completed the production phase and are currently being
upgraded or are in the spares support phase.
* SEI also supplies a lightweight Man-portable Surveillance and Target
Acquisition Radar ("MSTAR") that detects and classifies moving
personnel, vehicles, low-flying aircraft and artillery round impact.
MSTAR has multiple applications as a stand-alone radar and as the radar
component of an integrated sensor suite.
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* Automatic test equipment ("ATE") for ground support of radar and other
avionics equipment is also produced by SEI. SEI is currently developing a
High Power Device Test ("HPDT") system which will be a part of the U.S.
Navy's family of avionics test equipment. In addition, Mobile Electronic
Test Sets ("METS") that are utilized for testing equipment on high
performance fighter aircraft and specialized military transport aircraft
are being upgraded or are in the spares support phase. SEI also provides
interface adapters and test program software to meet the needs of each
particular unit under test.
* Rantec produces microwave antennas and antenna mounting and positioning
systems for airborne radar, missile guidance, electronic warfare,
military air traffic control and communications. Rantec also produces
power systems for use in electronic warfare and cockpit display
systems.
DEFENSE SYSTEMS
---------------
SEI supplies light, medium and heavy transportation systems and weapon
subsystems to the armed forces. Currently in production is a multiple-wheeled
trailer with individually-steerable axles for transporting battle tanks and
other large loads (the "M1000"). SEI also supplies high-capacity aircraft cargo
loaders which aid in rapid tactical and strategic deployment. The first
production deliveries of the 60,000 pound capacity Tunner aircraft cargo loader
developed for the U.S. Air Force were made in late fiscal year 1997. In fiscal
year 1998, this loader completed the U.S. Air Force Initial Operational Test and
Evaluation, and 38 loaders have been delivered to date. The total Air Force
requirement for the loader is expected to exceed 300 units, making this loader
an important program at SEI for the foreseeable future. However, although this
is a high-priority Air Force program, there can be no assurance that orders will
be placed to meet this requirement. SEI also produces light and heavy tactical
bridging systems.
MARKETING AND SALES
The Company's commercial products generally are distributed to OEMs and
aftermarket users through a domestic and foreign network of distributors, sales
representatives and factory salespersons. Utility communication systems are sold
directly to the electric utilities.
The Company's defense products predominantly are sold directly or
indirectly to the U.S. Government under contracts with the Army, Navy and Air
Force and subcontracts with prime contractors of such entities. Direct and
indirect sales to the U.S. Government accounted for approximately 41%, 44%, and
53% of the Company's total sales in the fiscal years ended September 30, 1998,
1997 and 1996, respectively. The percentage figure for fiscal year 1996 includes
16% attributable to U.S. Government sales of Hazeltine Corporation, a former
subsidiary of ESCO which was sold to GEC-Marconi Electronic Systems Corporation
("GEC-Marconi") in July 1996. See Notes 2 and 11 of the Notes to Consolidated
Financial Statements in the 1998 Annual Report, which Notes are herein
incorporated by reference.
For its defense products, the Company maintains a domestic field
marketing/sales network with offices located in the Washington, D.C. area and at
several major U.S. Government defense procurement centers. The Washington, D.C.
office carries out legislative activities, and conducts customer liaison
activities with all branches of the U.S. armed services and with foreign
government offices in the Washington, D.C. area. The primary responsibility for
individual products or programs is handled within the product line
organizations, with the field organization providing closely coordinated
assistance.
International sales accounted for approximately 16%, 18% and 33% of the
Company's total sales in the fiscal years ended September 30, 1998, 1997 and
1996, respectively. The decrease in fiscal year 1998 was primarily due to lower
Far East sales at SEI, partially offset by increased European sales at
Filtertek. The decrease in fiscal year 1997 was primarily due to the divestiture
of Hazeltine and lower
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Middle East sales at SEI. Hazeltine's international sales in the fiscal year
ended September 30, 1996 amounted to 13% of the Company's total sales. See Notes
2 and 11 of the Notes to Consolidated Financial Statements in the 1998 Annual
Report. The majority of these international sales involve defense products.
Since most of the Company's foreign export sales involve technologically
advanced products, services and expertise, U.S. export control regulations limit
the types of products and services that may be offered and the countries and
governments to which sales may be made. The Department of State issues and
maintains the International Traffic in Arms Regulations pursuant to the Arms
Export Control Act. Pursuant to these regulations, certain products and services
cannot be exported without obtaining a license from the Department of State.
Most of the defense products that the Company sells abroad cannot be sold
without such a license. Consequently, the Company's international sales may be
adversely affected by changes in the U.S. Government's export policy or by any
suspension or revocation of the Company's foreign export control licenses.
In addition, the Company's international sales are subject to risks
inherent in foreign commerce, including currency fluctuations and devaluations,
the risk of war, changes in foreign governments and their policies, differences
in foreign laws, uncertainties as to enforcement of contract rights, and
difficulties in negotiating and litigating with foreign sovereigns.
GOVERNMENT DEFENSE CONTRACTS
A portion of the Company's defense contracts with the U.S. Government and
subcontracts with prime contractors of the U.S. Government are firm fixed-price
contracts. Under firm fixed-price contracts, work is performed and paid for at a
fixed amount without adjustment for the actual costs experienced in connection
with the contracts. Therefore, unless the customer actually or constructively
alters or impedes the work performed, all risk of loss due to cost overruns is
borne by the Company. All Government prime contracts and virtually all of the
Company's subcontracts provide that they may be terminated at the convenience of
the Government. Upon such termination, the Company is normally entitled to
receive the purchase price for delivered items, reimbursement for allowable
costs incurred and allocable to the contract (which do not include many ordinary
costs of doing business in a commercial context) and an allowance for profit on
the allowable costs incurred or adjustment for loss if completion of performance
would have resulted in a loss. The Company is also normally entitled to
reimbursement of the cost it incurs to prepare and to negotiate a settlement of
the termination for convenience.
In addition, the Company's prime and subcontracts provide for termination
for default if the Company fails to perform or breaches a material obligation.
In the event of a termination for default, the customer may have the unilateral
right at any time to require the Company to return unliquidated progress
payments pending final resolution of the propriety of the termination for
default. If the customer purchases the same or similar products from a third
party, the Company may also have to pay the excess, if any, of the cost of
purchasing the substitute items over the contract price in the terminated
contract. A customer, if it has suffered other ascertainable damages as a result
of a sustained default, could demand payment of such damages by the Company.
The Company incurs significant work-in-progress costs in the performance of
U.S. Government contracts. However, the Company is usually entitled to invoice
the Government for monthly progress payments. The current progress payment rate
is 75%; however, there is no assurance that this rate will not change in the
future. Any reduction in the rate would increase the amount of working capital
required for these contracts. The Government does not recognize interest expense
as an allowable contract expenditure; therefore, a progress payment rate
decrease may have an adverse effect on the Company's cash flow and
profitability.
The Company's backlog includes firm fixed-price U.S. Government contracts,
development
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programs and production programs in their early phases. These programs have
inherently high risks associated with design, first article testing and customer
acceptance. The profitability of such programs cannot be assured, and they could
represent exposure to the Company. In the event of development or production
problems that are not actually or constructively caused by the customer, the
Company would have the responsibility for proposing and providing curative
action with no additional compensation. In the event the customer does not
accept the curative action or the curative action does not succeed, the contract
could be terminated for default.
In connection with the Company's U.S. Government business, the Company is
also subject to Government investigations of its policies, procedures and
internal controls for compliance with procurement regulations and applicable
laws. The Company may be subject to downward contract price adjustments, refund
obligations or civil and criminal penalties, and suspension or debarment from
Government contracting. It is the Company's policy to cooperate with the
Government in any investigations of which it has knowledge, but the outcome of
any such Government investigations cannot be predicted with certainty.
As a U.S. Government contractor, the Company faces additional risks,
including dependence on Congressional appropriations and administrative
allotment of funds, changes in Governmental policies which may reflect military
and political developments, substantial time and effort required for design and
development, significant changes in contract scheduling, complexity of designs
and the rapidity with which products become obsolete due to technological
advances, constant necessity for design improvements, intense competition for
available Government business, and difficulty of forecasting costs and schedules
when bidding on developmental and highly sophisticated technical work (possibly
resulting in unforeseen technological difficulties and/or cost overruns).
Foreign sales involve additional risks due to possible changes in economic and
political conditions. See "Marketing and Sales" above.
As a U.S. Government contractor, the Company's recognition of revenue is
based upon certain accounting policies described in Notes 1(d) and 1(f) of the
Notes to Consolidated Financial Statements in the 1998 Annual Report, which
Notes are herein incorporated by reference. The Company's revenues are impacted
by the timing of the receipt of orders during the year, which may cause
fluctuations in quarterly sales comparisons on a year-to-year basis. The Company
periodically reviews contracts in the ordinary course to ascertain if customer
actions or inactions have caused or will cause increased costs. In the past, the
Company has submitted requests for equitable adjustments ("REAs") and claims
seeking additional compensation, which involved substantial amounts of money.
Currently, the Company has no such REAs or claims outstanding. However, in the
future, to the extent any such REAs and claims are finally resolved for less
than the amounts anticipated, the Company's financial position and operating
results could be adversely affected.
INTELLECTUAL PROPERTY
The Company owns or has other rights in various forms of intellectual
property (i.e., patents, trademarks, copyrights, mask works and other items).
However, the Company believes that, although in its commercial business certain
patents are significant with respect to certain products, currently its
business, taken as a whole, is not materially dependent on intellectual property
rights. With respect to patents in particular, most of the Company's U.S.
Government contracts authorize it to use U.S. patents owned by others if
necessary in performing such contracts. Corresponding provisions in Government
contracts awarded to other companies make it impossible for the Company to
prevent others from using its patents in most domestic defense work. As the
Company expands its presence in commercial markets, it is placing a greater
emphasis on developing intellectual property and protecting its rights therein.
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BACKLOG
The backlog of firm orders was approximately $292.7 million at September
30, 1998 and approximately $225.0 million at September 30, 1997. As of September
30, 1998, it is estimated that: (i) commercial business accounted for
approximately 57% of the firm orders and defense business accounted for
approximately 43%, and (ii) domestic customers accounted for approximately 85%
of the firm orders and foreign customers accounted for approximately 15%. Of the
total backlog of orders at September 30, 1998, approximately 80% (including all
commercial orders) is expected to be completed in the fiscal year ending
September 30, 1999.
PURCHASED COMPONENTS AND RAW MATERIALS
The Company's products require a wide variety of components and materials.
Although the Company has multiple sources of supply for most of its material
requirements, certain components are supplied by sole-source vendors, and the
Company's ability to perform certain contracts depends on their performance. In
the past, these required raw materials and various purchased components
generally have been available in sufficient quantities.
COMPETITION
The Company faces intense competition from a large number of firms for
nearly all of its products. Although the Company is a leading supplier in
several of the markets it serves, the Company maintains a relatively small share
of the business in many of the markets in which it participates. Because of the
diversity and specialized nature of the Company's products, it is impossible to
state precisely its competitive position with respect to each of its products.
Substantial efforts are required in order to maintain existing business levels.
In filtration/ fluid flow, EMC test and commercial communications markets,
competition is driven primarily by quality, price, technology and delivery
performance. The principal competitive factors in the defense markets are price,
service, quality, technical expertise and the ability to design and manufacture
products to desired specifications. For most of its defense products and many of
its commercial products, the Company's competitors are larger and have greater
financial resources than the Company. As defense budgets decline, larger prime
contractors may retain work which previously would have been subcontracted.
Competition in the Company's commercial markets is broadly based, and
global in scope. Individual competitors range in size from annual revenues of
less than $1 million to billion dollar enterprises, such as Pall Corporation, a
major competitor in the filtration/fluid flow market. While the Company's
commercial markets generally enjoy greater growth prospects than the defense
markets, competition can be equally intense, particularly during periods of
economic slowdown.
The reduced military threat posed by the former Soviet Union and the
continued domestic pressure to balance the Federal budget have led to reductions
in U.S. defense spending for military equipment. These reductions have resulted
in consolidations within the defense industry. In addition, the U.S.
Government's increasing willingness to purchase commercial products where
feasible has introduced new competitors in traditional defense markets. Further,
the U.S. Government's adoption of the Foreign Comparison Test program, wherein
the Government evaluates foreign products as a potential alternative to products
developed by U.S. suppliers, has increased competitive pressures in these
markets. These factors have all contributed to a highly competitive marketplace
for defense products. In the international defense markets, the continuing
decline in business in most areas in which the Company participates together
with the globalization of competition have resulted in a highly competitive
environment. However, the Company's strategy of forming alliances with several
foreign companies should result in strengthening
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the Company's competitive position in these markets as well as domestic markets.
Political factors also enter into foreign sales, including a foreign
government's evaluation of the Company's willingness to subcontract work content
to companies located in the foreign country involved.
The Company recognizes that domestic and international defense markets may
continue to decline, which would result in even stronger competitive pressures.
This trend could adversely affect the Company's future results unless offset by
greater foreign sales or new programs or products. The Company's on-going
commercial diversification program should allow the Company to continue to
reduce its dependence on its defense business and may alleviate some of the
downward pressure on sales from the increased defense market competition.
RESEARCH AND DEVELOPMENT
Research and development and the Company's technological expertise are
important factors in the Company's business. Research and development programs
are designed to develop technology for new products or to extend or upgrade the
capability of existing products and to assess their commercial potential.
In addition to its work under development contracts, the Company performs
research and development at its own expense. For the fiscal years ended
September 30,1998, 1997 and 1996, total Company-sponsored research and
development expenses were approximately $5.9 million, $6.2 million and $11.9
million, respectively. Company-sponsored research and development expenses
attributable to Hazeltine were approximately $6.1 million for the fiscal year
ended September 30, 1996. Total customer-sponsored research and development
expenses were approximately $10.2 million, $6.3 million and $3.9 million for the
fiscal years ended September 30, 1998, 1997 and 1996, respectively. Such
customer-sponsored expenses attributable to Hazeltine were approximately $3.9
million for the fiscal year ended September 30, 1996. The increase in fiscal
year 1998 for customer-sponsored research and development expenses was due to
the increased activity at Rantec and Filtertek. The increase in fiscal year 1997
for such research and development expenses was due to the acquisition of
Filtertek and increased activity at Rantec.
ENVIRONMENTAL MATTERS
The Company is involved in various stages of investigation and cleanup
relating to environmental matters. These matters primarily relate to Company
facilities located in Newbury Park, California and Riverhead, New York. Textron,
Inc. has indemnified the Company in respect of the cleanup expenses at the
Newbury Park facility. In connection with the sale of Hazeltine, the Company
retained ownership of the Riverhead facility (which is currently vacant), and
agreed to indemnify Hazeltine and GEC-Marconi against certain environmental
remediation expenses related to Hazeltine's facility at Quincy, Massachusetts.
The Company is also involved in the remediation of off-site waste disposal
facilities located in Winter Park, Florida and Jackson County, Arkansas, with
regard to both of which the Company is one of a number of potentially
responsible parties, and thus bears a proportionate share of the total
remediation expenses. It is very difficult to estimate the potential costs of
such matters and the possible impact of these costs on the Company at this time
due in part to: the uncertainty regarding the extent of pollution; the
complexity of Government laws and regulations and their interpretations; the
varying costs and effectiveness of alternative cleanup technologies and methods;
the uncertain level of insurance or other types of cost recovery; and in the
case of off-site waste disposal facilities, the uncertain level of the Company's
relative involvement and the possibility of joint and several liability with
other contributors under applicable law. Based on information currently
available, the Company does not believe that the aggregate costs involved in the
resolution of these environmental matters will have a material adverse
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<PAGE> 13
effect on the Company's financial statements. See Item 3. "Legal Proceedings".
EMPLOYEES
As of October 31, 1998, the Company employed approximately 3,550 persons.
Approximately 420 of the Company's employees are covered by a collective
bargaining agreement, which expires in fiscal year 2000.
FINANCING
The Company has a credit agreement, which has been amended and restated as
of February 7, 1997, and further amended as of May 6, 1997, November 21, 1997
and June 29, 1998, for a $59 million term loan, amortizing at $2 million per
quarter through maturity, and a $73 million revolving credit facility (together
the "Credit Facilities") with a group of seven banks agented by Morgan Guaranty
Trust Company of New York. The Credit Facilities will mature and expire on
September 30, 2000, and contain customary events of default, including change in
control of the Company. In addition, under the Credit Facilities an event of
default would occur if, for any reason other than payment or performance in
accordance with the terms of one of the Company's contracts guaranteed by
Emerson as referenced in the following section, Emerson shall cease to be liable
under its guarantees with respect to any such contract. See "History Of The
Business" below, "Management's Discussion and Analysis--Capital Resources and
Liquidity" in the 1998 Annual Report, and Notes 7 and 12 of the Notes to
Consolidated Financial Statements in the 1998 Annual Report, which Notes are
herein incorporated by reference.
HISTORY OF THE BUSINESS
ESCO was incorporated in Missouri in August 1990 as a wholly-owned
subsidiary of Emerson Electric Co. ("Emerson") to be the holding company for
Electronics & Space Corp. ("E&S"), Hazeltine, Southwest Mobile Systems
Corporation ("Southwest"), Rantec, VACCO and DCSI, which were then Emerson
subsidiaries. Ownership of ESCO and its subsidiaries was distributed on October
19, 1990 (the "Distribution Date") by Emerson to its shareholders through a
special distribution (the "Distribution"). On September 30, 1992, ESCO acquired
ownership of Textron Filtration Systems, Inc. from Textron, Inc. and renamed the
entity "PTI Technologies Inc." On March 12, 1993, ESCO acquired The
Electro-Mechanics Company, a privately held company, from its shareholders. On
December 1, 1993, ESCO acquired all outstanding stock of Schumacher Filters
Limited (located in England) from Kraftanlagen, AG of Germany, and renamed this
entity "PTI Technologies Limited". On December 29, 1994, ESCO acquired the
assets of Ray Proof North America, a division of Shielding Systems Corporation,
a subsidiary of Bairnco Corporation.
Effective September 30, 1995, E&S was merged into Southwest. Subsequently,
the latter entity's name was changed to Systems & Electronics Inc.
Effective October 19, 1995, the assets of EMCO, the assets acquired from
Ray Proof North America, and the assets comprising Rantec's California and
Oklahoma radio/frequency anechoics business were transferred to a newly-formed
Texas limited partnership, EMC Test Systems, L.P. ("ETS"). The sole general
partner of ETS is Rantec Commercial, Inc., a wholly-owned subsidiary of Rantec.
The sole limited partner of ETS is Rantec Holdings, Inc., a wholly-owned
subsidiary of Defense Holding Corp.
On July 22, 1996, ESCO sold 100% of the capital stock of Hazeltine to
GEC-Marconi. On February 7, 1997, ESCO acquired the filtration products and the
thermoform packaging businesses ("Filtertek") of
9
<PAGE> 14
Schawk, Inc. On December 31, 1997, ESCO acquired the stock of Euroshield OY
(located in Finland), and on July 1, 1998, ESCO acquired the stock of Advanced
Membrane Technology, Inc. and renamed it "PTI Advanced Filtration Inc." See Note
2 of the Notes to Consolidated Financial Statements in the 1998 Annual Report.
By means of the Distribution, Emerson distributed one share of ESCO's
common stock, par value $0.01 per share (the "Common Stock"), for every 20
shares of Emerson common stock owned on October 5, 1990. Pursuant to a Deposit
and Trust Agreement (the "Deposit and Trust Agreement") by and among Emerson,
ESCO and Boatmen's Trust Company, as voting trustee, in lieu of receiving a
share of Common Stock on the Distribution Date, each Emerson shareholder
received a Common Stock trust receipt (a "Receipt") representing the Common
Stock and its associated preferred stock purchase rights.
In connection with the Distribution, Emerson, ESCO and ESCO's subsidiaries
entered into various agreements which deal with, among other things, Emerson's
guarantee of certain contracts of ESCO's subsidiaries existing at September 30,
1990 pursuant to which ESCO paid Emerson a guarantee fee of $7.4 million per
year during the subsequent five (5) year period, which ended September 30, 1995
(as of September 30, 1998, the aggregate backlog of firm orders received by the
Company was approximately $292.7 million which included guaranteed contracts
totaling approximately $1.6 million, and there were open letters of credit with
an aggregate value of approximately $2.4 million related to foreign advance
payments in support of various contracts guaranteed by Emerson). See Note 12 of
the Notes to Consolidated Financial Statements in the 1998 Annual Report. Copies
of certain of these agreements, as well as the Deposit and Trust Agreement, are
incorporated by reference as exhibits to this Form 10-K.
Pursuant to the Deposit and Trust Agreement, if ESCO should fail in certain
circumstances to collateralize its obligation to indemnify Emerson with respect
to contracts that are directly or indirectly guaranteed by Emerson, Emerson
would have the right to direct the voting of the ESCO Common Stock represented
by the Receipts with respect to the election of directors (including changing
the size of the Board or removing directors and filling any vacancies). Emerson
has the right to require ESCO to provide collateral upon: (A) the occurrence of
certain events relating to such guaranteed contracts, including defaults; (B)
ESCO's failure to provide certain information, notices or consultation to
Emerson or to maintain certain financial ratios and covenants; (C) the
acquisition of beneficial ownership of 20% or more of the voting power of ESCO's
outstanding capital stock by any person or group; or (D) the divestiture by ESCO
of any business or assets which would constitute a significant subsidiary under
Regulation S-X of the Commission without the consent of Emerson. If Emerson
requires such collateral, it is uncertain whether ESCO would be able to provide
it in light of, among other things, the amount of collateral which would be
required to secure its obligations under the guaranteed contracts, which
obligations may continue even after completion of the contracts, and
restrictions in its financing arrangements unless a waiver is obtained from its
lenders. See "Financing" above and Note 8 of the Notes to Consolidated Financial
Statements in the 1998 Annual Report, which Note is herein incorporated by
reference.
Effective September 30, 1993, ESCO's Board of Directors authorized an
accounting readjustment of the Company's balance sheet in accordance with the
accounting provisions applicable to a "quasi-reorganization," an elective
accounting procedure intended to restate assets and liabilities to fair values
and to eliminate any accumulated deficit in retained earnings. See Note 1(b) of
the Notes to Consolidated Financial Statements in the 1998 Annual Report, which
Note is herein incorporated by reference.
FORWARD-LOOKING INFORMATION
The statements contained in this Item 1. "Business" and in Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" concerning the Company's future revenues, profitability, financial
resources, utilization of net deferred tax assets, costs of Year 2000
compliance,
10
<PAGE> 15
product mix, production and deliveries, market demand, product development,
competitive position and statements containing phrases such as "believes",
"anticipates", "may", "could", "should", and "is expected to" are
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. 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: changing priorities or
reductions in the U.S. and worldwide defense budgets; termination of government
contracts due to unilateral government action; the Company's failure to perform
commercial or government contracts; delivery delays or defaults by customers;
performance issues with key suppliers and subcontractors; the Company's
successful execution of internal operating plans; and collective bargaining
labor disputes.
ITEM 2. PROPERTIES
The Company's principal buildings contain approximately 1,951,600 square
feet of floor space. Approximately 1,585,800 square feet are owned by the
Company and approximately 365,800 square feet are leased. Substantially all of
the Company's owned properties are encumbered in connection with the Company's
Credit Facilities. See Item 1. "Business--Financing" and Note 7 of the Notes to
Consolidated Financial Statements in the 1998 Annual Report. The principal
plants and offices are as follows:
<TABLE>
<CAPTION>
SIZE SQ. FT. PRINCIPAL USE
LOCATION (SQ. FT.) OWNED/LEASED (INDUSTRY SEGMENT)
-------- --------- ------------ ----------------
<S> <C> <C> <C>
West Plains, MO 395,300 Owned Manufacturing
(Defense and Commercial)
St. Louis, MO 260,500 Owned Management and Engineering
(Defense and Commercial)
Sanford, FL 172,200 Owned Manufacturing (Defense and
Commercial)
Newbury Park, CA 144,600 Leased Management, Engineering and
Manufacturing (Defense and
Commercial)
Huntley, IL 127,000 Owned Manufacturing (Commercial)
Patillas, PR 110,000 Owned Manufacturing (Commercial)
Durant, OK 100,000 Owned Manufacturing (Commercial)
Hebron, IL 99,800 Owned Management, Engineering and
Manufacturing (Commercial)
South El Monte, CA 80,800 Owned Management, Engineering and
Manufacturing (Defense and
Commercial)
Calabasas, CA 61,700 Owned Management, Engineering and
Manufacturing (Defense and
</TABLE>
11
<PAGE> 16
<TABLE>
<S> <C> <C> <C>
Commercial)
Stockton, CA 55,000 Leased Manufacturing (Commercial)
Austin, TX 50,000 Leased Management, Engineering and
Manufacturing (Commercial)
Los Osos, CA 40,000 Owned Engineering and Manufacturing
(Defense and Commercial)
San Diego, CA 38,000 Leased Management, Engineering and
Manufacturing (Commercial)
Newcastle West, 37,000 Owned Manufacturing (Commercial)
Ireland
St. Louis, MO 35,000 Owned Management, Engineering and
Manufacturing (Commercial)
Juarez, Mexico 34,400 Leased Manufacturing (Defense and
Commercial)
Sheffield, England 33,500 Owned Management, Manufacturing and
Distributor (Commercial)
Plailly, France 33,000 Owned Manufacturing (Commercial)
Sao Paulo, Brazil 22,000 Leased Manufacturing (Commercial)
St. Louis, MO 21,800 Leased ESCO Headquarters (Defense and
Commercial)
</TABLE>
The Company believes its buildings, machinery and equipment have been
generally well maintained, are in good operating condition and are adequate for
the Company's current production requirements.
ITEM 3. LEGAL PROCEEDINGS
In August 1994, a class action lawsuit was filed by Ronald and Angela Aprea
and other persons against Hazeltine in the Supreme Court of the State of New
York, Suffolk County, alleging personal injury and property damage caused by
Hazeltine's purported releases of hazardous materials at Hazeltine's facility at
Greenlawn, New York. In connection with the sale of Hazeltine, the Company
indemnified Hazeltine and GEC-Marconi against expenses and potential liability
related to this suit. The suit seeks compensatory and punitive damages, and an
order enjoining Hazeltine from discharging further hazardous materials and for
Hazeltine to remediate all damage to the property of the plaintiffs. The Company
believes that no one and no property has been injured by any release of
hazardous materials from Hazeltine's facility. In fiscal year 1995, the Court
dismissed two counts of the complaint as a result of Hazeltine's motion to
dismiss, and the plaintiffs filed an amended complaint. The plaintiffs filed a
motion to be certified as a class, and, early in fiscal year 1997, the Court
denied this motion. The plaintiffs appealed, and the state appellate court
affirmed the denial in fiscal year 1998. Based upon current facts, the Company
is not able to estimate the probable outcome. Therefore,
12
<PAGE> 17
no provision for this litigation has been made in the consolidated financial
statements in the 1998 Annual Report. Management believes the Company will be
successful in defending this action and that the outcome will not have a
material adverse effect on the Company's financial statements. See Note 13 of
the Notes to Consolidated Financial Statements in the 1998 Annual Report, which
Note is herein incorporated by reference. See also Item 1. "Business--Government
Defense Contracts" and "Business--Environmental Matters".
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT.
The following sets forth certain information as of December 13 , 1998 with
respect to ESCO's executive officers. These officers have been elected to terms
which expire at the first meeting of the Board of Directors after the next
annual meeting of stockholders.
Name Age Position(s)
---- --- -----------
Dennis J. Moore * 60 Chairman, President and Chief Executive Officer
Philip M. Ford 58 Senior Vice President and Chief Financial Officer
Walter Stark 55 Senior Vice President, Secretary and General
Counsel
- ------------
* Also a director and Chairman of the Executive Committee of the Board of
Directors.
There are no family relationships among any of the executive officers and
directors.
Since October 1992, Mr. Moore has been Chairman, President and Chief
Executive Officer of ESCO.
Mr. Ford has been Senior Vice President and Chief Financial Officer of
ESCO since October 1, 1990.
Since October 1992, Mr. Stark has been Senior Vice President, Secretary
and General Counsel of ESCO.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required by this item is incorporated herein by reference
to Notes 7 and 8 of the Notes to Consolidated Financial Statements, "Common
Stock Market Prices" and "Shareholders' Summary--Capital Stock Information"
appearing in the 1998 Annual Report. A special cash distribution of $3.00 per
share was paid to Stockholders in September 1996. No other cash dividends have
been declared on the Common Stock underlying the Receipts, and ESCO does not
anticipate, currently or in the foreseeable future, paying cash dividends on the
Common Stock, although it reserves the right to do so to the extent permitted by
applicable law and agreements. ESCO's dividend policy will be reviewed by the
Board of Directors at such future time
13
<PAGE> 18
as may be appropriate in light of relevant factors at that time, based on ESCO's
earnings and financial position and such other business considerations as the
Board deems relevant at that time.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item, with respect to selected financial
data, is incorporated herein by reference to "Five-Year Financial Summary" and
Note 2 of the Notes to Consolidated Financial Statements appearing in the 1998
Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this item is incorporated herein by reference
to "Management's Discussion and Analysis" appearing in the 1998 Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference
to "Management's Discussion and Analysis - Capital Resources and Liquidity"
appearing in the 1998 Annual Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated herein by reference
to the Consolidated Financial Statements of the Company on pages 19 through 36
and the report thereon of KPMG Peat Marwick LLP, independent certified public
accountants, appearing on page 37 of the 1998 Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding nominees and directors appearing under "Nominees and
Continuing Directors" in ESCO's Notice of the Annual Meeting of the Stockholders
and Proxy Statement dated December 4, 1998 (the "1999 Proxy Statement") is
hereby incorporated by reference. Information regarding executive officers is
set forth in Part I of this Form 10-K.
Information appearing under "Section 16(a) Beneficial Ownership Reporting
Compliance" in the 1999 Proxy Statement is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information appearing under "Board of Directors and Committees" and
"Executive Compensation" (except for the "Report of the Human Resources And
Ethics Committee On Executive Compensation" and
14
<PAGE> 19
the "Performance Graph") in the 1999 Proxy Statement is hereby incorporated by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information regarding beneficial ownership of Receipts representing
shares of common stock by nominees and directors, by executive officers, by
directors and executive officers as a group and by any five percent stockholders
appearing under "Security Ownership of Management" and "Security Ownership of
Certain Beneficial Owners" in the 1999 Proxy Statement is hereby incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report:
1. The Consolidated Financial Statements of the Company on pages 19
through 36 and the Independent Auditors' Report thereon of KPMG Peat
Marwick LLP appearing on page 37 of the 1998 Annual Report.
2. Financial statement schedules have been omitted because the subject
matter is disclosed elsewhere in the financial statements and notes
thereto, not required or not applicable, or the amounts are not
sufficient to require submission.
3. Exhibits
<TABLE>
<CAPTION>
Filed Herewith or Incorporated by
Exhibit Reference to Document Indicated By
Number Description Footnote
------ ----------- --------
<S> <C> <C>
2(a)(i) Stock Purchase Agreement dated as of May Incorporated by Reference, Exhibit 2
23, 1996 between ESCO and GEC-Marconi [1]
2(a)(ii) First Amendment Agreement dated as of July
19, 1996 to Stock Purchase Agreement listed Incorporated by Reference, Exhibit 2
as Exhibit 2(a)(i) above [1]
2(b)(i) Acquisition Agreement dated December 18, Incorporated by Reference, Exhibit
1996 between the Company and Schawk, Inc. 2(a) [2]
2(b)(ii) First Amendment dated as of February 6, Incorporated by Reference, Exhibit
1998 to Acquisition Agreement listed as 2(b) [2]
Exhibit 2(b)(i) above
</TABLE>
15
<PAGE> 20
<TABLE>
<S> <C> <C>
3(a) Restated Articles of Incorporation of ESCO Incorporated by Reference,
Exhibit 3.1 [3]
3(b) Bylaws of ESCO, as amended Incorporated by Reference,
Exhibit 3(b) [4]
4(a) Specimen certificate for ESCO's Common Stock Incorporated by Reference,
Trust Receipts Exhibit 4(a) [5]
4(b) Rights Agreement dated as of September 24, Incorporated by Reference,
1990 between ESCO and Boatmen's Trust Exhibit 4.2 [3]
Company, as
4(c)(i) Rights Agent Credit Agreement dated as of Incorporated by Reference,
September 23, 1990 (as amended and restated Exhibit 4 [2]
as of December 30, 1992, amended as of January
15, 1993, October 15, 1993 and November 29,
1993, amended and restated as of May 27, 1994,
amended as of August 5, 1994, amended and restated
as of September 29, 1995, amended as of June 6,
1996 and August 2, 1996, and amended and
restated as of February 7, 1997) among ESCO,
Defense Holding Corp., the Banks listed therein
and Morgan Guaranty Trust Company of New York,
as Agent
4(c)(ii) Amendment dated as of May 6, 1997 to Credit Incorporated by Reference, Exhibit
Agreement listed as Exhibit 4(c)(i) above 4(c)(ii)[6]
4(c)(iii) Amendment dated as of November 21, 1997 to Incorporated by Reference, Exhibit
Credit Agreement listed as Exhibit 4(c)(i) 4(c)(iii)[6]
above
4(c)(iv) Amendment dated as of June 29, 1998 to Incorporated by Reference, Exhibit
Credit Agreement listed as Exhibit 4(c)(i) 4[7]
above
No other long-term debt instruments are filed
since the total amount of securities authorized
under any such instrument does not exceed ten
percent of the total assets of ESCO and its
subsidiaries on a consolidated basis. ESCO
agrees to furnish a copy of such instruments to
the Securities and Exchange Commission upon
request.
</TABLE>
16
<PAGE> 21
<TABLE>
<S> <C> <C>
4(d) Deposit and Trust Agreement dated as of Incorporated by Reference,
September 24, 1990 among ESCO, Emerson Exhibit 4.3 [3]
Electric Co., Boatmen's Trust Company,
as Trustee, and the holders of Receipts
from time to time
10(a) Distribution Agreement dated as of Incorporated by Reference,
September 24, 1990 by and among ESCO, Exhibit 2.1 [3]
Emerson Electric Co., and ESCO's direct
and indirect subsidiaries
10(b) Tax Agreement dated as of September 24, Incorporated by Reference,
1990 by and among ESCO, Emerson Electric Exhibit 2.2 [3]
Co., and ESCO's direct and indirect
subsidiaries
10(c)(i) 1990 Stock Option Plan* Incorporated by Reference,
Exhibit 10.3 [3]
10(c)(ii) Amendment to 1990 Stock Option Plan Incorporated by Reference,
dated as of September 4, 1996* Exhibit 10(c)(ii) [8]
10(d) Form of Incentive Stock Option Agreement* Incorporated by Reference,
Exhibit 10(g) [5]
10(e) Form of Incentive Stock Option Agreement Incorporated by Reference,
- Alternative* Exhibit 10(h) [5]
10(f) Form of Non-Qualified Stock Option Incorporated by Reference,
Agreement* Exhibit 10(i) [5]
10(g) Form of Split Dollar Agreement* Incorporated by Reference,
Exhibit 10(j) [4]
10(h) Form of Indemnification Agreement with Incorporated by Reference,
each of ESCO's directors. Exhibit 10(k) [4]
10(i) Stock Purchase Agreement dated as of Incorporated by Reference,
August 20, 1992 by and between Textron, Exhibit 10(l) [9]
Inc. and ESCO
10(j)(i) 1993 Performance Share Plan* Incorporated by Reference [10]
10(j)(ii) Amendment to 1993 Performance Share Incorporated by Reference,
Plan dated as of September 4, 1996* Exhibit 10(j)(ii) [8]
10(k) Supplemental Executive Retirement Plan Incorporated by Reference,
as amended and restated as of August 2, Exhibit 10(n) [11]
1993*
10(l)(i) Directors' Extended Compensation Plan* Incorporated by Reference,
Exhibit 10(o) [11]
10(l)(ii) Compensatory Arrangement with former Incorporated by Reference,
ESCO director* Exhibit 10(l)(ii) [8]
10(m)(i) 1994 Stock Option Plan* Incorporated by Reference [12]
</TABLE>
17
<PAGE> 22
<TABLE>
<S> <C> <C>
10(m)(ii) Amendment to 1994 Stock Option Plan Incorporated by Reference,
dated as of September 4, 1996* Exhibit 10(m)(ii) [8]
10(n) Form of Incentive Stock Option Agreement* Incorporated by Reference,
Exhibit 10(n) [13]
10(o) Form of Non-Qualified Stock Option Incorporated by Reference,
Agreement* Exhibit 10(o) [13]
10(p) Severance Plan* Incorporated by Reference,
Exhibit 10(p)[13]
10(q) Performance Compensation Plan dated as Incorporated by Reference,
of August 2, 1993 (as amended and Exhibit 10(q) [8]
restated as of October 1, 1995)*
10(r) 1997 Performance Share Plan* Incorporated by Reference [14]
10(s) Notice Of Award--stock award to Incorporated by Reference, Exhibit
executive officer* 10(s)[6]
10(t) Notice of Award--stock award to executive Incorporated by Reference,
officer* Exhibit 10(a)[7]
10(u) Notice of Award--stock award to executive Incorporated by Reference,
officer* Exhibit 10(b)[7]
13 The following-listed sections of the
Annual Report to Stockholders for the
year ended September 30, 1998:
Five-Year Financial Summary (p. 38)
Management's Discussion and Analysis
(pgs. 12-18)
Consolidated Financial Statements (pgs.
19-36) and Independent Auditors' Report
(p. 37)
Shareholders' Summary--Capital Stock
Information (p. 39)
Common Stock Market Prices (p. 38)
21 Subsidiaries of ESCO
23 Independent Auditors' Consent
27 Financial Data Schedule
</TABLE>
[1] Incorporated by reference to Current Report on Form 8-K--date of
earliest event reported: July 22, 1996, at the Exhibit indicated
18
<PAGE> 23
[2] Incorporated by reference to Form 10-Q for the fiscal quarter ended
December 31, 1996, at the Exhibit indicated
[3] Incorporated by reference to Registration Statement on Form 10, as
amended on Form 8 filed September 27, l990, at the Exhibit indicated
[4] Incorporated by reference to Form l0-K for the fiscal year ended
September 30, l991, at the Exhibit indicated
[5] Incorporated by reference to Form 10-K for the fiscal year ended
September 30, 1990, at the Exhibit indicated
[6] Incorporated by reference to Form 10-K for the fiscal year ended
September 30, 1997, at the Exhibit indicated.
[7] Incorporated by reference to Form 10-Q for the fiscal quarter ended June
30, 1998, at the Exhibit indicated.
[8] Incorporated by reference to Form 10-K for the fiscal year ended
September 30, 1996, at the Exhibit indicated.
[9] Incorporated by reference to Form 10-K for the fiscal year ended
September 30, 1992, at the Exhibit indicated
[10] Incorporated by reference to Notice of the Annual Meeting of the
Stockholders and Proxy Statement dated December 9, 1992
[11] Incorporated by reference to Form 10-K for the fiscal year ended
September 30, 1993, at the Exhibit indicated
[12] Incorporated by reference to Notice of the Annual Meeting of the
Stockholders and Proxy Statement dated December 8, 1994
[13] Incorporated by reference to Form 10-K for the fiscal year ended
September 30, 1995, at the Exhibit indicted
[14] Incorporated by reference to Notice of the Annual Meeting of the
Stockholders and Proxy Statement dated December 6, 1996.
* Represents a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c)
of this Part IV.
(b) No report on Form 8-K was filed during the quarter ended September 30,
1998.
(c) Exhibits: Reference is made to the list of exhibits in this Part IV,
Item 14(a)3 above.
(d) Financial Statement Schedules: Reference is made to Part IV, Item
14(a)2 above.
19
<PAGE> 24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(D) 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 ELECTRONICS CORPORATION
By (s) D. J. Moore
-----------------------------------------
D.J. Moore
Chairman, President and
Chief Executive Officer
Dated: December 18, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below effective December 18, 1998, by the following
persons on behalf of the registrant and in the capacities indicated.
SIGNATURE TITLE
(s) D. J. Moore
--------------------------------- Chairman, President, Chief
D.J. Moore Executive Officer and Director
(s) P. M. Ford
--------------------------------- Senior Vice President and Chief
P.M. Ford Financial Officer (Principa
Accounting Officer)
(s) J. J. Adorjan
--------------------------------- Director
J.J. Adorjan
(s) W. S. Antle III
--------------------------------- Director
W.S. Antle III
(s) J. J. Carey
--------------------------------- Director
J.J. Carey
(s) J.M. McConnell
--------------------------------- Director
J.M. McConnell
(s) D. C. Trauscht
--------------------------------- Director
D.C. Trauscht
20
<PAGE> 25
INDEX TO EXHIBITS
Exhibits are listed by numbers corresponding to the Exhibit Table of Item 601 in
Regulation S-K.
Exhibit No. Exhibit
- ----------- -------
13 The following-listed sections of the Annual Report to
Stockholders for the year ended September 30, 1998:
Five-year Financial Summary (p. 38)
Management's Discussion and Analysis (pgs. 12-18)
Consolidated Financial Statements (pgs. 19-36) and
Independent Auditors' Report (p. 37)
Shareholders' Summary--Capital Stock Information
(p. 39)
Common Stock Market Prices (p. 38)
21 Subsidiaries of ESCO
23 Independent Auditors' Consent
27 Financial Data Schedule
See Item 14(a)3 for a list of exhibits incorporated by reference
21
<PAGE> 1
EXHIBIT 13
FIVE-YEAR FINANCIAL SUMMARY
<TABLE>
<CAPTION>
(Dollars in millions, except per share amounts) 1998(1) 1997(2) 1996(3) 1995(4) 1994
- ------------------------------------------------------------------------------------------------------------------------------------
For years ended September 30:
<S> <C> <C> <C> <C> <C>
Net sales $365.1 378.5 438.5 441.0 473.9
Interest expense 7.7 5.2 4.8 5.5 3.6
Earnings (loss) before income taxes 16.3 17.9 14.8 (29.5) 12.7
Net earnings (loss) 11.3 11.8 26.1 (30.3) 8.3
Earnings (loss) per share:
Basic .94 1.00 2.32 (2.76) .72
Diluted .90 .96 2.26 (2.76) .72
As of September 30:
Working capital 60.3 62.3 86.2 71.4 86.6
Total assets 409.3 378.2 307.8 378.0 347.5
Long-term debt 50.1 50.0 11.4 23.5 25.1
Shareholders' equity 224.1 205.0 191.1 182.3 187.4
</TABLE>
(1) Includes the acquisitions of Euroshield (December 31, 1997) and PTA (July
1, 1998) (see Footnote 2 of Notes to Consolidated Financial Statements).
(2) Includes the acquisition of Filtertek in February 1997 (see Footnote 2 of
Notes to Consolidated Financial Statements).
(3) Includes the sale of Hazeltine; $25.3 million of other charges related to
cost of sales; and includes an adjustment to the income tax valuation
reserve (see Footnotes 2, 6 and 14 of Notes to Consolidated Financial
Statements).
(4) Includes $16.5 million of other charges related to cost of sales and a
change in accounting estimate.
38
<PAGE> 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto.
BUSINESS ENVIRONMENT
ESCO Electronics Corporation (ESCO, the Company) operates
within two primary business segments: commercial (primarily
filtration/fluid flow and communications/test) and defense.
Overall, 1998 was a challenging yet successful year for ESCO.
The Company achieved several significant accomplishments in 1998,
including:
-- a 28% increase in entered orders, led by additional Tunner
aircraft loaders and M1000 tank transporters at Systems &
Electronics Inc. (SEI); two orders totalling $54 million at
Distribution Control Systems, Inc. (DCSI) to supply automatic meter
reading and electric utility communications systems to Puerto Rico
Electric Power Authority (PREPA); and higher volume of
filtration/fluid flow products at PTI Technologies Inc. (PTI).
-- achieving an 8% operating profit margin, as adjusted for the
$2.5 million one-time charge for the settlement of a long-standing
contractual dispute with the U.S. Army on the original M1000 tank
trans-porter program. The operating margin improvement occurred
despite a slowdown in some of the Company's industrial markets and
the impact of the General Motors Corporation strike on the Company's
Filtertek operations.
-- the completion of two commercial acquisitions, Euroshield
OY, a manufacturer of high-quality shielding products used in the
electromagnetic compatibility (EMC) industry, and Advanced Membrane
Technology, Inc., a manufacturer of filtration membrane and systems
used in a variety of process industries.
-- increasing the commercial sales content to 57% of total re-
venues.
These accomplishments provide further evidence of management's
strategy of deliberate diversification and its ongoing commitment to
create shareholder value.
In 1997, the Company significantly strengthened its presence in
the fast-growing and profitable filtration industry through its
February 1997 acquisition of Filtertek, Inc. (Filtertek). Filtertek,
in conjunction with the 1998 commercial acquisitions noted above,
effectively increased the commercial content of the Company's sales
to over 50% for the first time in the Company's history.
During 1998, the overall defense industrial base continued its
consolidation, and ESCO responded to this competitive challenge by
continuing to reposition itself to compete in the global marketplace
and to apply defense technologies to commercial products. Management
continues to believe the Company's strong product diversification
and technology niches in its core defense businesses will enable it
to compete effectively in the defense market.
New program opportunities in both the defense and commercial
segments, in addition to the ongoing commercial acquisitions,
effectively reposition the Company's business base for the remainder
of the decade. This should allow ESCO to continue to increase its
commercial segment contributions while continuing to reduce its
overall dependence on its defense business.
ESCO's improved financial position and strong balance sheet at
September 30, 1998 should allow the Company to continue its strategy
of deliberate diversification through internal new product
development and selective acquisitions, thereby increasing
shareholder value.
RESULTS OF OPERATIONS
1998 COMPARED WITH 1997
Net sales of $365.1 million in 1998 were $13.4 million (3.5%)
lower than net sales of $378.5 million in 1997. The decrease was
primarily the result of lower sales of Tunner aircraft loaders and
material handling equipment for the U.S. Postal Service at SEI
resulting from the timing of the receipt of orders. The 1998 portion
of the multi-year Tunner contract was awarded in the fiscal 1998
fourth quarter. The 1998 sales
12
<PAGE> 3
decrease was partially offset by sales increases at all other
operating units. The largest increases in 1998 were recorded at
Filtertek ($24.8 million) and PTI ($11 million). Filtertek's 1997
sales of $48.6 million were for eight months of operations
subsequent to the February 1997 acquisition.
In 1998, commercial sales were $206.1 million (56.5%) and
defense sales were $159.0 million (43.5%) compared with 1997
commercial and defense sales of $187.5 million (49.5%) and $191
million (50.5%), respectively. The increase in 1998 commercial sales
is primarily attributable to the inclusion of Filtertek for the full
year and additional volume at PTI and DCSI.
The Company is involved in the design, development and
manufacture of products for the commercial and defense markets. The
Company generally manufactures products only upon receipt of firm
customer orders and delivers the products in accordance with the
customer's schedule. As a result, the Company's beginning backlog of
firm orders, the level of orders received during the year and the
mix of products to be produced all influence the Company's operating
results.
Firm order backlog was $292.7 million at September 30, 1998,
compared to $225 million at September 30, 1997. The increase in
backlog reflects the timing of receipt of orders and their related
sales throughout the various programs' life cycles, principally at
SEI and DCSI. As ESCO continues its transition towards a
predominantly commercial company, backlog plays a less significant
role as commercial products tend to be ordered by the customer and
shipped by the Company within the same fiscal year. Approximately
20% of the September 30, 1998 backlog is expected to be delivered
beyond one year.
Orders aggregating $432.7 million were received in 1998,
compared with $338.7 million in 1997 reflecting a $94 million
(27.8%) increase. The largest increases in orders during 1998 were
recorded at DCSI (PREPA), SEI (Tunner) and PTI (filtration/fluid
flow), partially offset by decreased orders at Rantec. The most
significant orders in 1998 were for filtration/fluid flow products;
Tunner aircraft loaders; electric utility communications and
automatic meter reading systems; M1000 tank transporters and
airborne radar systems.
The Company computes gross profit as: net sales, less cost of
sales, less other charges related to cost of sales. The gross profit
margin is the gross profit divided into net sales, expressed as a
percentage.
The gross profit margin in 1998 was 26.1% compared to 24.2% in
1997. The improvement in 1998 gross margin compared to the 1997
gross margin is the result of a more favorable sales mix. Although
higher, the 1998 gross margin was adversely affected by the $2.5
million claim settlement noted below, the General Motors Corporation
strike and Hurricane Georges, which impacted Filtertek in
particular, and a slowdown in some of the Company's industrial
markets. The 1997 gross margin was negatively impacted by the higher
volume of Tunner sales at SEI which were recorded at break-even. The
gross profit margin attributable to the commercial segment was
consistent in both periods presented.
Other charges related to cost of sales of $2.5 million in 1998
resulted from the Company's settlement of a long-standing contract
dispute related to the original M1000 tank transporter program. The
settlement agreement requires the customer to pay the Company $7.5
million in 1999, in exchange for the Company dropping its claim for
damages and recovery of additional program costs incurred. All units
related to the original contract have been delivered. This
settlement allows the Company to avoid a lengthy and expensive
lawsuit against one of its largest customers, the U.S. Army. After
considering all factors, management determined that settling the
dispute was in the Company's long-term best interest.
Selling, general and administrative expenses (SG&A) for 1998
were $68.3 million, or 18.7% of net sales, compared with $64.1
million, or 16.9% of net sales, for 1997. The 1998 SG&A expenses
included $4.6 million of additional expense at Filtertek as a result
of it being included in 1998 for the entire year versus eight months
of 1997. The percentage increase in 1998 is the result of lower
sales at SEI available to cover certain fixed costs.
Interest expense increased to $7.7 million in 1998 from $5.2
million in 1997, primarily as a result of higher average outstanding
borrowings throughout 1998. A significant amount of the outstanding
borrowings in 1998 was incurred with the February 1997 acquisition
of Filtertek. The timing of operating cash flows throughout 1998
also increased the average outstanding borrowings.
13
<PAGE> 4
Other costs and expenses, net, decreased in 1998 to $2.9
million from $4.5 million in 1997, primarily due to PTI receiving a
$1.6 million lease surrender payment (recorded as other
miscellaneous income) from its landlord for agreeing to vacate its
current manufacturing facility in Newbury Park, California. The
agreement required the landlord to pay PTI $1.6 million immediately
upon signing the agreement and to pay an additional $2.9 million on
December 31, 2000, or earlier, upon PTI vacating the property. PTI
is evaluating its relocation alternatives regarding leasing other
appropriate facilities or constructing a new facility. The remainder
of other costs and expenses, net was consistent in both periods
presented. This account reflects all miscellaneous non-operating
costs, including amortization of intangible assets.
Income tax expense of $5.1 million for 1998 reflects deferred
tax expense of $6.1 million and foreign, state and local tax
benefits of ($1) million. Income tax expense of $6.1 million for
1997 reflects current Federal tax expense of $.2 million, deferred
tax expense of $4.8 million and foreign, state and local taxes of $1
million.
Based on the Company's historical pretax income, adjusted for
significant nonrecurring items such as the facilities consolidation
program and other costs related to cost of sales, together with
management's projection of future taxable income based upon its
shift in strategic direction, management believes it is more likely
than not that the Company will realize a majority of the benefits of
the net deferred tax asset existing at September 30, 1998. In order
to realize the aforementioned net deferred tax asset the Company
will need to generate future taxable income of approximately $128
million, of which $114 million is required to be realized prior to
the expiration of the net operating loss (NOL) carryforwards, of
which $33 million will expire in 2006; $6 million will expire in
2007; $23 million will expire in 2009; $38 million will expire in
2010; $7 million will expire in 2011; and $7 million will expire in
2018. These net operating loss carryforwards may be used to reduce
future income tax cash payments.
As a result of the sale of Hazeltine in 1996, the Company has
available capital loss carryforwards for tax purposes of
approximately $77 million. This capital loss may be used as a
reduction of future capital gains recognized by the Company, at
which time the Company may realize additional tax benefits. Any
unused capital loss carryforward will expire in 2001.
The Company's deferred tax valuation allowance of $41 million
at September 30, 1998 was comprised of approximately $13.9 million,
which represents management's best estimate of the portion of the
deferred tax asset associated with temporary differences and NOLs
which may not be realized, and a full valuation reserve in the
amount of $27.1 million for the portion of the deferred tax asset
represented by the capital loss. There can be no assurance, however,
that the Company will generate sufficient taxable income or a
specified level of continuing taxable income in order to fully
utilize the deferred tax assets in the future.
The effective tax rate in 1998 was 30.9% compared with 33.9% in
1997. An analysis of the effective tax rates for 1998, 1997 and 1996
is included in the notes to consolidated financial statements.
1997 Compared with 1996
Net sales of $378.5 million in 1997 were $60 million (13.7%)
lower than net sales of $438.5 million in 1996. The decrease was
primarily the result of the sale of Hazeltine in July 1996,
partially offset by the acquisition of Filtertek in February 1997.
Hazeltine's sales for the ten-month period of 1996 prior to its
divestiture were $94 million, offset by Filtertek's eight-month
sales of $48.6 million. Net sales at the remainder of the Company's
operating units decreased $14.6 million in 1997 compared to 1996 due
to lower sales volume at SEI, partially offset by increased sales at
all other operating units. In 1997, commercial sales were $187.5
million (49.5%) and defense sales were $191 million (50.5%) compared
with 1996 commercial and defense sales of $137.6 million (31.4%) and
$301 million (68.6%), respectively. The increase in 1997 commercial
sales was primarily attributable to the acquisition of Filtertek and
additional volume at PTI. Hazeltine's commercial sales were not
significant in 1996.
Firm order backlog was $225 million at September 30, 1997,
compared to $244 million at September 30, 1996. The decrease in
backlog reflects the timing of receipt of orders and related sales
throughout the various programs' life cycles, principally at SEI.
Order backlog increased $24 million in conjunction with the
14
<PAGE> 5
February 1997 acquisition of Filtertek. Approximately 11% of the
September 30, 1997 backlog was expected to be delivered beyond
one year.
Orders aggregating $338.7 million were received in 1997,
compared with $296.2 million in 1996 (excluding Hazeltine),
reflecting a $42.5 million (14.3%) increase. Orders during 1996 as
reported including Hazeltine were $373.6 million. Orders received by
Hazeltine in 1996 prior to its sale were $77.4 million, and orders
received by Filtertek since February 1997 were $47.5 million. The
largest increases in orders during 1997 were recorded at PTI, Rantec
and EMC Test Systems, L.P. (ETS), offset by decreased orders at SEI.
The most significant orders in 1997 were for filtration/fluid flow
products; M1000 tank transporters; airborne radar systems; EMC test
equipment; integrated mail handling and sorting systems; and
automatic meter reading equipment.
The gross profit margin in 1997 was 24.2% compared to 10.6% in
1996. The lower margin in 1996 was primarily attributable to two
factors: a $23 million adjustment of the estimate of the costs to
complete the 60K Loader program at SEI; and the components of other
charges related to cost of sales as discussed below. The 1996 gross
profit margin, if "adjusted" to exclude the 60K Loader adjustment
and the other charges related to cost of sales would have been
21.6%. The improvement in 1997 gross margin compared to the
"adjusted" 1996 gross margin is the result of a more favorable sales
mix at all operating units. The gross profit margin attributable to
the commercial segment was consistent in both periods presented.
During 1996, and in connection with the sale of Hazeltine and
management's decision to pursue a strategy of deliberate
diversification from defense to commercial, the Company reevaluated
the carrying value of certain assets. As a result of this
reevaluation, the Company recorded $25.3 million of other charges
related to cost of sales in 1996. These strategic decisions were
intended to increase the contributions of the commercial segment and
to reduce the Company's overall dependence on the defense
businesses.
The 1996 charge included $14.3 million of inventories related
to defense programs which management no longer intended to actively
pursue; $6 million of costs included in other assets incurred in
anticipation of certain defense contract awards (Precontract Costs)
which the Company no longer intended to actively pursue; and a $5
million adjustment in the Company's estimate of recoveries in a
contract dispute related to the M1000 tank transporter program. This
dispute was subsequently settled in 1998.
Selling, general and administrative expenses (SG&A) for 1997
were $64.1 million, or 16.9% of net sales, compared with $70.5
million, or 16.1% of net sales, for 1996. The 1997 SG&A expenses
included $7.2 million for Filtertek and the 1996 SG&A included $12.9
million for Hazeltine. The net decrease in 1997 SG&A spending was
the result of successful cost containment programs throughout the
Company.
Interest expense increased to $5.2 million in 1997 from $4.8
million in 1996, primarily as a result of higher average outstanding
borrowings throughout 1997. A significant amount of the outstanding
borrowings in 1997 was incurred with the acquisition of Filtertek.
Other costs and expenses, net, decreased in 1997 to $4.5
million from $5 million in 1996, primarily due to lower
miscellaneous non-operating costs.
The 1996 gain on the sale of Hazeltine represented the net gain
after deducting selling costs and expenses and after adjusting for
certain assets and liabilities retained by ESCO.
Income tax expense of $6.1 million for 1997 reflects current
Federal tax expense of $.2 million, deferred tax expense of $4.8
million and foreign, state and local taxes of $1 million. Income tax
benefit of $11.4 million for 1996 reflects an increase in net
deferred tax assets of $27.7 million, of which $15.1 million was
credited to additional paid-in capital. Foreign, state and local
taxes amounted to $1.2 million in 1996.
In 1997, the Company reduced its deferred tax valuation
allowance by $3.7 million. The deferred tax valuation allowance of
$39.6 million at September 30, 1997 included approximately $12.5
million, which represented management's best estimate of the portion
of the deferred tax asset associated with temporary differences and
NOLs which may not be realized, and a full valuation reserve in the
amount of $27.1 million for the portion of the deferred tax asset
represented by the capital loss.
15
<PAGE> 6
The effective tax rate in 1997 was 33.9% compared with (77%) in
1996. The tax provision for 1996 was impacted by the effect of the
Hazeltine divestiture, the Corporate Readjustment implemented in
1993 and other items. An analysis of the effective tax rates is
included in the notes to consolidated financial statements.
CAPITAL RESOURCES & LIQUIDITY
The Company has been, and will continue to be, impacted by
changes in the defense industry brought about by the changing
international political environment and the U.S. Government's
deficit reduction measures, including procurement policies and tax
reform. This operating environment requires defense contractors to
make significant capital commitments to programs for extended
periods of time. The Company has been successful in continuing to
shift its business from development programs to production programs
and on increasing the commercial content of its business base,
thereby reducing the risk inherent in the defense industry.
Net cash provided by operating activities in 1998 was $20.3
million compared to $25.3 million in 1997. The 1998 net cash
provided by operating activities was lower than 1997 due to the
increased operating working capital requirements. The additional
investment in operating working capital in 1998 is the result of
increased inventories necessary to support near-term production and
delivery requirements, primarily at SEI (Tunner). The 1998 cash
investment for inventories was partially offset by the improvement
in costs and estimated earnings on long-term contracts and the
additional receipt of advance payments on long-term contracts.
Net cash provided by operating activities was $25.3 million in
1997, compared to $1 million in 1996. The 1997 net cash provided by
operating activities improved compared to 1996, net of the gain on
the sale of Hazeltine, primarily due to the positive impact of 1997
operating earnings.
In 1998 and 1997, capital expenditures of $12.9 million and
$10.5 million, respectively, included manufacturing equipment at
Filtertek, SEI and PTI. In 1996, capital expenditures of $8.6
million included capitalized facility costs at SEI, process
equipment at PTI and capital expenditures of $1.5 million related to
Hazeltine. There were no commitments outstanding that were
considered material for capital expenditures at September 30, 1998.
At September 30, 1998, the Company had available net operating
loss carryforwards (NOLs) for tax purposes of approximately $114
million. These NOLs will expire beginning in year 2006 and ending in
year 2018. These NOLs will be used to reduce future Federal income
tax cash payments.
On July 1, 1998, the Company completed the acquisition of
Advanced Membrane Technology, Inc. (AMT) and renamed the company PTI
Advanced Filtration Inc. (PTA). PTA, headquartered in San Diego,
California, designs and manufactures several types of filtration
membrane and provides filtration systems for a variety of
applications in the process industries. The transaction involved the
purchase of AMT common stock for approximately $7 million in cash
plus approximately 450,000 shares of ESCO Common Stock valued at
$8.6 million. The cash portion was financed with the Company's bank
credit facility.
On December 31, 1997, the Company completed the purchase of
Euroshield OY for consideration which included $3.5 million in cash.
Euroshield, located in Eura, Finland, designs and manufactures high-
quality shielding products used in the electromagnetic compatibility
(EMC) industry.
On February 7, 1997, the Company completed the acquisition of
the filtration and the thermoform packaging businesses (Filtertek)
of Schawk, Inc. The transaction involved the purchase of assets and
stock of certain subsidiary corporations of Schawk, Inc. for $92
million in cash plus working capital adjustments in 1998. The
purchase was financed with cash and borrowings from the Company's
bank credit facility. Filtertek is a leader in the manufacture of
plastic insert injection molded filter assemblies.
The Company's existing $132 million bank credit facility was
amended on June 29, 1998 to increase the amount of the outstanding
term loan by $7 million to $59 million, and to reduce the revolving
credit facility by $7 million to $73 million. The term loan has
scheduled amortization payments of $2 million per quarter.
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<PAGE> 7
The revolving credit facility (subject to borrowing base asset
limitations) is available for direct borrowings and/or the issuance
of letters of credit. The maturity of the bank credit facility is
September 30, 2000. These credit facilities are provided by a group
of banks, led by Morgan Guaranty Trust Company of New York. At
September 30, 1998, the Company had $48.3 million available under
the revolving credit facility.
In 1996, the Company authorized an open market share repurchase
program for up to two million shares of common stock over a period
ended September 30, 1998. Approximately 180,000 shares were
repurchased throughout that two-year period. Subsequent to September
30, 1998, the Company authorized an additional open market
repurchase program of up to 1.3 million shares, which is subject to
market conditions and other factors and will cover a period ending
September 29, 2000.
Cash flow from operations and borrowings under the bank credit
facility are expected to provide adequate resources to meet the
Company's capital requirements and operational needs for the
foreseeable future.
All of the Company's debt is priced at a percentage over LIBOR.
The Company has reduced this risk through a rate swap agreement that
provides a cap on LIBOR of 7% on $50 million of the long-term debt
through September 30, 1998, reducing to $40 million through
September 30, 1999. The Company does not have significant risk or
exposure to fluctuations in foreign currencies, which are hedged in
part through the purchase of forward currency contracts.
Management believes that, for the periods presented, inflation
has not had a material effect on the Company's operations.
The Company is currently involved in various stages of
investigation, remediation and litigation relating to environmental
matters. Based on current information available, management does not
believe the aggregate costs involved in the resolution of these
matters will have a material adverse effect on the Company's
operating results, capital expenditures or competitive position.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income." This Statement establishes
standards for the reporting and display of comprehensive income and
its components in a full set of general purpose financial
statements. All items that are required to be recognized under
accounting standards as components of comprehensive income must be
reported in a financial statement with the same prominence as other
financial statements. SFAS No. 130 is effective beginning with the
Company's first fiscal quarter ending December 31, 1998.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information". This
Statement establishes standards for the manner in which public
business enterprises report information about operating segments in
interim and annual financial statements, and the related disclosures
about products and services, geographic areas and major customers.
The effect of adopting this provision is not expected to provide
additional disclosures materially different than those previously
disclosed by the Company, on an annual basis. SFAS No. 131 is
effective beginning with the Company's first fiscal quarter ending
December 31, 1998.
In February 1998, the FASB issued SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88, and 106". This Statement
amends the disclosure requirements with respect to pension and other
postretirement benefits. It does not change any of the current
guidance on measurement or recognition related to these areas. SFAS
No. 132 is effective for the Company's fiscal year ending September
30, 1999.
In April 1998, the FASB issued Statement of Position (SOP)
98-5, "Reporting on the Costs of Start-up Activities". This SOP is
applicable to all non-governmental entities and provides guidance on
accounting for start-up activities, including organization costs and
pre-contract costs. Pre-contract costs were incurred and
17
<PAGE> 8
capitalized under the existing guidance provided by SOP 81-1,
"Accounting for Performance of Construction-type Contracts". Under
the current guidance of SOP 81-1, costs incurred for a specific
anticipated contract may be capitalized if these costs can be
directly associated with the specific anticipated contract and if
their recoverability from that contract is probable. SOP 98-5 amends
and supersedes the current guidance of SOP 81-1. The Company is
required to adopt this change in accounting principle no later than
the first quarter of fiscal year 2000. This change in accounting
principle will result in a non-cash, after-tax charge of $15-$25
million, which will be recognized as a cumulative effect of an
accounting change. This change will be presented below net earnings.
YEAR 2000 ISSUES
The Year 2000 ("Y2K") issue refers to the inability of a
date-sensitive computer program to recognize a two-digit date field
designated as "00" as the year 2000. Mistaking "00" for 1900 could
result in a system failure or miscalculations causing disruptions to
operations, including manufacturing, a temporary inability to
process transactions, send invoices, or engage in other normal
business activities. This is a significant issue for most, if not
all, companies with far-reaching implications, some of which cannot
be anticipated or predicted with any degree of certainty.
The Company is currently assessing the magnitude of its Y2K
issue and has already determined that it may be required to modify
or replace certain portions of its software so that its computer
systems will be able to function properly beyond December 31, 1999.
This may require certain hardware and software replacement,
reprogramming or other remedial action. The Company is also
communicating with its suppliers and customers to determine the
extent of the Company's vulnerability to the failure of third
parties to remediate their own Y2K issue.
In conjunction with this assessment, the Company is
implementing its action plans to address the Y2K issue, including
contingencies to address unforeseen problems. The Company is using
both internal and external resources to complete Y2K reprogramming,
hardware and software replacement and testing. Preliminary plans
anticipate completion of the Y2K remedial work by September 30,
1999. To date, the Company has incurred approximately $2.5 million
related to the Y2K remedial work. The total cost of the Y2K remedial
work is estimated to be less than $5 million and, with the exception
of certain capitalizable hardware and software costs, will be
expensed as incurred over the next 12 months.
The Company is currently exploring contingency planning in the
event that vendors, suppliers, customers or other third parties fail
to meet Y2K compliance. At present, the Company does not anticipate
a material impact internally or externally from Y2K noncompliance.
The expected costs of the project and the date on which the
Company plans to complete the Y2K remediation work are based on
management's best estimates, which were derived from numerous
assumptions about future events, including the availability of
certain resources, third-party modification plans, and other
factors. However, there can be no guarantee that these estimates
will be achieved and actual results could differ materially from
those plans. Specific factors that might cause material differences
include, but are not limited to, the availability and cost of
personnel trained in this area and the ability to identify and
correct all relevant computer codes.
18
<PAGE> 9
ESCO Electronics Corporation and Subsidiaries
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended September 30,
<S> <C> <C> <C>
(Dollars in thousands, except per share amounts) 1998 1997 1996
- -------------------------------------------------------------------------------
Net sales $365,083 378,524 438,543
Costs and expenses:
Cost of sales 267,332 286,790 366,719
Other charges related to cost of sales 2,500 -- 25,300
Selling, general and administrative expenses 68,326 64,142 70,464
Interest expense 7,703 5,220 4,781
Other, net 2,875 4,522 5,017
Gain on sale of Hazeltine -- -- (48,500)
------- ------- --------
Total costs and expenses 348,736 360,674 423,781
------- ------- --------
Earnings before income tax 16,347 17,850 14,762
Income tax expense (benefit) 5,051 6,053 (11,374)
------- ------- --------
Net earnings $ 11,296 11,797 26,136
- -------------------------------------------------------------------------------
Earnings per share:
Basic $ .94 1.00 2.32
Diluted $ .90 .96 2.26
- -------------------------------------------------------------------------------
</TABLE>
19
<PAGE> 10
ESCO Electronics Corporation and Subsidiaries
- -------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended September 30,
<S> <C> <C>
(Dollars in thousands) 1998 1997
- -------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 4,241 5,818
Accounts receivable, less allowance for doubtful accounts
of $664 and $462 in 1998 and 1997, respectively 51,530 48,612
Costs and estimated earnings on long-term contracts,
less progress billings of $51,529 and $56,451 in 1998
and 1997, respectively 26,995 34,907
Inventories 81,579 64,836
Other current assets 2,776 2,794
------- -------
Total current assets 167,121 156,967
-------- --------
Property, plant and equipment:
Land and land improvements 14,318 12,449
Buildings and leasehold improvements 47,940 43,573
Machinery and equipment 83,356 74,067
Construction in progress 4,718 4,913
-------- --------
150,332 135,002
Less accumulated depreciation and amortization 52,323 38,470
-------- --------
Net property, plant and equipment 98,009 96,532
Excess of cost over net assets of purchased businesses,
less accumulated amortization of $4,557 and $2,735 in
1998 and 1997, respectively 72,512 54,996
Deferred tax assets 44,740 48,510
Other assets 26,920 21,182
-------- --------
$409,302 $378,187
- -------------------------------------------------------------------------------
</TABLE>
20
<PAGE> 11
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1998 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current maturities of long-term debt $ 30,111 25,500
Accounts payable 39,908 38,238
Advance payments on long-term contracts, less costs incurred
of $5,046 and $1,624 in 1998 and 1997, respectively 11,442 6,348
Accrued expenses 25,346 24,590
-------- -------
Total current liabilities 106,807 94,676
-------- -------
Other liabilities 28,339 28,548
Long-term debt 50,077 50,000
-------- -------
Total liabilities 185,223 173,224
-------- -------
Commitments and contingencies - -
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 12,641,664 and 12,478,328 shares in 1998 and 1997, respectively 126 125
Additional paid-in capital 200,913 194,663
Retained earnings since elimination of deficit at September 30, 1993 27,277 15,981
Cumulative foreign currency translation adjustments 520 196
Minimum pension liability (2,260) (181)
-------- -------
226,576 210,784
Less treasury stock, at cost (234,025 and 689,945 common shares in 1998
and 1997, respectively) (2,497) (5,821)
-------- -------
Total shareholders' equity 224,079 204,963
-------- -------
$409,302 378,187
==========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE> 12
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Cumulative
Foreign
Common Stock Additional Retained Currency Minimum
Years ended September 30, ------------ Paid-in Earnings Translation Pension Treasury
(In thousands) Shares Amount Capital (Deficit) Adjustments Liability Stock
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1995 11,574 $ 116 210,205 (21,952) 292 (1,998) (4,408)
Stock options and stock
compensation plans 841 8 3,214 -- -- -- 28
Net earnings -- -- -- 26,136 -- -- --
Effect of Corporate Readjustment
on taxes -- -- 15,094 -- -- -- --
Cash distribution ($3.00 per share) -- -- (35,546) -- -- -- --
Translation adjustments -- -- -- -- (185) -- --
Minimum pension liability -- -- -- -- -- 129 --
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1996 12,415 124 192,967 4,184 107 (1,869) (4,380)
Stock options and stock
compensation plans 63 1 1,696 -- -- -- 45
Net earnings -- -- -- 11,797 -- -- --
Purchases into treasury -- -- -- -- -- -- (1,486)
Translation adjustments -- -- -- -- 89 -- --
Minimum pension liability -- -- -- -- -- 1,688 --
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1997 12,478 125 194,663 15,981 196 (181) (5,821)
Stock options and stock
compensation plans 164 1 1,137 -- -- -- 405
Net earnings -- -- -- 11,296 -- -- --
Acquisition of business -- -- 5,113 -- -- -- 3,496
Purchases into treasury -- -- -- -- -- -- (577)
Translation adjustments -- -- -- -- 324 -- --
Minimum pension liability -- -- -- -- -- (2,079) --
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1998 12,642 $ 126 200,913 27,277 520 (2,260) (2,497)
==================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 13
CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
Years ended September 30,
(Dollars in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 11,296 11,797 26,136
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 17,460 14,423 13,486
Changes in operating working capital (11,094) (2,666) 5,852
Write-off of certain assets 2,500 - 25,300
Gain on sale of Hazeltine - - (48,500)
Effect of deferred taxes on tax provision 6,121 4,816 (12,598)
Other (5,971) (3,033) (8,698)
-------- -------- -------
Net cash provided by operating activities 20,312 25,337 978
-------- -------- -------
Cash flows from investing activities:
Capital expenditures (12,896) (10,526) (8,558)
Divestiture (acquisition) of businesses (11,323) (93,200) 110,000
-------- -------- -------
Net cash provided (used) by investing activities (24,219) (103,726) 101,442
-------- -------- -------
Cash flows from financing activities:
Proceeds from long-term debt 7,000 60,000 -
Principal payments on long-term debt (7,504) (15,675) (15,386)
Net increase (decrease) in short-term borrowings 3,476 18,500 (33,000)
Special cash distribution/purchases of common stock into treasury (695) (1,486) (35,546)
Other 53 659 3,401
-------- -------- -------
Net cash provided (used) by financing activities 2,330 61,998 (80,531)
-------- -------- -------
Net increase (decrease) in cash and cash equivalents (1,577) (16,391) 21,889
Cash and cash equivalents at beginning of year 5,818 22,209 320
-------- -------- -------
Cash and cash equivalents at end of year $ 4,241 5,818 22,209
===================================================================================================================================
Changes in operating working capital:
Accounts receivable, net $ (1,745) (2,997) 5,487
Costs and estimated earnings on long-term contracts, net 4,858 (3,048) (14,382)
Inventories (17,737) 18,618 20,730
Other current assets 143 734 (15)
Accounts payable 245 (8,522) 133
Advance payments on long-term contracts, net 5,094 (1,988) (7,183)
Accrued expenses (1,952) (5,463) 1,082
-------- -------- -------
$(11,094) (2,666) 5,852
===================================================================================================================================
Supplemental cash flow information:
Interest paid $ 7,521 4,981 4,765
Income taxes paid 353 720 673
===================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of ESCO
Electronics Corporation (ESCO) and its wholly owned subsidiaries (the
Company). All significant intercompany transactions and accounts have been
eliminated in consolidation. Certain prior year amounts have been
reclassified to conform with the 1998 presentation.
(B) BASIS OF PRESENTATION
Effective September 30, 1990, Emerson Electric Co. (Emerson)
transferred the stock of certain of its subsidiaries, primarily related to
its government and defense business, to ESCO and distributed all of the
issued and outstanding ESCO common stock to Emerson shareholders (the
spin-off). Effective September 30, 1993, the Company implemented an
accounting readjustment in accordance with the accounting provisions
applicable to a "quasi-reorganization" which restated assets and
liabilities to fair values and eliminated the deficit in retained earnings.
Fair values of the Company's financial instruments are estimated by
reference to quoted prices from market sources and financial institutions,
as well as other valuation techniques. The estimated fair value of each
class of financial instruments approximated the related carrying value at
September 30, 1998 and 1997.
(C) NATURE OF OPERATIONS
The Company is engaged in the research, development, manufacture, sale
and support of a wide variety of defense and commercial systems and
products. Defense items principally are supplied to the United States
Government under prime contracts from the Army, Navy and Air Force and
under subcontracts with their prime contractors, and are also sold to
foreign customers. Commercial items are supplied to a variety of customers
worldwide, and include filtration/fluid flow products sold to aerospace,
automotive, industrial and medical/health care markets. Commercial products
also include electromagnetic compatibility (EMC) test equipment and
communications systems used by electric utilities.
The Company operates in two principal industry segments: commercial
and defense. The Company's main products include defense electronics,
defense systems, filtration/fluid flow, communications/test and other
industrial and government products.
(D) USE OF ESTIMATES AND BUSINESS RISKS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions, including estimates of anticipated contract costs and revenues
utilized in the earnings process, that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Sales to the U.S. Government may be affected by changes in
procurement policies, budget considerations, changing concepts of national
defense and other factors. Fluctuations and changes in any of these areas
could materially impact the Company's financial statements in future years.
(E) ACCOUNTING CHANGES
Effective September 30, 1997, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation". SFAS No. 123 allows, and the
Company elected, to continue its accounting under Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees". The
Company adopted the provisions of SFAS No. 123 requiring disclosure of the
pro forma effect on net earnings and earnings per share as if compensation
cost had been recognized based upon the estimated fair value at the date of
grant for options and performance shares.
Effective October 1, 1997, the Company adopted SFAS No. 128, "Earnings
Per Share", and SFAS No. 129, "Disclosure of Information about Capital
Structure".
24
<PAGE> 15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(F) REVENUE RECOGNITION
Revenue on production contracts is recorded when specific contract
terms are fulfilled, usually by delivery or acceptance (the units of
production or delivery methods). The costs attributed to units delivered
are based on the estimated average costs of all units expected to be
produced in a contract or group of contracts. Revenue under long-term
contracts for which units of production or delivery are inappropriate
measures of performance is recognized on the percentage-of-completion
method based upon incurred costs compared to total estimated costs under
the contract, or are based upon equivalent units produced. Revenue under
engineering contracts is generally recognized as milestones are attained.
Revenues from cost reimbursement contracts are recorded as costs are
incurred, plus fees earned. Estimated amounts for contract changes and
claims are included in contract revenues only when realization is probable.
Revisions to assumptions and estimates, primarily in contract value and
estimated costs used for recording sales and earnings, are reflected in the
accounting period in which the facts become known. Losses recognized on
certain contracts include a provision for the future selling, general and
administrative costs applicable to the respective contracts.
Revenue is recognized on commercial sales when products are shipped or
when services are performed.
(G) CASH AND CASH EQUIVALENTS
Cash equivalents include temporary investments that are readily
convertible into cash, such as certificates of deposit, commercial paper
and treasury bills with original maturities of three months or less.
(H) COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS
Costs and estimated earnings on long-term contracts represent unbilled
revenues, including accrued profits on long-term contracts accounted for
under the percentage-of-completion method, net of progress billings.
(I) INVENTORIES
Inventories under long-term contracts reflect accumulated production
costs, factory overhead, initial tooling and other related costs less the
portion of such costs charged to cost of sales and any progress payments
received. In accordance with industry practice, costs incurred on contracts
in progress include amounts relating to programs having production cycles
longer than one year, and a portion thereof will not be realized within one
year.
Other inventories are carried at the lower of cost (first-in,
first-out) or market.
(J) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation and
amortization are computed on accelerated methods over the estimated useful
lives of the assets: buildings, 10-40 years; machinery and equipment, 5-10
years; and office furniture and equipment, 5-10 years. Leasehold
improvements are amortized over the remaining term of the applicable lease
or their estimated useful lives, whichever is shorter.
(K) EXCESS OF COST OVER NET ASSETS OF PURCHASED BUSINESSES
Assets and liabilities related to business combinations accounted for
as purchase transactions are recorded at their respective fair values.
Excess of cost over the fair value of net assets purchased (goodwill) is
amortized on a straight-line basis over the periods estimated to be
benefited, not exceeding 40 years. The Company assesses the recoverability
of this intangible asset by determining whether the amortization of the
asset balance over its remaining life can be recovered through undiscounted
future operating cash flows.
(L) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Deferred tax
assets are reduced by a valuation allowance if it is more likely than not
that some portion or all of the deferred tax assets will not be realized.
The effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
25
<PAGE> 16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(M) RESEARCH AND DEVELOPMENT COSTS
Company-sponsored research and development costs include research and
development and bid and proposal efforts related to U.S. Government and
commercial products and services. Company-sponsored product development
costs are charged to expense when incurred. Customer-sponsored research and
development costs incurred pursuant to contracts are accounted for similar
to other program costs.
(N) FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign operations are
translated into U.S. dollars in accordance with SFAS No. 52, "Foreign
Currency Translation". The resulting translation adjustments are recorded
as a separate component of shareholders' equity.
(O) EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted average
number of common shares outstanding during the period. Diluted earnings per
share 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 performance shares by using
the treasury stock method. The number of shares used in the calculation of
earnings per share for each year presented is as follows:
<TABLE>
<CAPTION>
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted Average Shares Outstanding-- Basic 12,015 11,805 11,262
Dilutive Options and Performance Shares 535 469 318
------ ------ ------
Adjusted Shares-- Diluted 12,550 12,274 11,580
================================================================================
</TABLE>
Options to purchase 84,000, 94,800 and 41,300 shares of common stock
at per share prices ranging from $18 to $19.22 in 1998, $12.38 in 1997 and
$12 in 1996 were outstanding during the years ended September 30, 1998,
1997 and 1996, respectively, but were not included in the respective
computations of diluted EPS because the options' exercise price was greater
than the average market price of the common shares. These options expire in
2007 and 2008. Approximately 166,000, 338,000 and 53,000 performance shares
were outstanding but unearned at September 30, 1998, 1997 and 1996,
respectively, and therefore, were not included in the respective
computations of diluted EPS. The unearned performance shares expire in
2001.
2. ACQUISITIONS/DIVESTITURES (UNAUDITED)
On July 1, 1998, the Company completed the acquisition of Advanced
Membrane Technology, Inc. (AMT) and renamed the company PTI Advanced
Filtration Inc. (PTA). PTA, headquartered in San Diego, California, designs
and manufactures several types of filtration membrane and provides
filtration systems for a variety of applications in the process industries.
The transaction involved the purchase of AMT common stock for approximately
$7 million in cash plus approximately 450,000 shares of ESCO common stock
valued at $8.6 million.
On December 31, 1997, the Company completed the purchase of Euroshield
OY for consideration which included $3.5 million in cash. Euroshield,
located in Eura, Finland, designs and manufactures high quality shielding
products used in the electromagnetic compatibility (EMC) industry.
On February 7, 1997, the Company completed the acquisition of the
filtration and the thermoform packaging businesses (Filtertek) of Schawk,
Inc. The transaction involved the purchase of assets and stock of certain
subsidiary corporations of Schawk, Inc. for $92 million in cash plus
working capital adjustments in 1998. Filtertek is a leader in the
manufacture of plastic insert injection molded filter assemblies.
26
<PAGE> 17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On July 22, 1996, the Company completed the sale of its Hazeltine
subsidiary to GEC-Marconi Electronic Systems Corporation (GEC). The Company
sold 100% of the common stock of Hazeltine for $110 million in cash,
resulting in a $48.5 million gain. Certain assets and liabilities of
Hazeltine were retained by the Company.
Included in the 1996 consolidated statements of operations are the
operating results of Hazeltine prior to its divestiture as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1996
- --------------------------------------------------------------------------------
<S> <C>
Net sales $93,987
Cost of sales 75,598
Selling, general and administrative expenses 12,859
Other costs and expenses, net 941
-------
Earnings before income taxes $ 4,589
================================================================================
</TABLE>
All of the Company's acquisitions have been accounted for using the
purchase method of accounting, and accordingly, the respective purchase
prices were allocated to the assets (including intangible assets) acquired
and liabilities assumed based on estimated fair values at the date of
acquisition. The excess cost of the acquisitions over the estimated fair
value of the net assets acquired is being amortized on a straight-line
basis over periods ranging from 15-40 years, depending on management's
assessment of its useful life. The financial results from these
acquisitions have been included in the Company's financial statements from
the date of acquisition.
The following unaudited pro forma financial information assumes the
acquisitions of AMT, Euroshield and Filtertek had occurred on October 1,
1996. The pro forma summary is not necessarily indicative of the results of
operations that would have occurred had the acquisitions been completed on
October 1, 1996, or of future results of operations.
<TABLE>
<CAPTION>
Years ended September 30, Pro forma (Unaudited)
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Net sales $ 374,751 416,281
Net earnings 11,421 11,412
Earnings per share:
Basic .95 .97
Diluted .91 .93
================================================================================
</TABLE>
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following at September 30, 1998 and
1997:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
U.S. Government and prime contractors $10,801 11,191
Commercial 38,371 35,482
Other 2,358 1,939
------- -------
Total $51,530 48,612
================================================================================
</TABLE>
The increase in commercial accounts receivable in 1998 is primarily
due to increased sales volume in the fiscal fourth quarter at DCSI.
27
<PAGE> 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. INVENTORIES
Inventories consist of the following at September 30, 1998 and 1997:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Finished goods $ 9,491 8,542
Work in process-- including long-term contracts 54,754 42,697
Raw materials 17,334 13,597
------- -------
Total $81,579 64,836
================================================================================
</TABLE>
Under the contractual arrangements by which progress payments are
received, the U.S. Government has a security interest in the inventories
associated with specific contracts. Inventories are net of progress payment
receipts of $14 million and $3.2 million at September 30, 1998 and 1997,
respectively.
Work in process includes $24.7 million and $19.7 million at September
30, 1998 and 1997, respectively, of Tunner inventory relating to specific
future contract awards. These precontract costs were incurred based on the
U.S. Air Force's identified future loader requirements. The Company is
currently amortizing these costs over the multi-year contracts as awarded.
5. PROPERTY, PLANT AND EQUIPMENT
Depreciation and amortization of property, plant and equipment for the
years ended September 30, 1998, 1997 and 1996 were $14,589,000, $12,441,000
and $12,163,000, respectively.
The Company leases certain real property, equipment and machinery
under noncancelable operating leases. Rental expense under these operating
leases for the years ended September 30, 1998, 1997 and 1996 amounted to
$5,675,000, $4,502,000 and $4,759,000, respectively. Future aggregate
minimum lease payments under operating leases that have initial or
remaining noncancelable lease terms in excess of one year as of September
30, 1998 are:
<TABLE>
<CAPTION>
(Dollars in thousands) Years ending September 30:
- --------------------------------------------------------------------------------
<S> <C>
1999 $ 5,354
2000 3,599
2001 2,822
2002 2,417
2003 and thereafter 2,797
-------
Total $16,989
================================================================================
</TABLE>
6. INCOME TAX EXPENSE (BENEFIT)
The principal components of income tax expense (benefit) for the years
ended September 30, 1998, 1997 and 1996 consist of:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal:
Current $ -- 223 --
Deferred 6,121 4,816 (12,598)
State, local and foreign (1,070) 1,014 1,224
------ ------- -------
Total $5,051 6,053 (11,374)
===================================================================================================================================
</TABLE>
The actual income tax expense for the years ended September 30, 1998,
1997 and 1996 differs from the expected tax expense for those years
(computed by applying the U.S. Federal statutory rate) as follows:
28
<PAGE> 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal corporate statutory rate 35.0% 35.0% 35.0%
Effect of Corporate Readjustment on temporary differences -- -- 102.2
Net change in the balance of the tax valuation allowance 3.0 (6.8) 100.2
Effect of subsidiary divestiture on temporary differences -- -- (314.0)
Income taxes, net of Federal benefits:
State and local (2.8) (2.7) 4.3
Foreign .4 (1.1) 1.1
Other, net (4.7) 4.1 (5.8)
------ ------ ------
Effective income tax rate 30.9% 33.9% (77.0)%
==================================================================================================================================
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at September 30, 1998,
1997 and 1996 are presented below:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred tax assets:
Inventories, long-term contract accounting,
contract cost reserves and others $ -- 7,371 14,538
Pension and other postretirement benefits 10,110 10,272 9,402
Net operating loss carryforwards 39,961 34,036 42,188
Capital loss carryforwards 27,074 27,074 30,567
Other compensation-related costs and other
cost accruals 10,815 11,960 2,948
--------- --------- -------
Total deferred tax assets 87,960 90,713 99,643
Deferred tax liabilities:
Inventories, long-term contract accounting,
contract cost reserves and others (367) -- --
Plant and equipment, depreciation methods
and acquisition asset allocations (1,883) (2,640) (3,011)
--------- --------- -------
Net deferred tax asset before valuation allowance 85,710 88,073 96,632
Less valuation allowance (40,970) (39,563) (43,306)
--------- --------- -------
Net deferred tax asset $ 44,740 48,510 53,326
===================================================================================================================================
</TABLE>
Management believes it is more likely than not that with its
projections of future taxable income, its shift in strategic direction, and
after consideration of the valuation allowance, the Company will generate
sufficient taxable income to realize the benefits of the net deferred tax
assets existing at September 30, 1998.
In order to fully realize the deferred tax assets existing at
September 30, 1998, the Company will need to generate future taxable income
of approximately $128 million of which $114 million is required to be
realized prior to the expiration of the net operating loss (NOL)
carryforwards, of which $33 million will expire in 2006; $6 million will
expire in 2007; $23 million will expire in 2009; $38 million will expire in
2010; $7 million will expire in 2011; and $7 million will expire in 2018.
Also, the Company will need to generate future capital gains of
approximately $77 million prior to 2001, at which time the capital loss
carryforward, resulting from the 1996 divestiture of Hazeltine, will
expire. There can be no assurance, however, that the Company will generate
sufficient taxable income or specified level of continuing taxable income.
During the year ended September 30, 1998, the Company increased its
deferred tax valuation allowance to $41 million. A full valuation allowance
of $27.1 million is being maintained against the deferred tax asset
associated with the capital loss. The remaining balance of $13.9 million
represents management's best estimate of the portion of deferred tax asset
associated with temporary differences and NOLs which may not be realized.
29
<PAGE> 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEBT
Long-term debt consists of the following at September 30, 1998 and
1997:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Term loan $57,000 57,000
Other debt 1,188 --
Less current maturities (8,111) (7,000)
------- -------
Long-term debt $50,077 50,000
====================================================================================================================================
</TABLE>
The Company's existing $132 million bank credit facility was amended
on June 29, 1998 to increase the amount of the outstanding term loan by $7
million to $59 million, and to reduce the revolving credit facility by $7
million to $73 million. The term loan has scheduled amortization payments
of $2 million per quarter. The revolving credit facility (subject to
borrowing base asset limitations) is available for direct borrowings and/or
the issuance of letters of credit. The maturity of the bank credit facility
is September 30, 2000. These credit facilities are provided by a group of
banks, led by Morgan Guaranty Trust Company of New York. At September 30,
1998, the Company had $48.3 million available under the revolving credit
facility.
The amended credit facility requires, as determined by certain
financial ratios, a commitment fee ranging from 5/16% to 7/16% per annum on
the unused portion. The terms of the credit facility provide that interest
on borrowings may be calculated at a spread over the London Interbank
Offered Rate (LIBOR), or certificate of deposit rates for various
maturities, or based on the prime rate, at the Company's election.
Substantially all of the assets of the Company are pledged under the credit
facility. The most restrictive financial covenants of the credit facility
include minimum interest coverage, limitations on leverage and minimum
tangible net worth. Dividends may not exceed 25% of the Company's
consolidated net earnings.
During 1998 and 1997, the maximum aggregate short-term borrowings at
any month-end were $55.5 million and $55 million, respectively; the average
aggregate short-term borrowings outstanding based on month-end balances
were $39.8 million and $24.7 million, respectively; and the weighted
average interest rates were 6.9% in 1998, 1997 and 1996. The letters of
credit issued and outstanding under the credit facility totaled $2.7
million at September 30, 1998 and 1997. Borrowings under the revolving
credit facility were $22 million at September 30, 1998.
Other debt of $1.2 million at September 30, 1998 relates to Euroshield
borrowings existing at the date of acquisition.
8. CAPITAL STOCK
The 12,641,664 and 12,478,328 common shares as presented in the
accompanying consolidated balance sheets at September 30, 1998 and 1997
represent the actual number of shares issued at the respective dates. The
Company held 234,025 and 689,945 common shares in treasury at September 30,
1998 and 1997, respectively. The decrease in treasury shares in 1998 is the
result of the reissuance of approximately 450,000 treasury shares in
conjunction with the July 1998 acquisition of PTA.
Pursuant to a Deposit and Trust Agreement (the Trust Agreement), all
of the outstanding shares of the Company's common stock are held in trust
by a trustee on behalf of the persons otherwise entitled to hold the
Company's common stock, and such persons, instead, hold common stock trust
receipts (Receipts) representing the Company's common stock and associated
preferred stock purchase rights (the Rights). Although the trustee is the
record holder of the Company's common stock, each holder of a Receipt is
generally entitled to all of the rights of a holder of the Company's common
stock (including the right to vote and to receive dividends or other
distributions), except in certain circumstances. If the Company fails in
certain circumstances to collateralize its obligations to indemnify Emerson
with respect to Emerson's guarantees of certain of the Company's government
contracts and for so long as such failure continues, Emerson will have the
right to direct the trustee how to vote in the election of directors and
certain related matters.
30
<PAGE> 21
During 1995, the Company adopted the 1994 Stock Option Plan, and in
1991, the Company adopted the 1990 Stock Option Plan (the Option Plans).
The Option Plans permit the Company to grant key management employees (1)
options to purchase shares of the Company's common stock (or Receipts
representing such shares) or (2) stock appreciation rights with respect to
all or any part of the number of shares covered by the options. As long as
the Trust Agreement is in effect, an optionee will receive Receipts in lieu
of shares. All outstanding options were granted at prices equal to fair
market value at the date of grant. As a result of the $3.00 per share
special cash distribution paid to shareholders in 1996 as a non-taxable
return of capital, unexercised stock options were repriced, and the number
of options outstanding were adjusted, using a method which resulted in no
additional compensation expense to the Company. Information regarding stock
options awarded under the Option Plans is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ------------------------ -----------------------
Estimated Estimated Estimated
Shares Avg. Price Shares Avg. Price Shares Avg. Price
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
October 1, 998,486 $ 6.18 889,930 $ 6.04 1,135,301 $ 5.77
Granted 89,500 $ 18.14 227,450 $ 10.78 497,250 $ 10.38
Exercised (107,964) $ 7.58 (68,371) $ 6.87 (806,255) $ 5.77
Cancelled (26,306) $ 7.20 (50,523) $ 9.28 (119,257) $ 10.31
Repricing -- -- -- -- 182,891 $ 8.06
- -----------------------------------------------------------------------------------------------------------------------------------
September 30, 953,716 $ 8.61 998,486 $ 6.18 889,930 $ 6.04
At September 30,
Reserved for future grant 133,128
Exercisable 509,559 $ 7.46 404,387 $ 6.18 264,265 $ 6.04
===================================================================================================================================
</TABLE>
During 1996, the Company announced a stock repurchase program. Under
this program, the Company was authorized to purchase up to two million
shares of its common stock in the open market through September 30, 1998.
Approximately 180,000 shares were repurchased throughout that two-year
period. Subsequent to September 30, 1998, the Company authorized an
additional open market repurchase program of up to 1.3 million shares,
which is subject to market conditions and other factors and will cover a
period ending September 29, 2000.
During 1993 and 1997, the Board of Directors authorized, and the
shareholders approved, the Performance Share Plans (the Plans). The maximum
number of shares available for issue under the Plans is 875,000 shares. As
of September 30, 1998, 848,000 shares have been awarded, 503,000 shares
have been earned and 310,000 shares have been issued under the terms of the
Plans.
At September 30, 1998, there were 50,000 shares of restricted stock
outstanding and held by certain key executives. These shares will be earned
ratably through the period ending September 30, 2001.
The Company has a Preferred Stock Purchase Rights Plan pursuant to
which a dividend of one Right was declared for each outstanding share of
the Company's common stock. Each Right entitles the holder to purchase one
one-hundredth of a share of preferred stock at an initial purchase price of
$25. Approximately 120,000 preferred shares are reserved for issuance under
this plan. Under certain conditions involving the acquisition of, or an
offer for, 20% or more of the Company's common stock, all holders of
Rights, except an acquiring entity, would be entitled (1) to purchase, at a
defined price, common stock of the Company or an acquiring entity at a
value twice the defined price, or (2) at the option of the Board, to
exchange each Right for one share of common stock. The Rights remain in
existence until September 30, 2000, unless redeemed earlier (at one cent
per Right), exercised or exchanged under the terms of the plan.
The Company adopted the disclosure-only provisions of SFAS No. 123.
Under APB No. 25, no compensation cost was recognized for the Company's
stock option plans. Had compensation cost for the Company's stock option
plans and performance share plans been determined based on the fair value
at the grant date for awards in 1998 and 1997 consistent with the
provisions of this statement, the Company's net earnings and net earnings
per share would have been as follows:
31
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Pro forma (unaudited)
(Dollars in thousands, except per share amounts) 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net earnings $11,221 10,873
Net earnings per share:
Basic .93 .92
Diluted .89 .89
==================================================================================================================================
</TABLE>
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 1998 and 1997,
respectively: expected dividend yield of 0% in both periods; expected
volatility of 37.19% and 35.45%; risk-free interest rate of 4.42% and
6.299% and expected life based on historical exercise periods of 4.11 years
and 3.68 years.
To determine the fair value of grants under the Performance Share
Plans, the probability that performance milestones would be met were
applied to the ESCO stock price on the date of grant. This probability was
based on an estimated average annual growth rate of 10.0% and an annualized
volatility of 32.5%.
9. RETIREMENT AND OTHER BENEFIT PLANS
Substantially all employees are covered by defined benefit or defined
contribution pension plans maintained by the Company for the benefit of its
employees. Benefits are provided to employees under defined benefit
pay-related and flat-dollar plans which are primarily noncontributory.
Annual contributions to retirement plans equal or exceed the minimum
funding requirements of the Employee Retirement Income Security Act or
applicable local regulations. Pension expense for the years ended September
30, 1998, 1997 and 1996 is comprised of the following:
<TABLE>
<CAPTION>
(Dollars in millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Defined benefit plans:
Service cost (benefits earned during the period) $ 3.5 3.3 3.2
Interest cost 6.1 5.4 5.0
Actual return on plan assets .7 (19.0) (5.5)
Net amortization and deferral (7.1) 13.5 .8
----- ------ -----
Net periodic pension expense 3.2 3.2 3.5
Defined contribution plans .4 .4 2.1
----- ------ -----
Total $ 3.6 3.6 5.6
===================================================================================================================================
</TABLE>
The funded status of the Company's defined benefit pension plans as of
September 30, 1998 and 1997 is shown below:
<TABLE>
<CAPTION>
(Dollars in millions) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Accumulated benefit obligation, including vested benefit obligation of
$74.7 and $59.4 at September 30, 1998 and 1997, respectively $78.7 63.1
----- -----
Projected benefit obligation 96.0 77.6
Plan assets at fair value, primarily corporate equity and
fixed income securities 77.9 78.9
----- -----
Projected benefit obligation in excess of (less than) plan assets 18.1 (1.3)
Unrecognized transition amount -- --
Unrecognized net gain (loss) (7.3) 12.2
Unrecognized prior service costs (1.9) (2.5)
Additional minimum liability 4.1 2.3
----- -----
Net pension liability (included in other liabilities) $13.0 10.7
===================================================================================================================================
</TABLE>
32
<PAGE> 23
The benefit obligations of the defined benefit plans as of September
30, 1998 and 1997 were based on discount rates of 6.75% and 7.5%,
respectively, and an assumed rate of increase in compensation levels of 4%.
The 1998, 1997 and 1996 pension expense for the defined benefit plans was
based on a 6.75%, 7.5% and 7.5% discount rate, respectively, a 4% increase
in compensation levels, and a 10% expected long-term rate of return on plan
assets.
In addition to providing retirement income benefits, the Company
provides unfunded postretirement health and life insurance benefits to
certain retirees. To qualify, an employee must retire at age 55 or later
and the employee's age plus service must equal or exceed 75. Retiree
contributions are defined as a percentage of medical premiums.
Consequently, retiree contributions increase with increases in the medical
premiums. The life insurance plans are noncontributory and provide coverage
of a flat dollar amount for qualifying retired employees.
Net periodic postretirement benefit cost is comprised of the
following:
<TABLE>
<CAPTION>
(Dollars in millions) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ .2 .2 .2
Interest cost 1.1 1.2 1.3
------ ------ -----
Net periodic postretirement benefit cost $1.3 1.4 1.5
===================================================================================================================================
</TABLE>
Accumulated postretirement benefit obligation as of September 30, 1998
and 1997 is shown below:
<TABLE>
<CAPTION>
(Dollars in millions) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Retirees $12.1 12.1
Fully eligible active plan participants .6 .5
Other active participants 3.3 3.0
----- -----
Total accumulated postretirement benefit obligation 16.0 15.6
Plan assets - -
----- -----
Accumulated postretirement benefit obligation in excess of plan assets 16.0 15.6
Unrecognized prior service cost .1 .1
Unrecognized net gain (loss) (1.1) .1
----- -----
Accrued postretirement benefit obligation (included in other liabilities) $15.0 15.8
===================================================================================================================================
</TABLE>
The accumulated postretirement benefit obligations of the plans as of
September 30, 1998 and 1997 were based on discount rates of 6.75% and 7.5%,
respectively. The September 30, 1997 accumulated postretirement benefit
obligation was based on a health care cost trend of 7.5% for 1998,
gradually grading down to an ultimate rate of 5.5% by 2002. The September
30, 1998 accumulated postretirement benefit obligation was based on a
health care cost trend of 7% for 1999, gradually grading down to an
ultimate rate of 5.5% by 2002. A 1% increase in the health care cost trend
rate for each year would increase the September 30, 1998 accumulated
postretirement benefit obligation by approximately $400,000.
The 1998, 1997 and 1996 net periodic postretirement benefit costs were
based on discount rates of 6.75%, 7.5%, and 7.5%, respectively. The net
periodic postretirement benefit cost was based on an assumed health care
cost trend of 7.5%, 8% and 8.5% for 1998, 1997 and 1996, respectively,
gradually grading down to 5.5% by fiscal 2002. A 1% increase in the health
care cost trend rate for each year would increase the aggregate of the
service cost and interest cost components of the 1998 net periodic
postretirement benefit cost by approximately $35,000.
33
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. OTHER FINANCIAL DATA
Items charged to operations during the years ended September 30, 1998,
1997 and 1996 included the following:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Maintenance and repairs $ 6,751 5,828 5,826
Salaries and wages 133,507 113,953 136,783
--------- ------- --------
Research and development costs:
Company-sponsored $ 5,866 6,161 11,905
Customer-sponsored 10,201 6,341 3,894
--------- ------- --------
Total $ 16,067 12,502 15,799
===================================================================================================================================
</TABLE>
The increase in 1998 research and development costs is due to the
inclusion of Filtertek for the full year and additional expenditures at
Rantec. The decrease in 1997 from 1996 is due to the divestiture of
Hazeltine in 1996.
Accrued expenses included accrued employee compensation of $10.2
million and $9.3 million at September 30, 1998 and 1997, respectively.
11. BUSINESS SEGMENT INFORMATION
The Company's principal business segments are defense and commercial.
Summarized below is the Company's business segment information for the
years ended September 30, 1998, 1997 and 1996. Sales between segments have
been eliminated. Corporate expenses and assets have been allocated to the
segment data on a systematic basis. Hazeltine primarily operated within the
defense segment prior to its divestiture in 1996. Filtertek is included in
the commercial results for 1998 and 1997. Operating profit (loss) is
calculated as: net sales, less cost of sales, less other charges related to
cost of sales, less selling, general and administrative expenses.
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales:
Defense $ 158,944 191,039 300,970
Commercial 206,139 187,485 137,573
--------- -------- -------
$ 365,083 378,524 438,543
- -----------------------------------------------------------------------------------------------------------------------------------
Operating profit (loss):
Defense $ 9,682 13,408 (31,842)
Commercial 17,243 14,184 7,902
--------- -------- -------
$ 26,925 27,592 (23,940)
- -----------------------------------------------------------------------------------------------------------------------------------
Identifiable assets:
Defense $ 165,136 166,063 191,588
Commercial 244,166 212,124 116,244
--------- -------- -------
$ 409,302 378,187 307,832
- -----------------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization:
Defense $ 4,500 4,644 8,001
Commercial 12,960 9,779 5,485
--------- -------- -------
$ 17,460 14,423 13,486
- -----------------------------------------------------------------------------------------------------------------------------------
Capital Expenditures:
Defense $ 2,350 3,131 5,204
Commercial 10,546 7,395 3,354
--------- -------- -------
$ 12,896 10,526 8,558
===================================================================================================================================
</TABLE>
34
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net sales derived from U.S. Government agencies, either through direct
sales or through prime contractors, totaled $148,273,000, $164,660,000 and
$231,503,000 for the years ended September 30, 1998, 1997 and 1996,
respectively.
International sales included in net sales for the years ended
September 30, 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
(Dollars in thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Europe $37,619 31,075 53,856
Middle East 3,944 6,024 19,223
Far East 8,599 17,773 48,391
Other 8,535 13,954 23,215
------- ------ -------
Total $58,697 68,826 144,685
===================================================================================================================================
</TABLE>
The decrease in 1998 compared to 1997 is primarily due to lower Far
East defense sales at SEI, partially offset by increased European sales at
Filtertek.
The decrease in 1997 compared to 1996 reflects the divestiture of
Hazeltine in July 1996 and lower Middle East sales at SEI; offset by the
addition of Filtertek ($10.3 million, primarily Europe) and higher volume
at all other operating units. Hazeltine's international sales for 1996 were
$58.6 million.
12. EMERSON CONTRACT GUARANTEES
Emerson has directly or indirectly guaranteed or is otherwise liable
for the performance of most of the Company's contracts with its customers
which existed at September 30, 1990 (the Guaranteed Contracts). The
Guaranteed Contracts include certain U.S. Government contracts entered into
by the Company prior to September 30, 1990. As of September 30, 1998, the
aggregate backlog of all firm orders received by the Company included
Guaranteed Contracts of $1,591,000. At September 30, 1998, there were open
letters of credit with an aggregate value of $2,443,000 related to foreign
advance payments in support of various contracts that are directly or
indirectly guaranteed by Emerson.
13. COMMITMENTS AND CONTINGENCIES
At September 30, 1998, the Company had $5.1 million in letters of
credit outstanding as guarantees of contract performance.
In 1994, an action was commenced against the Company's Hazeltine
subsidiary alleging injury caused by Hazeltine's purported release of
hazardous materials. The Company believes that no one and no property were
injured by any release of hazardous substances from Hazeltine's plant. In
1996, the plaintiffs filed a motion to be certified as a class. This motion
was denied and the plaintiffs appealed. The appellate court affirmed the
denial. Based upon the current facts, the Company is not able to estimate
the probable outcome. Therefore, no provision for this litigation has been
made in the accompanying consolidated financial statements. Management
believes the Company will be successful in defending this action and that
the outcome will not have a material adverse effect on the Company's
financial statements. This contingent liability was retained by the Company
when Hazeltine was divested in 1996.
As a normal incidence 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.
35
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. OTHER CHARGES RELATED TO COST OF SALES
Other charges related to cost of sales of $2.5 million in 1998
resulted from the Company's settlement of a long-standing contract dispute
related to the original M1000 tank transporter program. The settlement
agreement requires the customer (the U.S. Army) to pay the Company $7.5
million in 1999, in exchange for the Company dropping its claim for damages
and recovery of additional program costs incurred.
During 1996, and in conjunction with the sale of Hazeltine and
management's decision to pursue a strategy of deliberate diversification
from defense to commercial, the Company reevaluated the carrying value of
certain assets. As a result of this reevaluation, the Company recorded
$25.3 million of other charges related to cost of sales in 1996.
The 1996 charge included $14.3 million of inventories related to
defense programs which the Company no longer intended to actively pursue;
$6 million of costs included in other assets incurred in anticipation of
certain defense contract awards which the Company is no longer actively
pursuing; and a $5 million adjustment in the Company's estimate of
recoveries in a contract dispute related to the M1000 tank transporter
program.
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in thousands, First Second Third Fourth Fiscal
except per share amounts) Quarter Quarter Quarter Quarter Year
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998
Net sales $ 78,077 86,030 98,236 102,740 365,083
Gross profit 22,029 24,596 25,641 22,985 95,251
Net earnings 2,610 3,240 3,847 1,599 11,296
Earnings per share:
Basic $ .22 .27 .32 .13 .94
Diluted .21 .26 .31 .12 .90
===================================================================================================================================
1997
Net sales $ 68,899 88,811 109,348 111,466 378,524
Gross profit 16,960 22,427 25,513 26,834 91,734
Net earnings 2,182 2,767 3,330 3,518 11,797
Earnings per share:
Basic $ .18 .23 .28 .30 1.00
Diluted .18 .23 .27 .28 .96
===================================================================================================================================
</TABLE>
Gross profit is computed as net sales, less cost of sales, less other
charges related to cost of sales.
The 1997 quarterly financial information includes the results of
Filtertek subsequent to the February 1997 acquisition.
36
<PAGE> 27
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
ESCO ELECTRONICS CORPORATION:
We have audited the accompanying consolidated balance sheets of
ESCO Electronics Corporation and subsidiaries as of September 30,
1998 and 1997, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended September 30, 1998. These
consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of ESCO Electronics Corporation and subsidiaries as of
September 30, 1998 and 1997, and the results of their operations and
their cash flows for each of the years in the three-year period
ended September 30, 1998, in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
St. Louis, Missouri
November 11, 1998
37
<PAGE> 28
SHAREHOLDERS' SUMMARY
CAPITAL STOCK INFORMATION
ESCO Electronics Corporation common stock trust receipts (and
the underlying common stock and associated preferred stock purchase
rights) (symbol ESE) are listed on the New York Stock Exchange.
There were approximately 8,700 holders of record of trust
receipts representing shares of common stock at September 30, 1998.
39
<PAGE> 29
COMMON STOCK MARKET PRICES
The Company's common stock trust receipts and the underlying common
stock and associated preferred stock purchase rights (subsequently referred
to as common stock) are listed on the New York Stock Exchange under the
symbol "ESE." The following table summarizes the high and low prices of the
Company's common stock for each quarter of 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------------------------------------------------------------------
Quarter High Low High Low
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
First 19 15/16 16 3/16 10 3/8 8 5/8
Second 18 7/16 16 13 1/4 9 7/8
Third 20 3/4 16 5/8 12 13/16 9 5/8
Fourth 19 5/16 8 5/8 18 1/4 12 3/8
</TABLE>
38
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF
ESCO ELECTRONICS CORPORATION
<TABLE>
<CAPTION>
STATE OR JURISDICTION OF
INCORPORATION OR NAME UNDER WHICH IT
NAME ORGANIZATION DOES BUSINESS
- ---- ------------ -------------
<S> <C> <C>
Defense Holding Corp. Delaware Same
Distribution Control Systems Puerto Rico Same
Caribe, Inc.
Distribution Control Systems, Inc. Missouri Same
EMC Test Systems, L.P. Texas Same
Euroshield OY Finland Same
Filtertek Inc. Delaware Same and Tek
Packaging Division
Filtertek BV Netherlands Same
Filtertek de Puerto Rico, Inc. Delaware Same
Filtertek SA France Same
PTI Advanced Filtration Inc. Delaware Same
PTI Technologies Inc. Delaware Same
PTI Technologies Limited England Same
Rantec Microwave & Electronics, Delaware Same
Inc.
Systems & Electronics Inc. Delaware Same and
Comtrak Division
VACCO Industries California Same
</TABLE>
<PAGE> 1
Exhibit 23
Independent Auditors' Consent
The Board of Directors
ESCO Electronics Corporation:
We consent to incorporation by reference in the registration statements (Nos.
33-39737, 33-47916, and 33-98112) on Form S-8 of ESCO Electronics Corporation of
our report dated November 11, 1998, relating to the consolidated balance sheets
of ESCO Electronics Corporation and subsidiaries as of September 30, 1998 and
1997, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period ended
September 30, 1998, which report appears in the September 30, 1998 Annual Report
on Form 10-K of ESCO Electronics Corporation.
KPMG Peat Marwick LLP
St. Louis, Missouri
December 21, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 4,241
<SECURITIES> 0
<RECEIVABLES> 52,193<F1>
<ALLOWANCES> 664
<INVENTORY> 81,579
<CURRENT-ASSETS> 167,121
<PP&E> 150,332
<DEPRECIATION> 52,323
<TOTAL-ASSETS> 409,302
<CURRENT-LIABILITIES> 106,807
<BONDS> 0
0
0
<COMMON> 126
<OTHER-SE> 223,953
<TOTAL-LIABILITY-AND-EQUITY> 409,302
<SALES> 365,083
<TOTAL-REVENUES> 365,083
<CGS> 267,332
<TOTAL-COSTS> 338,158
<OTHER-EXPENSES> 2,875
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,703
<INCOME-PRETAX> 16,347
<INCOME-TAX> 5,051
<INCOME-CONTINUING> 11,296
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,296
<EPS-PRIMARY> .94
<EPS-DILUTED> .90
<FN>
<F1>This number does not include 51.5 million of Costs and Estimated Earnings on
Long-Term Contracts.
</FN>
</TABLE>
