10-K 1 y94563e10vk.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2003 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 1-3985 --------------------- EDO CORPORATION (Exact name of registrant as specified in its charter) NEW YORK 11-0707740 (State of Incorporation) (IRS Employer Identification No.) 60 EAST 42ND STREET, 42ND FLOOR 10165 NEW YORK, NEW YORK (Zip Code) (Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 716-2000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS: NAME OF EACH EXCHANGE ON WHICH REGISTERED: -------------------- ------------------------------------------ Common Shares, par value $1 per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] The aggregate market value of the registrant's common stock held by non-affiliates was $259,747,032 based on the reported last sale price of common stock on June 28, 2003, which is the last business day of the registrant's most recently completed second fiscal quarter. The number of shares of EDO common stock outstanding as of February 20, 2004 was 19,898,145 shares. DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of the Registrant's definitive proxy statement (filed pursuant to Reg. 14A) relating to its 2004 Annual Meeting of Shareholders are incorporated by reference in Part III of this Report. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- EDO CORPORATION TABLE OF CONTENTS
PART I Item 1 Business.................................................... 2 Introduction................................................ 2 Acquisitions................................................ 2 Segments.................................................... 3 Defense Segment........................................... 3 Communications and Space Products Segment................. 7 Engineered Materials Segment.............................. 9 Research and Development.................................... 10 Marketing and International Sales........................... 10 Backlog..................................................... 11 Government Contracts........................................ 11 Competition and Other Factors............................... 12 Environmental............................................... 12 Employees................................................... 12 Risk Factors................................................ 12 Item 2 Properties.................................................. 18 Item 3 Legal Proceedings........................................... 18 Item 4 Submission of Matters to a Vote of Security Holders......... 19 PART II Item 5 Market for Registrant's Common Equity and Related Stockholder Matters......................................... 19 Item 6 Selected Financial Data..................................... 20 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 21 Item 7A Quantitative and Qualitative Disclosure About Market Risk... 21 Item 8 Financial Statements and Supplementary Data................. 34 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 75 Item 9A Controls and Procedures..................................... 75 PART III Item 10 Directors and Executive Officers of the Registrant.......... 76 Item 11 Executive Compensation...................................... 77 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.................. 77 Item 13 Certain Relationships and Related Transactions.............. 77 Item 14 Principal Accountant Fees and Services...................... 77 PART IV Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................................... 77 (a) Financial Statements and Financial Statement Schedules and Exhibits................................................ 77 1. Financial Statements..................................... 77 2. Financial Statement Schedules............................ 78 3. Exhibits................................................. 78 (b) Reports on Form 8-K..................................... 81 Signatures............................................................ 82
1 PART I ITEM 1. BUSINESS INTRODUCTION EDO Corporation was incorporated in New York in 1925 by Earl Dodge Osborn, from whose initials "EDO" is derived. EDO Corporation provides military and commercial products and professional services, with core competencies in a wide range of critical defense areas, including: - Defense Electronics - Aircraft Armament - Undersea Warfare - Professional Services - C4I -- Command, Control, Communications, Computers, and Intelligence - Integrated Composite Structures A disciplined acquisition program is diversifying the base of major platforms and customers. The Company's Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and the Proxy Statement for its Annual Meeting of Shareholders are made available, free of charge, on its Web site www.edocorp.com, as soon as reasonably practicable after such reports have been filed with or furnished to the Securities and Exchange Commission ("SEC"). ACQUISITIONS Acquisitions have been the primary driver of our growth in recent years. Since 1999, we have completed the following acquisitions: In April 2000, we acquired AIL Technologies, Inc. (AIL), a privately-held defense electronics company based in Deer Park, New York. In the transaction, a merger of AIL with a wholly-owned EDO subsidiary accounted for as a tax-free reorganization, each share of AIL common stock was exchanged for 1.3296 EDO common shares (equivalent to 6,553,194 EDO common shares valued at $39.4 million). In addition, AIL stockholders received a cash payment of $13.3 million. The merged company also assumed AIL debt of $29.7 million. AIL added extensive capabilities in defense electronics, such as aircraft electronic warfare systems in use on the B-1B bomber and the EA-6B Prowler radar-jamming aircraft. In October 2001, we acquired Dynamic Systems, Inc., a privately-held company based in Alexandria, Virginia, for $13.6 million in cash. Dynamic Systems added to our range of professional and information technology services that are provided primarily to the U.S. Department of Defense (DoD) and other government agencies. In July 2002, we acquired, in an auction under section 363 of the U.S. Bankruptcy Code, substantially all of the assets of Condor Systems, Inc., a privately-held defense-electronics company and its subsidiary (together, "Condor") based in Morgan Hill and Simi Valley, California for $62.5 million in cash, plus transaction costs of $5.0 million. We also assumed $28.0 million in outstanding standby letters of credit. The acquisition of Condor's business has significantly expanded our defense-electronics capabilities in the areas of reconnaissance and surveillance systems and communications and countermeasures. In February 2003, we acquired all of the stock of Advanced Engineering & Research Associates, Inc. (AERA), a privately-held company located in Alexandria, Virginia, for $38.1 million in cash, plus transaction costs of $0.3 million. In addition, we acquired and immediately paid off debt of $3.8 million. AERA strengthened and expanded our range of professional services. AERA was merged with our Professional Services business unit. In March 2003, we acquired all of the stock of Darlington, Inc., a privately-held defense-communications company based in Alexandria, Virginia, for $25.6 million in cash, plus transaction costs of approximately $0.3 million. In addition, we acquired and immediately paid off debt of $4.9 million. The Darlington acquisition expanded our capabilities in the areas of C4I (Command, Control, Communications, Computers, 2 and Intelligence) and communications-related professional services. Darlington operates with our Combat Systems business unit. In June 2003, we acquired all of the stock of Emblem Group Ltd. ("Emblem"), a privately-held company based in Brighton, England, for $27.3 million plus transaction costs of approximately $1.9 million. Emblem operated through its MBM Technology unit in England and Artisan Technologies Inc. subsidiary in the United States. Emblem, which has been renamed EDO (UK) Ltd, reinforces our position as a global leader in aircraft armament-release systems and broadens our customer base in Europe. The acquisition also added capabilities in C4I, with a product line of rugged computers and related devices. In addition, we have completed four other acquisitions since 1998, all of which have been disclosed in our prior Annual Reports on Form 10-K. SEGMENTS We have historically reported our results in three reporting segments: Defense, Communications and Space Products, and Engineered Materials. Because the company continues to grow and evolve through acquisitions primarily related to defense products, the Defense segment has become the dominant segment of our business. Operations associated with the three acquisitions completed in 2003 were added to the Defense Segment. Management is currently evaluating other possible reporting segments and organizational structures in view of the expected continuation of our acquisition strategy. Our reporting segments currently consist of the following business units:
DEFENSE COMMUNICATIONS AND SPACE PRODUCTS ENGINEERED MATERIALS ------- --------------------------------- ------------------------ Marine and Aircraft Systems Antenna Products and Technologies Electro-Ceramic Products MTech Communications and Fiber Science Countermeasures Systems Defense Programs and Technologies Space Products portion of DPT Specialty Plastics (DPT) Combat Systems Technical Services Operations Professional Services Reconnaissance and Surveillance Systems EDO (UK) Ltd.
We set forth certain business segment information including information on revenues from external customers, operating earnings, assets and capital expenditures in Note 19 on pages 62 through 65 of this Report. DEFENSE SEGMENT The Defense segment, which accounted for 78% of consolidated net sales in 2003, 74% in 2002, and 71% in 2001, includes electronic warfare systems, reconnaissance and surveillance systems, aircraft weapons-suspension and release systems, integrated combat systems, C4I products and systems, undersea-warfare systems and professional and engineering services. ELECTRONIC WARFARE SYSTEMS Electronic warfare systems sales accounted for 12% of consolidated net sales in 2003, 24% in 2002, and 25% in 2001. Our AN/ALQ-161 is the defensive-avionics system that protects the U.S. Air Force B-1B bomber from radar-guided and infrared-guided missile threats. Designed in the early 1980's specifically for the B-1B aircraft, we delivered the AN/ALQ-161 system and spares to all 100 aircraft in the B-1B fleet. Currently we 3 provide logistic support and capability upgrades to the AN/ALQ-161 systems, including software upgrades that have occurred every 12-24 months, as well as hardware improvements to address both situation awareness and jamming effectiveness. In 2003, the Air Force decided to extend the life of AN/ALQ-161 defensive suite until at least 2015, and has begun a significant upgrade program. EDO's first award in the upgrade program was made in mid-2003, to modernize the digital radio-frequency memory. This will provide advanced technique waveforms to counter known threats. The memory upgrade begins an expected modernization of the entire B-1B fleet. We have also received a contract to continue development on the next generation of AN/ALQ-161 preprocessor flight software. The DoD currently expects B-1B aircraft to be in operation through 2040. We were the original designer and integrator of the AN/ALQ-99 Tactical Support Jamming System for the EA-6B aircraft in the 1960s. We have been under contract for support and modifications for this aircraft's systems and subsystems since then. In 2003, we completed a substantial contract with the U.S. Navy to upgrade the Universal Exciter on the EA-6B aircraft. The Universal Exciter is the unit in the AN/ALQ-99 that provides the specific electronic-jamming-technique waveforms and modulations that defeat enemy air- defense systems. As a result of this contract completion, revenues related to the Universal Exciter Upgrade program declined from 14 percent of total revenues in 2002 to two percent of total revenues in 2003. We continue to maintain and support the AN/ALQ-99 system. The DoD currently expects EA-6B aircraft to be in operation through 2015. We design and produce a line of test equipment for electronic-warfare testing, data acquisition, and radar simulation. In 2003, we received orders for 238 AN/PLM-4 radar signal simulators from the U.S. Air Force and international customers. This brought the total number of systems ordered to 485, of which more than 360 have been delivered to customers. RECONNAISSANCE AND SURVEILLANCE SYSTEMS Our reconnaissance and surveillance systems include the AN/USQ-149 Radar Narrow Band (RNB) Subsystem, the AN/ALR-95 automatic Electronic Support Measures (ESM) system and variants of the ES-3701 ESM system which intercept, analyze and identify radar emissions and provide situational awareness to military personnel. Sales of reconnaissance and surveillance systems accounted for 17% of consolidated net sales in 2003, 8% in 2002, and 0% in 2001. The ES-3701 is a leading international electronic-support system for naval applications. More than 50 systems have been sold, many of which are already in operation providing effective at-sea performance. A key feature is the system's precision direction-finding at long range, even in difficult electromagnetic environments. It can be integrated into any type of combat-system multi-function console and enables the interception of radar threats. INTEGRATED COMBAT SYSTEMS We act as a systems integrator for naval C4I systems. In this role, we integrate a ship's sensor systems, including radar and sonar, communications systems, navigation and integrated bridge systems, and aircraft control systems to provide situational awareness in a common data and display format for a ship's commander. Integration contracts typically provide for the development of integration software that allows the various subsystems to intercommunicate and produce common information displays. In 1998, we began integration of a combat system for the upgrade of a major class of ship for the Norwegian Coast Guard. In 2003, we completed live-fire sea-acceptance trials of our Command, Control and Information System (CCIS) on board three vessels. A fourth Norwegian Coast Guard vessel under contract for CCIS installation is scheduled to begin modernization in 2004. CCIS is an open-architecture system that enhances maritime operations in both the littoral and open-ocean environments. It includes modules for surface-search radar, electro-optic fire-control system, hull-mounted sonar, integrated-bridge system, navigation system and helicopter-control system, all fully integrated with EDO's Piranha I Command Management System (CMS). CMS is designed for modular integration of 4 sensor and weapons systems and complies with U.S. Navy Open Architecture Computing Environment (NOACE) standards. It also provides automated decision aids for on-scene command, real-time tactical display management, aircraft control, search and rescue, and weapon engagement. In 2003, through successful international competition, we won a contract from the Royal Norwegian Navy to upgrade the communications and data-link systems on ULA-class submarines. Under the contract, EDO will provide engineering, manufacturing, and integration services to deliver open-systems-architecture, tactical-data-link systems. EDO will also upgrade the existing submarine communications systems to provide new line-of-sight, over-the-horizon, and satellite-data-communications capabilities, allowing interoperability with all NATO forces. Information from EDO's data-link system will be fully integrated with the submarine's on-board command and control system to give the crew a common operational picture that will be distributed throughout the submarine. MOBILE COMMUNICATION SYSTEMS With the acquisition of Darlington in 2003, we added the AN/TSQ-231 Joint Enhanced Core Communication System (JECCS) product line. JECCS provides the Marine Corps with a mobile, first-in system for network management, data and voice transmission, and switching services. RUGGED COMPUTERS AND ELECTRONICS We also added to our C4I capabilities with our acquisition of Emblem in 2003. Emblem, which has been renamed EDO (UK) Ltd., added a new product line of rugged computers and related electronic devices. This product line is the result of significant investment by Emblem prior to the acquisition. It has been designed to balance exceptional performance with user friendliness and the rugged protection to withstand rough treatment on the battlefield. It has passed the highest standards (Land Class A) for resistance to electro-magnetic interference and low signal emission, allowing it to perform safely alongside other electronic systems. The flagship "Termite" product is the only UK-designed and developed rugged, handheld computer. AIRCRAFT ARMAMENT Aircraft armament includes a broad range of sophisticated devices that allow for the storage and release of the bombs and missiles carried on military aircraft. This includes electronic interfaces between the weapon and the aircraft that allow for targeting and release. Aircraft armament equipment sales accounted for 12% of consolidated net sales in 2003, 13% in 2002, and 13% in 2001. EDO continues to make significant investments in technologies to meet the worldwide demand for smart, lightweight, high-performance weapons-interface systems. Over the last two decades, we have developed and manufactured bomb release units (BRU) for the F-15 aircraft, ejection release units (ERU) for the Tornado multi-role combat aircraft, jettison release mechanisms for the F-14, pneumatic missile-eject launchers for the F/A-22, and smart-weapon, multiple-carriage systems for the F-16 and F-18. In 2003, we: - continued production of F-15 BRUs for the U.S. Air Force and international customers and provided spare-parts support for Tornado ERUs and F-15 BRUs worldwide. - received production orders for 258 additional LAU-142/A missile launchers for the F/A-22 aircraft. Known as AVEL, for AMRAAM (Advanced Medium Range Air to Air Missile) Vertical Ejection Launcher, the LAU-142/A carries and ejects missiles from internal bays. During in-flight launch, the AVEL system ejects missiles through the jet fighter's air-flow-boundary layer very rapidly, assuring safe aircraft separation at supersonic speeds. The AVEL employs a highly reliable pneumatic-ejection system controlled by the aircraft's stores-management system. We have also received our first depot-support contract, and anticipate providing depot support through the life of the F/A-22. - continued development and testing of the pneumatic suspension-and-release system for the F-35 Joint Strike Fighter program. 5 - began development and testing of a new electronic assembly for the LAU-117 Maverick launcher for Raytheon Missile Systems. This assembly will allow the analog-controlled Maverick missile to be carried on the F-16, F-35 and other digital-control aircraft. - received additional production orders for the BRU-57 smart-weapon carriage and electronics system as well as continued the integration of the BRU-55 onto the F-18 aircraft. AIRBORNE MINE COUNTERMEASURES SYSTEMS We believe we are the only manufacturer of airborne naval-minesweeping equipment in the world. The principal system of this type used by the U.S. Navy, the MK105 helicopter-towed system was designed and developed by us starting in 1967. In the early 1990s, we developed a significant upgrade under contract, followed by an initial production contract in 1996. We continue to provide spares and logistics support for these systems to the Navy and an international customer, and we continue to function as the Navy maintenance depot for the MK105 systems. In 1994, we began work under contract with the Navy to develop a lightweight, helicopter-towed minesweeper for shallow water applications. We received a production contract for these systems in 1999 with delivery completed in 2002. In 2002, we won the competitive contract from the Navy for the next generation minesweeping system, the Organic Airborne/Surface Influence Sweep (OASIS). Development work will continue through 2005 followed by production for fleet systems. In 2003, EDO was awarded a contract from the Navy to demonstrate the feasibility of unmanned-surface-vessel mine-warfare technology and the application of this technology for fleet integration. This technology will be directly applicable to mine-warfare mission modules slated for use on the Littoral Combat Ship. SONAR SYSTEMS We have been a supplier of undersea systems including sonar sensors, underwater-communication systems, and depth-sounding and speed-measuring equipment for more than 40 years. During 2003, work continued on a contract for the Brazilian Navy to deliver a major upgrade to the EDO Model 610E sonar system. Work also continued on a contract with Singapore to deliver the recently developed EDO Model 980 sonar system for installation in their new class of naval ship. Development and delivery of the systems will extend into 2006. We continued our work with Ultra Electronics, the UK-based aerospace and defense-electronics group, to provide bow-mounted Medium Frequency Sonar -- 7000 (MFS-7000) systems to the United Kingdom's Type 45 destroyer program. Under our contract, we will provide systems for six ships. Deliveries under the contract will extend through 2006. PROFESSIONAL SERVICES We are a supplier of professional services consisting of acquisition and logistics management, training and performance support systems, information technology services, systems engineering, operation analysis, and program management. We provide these services to the U.S. defense, federal-services, and information-technology markets. Our professional-services capabilities increased significantly in 2003 with the acquisitions of AERA and Darlington. Professional Services accounted for 22% of consolidated net sales in 2003, 13% in 2002, and 13% in 2001. - Acquisition Logistics and Management We support several of the Navy's program executive offices by providing logisticians, acquisition specialists, engineers and financial analysts. These professionals perform functions such as configuration management, budget analysis, analysis of ship casualty reports, ship-manning assessments, and review of training requirements. We also provide acquisition and logistics support to the Marine Corps, including several 6 logistic bases and systems-command centers. We have provided acquisition support to the Coast Guard's Deepwater program office as they faced the challenges of creating a transformational fleet of vessels. In 2003, we assisted the Navy in reviewing approaches to the management of shore-infrastructure. - Training & Performance Systems With the acquisition of AERA, we added capabilities in interactive, multimedia instruction and computer-based training. This includes the development of training courseware for the Virginia-class submarine platforms. We are a prime contractor on the Naval Air Systems Command "Training Systems Contract II" that will be the source of courseware development for many of the Navy and Marine Corps air platforms over the next eight years. We are applying this competency internally to develop automated training and interactive technical manuals for new EDO platforms, such as the OASIS mine-sweeping system. Our logisticians and engineers support the Marine Corps' Warfighting Laboratory, with concept-based experimentation and design, technology evaluation, and identification of improved procedures. Similar support is also provided to the Joint Forces Command's "Joint Concept Development and Experimentation Process." - Systems Engineering In 2003, we continued to perform services under contracts for design, planning, execution, analysis and reporting for the AN/ALQ-161A preprocessor flight software for Warner Robins Air Logistics Center. In addition, we perform engineering services under contracts to the Navy for threat-simulator-validation support at China Lake Naval Air Warfare Center, to the Air Force EW Directorate at Edwards AFB for F/A-22 and various other aircraft platforms, and provide technical and engineering support to various Boeing Satellite Systems programs. We also provide marine, propulsion, and systems engineering services in areas such as test and evaluation, systems integration, performance modeling and computer-aided design to a number of Navy, Coast Guard, and waterfront clients. - Information Technology Services The military continues to outsource a significant amount of IT-related professional services. With our AERA and Darlington acquisitions, we added support contracts in key programs with the Navy, Army and civilian agencies. In 2003, we were competitively awarded a contract from the Navy to provide fleet support worldwide for existing and planned C4I systems, both afloat and ashore. This contract is a large expansion of the previous $55 million Darlington contract and has a contract ceiling of $107.7 million (base year plus four option years). Deployed carriers and large-deck ships have an EDO Fleet Systems Engineering Team (FSET) onboard. The FSETs include highly-skilled engineers and technicians with IT and communication system expertise who serve at US Navy shore stations as well as aboard active-duty ships. In addition to operations, maintenance, and training support, the contract also requires support for the rapid injection of new C4I technologies into Navy ships. - Operation Analysis and Program Management In 2003, we were awarded a contract from the Department of the Navy to continue support for the Explosive Ordnance Disposal Program Management Office (PMS-EOD). The task-order contract has a base year plus four option years, and a contract ceiling of $17.5 million. We have successfully maintained this contract since 1984. COMMUNICATIONS AND SPACE PRODUCTS SEGMENT The Communications and Space Products segment, which accounted for 12% of consolidated net sales in 2003, 14% in 2002, and 15% in 2001, includes antenna product and ultra-miniature electronics and systems. 7 ANTENNA PRODUCTS We design and produce antenna systems for a wide variety of military and commercial applications including communications, electronic warfare, navigation, radar and wireless Local Area Networks. Our antenna business is approximately 60% military and 40% commercial. Our military antennas are deployed on many different types of platforms and vehicles including fixed wing and rotary aircraft, unmanned aerial vehicles (UAVs), satellites, surface ships, submarines, and ground vehicles. Our commercial antennas are used on commercial airliners as well as general-aviation aircraft. We have a broad customer and product base in this business. In 2003, we sold more than 35,000 antennas of 200 different types to more than 350 different original-equipment manufacturers and after-market customers. A large portion of our revenue results from spare part sales and repair services for an installed base of antennas in excess of 500,000 units. We continually work on the development of new antenna products via internally funded and customer-sponsored research and development. For example, in 2003 we were awarded a $1.1 million contract by Boeing Integrated Defense Systems for a specialized, multi-function antenna for use on the F/A-18 E/F Super Hornet strike fighter. The antenna operates over a very wide bandwidth in a low radar-cross-section configuration. We also received two multi-million dollar awards from Northrop Grumman for antennas pertaining to the instrument landing sensors for the F-35 aircraft, and ground mobile communications for the new Joint Tactical Radio System. We anticipate many years of production for all three of these major platforms. We also provide critical aerospace antennas for the Ground-Based Midcourse Defense System. These antenna types have passed rugged electrical and environmental missile-qualification requirements. Other leading technologies include direction-finding antenna systems and microwave antennas. INTERFERENCE CANCELLATION EDO has been a world leader in interference cancellation technology for more than 25 years. Our technology is used to eliminate interference in dense electromagnetic environments that can degrade the effectiveness of radios and other electronic equipment. Our systems allow full operational capability, mitigating both friendly and intentional sources of interference. Most recently, this technology has given EDO a significant role in both of the Coast Guard's two major modernization projects, known as Rescue 21 and Deepwater. EDO is also developing a subsystem for the CV-22 Osprey tiltrotor aircraft that will mitigate interference between onboard radios, allowing unimpeded communications. FORCE PROTECTION TECHNOLOGY EDO is the world's only supplier of the Shortstop Electronic Protection System (SEPS), life-saving technology that protects people and equipment from proximity-fused weapons such as mortar rounds, rockets, and artillery shells. Shortstop works automatically and silently. It acts as an "electronic umbrella" that can protect military forces, equipment, personnel and high-value assets. The Shortstop program was initiated in 1990 by the US Central Command as a quick-reaction response capability for Operation Desert Storm. Our Shortstop product line includes modified versions that provide protection in various military situations. SPACE PRODUCTS We manufacture products for space payloads that meet the high reliability standards required by the industry, including components, subassemblies and major subsystems that are sold directly to the government for military and civil systems, or to prime contractors for both government and commercial applications. Our sensors and subsystems include larger subsystems, up to full satellite payloads, for remote sensing instruments employing microwave measurements of the earth and its atmosphere, and classified government programs. 8 ENGINEERED MATERIALS SEGMENT The Engineered Materials segment, which accounted for 10% of consolidated net sales in 2003, 12% in 2002, and 12% in 2001, includes electro-ceramic products and advanced fiber-composite structural products. ELECTRO-CERAMIC PRODUCTS Piezoelectric-ceramic elements convert acoustic energy to electrical energy and vice versa, and form the basis of many defense and commercial products ranging from military sonar to ink-jet printers. We are one of North America's leading manufacturers of piezoelectric-ceramic components for defense applications and we also provide material and related transducers to several commercial markets. While more than 50% of our piezoelectric-ceramic sales are for defense applications, we are increasing our efforts to expand our commercial business, while maintaining our position in the defense market. Our business is vertically integrated with in-house manufacturing and development of piezoelectric and dielectric ceramic materials, coupled with state-of-practice mixed analog and digital electronics and software engineering. We believe this combination of engineered active materials and electronics capabilities makes us competitive in several niche markets. Examples of our products include underwater acoustic transducers for use in all areas of undersea warfare and piezoelectric shapes for a variety of industries. In 2003, the Naval Sea System Command (NAVSEA) awarded us contract options worth $7.6 million for additional production of SQS-53C sonar arrays for the Arleigh Burke Class of guided-missile destroyer and for foreign military sales. The sonar is used for detection, classification, and localization of submarines. This latest order covers production of four shipments of sonar arrays. These arrays include piezoelectric-ceramic rings incorporated into high-power transducers, and associated array framework and cable assemblies. The transducers and other hardware will be integrated by EDO into the cylindrical arrays that are mounted in the bow of the ships. The SQS-53C sonar arrays are a major component of the SQQ-89 combat system, which integrates detection, classification, and engagement subsystems for control of the undersea battlespace. If all options are exercised, deliveries will extend to approximately 2010. In 2003, EDO won a competitively awarded contract to develop new passive-sonar technology on U.S. Navy submarines. The IDIQ, indefinite-delivery/indefinite-quantity, contract has a base year plus four option years, and a ceiling of $7.7 million. The contract includes the design, development, and multi-year production of wide-band multi-mode and radius-of-curvature sensors with associated electronics and electro-optics. These are critical components of new hydrophone-array technology being developed to improve detection of threats and counteract increasingly quieter submarines. Wide-band multi-mode sensors allow identification of specific sounds made by submarines and weapons. Radius-of-curvature sensors will improve the ability to compute the distance to various threat emissions, a limitation of current passive-sonar systems. INTEGRATED COMPOSITE STRUCTURES Our capabilities in the area of fiber-reinforced advanced composite structures include product and system design, engineering analysis, process development, tooling design and fabrication, qualification testing and validation, production, and after-market support. The primary focus of our business-development effort is advanced composite structures for all types of platforms including manned and unmanned aircraft, missiles, ships and ground vehicles. In 2003, we secured a number of development contracts for the next generation Boeing X-45 UCAV (Unmanned Combat Air Vehicle). Our success on these development contracts led to a production contract, near the end of 2003, for composite structures for two proof-of-concept aircraft, with options for 12 additional aircraft. These structures will elevate our production expertise by using the latest in technology and materials used in the fabrication of modern military aircraft. In 2003, we delivered the first production filament-wound launch canisters for the new Thales VT-1 missile program. This contract extends out into 2005. We also continued production of composite tanks for the 9 Boeing C-17 aircraft. We have been the sole supplier of these tanks since production began, more than 10 years ago. In commercial markets, 2003 marked the 36th year in which we have been a provider to Boeing for composite tanks on commercial airliners. In the medical device market, we supply special water/chemical dilution tanks for use in the Aksys Personal Hemo-Dialysis Plus (PHD+) system. We also produce similar tanks for Teijin Pharma, an Aksys licensee in Japan. For the offshore oil industry, we produce the "Fiberbond" line of composite piping. In 2003, we initiated the fabrication and installation of topside piping systems for offshore oil platforms in Malaysia, Brazil and the UK. We also won production contracts for composite piping on four large Gulf of Mexico deep-water oil platforms. RESEARCH AND DEVELOPMENT Research and development is important to the success of our business, because we focus on niche markets where we have leading-edge technology. In 2003, our research and development efforts involved about 130 employees. Most of our research and development is funded by long-term development contracts with customers, with the remainder funded at our own expense. Customer-funded research and development is principally related to military programs. Major customer-sponsored programs include the development of: mine-countermeasures systems; aircraft weapons-carriage technology; command-and-control software for combat-systems integration; shallow-water sonar; low-observable, anti-jam, GPS antennas; mobile-communications and data systems; and underwater-communications transducer products. Expenditures under development contracts with customers vary in amount from year to year because of the timing of contract funding and other factors. Company-funded research and development is intended primarily to develop new products and extend the capabilities of existing products. Principal current company-funded research and development includes: digital signal-processing technology for electronic intelligence and support systems; image and signal processing, computer software, and other improvements for combat systems; minesweeping technology; aircraft weapons-carriage systems; application of composites for structural uses; various types of communication equipment; electronic countermeasures; advanced antennas; sonar systems, including processing and detection enhancements; noise reduction and interference cancellation; piezoelectric and composite materials; and new capabilities for our radar-signal simulator products. The following table sets forth research and development expenditures for the years presented.
YEARS ENDED DECEMBER 31, --------------------------- 2003 2002 2001 ------- ------- ------- (IN THOUSANDS) Customer-sponsored...................................... $48,800 $38,300 $35,700 Company-funded.......................................... 8,600 8,500 8,700 ------- ------- ------- Total................................................. $57,400 $46,800 $44,400 ======= ======= =======
MARKETING AND INTERNATIONAL SALES We sell defense products as a prime contractor and through subcontracts with other prime contractors. In addition to defense sales to the U.S. DoD, we also sell defense equipment to the U.S. Government on behalf of foreign governments under the Foreign Military Sales program. Subject to approval by the U.S. Department of State, we sell to foreign governments both directly and through Foreign Military Funded programs and commercial sales. Sales of our defense products are usually made under long-term contracts or subcontracts covering one or more years of production. These contracts are obtained either through competitive bidding or contract negotiation. We believe that our long history of association with our military customers is an important factor 10 in our overall business, and that the experience gained through this history has enhanced our ability to anticipate our customers' needs. Our approach to defense business is to anticipate specific customer needs and to develop systems to meet those needs either at our own expense or pursuant to research and development contracts. Many of our employees, including our chief executive officer and our vice president of Washington operations, are actively involved in the marketing of our defense products in the U.S. and abroad. We also have about 50 independent international sales representatives concentrating on the marketing of our defense products in foreign countries. Commercial products are sold in industrial and commercial markets. In foreign markets, piezoelectrics, antennas and electronic products are generally sold commercially through a network of sales representatives. Fiber-reinforced composite products are sold directly and through sales representatives. It is generally the policy of our U.S. business units to denominate all foreign contracts in U.S. dollars and seek not to incur significant costs in connection with long-term foreign contracts until we have received advance payments or letters-of-credit on amounts due under the contracts. EDO (UK) Ltd generally denominates its contracts in British pounds. International sales comprised 18% of consolidated net sales in 2003, 15% in 2002, and 15% in 2001. BACKLOG We define backlog as the funded value of contracts and orders that has not been recognized as sales. As of December 31, 2003 our total backlog was $462.3 million compared with $375.0 million as of December 31, 2002. Approximately 75% of the total backlog at December 31, 2003 is scheduled for delivery in 2004. Our backlog consists primarily of current orders under long-lived, mission-critical programs of key defense platforms on which we have a strong strategic position. A significant portion of our sales is to prime contractors, the U.S. DoD and foreign governments pursuant to long-term contracts. Accordingly, our backlog consists in large part of orders under these contracts. Backlog does not include portions of contracts for which the U.S. Government has not appropriated funds, nor does it include unexercised options in any contract. There is about $520 million in unfunded contracts and unexercised options at the end of 2003. GOVERNMENT CONTRACTS Net sales to the U.S. Government, as a prime contractor and through subcontracts with other prime contractors, accounted for 76% of our 2003 consolidated net sales compared with 75% in 2002 and 69% in 2001, and consisted primarily of sales to the DoD. Such sales include sales of military equipment to the U.S. Government for resale to foreign governments under the Foreign Military Sales program. Our business is not substantially dependent on any contract. Our defense business can be and has been significantly affected by changes in national-defense policy and spending. Our U.S. Government contracts and subcontracts and certain foreign-government contracts contain the usual required provisions permitting termination at any time for the convenience of the government with payment for work completed and committed along with associated profit at the time of termination. Our contracts with the DoD are made on either a fixed-price or cost-reimbursable basis. Both types may include incentive provisions. Fixed-price contracts provide fixed compensation for specified work. Cost- reimbursable contracts require us to perform specified work in return for reimbursement of costs (to the extent allowable under U.S. Government regulations) plus a specified fee. Under both contract types, an incentive adjustment may be made to our fee based on attainment of performance, scheduling, cost, quality or other goals. In general, with fixed-price contracts we assume a greater risk of loss, but also have the potential for higher profit margins, compared to cost-reimbursable contracts. The distribution of our government contracts between fixed-price and cost-reimbursable contracts varies from time to time. 11 COMPETITION AND OTHER FACTORS Some of our products are sold in markets containing a number of competitors substantially larger than us and with greater financial resources. Direct sales of military products to the U.S. and foreign governments are based principally on product performance, cost and reliability. Such products are generally sold in competition with products of other manufacturers that may fulfill an equivalent function, but which are not direct substitutes. We purchase some materials and components used in our systems and equipment from independent suppliers. These materials and components are normally not purchased under long-term contracts unless a long-term sales contract with one of our customers so requires. We believe that most of the items we purchase are obtainable from a variety of suppliers. We normally seek to have alternative sources for major items, although we are sometimes dependent on a single supplier or a few suppliers for some items. It is difficult to state precisely our market position in all of our product lines because information as to the volume of sales of similar products by our competitors is not generally available and the relevant markets are often not precisely defined. However, we believe that we are a significant factor in the markets for stores-release mechanisms for military aircraft, military sonar systems, military data-links, helicopter-towed mine-countermeasures systems, piezoelectric ceramics, electronic-countermeasures systems, and antennas. Although we own a significant number of patents and have filed applications for additional patents, we do not believe that our businesses depend heavily upon our patents. In addition, most of our U.S. Government contracts license us to use patents owned by others. Similar provisions in the U.S. government contracts awarded to other companies make it impossible for us to prevent the use by other companies of our patents in most domestic defense work. ENVIRONMENTAL Refer to Note 18 on page 62 of this Report for information regarding the cost of compliance with environmental regulations. EMPLOYEES As of December 31, 2003, we employed 2,640 persons. RISK FACTORS REDUCTIONS IN GOVERNMENT SPENDING WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS. A reduction in purchases of our products by domestic and foreign government agencies would have a material adverse effect on our business because a significant portion of our net sales are derived from contracts directly or indirectly with government agencies. In 2003, 2002 and 2001, we derived about 76%, 75% and 69%, respectively, of net sales from direct and indirect contracts with the U.S. Government and derived about 18%, 15% and 15%, respectively, of net sales from international sales to foreign governments. The development of our business will depend upon the continued willingness of the U.S. and foreign governments to fund existing and new defense programs and, in particular, to continue to purchase our products and services. Although defense spending in the United States has recently increased, further increases may not continue and any proposed budget or supplemental budget request may not be approved. In addition, the U.S. Department of Defense may not continue to focus its spending on technologies that we incorporate in our products. THE U.S. GOVERNMENT MAY TERMINATE OR MODIFY OUR EXISTING CONTRACTS OR ITS CONTRACTS WITH THE PRIME CONTRACTORS FOR WHICH WE ARE A SUBCONTRACTOR, WHICH WOULD ADVERSELY AFFECT OUR REVENUE. A significant portion of our revenues are derived from U.S. Government contracts, directly or indirectly. There are inherent risks in contracting with the U.S. Government, including risks peculiar to the defense 12 industry, which could have a material adverse effect on our business, financial condition or results of operations. Laws and regulations permit the U.S. Government to: - terminate contracts for its convenience; - reduce or modify contracts or subcontracts if its requirements or budgetary constraints change; - cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable; - adjust contract costs and fees on the basis of audits done by its agencies; and - control or prohibit the export of our products. If the U.S. Government terminates our contracts for convenience, we may only recover our costs incurred or committed for settlement expenses and profit on work completed before the termination. Additionally, most of our backlog could be adversely affected by any modification or termination of contracts with the U.S. Government or contracts the prime contractors have with the U.S. Government. The U.S. Government regularly reviews our costs and performance on its contracts, as well as our accounting and general business practices. The U.S. Government may reduce the reimbursement for our fees and contract-related costs as a result of an audit. OUR BUSINESS IS SUBJECT TO VARIOUS RESTRICTIVE LAWS AND REGULATIONS BECAUSE WE ARE A CONTRACTOR AND SUBCONTRACTOR TO THE U.S. GOVERNMENT AND BECAUSE WE PROVIDE MILITARY PRODUCTS TO FOREIGN GOVERNMENTS. As a contractor and subcontractor to the U.S. Government, we are subject to various laws and regulations that are more restrictive than those applicable to non-government contractors. We are required to obtain and maintain material governmental authorizations and approvals to run our business as it is currently conducted. For example, we need a license to operate an FAA repair station. In addition, because we provide defense equipment and related services to foreign governments, we must obtain licenses from the U.S. State Department for our foreign exports. Our failure or inability to obtain these licenses could have a material adverse effect on our business. New or more stringent laws or government regulations concerning government contracts and defense exports, if adopted and enacted, could have a material adverse effect on our business. Responding to governmental audits, inquiries or investigations may involve significant expense and divert management attention from regular operations. Also, an adverse finding in any such audit, inquiry or investigation could involve debarment, fines, injunctions or other sanctions. IF WE FAIL TO WIN COMPETITIVELY AWARDED CONTRACTS IN THE FUTURE, WE MAY EXPERIENCE A REDUCTION IN OUR SALES, WHICH COULD NEGATIVELY AFFECT OUR PROFITABILITY. We obtain many of our U.S. Government contracts through a competitive bidding process. We cannot assure you that we will continue to win competitively awarded contracts or that awarded contracts will generate sales sufficient to result in our profitability. We are also subject to risks associated with the following: - the frequent need to bid on programs in advance of the completion of their design (which may result in unforeseen technological difficulties and cost overruns); - the substantial time and effort, including the relatively unproductive design and development required to prepare bids and proposals, spent for competitively awarded contracts that may not be awarded to us; - design complexity and rapid technological obsolescence; and - the constant need for design improvement. Our government contracts may be subject to protest or challenge by unsuccessful bidders or to termination, reduction or modification in the event of changes in government requirements, reductions in federal spending or other factors. In addition, failure to obtain a renewal or follow-on contract with respect to any significant contract or a number of lesser contracts with the U.S. Government or foreign governments 13 would result in a loss of revenues. If revenues from the award of new contracts fail to offset this loss, it could have a material adverse effect on our results of operations and financial position. A LARGE MAJORITY OF OUR CONTRACTS ARE FIXED-PRICE, AND WE MAY FACE INCREASED RISKS OF COST OVERRUNS OR LOSSES ON OUR CONTRACTS. The majority of our government contracts and subcontracts are firm, fixed-price contracts providing for a predetermined fixed price for the products we make regardless of the costs we incur. At times, we must therefore make pricing commitments to our customers based on our expectation that we will achieve more cost-effective product designs and automate more of our manufacturing operations. The manufacture of our products requires a complex integration of demanding processes involving unique technical skill sets. In addition, the expense of producing products can rise due to increased costs of materials, components, labor, capital equipment or other factors. As a result, we face risks of cost overruns or order cancellations if we fail to achieve forecasted product design and manufacturing efficiencies or if products cost more to produce than expected. WE MAY BE REQUIRED TO REDUCE OUR PROFIT MARGINS ON CONTRACTS ON WHICH WE USE THE PERCENTAGE-OF-COMPLETION ACCOUNTING METHOD. We record sales and profits on many of our contracts using percentage-of-completion methods of accounting. As a result, revisions made to our estimates of sales and profits are recorded in the period in which the conditions that require such revisions become known and can be estimated. Although we believe that our profit margins are fairly stated and that adequate provisions for losses for our fixed price contracts are recorded in our financial statements, as required under U.S. generally accepted accounting principles, we cannot assure you that our contract profit margins will not decrease or our loss provisions will not increase materially in the future. OUR PRODUCTS AND SYSTEMS MAY BE RENDERED OBSOLETE BY OUR INABILITY TO ADAPT TO TECHNOLOGICAL CHANGE. The rapid change of technology continually affects our product applications and may directly impact the performance of our products. For our electronic warfare products, we are required to improve reliability and maintainability, extend frequency ranges and provide advanced jamming techniques. We can give you no assurances that we will successfully maintain or improve the effectiveness of our existing products, nor can we assure you that we will successfully identify new opportunities and continue to have the needed financial resources to develop new products in a timely or cost-effective manner. In addition, products manufactured by others may render our products and systems obsolete or non-competitive. If any of these events occur, our results of operations would be adversely affected. THE UNSUCCESSFUL INTEGRATION OF A BUSINESS OR BUSINESS SEGMENT WE ACQUIRE COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING RESULTS. One of our key operating strategies is to pursue selective acquisitions. We review and actively pursue possible acquisitions on a continuous basis. Except as previously disclosed in our public filings, we do not currently have any commitments, agreements or understandings to acquire any specific businesses or other material assets. Our acquisition strategy may require additional debt or equity financing, resulting in additional leverage or dilution of ownership. We cannot assure you that any future acquisition will be consummated, or that if consummated, we will be able to integrate such acquisition successfully without a material adverse effect on our financial condition or results of operations. Moreover, any acquisition could involve other risks, including: - diversion of management's attention from existing operations; - potential loss of key employees or customers of acquired companies; and - exposure to unforeseen liabilities of acquired companies. 14 WE ARE DEPENDENT IN PART UPON OUR RELATIONSHIPS AND ALLIANCES WITH INDUSTRY PARTICIPANTS IN ORDER TO GENERATE REVENUE. We rely on the strength of our relationships with other contractors to form strategic alliances. Some of our partners assist us in the development of some of our products through teaming arrangements. Under these teaming arrangements, our partners usually have borne a portion of the expenses associated with our research and development of new and existing products that are the subject of such agreements. We cannot assure you that our partners will continue to bear these expenses in the future. If any of our existing relationships with our partners were impaired or terminated, we could experience significant delays in the development of our new products ourselves, and we would incur additional development costs. We would need to fund these costs internally or identify new partners. Some of our partners are also potential competitors, which may impair the viability of new strategic relationships. While we must compete effectively in the marketplace, our future alliances may depend on our partners' perception of us. Our ability to win new and/or follow-on contracts may be dependent upon our relationships within the military industry. WE HAVE DEVELOPED OUTSOURCING ARRANGEMENTS FOR THE MANUFACTURE OF MANY OF THE COMPONENTS AND SUB-ASSEMBLIES OF OUR PRODUCTS. IF THIRD PARTIES FAIL TO DELIVER QUALITY PRODUCTS AND COMPONENTS AT REASONABLE PRICES ON A TIMELY BASIS, WE MAY ALIENATE SOME OF OUR CUSTOMERS AND OUR REVENUES, PROFITABILITY AND CASH FLOW MAY DECLINE. We use contract manufacturers as an alternative to our own manufacture of the components and sub-assemblies of our products. If these contract manufacturers are not willing to contract with us on competitive terms or devote adequate resources to fulfill their obligations to us, or we do not properly manage these relationships, our existing customer relationships may suffer. In addition, by undertaking these activities, we run the risks that - the reputation and competitiveness of our products and services may deteriorate as a result of the reduction of our control and quality and delivery schedules and the consequent risk that we will experience supply interruptions and be subject to escalating costs; and - our competitiveness may be harmed by the failure of our contract manufacturers to develop, implement or maintain manufacturing methods appropriate for our products and customers. WE MAY BE REQUIRED TO DEFEND LAWSUITS OR PAY DAMAGES IN CONNECTION WITH THE ALLEGED OR ACTUAL HARM CAUSED BY OUR PRODUCTS. We face an inherent business risk of exposure to product liability claims in the event that the use of some of our products is alleged to have resulted in unintended harm to others or to property. Although we maintain general liability and product liability insurance, we may incur significant liability if product liability lawsuits against us are successful. We cannot assure you that such coverage will be adequate to cover all claims that may arise or that it will continue to be available to us on acceptable terms. WE MAY INCUR SUBSTANTIAL ENVIRONMENTAL LIABILITY ARISING FROM OUR ACTIVITIES INVOLVING THE USE OF HAZARDOUS MATERIALS. Our business is subject to federal, state, local and foreign laws, regulations and ordinances governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. From time to time, our operations have resulted or may result in noncompliance with environmental laws or liability for the costs of investigating and cleaning up, and certain damages resulting from, sites of past spills, disposals or other releases of hazardous materials. In addition, we have been identified as a potentially responsible party pursuant to the federal Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or corresponding state environmental laws, for the cleanup of contamination resulting from past disposals of hazardous materials at some sites where we, along with others, sent waste in the past. We are a party to consent decrees as a result of our potential responsibility for contamination caused by the disposal of 15 hazardous materials. We cannot assure you that such matters, or any similar liabilities that arise in the future, will not exceed our resources, nor can we completely eliminate the risk of accidental contamination or injury from these materials. POLITICAL AND ECONOMIC INSTABILITY IN FOREIGN MARKETS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING RESULTS. Foreign sales represented about 18% of our total sales in 2003, and we intend to increase the amount of foreign sales we make in the future. Foreign sales are subject to numerous risks, including political and economic instability in foreign markets, restrictive trade policies of foreign governments, economic conditions in local markets, inconsistent product regulation by foreign agencies or governments, the imposition of product tariffs and the burdens of complying with a wide variety of international and U.S. export laws and differing regulatory requirements. If we fail to increase our foreign sales it could have a material adverse effect on our results of operations. CONCENTRATION OF VOTING POWER AND CERTAIN PROVISIONS IN OUR CHARTER DOCUMENTS COULD MAKE A MERGER, TENDER OFFER OR PROXY CONTEST DIFFICULT AND MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON SHARES. At December 31, 2003, the EDO Employee Stock Ownership Trust, or ESOT, owned 4,099,033 common shares (or about 21% of the outstanding common shares). The trustee of the plan has obligations under the trust agreement and its fiduciary duties when voting allocated shares under the plan. The procedure the trustee generally follows is to receive direction from each of the plan participants with respect to his or her allocated shares, and then to vote all shares in accordance with the direction received. The market may perceive that the concentration of voting power in the hands of a single employee stock ownership plan creates a potential barrier against another party acquiring us. This perception could result in lower market prices for our common shares. In addition, our Certificate of Incorporation and By-Laws provide for a classified board of directors and restrict the ability of shareholders to call special meetings. These provisions could delay or impede the removal of incumbent directors and could make it more difficult to effect a merger, tender offer or proxy contest, even if such events might be favorable to our shareholders. Moreover, certain agreements to which we are a party, including loan and executive officer agreements, contain provisions that impose increased costs in the event of a change of control. Our Board of Directors and management are recommending that our shareholders agree to amend our certificate of incorporation to eliminate the classified board. If the holders of 80% of EDO's outstanding common shares vote in favor of this amendment at our annual meeting of shareholders to be held on April 27, 2004, then the risk of delay or impediment to a merger, tender offer or proxy contest will be significantly lessened. IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS ADEQUATELY, THE VALUE OF OUR COMMERCIAL PRODUCTS COULD BE DIMINISHED. The value of our commercial products is increased, in part, by obtaining, maintaining and enforcing our patents and other proprietary rights. While we take precautionary steps to protect our technological advantages and intellectual property and rely in part on patent, trademark, trade secret and copyright laws, we cannot assure you that the precautionary steps we have taken will completely protect our intellectual property rights. In the event a competitor successfully challenges our patents or licenses, we could incur substantial litigation costs that could have a material adverse effect on our operating results and financial condition. THE U.S. GOVERNMENT'S RIGHT TO USE TECHNOLOGY DEVELOPED BY US LIMITS OUR INTELLECTUAL PROPERTY RIGHTS. We seek to protect the competitive benefits we derive from our patents, proprietary information and other intellectual property. However, we do not have the right to prohibit the U.S. Government from using certain technologies developed or acquired by us or to prohibit third party companies, including our competitors, from using those technologies in providing products and services to the U.S. Government. The U.S. Government has the right to royalty-free use of technologies that we have developed under U.S. Government contracts. We 16 are free to commercially exploit those government-funded technologies and may assert our intellectual property rights to seek to block other non-government users thereof, but we cannot assure you we could successfully do so. A FAILURE TO ATTRACT AND RETAIN TECHNICAL PERSONNEL COULD REDUCE OUR REVENUES AND OUR OPERATIONAL EFFECTIVENESS. There is a continuing demand for qualified technical personnel, and we believe that our future growth and success will depend upon our ability to attract, train and retain such personnel. Competition for personnel in the military industry is intense, and there is a limited number of persons with knowledge of, and experience in, this industry. Although we currently experience relatively low rates of turnover for our technical personnel, the rate of turnover may increase in the future. An inability to attract or maintain a sufficient number of technical personnel could have a material adverse effect on our contract performance or on our ability to capitalize on market opportunities. INCREASED SCRUTINY OF FINANCIAL DISCLOSURE COULD ADVERSELY AFFECT INVESTOR CONFIDENCE, AND ANY RESTATEMENT OF EARNINGS COULD INCREASE LITIGATION RISKS AND LIMIT OUR ABILITY TO ACCESS THE CAPITAL MARKETS. Congress, the SEC, other regulatory authorities and the media are intensely scrutinizing a number of financial reporting issues and practices. Although all businesses face uncertainty with respect to how the U.S. financial disclosure regime may be affected by this process, particular attention has been focused recently on companies' interpretations of generally accepted accounting principles. If we are required to restate our financial statements as a result of a determination that we had incorrectly applied generally accepted accounting principles, that restatement could adversely affect our ability to access the capital markets or the trading price of our securities. The recent scrutiny regarding financial reporting may also result in an increase in litigation involving companies with publicly traded securities, such as us. There can be no assurance that any such litigation against us would not materially adversely affect our business or the trading price of our securities. IF WE ARE UNABLE TO COMPLY WITH THE RESTRICTIONS AND COVENANTS IN OUR DEBT AGREEMENTS, THERE WOULD BE A DEFAULT UNDER THE TERMS OF THOSE AGREEMENTS, AND THIS COULD RESULT IN AN ACCELERATION OF PAYMENT OF FUNDS THAT HAVE BEEN BORROWED. If we are unable to comply with the restrictions and covenants in our debt agreements, there would be a default under the terms of these agreements. Some of the debt agreements also require us to maintain specified financial ratios and satisfy financial tests. Our ability to meet these financial ratios and tests may be affected by events beyond our control, including, without limitation, sales levels, contract terminations and potential acquisitions. As a result, there can be no assurance that we will be able to meet these tests. In the event of a default under these agreements, the lenders could terminate their commitments to lend or accelerate the loans and declare all amounts borrowed due and payable. Borrowings under other debt instruments that contain cross-acceleration or cross-default provisions may also be accelerated and become due and payable. If any of these events occur, there can be no assurance that we would be able to make necessary payments to the lenders or that we would be able to find alternative financing. Even if we are able to obtain alternative financing, it may not be on terms that are acceptable to us. RESTRICTIONS AND COVENANTS IN OUR DEBT AGREEMENTS LIMIT OUR ABILITY TO CONDUCT OUR BUSINESS AND COULD PREVENT US FROM OBTAINING NEEDED FUNDS IN THE FUTURE. Our debt and financing arrangements contain a number of significant limitations that restrict our ability to, among other things: - borrow additional money or issue guarantees; - pay dividends or other distributions to shareholders; - make investments; 17 - create liens on assets; - sell assets; - enter into transactions with affiliates; and - engage in mergers or consolidations. These restrictions may limit our ability to obtain future financing, fund needed capital expenditures or withstand a future downturn in business or the economy. ITEM 2. PROPERTIES All of our operating facilities are leased except a Charleston, SC facility obtained in the Darlington acquisition. In 2003, we sold our facility in Deer Park, NY. As part of the sale agreement, we are leasing the facility for a period not to exceed two years. We believe our facilities are adequate for our present purposes. All facilities in the following listing are suitable for expansion by using available but unused space, leasing additional available space, or by physical expansion of leased buildings. However, in light of recent acquisitions, we are reviewing the status of all of our facilities. We believe that, with respect to leases which expire during 2004 and 2005, we will be able to either extend the lease or lease other facilities on reasonable terms. Our obligations under the various leases are set forth in Note 17 on page 62 of this Report. Set forth below is a listing of our principal plants and other materially important physical properties.
APPROXIMATE FLOOR AREA BUSINESS UNIT SEGMENT LOCATION (IN SQ. FT.) ------------- ------- -------- ------------ EDO Antenna Products and Technology and EDO Defense Programs and Technologies..... Communications and Space Products and Defense Deer Park, NY 726,000 EDO Reconnaissance and Surveillance Systems.......... Defense Morgan Hill, CA 160,000 EDO Electro-Ceramic Products.... Engineered Materials Salt Lake City, UT 117,000 EDO Fiber Science............... Engineered Materials Salt Lake City, UT 105,000 EDO Marine & Aircraft Systems... Defense North Amityville, NY 92,000 EDO Communications and Countermeasures Systems....... Communications and Space Products Simi Valley & Westlake Village, CA 83,000 EDO Professional Services....... Defense Alexandria, VA 118,000 EDO (UK) Ltd.................... Defense Brighton, UK 43,000 EDO Combat Systems.............. Defense Chesapeake, VA 37,000 EDO Technical Services Operations.................... Defense Lancaster, CA 33,000 EDO Specialty Plastics.......... Engineered Materials Baton Rouge, LA 29,000 EDO Darlington.................. Defense Alexandria, VA & Charleston, SC 43,000 EDO Artisan..................... Defense Parsippany, NJ 25,000 EDO MTech....................... Defense Huntingdon, PA 14,000
ITEM 3. LEGAL PROCEEDINGS The Company and/or its subsidiaries are parties to various legal proceedings arising in the normal course of business, including various environmental actions described in Note 18 on page 62 of this Report. While litigation is subject to inherent uncertainties, management currently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on the Company's 18 consolidated financial position, cash flow or overall results of operations. The following is a description of certain proceedings: U.S. v. EDO Corporation et al.; EDO Corporation et al. v. Elinco Associates L.P. et al. (United States District Court, District of Connecticut). The Company and three other companies entered into a consent decree in 1990 with the Federal government for the remediation of a Superfund site in Norwalk, CT. The Superfund site has been divided into three operable units. The consent decree relates to two of the operable units. The third operable unit has not been formally studied and the Company is unable to determine whether the EPA will address the third operable unit or, if it does, whether it will conclude that specific remedial response action will be required for it, and in such event, what the costs, if any, or the Company's degree of responsibility will be. As of December 31, 2003, the Company estimates that its discounted liability over the remainder of the twenty-two years related to the two operable units is approximately $2.0 million. See also Note 18 on page 62 of this Report. Technip Offshore Inc. v. EDO Fiber Science and EDO Corporation (U.S. District Court for the Southern District of Texas). Technip Offshore Inc. (Technip), a U.S. subsidiary of Technip-Coflexip, S.A., a French corporation, brought a declaratory judgment action seeking a declaration that Technip Offshore Inc. is the owner of a patent application jointly filed by Technip and the Company and that Technip has not breached an agreement with the Company by offering to sell products described in the patent application to certain third parties. The Company has denied the allegations and filed a counterclaim seeking damages pursuant to certain agreements between the Company and Technip. Technip does not seek damages. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information responsive to this item is set forth under the headings "Common Share Prices" on page 32 and "Dividends" on page 32, together with dividend information contained in the "Consolidated Statements of Shareholders' Equity" on pages 36 and 37 and Note 9 on pages 50 and 51 of this Report. The information regarding equity compensation plans can be found in Notes 1(l) on page 45 and 14 on pages 54 and 55 of this Report. 19 ITEM 6. SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA EDO CORPORATION AND SUBSIDIARIES (NOT COVERED BY INDEPENDENT AUDITORS' REPORTS)
2003 2002 2001 2000 1999 -------- -------- -------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF EARNINGS DATA: Net sales.............................................. $460,667 $328,876 $259,961 $206,822 $97,936 Costs and expenses: Cost of sales........................................ 338,259 240,850 189,733 151,512 72,337 Selling, general and administrative.................. 71,855 47,584 34,013 29,205 13,602 Research and development............................. 8,594 8,492 8,750 5,371 2,748 Other expenses (income)(a)........................... 1,871 2,565 389 11,495 -- Impairment loss on Deer Park facility................ 9,160 -- -- -- -- -------- -------- -------- -------- ------- 429,739 299,491 232,885 197,583 88,687 -------- -------- -------- -------- ------- Operating earnings..................................... 30,928 29,385 27,076 9,239 9,249 Net interest expense................................... (8,152) (4,956) (2,216) (2,438) (785) Other non-operating income (expense), net.............. 279 (95) (971) (216) 230 -------- -------- -------- -------- ------- (7,873) (5,051) (3,187) (2,654) (555) -------- -------- -------- -------- ------- Earnings before income taxes and cumulative effect of a change in accounting principle....................... 23,055 24,334 23,889 6,585 8,694 Income tax expense..................................... (9,644) (10,342) (9,210) (5,264) (2,610) -------- -------- -------- -------- ------- Earnings before cumulative effect of a change in accounting principle from: Continuing operations................................ 13,411 13,992 14,679 1,321 6,084 Discontinued operations.............................. 1,398 -- 273 -- (4,064) -------- -------- -------- -------- ------- Earnings before cumulative effect of a change in accounting principle................................. 14,809 13,992 14,952 1,321 2,020 Cumulative effect of a change in accounting principle, net of tax of $790(b)................................ -- (3,363) -- -- -- Dividends on preferred shares(c)....................... -- -- (194) (881) (1,000) -------- -------- -------- -------- ------- Net earnings available for common shares............... $ 14,809 $ 10,629 $ 14,758 $ 440 $ 1,020 ======== ======== ======== ======== ======= PER COMMON SHARE DATA: Basic net earnings (loss): Continuing operations................................ $ 0.78 $ 0.82 $ 1.14 $ 0.05 $ 0.76 Discontinued operations.............................. 0.08 -- 0.02 -- (0.61) -------- -------- -------- -------- ------- Basic net earnings before cumulative effect of a change in accounting principle.............................. 0.86 0.82 1.16 0.05 0.15 Cumulative effect of a change in accounting principle............................................ -- (0.20) -- -- -- -------- -------- -------- -------- ------- Basic net earnings..................................... $ 0.86 $ 0.62 $ 1.16 $ 0.05 $ 0.15 -------- -------- -------- -------- ------- Diluted net earnings (loss): Continuing operations................................ $ 0.76 $ 0.81 $ 1.09 $ 0.05 $ 0.65 Discontinued operations.............................. 0.08 -- 0.02 -- (0.50) -------- -------- -------- -------- ------- Diluted net earnings before cumulative effect of a change in accounting principle....................... 0.84 0.81 1.11 0.05 0.15 Cumulative effect of a change in accounting principle............................................ -- (0.20) -- -- -- -------- -------- -------- -------- ------- Diluted net earnings................................... $ 0.84 $ 0.61 $ 1.11 $ 0.05 $ 0.15 ======== ======== ======== ======== ======= Cash dividends per common share........................ $ 0.12 $ 0.12 $ 0.12 $ 0.12 $ 0.12 Weighted-average common shares outstanding: Basic................................................ 17,308 17,080 12,776 9,601 6,701 Diluted.............................................. 17,561 17,379 14,254 10,662 8,032
20
2003 2002 2001 2000 1999 -------- -------- -------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) OTHER DATA: Depreciation and amortization.......................... $ 17,065 $ 11,321 $ 11,396 $ 9,441 $ 3,390 Capital expenditures................................... 8,865 7,093 14,298 3,861 4,032 Backlog................................................ 462,327 375,029 294,812 252,888 133,880 -------- -------- -------- -------- ------- CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents, marketable securities and restricted cash...................................... $ 86,632 $159,860 $ 58,031 $ 16,621 $29,642 Working capital........................................ 172,278 204,382 105,177 37,552 35,110 Total assets........................................... 494,696 481,574 285,630 214,254 124,491 Total debt(d).......................................... 137,800 137,800 463 49,444 36,483 Shareholders' equity................................... 190,332 168,273 174,498 65,818 40,241 -------- -------- -------- -------- -------
--------------- (a) Reflects $0.9 million in 2003 and $0.4 million in 2002 for the write-off of purchased in-process research and development ("IPR&D") and other merger-related costs, respectively, associated with our acquisition of the assets of Condor Systems, Inc., as well as a $0.9 million curtailment loss in 2003 and a $2.0 million curtailment loss in 2002 associated with our benefit plans; a $0.9 million post-retirement curtailment gain in 2001; $1.3 million and $11.5 million in the years 2001 and 2000, respectively, for the write-off of IPR&D (in 2000); and other EDO-AIL merger-related costs (in 2001 and 2000). (b) Upon adoption of Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets," we recorded a cumulative effect of a change in accounting principle effective January 1, 2002. See Note 1(g) to the consolidated financial statements. (c) ESOP Convertible Cumulative Preferred Shares, Series A. On March 8, 2001, all outstanding preferred shares were converted into common shares. No preferred dividends were paid after March 8, 2001. (d) Includes note payable, Employee Stock Ownership Trust loan obligation and current portions of long-term debt. ITEMS 7. AND 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW EDO Corporation (the "Company") is a leading supplier of sophisticated, highly engineered products and systems for defense, aerospace and industrial applications. We believe our advanced electronic, electromechanical systems, information systems and engineered materials are mission-critical on a wide range of military programs. We have three reporting segments: Defense, Communications and Space Products, and Engineered Materials, which represented 78%, 12% and 10%, respectively, of our net sales for the year ended December 31, 2003. Our Defense segment provides integrated front-line warfighting systems and components including electronic-warfare systems, reconnaissance and surveillance systems, aircraft weapons suspension and release systems, integrated combat systems, command, control, communications, computers, and intelligence (C4I) products and systems, undersea-warfare systems and professional and engineering services for military forces and friendly governments worldwide. Our Communications and Space Products segment supplies antenna products and ultra-miniature electronics and systems for the remote sensing and electronic warfare industries. Our Engineered Materials segment supplies commercial and military piezo-electric ceramic products and integrated composite structures for the aircraft and oil industries. ACQUISITIONS Acquisitions of businesses that we believe will enhance our position in the markets that we serve have been an important factor in our growth. 21 On June 16, 2003, we acquired for cash all of the stock of Emblem Group Ltd. ("Emblem"), a privately-held company based in Brighton, England. Emblem, now known as EDO (UK) Ltd., is a supplier of aerospace and defense products and services, primarily through its MBM Technology unit in England and Artisan Technologies, Inc., a subsidiary in the United States. Emblem has a core competency in aircraft weapons-carriage and interfacing systems that will reinforce our position as a global leader in aircraft armament release systems. Emblem is expected to broaden our customer base in Europe. The purchase price was L16.3 million ($27.3 million), excluding transaction costs of approximately $1.9 million. Emblem became part of our Defense segment. On March 10, 2003, we 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 our 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, we acquired and immediately paid off debt of $4.9 million. Darlington became part of our Defense segment. On February 5, 2003, a wholly-owned subsidiary of the Company acquired for cash all of the stock of Advanced Engineering & Research Associates, Inc. ("AERA"), a privately-held company located in Alexandria, Virginia. AERA, which was merged with another EDO subsidiary in 2004 and is now known as EDO Professional Services Inc., 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 we offer. The purchase price was $38.1 million, excluding transaction costs of $0.3 million. In addition, we acquired and immediately paid off debt of $3.8 million. AERA became part of our 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 expanded our electronic warfare business in the areas of reconnaissance and surveillance systems. The assets became part of our Defense and Communications and Space Products segments. In October 2001, we acquired all of the stock of Dynamic Systems, Inc., a privately-held company based in Alexandria, Virginia, for $13.6 million in cash, excluding transaction costs of approximately $0.1 million. The acquisition strengthened and expanded the range of professional and information technology services we offered to both existing and new customers in the Defense segment. These acquisitions were accounted for as purchases and, accordingly, their operating results are included in our consolidated financial statements since their respective acquisition dates. SALE OF PROPERTY On June 24, 2003, the Board of Directors of the Company approved the decision to sell our 726,000 square foot facility in Deer Park, NY. This decision was based on a company-wide facility plan that evaluated potential uses for the property. We concluded that the Deer Park facility would not meet future requirements, and thus an outright sale was completed, freeing assets for more productive use, including acquisitions. A pre-tax impairment loss of $9.2 million was recorded 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 represents the entire loss we expect 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. We closed on the sale in October 2003 and received the cash less closing payments. The note receivable is due when we vacate the facility. As part of the agreement, we will lease the facility for a period not to exceed two years. The lease agreement does not have any renewal or buyout options. 22 DISCUSSION OF 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 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 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 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 23 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. Our estimates of undiscounted cash flow may differ from actual cash flow due to such factors including technological advances, changes to the our business model, or changes in our 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 the unit 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 profits, 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 and expected return on plan assets 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. In 2003, 2002 and 2001 we used the building block approach to the estimation of the long-term rate of return on assets. Under this approach, we reviewed the publicly available common source data for the range of returns on basic types of equity and fixed income instruments and the differential to those rates provided by active investment management. In consultation with our actuarial and active asset management consultants and taking into account the funds' actual performance and expected asset allocation going forward, we selected an overall return rate within the resulting range. The expected long-term rate of return on plan assets to be used for 2004 expense is 8.25%. This rate of return was determined by application of a statistical forecast modeling algorithm which, using the pension investment mix and pension demographic data, simulates the long term performance of the plan over a series of 2000 trials of variable economic conditions, rounded to the nearest quarter-percent. The resulting rate is a 50 basis-point reduction in the forecast from that used in 2003. The discount rate also reflects a similar 50 basis-point reduction from that used in 2003. The discount rate is selected based on review of selected widely available index information for high quality corporate bonds such as Factiva, adjusted for term. FINANCIAL HIGHLIGHTS Net sales for 2003 increased 40.1% to $460.7 million from $328.9 million for 2002. These results included sales of three acquisitions made in 2003. Also included in 2003 are a full year's sales from the acquisition of substantially all of the assets of the former Condor business compared to five months' worth in 2002. For 2003, net earnings were $14.8 million or $0.84 per diluted share. These results include a pre-tax impairment loss on the sale of the Deer Park facility of $9.2 million, pre-tax acquisition-related costs of $0.9 million associated with our acquisition of substantially all of the assets of Condor in July 2002, and a pre-tax curtailment loss of $0.9 million on the non-qualified pension plan. Also included in 2003 is $1.4 million net of tax earnings from discontinued operations. In 2002, we recorded a $3.4 million net of tax charge ($0.20 per diluted share) to account for the cumulative effect of a change in accounting principle upon our adoption of SFAS No. 142, "Goodwill and Other Intangible Assets." This charge occurred in the Engineered Materials segment and was comprised of $2.3 million and $1.9 million of impaired goodwill and trademark, respectively, offset by a tax 24 benefit of $0.8 million. Including the cumulative effect, net earnings available for common shares were $10.6 million or $0.61 per diluted share. Also, in 2002, there was a pre-tax defined benefit pension plan curtailment charge of $2.0 million and pre-tax acquisition related costs of $0.6 million associated with Condor. RESULTS OF OPERATIONS COMPARISON OF 2003 TO 2002 Net sales by segment were as follows:
TWELVE MONTHS ENDED DECEMBER 31, INCREASE ---------------------- FROM SEGMENT 2003 2002 PRIOR PERIOD ------- --------- --------- ------------ (DOLLARS IN MILLIONS) Defense............................................... $360.0 $243.5 47.8% Communications and Space Products..................... 55.5 47.3 17.3% Engineered Materials.................................. 45.2 38.1 18.4% ------ ------ Total................................................. $460.7 $328.9 40.1% ====== ======
Net sales for the year ended December 31, 2003 increased 40.1% to $460.7 million from $328.9 million for the year ended December 31, 2002. This increase comprised sales growth of $116.5 million for the Defense segment, $8.2 million for the Communications and Space Products segment and $7.1 million for the Engineered Materials segment. In the Defense segment, $91.3 million of the net increase was attributable to sales of Emblem Group Ltd. ("Emblem"), Darlington, Inc. ("Darlington"), and Advanced Engineering & Research Associates, Inc. ("AERA") since their acquisition dates of June 16, March 10, and February 5, 2003, respectively. In addition, $48.4 million of the increase is attributable to a full year's worth of sales of reconnaissance and surveillance systems associated with the acquisition of substantially all of the assets of Condor Systems, Inc. ("Condor"), compared to only five months in 2002. In addition, there were increases in sales of aircraft weapons suspension and release systems due in part to the F/A-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 2003 compared to 2002. These increases were offset by decreases in sales of electronic warfare equipment as well as integrated combat 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. In the Communications and Space Products segment, most of the net increase in sales was attributable to a full year's worth of sales of electronic protection systems from the aforementioned acquisition of Condor compared to only five months in 2002. Additionally, sales increases in our antenna product line were more than offset by decreases in sales of our space sensor communication products. In the Engineered Materials segment, there were increases in sales of electro-ceramic products, attributable to transducers and sonar arrays. There were also increases in sales of integrated composite structures 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. Operating earnings for the year ended December 31, 2003 were $30.9 million or 6.7% of net sales. This compares to operating earnings for the year ended December 31, 2002 of $29.4 million or 8.9% of net sales. The 2003 results were negatively impacted by a $9.2 million loss on the sale of our facility in Deer Park, a $0.9 million curtailment loss associated with our non-qualified pension plan, and $0.9 million of costs associated with the acquisition of the former Condor business. In 2002, operating earnings included a 25 $2.0 million curtailment loss associated with our defined benefit pension plan and $0.6 million of costs associated with the acquisition of substantially all of the assets of the former Condor business. In addition, 2003 operating earnings include $4.9 million of intangible asset amortization expense associated with the Condor, AERA, Darlington and Emblem acquisitions. This compares to total amortization expense of approximately $1.0 million for 2002. Also included in operating earnings for the year ended December 31, 2003 is pension expense of $3.9 million and ESOP compensation expense of $3.3 million. Included in operating earnings for the year ended December 31, 2002 is pension expense of $4.0 million and ESOP compensation expense of $4.0 million. The lower ESOP compensation expense for 2003 is attributable to our lower average stock price in 2003 compared to 2002. Pension and ESOP compensation expense are allocated between cost of sales and selling, general and administrative expense. The Defense segment's operating earnings for the year ended December 31, 2003 were $35.1 million or 9.7% of this segment's net sales compared to $28.7 million or 11.8% of this segment's net sales for the year ended December 31, 2002. In 2003, operating earnings were positively affected by higher-margin sales of reconnaissance and surveillance systems from the acquisition of substantially all of the assets of Condor, efficiencies achieved on higher production volume associated with our radar signal simulator, and higher margin sales of aircraft weapons suspension and release systems. The completion of production activities on certain long-term programs, including the UEU, also resulted in earnings at relatively high margins. In addition, there were high margins recognized on various B-1B spares and repairs contracts. These increases were offset in part by a shift in the margins of mine countermeasure systems from higher-margin production on the MK105 program last year to lower-margin, non-recurring development efforts this year associated with OASIS, as well as by the aforementioned lower sales of combat systems. Operating earnings for 2003 were also negatively impacted by amortization expense pertaining to intangible assets associated with acquisitions. The Communications and Space Products segment's operating earnings for the year ended December 31, 2003 were $3.6 million or 6.5% of this segment's net sales compared to an operating loss of $0.4 million or 0.9% of this segment's net sales in 2002. In 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 receipt of an award fee on a classified program as well as the contribution from the higher sales of communications systems from the acquisition of substantially all of the assets of Condor. Included in the 2002 operating loss was a $1.5 million charge to provide for manufacturing inefficiencies resulting from our primary customer's decrease in its forecasted purchases of our satellite down converters. The Engineered Materials segment's operating earnings for the year ended December 31, 2003 were $2.4 million or 5.3% of this segment's net sales compared to operating earnings of $3.2 million or 8.3% of this segment's net sales in 2002. During the year ended December 31, 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 for the year ended December 31, 2003 increased to $71.9 million or 15.6% of net sales from $47.6 million or 14.5% of net sales for the year ended December 31, 2002. This increase was primarily attributable to three acquisitions made in 2003. Research and development expense for the year ended December 31, 2003 increased slightly to $8.6 million or 1.9% of net sales from $8.5 million or 2.6% of net sales for the year ended December 31, 2002. As a percent of sales, the decrease is attributable to the absence of such expenditures in the services businesses. 26 Interest expense, net of interest income, for the year ended December 31, 2003 increased 64.5% to $8.2 million from $5.0 million for the year ended December 31, 2002, due primarily to interest expense associated with our $137.8 million principal amount Notes issued in April 2002, increased amortization expense of deferred debt issuance costs associated with the offering of the Notes and increased amortization of deferred financing costs associated with our credit facility amended in November 2002. Income tax expense reflects an effective rate of 41.8% for the year ended December 31, 2003 compared to 42.5% for the year ended December 31, 2002. The decrease in the effective tax rate was principally attributable to the decreased amount of non-deductible, non-cash ESOP compensation expense in 2003. For the year ended December 31, 2003, earnings available for common shares were $14.8 million or $0.84 per diluted common share on 17.6 million diluted shares compared to earnings before cumulative effect of change in accounting principle of $14.0 million or $0.81 per diluted common share on 17.4 million diluted shares for the year ended December 31, 2002. The cumulative effect of a change in accounting principle for the year ended December 31, 2002 was recorded as of January 1, 2002 and is shown net of a tax benefit of $0.8 million on the consolidated statement of earnings. This charge pertained to the impairment of goodwill and a trademark resulting from impairment tests performed in 2002, as required by SFAS No. 142. The impairment occurred in the Engineered Materials segment and is comprised of the following: $2.2 million and $1.9 million of goodwill and a trademark, respectively, related to our acquisition of Specialty Plastics and $0.1 million of goodwill related to our acquisition of Zenix. COMPARISON OF 2002 TO 2001 Net sales by segment were as follows:
TWELVE MONTHS ENDED DECEMBER 31, INCREASE ---------------------- FROM SEGMENT 2002 2001 PRIOR PERIOD ------- --------- --------- ------------ (DOLLARS IN MILLIONS) Defense............................................... $243.5 $183.5 32.7% Communications and Space Products..................... 47.3 40.0 18.3% Engineered Materials.................................. 38.1 36.5 4.5% Total................................................. $328.9 $260.0 26.5%
Net sales for the year ended December 31, 2002 increased 26.5% to $328.9 million from $260.0 million of net sales from continuing operations for the year ended December 31, 2001. This increase comprised sales growth of $60.0 million for the Defense segment, $7.3 million for the Communications and Space Products segment and $1.6 million for the Engineered Materials segment. In the Defense segment, $28.7 million or 47.8% of the net increase was attributable to five months of sales of Condor since its acquisition on July 26, 2002. Additionally in the Defense segment, there were increases in sales of technology services attributable to twelve months of Dynamic Systems' net sales in 2002 as compared to approximately three months in 2001 due to its acquisition in October 2001, electronic warfare equipment attributable in part to the Universal Exciter Upgrade program, aircraft weapons suspension and release systems due in part to efforts on the production phase of the AMRAAM Vertical Eject Launcher program for the F/A-22, efforts on the production lots of the BRU-57 Multiple-Carriage Smart Bomb Rack platform with the U.S. Air Force, efforts on the Joint Strike Fighter's suspension and release subsystem and weapons release units programs and development efforts associated with the Small Diameter Bomb program. There was also an increase in our sales of undersea sonar systems. These increases in the Defense segment were partially offset most notably by the decreases in sales of mine countermeasures systems as well as integrated combat systems, the latter of which was due primarily to the delay in orders anticipated to be awarded to us in 2002 from international customers. In the Communications and Space Products segment, $7.6 million of the net increase in sales was attributable to sales of electronic protection systems from the aforementioned acquisition of Condor. 27 Additionally, sales increases in our antenna product line were more than offset by decreases in sales of our space sensor communication products. In the Engineered Materials segment, there were increases in sales of electro-ceramic products, attributable to transducers and sonar arrays, and advanced fiber composite structural products. Operating earnings for the year ended December 31, 2002 were $32.0 million or 9.7% of net sales, before the write-off of $0.2 million of purchased in-process research and development ("IPR&D") and $0.4 million of other merger-related costs associated with our acquisition of the assets of Condor, as well as a $2.0 million defined benefit pension plan curtailment loss. This compares to operating earnings for the year ended December 31, 2001 of $27.5 million or 10.6% of net sales, before EDO-AIL merger-related costs of $1.3 million and a post-retirement benefits curtailment gain of $0.9 million. Including the respective aforementioned charges or gain in each year, operating earnings for the year ended December 31, 2002 were $29.4 million or 8.9% of net sales compared to $27.1 million or 10.4% of net sales for the year ended December 31, 2001. The decrease in operating margin for the year ended December 31, 2002 compared to the year ended December 31, 2001 was due primarily to the recording of $6.0 million of defined benefit pension plan expense, which includes $2.0 million of a curtailment loss, and ESOP compensation expense of $4.0 million in 2002 compared to $2.6 million of pension income and $1.8 million of ESOP compensation expense in 2001. The change to pension expense in 2002 from pension income in 2001 was due primarily to continued poor performance of plan assets invested in the stock market and the lowering of the discount rate in 2002 reflecting the general decline in interest rates. Additionally, pension expense in 2002 included a $2.0 million curtailment loss upon an amendment to the pension plan whereby benefits accrued were frozen as of December 31, 2002. The increase in ESOP compensation expense is attributable in part to our higher average stock price in 2002 compared to 2001. Pension and ESOP compensation expense or income is allocated between cost of sales and selling, general and administrative expense. The Defense segment's operating earnings for the year ended December 31, 2002 were $28.7 million or 11.8% of this segment's net sales compared to operating earnings for the year ended December 31, 2001 of $21.9 million or 11.9% of this segment's net sales. The increase in operating earnings in the Defense segment is due primarily to the completion of some MK-105 Mod 4 mine countermeasures systems in 2002 and final deliveries of Lots 4 and 5 of the Universal Exciter Upgrade program resulting in additional profit based on final costs at completion compared to prior estimates. These increases were offset in part by a decrease in aircraft weapons suspension and release systems resulting from a shift from primarily production efforts last year to lower-margin non-recurring development efforts on recently awarded long-term programs. The Communications and Space Products segment's operating loss for the year ended December 31, 2002 was $0.4 million or 0.9% of this segment's net sales compared to a loss of $0.4 million or 1.0% of this segment's net sales in 2001. Included in the 2002 operating loss was a $1.5 million charge taken in the first quarter to provide for manufacturing inefficiencies resulting from lowering our production levels of the Ku-Band down converter. Such production level decrease was prompted primarily by one of our primary customer's decrease in its forecasted demand for our Ku-Band down converters. The Engineered Materials segment's operating earnings for the year ended December 31, 2002 were $3.2 million or 8.3% of this segment's net sales compared to operating earnings for the year ended December 31, 2001 of $4.6 million or 12.6% of this segment's net sales. The net decrease in the Engineered Materials segment's operating earnings was due primarily to the aforementioned pension expense in 2002 compared to pension income in 2001, as well as a decrease in contribution from fiber composite waste tanks, due primarily to the commercial aviation industry's decreased demand for such tanks in 2002. Selling, general and administrative expenses for the year ended December 31, 2002 increased to $47.6 million or 14.5% of net sales from $34.0 million or 13.1% of net sales for the year ended December 31, 2001. This increase was primarily attributable to the acquisition of Condor in July 2002, twelve months of Dynamic Systems' expenses in 2002, and the aforementioned change to pension expense in 2002 compared to pension income in 2001 and increased ESOP compensation expense. Research and development expense for the year ended December 31, 2002 decreased to $8.5 million or 2.6% of net sales from $8.8 million or 3.4% of net sales for the year ended December 31, 2001. The decrease 28 was primarily attributable to higher expenditures in the Communications and Space Products segment in 2001 relating to fiber optics product development. Interest expense, net of interest income, for the year ended December 31, 2002 increased 123.6% to $5.0 million from $2.2 million for the year ended December 31, 2001, due primarily to interest expense associated with our $137.8 million principal amount Notes, increased amortization expense of deferred debt issuance costs associated with the offering of the Notes and increased amortization of deferred financing costs associated with our credit facility amended in November 2002, partially offset by an $0.8 million increase in interest income due primarily to a higher average cash and cash equivalent balance resulting from our offering of the Notes in April 2002 and stock offering in 2001. Interest expense for the year ended December 31, 2001 consisted primarily of interest expense on our Debentures, which were fully converted into common shares or redeemed in the fourth quarter of 2001. Income tax expense reflects an effective rate of 42.5% for the year ended December 31, 2002 compared to 38.6% for the year ended December 31, 2001. The increase in the effective tax rate was principally attributable to the increased amount of nondeductible, non-cash ESOP compensation expense and increase in state taxes in 2002. For the year ended December 31, 2002, earnings available for common shares before cumulative effect of a change in accounting principle decreased to $14.0 million or $0.81 per diluted common share on 17.4 million diluted shares from $14.8 million or $1.11 per diluted common share on 14.3 million diluted shares for the year ended December 31, 2001. For the year ended December 31, 2002, net earnings available for common shares after the cumulative effect of a change in accounting principle decreased to $10.6 million or $0.61 per diluted common share on 17.4 million diluted shares from $14.8 million or $1.11 per diluted common share on 14.3 million diluted shares for the year ended December 31, 2001. The cumulative effect of a change in accounting principle for the year ended December 31, 2002 was recorded as of January 1, 2002 and is shown net of a tax benefit of $0.8 million on the consolidated statement of earnings. This charge pertained to the impairment of goodwill and a trademark resulting from impairment tests performed in 2002, as required by SFAS No. 142. The impairment occurred in the Engineered Materials segment and is comprised of the following: $2.2 million and $1.9 million of goodwill and a trademark, respectively, related to our acquisition of Specialty Plastics and $0.1 million of goodwill related to our acquisition of Zenix. Dividends on preferred shares for the year ended December 31, 2001 were $0.2 million. On March 8, 2001, we converted all of our outstanding preferred shares into 1,067,281 common shares. No preferred dividends were paid after March 8, 2001. IN-PROCESS RESEARCH AND DEVELOPMENT For the year ended December 31, 2002, IPR&D of $0.2 million related to a Condor project that had not reached technological feasibility and that had no alternative future uses. The amount allocated to such project was expensed as of the date of the acquisition. LIQUIDITY AND CAPITAL RESOURCES BALANCE SHEET Our cash, cash equivalents and marketable securities decreased 34.6% to $86.6 million at December 31, 2003 from $132.5 million at December 31, 2002. This decrease was due primarily to the cash outlays related to the three acquisitions made in 2003. Also, $8.9 million was used for the purchase of capital equipment and $2.4 million for the payment of common share dividends. Partially offsetting these decreases were the net proceeds of $21.3 million received from the sale of the Deer Park facility and the release of $27.3 million of restricted cash. Cash provided by operations was $17.6 million. Restricted cash of $27.3 million at December 31, 2002 represented collateral backing 105% of outstanding letters of credit assumed in connection with the acquisition of substantially all of the assets of Condor. As the letters of credit expired or were cancelled, the collateral was released. At December 31, 2003 there was no restricted cash. 29 Accounts receivable increased 33.5% to $134.3 million at December 31, 2003 from $100.6 million at December 31, 2002 due primarily to the acquisitions of AERA, Darlington and Emblem. Excluding the effects of these acquisitions and adjustments finalizing the purchase price allocation of Condor, accounts receivable increased $3.2 million from December 31, 2002. Inventories increased 7.2% to $34.7 million at December 31, 2003 from $32.4 million at December 31, 2002 due primarily to the Emblem acquisition. Excluding the effect of the acquisition, inventories decreased by $1.4 million. In 2003, satellite-related inventory was written down by $1.1 million to net realizable value due to competitive price pressures from a major customer as well as some obsolescence. Also in 2003, inventory in the microwave product line in the Engineered Materials segment was written down by $0.6 million to net realizable value as sales in this product line were not materializing to expected levels. The note receivable of $6.5 million at December 31, 2003 represents the note receivable from the sale of our facility in Deer Park in 2003. Included in other current assets is $1.6 million in notes related to the sale of our former College Point facility in January 1996. The College Point facility notes are due in annual amounts through September 2004 with a final payment of $1.3 million due on December 31, 2004 and bear interest at 7.0% per annum. The latter notes receivable are secured by a mortgage on the facility. A note receivable related to the sale of property in Deer Park in June 2000, which had a balance of $1.1 million at December 31, 2002, was collected in 2003. Contract advances decreased 59.6% to $8.2 million at December 31, 2003 from $20.3 million at December 31, 2002 due to the use of previously received advances for costs incurred on foreign contracts. In 2003, capital expenditures of $8.9 million increased 25% compared to 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 December 31, 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 standby letters of credit financing. The potential cash borrowing under the facility is reduced by the amount of outstanding letters of credit. Borrowings under the facility will be priced initially at LIBOR plus a predetermined amount, ranging from 1.25% to 1.75%, depending on our consolidated leverage ratio at the time of the borrowing. At December 31, 2003, LIBOR was approximately 1.15% and the applicable adjustment to LIBOR was 1.25%. The facility requires us to pay each lender in the consortium a commitment fee on the average daily unused portion of their respective commitment at a rate equal to 0.25%. There were no direct borrowings outstanding under the credit facility at December 31, 2003 or 2002. Letters of credit outstanding at December 31, 2003 pertaining to the credit facility were $52.3 million, resulting in $72.7 million available at year end for standby letters of credit, if needed. In connection with the credit facility, we are required to maintain both financial and non-financial covenants and ratios, including but not limited to minimum tangible net worth plus subordinated debt, leverage ratio, fixed charge coverage ratio, earnings before interest and taxes to interest expense ratio, total unsubordinated debt to tangible net worth, net income and dividends. 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 December 31, 2003, we were in compliance with our covenants. The credit facility is secured by our accounts receivable, inventory and machinery and equipment. 30 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, commencing on October 15, 2002. Accrued interest payable, included in accrued expenses on our consolidated balance sheet, at December 31, 2003 and 2002 was $1.5 million. 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 December 31, 2003, there had been no conversions. Shelf Registration On December 23, 2003, we filed a shelf registration statement to potentially offer for sale common shares, preferred shares, debt securities and warrants. We may sell any combination of the foregoing securities in one or more offerings up to an aggregate initial offering price of $500,000,000. 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 funding of our pension and post-retirement benefit obligations. 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 In order to aggregate all commitments and contractual obligations as of December 31, 2003, we have included the following table. We are obligated under building and equipment leases expiring between 2004 and 2012. The aggregate future minimum lease commitments under those obligations with noncancellable terms in excess of one year are shown below. Our commitments under letters of credit and advance payment and performance bonds relate primarily to advances received on foreign contracts should we fail to perform in accordance with the contract terms. We do not expect to have to make payments under these letters of credits 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: -------------------------------------------------------- 2009 AND TOTAL 2004 2005 2006 2007 2008 BEYOND ------ ----- ----- ---- ------ ---- -------- (IN MILLIONS) 5.25% Convertible Subordinated Notes due 2007.............. $137.8 $ -- $ -- $ -- $137.8 $ -- $ -- Operating leases.............. 72.1 13.6 11.0 7.8 6.8 6.3 26.6 Letters of credit............. 53.7 26.0 27.4 -- -- 0.3 -- Advance payment and performance bonds........... 1.9 0.2 -- -- -- -- 1.7 ------ ----- ----- ---- ------ ---- ----- Total......................... $265.5 $39.8 $38.4 $7.8 $144.6 $6.6 $28.3 ====== ===== ===== ==== ====== ==== =====
Additionally, we are subject to certain legal actions that arise out of the normal course of business. It is our belief that the ultimate outcome of these actions will not have a material adverse effect on our consolidated financial position, results of operations or liquidity. CONCENTRATION OF SALES We conduct a significant amount of our business with the United States Government. Domestic U.S. Government sales, including sales to prime contractors of the U.S. Government, accounted for 31 approximately 76%, 75% and 69% of our total net sales for 2003, 2002 and 2001, respectively. In addition, sales from the Universal Exciter Upgrade program accounted for approximately 2%, 14% and 15% of our total net sales in 2003, 2002 and 2001, respectively. Although there are currently no indications of a significant change in the status of government funding of certain programs, should this occur, our results of operations, financial position and liquidity could be materially affected. Such a change could have a significant impact on our profitability and our stock price. This could also affect our ability to acquire funds from our credit facility due to covenant restrictions or from other sources. As of December 31, 2003, one customer, a prime contractor, in addition to the U.S. Government accounted for more than 10% of our consolidated accounts receivable. BACKLOG The funded backlog of unfilled orders at December 31, 2003 increased to $462.3 million from $375.0 million at December 31, 2002. Our backlog consists primarily of current orders under long-lived, mission-critical programs of key defense platforms. COMMON SHARE PRICES EDO common shares are traded on the New York Stock Exchange. As of February 25, 2004, there were 1,904 shareholders of record (brokers and nominees counted as one each). The price range in 2003 and 2002 was as follows:
2003 2002 ----------------- ----------------- HIGH LOW HIGH LOW ------- ------- ------- ------- 1st Quarter.................................... 21.6000 14.7500 31.1500 21.9900 2nd Quarter.................................... 20.3100 14.9700 32.9000 25.9000 3rd Quarter.................................... 23.5900 17.0900 28.4900 17.5000 4th Quarter.................................... 25.9500 19.7000 22.6500 15.5000
DIVIDENDS During 2003 and 2002, the Board of Directors approved the payment of quarterly cash dividends of $0.03 per common share. The Company's credit facility places certain limits on the payment of cash dividends. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The statements in this Annual 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, the general state of world military readiness and deployment; and the ability to obtain export licenses. 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 32 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, nondeductibility of goodwill amortization and IPR&D acquired in a stock purchase business combination and the nondeductibility of our noncash ESOP compensation expense. The Company has no obligation to update any forward-looking statements. 33 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED STATEMENTS OF EARNINGS EDO CORPORATION AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, ------------------------------ 2003 2002 2001 -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) CONTINUING OPERATIONS: NET SALES................................................. $460,667 $328,876 $259,961 -------- -------- -------- COSTS AND EXPENSES Cost of sales........................................... 338,259 240,850 189,733 Selling, general and administrative..................... 71,855 47,584 34,013 Research and development................................ 8,594 8,492 8,750 Write-off of purchased in-process research and development and merger-related costs................. 929 567 1,318 Benefit plan curtailment loss (gain).................... 942 1,998 (929) Impairment loss on Deer Park facility................... 9,160 -- -- -------- -------- -------- 429,739 299,491 232,885 -------- -------- -------- OPERATING EARNINGS........................................ 30,928 29,385 27,076 NON-OPERATING INCOME (EXPENSE) Interest income......................................... 941 1,729 915 Interest expense........................................ (9,093) (6,685) (3,131) Other, net.............................................. 279 (95) (971) -------- -------- -------- (7,873) (5,051) (3,187) -------- -------- -------- Earnings from continuing operations before income taxes and cumulative effect of a change in accounting principle............................................ 23,055 24,334 23,889 Income tax expense...................................... (9,644) (10,342) (9,210) -------- -------- -------- EARNINGS FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE.............. 13,411 13,992 14,679 DISCONTINUED OPERATIONS: Gain from discontinued operations, net of tax............. 1,398 -- 273 -------- -------- -------- EARNINGS FROM DISCONTINUED OPERATIONS..................... 1,398 -- 273 -------- -------- -------- EARNINGS BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE................................................. 14,809 13,992 14,952 -------- -------- -------- Cumulative effect of a change in accounting principle, net of tax of $790............................................ -- (3,363) -- Dividends on preferred shares............................... -- -- 194 -------- -------- -------- NET EARNINGS AVAILABLE FOR COMMON SHARES.................... $ 14,809 $ 10,629 $ 14,758 ======== ======== ======== EARNINGS PER COMMON SHARE: Basic: Continuing operations................................... $ 0.78 $ 0.62 $ 1.14 Discontinued operations................................. 0.08 -- 0.02 -------- -------- -------- NET EARNINGS PER COMMON SHARE -- BASIC...................... $ 0.86 $ 0.62 $ 1.16 ======== ======== ======== Diluted: Continuing operations................................... $ 0.76 $ 0.61 $ 1.09 Discontinued operations................................. 0.08 -- 0.02 -------- -------- -------- NET EARNINGS PER COMMON SHARE -- DILUTED.................... $ 0.84 $ 0.61 $ 1.11 ======== ======== ======== UNAUDITED PRO FORMA AMOUNTS ASSUMING RETROACTIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE: Net Earnings Available for Common Shares.................. $ 15,329 Basic Net Earnings per Common Share....................... $ 1.18 Diluted Net Earnings per Common Share..................... $ 1.13 ========
See accompanying Notes to Consolidated Financial Statements. 34 CONSOLIDATED BALANCE SHEETS EDO CORPORATION AND SUBSIDIARIES
DECEMBER 31, --------------------- 2003 2002 --------- --------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) ASSETS Current assets: Cash and cash equivalents................................. $ 86,416 $132,320 Restricted cash........................................... -- 27,347 Marketable securities..................................... 216 193 Accounts receivable, net.................................. 134,303 100,594 Inventories............................................... 34,733 32,406 Deferred income tax asset, net............................ 3,594 3,222 Prepayments and other..................................... 5,954 3,133 -------- -------- Total current assets................................... 265,216 299,215 -------- -------- Property, plant and equipment, net.......................... 31,355 64,472 Notes receivable............................................ 6,538 2,556 Goodwill.................................................... 92,527 61,352 Other intangible assets..................................... 55,898 11,867 Deferred income tax asset, net.............................. 21,774 20,439 Other assets................................................ 21,388 21,673 -------- -------- $494,696 $481,574 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 22,801 $ 19,108 Accrued liabilities....................................... 61,942 55,448 Contract advances and deposits............................ 8,195 20,277 -------- -------- Total current liabilities.............................. 92,938 94,833 -------- -------- Long-term debt.............................................. 137,800 137,800 Post-retirement benefits obligations........................ 71,898 78,643 Environmental obligation.................................... 1,728 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, 19,832,108 issued in 2003 and 19,790,477 issued in 2002.............................. 19,832 19,790 Additional paid-in capital................................ 150,097 147,091 Retained earnings......................................... 69,059 56,325 Accumulated other comprehensive loss, net of income tax benefit................................................ (29,281) (33,899) Treasury shares at cost (88,128 shares in 2003 and 94,322 shares in 2002)........................................ (1,255) (1,321) Unearned Employee Stock Ownership Plan shares............. (17,290) (18,541) Deferred compensation under Long-Term Incentive Plan...... (479) (579) Management group receivables.............................. (351) (593) -------- -------- Total shareholders' equity............................. 190,332 168,273 -------- -------- $494,696 $481,574 ======== ========
See accompanying Notes to Consolidated Financial Statements. 35 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY EDO CORPORATION AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, --------------------------------------------------------- 2003 2002 2001 ----------------- ----------------- ----------------- AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES -------- ------ -------- ------ -------- ------ (IN THOUSANDS) PREFERRED SHARES Balance at beginning of year............................ $ -- -- $ -- -- $ 49 49 Shares converted to common shares....................... -- -- -- -- (49) (49) -------- ------ -------- ------ -------- ------ Balance at end of year.................................. -- -- -- -- -- -- -------- ------ -------- ------ -------- ------ COMMON SHARES Balance at beginning of year............................ 19,790 19,790 19,790 19,790 15,007 15,007 Exercise of stock options............................... 31 31 -- -- -- -- Shares used for Long-Term Incentive Plan................ 11 11 -- -- -- -- Conversion of preferred shares to common shares......... -- -- -- -- 1,067 1,067 Sale of stock in public offering........................ -- -- -- -- 3,716 3,716 -------- ------ -------- ------ -------- ------ Balance at end of year.................................. 19,832 19,832 19,790 19,790 19,790 19,790 -------- ------ -------- ------ -------- ------ ADDITIONAL PAID-IN CAPITAL Balance at beginning of year............................ 147,091 143,747 58,614 Exercise of stock options............................... 150 (466) (2,405) Income tax benefit related to stock options and Long-Term Incentive Plan.............................. 328 713 1,118 Shares used for payment of directors' fees.............. 28 64 35 Shares used for Long-Term Incentive Plan................ 178 241 (73) Conversion of preferred shares to common shares......... -- -- (1,018) Conversion of subordinated debentures................... -- -- 8,525 Sale of stock in public offering........................ -- -- 77,775 Compensation expense on accelerated options............. 292 -- 276 Employee Stock Ownership Plan shares committed-to-be- released.............................................. 2,030 2,792 900 -------- -------- -------- Balance at end of year.................................. 150,097 147,091 143,747 -------- -------- -------- RETAINED EARNINGS Balance at beginning of year............................ 56,325 47,744 34,803 Net earnings............................................ 14,809 10,629 14,952 Common share dividends (12 cents per share)............. (2,075) (2,048) (1,840) Dividends on preferred shares........................... -- -- (194) Tax benefit on unallocated preferred share dividends.... -- -- 23 -------- -------- -------- Balance at end of year.................................. 69,059 56,325 47,744 -------- -------- -------- ACCUMULATED OTHER COMPREHENSIVE LOSS Balance at beginning of year............................ (33,899) (13,385) (61) Unrealized gain on marketable securities, net of tax.... -- -- 61 Unrealized gain on foreign currency, net of tax......... 50 86 -- Additional minimum pension liability, net of tax........ 4,568 (20,600) (13,385) -------- -------- -------- Balance at end of year.................................. (29,281) (33,899) (13,385) -------- -------- -------- TREASURY SHARES AT COST Balance at beginning of year............................ (1,321) (94) (2,461) (182) (19,388) (1,370) Shares used for exercise of stock options............... 87 6 952 69 4,297 314 Shares used for payment of directors' fees.............. 80 6 78 6 122 9 Shares used for (repurchased from) Long-Term Incentive Plan.................................................. (101) (6) 110 13 (63) (6) Shares used for conversion of subordinated debentures... -- -- -- -- 13,591 1,005 Repurchase of Employee Stock Ownership Plan shares...... -- -- -- -- (1,020) (134) -------- ------ -------- ------ -------- ------ Balance at end of year.................................. (1,255) (88) (1,321) (94) (2,461) (182) -------- ------ -------- ------ -------- ------
36
YEARS ENDED DECEMBER 31, --------------------------------------------------------- 2003 2002 2001 ----------------- ----------------- ----------------- AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES -------- ------ -------- ------ -------- ------ (IN THOUSANDS) EMPLOYEE STOCK OWNERSHIP TRUST LOAN OBLIGATION Balance at beginning of year............................ -- -- (5,781) Repayments made during year............................. -- -- 890 Restructuring of EDO Employee Stock Ownership Plan...... -- -- 4,891 -------- -------- -------- Balance at end of year.................................. -- -- -- -------- -------- -------- DEFERRED COMPENSATION UNDER LONG-TERM INCENTIVE PLAN Balance at beginning of year............................ (579) (300) (423) Shares used for Long-Term Incentive Plan................ (189) (480) (148) Amortization of Long-Term Incentive Plan deferred compensation expense.................................. 289 201 271 -------- -------- -------- Balance at end of year.................................. (479) (579) (300) -------- -------- -------- UNEARNED EMPLOYEE STOCK OWNERSHIP PLAN COMPENSATION Balance at beginning of year............................ (18,541) (19,792) (15,782) Restructuring of EDO Employee Stock Ownership Plan...... -- -- (4,891) Employee Stock Ownership Plan Shares committed-to-be- released.............................................. 1,251 1,251 881 -------- -------- -------- Balance at end of year.................................. (17,290) (18,541) (19,792) -------- -------- -------- MANAGEMENT GROUP RECEIVABLES Balance at beginning of year............................ (593) (845) (1,220) Payments received on management loans................... 242 252 375 -------- -------- -------- Balance at end of year.................................. (351) (593) (845) -------- -------- -------- TOTAL SHAREHOLDERS' EQUITY................................ $190,332 $168,273 $174,498 ======== ======== ======== COMPREHENSIVE INCOME (LOSS) Net earnings............................................ $ 14,809 $ 10,629 $ 14,952 Additional minimum pension liability, net of income tax expense of $3,175 in 2003 and net of income tax benefit of $14,316 in 2002 and $9,302 in 2001......... 4,568 (20,600) (13,385) Unrealized gain on marketable securities, net of income tax expense of $31 in 2001............................ -- -- 61 Unrealized gain on foreign currency..................... 50 86 -- -------- -------- -------- Comprehensive income (loss)............................. $ 19,427 $ (9,885) $ 1,628 ======== ======== ========
See accompanying Notes to Consolidated Financial Statements. 37 CONSOLIDATED STATEMENTS OF CASH FLOWS EDO CORPORATION AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, ------------------------------ 2003 2002 2001 -------- -------- -------- (IN THOUSANDS) OPERATING ACTIVITIES: Earnings from operations.................................. $ 13,411 $ 10,629 $ 14,679 Adjustments to earnings to arrive at cash provided by operations: Depreciation........................................... 12,180 10,365 9,686 Amortization........................................... 4,885 956 1,710 Deferred tax (benefit) expense......................... (6,840) (2,984) 5,941 Write-off of purchased in-process research and development.......................................... -- 150 -- Real estate tax assessment adjustment.................. -- -- 7,846 Bad debt expense....................................... 568 407 220 Gain on repurchase of debentures....................... -- -- (171) Loss on sale of Deer Park facility..................... 9,160 -- -- (Gain) loss on sale of property, plant and equipment... (131) 53 (76) Gain on sale of marketable securities.................. -- -- (81) Deferred compensation expense.......................... 289 201 271 Non-cash Employee Stock Ownership Plan compensation expense.............................................. 3,281 4,043 1,781 Dividends on unallocated Employee Stock Ownership Plan shares............................................... 292 312 80 Non-cash compensation expense.......................... 292 -- 276 Common shares issued for directors' fees............... 108 142 157 Income tax benefit from stock options and Long-Term Incentive Plan....................................... 328 713 1,118 Cumulative effect of a change in accounting principle............................................ -- 3,363 -- Changes in operating assets and liabilities, excluding effects of acquisitions: Accounts receivable.................................. (3,203) (2,519) (10,753) Inventories.......................................... 1,406 (2,926) 2,033 Prepayments and other assets......................... 4,032 220 (629) Contribution to defined benefit pension plan......... (5,000) -- -- Accounts payable, accrued liabilities and other...... (5,402) 5,217 (4,974) Contract advances and deposits....................... (12,082) 3,575 (15,017) -------- -------- -------- Cash provided by operations................................. 17,574 31,917 14,097 -------- -------- -------- Net cash provided by discontinued operations................ 79 -- -- -------- -------- --------
38
YEARS ENDED DECEMBER 31, ------------------------------ 2003 2002 2001 -------- -------- -------- (IN THOUSANDS) INVESTING ACTIVITIES: Purchase of plant and equipment........................... (8,865) (7,093) (14,298) Payments received on notes receivable..................... 1,385 350 347 Proceeds from sale of property, plant and equipment....... 21,304 1 280 Purchase of marketable securities......................... (23) (3) (59) Sale or redemption of marketable securities............... -- -- 14,455 Restricted cash........................................... 27,347 (27,347) -- Cash paid for acquisitions, net of cash acquired.......... (94,188) (59,024) (13,938) -------- -------- -------- Cash used by investing activities........................... (53,040) (93,116) (13,213) -------- -------- -------- FINANCING ACTIVITIES: Issuance of convertible subordinated notes................ -- 137,800 -- Proceeds from exercise of stock options................... 268 486 1,892 Proceeds from management group receivables................ 242 252 375 Proceeds from sale of stock in public offering, net of expenses............................................... -- -- 81,491 Borrowings under revolver................................. -- -- 20,800 Repayments of borrowings under revolver................... -- -- (20,800) Repayments of long-term debt.............................. -- -- (17,300) Repayments of acquired debt............................... (8,660) -- -- Repurchase of debentures.................................. -- -- (3,184) Purchase of treasury shares............................... -- -- (1,020) Payment of EDO ESOP loan obligation....................... -- -- (4,891) Payment made on note payable.............................. -- (500) (500) Payment of common share cash dividends.................... (2,367) (2,360) (1,920) Payment of preferred share cash dividends................. -- -- (194) -------- -------- -------- Cash provided (used) by financing activities................ (10,517) 135,678 54,749 -------- -------- -------- Net increase (decrease) in cash and cash equivalents........ (45,904) 74,479 55,633 Cash and cash equivalents at beginning of year.............. 132,320 57,841 2,208 -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 86,416 $132,320 $ 57,841 ======== ======== ======== Supplemental disclosures: Cash paid for: Interest............................................... $ 7,234 $ 3,878 $ 2,166 ======== ======== ======== Income taxes........................................... $ 11,880 $ 14,063 $ 5,913 ======== ======== ========
See accompanying Notes to Consolidated Financial Statements. 39 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) PRINCIPLES OF CONSOLIDATION AND BUSINESS The consolidated financial statements include the accounts of EDO Corporation and all wholly-owned subsidiaries (the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation. The Company operates in three segments: Defense, Communications and Space Products, and Engineered Materials. The Company discontinued its former satellite products business (Barnes Engineering Company) in 1999. (B) RESTRICTED CASH At December 31, 2003, there was no restricted cash. At December 31, 2002 the $27.3 million of restricted cash related to amounts collateralizing the outstanding letters of credit assumed as part of the acquisition of Condor Systems, Inc. (Note 2). As the letters of credit expired or were cancelled, collateral was released. (C) CASH EQUIVALENTS The Company considers all securities with an original maturity of three months or less at the date of acquisition to be cash equivalents. (D) 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. Our gross profit is affected by a variety of factors, including the mix of products, systems and services sold or provided, production efficiencies, price competition and general economic conditions. Estimated losses on long-term contracts are recorded when identified. (E) 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 inventories, including our decision to exit a product line, technological change, new product development and/or revised estimates of future product demand. If 40 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. (F) LONG-LIVED ASSETS, OTHER THAN GOODWILL AND OTHER INTANGIBLES 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 the Company determines that the useful life of property, plant and equipment should be shortened, the Company would depreciate the net book value in excess of salvage value over its revised remaining useful life thereby increasing depreciation expense. Factors such as technological advances, changes to the Company's business model, changes in the Company's 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. The Company accounts for its investments in long-lived assets in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standard ("SFAS") No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". The Company adopted SFAS No. 144 on January 1, 2002. SFAS No. 144 requires the Company to review its long-lived assets 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 such 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. Costs associated with the acquisition and development of software for internal use are recognized in accordance with Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." In 2003 and 2002, the Company capitalized approximately $1.1 million and $0.3 million, respectively, of such costs. These costs are being amortized on a straight-line basis over a period of two to four years. Deferred financing costs are amortized on a straight-line basis over the life of the related financing. The unamortized balances of $4.1 million and $5.5 million are included in other assets at December 31, 2003 and 2002, respectively. (G) BUSINESS COMBINATIONS AND GOODWILL AND OTHER INTANGIBLE ASSETS In June 2001, the 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; however, the provisions that provide 41 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) for the non-amortization of goodwill were effective July 1, 2001 for acquisitions completed after the issuance of SFAS No. 141. 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 the 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 profits, 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. In 2003, the Company performed the required impairment tests of goodwill as of October 1, 2003. There was no indication of impairment. In 2002 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, net of a tax benefit of $0.8 million, occurred in the Engineered Materials segment and is comprised of $2.2 million and $1.9 million of impaired goodwill and trademark, respectively, related to the acquisition of Specialty Plastics and $0.1 million of impaired goodwill related to the acquisition of Zenix. In the case of Zenix, the trend in sales and earnings performance has been lower than expected resulting in the impairment of the entire goodwill carrying value. In the case of Specialty Plastics, the fair value of this reporting unit was estimated using a discounted cash flow analysis, also resulting in an impairment loss of the entire goodwill carrying value. The changes in the carrying amount of goodwill by segment for the years ended December 31, 2003 and 2002 are as follows:
COMMUNICATIONS AND SPACE ENGINEERED DEFENSE PRODUCTS MATERIALS TOTAL ------- -------------- ---------- ------- (IN THOUSANDS) Balance as of January 1, 2002............ $20,601 $ -- $ 2,274 $22,875 Impairment Loss.......................... -- -- (2,274) (2,274) Acquisition of Condor Systems, Inc. ..... 37,059 3,692 -- 40,751 ------- ------- ------- ------- Balance as of January 1, 2003............ $57,660 $ 3,692 $ -- $61,352 Settlement of certain pre-acquisition Condor liabilities..................... 1,569 (2,031) -- (462) Adjustments to pre-acquisition tax liabilities............................ (3,059) -- -- (3,059) Acquisition of AERA...................... 11,626 -- -- 11,626 Acquisition of Darlington................ 13,462 -- -- 13,462 Acquisition of Emblem.................... 9,608 -- -- 9,608 ------- ------- ------- ------- Balance as of December 31, 2003.......... $90,866 $ 1,661 $ -- $92,527 ======= ======= ======= =======
42 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Summarized below are intangible assets subject to amortization as of December 31:
2003 2002 LIFE ------- ------- ----------- (IN THOUSANDS) Capitalized non-compete agreements related to the acquisitions of DSI/AERA/Darlington/Emblem......... $ 2,968 $ 200 1-5 years Purchased technologies related to the acquisitions of Condor/Emblem...................................... 17,003 11,648 8-20 years Customer contracts and relationships related to the acquisitions of AERA/Darlington/Emblem............. 39,198 -- 10-20 years Tradename related to the acquisitions of AERA/ Darlington/Emblem.................................. 1,569 -- 5-10 years Other intangible assets related to the acquisition of Condor Systems, Inc. .............................. 916 916 2 years ------- ------- 61,654 12,764 Less accumulated amortization........................ (5,756) (897) ------- ------- $55,898 $11,867 ======= =======
The amortization expense for the years ended December 31, 2003, 2002 and 2001 amounted to $4.9 million, $0.9 million and $0.1 million, respectively. Amortization expense for 2004, 2005, 2006, 2007, 2008 and thereafter related to these intangible assets is estimated to be $5.5 million, $5.2 million, $5.2 million, $5.2 million, $4.6 million and $30.2 million, respectively. Since the total trademark carrying amount of $1.9 million 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 that are not subject to amortization. 43 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table represents a reconciliation of reported net earnings from continuing operations available for common shares to adjusted net earnings from continuing operations available for common shares exclusive of amortization expense associated with goodwill and intangible assets that are no longer being amortized subsequent to the adoption of SFAS No. 142, effective January 1, 2002:
YEARS ENDED DECEMBER 31, --------------------------- 2003 2002 2001 ------- ------- ------- (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) Reported net earnings from continuing operations available for common shares........................... $13,411 $10,629 $14,485 Add back: Goodwill and trademark amortization, net of taxes................................................. -- -- 571 ------- ------- ------- Pro Forma............................................... $13,411 $10,629 $15,056 ======= ======= ======= Basic earnings per share: Reported net earnings from continuing operations available for common shares........................ $ 0.78 $ 0.62 $ 1.14 Add back: Goodwill and trademark amortization, net of taxes................................................. -- -- 0.04 ------- ------- ------- Adjusted net earnings................................... $ 0.78 $ 0.62 $ 1.18 ======= ======= ======= Diluted earnings per share: Reported net earnings from continuing operations available for common shares........................ $ 0.76 $ 0.61 $ 1.09 Add back: Goodwill and trademark amortization, net of taxes................................................. -- -- 0.04 ------- ------- ------- Adjusted net earnings................................... $ 0.76 $ 0.61 $ 1.13 ======= ======= =======
(H) INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (I) TREASURY SHARES Common shares held as treasury shares are recorded at cost, with issuances from treasury recorded at average cost. Treasury shares issued for directors' fees are recorded as an expense for an amount equal to the fair market value of the common shares on the issuance date. (J) FINANCIAL INSTRUMENTS The net carrying value of notes receivable approximates fair value based on current rates for comparable commercial mortgages. The fair value of the Company's 5.25% Convertible Subordinated Notes due 2007 (the "Notes") at December 31, 2003 was approximately $150.6 million based on recent market transactions compared to a carrying value of $137.8 million. At December 31, 2002, the fair value of the Notes approximated the carrying value of $137.8 million. The fair value of the environmental obligation approximates its carrying value since it has been discounted. The fair values of all other financial instruments approximate book values because of the short-term maturities of these instruments. 44 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (K) USE OF ESTIMATES Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Actual results could differ from these and other estimates. (L) 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 market value recognition provisions of SFAS No. 123 "Accounting for Stock-Based Compensation" whereby compensation expense would be recognized as incurred for stock-based employee compensation. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The per share weighted-average fair value of stock options granted was $10.63, $15.28 and $4.88 in 2003, 2002 and 2001, respectively, on the dates of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 2003 -- expected dividend yield of 1%, risk free interest rate of 3.6%, expected volatility of 51%, and an expected option life of 7 1/2 years; 2002 -- expected dividend yield of 1%, risk free interest rate of 4.8%, expected stock volatility of 51%, and an expected option life of 7 1/2 years; 2001 -- expected dividend yield of 1%, risk free interest rate of 4.9%, expected stock volatility of 47%, and an expected option life of 7 1/2 years.
2003 2002 2001 ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Earnings: As reported........................................... $13,411 $10,629 $14,679 Stock option compensation expense based on fair value method, net of tax................................. (1,626) (1,078) (466) ------- ------- ------- Pro forma............................................. $11,785 $ 9,551 $14,213 Basic earnings per common share: As reported........................................... $ 0.78 $ 0.62 $ 1.14 Pro forma............................................. 0.68 0.56 1.10 Diluted earnings per common share: As reported........................................... $ 0.76 $ 0.61 $ 1.09 Pro forma............................................. 0.67 0.55 1.05 ======= ======= =======
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. In addition, SFAS No. 148 requires more prominent and more frequent disclosures in both annual and interim financial statements about the method of accounting used for stock-based compensation and the effect of the method used on reported results. The disclosure provisions of SFAS No. 148 are effective for years ending after December 15, 2002 and accordingly are reflected above. Presently, the Company does not plan to voluntarily change its method of accounting for stock-based compensation. However, should the Company change its method of accounting for stock-based compensation in the future that change would fall under the provisions of SFAS Nos. 123 and 148. 45 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (M) ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and on June 15, 2000, issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities -- an Amendment to FASB Statement No. 133." These statements establish methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. The Company adopted these statements in the first quarter of 2001. The effect of the adoption of these statements was not material to the Company's operating results or financial position. (N) RECLASSIFICATIONS Certain reclassifications have been made to prior year presentations to conform to current year presentations. (2) 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, now known as EDO (UK) Ltd., 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 purchase price was L16.3 million ($27.3 million), excluding transaction costs of approximately $1.9 million. Emblem became part of the Company's Defense segment. The excess of the purchase price over the net assets acquired recorded as goodwill and other intangibles related to Emblem's units located in England is deductible for U.S. income tax purposes over 15 years. The excess of the purchase price over the net assets acquired related to Artisan Technologies, Inc. is not deductible for income tax purposes. 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. The excess of the purchase price over the net assets acquired recorded as goodwill and other intangible assets is deductible for income tax purposes over 15 years. On February 5, 2003, a wholly-owned subsidiary of the Company acquired for cash all of the stock of Advanced Engineering & Research Associates, Inc.("AERA"), a privately-held company located in Alexandria, Virginia. AERA, which was merged with another EDO subsidiary and renamed EDO Professional Services Inc., 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. The excess of the purchase price over the net assets acquired recorded as goodwill and other intangible assets is deductible for income tax purposes over 15 years. 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 46 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) $5.0 million. The acquisition expanded 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. The excess of the purchase price over the net assets acquired recorded as goodwill, IPR&D and other intangible assets is deductible for income tax purposes over 15 years. In October 2001, the Company acquired all of the stock of Dynamic Systems, Inc., a privately-held company based in Alexandria, Virginia, which provides professional and information technology services primarily to the Department of Defense and other government agencies. The acquisition strengthened and expanded the range of services the Company offered to both existing and new customers. The Company paid $13.7 million, including transaction costs and subsequent to a $0.2 million reduction in the purchase price, and accounted for the acquisition as a purchase. Accordingly, the operating results of Dynamic Systems, Inc. have been included in the Company's consolidated financial statements since the date of acquisition. The excess of the purchase price over the fair market value of net assets acquired recorded as goodwill is not deductible for income tax purposes. 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. Associated with the acquisition and included in operating earnings for 2003 and 2002 is $0.9 million and $0.6 million, respectively, of acquisition-related costs, of which $0.2 million in 2002 represents the write-off of purchased in-process research and development ("IPR&D"). This IPR&D was determined to not have reached technological feasibility and to not have alternative future use. The development project related to detecting and locating weak modulated continuous wave signals. 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.
YEAR ENDED ----------------------------------------- DECEMBER 31, 2003 DECEMBER 31, 2002 ------------------- ------------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net sales........................................... $489,531 $494,332 Earnings available for common shares, before discontinued operations and cumulative effect of a change in accounting principle.................... $ 15,995 $ 15,456 Diluted earnings per common share................... $ 0.91 $ 0.89
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. 47 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 AT CONDOR AT AT JUNE 16, AT MARCH 10, FEBRUARY 5, JULY 26, 2003 2003 2003 2002 ----------- ------------ -------------- ----------- (IN THOUSANDS) Current assets........................ $ 9,314 $ 11,943 $13,022 $ 31,775 Plant and equipment................... 3,537 1,534 1,048 5,543 Customer contracts and relationships....................... 7,698 14,400 17,100 -- Purchased in-process research and development......................... -- -- -- 150 Purchased technologies................ 5,355 -- -- 11,648 Purchased backlog..................... -- -- -- 916 Non-compete agreements................ 318 30 2,420 -- Tradename............................. 669 400 500 -- Goodwill.............................. 9,608 13,462 11,626 40,290 Other assets.......................... -- 446 414 76 Liabilities........................... (7,257) (16,326) (7,768) (22,922) ------- -------- ------- -------- Total purchase price.................. $29,242 $ 25,889 $38,362 $ 67,476 ======= ======== ======= ========
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 first half of 2004. (3) DISCONTINUED OPERATIONS In 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 second quarter of 2003. 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. (4) MARKETABLE SECURITIES The Company determines the appropriate classification of securities at the time of purchase and reevaluates such designation as of each balance sheet date. All marketable securities are classified as available-for-sale securities. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Realized gains and losses, interest and dividends and declines in value judged to be other-than-temporary declines are included in interest income (expense). The cost of securities sold is based on the specific identification method. At December 31, 2003 and 2002, the marketable securities balance represents amounts in mutual funds. (5) ACCOUNTS AND NOTES RECEIVABLE Accounts receivable included $ 44.1 million and $43.0 million at December 31, 2003 and 2002, respectively, of unbilled revenues. Substantially all of the unbilled balances at December 31, 2003 will be billed and are expected to be collected during 2004. Total billed receivables due from the United States Government, either directly or as a subcontractor to a prime contractor with the Government, were $67.6 million and $31.0 million at December 31, 2003 and 2002, respectively. 48 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Notes receivable at December 31, 2003 and 2002 include $1.6 million and $1.9 million, respectively, from the sale of the Company's College Point facility in January 1996 all of which is included in current assets at December 31, 2003 and $0.4 million is in current assets at December 31, 2002. The notes are due in equal quarterly amounts through September 2004 with a final payment of $1.3 million due on December 31, 2004 and bear interest at 7% per annum. The notes receivable are secured by a mortgage on the facility. Also included in notes receivable at December 31, 2003 is $6.5 million from the sale in July 2003 of the Company's Deer Park facility. At December 2002, notes receivable included $1.1 million from the sale of certain parcels of land and a building at the Company's Deer Park facility, which was collected in 2003. (6) INVENTORIES Inventories are summarized by major classification as follows at December 31:
2003 2002 -------- ------- (IN THOUSANDS) Raw material and supplies................................... $ 8,624 $ 7,804 Work-in-process............................................. 38,052 27,024 Finished goods.............................................. 1,870 2,041 Less: Unliquidated progress payments...................... (13,813) (4,463) -------- ------- Finished goods.............................................. $ 34,733 $32,406 ======== =======
(7) PROPERTY, PLANT AND EQUIPMENT, NET The Company's property, plant and equipment at December 31 and their related useful lives are summarized as follows:
2003 2002 LIFE -------- -------- ----------- (IN THOUSANDS) Land.............................................. $ 128 $ 18,080 Buildings and improvements........................ 1,015 25,906 10-30 years Machinery and equipment........................... 70,079 59,550 3-19 years Software.......................................... 3,158 2,030 2-4 years Leasehold improvements............................ 16,039 13,151 Lease terms -------- -------- 90,419 118,717 Less accumulated depreciation and amortization.... (59,064) (54,245) -------- -------- $ 31,355 $ 64,472 ======== ========
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. 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 represents 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. 49 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (8) ACCRUED LIABILITIES Accrued liabilities consisted of the following at December 31:
2003 2002 ------- ------- (IN THOUSANDS) Employee compensation and benefits.......................... $22,453 $16,744 Deferred revenue and accrual for future costs related to acquired contracts........................................ 11,161 11,562 Income taxes payable........................................ 7,175 3,991 Accrued interest............................................ 1,673 1,782 Warranty.................................................... 1,612 1,622 Current portion of environmental obligation................. 264 250 Other....................................................... 17,604 19,497 ------- ------- $61,942 $55,448 ======= =======
(9) LONG-TERM DEBT AND CREDIT FACILITY CREDIT FACILITY At December 31, 2003, the Company has a $200 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 and amended the $69 million credit facility in place at December 31, 2001. In connection with the amended facility, $0.9 million and $1.2 million of deferred finance costs are included in other assets on the accompanying consolidated balance sheet at December 31, 2003 and 2002, respectively, and are being amortized using the straight-line method over the term of the agreement. The credit facility provides sub-limits of borrowing up to $125.0 million for acquisition-related financing and up to $125.0 million in standby letters of credit financing. The potential cash borrowing under the facility is reduced by the amount of outstanding letters of credit. Borrowings under the facility will be priced initially at LIBOR plus a predetermined amount, ranging from 1.25% to 1.75%, depending on the Company's consolidated leverage ratio at the time of the borrowing. At December 31, 2003, LIBOR was approximately 1.15% and the applicable adjustment to LIBOR was 1.25%. The facility requires the Company to pay each lender in the consortium a commitment fee on the average daily unused portion of their respective commitment at a rate equal to 0.25%. There were no direct borrowings outstanding under the credit facility at December 31, 2003 or 2002. Letters of credit outstanding at December 31, 2003 pertaining to the credit facility were $52.3 million, resulting in $72.7 million available for additional letters of credit, if needed. In connection with the credit facility, the Company is required to maintain both financial and non-financial covenants and ratios, including but not limited to minimum tangible net worth plus subordinated debt, leverage ratio, fixed charge coverage ratio, earnings before interest and taxes to interest expense ratio, total unsubordinated debt to tangible net worth, net income and dividends. 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 December 31, 2003, the Company was in compliance with its covenants. The credit facility is secured by the Company's accounts receivables, inventory and machinery and equipment. 50 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5.25% CONVERTIBLE SUBORDINATED NOTES DUE 2007 In April 2002, the Company completed its offering of $137.8 million of 5.25% Convertible Subordinated Notes due 2007 and received $133.7 million, net of commissions paid. Interest payments on the Notes are due April 15 and October 15 of each year, commencing on October 15, 2002. Accrued interest payable, included in accrued liabilities on the accompanying consolidated balance sheet, was $1.5 million at December 31, 2003 and 2002. In connection with the offering of the Notes, there are $3.1 million and $4.1 million of unamortized debt issuance costs at December 31, 2003 and 2002, respectively, which are included in other assets on the accompanying consolidated balance sheet and are being amortized using the straight-line method through April 2007. 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 stock at an initial conversion price of $31.26 per share, subject to adjustment in certain events. As of December 31, 2003, there had been no such conversions. 7% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2011 During the fourth quarter of 2001, the Company redeemed all of its outstanding 7% Convertible Subordinated Debentures due 2011 (the "Debentures"). As a result of the redemption, $22.1 million face value of the Debentures were converted into 1,005,250 common shares and $0.2 million face value were redeemed for cash. During 2001, the Company also purchased $3.4 million of the Debentures for $3.2 million and recognized a gain of $0.2 million, which is included in other non-operating income in the accompanying consolidated statement of earnings. (10) EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST Prior to 2001 the Company sponsored two employee stock ownership plans: the existing EDO Employee Stock Ownership Plan ("EDO ESOP"); and the AIL Employee Stock Ownership Plan ("AIL ESOP") that was acquired in connection with the EDO-AIL merger. These two plans were merged into a single plan effective as of January 1, 2001 ("merged ESOP"), and the preferred shares from the EDO ESOP were converted into 1,067,281 common shares as of March 8, 2001. The merged ESOP provides retirement benefits to substantially all employees. As of June 30, 2001, the merged ESOP restructured its indirect loan from the Company to extend the maturity date to December 31, 2017. As part of this restructuring, the EDO ESOP bank loan obligation was paid in full on July 30, 2001. As quarterly payments are made under the indirect loan, unallocated common shares in the merged ESOP are committed-to-be-released. The allocation to participants is based on (i) a match of 50% of the first 6% of the participants' 401(k) contributions; (ii) a special allocation for employees who meet certain service requirements (iii) a fixed amount per participant chosen annually; and (iv) any remaining distribution is based on participants' relative compensation. The cost basis of the unearned/unallocated shares is initially recorded as a reduction to shareholders' equity. Compensation expense is recorded based on the market value of the Company's common shares as they are committed-to-be-released. The difference between the market value and the cost basis of the shares is recorded as additional paid-in capital. Dividends on unallocated shares are recorded as compensation expense. In 2003, 2002 and 2001 non-cash ESOP compensation expense recorded by the Company amounted to $3.3 million, $4.0 million, and $1.8 million, respectively. At December 31, 2003, there are 2,330,684 unearned/unallocated shares which have an aggregate market value of $57.5 million and 1,768,349 allocated 51 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) shares. Total principal and interest payments made in 2003, 2002, and 2001 under the merged ESOP indirect loan amounted to $1.7 million, $1.7 million, and $1.1 million, respectively. (11) INCOME TAXES The 2003, 2002 and 2001 significant components of the provision for income taxes attributable to continuing operations are as follows:
2003 2002 2001 ------- ------- ------ (IN THOUSANDS) Federal Current................................................ $12,927 $10,659 $2,345 Deferred............................................... (5,900) (2,503) 5,598 ------- ------- ------ $ 7,027 $ 8,156 $7,943 ------- ------- ------ Foreign Current................................................ 207 -- -- Deferred............................................... 82 -- -- ------- ------- ------ $ 289 $ -- $ -- ------- ------- ------ State Current................................................ $ 3,350 $ 2,667 $1,097 Deferred............................................... (1,022) (481) 170 ------- ------- ------ $ 2,328 $ 2,186 $1,267 ------- ------- ------ Total.................................................... $ 9,644 $10,342 $9,210 ======= ======= ======
The reconciliation of income tax attributable to continuing operations computed at the U.S. Federal tax rate to income tax expense is:
PERCENT OF PRE-TAX EARNINGS ------------------ 2003 2002 2001 ---- ---- ---- Tax at statutory rate....................................... 35.0% 35.0% 35.0% State taxes, net of Federal benefit......................... 5.0 5.0 3.0 Non-deductible goodwill amortization........................ -- -- 1.0 Non-cash ESOP compensation expense.......................... 2.0 3.0 0.5 Foreign sales benefit....................................... (1.3) (1.4) (1.4) Other, net.................................................. 1.1 0.9 0.5 ---- ---- ---- Effective income tax rate................................... 41.8% 42.5% 38.6% ==== ==== ====
52 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The significant components of deferred tax assets and liabilities as of December 31 are as follows:
2003 2002 ------- ------- (IN THOUSANDS) DEFERRED TAX ASSETS Retirement plans' additional minimum liability.............. $20,442 $23,617 Post-retirement benefits obligation other than pensions..... 5,233 5,001 Deferred revenue............................................ 1,697 980 Deferred compensation....................................... 3,614 2,843 Inventory valuation......................................... 1,897 2,242 Other....................................................... 404 99 ------- ------- Total deferred tax assets................................... 33,287 34,782 ------- ------- DEFERRED TAX LIABILITIES Depreciation and amortization............................... 4,306 7,946 Prepaid pension asset....................................... 3,613 3,175 ------- ------- Total deferred tax liabilities.............................. 7,919 11,121 ------- ------- Net deferred tax asset...................................... $25,368 $23,661 ======= =======
(12) SHAREHOLDERS' EQUITY On October 31, 2001, the Company completed the public sale of 3,716,100 of its common shares and received net proceeds of approximately $81.5 million. At various times beginning in 1983, the Board of Directors has authorized and subsequently increased by amendments, a plan to purchase an aggregate amount of 4,190,000 common shares. As of December 31, 2003, the Company had acquired approximately 4,091,000 common shares in open market transactions at prevailing market prices. Approximately 4,041,000 of these shares have been used for various purposes, including: conversion of preferred shares; contributions of common shares to the EDO ESOP; grants pursuant to the Company's Long-Term Incentive Plans; payment of directors' fees; partial payment of a 50% stock dividend; and stock options exercised. As of December 31, 2003 and 2002, respectively, the Company held 88,128 and 94,322 common shares in its treasury for future use. At December 31, 2003, the Company had reserved 6,113,646 authorized and unissued common shares for stock option and long-term incentive plans and conversion of the Notes. 53 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (13) EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
2003 2002 2001 ------- ------- ------- (IN THOUSANDS) Numerator: Earnings from continuing operations available for common shares for basic calculation................ $13,411 $10,629 $14,485 Effect of dilutive securities: Convertible debentures............................. -- -- 998 Convertible preferred shares....................... -- -- 5 ------- ------- ------- Numerator for diluted calculation..................... $13,411 $10,629 $15,488 ======= ======= ======= Denominator: Denominator for basic calculation..................... 17,308 17,080 12,776 Effect of dilutive securities: Stock options...................................... 253 299 270 Convertible preferred shares....................... -- -- 153 Convertible debentures............................. -- -- 1,055 ------- ------- ------- Denominator for diluted calculation................... 17,561 17,379 14,254 ======= ======= =======
The assumed conversion of the Notes was anti-dilutive for 2002 and 2003. The following table summarizes, for each year presented, the number of shares excluded from the computation of diluted earnings per share, as their effect upon potential issuance was anti-dilutive.
FOR THE YEARS ENDED DECEMBER 31, -------------------- 2003 2002 2001 ----- ----- ---- (IN THOUSANDS) 5.25% Convertible Subordinated Notes........................ 4,408 3,285 -- Unexercised Stock Options................................... 311 326 4 ----- ----- ---- 4,719 3,611 4 ===== ===== ====
(14) STOCK PLANS The Company has granted nonqualified stock options to officers, directors and other key employees under plans approved by the shareholders in 2002 for the purchase of its common shares at the fair market value of the common shares on the dates of grant. Options under the 2002 Long-Term Incentive Plan ("LTIP") generally become exercisable on the third anniversary of the date of the grant and expire on the tenth anniversary of the date of the grant. The 2002 LTIP will expire in 2012. Options under the 2002 Non-Employee Director Stock Option Plan ("NEDSOP"), which pertains only to non-employee directors, are immediately exercisable and expire on the tenth anniversary of the date of the grant. The 2002 NEDSOP will also expire in 2012. 54 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Changes in options outstanding are as follows:
2003 2002 2001 ---------------------- ---------------------- ---------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE SHARES AVERAGE SHARES AVERAGE SHARES EXERCISE SUBJECT TO EXERCISE SUBJECT TO EXERCISE SUBJECT TO PRICE OPTION PRICE OPTION PRICE OPTION --------- ---------- --------- ---------- --------- ---------- Beginning of year..... $13.59 1,057,143 $ 7.75 805,876 $6.46 848,211 Options granted....... 19.00 224,405 26.72 327,850 9.76 275,350 Options exercised..... 6.66 (37,327) 6.98 (69,433) 6.02 (314,458) Options expired/cancelled... 18.53 (38,125) 22.02 (7,150) 7.08 (3,227) ------ --------- ------ --------- ----- -------- End of year........... $14.65 1,206,096 $13.59 1,057,143 $7.75 805,876 ------ --------- ------ --------- ----- -------- Exercisable at year end................. $11.26 602,916 $10.70 490,243 $6.76 455,426 ====== ========= ====== ========= ===== ========
The options outstanding as of December 31, 2003 are summarized as follows:
WEIGHTED- NUMBER OF WEIGHTED- RANGE OF AVERAGE OPTIONS AVERAGE EXERCISE PRICES EXERCISE PRICE OUTSTANDING REMAINING LIFE --------------- -------------- ----------- -------------- $3.07-5.69..................................... $ 3.88 31,500 1 year 6.13-9.60...................................... 7.90 645,591 6 years 17.10-31.40.................................... 23.54 529,005 9 years --------- 1,206,096 =========
The 2002 plan also provides for restricted common share long-term incentive awards as defined under the plan. As of December 31, 2003 plan participants had been awarded 405,000 restricted common shares. Deferred compensation is recorded for the fair value of the restricted common share awards on the date of grant and is amortized over the five-year period the related services are provided. The fair value of a restricted common share award is calculated as the average of the high and low market values of our common shares on the grant date, as reported for such date on a national exchange or nationally recognized system of price quotation. In the event that there are no transactions reported on such exchange or system on such date, the average would be based on the high and low market values of our common shares on the immediately preceding date. The amount charged to operations in 2003, 2002 and 2001 was $0.3 million, $0.2 million and $0.3 million, respectively. As of December 31, 2003, 499,361 shares are available for additional awards. (15) OTHER EMPLOYEE BENEFIT PLANS DEFINED BENEFIT PLANS The Company maintains a qualified noncontributory defined benefit pension plan covering less than one half of its employees. In November 2002, the plan was amended whereby benefits accrued under the plan were frozen as of December 31, 2002. The Company's funding policy is to make annual contributions to the extent such contributions are actuarially determined and tax deductible. In 2003, the Company recorded pension expense of $3.9 million. In 2002, the Company recorded pension expense of $6.0 million, which included a curtailment loss of $2.0 million resulting from the aforementioned amendment to the plan. In 2001, the Company recorded pension income of $2.8 million. 55 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of the assumptions used in pension calculations follows:
WEIGHTED-AVERAGE RATE ASSUMPTIONS AS OF DECEMBER 31 ---------------------------------- 2004 2003 2002 2001 ------- ------- ----- ------ Discount Rate (for obligations as of Dec 31)......... n/a 6.25% 6.75% 7.25% Expected long-term return on plan assets............. 8.25% 8.75% 9.50% 10.00% Rate of compensation increase........................ Note 1 Note 1 4.95% 4.95%
--------------- Note 1: The Company froze the Defined Benefit plan in December 2002, therefore there is no future compensation increase for subsequent years. The expected long-term rate of return on plan assets to be used for 2004 expense is 8.25% as shown above. This rate of return was determined by application of a statistical forecast modeling algorithm which, using the pension investment mix and pension demographic data, simulates the long term performance of the plan over a series of 2000 trials of variable economic conditions, rounded to the nearest quarter-percent. The resulting rate is a 50 basis-point reduction in the forecast from the previous year. Previously, the company used the building block approach to the estimation of the long-term rate of return on assets. Under this approach, the Company reviewed the publicly available common source data for the range of returns on basic types of equity and fixed income instruments and the differential to those rates provided by active investment management. In consultation with the Company's actuarial and active asset management consultants and taking into account the funds' actual performance and expected asset allocation going forward, the Company selected an overall return rate within the resulting range. Plan asset investment decisions are made by the Pension Investment Committee of the Board of Directors. This committee utilizes the services of a financial advisor in the selection and monitoring of specific asset managers. At its periodic meetings the committee reviews the performance of various funds against benchmarks and makes investment decisions which are then carried out by the fund trustee. The target asset allocation is 65% equity instruments and 35% fixed income instruments. Each asset class has a minimum and maximum range as follows: For equity-based securities -- a minimum of 60% and a maximum of 70%; for fixed-income-based securities -- a minimum of 30% and a maximum of 40%. The plan may also have a minimum of 0% and a maximum of 5% in cash and cash equivalents. The assets are invested in a variety of both actively managed and passive funds chosen by the committee. The investment mix of plan assets as of December 31 in each year was:
AS OF DECEMBER 31 --------------------- 2003 2002 2001 ----- ----- ----- (AS A % OF PLAN ASSET FAIR VALUE) Equity Securities........................................... 69.7% 65.0% 66.9% Debt Securities............................................. 29.7% 34.4% 33.1% Cash........................................................ 0.6% 0.6% 0.0% ----- ----- ----- Total....................................................... 100.0% 100.0% 100.0% ===== ===== =====
In 2003, the Company made a $5.0 million contribution to the plan. With regard to the Company's planned contributions in the next calendar year, the Company does not foresee any required or voluntary contributions. 56 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of the components of net periodic pension (expense) income follows:
2003 2002 2001 -------- -------- -------- (IN THOUSANDS) Service cost......................................... $ -- $ (4,353) $ (3,693) Interest on projected benefit obligation............. (12,727) (15,091) (14,281) Expected return on plan assets....................... 12,250 17,217 20,820 Amortization of transitional assets.................. -- -- 8 Amortization of prior service cost................... -- (261) (85) Recognized net actuarial loss........................ (3,454) (1,476) -- Curtailment loss..................................... -- (1,998) -- -------- -------- -------- Net pension (expense) income......................... $ (3,931) $ (5,962) $ 2,769 ======== ======== ========
The following sets forth the funded status of the plan as of December 31:
2003 2002 -------- -------- (IN THOUSANDS) Change in projected benefit obligation: Projected benefit obligation at beginning of year........... $197,188 $214,273 Service cost................................................ -- 4,353 Interest cost............................................... 12,727 15,091 Benefits paid............................................... (20,058) (17,279) Actuarial loss.............................................. 14,582 12 Effect of curtailment....................................... -- (19,262) -------- -------- Projected benefit obligation at end of year................. $204,439 $197,188 -------- -------- Change in plan assets: Fair value of plan assets at beginning of year.............. $148,635 $187,350 Actual return on plan assets................................ 30,447 (21,436) Employer contribution....................................... 5,000 -- Benefits paid............................................... (20,058) (17,279) -------- -------- Fair value of plan assets at end of year.................... $164,024 $148,635 -------- -------- Funded status............................................... $(40,415) $(48,553) Unrecognized net loss....................................... 48,362 55,432 -------- -------- Prepaid pension cost........................................ $ 7,947 $ 6,879 ======== ========
In accordance with the provisions of SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Plans and for Termination Benefits," since the curtailment of $19.3 million did not exceed the previous unrecognized net loss, no portion of the $19.3 million curtailment was recognized in earnings for 2002. Accordingly, the remaining unrecognized net loss will be accounted for in future pension plan expense consistent with SFAS No. 87, "Employers' Accounting for Pensions." Due to the lower discount rate offset by fund performance and Company contributions in 2003, the accumulated benefit obligation at December 31, 2003 and 2002 exceeded the fair value of plan assets by $40.4 million and $48.6 million, respectively. The Company recorded an additional minimum liability of $48.4 million and $55.4 million in 2003 and 2002, respectively, and net of tax comprehensive income of 57 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) $4.2 million and loss of $19.8 million were charged against shareholders' equity in 2003 and 2002, respectively. Amounts recognized in the consolidated balance sheets at December 31 are as follows:
2003 2002 -------- -------- (IN THOUSANDS) Prepaid pension cost (included in other assets)............. $ 7,947 $ 6,879 ======== ======== Additional minimum liability (included in post-retirement benefits obligations)..................................... $(48,362) $(55,432) ======== ======== Accumulated other comprehensive loss (included in shareholders' equity)..................................... $ 48,362 $ 55,432 ======== ========
NON-QUALIFIED PLANS The Company has a supplemental defined benefit plan for employees with long term service at AIL and EDO under which employees may receive an amount by which benefits earned under the pension plan exceed the limitations imposed by the Internal Revenue Code. The Company also has a supplemental retirement plan for officers and certain employees. Benefits are based on years of service and certain compensation that is excluded under the qualified plan. In November 2003 the plan was amended whereby benefits under the plan were frozen for all but two individuals as of December 31, 2003. Consequently, a curtailment charge of $0.9 million was recorded. The plan is unfunded and has no assets. The following is a table of the weighted average assumptions as of December 31 on each year:
RATE 2003 2002 2001 ---- ---- ---- ---- Discount Rate............................................... 6.25% 6.75% 7.25% Expected rate of Return on Assets........................... n/a n/a n/a Rate of Compensation Increase............................... 5.00% 4.95% 4.95%
Total expenses under the non-qualified plans in 2003, 2002 and 2001 were $2.6 million, $1.4 million and $0.7 million, respectively. The supplemental plans of EDO and AIL were combined in 2001. A summary of the components of net periodic pension expense follows:
2003 2002 ------ ------ (IN THOUSANDS) Service cost................................................ $ 372 $ 190 Interest on projected benefit obligation.................... 802 815 Amortization of transitional assets......................... 3 32 Amortization of prior service cost.......................... 184 141 Recognized net actuarial loss............................... 273 225 Effect of curtailment....................................... 942 -- ------ ------ Net pension expense......................................... $2,576 $1,403 ====== ======
58 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Summarized below is the funded status of the combined supplemental plans as of December 31:
2003 2002 -------- -------- (IN THOUSANDS) Change in projected benefit obligation: Projected benefit obligation at beginning of year........... $ 13,047 $ 11,538 Service cost................................................ 372 190 Interest cost............................................... 802 815 Benefits paid............................................... (987) (847) Actuarial loss.............................................. 158 951 Plan amendments............................................. -- 400 Effect of curtailment....................................... (1,752) -- -------- -------- Projected benefit obligation at end of year................. $ 11,640 $ 13,047 -------- -------- Change in plan assets: Fair value of plan assets at beginning of the year.......... $ -- $ -- Employer contribution....................................... 987 847 Benefits paid............................................... (987) (847) -------- -------- Fair value of plan assets at end of year.................... $ -- $ -- -------- -------- Funded status............................................... $(11,640) $(13,047) Unrecognized net loss....................................... 2,338 4,204 Unrecognized prior service cost............................. 558 1,684 Unrecognized net obligation................................. 7 10 -------- -------- Accrued benefit cost........................................ $ (8,737) $ (7,149) ======== ========
The accumulated benefit obligation at December 31, 2003 and 2002 exceeded the fair value of plan assets by $10.8 million and $11.0 million, respectively. The Company recorded an additional minimum liability of $2.1 million and $3.9 million in 2003 and 2002, respectively, and net of tax comprehensive income of $0.4 million and loss of $0.8 million were charged against shareholders' equity in 2003 and 2002, respectively. Amounts recognized in the consolidated balance sheets at December 31 are as follows:
2003 2002 ------- ------- (IN THOUSANDS) Accrued benefit cost (included in post-retirement benefits obligation)............................................... $(8,737) $(7,149) ======= ======= Intangible asset (included in other assets)................. $ 565 $ 1,694 ======= ======= Additional minimum liability (included in post-retirement benefits obligations)..................................... $(2,062) $(3,864) ======= ======= Accumulated other comprehensive loss (included in shareholders' equity)..................................... $ 1,497 $ 2,170 ======= =======
401(K) PLANS The Company sponsors a 401(k) plan covering substantially all employees which provides for a match by the Company of 50% of the first 6% of employee contributions. The match is provided in the Company's common stock under the ESOP plan. 59 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (16) POST-RETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS The Company provides certain health care and life insurance benefits to qualified retired employees and dependents at certain locations. These benefits are funded as benefits are provided, with the retiree paying a portion of the cost through contributions, deductibles and coinsurance provisions. The Company has always retained the right to modify or terminate the plans providing these benefits. In accordance with SFAS No. 106, "Employers' Accounting for Post-Retirement Benefits Other Than Pensions," the Company recognizes these benefit expenses on an accrual basis as the employees earn them during their employment rather than when they are actually paid. EDO POST-RETIREMENT BENEFIT PLAN Post-retirement health care and life insurance expense (income) included the following components:
2003 2002 2001 ---- ---- ----- (IN THOUSANDS) Service cost................................................ $ -- $ -- $ 69 Interest cost............................................... 126 171 229 Curtailment gain............................................ -- -- (929) ---- ---- ----- Total post-retirement health care and life insurance expense (income).................................................. $126 $171 $(631) ==== ==== =====
In 2001, the Company recognized a curtailment gain as a result of a plan amendment whereby coverage will not be provided for future retirees. The funded status of the EDO post-retirement health care and life insurance benefits plan is as follows as of December 31:
2003 2002 ------ ------ (IN THOUSANDS) Change in accumulated post-retirement benefit obligation: Accumulated benefit obligation at beginning of year....... $2,113 $2,317 Interest cost............................................. 126 171 Benefits paid............................................. (432) (448) Participant contributions................................. 27 31 Actuarial loss............................................ 608 42 ------ ------ Unfunded accumulated post-retirement benefit obligation at end of year............................................... $2,442 $2,113 Unrecognized net (loss) gain................................ (569) 39 ------ ------ Accrued post-retirement benefit cost........................ $1,873 $2,152 ====== ======
Actuarial assumptions used in determining the accumulated post-retirement benefit obligation include a discount rate of 6.25% and 6.75% at December 31, 2003 and 2002, respectively, and estimated increases in health care costs. The Company has limited its increase in health care costs to 5% per year by requiring the retirees to absorb any costs in excess of 5% and has used such rate to measure its obligation. Since no increase above the said 5% rate is possible no effect would take place if the actual rate were above the assumed rate. A 1% decrease in the trend rate would decrease the benefit obligation at the end of the year by approximately $13,000 and the interest cost by $1,000. 60 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) AIL POST-RETIREMENT BENEFIT PLAN Post-retirement expense included in the consolidated financial statements comprised the following:
2003 2002 2001 ------ ----- ---- (IN THOUSANDS) Service cost................................................ $ 453 $ 313 $ 86 Interest cost............................................... 765 431 663 Recognized net actuarial loss (gain)........................ 40 (269) (11) ------ ----- ---- Total post-retirement expense............................... $1,258 $ 475 $738 ====== ===== ====
The funded status of the AIL post-retirement benefit plan is as follows as of December 31:
2003 2002 ------- ------- (IN THOUSANDS) Change in accumulated post-retirement benefit obligation: Accumulated benefit obligation.............................. $11,771 $ 8,737 Service cost................................................ 453 313 Interest cost............................................... 765 431 Benefits paid............................................... (441) (449) Actuarial (gain) loss....................................... (291) 2,739 ------- ------- Unfunded accumulated post-retirement benefit obligation at end of year............................................... $12,257 $11,771 Unrecognized loss........................................... (1,394) (1,725) ------- ------- Accrued post-retirement benefit cost........................ $10,863 $10,046 ======= =======
Actuarial assumptions used in determining the accumulated post-retirement benefit obligation include a discount rate of 6.25% and 6.75% at December 31, 2003 and 2002, respectively. The accumulated benefit obligation would not be affected by increases in healthcare costs for retirees since such costs are funded by the participants. Healthcare trend costs will only affect the amounts related to disabled participants. An increase of 1% in the trend rate would increase the benefit obligation at the end of the year by approximately $0.5 million and the interest cost and service cost by approximately $58,000. A decrease of 1% in the trend rate would decrease the benefit obligation at the end of the year by approximately $0.5 million and interest cost and service cost by approximately $52,000. 61 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (17) COMMITMENTS AND CONTINGENCIES In order to aggregate all commitments and contractual obligations as of December 31, 2003, the following table is included. The Company is obligated under building and equipment leases expiring between 2004 and 2012. The aggregate future minimum lease commitments under those obligations with noncancellable terms in excess of one year are shown below. The Company's commitments under letters of credit and advance payment and performance bonds relate primarily to advances received on foreign contracts which would be paid only if the Company failed to perform in accordance with the contract terms. The Company does not expect to have to make payments under these letters of credits 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: -------------------------------------------------------- 2009 AND TOTAL 2004 2005 2006 2007 2008 BEYOND ------ ----- ----- ---- ------ ---- -------- (IN MILLIONS) 5.25% Convertible Subordinated Notes due 2007................................... $137.8 $ -- $ -- $ -- $137.8 $ -- $ -- Operating leases......................... 72.1 13.6 11.0 7.8 6.8 6.3 26.6 Letters of credit........................ 53.7 26.0 27.4 -- -- 0.3 -- Advance payment and performance bonds.... 1.9 0.2 -- -- -- -- 1.7 ------ ----- ----- ---- ------ ---- ----- Total.................................... $265.5 $39.8 $38.4 $7.8 $144.6 $6.6 $28.3 ====== ===== ===== ==== ====== ==== =====
Rental expense for the years ended December 31, 2003, 2002 and 2001 amounted to $10.7 million, $5.4 million and $4.7 million, respectively. (18) LEGAL MATTERS The Company and three other companies entered into a consent decree in 1990 with the Federal government for the remediation of a Superfund site. The Superfund site has been divided into three operable units. The consent decree relates to two of the operable units. The third operable unit has not been formally studied and, accordingly, no liability has been recorded by the Company. The Company believes that the aggregate amount of the obligation and timing of cash payments associated with the two operable units subject to the consent decree are reasonably fixed and determinable. Accordingly, the environmental obligation has been discounted at five percent. Management estimates that as of December 31, 2003, the discounted liability over the remainder of the twenty two years related to these two operable units is approximately $2.0 million of which approximately $0.3 million has been classified as current and is included in accrued liabilities. Approximately $0.6 million of the $2.0 million liability will be incurred over the next five years. The Company is also involved in other environmental cleanup efforts, none of which management believes is likely to have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. Additionally, the Company and its subsidiaries are subject to certain legal actions that arise out of the normal course of business. It is management's belief that the ultimate outcome of these actions will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. (19) BUSINESS SEGMENTS The Company determines its operating segments based upon an analysis of its products and services, production processes, types of customers, economic characteristics and the related regulatory environment, which is consistent with how management operates the Company. The Company's continuing operations are 62 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) conducted in three business 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. Domestic U.S. Government sales, which include sales to prime contractors of the U.S. Government, amounted to 76%, 75% and 69% of net sales, which were 80%, 82% and 77% of Defense's net sales, 71%, 62% and 55% of Communications and Space Products' net sales and 49%, 42% and 41% of Engineered Materials' net sales for 2003, 2002 and 2001, respectively. International sales comprised 18%, 15% and 15% of net sales for 2003, 2002 and 2001, respectively. In addition, the Universal Exciter Upgrade program in the Defense segment comprised approximately 2%, 14% and 15% of net sales for 2003, 2002 and 2001, respectively. Principal products and services by segment are as follows: DEFENSE SEGMENT - Electronic Warfare - Reconnaissance and Surveillance Systems - Integrated Combat Systems - Mobile Communication Systems - Rugged Computer and Electronics - Aircraft Armament - Undersea Warfare Sonar Systems - Airborne Mine Countermeasures Systems - Sonar Systems - Professional Services COMMUNICATIONS AND SPACE PRODUCTS SEGMENT - Antenna Products - Interference Cancellation - Force Protection Technology ENGINEERED MATERIALS SEGMENT - Electro-Ceramic Products - Integrated Composite Structures Products 63 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Information by segment on sales, operating earnings, identifiable assets, depreciation and amortization, and capital expenditures is as follows for each of the three years ended December 31:
2003 2002 2001 -------- -------- -------- (IN THOUSANDS) Net sales: Defense............................................ $360,001 $243,447 $183,454 Communications and Space Products.................. 55,458 47,262 39,998 Engineered Materials............................... 45,208 38,167 36,509 -------- -------- -------- $460,667 $328,876 $259,961 -------- -------- -------- Operating earnings: Defense............................................ $ 35,062 $ 28,674 $ 21,927 Communications and Space Products.................. 3,583 (441) (383) Engineered Materials............................... 2,385 3,150 4,603 Impairment loss on Deer Park facility.............. (9,160) -- -- Curtailment (loss) gain............................ (942) (1,998) 929 -------- -------- -------- $ 30,928 $ 29,385 $ 27,076 Net interest expense................................. (8,152) (4,956) (2,216) Other expense, net................................... 279 (95) (971) -------- -------- -------- Earnings from continuing operations before income taxes and cumulative effect of a change in accounting principle............................... $ 23,055 $ 24,334 $ 23,889 -------- -------- -------- Identifiable assets: Defense............................................ $303,881 $224,017 $129,631 Communications and Space Products.................. 34,684 40,001 49,769 Engineered Materials............................... 30,482 28,496 27,690 Corporate.......................................... 125,649 189,060 78,540 -------- -------- -------- $494,696 $481,574 $285,630 -------- -------- -------- Depreciation and amortization: Defense............................................ $ 12,551 $ 7,440 $ 6,081 Communications and Space Products.................. 2,335 1,895 2,438 Engineered Materials............................... 1,893 1,800 2,029 Corporate.......................................... 286 186 848 -------- -------- -------- $ 17,065 $ 11,321 $ 11,396 -------- -------- -------- Capital expenditures: Defense............................................ $ 4,309 $ 3,587 $ 7,896 Communications and Space Products.................. 956 816 4,308 Engineered Materials............................... 2,347 1,819 1,479 Corporate.......................................... 1,253 871 615 -------- -------- -------- $ 8,865 $ 7,093 $ 14,298 ======== ======== ========
64 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Acquisition-related costs in 2003 and 2002, including IPR&D, attributable to the Condor acquisition and in 2001 attributable to the EDO-AIL merger are included in the segments as follows:
2003 2002 2001 ---- ---- ------ (IN THOUSANDS) Defense..................................................... $929 $567 $ 937 Communications and Space Products........................... -- -- 184 Engineered Materials........................................ -- -- 197 ---- ---- ------ Total....................................................... $929 $567 $1,318 ==== ==== ======
(20) GUARANTOR AND NON-GUARANTOR SUBSIDIARIES The Company may, from time to time, issue indebtedness, a condition of which would be the guarantee of this indebtedness by certain of its subsidiaries. Presented below is condensed consolidating financial information for the Company and the contemplated subsidiary guarantors and non-guarantors at December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003. There were no subsidiaries that would have been non-guarantor subsidiaries for 2002 and 2001. Each contemplated subsidiary guarantor is 100% owned, directly or indirectly, by the Company. Any guarantees that may be issued will be full and unconditional, as well as joint and several. In connection with the Company's credit facility, 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. 65 EDO CORPORATION CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2003
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- -------------- ------------ ------------ ASSETS Current assets: Cash and cash equivalents.... $ 69,877 $ 11,371 $ 5,168 -- $ 86,416 Marketable securities........ 216 -- -- -- 216 Accounts receivable, net..... 29,087 101,233 3,984 (1) 134,303 Inventories.................. 5,320 26,124 3,289 -- 34,733 Deferred income tax asset, net........................ 3,594 -- -- -- 3,594 Prepayments and other........ 2,610 3,014 330 -- 5,954 -------- -------- ------- --------- -------- Total current assets......... 110,704 141,742 12,771 (1) 265,216 Investment in subsidiaries... 261,950 -- -- (261,950) -- Property, plant and equipment, net............. 6,966 20,674 3,715 -- 31,355 Notes receivable............. 6,538 -- -- -- 6,538 Goodwill..................... -- 82,919 9,608 -- 92,527 Other intangible assets, net........................ -- 42,276 13,622 -- 55,898 Deferred income tax asset, net........................ 21,774 -- -- -- 21,774 Other assets................. 19,850 1,538 -- -- 21,388 -------- -------- ------- --------- -------- $427,782 $289,149 $39,716 $(261,951) $494,696 ======== ======== ======= ========= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities................ $ 34,061 $ 44,679 $ 6,004 $ (1) 84,743 Contract advances and deposits................... 2,788 5,407 -- -- 8,195 -------- -------- ------- --------- -------- Total current liabilities.... 36,849 50,086 6,004 (1) 92,938 Long-term debt............... 137,800 -- -- -- 137,800 Deferred income tax liabilities, net........... (82) -- 82 -- -- Post retirement benefits obligations................ 61,035 10,863 -- -- 71,898 Environmental obligation..... 1,728 -- -- -- 1,728 Intercompany accounts........ -- 126,326 26,611 (152,937) -- Shareholders' equity: Preferred shares............. -- -- -- -- -- Common shares................ 19,832 99 -- (99) 19,832 Additional paid-in capital... 150,097 25,221 6,486 (31,707) 150,097 Retained earnings............ 69,059 80,878 548 (81,426) 69,059 Accumulated other comprehensive loss, net of income tax benefit......... (29,512) 79 (15) 167 (29,281) Treasury shares.............. (1,255) (4,052) 4,052 (1,255) Unearned ESOP shares......... (17,290) -- -- -- (17,290) Management group receivables................ -- (351) -- -- (351) Deferred compensation under Long-Term Incentive Plan... (479) -- -- -- (479) -------- -------- ------- --------- -------- Total shareholders' equity... 190,452 101,874 7,019 (109,013) 190,332 -------- -------- ------- --------- -------- $427,782 $289,149 $39,716 $(261,951) $494,696 ======== ======== ======= ========= ========
66 EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS DECEMBER 31, 2003
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- -------------- ------------ ------------ Continuing Operations: Net Sales.................... $91,420 $371,306 $16,047 $(18,106) $460,667 Costs and expenses: Cost of sales................ 76,684 271,384 8,297 (18,106) 338,259 Selling, general and administrative............. 5,420 60,132 6,303 -- 71,855 Research and development..... 2,970 5,210 414 -- 8,594 Acquisition-related costs.... 250 679 -- -- 929 Benefit plan curtailment loss....................... 942 -- -- -- 942 Impairment loss on Deer Park facility................... -- 9,160 -- -- 9,160 ------- -------- ------- -------- -------- 86,266 346,565 15,014 (18,106) 429,739 ------- -------- ------- -------- -------- Operating Earnings........... 5,154 24,741 1,033 -- 30,928 Non-operating income (expense) Interest income.............. 630 282 29 -- 941 Interest expense............. (9,093) -- -- -- (9,093) Other, net................... (42) 321 -- -- 279 ------- -------- ------- -------- -------- (8,505) 603 29 -- (7,873) (Loss) earnings from continuing operations before income taxes........ (3,351) 25,344 1,062 -- 23,055 Income tax (benefit) expense.................... (1,068) 10,198 514 -- 9,644 ------- -------- ------- -------- -------- (Loss) earnings from continuing operations...... (2,283) 15,146 548 -- 13,411 Equity in undistributed earnings of subsidiaries... 15,694 -- -- (15,694) -- ------- -------- ------- -------- -------- 13,411 15,146 548 (15,694) 13,411 Earnings from discontinued operations................. 1,398 -- -- -- 1,398 ------- -------- ------- -------- -------- Net earnings................. $14,809 $ 15,146 $ 548 $(15,694) $ 14,809 ======= ======== ======= ======== ========
67 EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS DECEMBER 31, 2003
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- -------------- ------------ ------------ Operating Activities: Earnings from continuing operations.......... $ 13,411 $ 15,146 $ 548 $(15,694) $ 13,411 Adjustments to earnings to arrive at cash provided (used) by continuing operations: Depreciation................................. 1,748 10,082 350 -- 12,180 Amortization................................. 0 4,466 419 -- 4,885 Deferred tax benefit......................... (7,227) 387 -- -- (6,840) Bad debt expense............................. -- 568 -- -- 568 Loss (gain) on sale of property, plant and equipment.................................. 6 (137) -- -- (131) Impairment loss on assets held for sale...... 9,160 -- -- 9,160 Deferred compensation expense................ 289 -- -- -- 289 Non-cash Employee Stock Ownership Plan compensation expense....................... 3,281 -- -- -- 3,281 Non-cash stock option compensation expense... 292 -- -- -- 292 Dividends on unallocated Employee Stock Ownership Plan shares...................... 292 -- -- -- 292 Common shares issued for directors' fees..... 108 -- -- -- 108 Income tax benefit from stock options........ 328 -- -- -- 328 Changes in operating assets and liabilities, excluding effects of acquisitions: Equity in earnings of subsidiaries........... (15,694) -- -- 15,694 -- Intercompany................................. 33,636 (36,859) 3,223 -- -- Accounts receivable.......................... (4,500) 217 1,080 -- (3,203) Inventories.................................. (4,228) 5,190 444 -- 1,406 Prepayments and other assets................. 4,334 (295) (7) -- 4,032 Contribution to defined benefit pension plan....................................... (5,000) -- -- -- (5,000) Accounts payable, accrued liabilities and other...................................... 22,406 (27,447) (361) -- (5,402) Contract advances and deposits............... (8,297) (3,785) -- -- (12,082) -------- -------- ------ -------- -------- Cash provided (used) by continuing operations................................. 35,185 (23,307) 5,696 -- 17,574 Net cash provided by discontinued operations................................. 79 -- -- -- 79 Investing Activities: Purchase of plant and equipment.............. (3,224) (5,113) (528) -- (8,865) Proceeds from sale of property, plant and equipment.................................. -- 21,304 -- -- 21,304 Payments received on notes receivable........ 300 1,085 -- -- 1,385 Purchase of marketable securities............ (23) -- -- -- (23) Restricted cash.............................. 27,347 -- -- -- 27,347 Cash paid for acquisitions, net of cash acquired................................... (94,188) -- -- -- (94,188) -------- -------- ------ -------- -------- Cash (used) provided by investing activities................................. (69,788) 17,276 (528) -- (53,040) Financing Activities: Proceeds from exercise of stock options...... 268 -- -- -- 268 Proceeds from management group receivables... -- 242 -- -- 242 Repayments of acquired debt.................. (8,660) -- -- -- (8,660) Payment of common share cash dividends....... (2,367) -- -- -- (2,367) -------- -------- ------ -------- -------- Cash (used) provided by financing activities................................. (10,759) 242 -- -- (10,517) -------- -------- ------ -------- -------- Net decrease in cash and cash equivalents.... (45,283) (5,789) 5,168 -- (45,904) Cash and cash equivalents at beginning of year....................................... 115,160 17,160 -- -- 132,320 -------- -------- ------ -------- -------- Cash and cash equivalents at end of year..... $ 69,877 $ 11,371 $5,168 $ -- $ 86,416 ======== ======== ====== ======== ========
68 EDO CORPORATION CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2002
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- ------------ ------------ ASSETS Current assets: Cash and cash equivalents.................. $115,160 $ 17,160 -- $132,320 Restricted cash............................ 27,347 -- -- 27,347 Marketable securities...................... 193 -- -- 193 Accounts receivable, net................... 24,587 76,001 6 100,594 Inventories................................ 1,092 31,314 -- 32,406 Deferred income tax asset, net............. (10,202) 13,424 -- 3,222 Prepayments and other...................... 1,296 1,837 -- 3,133 -------- -------- --------- -------- Total current assets....................... 159,473 139,736 6 299,215 Investment in subsidiaries................. 192,099 -- (192,099) -- Property, plant and equipment, net......... 5,495 58,977 -- 64,472 Notes receivable........................... 1,525 1,031 -- 2,556 Goodwill................................... -- 61,352 -- 61,352 Other intangible assets, net............... -- 11,867 -- 11,867 Deferred income tax asset, net............. 20,439 -- - 20,439 Other assets............................... 20,467 1,206 -- 21,673 -------- -------- --------- -------- $399,498 $274,169 $(192,093) $481,574 ======== ======== ========= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities... $ 23,438 $ 51,112 $ 6 $ 74,556 Contract advances and deposits............. 11,085 9,192 20,277 -------- -------- --------- -------- Total current liabilities.................. 34,523 60,304 6 94,833 Long-term debt............................. 137,800 -- -- 137,800 Deferred income tax liabilities, net....... (12,227) 12,227 -- 0 Post retirement benefits obligations....... 68,597 10,046 -- 78,643 Environmental obligation................... 2,025 -- 2,025 Intercompany accounts...................... -- 111,690 (111,690) -- Shareholders' equity: Preferred shares........................... -- -- -- -- Common shares.............................. 19,790 93 (93) 19,790 Additional paid-in capital................. 147,091 14,708 (14,708) 147,091 Retained earnings.......................... 56,325 65,732 (65,732) 56,325 Accumulated other comprehensive loss, net of income tax benefit.................... (33,985) 86 -- (33,899) Treasury shares............................ (1,321) (124) 124 (1,321) Unearned ESOP shares....................... (18,541) -- (18,541) Management group receivables............... -- (593) -- (593) Deferred compensation under Long-Term Incentive Plan........................... (579) -- -- (579) -------- -------- --------- -------- Total shareholders' equity................. 168,780 79,902 (80,409) 168,273 -------- -------- --------- -------- $399,498 $274,169 $(192,093) $481,574 ======== ======== ========= ========
69 EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS DECEMBER 31, 2002
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- ------------ ------------ Continuing Operations: Net Sales.................................. $87,154 $254,772 $(13,050) $328,876 Costs and expenses: Cost of sales.............................. 68,827 185,073 (13,050) 240,850 Selling, general and administrative........ 5,891 41,693 -- 47,584 Research and development................... 3,698 4,794 -- 8,492 Write-off of purchased in-process research and development and related costs........ 42 525 -- 567 Defined benefit pension plan curtailment loss..................................... 1,998 -- -- 1,998 ------- -------- -------- -------- 80,456 232,085 (13,050) 299,491 ------- -------- -------- -------- Operating Earnings......................... 6,698 22,687 -- 29,385 Non-operating income (expense) Interest income............................ 1,515 214 -- 1,729 Interest expense........................... (6,685) -- -- (6,685) Other, net................................. (301) 206 -- (95) ------- -------- -------- -------- (5,471) 420 -- (5,051) Earnings from continuing operations before income taxes............................. 1,227 23,107 -- 24,334 Income tax expense......................... 1,048 9,294 -- 10,342 ------- -------- -------- -------- Earnings from continuing operations........ 179 13,813 -- 13,992 Equity in undistributed earnings of subsidiaries............................. 10,450 -- (10,450) -- ------- -------- -------- -------- 10,629 13,813 (10,450) 13,992 Cumulative effect of a change in accounting principle, net of tax.................... -- (3,363) -- (3,363) ------- -------- -------- -------- Net earnings............................... $10,629 $ 10,450 $(10,450) $ 10,629 ======= ======== ======== ========
70 EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS DECEMBER 31, 2002
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- ------------ ------------ Operating Activities: Earnings from continuing operations.................. $ 10,629 $10,450 $(10,450) $ 10,629 Adjustments to earnings to arrive at cash provided by continuing operations: Depreciation......................................... 1,751 8,614 -- 10,365 Amortization......................................... -- 956 956 Deferred tax benefit................................. (2,984) -- -- (2,984) Write-off of purchased in-process research and development........................................ -- 150 -- 150 Bad debt expense..................................... -- 407 -- 407 Loss on sale of property, plant and equipment........ -- 53 -- 53 Deferred compensation expense........................ 201 -- -- 201 Non-cash Employee Stock Ownership Plan compensation expense............................................ 4,043 -- -- 4,043 Dividends on unallocated Employee Stock Ownership Plan shares........................................ 312 -- -- 312 Common shares issued for directors' fees............. 142 -- -- 142 Income tax benefit from stock options and Long-Term Incentive Plan..................................... 713 -- -- 713 Cumulative effect of a change in accounting principle.......................................... 3,363 -- -- 3,363 Changes in operating assets and liabilities, excluding effects of acquisitions: Equity in earnings of subsidiaries................... (10,450) -- 10,450 -- Intercompany......................................... 1,412 (1,412) -- -- Accounts receivable.................................. (197) (2,322) -- (2,519) Inventories.......................................... 944 (3,870) -- (2,926) Prepayments and other assets......................... 3,859 (3,639) -- 220 Accounts payable, accrued liabilities and other...... 9,136 (3,919) -- 5,217 Contract advances and deposits....................... (3,484) 7,059 -- 3,575 -------- ------- -------- -------- Cash provided by operations.......................... 19,390 12,527 -- 31,917 Investing Activities: Purchase of plant and equipment...................... (3,099) (3,994) -- (7,093) Payments received on notes receivable................ 300 50 -- 350 Proceeds from sale of property, plant and equipment.......................................... -- 1 1 Purchase of marketable securities.................... (3) -- -- (3) Restricted cash...................................... (27,347) -- -- (27,347) Cash paid for acquisitions, net of cash acquired..... (59,024) -- -- (59,024) -------- ------- -------- -------- Cash used by investing activities.................... (89,173) (3,943) -- (93,116) Financing Activities: Issuance of convertible subordinated notes........... 137,800 -- -- 137,800 Proceeds from exercise of stock options.............. 486 -- -- 486 Proceeds from management group receivables........... -- 252 -- 252 Payment made on note payable......................... (500) -- -- (500) Payment of common share cash dividends............... (2,360) -- -- (2,360) -------- ------- -------- -------- Cash provided by financing activities................ 135,426 252 -- 135,678 -------- ------- -------- -------- Net increase in cash and cash equivalents............ 65,643 8,836 -- 74,479 Cash and cash equivalents at beginning of year....... 49,517 8,324 -- 57,841 -------- ------- -------- -------- Cash and cash equivalents at end of year............. $115,160 $17,160 $ -- $132,320 ======== ======= ======== ========
71 EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS DECEMBER 31, 2001
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- ------------ ------------ Continuing Operations: Net Sales.................................. $86,752 $181,406 $(8,197) $259,961 Costs and expenses: Cost of sales.............................. 62,392 135,538 (8,197) 189,733 Selling, general and administrative........ 4,351 29,662 -- 34,013 Research and development................... 3,803 4,947 -- 8,750 Write-off of merger-related costs.......... 1,318 -- -- 1,318 Postretirement curtailment gain............ (929) -- -- (929) ------- -------- ------- -------- 70,935 170,147 (8,197) 232,885 ------- -------- ------- -------- Operating Earnings......................... 15,817 11,259 -- 27,076 Non-operating income (expense) Interest income............................ 670 245 -- 915 Interest expense........................... (2,456) (675) -- (3,131) Other, net................................. (955) (16) -- (971) ------- -------- ------- -------- (2,741) (446) -- (3,187) Earnings from continuing operations before income taxes............................. 13,076 10,813 -- 23,889 Income tax expense......................... 4,940 4,270 -- 9,210 ------- -------- ------- -------- Earnings from continuing operations........ 8,136 6,543 -- 14,679 Equity in undistributed earnings of subsidiaries............................. 6,543 -- (6,543) -- ------- -------- ------- -------- 14,679 6,543 (6,543) 14,679 Discontinued operations.................... 273 -- -- 273 ------- -------- ------- -------- Net earnings............................... $14,952 $ 6,543 $(6,543) $ 14,952 ======= ======== ======= ========
72 EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS DECEMBER 31, 2001
EDO CORPORATION PARENT COMPANY SUBSIDIARY ONLY GUARANTORS ELIMINATIONS CONSOLIDATED --------------- ---------- ------------ ------------ Operating Activities: Earnings from operations.................................... $ 14,679 $ 6,543 $(6,543) $ 14,679 Adjustments to earnings to arrive at cash (used) provided by operations: Depreciation................................................ 1,529 8,157 -- 9,686 Amortization................................................ 717 993 -- 1,710 Deferred tax expense........................................ 5,941 -- -- 5,941 Real estate tax assessment adjustment....................... -- 7,846 -- 7,846 Bad debt expense............................................ 30 190 -- 220 Gain on repurchase of debentures............................ (171) -- -- (171) Gain on sale of property, plant and equipment............... -- (76) -- (76) Gain on sale of marketable securities....................... (81) -- -- (81) Deferred compensation expense............................... 271 -- -- 271 Non-cash Employee Stock Ownership Plan compensation expense................................................... 1,781 -- -- 1,781 Dividends on unallocated Employee Stock Ownership Plan shares.................................................... 80 -- -- 80 Non-cash compensation expense............................... 276 -- -- 276 Common shares issued for directors' fees.................... 157 -- -- 157 Income tax benefit from stock options and Long-Term Incentive Plan............................................ 1,118 -- -- 1,118 Changes in operating assets and liabilities, excluding effects of acquisitions: Equity in earnings of subsidiaries.......................... (6,543) -- 6,543 -- Intercompany................................................ (12,383) 12,383 -- -- Accounts receivable......................................... (2,880) (7,873) -- (10,753) Inventories................................................. 4,352 (2,319) -- 2,033 Prepayments and other assets................................ (6,243) 5,614 -- (629) Accounts payable, accrued liabilities and other............. (890) (4,084) -- (4,974) Contract advances and deposits.............................. (12,713) (2,304) -- (15,017) -------- -------- ------- -------- Cash (used) provided by operations.......................... (10,973) 25,070 -- 14,097 Investing Activities: Purchase of plant and equipment............................. (1,754) (12,544) -- (14,298) Payments received on notes receivable....................... 300 47 -- 347 Proceeds from sale of property, plant and equipment......... -- 280 -- 280 Purchase of marketable securities........................... (59) -- -- (59) Sale or redemption of marketable securities................. 14,455 -- -- 14,455 Cash paid for acquisitions, net of cash acquired............ (13,938) -- -- (13,938) -------- -------- ------- -------- Cash used by investing activities........................... (996) (12,217) -- (13,213) Financing Activities: Proceeds from exercise of stock options..................... 1,892 -- -- 1,892 Proceeds from management group receivables.................. -- 375 -- 375 Proceeds from sale of stock in public offering, net of expenses.................................................. 81,491 -- -- 81,491 Borrowings under revolver................................... 20,800 -- -- 20,800 Repayments of borrowings under revolver..................... (20,800) -- -- (20,800) Repayments of long-term debt................................ (14,450) (2,850) -- (17,300) Repurchase of debentures.................................... (3,184) -- -- (3,184) Purchase of treasury shares................................. (1,020) -- -- (1,020) Payment of EDO ESOP loan obligation......................... (4,891) -- -- (4,891) Payment made on note payable................................ (500) -- -- (500) Payment of common share cash dividends...................... (1,920) -- -- (1,920) Payment of preferred share cash dividends................... (194) -- -- (194) -------- -------- ------- -------- Cash provided (used) by financing activities................ 57,224 (2,475) -- 54,749 -------- -------- ------- -------- Net increase in cash and cash equivalents................... 45,255 10,378 -- 55,633 Cash and cash equivalents at beginning of year.............. 4,262 (2,054) 2,208 -------- -------- ------- -------- Cash and cash equivalents at end of year.................... $ 49,517 $ 8,324 $ -- $ 57,841 ======== ======== ======= ========
73 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders EDO Corporation We have audited the accompanying consolidated balance sheets of EDO Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EDO Corporation and subsidiaries at December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 1(g) to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill to conform with Statement of Financial Accounting Standard No. 142,"Goodwill and Other Intangible Assets." /s/ ERNST & YOUNG LLP New York, New York February 13, 2004 74 QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following table sets forth unaudited quarterly financial information for 2003 and 2002 (in thousands, except per share amounts).
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER ------------------ ------------------- ------------------ ------------------- 2003 2002 2003 2002 2003 2002 2003 2002 ------- -------- -------- ------- -------- ------- -------- -------- Net sales from continuing operations.................... $94,377 $ 66,909 $111,736 $73,719 $118,783 $85,104 $135,771 $103,144 Net earnings (loss): Continuing operations......... 2,982(a) 2,810 (1,626)(b) 3,074 5,559(c) 3,371(d) 6,496(e) 4,737(f) Discontinued operations....... -- -- 1,398 -- -- -- -- -- Cumulative effect of a change in accounting principle, net of tax........................... -- (3,363)(g) -- -- -- -- -- -- ------- -------- -------- ------- -------- ------- -------- -------- Earnings (loss)................. 2,982 (553) (228) 3,074 5,559 3,371 6,496 4,737 Earnings (loss) per share: Basic: Continuing operations....... 0.17 0.17 (0.09) 0.18 0.32 0.20 0.37 0.28 Discontinued operations..... -- -- 0.08 -- -- -- -- -- Cumulative effect of a change in accounting principle, net of tax..... -- (0.20) -- -- -- -- -- -- ------- -------- -------- ------- -------- ------- -------- -------- Earnings (loss) -- Basic.... 0.17 (0.03) (0.01) 0.18 0.32 0.20 0.37 0.28 Diluted: Continuing operations....... 0.17 0.16 (0.09) 0.18 0.30 0.19 0.34 0.26 Discontinued operations..... -- -- 0.08 -- -- -- -- -- Cumulative effect of a change in accounting principle, net of tax:.... -- (0.20) -- -- -- -- -- -- ------- -------- -------- ------- -------- ------- -------- -------- Earnings (loss) -- Diluted.... 0.17 (0.04) (0.01) 0.18 0.30 0.19 0.34 0.26 ------- -------- -------- ------- -------- ------- -------- --------
--------------- (a) Includes acquisition-related costs of $0.2 million. (b) Includes acquisition-related costs of $0.2 million and an impairment loss on the facility at Deer Park of $9.2 million. (c) Includes acquisition-related costs of $0.2 million. (d) Includes write-off of purchased in-process research and development costs of $0.2 million and acquisition-related costs of $0.2 million. (e) Includes acquisition-related costs of $0.3 million and a $0.9 million non-qualified pension plan curtailment loss. (f) Includes acquisition-related costs of $0.2 million and a $2.0 million defined benefit pension plan curtailment loss. (g) Upon adoption of Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets," the Company recorded a cumulative effect of a change in accounting principle effective January 1, 2002. See Note 1(g) to the consolidated financial statements. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of the end of the period covered by this Annual Report on Form 10-K, EDO carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures under the supervision 75 and with the participation of its management, including its Review and Disclosure Committee, its Chief Executive Officer and its Chief Financial Officer. The Chief Executive Officer and Chief Financial Officer concluded that EDO's 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 EDO's internal controls over financial reporting during EDO's last fiscal quarter that have materially affected, or are likely to materially affect internal controls over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information called for by Item 10 (except to the extent set forth in this Item) is incorporated in this Report by reference to the Company's definitive proxy statement relating to the Annual Meeting of Shareholders anticipated to be held on April 27, 2004. EXECUTIVE OFFICERS
NAME AGE POSITION, TERM OF OFFICE AND PRIOR POSITIONS ---- --- -------------------------------------------- James M. Smith............................ 62 Chairman of the Board (since May 2002) President and Chief Executive Officer (since April 2000). Previously, he was President and CEO of AIL Systems, Inc. Frederic B. Bassett....................... 57 Vice President (since September 2002), Chief Financial Officer and Treasurer (since January 2003). Prior thereto, he was Vice President, Treasurer and Chief Financial Officer of Condor Systems, Inc. (December 2000-July 2002). Prior thereto, he was U.S. Operations Controller for the Howmet Division of Alcoa. Patricia D. Comiskey...................... 53 Vice President-Human Resources (since June 2001) and Assistant Secretary (since September 2000). Previously, she was Director -- Corporate Human Resources (since September 2000). Prior thereto she was Director -- Human Resources and Assistant Secretary of AIL Systems, Inc. George Fox................................ 61 Vice President-Electronic Systems Group (since May 2000). Previously, he was Director of Operations of AIL Systems, Inc. (since 1998). Prior thereto, he was Director of Programs of AIL Systems, Inc. (since 1997). William J. Frost.......................... 62 Vice President-Administration and Shareholder Relations (since April 2000) and Secretary (since May 2001). Milo Hyde................................. 50 Vice President -- Systems & Analysis Group (since April 2000); prior thereto, he served as Systems and Analysis Group General Manager. Harvey N. Kreisberg....................... 67 Vice President-Corporate Development (since January 2001). Prior thereto, he was Director -- Diversified Products Group of AIL Systems, Inc.
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NAME AGE POSITION, TERM OF OFFICE AND PRIOR POSITIONS ---- --- -------------------------------------------- Frank Otto................................ 54 Executive Vice President (since September 2002) and Chief Operating Officer (since February 2004). Prior thereto, he was Vice President -- Integrated Systems and Structures Group (January 2001-September 2002). Prior thereto, he was General Manager of the Marine and Aircraft Systems Division. Lisa M. Palumbo........................... 45 Vice President, General Counsel and Assistant Secretary (since April 2002). Previously, she was Senior Vice President, General Counsel and Secretary of Moore Corporation Ltd. (from March to September 2001), and prior thereto, Vice President and General Counsel of Rayonier, Inc.
Each officer is either elected by the board of directors or, as provided in our By-Laws, appointed by the Chief Executive Officer and holds office until the first meeting of the board following the next succeeding annual meeting of shareholders, and thereafter until a successor is appointed and qualified, unless the executive officer dies, is disqualified, resigns or is removed in accordance with our By-Laws. ITEM 11. EXECUTIVE COMPENSATION The information called for by Item 11 is incorporated in this Report by reference to the Company's definitive proxy statement relating to the Annual Meeting of Shareholders anticipated to be held on April 27, 2004. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information called for by Item 12 is incorporated in this Report by reference to the Company's definitive proxy statement relating to the Annual Meeting of Shareholders anticipated to be held on April 27, 2004. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for by Item 13 is incorporated in this Report by reference to the Company's definitive proxy statement relating to the Annual Meeting of Shareholders anticipated to be held on April 27, 2004. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information called for by Item 14 is incorporated in this Report by reference to the Company's definitive proxy statement relating to the Annual Meeting of Shareholders anticipated to be held on April 27, 2004. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements and Financial Statement Schedules and Exhibits 1. FINANCIAL STATEMENTS. Consolidated Balance Sheets as of December 31, 2003 and 2002 Consolidated Statements of Earnings for the Years Ended December 31, 2003, 2002 and 2001 77 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements Report of Ernst & Young LLP 2. FINANCIAL STATEMENT SCHEDULES. See Schedule II -- Valuation and Qualifying Accounts below. All other schedules have been omitted because they are not applicable. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO CHARGED TO NET WRITE- BALANCE AT BEGINNING OF COSTS AND OTHER OFFS/ END OF DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD ----------- ------------ ---------- ---------- ----------- ---------- (IN THOUSANDS) Year ended December 31, 2003: Allowance for doubtful accounts...... $1,023 568 216(a) (448) $1,359 Year ended December 31, 2002: Allowance for doubtful accounts...... $ 893 407 44(b) (321) $1,023 Year ended December 31, 2001: Allowance for doubtful accounts...... $ 981 220 63(c) (371) $ 893
--------------- (a) Amounts acquired as a result of purchase of Emblem Group Ltd. on June 16, 2003, Darlington, Inc. on March 10, 2003, and Advanced Engineering & Research Associates, Inc. on February 5, 2003. (b) Amount acquired as a result of purchase of Condor Systems, Inc. on July 26, 2002. (c) Amount acquired as a result of purchase of Dynamic Systems, Inc. on October 9, 2001. 3. EXHIBITS
EXHIBIT NUMBER EXHIBIT ------- ------- 2(a) Agreement and Plan of Merger by and among the Company, EDO Acquisition III Inc. and AIL Technologies Inc. as amended and restated dated January 2, 2000 (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, Exhibit 2(a)). 2(b) Management Stock Purchase Agreement dated as of January 2, 2000 between the Company as Buyer and eleven individuals as Sellers, relating to the purchase and sale of shares of common stock of AIL Technologies Inc. (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, Exhibit 2(b)). 2(c) Stock Purchase Agreement dated as of January 2, 2000 between the Company, as Buyer, and Defense Systems Holding Co., as Seller, relating to the purchase and sale of shares of common and preferred stock of AIL Technologies Inc. (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, Exhibit 2(c)). 2(d) Stock Purchase Agreement dated as of October 9, 2001, by EDO Acquisition II, Inc. and the former stockholders of Dynamic Systems, Inc., with a list of the schedules and exhibits (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, Exhibit 2(d)). 2(e) Amended and Restated Asset Purchase Agreement and Amendment 1 thereto, dated as of May 31, 2002, between EDO Acquisition IV Inc., a wholly-owned subsidiary of the Company, as Buyer and Condor Systems Inc. and CEI Systems, Inc. as Seller (incorporated herein by reference to the Company's Current Report on Form 8-K dated July 26, 2002, Exhibits 2.1 and 2.2).
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EXHIBIT NUMBER EXHIBIT ------- ------- 2(f) Stock Purchase Agreement, dated as of February 5, 2003, between EDO Professional Services Inc, a wholly-owned subsidiary of the Company, as Buyer and four individuals as Sellers (incorporated herein by reference to the Company's Current Report on Form 8-K dated February 5, 2003, Exhibit 2.1). 2(g) Stock Purchase Agreement, dated as of March 10, 2003, by the Company, as Buyer, and three individuals as Sellers (incorporated by reference to the Company's Current Report on Form 8-K dated March 10, 2003, Exhibit 2.1). 3(a)(1)* Restated Certificate of Incorporation of the Company dated May 15, 2003. 3(b)* By-Laws of the Company as amended December 1, 2003. 4(a) Indenture, dated as of April 2, 2002, by and between the Company and HSBC Bank, USA, as trustee (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002, Exhibit 4(a)). 4(b) Registration Rights Agreement, dated as of April 2, 2002, by and among the Company and Salomon Smith Barney, Inc., SG Cowen Securities Corporation and Robertson Stephens, Inc., as representatives of the initial purchasers (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002, Exhibit 4(b)). 10(a)(1) Credit Agreement, dated as of November 8, 2002, by and among the Company and AIL Systems Inc., with Citibank N.A., Fleet National Bank, Wachovia Bank, N.A., et al. (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(a)(1)) 10(a)(2) Amendment No. 1, dated December 20, 2002, to the Credit Agreement dated as of November 8, 2002 described above (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(a)(2)). 10(a)(3) Amendment No. 2, dated February 4, 2003, to the Credit Agreement dated as of November 8, 2002 described above (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(a)(3)). 10(a)(4) Amendment No. 3, dated February 28, 2003, to the Credit Agreement dated as of November 8, 2002 described above (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(a)(4)). 10(b) EDO Corporation 1996 Long-Term Incentive Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, Exhibit 10(a)). 10(c)* EDO Corporation 2002 Long-Term Incentive Plan as amended January 1, 2004. 10(d) Executive Life Insurance Plan Agreements, as amended through January 23, 1990, between the Company and 28 employees and retirees (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Exhibit 10(g)). 10(e) Form of Directors' and Officers' Indemnity Agreements between the Company and 24 current Company directors and officers (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, Exhibit 10(d)). 10(f)* EDO Corporation Nonqualified Deferred Compensation Plan, effective January 1, 2004. 10(g) EDO Corporation 1997 Non-Employee Director Stock Option Plan (incorporated herein by reference to the Company's Registration Statement on Form S-8, File No. 333-77865, dated May 6, 1999). 10(h) EDO Corporation 2002 Non-Employee Director Stock Option Plan (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(h)). 10(i) EDO Corporation Compensation Plan for Directors (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998, Exhibit 10(g)).
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EXHIBIT NUMBER EXHIBIT ------- ------- 10(j) Supplemental Executive Retirement Plan, dated July 1, 2001 (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, Exhibit 10(i)). 10(k) Employment Agreement, dated as of February 1, 2003, by and between EDO Corporation and James M. Smith (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(k)). 10(l) Change in Control Agreement dated March 3, 2003 between the Company and Frederic B. Bassett (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(l)). 10(m) Change in Control Agreement dated March 21, 2003 between the Company and Patricia D. Comiskey (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(m)). 10(n) Change in Control Agreement dated March 25, 2003 between the Company and George P. Fox, Jr. (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(n)). 10(o) Change in Control Agreement dated March 21, 2003 between the Company and William J. Frost (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(o)). 10(p) Change in Control Agreement dated March 22, 2003 between the Company and Milo Hyde (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(p)). 10(q) Change in Control Agreement dated March 21, 2003 between the Company and Harvey N. Kreisberg (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(q)). 10(r) Change in Control Agreement dated March 26, 2003 between the Company and Frank W. Otto (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(r)). 10(s) Change in Control Agreement dated May 1, 2003 between the Company and Lisa M. Palumbo (incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, Exhibit 10(s)). 10(t)* Form of Amendment to the Change in Control Agreement. 10(u)* Form of 2004 Restricted Share and Retention Incentive Award Agreement. 10(v)* Form of 2003 Stock Option Agreement. 10(w) Consent Decree, entered on November 25, 1992, amongst the United States, the Company, Plessey, Inc., Vernitron Corporation and Pitney Bowes, Inc. Incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. 14* EDO Corporation Standards Ethical Business Conduct for all EDO Employees. 21* List of Subsidiaries. 23* Consent of Independent Auditors. 24* Powers of Attorney (included on the signature page). 31.1* Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2* Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32* Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
--------------- * Filed herewith. 80 (b) Reports on 8-K The following reports on 8-K were filed during the three months ended on December 31, 2003:
DATE OF REPORT ITEMS REPORTED -------------- -------------- November 5, 2003 Earnings Release, dated November 5, 2003, announcing financial results for the quarter ended September 27, 2003. December 23, 2003 Adding a footnote to the Company's Consolidated Financial Statements containing condensed consolidating financial information for the Registrant's subsidiaries which are expected to guarantee the indebtedness the Registrant may issue pursuant to its shelf registration statement on Form S-3 filed with the Securities and Exchange Commission on December 23, 2003.
81 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, its principal executive officer, thereunto duly authorized. EDO CORPORATION (REGISTRANT) By: /s/ JAMES M. SMITH ------------------------------------ James M. Smith President and Chief Executive Officer Dated: March 5, 2004 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Lisa M. Palumbo and William J. Frost, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to the Annual Report on Form 10-K for the Company's 2003 fiscal year, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or either of them, or their or his substitutes, may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on March 5, 2004 by the following persons on behalf of the Registrant and in the capacities indicated.
SIGNATURE TITLE --------- ----- /s/ JAMES M. SMITH Chairman, President, Chief Executive Officer and -------------------------------------- Director (principal executive officer) (James M. Smith) /s/ FREDERIC B. BASSETT Vice President -- Finance, Treasurer and -------------------------------------- Chief Financial Officer (Frederic B. Bassett) (principal financial and accounting officer) /s/ ROBERT E. ALLEN Director -------------------------------------- (Robert E. Allen) /s/ ROBERT ALVINE Director -------------------------------------- (Robert Alvine) /s/ GEORGE M. BALL Director -------------------------------------- (George M. Ball) /s/ DENNIS C. BLAIR Director -------------------------------------- (Dennis C. Blair)
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SIGNATURE TITLE --------- ----- /s/ ROBERT M. HANISEE Director -------------------------------------- (Robert M. Hanisee) Director -------------------------------------- (Michael J. Hegarty) /s/ LESLIE F. KENNE Director -------------------------------------- (Leslie F. Kenne) /s/ RONALD L. LEACH Director -------------------------------------- (Ronald L. Leach) Director -------------------------------------- (James Roth)
83