10-Q 1 y91458e10vq.txt EDO CORPORATION Page 1 of 27 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [x]Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended: September 27, 2003 [ ]Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 1-3985 EDO CORPORATION (Exact name of registrant as specified in its charter) New York No. 11-0707740 (State or other jurisdiction (I.R.S. Employee of incorporation or organization) Identification No.) 60 East 42nd Street, 42nd Floor, New York, NY 10165 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (212) 716-2000 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 requirement 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 [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at November 3, 2003 ------------------------------------- --------------------------------- Common shares, par value $1 per share 19,739,245 Page 2 of 27 EDO CORPORATION INDEX
Page Face Sheet 1 Index 2 Part I Financial Information Item 1. Financial Statements Consolidated Balance Sheets - September 27, 2003 and December 31, 2002 3 Consolidated Statements of Earnings - Three Months Ended September 27, 2003 and September 28, 2002 4 Consolidated Statements of Earnings - Nine Months Ended September 27, 2003 and September 28, 2002 5 Consolidated Statements of Cash Flows - Nine Months Ended September 27, 2003 and September 28, 2002 6 Notes to Consolidated Financial Statements 7-14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14-24 Item 3. Quantitative and Qualitative Disclosures about Market Risk 24 Item 4. Controls and Procedures 25 Part II Other Information Item 4. Submission of Matters to a Vote of Security Holders 25 Item 6. Exhibits and Reports on Form 8-K 25 Signature Page 26 Exhibit Index 27
Page 3 of 27 PART I - FINANCIAL INFORMATION Item 1. Financial Statements EDO Corporation and Subsidiaries Consolidated Balance Sheets (in thousands, except share and per share amounts)
September 27, 2003 December 31, 2002 (unaudited) Assets Current assets: Cash and cash equivalents $ 59,998 $ 132,320 Restricted cash - 27,347 Marketable securities 216 193 Accounts receivable, net 117,919 100,594 Inventories 35,265 32,406 Assets held for sale 26,892 - Deferred income tax asset, net 3,222 3,222 Prepayments and other 6,240 3,133 --------- --------- Total current assets 249,752 299,215 Property, plant and equipment, net 32,059 64,472 Notes receivable 1,375 2,556 Goodwill 93,903 61,352 Other intangible assets, net 57,196 11,867 Deferred income tax asset, net 23,256 20,439 Other assets 25,528 21,673 --------- --------- $ 483,069 $ 481,574 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 14,776 $ 19,108 Accrued liabilities 63,662 55,448 Contract advances and deposits 7,236 20,277 --------- --------- Total current liabilities 85,674 94,833 Long-term debt 137,800 137,800 Post-retirement benefits obligations 79,478 78,643 Environmental obligation 1,941 2,025 Shareholders' equity: Preferred shares, par value $1 per share, authorized 500,000 shares - - Common shares, par value $1 per share, authorized 50,000,000 shares in 2003,issued 19,828,727 in 2003 and 19,790,477 in 2002 19,829 19,790 Additional paid-in capital 149,255 147,091 Retained earnings 63,084 56,325 Accumulated other comprehensive loss, net of income tax benefit (34,178) (33,899) Treasury shares at cost (89,482 shares in 2003 and 94,322 shares in 2002) (1,274) (1,321) Unearned Employee Stock Ownership Plan shares (17,603) (18,541) Deferred compensation under Long-Term Incentive Plan (586) (579) Management group receivables (351) (593) --------- --------- Total shareholders' equity 178,176 168,273 --------- --------- $ 483,069 $ 481,574 ========= =========
See accompanying Notes to Consolidated Financial Statements. Page 4 of 27 EDO Corporation and Subsidiaries Consolidated Statements of Earnings (in thousands, except per share amounts)
For the three months ended September 27, 2003 September 28, 2002 (unaudited) Net sales $ 118,783 $ 85,104 Costs and expenses Cost of sales 84,818 62,541 Selling, general and administrative 20,388 12,766 Research and development 1,450 2,080 Write-off of purchased in-process research and development - 150 Acquisition-related costs 249 204 --------- --------- 106,905 77,741 --------- --------- Operating earnings 11,878 7,363 Non-operating income (expense) Interest income 273 512 Interest expense (2,295) (2,046) Other, net (103) 34 --------- --------- (2,125) (1,500) --------- --------- Earnings before income taxes 9,753 5,863 Income tax expense (4,194) (2,492) --------- --------- Net earnings $ 5,559 $ 3,371 ========= ========= Earnings per common share: Basic $ 0.32 $ 0.20 ========= ========= Diluted $ 0.30 $ 0.19 ========= ========= Weighted-average common shares outstanding: Basic 17,336 17,120 ========= ========= Diluted 21,999 17,401 ========= =========
See accompanying Notes to Consolidated Financial Statements. Page 5 of 27 EDO Corporation and Subsidiaries Consolidated Statements of Earnings (in thousands, except per share amounts)
For the nine months ended September 27, 2003 September 28, 2002 (unaudited) Continuing Operations: Net sales $ 324,896 $ 225,732 Costs and expenses Cost of sales 233,838 169,387 Selling, general and administrative 57,088 31,107 Research and development 5,938 5,941 Write-off of purchased in-process research and development - 150 Impairment loss on assets held for sale 9,160 - Acquisition-related costs 669 204 --------- --------- 306,693 206,789 --------- --------- Operating earnings 18,203 18,943 Non-operating income (expense) Interest income 673 1,284 Interest expense (6,769) (4,171) Other, net 25 40 --------- --------- (6,071) (2,847) --------- --------- Earnings from continuing operations before income taxes, discontinued operations and cumulative effect of a change in accounting principle 12,132 16,096 Income tax expense (5,217) (6,841) --------- --------- Earnings from continuing operations before discontinued operations and cumulative effect of a change in accounting principle 6,915 9,255 Earnings from discontinued operations, net of tax 1,398 - Cumulative effect of a change in accounting principle, net of tax - (3,363) --------- --------- Net earnings $ 8,313 $ 5,892 ========= ========= Earnings (loss) per common share: Basic: Continuing operations $ 0.40 $ 0.54 Discontinued operations 0.08 - Cumulative effect of a change in accounting principle - (0.19) --------- --------- $ 0.48 $ 0.35 ========= ========= Diluted: Continuing operations $ 0.39 $ 0.53 Discontinued operations 0.08 - Cumulative effect of a change in accounting principle - (0.19) --------- --------- $ 0.47 $ 0.34 ========= ========= Weighted-average common shares outstanding: Basic 17,281 17,050 ========= ========= Diluted 17,526 17,362 ========= =========
See accompanying Notes to Consolidated Financial Statements. Page 6 of 27 EDO Corporation and Subsidiaries Consolidated Statements of Cash Flows (in thousands)
For the nine months ended September 27, 2003 September 28, 2002 (unaudited) Operating activities: Net earnings from continuing operations $ 6,915 $ 5,892 Adjustments to net earnings from continuing operations to arrive at cash provided by operations: Depreciation 9,017 7,478 Amortization 3,529 549 Bad debt expense 170 - Write-off of purchased in-process research and development - 150 Deferred tax benefit (3,756) - Loss on sale of plant and equipment 92 13 Impairment loss on assets held for sale 9,160 - Deferred compensation expense 182 143 Non-cash Employee Stock Ownership Plan expense 2,356 3,230 Non-cash stock option compensation expense 292 - Dividends on unallocated ESOP shares 221 236 Common shares issued for directors' fees 79 119 Income tax benefit from stock options 147 426 Cumulative effect of a change in accounting principle - 3,363 Changes in operating assets and liabilities, excluding effects of acquisitions: Accounts receivable 13,579 75 Inventories 874 (4,258) Prepayments and other assets (126) (3,108) Contribution to defined benefit pension plan (5,000) - Accounts payable, accrued liabilities and other (17,804) 1,803 Contract advances and deposits (13,041) 2,099 --------- --------- Cash provided by continuing operations 6,886 18,210 Net cash provided by discontinued operations 47 - Investing activities: Cash paid for acquisitions, net of cash acquired (87,647) (58,543) Restricted cash 27,347 (28,238) Payments received on notes receivable 1,310 262 Purchase of plant and equipment (6,938) (4,094) Proceeds from the sale of plant and equipment - 6 Purchase of marketable securities (23) (3) --------- --------- Cash used by investing activities (65,951) (90,610) Financing activities: Repayment of acquired debt (11,998) - Proceeds from exercise of stock options 226 411 Proceeds from management group receivables 242 252 Issuance of convertible subordinated notes - 137,800 Payment of common share cash dividends (1,774) (1,770) --------- --------- Cash (used) provided by financing activities (13,304) 136,693 Net change in cash and cash equivalents (72,322) 64,293 Cash and cash equivalents at beginning of year 132,320 57,841 --------- --------- Cash and cash equivalents at end of period $ 59,998 $ 122,134 ========= ========= Supplemental disclosures: Cash paid for: Interest $ 3,617 $ - Income taxes $ 10,621 $ 11,949
See accompanying Notes to Consolidated Financial Statements. Page 7 of 27 Notes to Consolidated Financial Statements Unaudited Consolidated Financial Statements The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and, therefore, do not include all information and footnotes normally included in consolidated financial statements prepared in conformity with accounting principles generally accepted in the United States. They should be read in conjunction with the consolidated financial statements and notes thereto of EDO Corporation and Subsidiaries (the "Company") for the year ended December 31, 2002 filed by the Company on Form 10-K with the Securities and Exchange Commission on March 14, 2003. The accompanying consolidated financial statements include all adjustments (consisting of normal recurring adjustments) that management considers necessary for a fair presentation of its consolidated financial position and results of operations for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the entire year. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share.
Three months ended Nine months ended Sept. 27, Sept. 28, Sept. 27, Sept. 28, 2003 2002 2003 2002 (in thousands) Numerator: Net earnings for basic and diluted calculations $ 5,559 $ 3,371 $ 8,313 $ 5,892 Effect of dilutive securities: 5.25% Convertible Subordinated Notes due 2007 1,031 - - - ------- ------- ------- ------- $ 6,590 $ 3,371 $ 8,313 $ 5,892 ======= ======= ======= ======= Denominator: Denominator for basic calculation 17,336 17,120 17,281 17,050 Effect of dilutive securities: 5.25% Convertible Subordinated Notes due 2007 4,408 - - - Stock options 255 281 245 312 ------- ------- ------- ------- Denominator for diluted calculation 21,999 17,401 17,526 17,362 ======= ======= ======= =======
Page 8 of 27 The following table summarizes, for each period presented, the number of shares excluded from the computation of diluted earnings per share, as their effect upon potential issuance was antidilutive:
Three months ended Nine months ended Sept. 27, 2003 Sept. 28, 2002 Sept. 27, 2003 Sept. 28, 2002 (in thousands) 5.25% Convertible Subordinated Notes due 2007 - 4,408 4,408 2,928 Stock Options 361 305 471 104 --- ----- ----- ----- 361 4,713 4,879 3,032 === ===== ===== =====
Stock-Based Compensation The company accounts for its stock-based compensation plans in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Under APB No. 25, because the exercise price of the Company's stock options is set equal to the market price of the underlying stock on the date of grant, no compensation expense is recognized. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," whereby compensation expense would be recognized as incurred for stock-based employee compensation.
Three months ended Nine months ended Sept. 27, Sept. 28, Sept. 27, Sept. 28, 2003 2002 2003 2002 (in thousands, except per share amounts) Net earnings: As reported $ 5,559 $ 3,371 $ 8,313 $ 5,892 Stock option compensation expense based on fair value method, net of tax (384) (346) (1,208) (747) --------- --------- --------- --------- Pro forma $ 5,175 $ 3,025 $ 7,105 $ 5,145 ========= ========= ========= ========= Basic earnings per common share: As reported $ 0.32 $ 0.20 $ 0.48 $ 0.35 Pro forma $ 0.30 $ 0.18 $ 0.41 $ 0.30 Diluted earnings per common share: As reported $ 0.30 $ 0.19 $ 0.47 $ 0.34 Pro forma $ 0.28 $ 0.17 $ 0.41 $ 0.30
Page 9 of 27 Acquisitions On June 16, 2003, the Company acquired for cash all of the stock of Emblem Group Ltd. ("Emblem"), a privately-held company based in Brighton, England. Emblem is a supplier of aerospace and defense products and services, primarily through its MBM Technology unit in England and Artisan Technologies Inc. subsidiary in the United States. Emblem has a core competency in aircraft weapons-carriage and interfacing systems that will reinforce EDO's position as a global leader in aircraft armament release systems. Emblem is expected to broaden the Company's customer base in Europe. The preliminary purchase price was (pound)13.26 million ($22.3 million), excluding transaction costs of approximately $1.9 million. In addition, the Company acquired and immediately paid off debt of (pound)1.99 million ($3.3 million). Emblem became part of the Company's Defense segment. On March 10, 2003, the Company acquired for cash all of the stock of Darlington, Inc. ("Darlington"), a privately-held defense communications company based in Alexandria, Virginia. Darlington designs, manufactures and supports military communications equipment and information networking systems. The acquisition is expected to enhance the Company's existing positions on long-range platforms and programs across the U.S. military services and in particular the U.S. Marine Corps. The purchase price was $25.6 million, excluding transaction costs of approximately $0.3 million. In addition, the Company acquired and immediately paid off debt of $4.9 million. Darlington became part of the Company's Defense segment. On February 5, 2003, a wholly-owned subsidiary of the Company acquired for cash all of the stock of Advanced Engineering and Research Associates, Inc.("AERA"), a privately-held company located in Alexandria, Virginia. AERA provides professional and information technology services primarily to the Department of Defense and other government agencies. The acquisition is expected to strengthen and expand the range of such services that the Company offers. The purchase price was $38.1 million, excluding transaction costs of $0.3 million. In addition, the Company acquired and immediately paid off debt of $3.8 million. AERA became part of the Company's Defense segment. On July 26, 2002, a wholly-owned subsidiary of the Company acquired substantially all of the assets and assumed certain liabilities of Condor Systems, Inc., a privately-held defense electronics company and its domestic subsidiary (together, "Condor") for $62.5 million in cash, in addition to transaction costs of $5.0 million. The acquisition expands the Company's electronic warfare business in the areas of reconnaissance and surveillance systems. The assets became part of the Company's Defense and Communications and Space Products segments. These acquisitions were accounted for as purchases and, accordingly, their operating results are included in the Company's consolidated financial statements since their respective acquisition dates. Unaudited pro forma results of operations, assuming the acquisitions of Emblem, Darlington, AERA and Condor had been completed at the beginning of each period are summarized below. The results reflect adjustments to net sales, cost of sales, amortization expense, compensation expense, purchased in-process research and development costs, interest income and expense and income tax expense. The interest rate used in determining pro forma adjustments to interest income or expense was based on the average yield of the Company's invested cash and cash equivalents and approximated 1.0% for each of the respective periods presented below. Page 10 of 27
Nine months ended September 27, 2003 September 28, 2002 (in thousands, except per share amounts) Net sales $ 353,313 $ 370,040 Earnings available for common shares, before discontinued operations and cumulative effect of a change in accounting principle $ 8,473 $ 3,961 Diluted earnings per common share $ 0.48 $ 0.23
The pro forma results of operations are not necessarily indicative of the actual results of operations that would have occurred had these acquisitions been completed at the beginning of the periods, or of the results which may occur in the future. The following table summarizes the allocation of the purchase price to the assets acquired and liabilities assumed at the date of acquisition.
Emblem Darlington AERA Condor At June 16, At March 10, At February 5, At July 26, 2003 2003 2003 2002 Current assets $ 9,649 $ 11,942 $ 13,262 $ 31,775 Plant and equipment 3,228 1,534 1,048 5,543 Customer contracts and relationships 7,200 14,400 17,100 - Purchased in-process research and development - - - 150 Purchased technologies 5,120 - - 11,648 Purchased backlog - - - 916 Non-compete agreements 336 30 2,420 - Tradename 960 400 500 - Trademark 320 - - - Goodwill 6,433 13,463 11,672 41,734 Other assets 85 446 174 76 Liabilities (9,179) (16,326) (7,815) (24,351) -------- -------- -------- -------- Total purchase price $ 24,152 $ 25,889 $ 38,361 $ 67,491 ======== ======== ======== ========
Adjustments resulting from the settlement of purchase prices on Condor, AERA and Darlington have been made. In addition, there were adjustments due to the settlement of certain pre-acquisition Condor liabilities. Adjustments related to the settlement of the Emblem purchase price are expected to be determined in the fourth quarter of 2003. Business Combinations and Goodwill and Other Intangibles In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS Nos. 141, "Business Combinations," and 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment at least annually. Intangible assets with definite lives will continue to be amortized over their estimated useful lives. SFAS No. 142 was adopted by the Company effective January 1, 2002. Page 11 of 27 Impairment indicators include, among other conditions, cash flow deficits, an historic or anticipated decline in revenue or operating profit, adverse legal or regulatory developments, accumulation of costs significantly in excess of amounts originally expected to acquire the asset and a material decrease in the fair value of some or all of the assets. The Company performed the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002, using the two-step process prescribed in SFAS No. 142. The first step was a review for potential impairment, while the second step measured the amount of the impairment. The impairment charge resulting from these transitional impairment tests was reflected as a cumulative effect of a change in accounting principle as of January 1, 2002. The $3.4 million charge, which is net of a tax benefit of $0.8 million, occurred in the Engineered Materials segment and was comprised of $2.3 million and $1.9 million of pre-tax impaired goodwill and trademark, respectively. The changes in the carrying amount of goodwill by segment for the nine months ended September 27, 2003 are as follows:
Communications and Space Engineered Defense Products Materials Total (in thousands) Balance at January 1, 2003 $ 57,660 $ 3,692 $ - $ 61,352 Adjustment of Condor purchase price accounting 3,014 (2,031) - 983 Acquisition of AERA 11,672 - - 11,672 Acquisition of Darlington 13,463 - - 13,463 Acquisition of Emblem 6,433 - - 6,433 --------------------------------------------------------------------- Balance at September 27, 2003 $ 92,242 $ 1,661 $ - $ 93,903 =====================================================================
Summarized below are intangible assets subject to amortization:
Estimated September 27, December 31, Useful Lives 2003 2002 (years) (in thousands) Customer contracts and relationships $ 38,700 $ - 10-20 Purchased technologies 16,768 11,648 8-20 Non-compete agreements 2,986 200 1-5 Tradename/trademark 2,180 - 5-35 Purchased backlog 916 916 2 --------------------------------- 61,550 12,764 Less accumulated amortization (4,354) (897) --------------------------------- $ 57,196 $ 11,867 =================================
The amortization expense for the three months ended September 27, 2003 and September 28, 2002 amounted to $1.4 million and $0.4 million, respectively. The amortization expense for the nine months ended September 27, 2003 and September 28, 2002 amounted to $3.5 million and $0.5 million, respectively. Total amortization expense for the years 2003, 2004, 2005, 2006, 2007 and thereafter related to intangible assets are estimated to be $4.8 million, $5.4 million, $5.1 million, $5.1 million, $5.1 million and $35.1 million, respectively. Page 12 of 27 Since the total carrying amount of a trademark was written off in 2002 as part of the cumulative effect of a change in accounting principle, there are no intangible assets, other than goodwill, not subject to amortization as of September 27, 2003. Assets Held For Sale On June 24, 2003, the Board of Directors of the Company approved the decision to sell the Company's 726,000 square foot facility in Deer Park, NY. As of September 27, 2003, the facility is reflected on the accompanying consolidated balance sheet as assets held for sale at its fair value less costs to sell, including commissions and transfer taxes. The Company recorded a pre-tax impairment loss of $9.2 million in the second quarter of 2003, as the net book value of the assets exceeded the fair value less the costs to sell. The fair value was based on a $29.0 million sales price per the sales agreement entered into in July 2003. This impairment charge represented the entire loss the Company expects to incur. Of the $29.0 million sales price, $22.0 million is in cash and $7.0 million is in the form of a purchase money mortgage and note. The Company closed on the sale in October 2003 and received the cash less closing payments. The note receivable is due when the Company vacates the facility. As part of the agreement, the Company will lease the facility for a period not to exceed two years. The lease agreement does not have any renewal or buyout options. Inventories Inventories are summarized by major classification as follows:
September 27, 2003 December 31, 2002 (in thousands) Raw materials and supplies $ 8,847 $ 7,804 Work-in-process 40,606 27,024 Finished goods 2,149 2,041 Less: Unliquidated progress payments (16,337) (4,463) -------- -------- $ 35,265 $ 32,406 ======== ========
Credit Facility At September 27, 2003, the Company has a $200.0 million credit facility with a consortium of banks, led by Citibank, N.A. as the administrative agent, Fleet National Bank as the syndication agent and Wachovia Bank, N.A. as the documentation agent. The facility expires in November 2005. In connection with the amended facility, $1.0 million of deferred finance costs is included in other assets on the accompanying consolidated balance sheet and is being amortized using the straight-line method over the term of the agreement. The credit facility provides the Company with sub-limits of borrowing up to $125.0 million for acquisition-related financing and up to $125.0 million in stand-by letters of credit financing. The potential cash borrowing under the facility is reduced by the amount of outstanding letters of credit. There were no direct borrowings outstanding under the credit facility at September 27, 2003. Letters of credit outstanding at September 27, 2003 pertaining to the credit facility were $54.3 million, resulting in $70.7 million available at September 27, 2003 for stand-by letters of credit. Any future borrowings under the facility would be priced initially at LIBOR plus a predetermined amount, ranging from 1.25% to 1.75%, dependent on the Company's consolidated leverage ratio at the time of the borrowing. At September 27, 2003, LIBOR was approximately 1.2% and the applicable adjustment to LIBOR was 1.25%. The Page 13 of 27 facility requires a commitment fee of 0.25% on the average daily unused portion of the facility. In connection with the credit facility, the Company is required to maintain both financial and non-financial covenants and ratios. Also, the Company cannot declare or pay any dividend on its outstanding common stock in an amount that exceeds fifty percent of its consolidated net income for the immediately preceding quarter. As of September 27, 2003, the Company was in compliance with its covenants. The credit facility is secured by the Company's accounts receivable, inventory and machinery and equipment. 5.25% Convertible Subordinated Notes due 2007 In April 2002, the Company completed the offering of its 5.25% Convertible Subordinated Notes due 2007 (the "Notes") and received proceeds of $133.7 million, net of $4.1 million of commissions paid. Interest payments on the Notes are due April 15 and October 15 of each year. The Notes are convertible, unless previously redeemed or repurchased by the Company, at the option of the holder at any time prior to maturity, into the Company's common shares at an initial conversion price of $31.26 per share, subject to adjustment in certain events. As of September 27, 2003, there had been no conversions. Comprehensive Income As of September 27, 2003, accumulated other comprehensive loss included in the accompanying consolidated balance sheet primarily represents additional minimum liabilities on benefit plans. Comprehensive income from continuing operations for the three and nine month periods ended September 27, 2003 was $5.5 million and $6.8 million, respectively, compared to comprehensive income, before cumulative effect of a change in accounting principle, for the three and nine month periods ended September 28, 2002 of $3.4 million and $9.3 million, respectively. Business Segments EDO Corporation is a leading supplier of sophisticated, highly engineered products and systems for defense, aerospace and industrial applications. The Company's advanced electronic, electromechanical and information systems and engineered materials are mission-critical, standard equipment on a wide range of military platforms. The Company has three reporting segments: Defense, Communications and Space Products and Engineered Materials. The Defense segment provides integrated, front-line, warfighting systems and components including electronic warfare, radar countermeasures systems, reconnaissance and surveillance systems, aircraft weapons suspension and release systems, airborne mine countermeasures systems, integrated combat and sonar systems, command, control and communications systems and professional, operational, technical and information technology services for military forces and governments worldwide. The Communications and Space Products segment supplies antenna products and ultra-miniature electronics and systems for the remote sensing and electronic warfare industries. The Engineered Materials segment supplies commercial and military piezo-electric ceramic products and advanced fiber composite structural products for the aircraft, communication, navigation, chemical, petrochemical, paper and oil industries. Page 14 of 27
Three months ended Nine months ended Sept. 27, Sept. 28, Sept. 27, Sept. 28, 2003 2002 2003 2002 (in thousands) Net sales: Defense $ 94,108 $ 62,760 $ 251,051 $ 166,119 Communications and Space Products 13,308 12,444 41,011 31,560 Engineered Materials 11,367 9,900 32,834 28,053 --------- -------- --------- --------- $ 118,783 $ 85,104 $ 324,896 $ 225,732 ========= ======== ========= ========= Operating earnings (loss): Defense $ 10,781 $ 6,009 $ 23,520 $ 18,475 Communications and Space Products 295 366 2,346 (1,667) Engineered Materials 802 988 1,497 2,135 Impairment loss on assets held for sale - - (9,160) - --------- -------- --------- --------- 11,878 7,363 18,203 18,943 Net interest expense (2,022) (1,534) (6,096) (2,887) Other, net (103) 34 25 40 --------- -------- --------- --------- Earnings before income taxes, discontinued operations and cumulative effect of a change in accounting principle $ 9,753 $ 5,863 $ 12,132 $ 16,096 ========= ======== ========= =========
New Accounting Standards In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that a liability be recognized for costs associated with an exit or disposal activity only when the liability is incurred. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The effect of the adoption of this statement on January 1, 2003 was not material to the Company's operating results or financial position. In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123." SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The disclosure provisions of SFAS No. 148 were effective for years ending after December 15, 2002. Presently, the Company does not plan to voluntarily change its method of accounting for stock-based compensation. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following information should be read in conjunction with the Consolidated Financial Statements as of September 27, 2003. Page 15 of 27 Three Months Ended September 27, 2003 compared with Three Months Ended September 28, 2002 Net sales for the three months ended September 27, 2003 increased $33.7 million or 39.6% to $118.8 million from $85.1 million for the three months ended September 28, 2002. This increase comprised sales growth of $31.3 million in the Defense segment, $0.9 million in the Communications and Space Products segment and $1.5 million in the Engineered Materials segment. In the Defense segment, $12.8 million of the increase was due to sales of reconnaissance and surveillance systems attributable to the assets acquired from Condor Systems, Inc. ("Condor"). Such sales were included in sales for two months of the quarter ended September 28, 2002, as the Condor assets were acquired on July 26, 2002. Also, $27.9 million of the increase was attributable to sales of Emblem Group Ltd. ("Emblem"), Darlington, Inc. ("Darlington") and Advanced Engineering and Research Associates, Inc. ("AERA"), all of which were acquired in 2003. Aircraft weapons suspension and release systems sales increased due in part to the F-22 AMRAAM Vertical Eject Launcher program, the BRU-57 Multiple-Carriage Smart Bomb Rack program and development efforts on the Joint Strike Fighter weapons suspension and release units programs. Sales of undersea sonar systems and aircraft radar signal simulator units also increased in the third quarter of 2003 compared to the third quarter of 2002. These increases were partially offset by the decreases in electronic warfare equipment as well as integrated combat systems and mine countermeasures systems. The decrease in sales of electronic warfare equipment was due to the completion of the Universal Exciter Upgrade ("UEU") production program in the third quarter of 2003. The decrease in integrated combat systems was due primarily to delays in receipt of orders from foreign customers, resulting in lower sales of combat and command, control and communications systems. The net decrease in sales of mine countermeasure systems was due to lower sales from our MK-105 program, partially offset by an increase in sales relating to our development work associated with Organic Airborne/Surface Influence Sweep ("OASIS") systems. The last MK-105 system for the U.S. Navy was delivered in the third quarter of 2003. In the Communications and Space Products segment, the increase in sales was attributable primarily to sales of antenna and space products. In the Engineered Materials segment, there were increases in sales of composite structural products, including work associated with the Sikorsky Comanche program, and electro-ceramic products. Operating earnings for the three months ended September 27, 2003, increased $4.5 million or 61.3% to $11.9 million. This compares to operating earnings for the three months ended September 28, 2002 of $7.4 million. Included in the operating earnings for the three months ended September 27, 2003 is $1.4 million of intangible asset amortization expense related to our recent acquisitions. This compares to total amortization expense of approximately $0.4 million for the three months ended September 28, 2002. The Defense segment's operating earnings for the three months ended September 27, 2003 increased $4.8 million or 79.4% to $10.8 million or 11.5% of this segment's net sales compared to operating earnings for the three months ended September 28, 2002 of $6.0 million or 9.6% of this segment's net sales. The increase in operating earnings is due to increased margin sales of reconnaissance and surveillance systems acquired from Condor, efficiencies achieved on higher production volume associated with our radar signal simulator program and higher-margin sales of aircraft weapons suspension and release systems. In addition, the completion of production activities on certain long-term programs, which included the UEU, resulted in earnings at relatively high margin. These increases were offset in part by a shift in the margins of mine countermeasure systems from higher-margin production efforts on the MK-105 Page 16 of 27 program last year to lower-margin, non-recurring development efforts this year associated with OASIS. Additionally, the third quarter of 2003 was negatively impacted by the aforementioned increase in amortization expense, whereas the third quarter of 2002 was favorably impacted by the higher volume of sales on UEU production program on Lots 4 and 5. The Communications and Space Products segment's operating earnings for the three months ended September 27, 2003 were $0.3 million or 2.2% of this segment's net sales compared to operating earnings for the three months ended September 28, 2002 of $0.4 million or 2.9% of net sales for this segment. Operating earnings in the current period included a $1.1 million pre-tax charge to write down satellite-related inventory to net realizable value. This reduction was caused by competitive price pressure from our major customer as well as some obsolescence, determined as part of our normal, ongoing review of recoverability. This charge was substantially offset by the contribution from sales from other products in this segment. The Engineered Materials segment's operating earnings for the three months ended September 27, 2003 were $0.8 million or 7.1% of this segment's net sales compared to operating earnings for the three months ended September 28, 2002 of $1.0 million or 10.0% of this segment's net sales. The decrease in this segment's operating earnings was due to a decrease in contribution from composite structural products, resulting from a shift in sales to lower-margin non-recurring engineering efforts on the Sikorsky Comanche program. Selling, general and administrative expenses increased $7.6 million or 59.7% to $20.4 million or 17.2% of net sales for the three months ended September 27, 2003 from $12.8 million or 15.0% of net sales for the three months ended September 28, 2002. This increase is primarily attributable to the acquisitions of Condor, AERA, Darlington and Emblem, which accounted for approximately $8.4 million of the net increase and included $1.4 million of amortization expense associated with the intangible assets established as part of purchase accounting. In the third quarter of 2002, amortization expense was $0.4 million. Company-sponsored research and development expenditures of $1.5 million, or 1.2% of net sales, in the three months ended September 27, 2003 are lower on a percentage of net sales basis than the $2.1 million or 2.4% of net sales in the three months ended September 28, 2002. This is due to timing of such expenditures in addition to the absence of such expenditures in our services business, which includes AERA. Interest expense, net of interest income, for the three months ended September 27, 2003 was $2.0 million compared to $1.5 million for the three months ended September 28, 2002. Interest expense for each period reflects interest associated with our $137.8 million principal amount 5.25% Convertible Subordinated Notes due 2007 (the "Notes"), issued in April 2002, amortization of deferred debt issuance costs associated with the offering of the Notes, and amortization of deferred financing costs associated with our credit facility, which was amended in the fourth quarter of 2002. In the three months ended September 28, 2002, interest expense reflected lower amortization of deferred financing costs, as the costs to amend the credit facility and, therefore, the increased amortization expense, did not occur until the fourth quarter of 2002. Income tax expense for the three months ended September 27, 2003 reflects our estimated effective rate of 43.0% for the year ending December 31, 2003. This compares to an effective rate of 42.5% for the three months ended September 28, 2002, reflecting our estimated effective rate for the year ended December 31, 2002. For the three months ended September 27, 2003, net earnings were $5.6 million or $0.32 per common share on 22.0 million diluted common shares compared to net earnings of $3.4 million or $0.19 per diluted common share on 17.4 million diluted common shares for the three months ended September 28, 2002. The 5.25% Page 17 of 27 Convertible Subordinated Notes due 2007 were dilutive for the three months ended September 27, 2003. Nine Months Ended September 27, 2003 compared with Nine Months Ended September 28, 2002 Net sales for the nine months ended September 27, 2003 increased $99.2 million or 43.9% to $324.9 million from $225.7 million for the nine months ended September 28, 2002. This increase comprised sales growth of $84.9 million in the Defense segment, $9.5 million in the Communications and Space Products segment and $4.8 million in the Engineered Materials segment. In the Defense segment, $47.2 million of the increase was due to sales of reconnaissance and surveillance systems attributable to the assets acquired from Condor. Such sales were included in sales for the nine months ended September 28, 2002, however, only for approximately two months as the Condor assets were acquired on July 26, 2002. Also, $60.1 million of the increase was attributable to sales of Emblem, Darlington and AERA, all acquired in 2003. Aircraft weapons suspension and release systems sales increased due in part to the F-22 AMRAAM Vertical Eject Launcher program, the BRU-57 Multiple-Carriage Smart Bomb Rack program, and development efforts on the Small Diameter Bomb and the Joint Strike Fighter weapons suspension and release units programs. Sales relating to our aircraft radar signal simulator program and undersea sonar systems also increased in the nine months ended September 27, 2003 compared to the nine months ended September 28, 2002 due to increased production efforts. These increases were partially offset by the decreases in sales of electronic warfare equipment, integrated combat systems and mine countermeasure systems. The decrease in sales of electronic warfare equipment was due to higher sales in 2002 on the UEU production program which was completed in the third quarter of 2003. The decrease in sales of integrated combat systems was due primarily to delays in receipt of international orders. The net decrease in sales of mine countermeasure systems was due to lower sales from our MK-105 program, partially offset by an increase in sales relating to our development work associated with OASIS. In the Communications and Space Products segment, the increase in sales was attributable primarily to sales contributed by the assets acquired from Condor. In addition, there were increases in sales of antenna products. The increases in this segment were partially offset by a decrease in sales of space products. In the Engineered Materials segment, there were increases in sales of composite structural products, including work associated with the Sikorsky Comanche program as well as production and installation of our composite pipe on offshore oil rig projects resulting from increased activity in the Gulf of Mexico. In addition, there were sales increases of our electro-ceramic products, namely domestic sonar transducers. Operating earnings for the nine months ended September 27, 2003 decreased $0.7 million or 3.9% to $18.2 million or 5.6% of net sales compared to $18.9 million or 8.4% of net sales for the nine months ended September 28, 2002. Included in operating earnings for the nine months ended September 27, 2003 is a $9.2 million impairment loss related to the Deer Park facility and $3.4 million of intangible asset amortization expense associated with the Condor, AERA, Darlington and Emblem acquisitions. This compares to total amortization expense of approximately $0.5 million for the nine months ended September 28, 2002. Also included in operating earnings for the nine months ended September 27, 2003 is pension expense of $3.0 million and ESOP compensation expense of $2.4 million. Included in operating earnings for the nine months ended September 28, 2002 is pension expense of $3.0 million and ESOP compensation expense of $3.2 million. The lower ESOP compensation expense for the nine months ended September 27, 2003 is attributable to our lower average stock price in the first nine months of 2003 compared to the first nine months of 2002. Pension and ESOP compensation expense are allocated between cost of sales and selling, general and administrative expense. Page 18 of 27 The Defense segment's operating earnings for the nine months ended September 27, 2003 increased $5.0 million or 27.3% to $23.5 million or 9.4% of this segment's net sales compared to operating earnings for the nine months ended September 28, 2002 of $18.5 million or 11.1% of this segment's net sales. The increase in operating earnings is due primarily to higher-margin sales of reconnaissance and surveillance systems acquired from Condor and efficiencies achieved on higher production volume associated with our radar signal simulator. These increases were offset in part by a shift in the margins of mine countermeasure systems from higher-margin production on the MK-105 program last year to lower-margin, non-recurring development efforts this year associated with OASIS. Additionally, operating earnings in the nine months ended September 27, 2003 were negatively impacted by amortization expense pertaining to intangible assets associated with acquisitions. Operating earnings in the nine months ended September 28, 2002 were favorably impacted by the high-margin sales on the UEU production program on Lots 4 and 5. The Communications and Space Products segment's operating earnings for the nine months ended September 27, 2003 increased $4.0 million or 140.7% to $2.3 million or 5.7% of this segment's net sales. In the nine months ended September 27, 2003, operating earnings in this segment were negatively impacted by a $1.1 million pre-tax charge to write down satellite-related inventory to net realizable value. This reduction was caused by competitive price pressure from our major customer as well as some obsolescence. This charge was more than offset by the contribution from the higher sales of communications systems acquired from Condor. For the nine months ended September 28, 2002, this segment had an operating loss of $1.7 million, due primarily to a $1.5 million charge recorded to provide for manufacturing inefficiencies resulting from a primary customer's decrease in forecasted purchases of our satellite down converters. The Engineered Materials segment's operating earnings for the nine months ended September 27, 2003 were $1.5 million or 4.6% of this segment's net sales compared to operating earnings for the nine months ended September 28, 2002 of $2.1 million or 7.6% of this segment's net sales. During the nine months ended September 27, 2003, we incurred a pre-tax charge of $0.7 million to write down inventory and receivables related to the microwave product line that services the telecommunications industry. As sales from such product line were not materializing to expected levels set forth in the business plan for this line, we conducted an analysis of market potential. Such analysis was completed in the second quarter of 2003 and indicated that approximately $0.1 million of unbilled receivables were unrecoverable and that the net realizable value of the related inventory was $0.6 million lower than its book value. In addition, the decrease in this segment's operating earnings as a percentage of net sales was due to a decrease in contribution from composite structural products resulting from a shift in sales to lower-margin, non-recurring engineering efforts associated with the Sikorsky Comanche program. Selling, general and administrative expenses increased $26.0 million or 83.5% to $57.1 million or 17.6% of net sales for the nine months ended September 27, 2003 from $31.1 million or 13.8% of net sales for the nine months ended September 28, 2002. This increase is primarily attributable to the acquisitions of Condor, AERA, Darlington, and Emblem, which accounted for approximately $25.0 million of the net increase and included $3.4 million of amortization expense associated with the intangible assets established as part of purchase accounting. In the first nine months of 2002, amortization expense was $0.5 million. Company-sponsored research and development expenditures of $5.9 million or 1.8% of net sales in the nine months ended September 27, 2003 are lower on a percentage of net sales basis than the $5.9 million or 2.6% of net sales in the nine months ended September 28, 2002. This is due to the absence of such expenditures in our services business, which includes AERA. However, there has been an increase in the level of our customer-funded research and development. Page 19 of 27 Interest expense, net of interest income, for the nine months ended September 27, 2003 was $6.1 million compared to $2.9 million for the nine months ended September 28, 2002. Interest expense for each period reflects interest expense associated with our Notes, issued in April 2002, amortization of deferred debt issuance costs associated with the offering of the Notes and amortization of deferred financing costs associated with our credit facility, which was amended in the fourth quarter of 2002. In the nine months ended September 28, 2002, interest expense reflected lower amortization of deferred financing costs, as the costs to amend the credit facility and, therefore, the increased amortization expense, did not occur until the fourth quarter of 2002. Income tax expense for the nine months ended September 27, 2003 reflects our estimated effective rate of 43.0% for the year ending December 31, 2003. This compares to an effective rate of 42.5% for the nine months ended September 28, 2002, reflecting our estimated effective rate for the year ended December 31, 2002. For the nine months ended September 27, 2003, net earnings from continuing operations were $6.9 million or $0.39 per diluted common share on 17.5 million diluted common shares compared to net earnings before a cumulative effect of a change in accounting principle of $9.3 million or $0.53 per diluted common share on 17.4 million diluted common shares for the nine months ended September 28, 2002. In the nine months ended September 27, 2003, we received notification of final settlement of bankruptcy matters pertaining to our former energy business. Upon the discontinuance of such business in 1996, a liability was established pending final settlement of the bankruptcy. This liability was reversed in the nine months ended September 27, 2003, and consequently, $1.4 million, net of income tax expense of $0.9 million, was reported as earnings from discontinued operations in the accompanying statement of earnings. Net earnings including discontinued operations, were $8.3 million or $0.47 per diluted share for the nine months ended September 27, 2003. Considering the retroactive effect of a change in accounting principle, net earnings for the nine months ended September 28, 2002 were $5.9 million or $0.34 per diluted common share. This reflects a $3.4 million charge which was recorded as of January 1, 2002, and is shown net of a tax benefit of $0.8 million on the statement of earnings. This charge pertains to the impairment of goodwill and a trademark resulting from impairment tests performed in 2002, as required under Statement of Financial Accounting Standard ("SFAS") No. 142. The impairment occurred in the Engineered Materials segment and is comprised of $2.3 million of goodwill and $1.9 million related to a trademark. Liquidity and Capital Resources Balance Sheet Our cash, cash equivalents, restricted cash and marketable securities decreased $99.6 million or 62.3% to $60.2 million at September 27, 2003 from $159.9 million at December 31, 2002. The decrease was primarily due to cash outflows of $87.6 million to finance the acquisitions of Emblem, Darlington and AERA, net of cash acquired. Partially offsetting the cash used by investing activities for acquisitions was the release of $27.3 million of restricted cash. Cash provided by operations for the nine months ended September 27, 2003 was $6.9 million compared to $18.2 million for the nine months ended September 28, 2002. Cash flows from operations for the nine months ended September 27, 2003 were favorably impacted by the collection of receivables and were offset by cash outflows associated with a $5.0 million contribution to our defined benefit pension plan made in the third quarter of 2003, the reduction of accounts payable and the liquidation of contract advances. During the nine months ended Page 20 of 27 September 27, 2003, we also made payments of approximately $12.0 million in full settlement of the debt we assumed upon the acquisition of AERA, Darlington and Emblem. Such payments were made in order to remain in compliance with our credit facility. Accounts receivable increased $17.3 million or 17.2% to $117.9 million at September 27, 2003 from $100.6 million at December 31, 2002 due primarily to the acquisitions of Emblem, Darlington and AERA. Excluding the effects of the acquisitions, accounts receivable decreased $13.6 million or 13.5% from December 31, 2002. Inventories increased $2.9 million or 8.8% to $35.3 million at September 27, 2003 from $32.4 million at December 31, 2002. The increase was due primarily to the acquisition of Emblem. Excluding the acquisitions made in 2003, inventories decreased $0.9 million or 2.7% from December 31, 2002. The notes receivable of $1.7 million at September 27, 2003 (of which $0.3 million is included in current assets at September 27, 2003) represent notes related to the sale of our former College Point facility in January 1996. These notes bear interest at 7.0% per annum and are due in annual amounts through September 2004, with a final payment of $1.3 million due on December 31, 2004. The notes are secured by a mortgage on the College Point facility. In July 2003, our note receivable related to the sale of property in Deer Park in June 2000 was collected in full with accrued interest. Contract advances decreased $13.0 million or 64.3% to $7.2 million at September 27, 2003 from $20.3 million at December 31, 2002 due to the liquidation of previously received advances by cost input on foreign contracts and the resulting revenue recognition. Capital expenditures, excluding the effects of the acquisitions of Emblem, Darlington and AERA, for the nine months ended September 27, 2003 were $6.9 million compared to $4.1 million for the nine months ended September 28, 2002. Increases were in accordance with planned expenditures and partially attributable to leasehold improvements at the Company's headquarters as well as purchases of machinery and equipment. Financing Activities Credit Facility At September 27, 2003, we have a $200.0 million credit facility with a consortium of banks, led by Citibank, N.A. as the administrative agent, Fleet National Bank as the syndication agent and Wachovia Bank, N.A. as the documentation agent. The facility expires in November 2005. The credit facility provides us with sub-limits of borrowing up to $125.0 million for acquisition-related financing and up to $125.0 million in stand-by letters of credit financing. The potential cash borrowing under the facility is reduced by the amount of outstanding letters of credit. There were no direct borrowings outstanding under the credit facility at September 27, 2003. Letters of credit outstanding at September 27, 2003 pertaining to the credit facility were $54.3 million, resulting in $70.7 million available at September 27, 2003 for stand-by letters of credit. In connection with the credit facility, we are required to maintain both financial and non-financial covenants and ratios. Also, we cannot declare or pay any dividend on our outstanding common stock in an amount that exceeds fifty percent of our consolidated net income for the immediately preceding quarter. As of September 27, 2003, we were in compliance with our covenants. The credit facility is secured by our accounts receivable, inventory and machinery and equipment. Page 21 of 27 5.25% Convertible Subordinated Notes due 2007 In April 2002, we completed the offering of the Notes and received proceeds of $133.7 million, net of $4.1 million of commissions paid. Interest payments on the Notes are due April 15 and October 15 of each year. Accrued interest payable, included in accrued liabilities on our consolidated balance sheet, was $3.3 million at September 27, 2003 and $1.5 million at December 31, 2002, respectively. The Notes are convertible, unless previously redeemed or repurchased by us, at the option of the holder at any time prior to maturity, into our common shares at an initial conversion price of $31.26 per share, subject to adjustment in certain events. As of September 27, 2003, there had been no conversions. Employee Stock Ownership Trust ("ESOT") Loan We sponsor an ESOP which provides retirement benefits to substantially all employees. An indirect loan which is collateralized by unallocated EDO common shares is funded by quarterly cash contributions from us. As quarterly cash payments are made, the unallocated EDO common shares are committed-to-be-released and allocated to participants. We believe that, for the foreseeable future, we have adequate liquidity and sufficient capital to fund our currently anticipated requirements for working capital, capital expenditures including acquisitions, research and development expenditures, interest payments and servicing of the ESOP indirect loan. We continue to focus on positioning ourselves to be a significant player in the consolidation of first-tier defense suppliers and, to that end, have actively sought candidates for strategic acquisitions. Future acquisitions may be funded from any of the following sources: cash on hand; borrowings under our credit facility; issuance of our common stock or other equity securities; and/or convertible or other debt offerings. Commitments and Contingencies A summary of our commitments and contractual obligations as of September 27, 2003, is included in the following table. Our commitments under letters of credit and advance payment and performance bonds relate primarily to advances received on foreign contracts. We do not expect to have to make payments under these letters of credit or bonds since these obligations are removed as we perform under the related contracts. The amounts for letters of credit and performance bonds represent the amount of commitment expiration per period.
Payments Due In (in millions): 2007 and Total 2003 2004 2005 2006 Beyond ------- ------- ------- ------- ------- ------- 5.25% Convertible Subordinated Notes due 2007 $ 137.8 - - - - 137.8 Operating leases 53.8 2.6 9.2 7.4 5.8 28.8 Letters of credit 55.7 17.0 10.3 27.9 0.2 0.3 Advance payment and performance bonds 2.0 0.3 - - - 1.7 ------- ------- ------- ------- ------- ------- Total $ 249.3 19.9 19.5 35.3 6.0 168.6 ======= ======= ======= ======= ======= =======
Page 22 of 27 Additionally, we are subject to certain legal actions that arise out of the normal course of business. Although we believe that the ultimate outcome of these actions will not have a material adverse effect on our consolidated financial position, results of operations or liquidity, legal costs incurred in connection with these matters could materially impact our results of operations. Backlog The funded backlog of unfilled orders at September 27, 2003 increased $74.6 million or 19.9% to $449.6 from $375.0 million at December 31, 2002. Excluding the effects of the Emblem, Darlington and AERA acquisitions, backlog increased $7.3 million or 1.9%. Our backlog consists primarily of current orders under long-lived, mission-critical programs of key defense platforms. Critical Accounting Policies We make estimates and assumptions in the preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our consolidated financial condition and results of operations and which require our most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The following is a brief discussion of the critical accounting policies employed by us: Revenue Recognition Sales under long-term, fixed-price contracts, including pro-rata profits, are generally recorded based on the relationship of costs incurred to date to total projected final costs or, alternatively, as deliveries and other milestones are achieved or services are provided. These projections are revised throughout the lives of the contracts. Adjustments to profits resulting from such revisions are made cumulative to the date of change and may affect current period earnings. Sales under cost reimbursement contracts are recorded as costs are incurred. Sales on other than long-term contract orders, principally commercial products, are recorded as shipments are made. Our gross profit is affected by a variety of factors, including the mix of products, systems and services sold, production efficiencies, price competition and general economic conditions. Estimated losses on long-term contracts are recorded when identified. Inventories Inventories under long-term contracts and programs reflect all accumulated production costs, including factory overhead, initial tooling and other related costs (including general and administrative expenses relating to certain of our defense contracts), less the portion of such costs charged to cost of sales. All other inventories are stated at the lower of cost (principally first-in, first-out method)or market. Inventory costs in excess of amounts recoverable under contracts and which relate to a specific technology or application and which may not have alternative uses are charged to cost of sales when such circumstances are identified. From time to time, we manufacture certain products prior to receiving firm contracts in anticipation of future demand. Such costs are inventoried and are incurred to help maintain stable and efficient production schedules. Several factors may influence the sale and use of our Page 23 of 27 inventories, including our decision to exit a product line, technological change, new product development and/or revised estimates of future product demand. If inventory is determined to be overvalued due to one or more of the above factors, we would be required to recognize such loss in value at the time of such determination. Under the contractual arrangements by which progress payments are received, the United States Government has a title to or a security interest in the inventories identified with related contracts. Property, Plant and Equipment and Other Long-Lived Assets Property, plant and equipment is recorded at cost and is depreciated on a straight-line basis over the estimated useful lives of such assets. Leasehold improvements are amortized over the shorter of their estimated useful lives or their respective lease periods. In those cases where we determine that the useful life of property, plant and equipment should be shortened, we depreciate the net book value in excess of the salvage value over its revised remaining useful life thereby increasing depreciation expense. Factors such as technological advances, changes to our business model, changes in our capital strategy, changes in the planned use of equipment, fixtures, software or changes in the planned use of facilities could result in shortened useful lives. Long-lived assets, other than goodwill, are reviewed by us for impairment whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. The estimate of cash flow, which is used to determine recoverability, is based upon, among other things, certain assumptions about future operating performance. The Company's estimates of undiscounted cash flow may differ from actual cash flow due to factors including technological advances, changes to the Company's business model, or changes in the Company's capital strategy or planned use of long-lived assets. If the sum of the undiscounted cash flows, excluding interest, is less than the carrying value, we would recognize an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset. In accordance with SFAS No. 142, goodwill must be tested at least annually for impairment at the reporting unit level. If an indication of impairment exists, we are required to determine if such goodwill's implied fair value is less than its carrying value in order to determine the amount, if any, of the impairment loss required to be recorded. Impairment indicators include, among other conditions, cash flow deficits, an historic or anticipated decline in revenue or operating profit, adverse legal or regulatory developments, accumulation of costs significantly in excess of amounts originally expected to acquire the asset and/or a material decrease in the fair value of some or all of the assets. Pension and Post-Retirement Benefit Obligations We sponsor defined benefit pension and other retirement plans in various forms covering all eligible employees. Several statistical and other factors which attempt to anticipate future events are used in calculating the expense and liability related to the plans. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by us, within certain guidelines and in conjunction with our actuarial consultants. In addition, our actuarial consultants also use subjective factors such as withdrawal and mortality rates to estimate the expense and liability related to these plans. The actuarial assumptions used by us may differ significantly, either favorably or unfavorably, from actual results due to changing market, economic or regulatory conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. Page 24 of 27 New Accounting Standards See the notes accompanying the unaudited consolidated financial statements as of and for the three and nine months ended September 27, 2003. "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995 The statements in this quarterly report and in oral statements that may be made by representatives of the Company relating to plans, strategies, economic performance and trends and other statements that are not descriptions of historical facts may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27(a) of the Securities Act of 1933 and Section 21(e) of the Securities Exchange Act of 1934. Forward-looking statements are inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include but are not limited to the following for each of the types of information noted below. U.S. and international military program sales, follow-on procurement, contract continuance, and future program awards, upgrades and spares support are subject to: U.S. and international military budget constraints and determinations; U.S. congressional and international legislative body discretion; U.S. and international government administration policies and priorities; changing world military threats, strategies and missions; competition from foreign manufacturers of platforms and equipment; NATO country determinations regarding participation in common programs; changes in U.S. and international government procurement timing, strategies and practices; and the general state of world military readiness and deployment. Commercial satellite programs and equipment sales, follow-on procurement, contract continuance and future program awards, upgrades and spares support are subject to: establishment and continuance of various consortiums for satellite constellation programs; delay in launch dates due to equipment, weather or other factors beyond our control; and development of sufficient customer base to support a particular satellite constellation program. Commercial product sales are subject to: success of product development programs currently underway or planned; competitiveness of current and future production costs and prices and market and consumer base development of new product programs. Achievement of margins on sales, earnings and cash flow can be affected by: unanticipated technical problems; government termination of contracts for convenience; decline in expected levels of sales; underestimation of anticipated costs on specific programs; the ability to effect acquisitions; and risks inherent in integrating recent acquisitions into our overall structure. Expectations of future income tax rates can be affected by a variety of factors, including statutory changes in Federal and state tax rates, changes in the non-deductible portion of our non-cash ESOP compensation expense, changes in Federal and state regulations, and non-deductible expenses related to acquisitions. The Company has no obligation to update any forward-looking statements. Item 3. Quantitative and Qualitative Disclosure About Market Risk The information called for by this item is provided under Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations." Page 25 of 27 Item 4. Controls and Procedures Evaluation of disclosure controls and procedures As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of our management, including our Review and Disclosure Committee, our Chief Executive Officer and Chief Financial Officer. The Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Changes in internal controls There were no changes in our internal controls over financial reporting during our last fiscal quarter that have materially affected, or are likely to materially affect, internal controls over financial reporting. PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders. None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The Exhibits to this Report are listed in the Exhibit Index appearing herein. (b) Reports on Form 8-K On August 6, 2003, we filed a Current Report on Form 8-K to announce the release of our financial results for the quarter ended June 28, 2003, and to file such press release as an exhibit thereto. Page 26 of 27 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. EDO Corporation --------------------------------------------- (Registrant) by: /s/ Frederic B. Bassett --------------------------------------------- Frederic B. Bassett - Vice President- Finance (Principal Financial Officer) Date: November 10, 2003 Page 27 of 27 Exhibit Index
Exhibit Description ------- ----------- 3(a)(1) Certificate of Incorporation of the Company and amendments thereto dated June 14, 1984, July 18, 1988 and July 22, 1988 (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Exhibit 3(i)) 3(a)(2) Amendment to the Certificate of Incorporation of the Company dated July 29, 1998 (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998, Exhibit 3(i)) 3(a)(3) Amendment to the Certificate of Incorporation of the Company dated May 17, 2002 (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 3(a)(3)) 3(b) By-Laws of the Company effective October 1, 2002 (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 28, 2002, Exhibit 3(ii)) 31.1* Certification of Principal Executive Officer Pursuant to 15 U.S.C. Section 10A, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2* Certification of Principal Financial Officer Pursuant to 15 U.S.C. Section 10A, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1* Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2* Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
------------ * Filed herewith