UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______ COMMISSION FILE NUMBER 1-10596 ESCO TECHNOLOGIES INC. (Exact name of registrant as specified in its charter) MISSOURI 43-1554045 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8888 LADUE ROAD, SUITE 200 ST. LOUIS, MISSOURI 63124-2056 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (314) 213-7200 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No___ The number of shares of the registrant's common stock outstanding at July 31, 2005 was 12,736,707.
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ESCO TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Dollars in thousands, except per share amounts) Three Months Ended June 30, -------- 2005 2004 ------ ------ Net sales $ 108,800 107,911 Costs and expenses: Cost of sales 71,911 70,125 Asset impairment 790 - Selling, general and administrative expenses 21,722 19,670 Interest income (534) (129) Other (income) expense, net 198 71 ----- ------- Total costs and expenses 94,087 89,737 Earnings before income taxes 14,713 18,174 Income tax expense 2,312 6,958 -------- -------- Net earnings from continuing operations 12,401 11,216 Loss from discontinued operations, net of tax benefit of $(83) in 2004 - (1,100) Gain on sale of discontinued operations, net of tax benefit of $(1,153) in 2004 - 1,925 --------- --------- Net earnings from discontinued operations - 825 Net earnings $ 12,401 12,041 ====== ====== Earnings (loss) per share: Basic - Continuing operations $ 0.98 0.87 - Discontinued operations - 0.06 ------ ------ - Net earnings $ 0.98 0.93 ==== ==== Diluted - Continuing operations $ 0.95 0.84 - Discontinued operations - 0.06 ----- ----- - Net earnings $ 0.95 0.90 ==== ==== See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Dollars in thousands, except per share amounts) Nine Months Ended June 30, -------- 2005 2004 ------ ------ Net sales $ 319,335 306,477 Costs and expenses: Cost of sales 209,409 207,175 Asset impairment 790 - Selling, general and administrative expenses 62,804 57,549 Interest income (1,317) (648) Other (income) expense, net (492) 1,199 ------- -------- Total costs and expenses 271,194 265,275 Earnings before income taxes 48,141 41,202 Income tax expense 14,790 15,833 --------- -------- Net earnings from continuing operations 33,351 25,369 Loss from discontinued operations, net of tax benefit of $(1,291) in 2004 - (3,737) Gain on sale discontinued operations, net of tax benefit of $(1,153) in 2004 - 1,925 --------- -------- Net loss from discontinued operations - (1,812) Net earnings $ 33,351 23,557 ===== ===== Earnings (loss) per share: Basic - Continuing operations $ 2.62 1.97 - Discontinued operations - (0.14) ----- ------- - Net earnings $ 2.62 1.83 ==== ==== Diluted - Continuing operations $ 2.54 1.91 - Discontinued operations - (0.14) ----- ------- - Net earnings $ 2.54 1.77 ==== ==== See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) June 30, September 30, 2005 2004 ------ ------ ASSETS (Unaudited) Current assets: Cash and cash equivalents $ 85,765 72,281 Accounts receivable, net 71,045 77,729 Costs and estimated earnings on long-term contracts, less progress billings of $6,752 and $2,210, respectively 3,056 2,476 Inventories 53,881 44,287 Current portion of deferred tax assets 20,022 27,810 Other current assets 9,184 8,947 -------- ------- Total current assets 242,953 233,530 Property, plant and equipment, net 67,360 69,103 Goodwill 68,884 68,949 Other assets 30,423 30,858 -------- -------- $ 409,620 402,440 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Short-term borrowings and current maturities of long-term debt $ 37 151 Accounts payable 31,403 32,455 Advance payments on long-term contracts, less costs incurred of $11,825 and $8,017, respectively 6,012 4,305 Accrued salaries 10,763 11,896 Accrued taxes 992 4,454 Accrued other expenses 11,919 15,061 -------- -------- Total current liabilities 61,126 68,322 Deferred income 3,288 2,738 Pension obligations 13,902 13,899 Other liabilities 9,625 9,497 Long-term debt 360 368 ---- ---- Total liabilities 88,301 94,824 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 14,322,536 and 14,148,902 shares, respectively 143 142 Additional paid-in capital 226,264 221,711 Retained earnings 149,314 115,963 Accumulated other comprehensive loss (3,011) (3,698) ------- ------- 372,710 334,118 Less treasury stock, at cost: 1,589,013 and 1,257,352 common shares, respectively (51,391) (26,502) --------- -------- Total shareholders' equity 321,319 307,616 -------- ------- $ 409,620 402,440 ======= ======= See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) Nine Months Ended June 30, -------- 2005 2004 ------ ------ Cash flows from operating activities: Net earnings $ 33,351 23,557 Adjustments to reconcile net earnings to net cash provided by operating activities: Net loss from discontinued operations net of tax - 1,812 Depreciation and amortization 9,263 8,980 Changes in operating working capital (3,020) (6,843) Effect of deferred taxes 3,526 121 Other (2,689) 3,163 ------- ------- Net cash provided by operating activities - continuing operations 40,431 30,790 Net cash used by discontinued operations - (2,735) -------- ------- Net cash provided by operating activities 40,431 28,055 Cash flows from investing activities: Acquisition of business - continuing operations - (238) Proceeds from Riverhead note receivable - 2,120 Proceeds from divestiture of businesses - 23,275 Capital expenditures - continuing operations (6,580) (7,905) Capital expenditures - discontinued operations - (1,390) ------- ------- Net cash (used) provided by investing activities (6,580) 15,862 Cash flows from financing activities: Net decrease in short-term borrowings - (10,000) Proceeds from long-term debt - 378 Principal payments on long-term debt - continuing operations (122) (478) Principal payments on long-term debt - discontinued operations - (9,024) Purchases of common stock into treasury (24,928) - Other (including exercise of stock options) 4,683 1,466 ------- ------- Net cash used by financing activities (20,367) (17,658) -------- -------- Net increase in cash and cash equivalents 13,484 26,259 Cash and cash equivalents, beginning of period 72,281 31,285 -------- -------- Cash and cash equivalents, end of period $ 85,765 $ 57,544 ====== ====== See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements, in the opinion of management, include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the results for the interim periods presented. The consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all the disclosures required by accounting principles generally accepted in the United States of America (GAAP). For further information refer to the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2004. The results for the three and nine-month periods ended June 30, 2005 are not necessarily indicative of the results for the entire 2005 fiscal year. 2. DISCONTINUED OPERATIONS - 2004 Microfiltration and Separations Businesses (MicroSep) The MicroSep businesses consisted of PTI Advanced Filtration Inc., PTI Technologies Limited, and PTI S.p.A. Effective April 2, 2004, the Company completed the sale of PTI Advanced Filtration Inc. (Oxnard, California) and PTI Technologies Limited (Sheffield, England) to domnick hunter group plc for $18 million in cash. On June 8, 2004, the Company completed the sale of PTI S.p.A. (Milan, Italy) to a group of investors comprised of the subsidiary's senior management for $5.3 million. An after-tax gain of $0.8 million and an after-tax loss $(1.8) million related to the MicroSep businesses is reflected in the Company's fiscal 2004 results from discontinued operations for the three and nine-month periods ended June 30, 2004, respectively. 3. EARNINGS PER SHARE (EPS) Basic EPS is calculated using the weighted average number of common shares outstanding during the period. Diluted EPS is calculated using the weighted average number of common shares outstanding during the period plus shares issuable upon the assumed exercise of dilutive common share options and vesting of performance-accelerated restricted shares (restricted shares) by using the treasury stock method. The number of shares used in the calculation of earnings per share for each period presented is as follows (in thousands): Three Months Ended Nine Months Ended June 30, June 30, ----------- ----------- 2005 2004 2005 2004 ------ ------ ------ ------ Weighted Average Shares Outstanding - Basic 12,712 12,938 12,721 12,885 Dilutive Options and Restricted Shares 382 377 392 425 ------ ----- ----- ----- Adjusted Shares- Diluted 13,094 13,315 13,113 13,310 ====== ====== ====== ====== Options to purchase 4,000 shares of common stock at prices ranging from $79.72 - $100.52 and options to purchase 110,750 shares of common stock at prices ranging from $46.95 - $50.55 were outstanding during the nine-month periods ended June 30, 2005 and 2004, respectively, but were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market price of the common shares. The options expire at various periods through 2013. Approximately 19,000 and 16,000 restricted shares were excluded from the respective computation of diluted EPS based upon the application of the treasury stock method for the three month periods ended June 30, 2005 and 2004, respectively.
Had compensation cost for the Company's stock option plans and restricted share plans been determined based on the fair value at the grant date for awards outstanding during the three and nine-month periods ended June 30, 2005 and 2004 consistent with the provisions of SFAS 148, the Company's net earnings and net earnings per share would have been as shown in the table below: (Unaudited) (Dollars in thousands, except per share amounts) Three Months Ended Nine Months Ended June 30, June 30, ---------- ---------- 2005 2004 2005 2004 ------- ------ ------ ------ Net earnings, as reported $ 12,401 12,041 $ 33,351 23,557 Add: stock-based employee compensation expense included in reported net earnings, net of tax 202 162 952 704 Less: total stock-based employee compensation expense determined under fair value based methods, net of tax (704) (368) (2,549) (1,457) ----- ----- ------- ------- Pro forma net earnings $ 11,899 11,835 $31,754 22,804 ====== ====== ====== ====== Net earnings per share: Basic - as reported $ 0.98 0.93 $ 2.62 1.83 ==== ==== ==== ==== Basic - pro forma 0.94 0.91 2.50 1.77 ==== ==== ==== ==== Diluted - as reported $ 0.95 0.90 $ 2.54 1.77 ==== ==== ==== ==== Diluted - pro forma 0.91 0.89 2.42 1.71 ==== ==== ==== ==== The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the three and nine-month periods ended June 30, 2005 and 2004, respectively: expected dividend yield of 0% in both periods; expected volatility of 27.6% and 16.4%; risk-free interest rate of 3.7% and 4.6%; and expected life based on historical exercise periods of 4.17 years and 4.24 years. 4. INVENTORIES Inventories consist of the following (in thousands): June 30, September 30, 2005 2004 ------ ------ Finished goods $ 14,051 11,444 Work in process, including long- term contracts 16,358 13,759 Raw materials 23,472 19,084 -------- -------- Total inventories $ 53,881 44,287 ====== ====== 5. COMPREHENSIVE INCOME Comprehensive income for the three-month periods ended June 30, 2005 and 2004 was $11.2 million and $11.9 million, respectively. Comprehensive income for the nine-month periods ended June 30, 2005 and 2004 was $34.0 million and $25.8 million, respectively. For the three and nine-month periods ended June 30, 2005, the Company's comprehensive income was negatively impacted by foreign currency translation adjustments of $1.2 million and positively impacted by foreign currency translation adjustments of $0.7 million, respectively. For the three and nine-month periods ended June 30, 2004, the Company's comprehensive income was negatively impacted by foreign currency translation adjustments of $0.2 million and positively impacted by foreign currency translation adjustments of $2.1 million, respectively. 6. ASSET IMPAIRMENT In June 2005, the Company abandoned its plans to commercialize certain sensor products within the Filtration/Fluid Flow segment. This action resulted in an asset impairment charge of $0.8 million to write down certain patents and a related licensing agreement to their respective fair market values. The Company ended its development efforts on this program after it determined that the market was not developing as quickly as anticipated and the future costs and timeframe to fully commercialize the products were not acceptable. 7. INCOME TAX EXPENSE The third quarter fiscal 2005 effective income tax rate was 15.7% compared to 38.3% in the third quarter of fiscal 2004. The effective income tax rate in the first nine months of fiscal 2005 was 30.7% compared to 38.4% in the prior year period. The decrease in the effective income tax rate in the third quarter and in the first nine months of fiscal 2005 as compared to the prior year periods is primarily due to the timing and volume of profit contributions of the Company's foreign operations. The decrease in the third quarter effective tax rate was primarily driven by an adjustment to income tax expense due to the Company finalizing certain foreign tax returns in June; an adjustment to the current year tax provision resulting from higher foreign sourced pretax income; and a favorable state tax rate adjustment. The majority of the rate adjustment resulted from DCSI pretax income sourced in Puerto Rico. The third quarter effective tax rate, absent the adjustments mentioned above, would have been approximately 33%. The difference between the 15.7% actual third quarter effective income tax rate and the 33% tax rate approximated $0.20 per share in the quarter. The Company estimates the annual effective tax rate for fiscal 2005 to be approximately 32.5%. 8. BUSINESS SEGMENT INFORMATION The Company is organized based on the products and services that it offers. Under this organizational structure, the Company operates in three segments: Filtration/Fluid Flow, Communications and Test. Management evaluates and measures the performance of its operating segments based on "Net Sales" and "EBIT", which are detailed in the table below. EBIT is defined as earnings from continuing operations before interest and taxes. The table below is presented for continuing operations and excludes discontinued operations. ($ in thousands) Three Months ended Nine Months Ended June 30, June 30, ---------- ---------- NET SALES 2005 2004 2005 2004 --------- ---- ---- ---- ---- Filtration/Fluid Flow $ 44,652 44,034 $129,631 126,161 Communications 31,141 37,190 100,759 98,963 Test 33,007 26,687 88,945 81,353 ------ ------ ------- ------- Consolidated totals $108,800 107,911 $319,335 306,477 ======= ======= ======= ======= EBIT Filtration/Fluid Flow $ 5,887 6,416 $ 17,987 14,074(1) Communications 8,192 11,694 28,446 26,306 Test 3,274 2,836 8,694 8,310 Corporate (3,174) (2,901) (8,303) (8,136) ------- ------- ------- ------- Consolidated EBIT 14,179 18,045 46,824 40,554 Add: Interest income 534 129 1,317 648 --- --- ----- --- Earnings before income taxes $ 14,713 18,174 $ 48,141 41,202 ====== ====== ====== ====== (1) Includes $1.3 million of exit costs related to the Filtertek Puerto Rico facility. 9. RETIREMENT AND OTHER BENEFIT PLANS A summary of net periodic benefit expense for the Company's defined benefit plans and postretirement healthcare and other benefits for the three and nine-month periods ended June 30, 2005 and 2004 are shown in the following tables. Effective December 31, 2003, the Company's defined benefit plan was frozen and no additional benefits will be accrued after that date. Net periodic benefit cost for each period presented is comprised of the following: Three Months Ended Nine Months Ended June 30, June 30, ---------- ---------- (Dollars in thousands) 2005 2004 2005 2004 ------ ------ ------ ------ Defined benefit plans Service cost $ - 140 $ - 420 Interest cost 663 623 1,988 1,868 Expected return on assets (713) (675) (2,138) (2,025) Amortization of: Prior service cost - - - - Actuarial (gain) loss 125 100 375 300 --- --- --- --- Net periodic benefit cost $ 75 188 $ 225 563 --- --- --- --- Net periodic postretirement (retiree medical) benefit cost for each period presented is comprised of the following: Three Months Ended Nine Months Ended June 30, June 30, ---------- ---------- (Dollars in thousands) 2005 2004 2005 2004 ---- ---- ----- ---- Service cost $ 8 8 $ 23 24 Interest cost 10 13 30 38 Amortization of actuarial gain (5) (13) (14) (38) --- ---- ---- ---- Net periodic postretirement benefit cost $13 8 $ 39 24 === === === === 10. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (R), "Share-Based Payment" (SFAS No. 123 (R)). This Statement replaces SFAS No. 123, "Accounting for Stock-Based Compensation" and supersedes APB No. 25, "Accounting for Stock Issued to Employees." SFAS 123 (R) requires all stock-based compensation to be recognized as an expense in the financial statements and that such cost be measured according to the fair value of stock options. SFAS 123 (R) will be effective for the first annual period beginning after June 15, 2005. The Company plans to adopt the provisions of this Statement in the first quarter of fiscal 2006 on a prospective basis. The Company currently provides the pro forma disclosures required by SFAS No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure," on a quarterly basis (see "Note 3 - Earnings Per Share"). In December 2004, the FASB issued FASB Staff Position FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (FSP 109-2)." The American Jobs Creation Act of 2004, (the "Act") provides for a special one-time deduction of 85 percent of certain foreign earnings repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. The Company is currently evaluating the merits of repatriating funds under the Act. The range of reasonably possible amounts of unremitted earnings that are being considered for repatriation is between zero and $32.2 million, which would require the Company to pay income taxes in the range of zero to $2.6 million. Federal income taxes on the repatriated amounts would be based on the 5.25% effective statutory rate as provided in the Act, plus applicable withholding taxes. To date, the Company has not provided for income taxes on unremitted earnings generated by non-U.S. subsidiaries given the Company's historical intent to permanently invest these earnings abroad. As a result, additional taxes may be required to be recorded for any funds repatriated under the Act. The Company expects to complete its evaluation of the repatriation provision of the Act by September 30, 2006. ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following discussion refers to the Company's results from continuing operations, except where noted. The Microfiltration and Separations businesses (MicroSep), which were sold in the third quarter of fiscal 2004, are accounted for as discontinued operations in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Accordingly, the MicroSep businesses are reflected as discontinued operations in the financial statements and related notes for fiscal 2004. NET SALES Net sales were $108.8 million for the third quarter of fiscal 2005 and $107.9 million for the third quarter of fiscal 2004. Net sales increased $12.8 million (4.2%) to $319.3 million for the first nine months of fiscal 2005 from $306.5 million for the first nine months of fiscal 2004. Favorable foreign currency values resulted in approximately $0.9 million and $3.2 million of the sales increases realized in the 2005 third quarter and year-to-date periods, respectively. - -Filtration/Fluid Flow Net sales increased $0.7 million (1.6%) to $44.7 million for the third quarter of fiscal 2005 from $44.0 million for the third quarter of fiscal 2004. Net sales increased $3.4 million (2.7%) to $129.6 million for the first nine months of fiscal 2005 from $126.2 million for the first nine months of fiscal 2004. The sales increase during the fiscal quarter ended June 30, 2005 as compared to the prior year quarter is due to the following: higher commercial and military aerospace shipments at PTI of $1.1 million; a net sales increase at Filtertek of $0.6 million (mainly due to $1.6 million related to the termination of a supply agreement with one of its medical device customers); partially offset by lower defense spares shipments at VACCO of $1.1 million and lower automotive shipments at Filtertek. The sales increase for the first nine months of fiscal 2005 as compared to the prior year period is due to the following: higher commercial and military aerospace shipments at PTI of $4.1 million; a net sales increase at Filtertek of $0.7 million (mainly due to $1.6 million related to the termination of a supply agreement with one of its medical device customers); partially offset by lower defense spares shipments at VACCO of $1.4 million. - -Communications Net sales decreased $6.1 million (16.4%) to $31.1 million for the third quarter of fiscal 2005 from $37.2 million for the third quarter of fiscal 2004. Net sales increased $1.8 million (1.8%) to $100.8 million for the first nine months of fiscal 2005 from $99.0 million for the first nine months of fiscal 2004. The sales decrease in the third quarter of fiscal 2005 as compared to the prior year period was the result of lower shipments by DCSI of automatic meter reading (AMR) products to investor owned utility companies (IOU's) of $3.4 million (sales to Bangor Hydro-Electric Company and Idaho Power Company totaled $4.7 million in the prior year third quarter partially offset by sales to TXU Electric Delivery Company (TXU) of $1.3 million in the current year third quarter) and to Puerto Rico Electric Power Authority (PREPA) of approximately $3 million. The increase in sales in the first nine months of fiscal 2005 as compared to the prior year period was the result higher shipments of Comtrak's SecurVision video security products, which contributed $11.0 million to the sales increase, partially offset by a decrease in sales of AMR products (primarily PPL) of $9.2 million. Comtrak's sales were $2.3 million for the third quarter of fiscal 2005 as compared to $1.0 million for the prior year third quarter and $12.9 million for the first nine months of fiscal 2005 as compared to $1.9 million for the prior year nine-month period. The decrease in sales of AMR products for the first nine months of fiscal 2005 as compared to the prior year period is mainly due to the wind-down of the PPL Electric Utilities Corporation (PPL) contract. Sales to PPL were $0.5 million and $0.6 million in the fiscal quarters ended June 30, 2005 and 2004, respectively, and $1.9 million and $20.6 million in the first nine months of fiscal 2005 and 2004, respectively. The decrease in year-to-date sales to PPL was partially offset by higher AMR product sales to the electric utility cooperative (COOP) market and other customers. DCSI's sales to customers other than PPL were $28.4 million and $35.6 million in the fiscal quarters ended June 30, 2005 and 2004, respectively, and were $86.0 million and $76.5 million for the first nine months of fiscal 2005 and 2004, respectively. - -Test For the third quarter of fiscal 2005, net sales of $33.0 million were $6.3 million, or 23.6% higher than the $26.7 million of net sales recorded in the third quarter of fiscal 2004. Net sales of $88.9 million in the first nine months of fiscal 2005 were $7.5 million, or 9.2% higher than the $81.4 million recorded in the first nine months of fiscal 2004. The sales increase during the fiscal quarter ended June 30, 2005 as compared to the prior year quarter is mainly due to an increase from the Company's U.S. operations of approximately $7.1 million (driven by the successful completion of the critical design review on a large Boeing project, additional test chamber installations, component sales, and the installation of several government shielding projects); an increase in sales from the Company's Asian operations of approximately $2.5 million mainly due to a large test chamber installation in Japan and increased test chamber business throughout Asia; partially offset by a decrease in sales from the Company's European operations of approximately $3.3 million due to the conclusion of two large test chamber projects. The sales increase in the first nine months of fiscal 2005 as compared to the prior year period is mainly due to an increase from the Company's U.S. operations of approximately $9.9 million for reasons mentioned above; an increase in sales from the Company's Asian operations of approximately $4.0 million; partially offset by a decrease in sales from the Company's European operations of approximately $6.4 million due to the conclusion of two large test chamber projects. ORDERS AND BACKLOG Backlog was $251.4 million at June 30, 2005 compared with $249.1 million at September 30, 2004. The Company received new orders totaling $321.6 million in the first nine months of fiscal 2005. New orders of $138.9 million were received in the first nine months of fiscal 2005 related to Filtration/Fluid Flow products, $100.1 million related to Communications products (includes $91.2 million of new orders related to AMR products), and $82.6 million related to Test products. The new orders received in the Communications segment include an $18.5 million order from TXU for AMR products. The new orders received in the Filtration/Fluid Flow segment include a $15.9 million multi-year order for quiet valves and manifold assemblies used on the Virginia Class Submarine. GROSS PROFIT The Company computes gross profit as net sales less cost of sales less asset impairment charges. The gross profit margin is the gross profit divided by net sales, expressed as a percentage. The gross profit margin was 33.2% and 35.0% in the third quarter of fiscal 2005 and 2004, respectively. The gross profit margin was 34.2% and 32.4% for the first nine months of fiscal 2005 and 2004, respectively. The decrease in the gross profit margin in the third quarter of 2005 as compared to the prior year quarter is mainly due to cost overruns on certain government shielding projects, increases in raw material costs within the Test and Filtration Fluid Flow segments and the asset impairment charge recorded in the Filtration/Fluid Flow segment which contributed 0.7% to the decrease. The increase in gross profit margins in first nine months of fiscal 2005 was mainly due to higher margins on shipments in the Communications segment due to the favorable sales mix of AMR products resulting from additional sales to the COOP market, and additional shipments of Comtrak's products. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative (SG&A) expenses for the third quarter of fiscal 2005 were $21.7 million (20.0% of net sales), compared with $19.7 million (18.2% of net sales) for the prior year period. For the first nine months of fiscal 2005, SG&A expenses were $62.8 million (19.7% of net sales) compared with $57.5 million (18.8% of net sales) for the prior year period. The increase in SG&A spending in the fiscal quarter ended June 30, 2005 and in the first nine months of fiscal 2005 as compared to the respective prior year periods is mainly due to an increase of $0.8 million and $3.6 million, respectively, associated with engineering, marketing, and new product development within the Communications segment to further penetrate the investor owned utility market. In addition, Corporate professional fees have increased approximately $0.8 million in the first nine months of fiscal 2005 as compared to the prior year period due to the implementation of requirements under Section 404 of the Sarbanes-Oxley Act of 2002. OTHER (INCOME) EXPENSES, NET Other (income) expenses, net, were $0.2 million for the quarter ended June 30, 2005 compared to $0.1 million for the prior year quarter. Other (income) expenses, net, were ($0.5) million for the first nine months of fiscal 2005 compared to $1.2 million for the prior year period. Principal components of other (income) expenses, net, for the first nine months of fiscal 2005 included $1.5 million of royalty income; partially offset by $0.7 million of amortization expense of identifiable intangible assets (primarily patents, licenses and software); and a $0.5 million write down of fixed assets related to the termination of a supply agreement with a medical device customer. Principal components of other (income) expenses, net, for the first nine months of fiscal 2004 included $0.9 million of exit costs related to the Filtertek Puerto Rico facility; $0.7 million of amortization of identifiable intangible assets (primarily patents, licenses and software); a $0.6 million gain from a sales and use tax refund claim related to a former defense subsidiary (Systems & Electronics Inc.); partially offset by a $0.4 million charge for settlement of a claim involving a former defense subsidiary (Hazeltine). EBIT The Company evaluates the performance of its operating segments based on EBIT, defined below. EBIT was $14.2 million (13.0% of net sales) for the third quarter of fiscal 2005 and $18.0 million (16.7% of net sales) for the third quarter of fiscal 2004. For the first nine months of fiscal 2005, EBIT was $46.8 million (14.7% of net sales) and was $40.6 million (13.2% of net sales) for the first nine months of fiscal 2004. EBIT for the first nine months of fiscal 2004 was negatively impacted by $1.3 million of severance and exit costs related to the Filtertek Puerto Rico facility (Filtration/Fluid Flow segment). This Form 10-Q contains the financial measure "EBIT", which is not calculated in accordance with generally accepted accounting principles in the United States of America (GAAP). EBIT provides investors and Management with an alternative method for assessing the Company's operating results. The Company defines "EBIT" as earnings from continuing operations before interest and taxes. Management evaluates the performance of its operating segments based on EBIT and believes that EBIT is useful to investors to demonstrate the operational profitability of the Company's business segments by excluding interest and taxes, which are generally accounted for across the entire Company on a consolidated basis. EBIT is also one of the measures Management uses to determine resource allocations within the Company and incentive compensation. The following table represents a reconciliation of EBIT to net earnings from continuing operations. Three Months ended Nine Months ended June 30 June 30 ($ in thousands) ------- -------- 2005 2004 2005 2004 ---- ---- ---- ---- EBIT $14,179 18,045 $46,824 40,554 Interest income / (expense) 534 129 1,317 648 Less: Income taxes 2,312 6,958 14,790 15,833 ------ ------ ------ ------ Net earnings from continuing operations $12,401 11,216 $33,351 25,369 ====== ====== ====== ====== - -Filtration/Fluid Flow EBIT was $5.9 million (13.2% of net sales) and $6.4 million (14.6% of net sales) in the third quarters of fiscal 2005 and 2004, respectively, and $18.0 million (13.9% of net sales) and $15.4 million (12.2% of net sales) in the first nine months of fiscal 2005 and 2004, respectively. For the third quarter of fiscal 2005 as compared to the prior year quarter, EBIT decreased $0.5 million due to the following: a $1.0 million decrease at VACCO due to lower defense spares shipments; a $0.1 million net decrease at PTI primarily due to the asset impairment charge of $0.8 million; partially offset by a $0.5 million net increase at Filtertek primarily due to $1.0 million recorded upon the termination of a supply agreement with a medical device customer. For the first nine months of fiscal 2005 as compared to the prior year period, EBIT increased $2.6 million due to the following: a $2.1 million increase at Filtertek, which included $1.9 million related to the termination of a medical device customer (the first nine months of fiscal 2004 included $1.3 million of exit costs related to the Puerto Rico facility); a $1.5 million net increase at PTI (consisting of $2.3 million due to higher shipments of aerospace products partially offset by the $0.8 million asset impairment charge); and a $1.0 million decrease at VACCO due to lower defense spares shipments. Effective June 30, 2005, Filtertek signed an agreement to terminate its supply agreement with a medical device customer. During the third quarter of 2005, the Company received $2.1 million in cash and recognized $1.6 million of revenue and $1.0 million of income related to this transaction, after a $0.5 million write down of related fixed assets. During the first six months of fiscal 2005, the Company recorded $0.9 million of cost reimbursement related to a shortfall between its actual purchases versus the minimum contractually guaranteed amount from this customer, for a total profit contribution of $1.9 million recorded year-to-date. - -Communications EBIT in the third quarter of fiscal 2005 was $8.2 million (26.3% of net sales) as compared to $11.7 million (31.4% of net sales) in the prior year period. For the first nine months of fiscal 2005, EBIT was $28.4 million (28.2% of net sales) as compared to $26.3 million (26.6% of net sales) in the prior year period. The decrease in EBIT in the third quarter of fiscal 2005 is due to: a $4.2 million decrease at DCSI due to lower shipments of AMR products, partially offset by a $0.7 million increase at Comtrak due to higher shipments of its video security products. The increase in EBIT in the first nine months of fiscal 2005 as compared to the prior year period is due to: a $4.6 million increase at Comtrak due to higher shipments of its video security products, partially offset by a $2.5 million decrease at DCSI due to lower shipments of AMR products. The Company expects to continue to increase its engineering and new product development expenditures in the Communications segment in order to continue its growth in the AMR markets, and to further differentiate its technology from the competition. - -Test EBIT in the third quarter of fiscal 2005 was $3.3 million (9.9% of net sales) as compared to $2.8 million (10.6% of net sales) in the prior year period. For the first nine months of fiscal 2005, EBIT was $8.7 million (9.8% of net sales) as compared to $8.3 million (10.2% of net sales) in the prior year period. In the third quarter of fiscal 2005 and in the first nine months of fiscal 2005, EBIT was higher than in the prior year periods due primarily to the favorable changes in sales mix resulting from additional sales of antennas and other components and increases from the Company's Asian operations. EBIT in the third quarter of fiscal 2005 and in the first nine months of 2005 as compared to the prior year periods was adversely affected by installation cost overruns incurred on certain government shielding projects being installed in challenging areas throughout the world, as well as increased material costs (steel and copper). - -Corporate Corporate costs included in EBIT were $(3.2) million and $(8.3) million for the three and nine-month periods ended June 30, 2005, respectively, compared to $(2.9) million and $(8.1) million for the respective prior year periods. The increase of $0.3 million in Corporate costs in the third quarter of fiscal 2005 as compared to the prior year quarter is due to the implementation of requirements under Section 404 of the Sarbanes-Oxley Act of 2002. INTEREST INCOME, NET Interest income, net, was $0.5 million and $1.3 million for the three and nine-month periods ended June 30, 2005, respectively, compared to interest income of $0.1 million and $0.6 million for the respective prior year periods. The increase in interest income in the third quarter and in the first nine months of fiscal 2005 as compared to the respective prior year periods is due to higher average cash balances on hand in fiscal 2005 and a tax refund of lookback interest received in the first fiscal quarter. INCOME TAX EXPENSE The third quarter fiscal 2005 effective income tax rate was 15.7% compared to 38.3% in the third quarter of fiscal 2004. The effective income tax rate in the first nine months of fiscal 2005 was 30.7% compared to 38.4% in the prior year period. The decrease in the effective income tax rate in the third quarter and in the first nine months of fiscal 2005 as compared to the prior year periods is primarily due to the timing and volume of profit contributions of the Company's foreign operations. The decrease in the third quarter effective tax rate was primarily driven by an adjustment to income tax expense due to the Company finalizing certain foreign tax returns in June; an adjustment to the current year tax provision resulting from higher foreign sourced pretax income; and a favorable state tax rate adjustment. The majority of the rate adjustment resulted from DCSI pretax income sourced in Puerto Rico. The third quarter effective tax rate, absent the adjustments mentioned above, would have been approximately 33%. The difference between the 15.7% actual third quarter effective income tax rate and the 33% tax rate approximated $0.20 per share in the quarter. The Company estimates the annual effective tax rate for fiscal 2005 to be approximately 32.5%. CAPITAL RESOURCES AND LIQUIDITY Working capital (current assets less current liabilities) increased to $181.8 million at June 30, 2005 from $165.2 million at September 30, 2004. During the first nine months of fiscal 2005, cash increased $13.5 million, net of the $24.9 million share repurchase. Accounts receivable decreased by $6.7 million in the first nine months of fiscal 2005, of which $7.0 million related to collections of receivables within the Communications segment. Inventories increased by $9.6 million in the first nine months of fiscal 2005, of which $3.5 million related to the Test segment due to the timing of sales and $3.6 million related to the Communications segment (new product offerings and safety stock to satisfy customer requirements). In addition, accounts payable and accrued expenses decreased by $8.8 million in the first nine months of fiscal 2005 primarily due to the timing of vendor payments and personnel related costs. Net cash provided by operating activities from continuing operations increased $9.6 million to $40.4 million in the first nine months of fiscal 2005, compared to $30.8 million in the same period of fiscal 2004. During the second quarter of fiscal 2005, Filtertek signed an agreement to license certain of its patents related to needle-free connectors to a third party for $1.5 million in cash and recognized $0.2 million of royalty income related to this transaction, after deducting $0.2 million of professional fees. The unrealized gain of $1.1 million will be recognized on a straight-line basis over the remaining patent life, through 2011. Capital expenditures for continuing operations were $6.6 million and $7.9 million in the first nine months of fiscal 2005 and 2004, respectively. Major expenditures in the current period included manufacturing equipment used in the Filtration/Fluid Flow businesses. At June 30, 2005, the Company had approximately $7.5 million in commitments in the Communications segment to further differentiate its products and to further penetrate the investor owned utility market. This amount is expected to be spent during the next six months. The closure and relocation of the Filtertek Puerto Rico facility was completed in March 2004. The Puerto Rico facility is included in other current assets with a carrying value of $3.6 million at June 30, 2005. The facility continues to be actively marketed for sale. In October 2004, the Company entered into a new $100 million five-year revolving bank credit facility with a $50 million increase option, which replaced its then-existing credit facility. At June 30, 2005, the Company had approximately $98.6 million available to borrow under the credit facility in addition to $85.8 million cash on hand. Against the $100 million available under the revolving credit facility at June 30, 2005, the Company had outstanding letters of credit of $1.4 million. Cash flow from operations and borrowings under the Company's bank credit facility are expected to meet the Company's capital requirements and operational needs for the foreseeable future. SUBSEQUENT EVENT On August 5, 2005, the Company's Board of Directors approved a 2-for-1 stock split to be effected as a 100 percent stock dividend payable September 23, 2005 to shareholders of record as of September 9, 2005. CRITICAL ACCOUNTING POLICIES Management has evaluated the accounting policies used in the preparation of the Company's financial statements and related notes and believes those policies to be reasonable and appropriate. Certain of these accounting policies require the application of significant judgment by management in selecting appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, trends in the industry, information provided by customers and information available from other outside sources, as appropriate. The most significant areas involving management judgments and estimates may be found in the Critical Accounting Policies Section of Management's Discussion and Analysis and in Note 1 to the Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2004, at Exhibit 13. OTHER MATTERS Contingencies As a normal incident of the businesses in which the Company is engaged, various claims, charges and litigation are asserted or commenced against the Company. In the opinion of Management, final judgments, if any, which might be rendered against the Company in current litigation are adequately reserved, covered by insurance, or would not have a material adverse effect on its financial statements. FORWARD LOOKING STATEMENTS Statements in this report that are not strictly historical are "forward looking" statements within the meaning of the safe harbor provisions of the federal securities laws. Forward looking statements include those relating to the estimates or projections made in connection with the Company's accounting policies, annual effective tax rate, timing of Communications segment commitments and expenditures, continued growth in the AMR market, outcome of current claims and litigation, future cash flow, and capital requirements and operational needs for the foreseeable future and the amounts, if any, and timing of foreign earnings repatriated into the U.S. and the additional taxes resulting from such repatriation. Investors are cautioned that such statements are only predictions, and speak only as of the date of this report. The Company's actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company's operations and business environment including, but not limited to: weakening of economic conditions in served markets; changes in customer demands or customer insolvencies; competition; intellectual property rights; successful execution of the planned sale of the Company's Puerto Rico facility; material changes in the costs of certain raw materials including steel, copper and petroleum based resins; delivery delays or defaults by customers; termination for convenience of customer contracts; timing and magnitude of future contract awards; performance issues with key suppliers, customers and subcontractors; collective bargaining and labor disputes; changes in laws and regulations including changes in accounting standards and taxation requirements; changes in foreign or U.S. business conditions affecting the distribution of foreign earnings; costs relating to environmental matters; litigation uncertainty; and the Company's successful execution of internal operating plans. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risks relating to the Company's operations result primarily from changes in interest rates and changes in foreign currency exchange rates. There has been no material change to the Company's risks since September 30, 2004. Refer to the Company's 2004 Annual Report on Form 10-K for further discussion about market risk. ITEM 4. CONTROLS AND PROCEDURES The Company carried out an evaluation, under the supervision and with the participation of Management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of that date. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Securities Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. There has been no change in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS In August 2004, the Company's Board of Directors approved the extension of the previously authorized (February 2001) open market common stock repurchase program of up to 1.1 million shares, which is subject to market conditions and other factors and covers the period ending September 30, 2006. Approximately 575,000 remaining shares may be repurchased under the program. There were no stock repurchases during the third quarter of fiscal 2005. ITEM 6. EXHIBITS a) Exhibits Exhibit Number 3.1 Restated Articles of Incorporated by reference to Incorporation Form 10-K for the fiscal year ended September 30, 1999, at Exhibit 3(a) 3.2 Amended Certificate of Incorporated by reference to Designation Form 10-Q for the fiscal quarter Preferences and Rights ended March 31, 2000, at Exhibit of Series A 4(e) Participating Cumulative Preferred Stock of the Registrant 3.3 Articles of Merger Incorporated by reference to effective July 10, 2000 Form10-Q for the fiscal quarter ended June 30, 2000, at Exhibit 3(c) 3.4 Bylaws, as amended and Incorporated by reference to restated. Form10-K for the fiscal year ended September 30, 2003, at Exhibit 3.4 4.1 Specimen Common Stock Incorporated by reference to Certificate Form10-Q for the fiscal quarter ended June 30, 2000, at Exhibit 4(a) 4.2 Specimen Rights Incorporated by reference to Certificate Current Report on Form 8-K dated February 3, 2000, at Exhibit B to Exhibit 4.1 4.3 Rights Agreement dated Incorporated by reference to as of September 24, Current Report on Form 8-K dated 1990 (as amended and February 3, 2000, at Exhibit 4.1 Restated as of February 3, 2000) between the Registrant and Registrar and Transfer Company, as successor Rights Agent 4.4 Credit Agreement dated as of Incorporated by reference to October 6, 2004 among the Form10-K for the fiscal year Registrant, Wells Fargo ended September 30, 2004, at Bank, N.A., as agent, and Exhibit 4.4 the lenders listed therein 31.1 Certification of Chief Executive Officer relating to Form 10-Q for period ended June 30, 2005 31.2 Certification of Chief Financial Officer relating to Form 10-Q for period ended June 30, 2005 32 Certification of Chief Executive Officer and Chief Financial Officer relating to Form 10-Q for period ended June 30, 2005
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ESCO TECHNOLOGIES INC. /s/ Gary E. Muenster Gary E. Muenster Vice President and Chief Financial Officer (As duly authorized officer and principal accounting officer of the registrant) Dated: August 9, 2005