10-Q 1 y26742e10vq.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006 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)
(212) 716-2000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer (as defined in Rule 12b-2 of the Act), or a non-accelerated filer. Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No The number of shares of EDO common stock outstanding as of November 3, 2006 was 21,111,072 shares, with a par value $1 per share. ================================================================================ EDO CORPORATION TABLE OF CONTENTS
Page ---- PART I FINANCIAL INFORMATION ITEM 1 Financial Statements........................................ 3 Consolidated Balance Sheets - September 30, 2006 (unaudited) and December 31, 2005........................... 3 Consolidated Statements of Earnings - (unaudited) Three months ended September 30, 2006 and September 24, 2005.......................................... 4 Consolidated Statements of Earnings - (unaudited) Nine months ended September 30, 2006 and September 24, 2005.......................................... 5 Consolidated Statements of Cash Flows - (unaudited) Nine months ended September 30, 2006 and September 24, 2005.......................................... 6 Notes to Consolidated Financial Statements (unaudited)...... 7 ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 18 ITEM 3 Quantitative and Qualitative Disclosures about Market Risk.. 27 ITEM 4 Controls and Procedures..................................... 27 PART II OTHER INFORMATION ITEM 1A Risk Factors ITEM 4 Submission of Matters to a Vote of Security Holders......... 27 ITEM 6 Exhibits and Reports on Form 8-K............................ 27 SIGNATURE PAGE........................................................... 28
2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS EDO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31, 2006 2005 ------------- ------------ (UNAUDITED) (IN THOUSANDS) ASSETS Current assets: Cash and cash equivalents ................................................. $ 42,806 $108,731 Accounts receivable, net .................................................. 212,803 189,190 Inventories ............................................................... 74,231 56,567 Deferred income tax asset, net ............................................ 9,849 8,946 Notes receivable .......................................................... 7,000 7,100 Prepayments and other ..................................................... 6,414 3,809 -------- -------- Total current assets ................................................... 353,103 374,343 -------- -------- Property, plant and equipment, net ........................................... 58,103 49,574 Goodwill ..................................................................... 416,785 152,347 Other intangible assets, net ................................................. 55,017 55,925 Deferred income tax asset, net ............................................... 27,101 29,637 Other assets ................................................................. 30,276 25,573 -------- -------- $940,385 $687,399 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable .......................................................... $ 36,640 $ 33,111 Accrued liabilities ....................................................... 65,510 52,126 Contract advances and deposits ............................................ 43,438 42,244 Short-term borrowings under revolver ...................................... 200,000 -- Notes payable ............................................................. 7,766 2,000 -------- -------- Total current liabilities .............................................. 353,354 129,481 -------- -------- Income taxes payable ...................................................... 4,450 6,513 Notes payable, long-term .................................................. 16,533 5,000 Long-term debt ............................................................... 201,250 201,250 Post-retirement benefits obligations ......................................... 104,518 103,815 Environmental obligation ..................................................... 1,372 1,392 Other long-term liabilities .................................................. 44 55 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, 21,105,872 issued in 2006 and 20,305,815 issued in 2005 ................ 21,106 20,306 Additional paid-in capital ................................................ 174,414 167,219 Retained earnings ......................................................... 125,842 120,103 Accumulated other comprehensive loss, net of income tax benefit (32,454 in 2006 and 32,711 in 2005) .................................... (46,703) (47,072) Treasury shares at cost (111,561 shares in 2006 and 111,317 shares in 2005) ............................................................... (1,945) (1,868) Unearned Employee Stock Ownership Plan shares ............................. (13,850) (14,789) Deferred compensation under Long-Term Incentive Plan ...................... -- (3,866) Management group receivables .............................................. -- (140) -------- -------- Total shareholders' equity ............................................. 258,864 239,893 -------- -------- $940,385 $687,399 ======== ========
See accompanying Notes to Consolidated Financial Statements. 3 EDO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, 2006 2005 ------------- ------------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NET SALES .................................................................... $184,393 $175,884 -------- -------- COSTS AND EXPENSES Cost of sales ............................................................. 144,586 133,098 Selling, general and administrative ....................................... 30,207 21,626 Research and development .................................................. 4,701 3,578 Acquisition-related costs ................................................. 1,008 -- Impairment loss on other intangible assets ................................ 1,487 -- Environmental cost provision, Deer Park facility .......................... -- 288 -------- -------- 181,989 158,590 -------- -------- OPERATING EARNINGS ........................................................... 2,404 17,294 NON-OPERATING INCOME (EXPENSE) Interest income ........................................................... 1,096 407 Interest expense .......................................................... (3,624) (2,408) Other, net ................................................................ 113 (18) -------- -------- (2,415) (2,019) -------- -------- (Loss) earnings before income taxes .......................................... (11) 15,275 Income tax benefit (expense) ................................................. 2,076 (5,434) -------- -------- NET EARNINGS ................................................................. $ 2,065 $ 9,841 ======== ======== NET EARNINGS PER COMMON SHARE: Basic ..................................................................... $ 0.11 $ 0.54 ======== ======== Diluted ................................................................... $ 0.11 $ 0.48 ======== ======== Weighted-average common shares outstanding: Basic ..................................................................... 18,205 18,136 ======== ======== Diluted ................................................................... 18,598 22,794 ======== ======== Dividends declared per common share .......................................... $ 0.03 $ 0.03 ======== ========
See accompanying Notes to Consolidated Financial Statements. 4 EDO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE NINE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, 2006 2005 ------------- ------------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NET SALES .................................................................... $456,500 $448,504 -------- -------- COSTS AND EXPENSES Cost of sales ............................................................. 355,487 336,512 Selling, general and administrative ....................................... 79,021 61,928 Research and development .................................................. 10,913 11,990 Acquisition-related costs ................................................. 1,455 -- Impairment loss on other intangible assets ................................ 1,487 -- Environmental cost provision, Deer Park facility .......................... -- 1,538 -------- -------- 448,363 411,968 -------- -------- OPERATING EARNINGS ........................................................... 8,137 36,536 NON-OPERATING INCOME (EXPENSE) Interest income ........................................................... 3,218 1,202 Interest expense .......................................................... (8,285) (6,873) Other, net ................................................................ (144) (78) -------- -------- (5,211) (5,749) -------- -------- Earnings before income taxes ................................................. 2,926 30,787 Income tax benefit (expense) ................................................. 4,471 (11,949) -------- -------- NET EARNINGS ................................................................. $ 7,397 $ 18,838 ======== ======== NET EARNINGS PER COMMON SHARE: Basic: .................................................................... $ 0.41 $ 1.04 ======== ======== Diluted: .................................................................. $ 0.40 $ 0.97 ======== ======== Weighted-average common shares outstanding: Basic ..................................................................... 18,105 18,044 ======== ======== Diluted ................................................................... 18,563 22,725 ======== ======== Dividends declared per common share .......................................... $ 0.09 $ 0.09 ======== ========
See accompanying Notes to Consolidated Financial Statements 5 EDO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, 2006 2005 ------------- ------------- (UNAUDITED) (IN THOUSANDS) OPERATING ACTIVITIES: Earnings from operations .................................................. $ 7,397 $ 18,838 Adjustments to earnings to arrive at cash provided by operations: Depreciation ........................................................... 8,865 7,238 Amortization ........................................................... 5,121 4,319 Impairment loss on other intangible assets ............................. 1,487 -- Bad debt (recovery) expense ............................................ (6) 999 Deferred tax provision ................................................. 15 -- (Gain) loss on disposal of property, plant and equipment ............... (59) 3 Environmental cost provision, Deer Park facility ....................... -- 1,538 Long-Term Incentive Plan compensation expense .......................... 2,261 1,298 Stock option compensation expense ...................................... 838 -- Employee Stock Ownership Plan compensation expense ..................... 3,310 3,771 Dividends on unallocated Employee Stock Ownership Plan shares .......... 172 191 Common shares issued for directors' fees ............................... 162 148 Changes in operating assets and liabilities, excluding effects of acquisitions: Accounts receivable ................................................. 23,065 (22,214) Inventories ......................................................... (12,336) (10,133) Prepayments and other assets ........................................ 1,630 3,614 Accounts payable, accrued liabilities and other ..................... (23,831) (620) Contribution to defined benefit pension plan ........................ (6,000) (6,000) Contract advances and deposits ...................................... 1,194 17,108 --------- -------- Cash provided by operations .................................................. 13,285 20,098 --------- -------- INVESTING ACTIVITIES: Purchase of property, plant and equipment ................................ (14,216) (18,404) Proceeds from the sale of property, plant and equipment .................. 633 -- Payments received on notes receivable .................................... 100 225 Cash paid for acquisitions, net of cash acquired ......................... (265,318) (45,180) --------- -------- Cash used by investing activities ............................................ (278,801) (63,359) --------- -------- FINANCING ACTIVITIES: Short-term borrowings under revolver ...................................... 200,000 -- Proceeds from exercise of stock options ................................... 852 839 Excess income tax benefit from stock options and Long-Term Incentive Plan ......................................................... 429 661 Proceeds from management group receivables ................................ 140 11 Repayments of acquired debt ............................................... -- (6,931) Payment of common share cash dividends .................................... (1,830) (1,815) --------- -------- Cash provided (used) by financing activities ................................. 199,591 (7,235) --------- -------- Net decrease in cash and cash equivalents .................................... (65,925) (50,496) Cash and cash equivalents at beginning of period ............................. 108,731 98,884 --------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................... $ 42,806 $ 48,388 ========= ======== Supplemental disclosures: Cash paid for: Interest ............................................................... $ 3,891 $ 3,617 ========= ======== Income taxes ........................................................... $ 10,937 $ 11,017 ========= ========
See accompanying Notes to Consolidated Financial Statements. 6 EDO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and, therefore, do not include all information and footnotes normally included in consolidated financial statements prepared in conformity with accounting principles generally accepted in the United States. They should be read in conjunction with the consolidated financial statements and notes thereto of EDO Corporation and Subsidiaries (the "Company") for the year ended December 31, 2005 filed by the Company on Form 10-K with the Securities and Exchange Commission. The accompanying consolidated financial statements include all adjustments (consisting of normal recurring adjustments) that management considers necessary for a fair presentation of its consolidated financial position and results of operations for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the entire year. Certain reclassifications have been made to prior year's presentations to conform to current year's presentations. (2) ACQUISITIONS On September 15, 2006, the Company acquired all of the stock of Impact Science and Technology Inc., (IST) for $123.7 million, consisting of a cash payment of $106.4 million and a $17.3 million promissory note to be paid over three years. IST was a privately-held company providing signals intelligence (SIGINT) systems and analysis support to the intelligence community, and advanced countermeasures and electronic-attack systems to the U.S. Department of Defense (DoD) and other government agencies. The acquisition is expected to strengthen EDO's position in specialized communication products and expand the Company's business in the intelligence community. The acquired company became part of the Company's Electronic Systems and Communications segment. The Company has not yet completed its analysis of the fair value of the acquired assets and liabilities. Consequently, the excess purchase price over the net assets acquired has been temporarily assigned to goodwill, and amounts recorded are subject to change. The excess of the purchase price over the net assets acquired related to IST is not deductible for income tax purposes. On September 6, 2006, the Company acquired all of the stock of CAS Inc., (CAS) for $178.1 million, consisting of a cash payment of $173.2 million and 214,574 EDO common shares valued at $4.9 million. CAS was a privately-held company providing engineering services, logistics support, and weapon-systems analysis to the DoD. This acquisition is expected to strengthen and expand our range of professional and engineering services. The acquired company became part of the Company's Engineered Systems and Services segment. The Company has not yet completed its analysis of the fair value of the acquired assets and liabilities. Consequently, the excess purchase price over the net assets acquired has been temporarily assigned to goodwill, and amounts recorded are subject to change. The excess of the purchase price over the net assets acquired recorded as goodwill is deductible for income tax purposes over 15 years. On December 20, 2005, the Company acquired for cash all of the membership interest of NexGen Communications LLC (NexGen), a privately-held company specializing in the design and production of communications systems for a diverse set of U.S. government organizations. The acquisition strengthened EDO's position in specialized communication products. The acquired company became part of the Company's Electronic Systems and Communications segment. The excess of the purchase price over the net assets acquired related to NexGen is not deductible for income tax purposes. During the second quarter of 2006, the purchase price for NexGen was finalized and resulted in an additional cash payment of $0.4 million. On September 19, 2005, the Company acquired for cash all of the stock of Fiber Innovations, Inc., (Fiber Innovations) a privately-held company that is a designer and manufacturer of fiber reinforced-composites. This acquisition has added important complementary design and manufacturing capabilities to EDO's integrated-composite-structures business. The acquired company became part of the Company's Engineered Systems and Services segment. The excess of the purchase price over the net assets acquired related to Fiber Innovations is not deductible for income tax purposes. During the first quarter of 2006, the purchase price for Fiber Innovations was finalized and resulted in an additional cash payment of $0.4 million. On May 2, 2005, the Company acquired for cash all of the units of EVI Technology, LLC (EVI), a privately-held company. EVI 7 is a designer, manufacturer and integrator of classified intelligence systems. EVI has strengthened and expanded EDO's range of products and engineering expertise in a number of synergistic areas. The acquired company became part of the Company's Electronic Systems and Communications segment. The excess of the purchase price over the net assets acquired related to EVI recorded as goodwill and other intangible asset is deductible for income tax purposes over 15 years. Unaudited pro forma results of operations, assuming the acquisitions of IST and CAS had been completed at the beginning of each period are summarized below. The results reflect adjustments to net sales, cost of sales, compensation expense, interest income and expense, acquisition-related costs, and income tax expense. The interest rates used in determining pro forma adjustments to interest income are based on the average yield of the Company's invested cash and cash equivalents which approximated 4.4% and 4.1% for the three and nine months ended September 30, 2006 and 3.1% and 2.6% for the three and nine months ended September 24, 2005, respectively. The interest rates used in determining the pro forma adjustments for interest expense is related to our credit facility and approximated 6.8% and 6.6% for the three and nine months ended September 30, 2006, and 5.2% and 4.7% for the three and nine months ended September 24, 2005, respectively.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 30, SEPTEMBER 24, SEPTEMBER 30, SEPTEMBER 24, 2006 2005 2006 2005 ------------- ------------- ------------- ------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net sales .............................. $245,442 $233,849 $647,639 $617,521 Net earnings ........................... 9,459 10,746 10,680 21,127 Diluted earnings per common share ...... $ 0.43 $ 0.51 $ 0.57 $ 1.06 ======== ======== ======== ========
On a pro forma basis, the effect of the convertible subordinated notes was dilutive for the three months ended September 30, 2006, and anti-dilutive for the nine months ended September 30, 2006. The effect of the convertible subordinated notes was dilutive for the three and nine months ended September 24, 2005. 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. On a pro forma basis, had the acquisitions of NexGen, Fiber Innovations, and EVI taken place as of the beginning of each period, the results of operations would not have been materially affected. (3) STOCK-BASED COMPENSATION The Company has granted non-qualified stock options and restricted shares under the 2002 Long-Term Incentive Plan (LTIP), the 2002 Non-Employee Director Stock Option Plan (NEDSOP) and in connection with the CAS and IST acquisitions. These plans are described in Note 13 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. Prior to January 1, 2006, the Company accounted 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, as permitted by Financial Accounting Standard Board (FASB) Statement No. 123 (SFAS No. 123), "Accounting for Stock-based Compensation." 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 employee compensation expense was recognized in the Statement of Earnings. Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R) (FAS 123(R)), Share-Based Payment, using the modified prospective transition method. Under this method, compensation cost recognized in the nine months ended September 30, 2006 includes: (a) compensation cost for all options granted prior to January 1, 2006, but not yet vested, based on the fair value on the grant date and (b) compensation cost for all options granted to Directors under the NEDSOP subsequent to January 1, 2006, which are 100% vested on the date of grant. Results of prior periods are not required to be restated. As a result of adopting FAS 123(R) on January 1, 2006, the Company's income before income taxes and net income for the nine months ended September 30, 2006, were $0.8 million and $0.5 million lower, respectively, than if it had continued to account for share-based compensation under Opinion No. 25. Basic and diluted earnings per share for the nine months ended September 30, 2006 were $0.03 and $0.03 lower, respectively, than if the company had continued to account for share-based compensation under Opinion No. 25. Prior to the adoption of FAS 123(R), the Company presented all excess tax benefits on deductions resulting from the exercise of stock options as an operating cash flow in the Statement of Cash Flows. FAS 123(R) requires that this excess tax benefit now be classified as a financing cash flow. For the nine months ended September 30, 2006, $0.4 million excess tax benefit was classified as a financing cash flow. During the nine months ended September 30, 2006, the Company only granted options to its Board of Directors, which when issued were 100% vested. The Company estimated the fair value of the 2006 stock option awards as of the grant date by applying the 8 Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are judgmental and sensitive in the determination of compensation expense. The weighted average for key assumptions used in determining the fair value of options granted are as follows: expected dividend yield of 1%, risk free interest rate of 4.3%, expected volatility of 44%, and an expected option life of 7 years. A summary of the Company's stock option activity during the nine months ended September 30, 2006 is as follows:
WEIGHTED- AVERAGE WEIGHTED- REMAINING AGGREGATE AVERAGE CONTRACTUAL INTRINSIC OPTIONS EXERCISE TERM VALUE (IN THOUSANDS) PRICE (IN YEARS) (IN THOUSANDS) -------------- --------- ----------- -------------- Outstanding on January 1, 2006 ..... 1,045 $17.25 Options granted .................... 55 27.39 Options exercised .................. (69) 12.38 Options expired/canceled ........... (36) 23.86 ----- ------ ---- ------ Exercisable on September 30, 2006 .. 995 17.90 5.08 $6,829 =====
As of September 30, 2006, there was no unrecognized future compensation expense related to non-vested options not yet recognized in the consolidated statement of earnings. Stock based compensation expense recognized for restricted share awards was $0.7 million and $0.4 million for the three months ended September 30, 2006 and September 24, 2005, respectively. Stock based compensation expense recognized for restricted share awards was $2.3 million and $1.3 million for the nine months ended September 30, 2006 and September 24, 2005, respectively. The unrecognized compensation cost related to the unvested restricted shares at September 30, 2006 was approximately $13.4 million, which will be recognized over a weighted-average period of 2.5 years. A summary of the activity of restricted shares for the nine months ended September 30, 2006 is as follows:
WEIGHTED- AVERAGE SHARES GRANT DATE (IN THOUSANDS) FAIR VALUE -------------- ---------- Outstanding on January 1, 2006 ..... 219 $27.78 Granted ............................ 517 23.74 Vested ............................. -- -- Forfeited/Canceled ................. (7) 28.23 ---- ------ Outstanding on September 30, 2006 .. 729 $27.89 ==== ======
Prior to adoption of FAS 123(R), the fair value of restricted share awards was recorded as deferred compensation expense as a separate component of shareholders equity. In accordance with FAS 123(R), the deferred compensation expense balance of $3.9 million at December 31, 2005 was reclassified to additional paid-in-capital. The restricted share awards cliff vest in 3 years and are subject to continued employment. If such employment goal is not met, no compensation cost is recognized and any previously recognized compensation cost is reversed. The following table illustrates the effect on net earnings and earnings per share if, for the three and nine months ended September 24, 2005, the Company had applied the fair value recognition provisions of SFAS No. 123:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 24, SEPTEMBER 24, 2005 2005 ------------------ ----------------- Earnings: As reported ............................................................... $9,841 $18,838 Deferred compensation expense, net of tax ................................. 255 766 Stock option compensation expense based on fair value method, net of tax .. (417) (2,164) ------ ------- Pro forma ................................................................. $9,679 $17,440 ====== ======= Basic earnings per common share: As reported ............................................................... $ 0.54 $ 1.04 Pro forma ................................................................. $ 0.54 $ 0.98 Diluted earnings per common share: As reported ............................................................... $ 0.48 $ 0.97 Pro forma ................................................................. $ 0.48 $ 0.92
(4) BUSINESS COMBINATIONS AND GOODWILL AND OTHER INTANGIBLE ASSETS 9 Statement of Financial Accounting Standard ("SFAS") No. 141, "Business Combinations," 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, "Goodwill and Other Intangible Assets," prohibits the amortization of goodwill and other intangible assets with indefinite useful lives and requires that those assets be reviewed for impairment at least annually. Other intangible assets with definite lives are amortized over their estimated useful lives. 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, the Company is 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. The Company performs the required impairment tests of goodwill as of October 1, each year. The changes in the carrying amount of goodwill by segment for the nine months ended September 30, 2006 were as follows:
ENGINEERED SYSTEMS ELECTRONIC AND SYSTEMS AND SERVICES COMMUNICATIONS TOTAL ---------- -------------- -------- (IN THOUSANDS) Balance as of January 1, 2006 ..... $ 43,846 $108,501 $152,347 Purchase price adjustments ........ 328 (3,256) (2,928) Acquisition of CAS ................ 167,938 -- 167,938 Acquisition of IST ................ -- 99,428 99,428 -------- -------- -------- Balance as of September 30, 2006 .. $212,112 $204,673 $416,785 ======== ======== ========
Summarized below are other intangible assets:
SEPTEMBER 30, DECEMBER 31, 2006 2005 LIFE -------------- ------------ ---------- (IN THOUSANDS) Other intangible assets subject to amortization: Capitalized non-compete agreements related to acquisitions .... $ 2,888 $ 3,118 1-5 years Purchased technologies related to acquisitions ................ 21,663 21,103 8-25 years Customer contracts and relationships related to acquisitions .. 48,996 45,698 6-20 years Tradename related to acquisitions ............................. 1,734 2,069 5-10 years -------- -------- 75,281 71,988 Less accumulated amortization .............................. (20,664) (16,463) -------- -------- $ 54,617 $ 55,525 Other intangible assets not subject to amortization: Tradename related to acquisitions .......................... 400 400 -------- -------- $ 55,017 $ 55,925 ======== ========
The amortization expense for the three months ended September 30, 2006 and September 24, 2005 amounted to $1.7 million for both periods. The amortization expense for the nine months ended September 30, 2006 and September 24, 2005 amounted to $5.1 million and $4.3 million, respectively. Total remaining amortization expense for 2006, 2007, 2008, 2009, 2010 and thereafter related to these other intangible assets is estimated to be $1.7 million, $6.6 million, $5.8 million, $5.8 million, $5.1 million and $29.6 million, respectively. For the three and nine months ended September 30, 2006, the Company incurred an impairment charge of approximately $1.5 million related to certain other intangible assets associated with the Company's rugged computer product line. As sales and orders were not materializing to expected levels, the Company tested for impairment and it was determined that the future undiscounted cash flows associated with these assets were insufficient to recover their carrying values. These assets were written down to zero, which was determined on the basis of future discounted cash flows. (5) INVENTORIES Inventories are summarized by major classification as follows: 10
SEPTEMBER 30, DECEMBER 31, 2006 2005 ------------- ------------ (IN THOUSANDS) Raw material and supplies ................ $ 15,208 $ 11,976 Work-in-process .......................... 76,415 49,829 Finished goods ........................... 4,641 1,690 Less: Unliquidated progress payments .. (22,033) (6,928) -------- -------- $ 74,231 $ 56,567 ======== ========
(6) INCOME TAXES In the third quarter of 2006, the Company recorded a discrete income tax benefit of $2.3 million related primarily to claims for the federal research and development credit and extraterritorial income (ETI) exclusion tax benefits not previously claimed. The tax expense for the nine months ended September 30, 2006 reflects an additional tax benefit of $3.7 million due to the reversal of income tax contingency reserves related to the resolution of an outstanding tax matter. (7) EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 30, SEPTEMBER 24, SEPTEMBER 30, SEPTEMBER 24, 2006 2005 2006 2005 ------------- ------------- ------------- ------------- (IN THOUSANDS) Numerator: Earnings from continuing operations for basic calculation ................................. $ 2,065 $ 9,841 $ 7,397 $18,838 Effect of dilutive securities: Convertible Notes ........................... -- 1,067 -- 3,201 ------- ------- ------- ------- Numerator for diluted calculation .............. $ 2,065 $10,908 $ 7,397 $22,039 ======= ======= ======= ======= Denominator: Denominator for basic calculation .............. 18,205 18,136 18,105 18,044 Effect of dilutive securities: Stock options ............................... 393 250 458 273 Convertible Notes ........................... -- 4,408 -- 4,408 ------- ------- ------- ------- Denominator for diluted calculation ............ 18,598 22,794 18,563 22,725 ======= ======= ======= =======
The assumed conversion of the Notes was anti-dilutive for 2006 and dilutive for 2005. 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 NINE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, 2006 2005 ------------- ------------- (IN THOUSANDS) 4.00% Convertible Subordinated Notes .. 5,886 -- Unexercised stock options ............. 399 69 ----- --- 6,285 69 ===== ===
(8) DEFINED BENEFIT PLAN The Company maintains a qualified noncontributory defined benefit pension plan covering less than 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. For the three months ended September 30, 2006 and September 24, 2005, the Company recorded pension expense of $1.2 million and $1.1 million, respectively. For the nine months ended September 30, 2006 and September 24, 2005, the Company recorded pension expense of $3.6 million and $3.2 million, respectively. Summarized below are the components of the expense for each period presented: 11
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 30, SEPTEMBER 24, SEPTEMBER 30, SEPTEMBER 24, 2006 2005 2006 2005 ------------- ------------- ------------- ------------- (IN THOUSANDS) Interest cost .......................... $ 3,038 $ 3,089 $ 9,115 $ 9,266 Expected return on plan assets ......... (3,209) (3,181) (9,628) (9,543) Amortization of unrecognized net loss .. 1,365 1,162 4,095 3,486 ------- ------- ------- ------- $ 1,194 $ 1,070 $ 3,582 $ 3,209 ======= ======= ======= =======
(9) EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST The Company sponsors an employee stock ownership plan which provides retirement benefits to substantially all employees. The cost basis of the unearned/unallocated shares was 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 quarterly, as payments are made under the related indirect loan. The difference between the market value and the cost basis of the shares was recorded as additional paid-in capital. Dividends on unallocated shares are recorded as compensation expense. (10) COMPREHENSIVE INCOME As of September 30, 2006, accumulated other comprehensive loss included in the accompanying consolidated balance sheet primarily represents additional minimum liabilities on benefit plans. Comprehensive income for the three months ended September 30, 2006 was $2.1 million compared to comprehensive income for the three months ended September 24, 2005 of $9.8 million. Comprehensive income for the nine months ended September 30, 2006 was $7.8 million compared to comprehensive income from continuing operations for the nine months ended September 24, 2005 of $19.0 million. (11) 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 operations are reflected in two business segments: Engineered Systems and Services and Electronic Systems and Communications. The Engineered Systems and Services segment addresses the Integrated Systems and Structures, Undersea Warfare, and Professional Services markets. Primary products include aircraft armament systems, integrated composite structures, mine countermeasure systems, sonar systems and flight line products. The segment also includes a wide range of professional and engineering services. The Electronic Systems and Communications segment includes products that serve the Electronic Warfare, the C4 (Command, Control, Communications and Computers) products and systems, Information and Intelligence Warfare markets. Primary products include electronic force protection equipment, interference cancellation technology, airborne electronic warfare systems, signal intelligence systems, reconnaissance and surveillance systems, other specialized electronic systems, C4 products and services and antenna products.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 30, SEPTEMBER 24, SEPTEMBER 30, SEPTEMBER 24, 2006 2005 2006 2005 ------------- ------------- ------------- ------------- (IN THOUSANDS) Net Sales: Engineered Systems & Services ..................... $ 77,648 $ 57,325 $199,078 $169,986 Electronic Systems & Communications ............... 106,745 118,559 257,422 278,518 -------- -------- -------- -------- $184,393 $175,884 $456,500 $448,504 -------- -------- -------- -------- Operating earnings : Engineered Systems & Services ..................... 674 3,005 3,891 9,168 Electronic Systems & Communications ............... 1,730 14,577 4,246 28,906 Environmental cost provision, Deer Park facility .. -- (288) -- (1,538) -------- -------- -------- -------- 2,404 17,294 8,137 36,536 Net interest expense .............................. (2,528) (2001) (5,067) (5,671) Other, net ........................................ 113 (18) (144) (78) -------- -------- -------- -------- Loss (earnings) before income taxes ............... $ (11) $ 15,275 $ 2,926 $ 30,787 ======== ======== ======== ========
(12) RECENT ACCOUNTING PRONOUNCEMENTS In June 2006, the FASB issued FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)" which is effective for fiscal years beginning after December 15, 2006. This interpretation was issued to clarify the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and 12 measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We are currently evaluating the potential impact of this interpretation. In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The Company does not believe SAB 108 will have a material impact on our results from operations or financial position. In September 2006, the FASB issued Statement No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (Statement 158). Among other items, Statement 158 requires recognition of the overfunded or underfunded status of an entity's defined benefit postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit postretirement plan assets and obligations as of the end of the employer's fiscal year, and requires recognition of the funded status of defined benefit postretirement plans in other comprehensive income. Statement 158 is effective for fiscal years ending after December 15, 2006, and early application is encouraged. The Company has not yet determined the impact this interpretation will have on our financial position. (13) 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 September 30, 2006 and December 31, 2005 and for the three and nine month periods ended September 30, 2006 and September 24, 2005. 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 four quarters. EDO CORPORATION CONDENSED CONSOLIDATING BALANCE SHEET SEPTEMBER 30, 2006 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 25,288 $ 11,835 $ 5,683 $ -- $ 42,806 Accounts receivable, net 52,568 156,688 3,547 -- 212,803 Inventories 10,988 59,219 4,024 -- 74,231 Deferred income tax asset, net 9,038 811 -- -- 9,849 Notes receivable 7,000 -- -- -- 7,000 Prepayments and other 2,309 3,778 327 -- 6,414 -------- -------- ------- --------- -------- Total current assets 107,191 232,331 13,581 -- 353,103 Investment in subsidiaries 635,610 -- -- (635,610) -- Property, plant and equipment, net 26,806 27,791 3,506 -- 58,103 Goodwill -- 408,075 8,710 -- 416,785 Other intangible assets, net -- 45,638 9,379 -- 55,017 Deferred income tax asset, net 29,637 (2,536) -- -- 27,101 Other assets 28,322 1,954 -- -- 30,276 -------- -------- ------- --------- -------- $827,566 $713,253 $35,176 $(635,610) $940,385 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 19,790 $ 78,120 $ 4,240 $ -- $102,150 Contract advances and deposits 16,005 27,433 -- -- 43,438 Short-term borrowing under revolver 200,000 -- -- -- 200,000 Notes payable 7,766 -- -- -- 7,766 -------- -------- ------- --------- -------- Total current liabilities 243,561 105,553 4,240 -- 353,354 Income taxes payable 4,450 -- -- -- 4,450 Deferred income taxes (2,880) 2,497 383 -- -- Notes payable, long-term 16,533 -- -- -- 16,533 Long-term debt 201,250 -- -- -- 201,250 Post retirement benefits obligations 104,518 -- -- -- 104,518 Environmental obligation 1,372 -- -- -- 1,372 Other long-term liabilities 44 -- -- -- 44 Intercompany accounts -- 458,580 24,906 (483,486) --
13 Shareholders' equity: Preferred shares -- -- -- -- -- Common shares 21,106 98 -- (98) 21,106 Additional paid-in capital 174,414 61,555 6,418 (67,973) 174,414 Retained earnings 125,842 89,022 (917) (88,105) 125,842 Accumulated other comprehensive (loss) income, net of income tax benefit (46,849) -- 146 -- (46,703) Treasury shares (1,945) (4,052) -- 4,052 (1,945) Unearned ESOP shares (13,850) -- -- -- (13,850) -------- -------- ------- --------- -------- Total shareholders' equity 258,718 146,623 5,647 (152,124) 258,864 -------- -------- ------- --------- -------- $827,566 $713,253 $35,176 $(635,610) $940,385 ======== ======== ======= ========= ========
EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ Net Sales $53,878 $126,808 $ 6,687 $(2,980) $184,393 Costs and expenses: Cost of sales 43,901 99,740 3,925 (2,980) 144,586 Selling, general and administrative 7,513 20,658 2,036 -- 30,207 Research and development 1,076 3,446 179 -- 4,701 Acquisition-related costs -- 1,008 -- -- 1,008 Impairment loss on other intangible assets -- -- 1,487 -- 1,487 ------- -------- ------- ------- -------- 52,490 124,852 7,627 (2,980) 181,989 ------- -------- ------- ------- -------- Operating earnings (loss) 1,388 1,956 (940) -- 2,404 Non-operating income (expense) Interest income 918 103 75 -- 1,096 Interest expense (3,590) (34) -- -- (3,624) Other, net (1) 167 (53) -- 113 ------- -------- ------- ------- -------- (2,673) 236 22 -- (2,415) (Loss) earnings before income taxes (1,285) 2,192 (918) -- (11) Income tax benefit (expense) 4,066 (1,723) (267) -- 2,076 ------- -------- ------- ------- -------- Earnings (loss) after income taxes 2,781 469 (1,185) -- 2,065 Equity in undistributed earnings of subsidiaries (716) -- -- 716 -- ------- -------- ------- ------- -------- Net earnings (loss) $ 2,065 $ 469 $(1,185) $ 716 $ 2,065 ======= ======== ======= ======= ========
EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ Net Sales $151,218 $294,779 $19,098 $(8,595) $456,500 Costs and expenses: Cost of sales 125,091 226,766 12,225 (8,595) 355,487 Selling, general and administrative 17,206 55,169 6,646 -- 79,021 Research and development 2,891 7,565 457 -- 10,913 Acquisition-related costs -- 1,455 -- -- 1,455 Impairment loss on other intangible assets -- -- 1,487 -- 1,487 -------- -------- ------- ------- -------- 145,188 290,955 20,815 (8,595) 448,363 -------- -------- ------- ------- -------- Operating earnings (loss) 6,030 3,824 (1,717) -- 8,137 Non-operating income (expense) Interest income 2,933 103 182 -- 3,218 Interest expense (8,285) -- -- -- (8,285) Other, net (23) 15 (136) -- (144) -------- -------- ------- ------- -------- (5,375) 118 46 -- (5,211) Earnings (loss) before income taxes 655 3,942 (1,671) -- 2,926 Income tax benefit (expense) 8,610 (3,940) (199) -- 4,471 -------- -------- ------- ------- -------- Earnings (loss) after income taxes 9,265 2 (1,870) -- 7,397
14 Equity in undistributed earnings of subsidiaries (1,868) -- -- 1,868 -- -------- -------- ------- ------- -------- Net earnings (loss) $ 7,397 $ 2 $(1,870) $ 1,868 $ 7,397 ======== ======== ======= ======= ========
EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ OPERATING ACTIVITIES: Earnings (loss) from continuing operations $ 7,397 $ 2 $(1,870) $ 1,868 $ 7,397 Adjustments to earnings (loss) to arrive at cash (used) provided by continuing operations: Depreciation 3,722 4,454 689 -- 8,865 Amortization -- 4,370 751 -- 5,121 Impairment loss on other intangible assets -- -- 1,487 -- 1,487 Bad (recovery) debt expense (75) 69 -- -- (6) Deferred tax provision (2,591) 2,606 -- -- 15 Loss (gain) on sale of property, plant and equipment 15 (74) -- -- (59) Long-term Incentive Plan compensation expense 2,261 -- -- -- 2,261 Stock option compensation expense 838 -- -- -- 838 Employee Stock Ownership Plan compensation expense 3,310 -- -- -- 3,310 Dividends on unallocated Employee Stock Ownership Plan shares 172 -- -- -- 172 Common shares issued for directors' fees 162 -- -- -- 162 Changes in operating assets and liabilities, excluding effects of acquisitions: Equity in earnings of subsidiaries 1,868 -- -- (1,868) -- Intercompany (36,188) 36,053 135 -- -- Accounts receivable 16,110 7,079 (124) -- 23,065 Inventories 6,300 (17,744) (892) -- (12,336) Prepayments and other assets 8,454 (6,831) 7 -- 1,630 Accounts payable, accrued liabilities and other (18,561) (6,285) 1,015 -- (23,831) Contribution to defined benefit pension plan (6,000) -- -- -- (6,000) Contract advances and deposits 9,885 (8,691) -- -- 1,194 --------- -------- ------- ------- --------- Cash (used) provided by operations (2,921) 15,008 1,198 -- 13,285 --------- -------- ------- ------- --------- INVESTING ACTIVITIES: Purchase of property, plant and equipment (5,221) (8,048) (947) -- (14,216) Payments received on notes receivable 100 -- -- -- 100 Proceeds from sale of property, plant and equipment -- 633 -- -- 633 Cash paid for acquisitions, net of cash acquired (265,318) -- -- -- (265,318) --------- -------- ------- ------- --------- Cash used by investing activities (270,439) (7,415) (947) -- (278,801) --------- -------- ------- ------- --------- FINANCING ACTIVITIES: Proceeds from exercise of stock options 842 10 -- -- 852 Excess income tax benefit from stock options and Long-term Incentive Plan 429 -- -- -- 429 Proceeds from management group receivables 140 -- -- -- 140 Short-term borrowings under revolver 200,000 -- -- -- 200,000 Payment of common share cash dividends (1,830) -- -- -- (1,830) --------- -------- ------- ------- --------- Cash provided by financing activities 199,581 10 -- -- 199,591 --------- -------- ------- ------- --------- Net (decrease) increase in cash and cash equivalents (73,779) 7,603 251 -- (65,925) Cash and cash equivalents at beginning of period 99,067 4,232 5,432 -- 108,731 --------- -------- ------- ------- --------- Cash and cash equivalents at end of period $ 25,288 $ 11,835 $ 5,683 $ -- $ 42,806 ========= ======== ======= ======= =========
EDO CORPORATION CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2005 (IN THOUSANDS) 15
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 99,067 $ 4,232 $ 5,432 -- $108,731 Accounts receivable, net 68,603 117,164 3,423 -- 189,190 Inventories 17,288 36,147 3,132 -- 56,567 Deferred income tax asset, net 8,946 -- -- -- 8,946 Notes receivable 7,358 (258) -- -- 7,100 Prepayments and other 2,037 1,438 334 -- 3,809 -------- -------- ------- --------- -------- Total current assets 203,299 158,723 12,321 -- 374,343 -------- -------- ------- --------- -------- Investment in subsidiaries 317,356 -- -- (317,356) -- Property, plant and equipment, net 25,946 20,380 3,248 -- 49,574 Goodwill -- 143,637 8,710 -- 152,347 Other intangible assets, net -- 44,308 11,617 -- 55,925 Deferred income tax asset, net 29,637 -- -- -- 29,637 Other assets 24,751 822 -- -- 25,573 -------- -------- ------- --------- -------- $600,989 $367,870 $35,896 $(317,356) $687,399 -------- -------- ------- --------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 37,942 $ 43,729 $ 3,566 -- $ 85,237 Contract advances and deposits 6,120 36,124 -- -- 42,244 Notes payable 2,000 -- -- -- 2,000 -------- -------- ------- --------- -------- Total current liabilities 46,062 79,853 3,566 -- 129,481 -------- -------- ------- --------- -------- Long-term debt 201,250 -- -- -- 201,250 Income taxes payable 6,513 -- -- -- 6,513 Deferred income tax liabilities, net (3,244) 2,891 353 -- -- Post retirement benefits obligations 103,815 -- -- -- 103,815 Notes payable 5,000 -- -- -- 5,000 Environmental obligation 1,392 -- -- -- 1,392 Other long-term liabilities 55 -- -- -- 55 Inter-company accounts -- 174,844 24,771 (199,615) -- Shareholders' equity: Preferred shares -- -- -- -- -- Common shares 20,306 98 -- (98) 20,306 Additional paid-in capital 167,219 25,221 6,418 (31,639) 167,219 Retained earnings 120,103 89,103 953 (90,056) 120,103 Accumulated other comprehensive loss, net of income tax benefit (46,819) (88) (165) -- (47,072) Treasury shares (1,868) (4,052) -- 4,052 (1,868) Unearned ESOP shares (14,789) -- -- -- (14,789) Management group receivables (140) -- -- -- (140) Deferred compensation under Long-Term Incentive Plan (3,866) -- -- -- (3,866) -------- -------- ------- --------- -------- Total shareholders' equity 240,146 110,282 7,206 (117,741) 239,893 -------- -------- ------- --------- -------- $600,989 $367,870 $35,896 $(317,356) $687,399 ======== ======== ======= ========= ========
EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS FOR THE THREE MONTHS ENDED SEPTEMBER 24, 2005 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ Net Sales $45,238 $125,549 $7,849 $(2,752) $175,884 Costs and expenses: Cost of sales 37,270 93,426 5,154 (2,752) 133,098
16 Selling, general and administrative 3,696 16,138 1,792 -- 21,626 Research and development 679 2,686 213 -- 3,578 Environmental cost provision, Deer Park facility 288 -- -- -- 288 ------- -------- ------ ------- -------- 41,933 112,250 7,159 (2,752) 158,590 ------- -------- ------ ------- -------- Operating earnings 3,305 13,299 690 -- 17,294 Non-operating income (expense) Interest income 351 16 40 -- 407 Interest expense (2,408) -- -- -- (2,408) Other, net (6) 29 (41) -- (18) ------- -------- ------ ------- -------- (2,063) 45 (1) -- (2,019) Earnings before income taxes 1,242 13,344 689 -- 15,275 Income tax benefit (expense) 628 (5,751) (311) -- (5,434) ------- -------- ------ ------- -------- Earnings after income taxes 1,870 7,593 378 -- 9,841 Equity in undistributed earnings of subsidiaries 7,971 -- -- (7,971) -- ------- -------- ------ ------- -------- Net earnings $ 9,841 $ 7,593 $ 378 $(7,971) $ 9,841 ======= ======== ====== ======= ========
EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF EARNINGS FOR THE NINE MONTHS ENDED SEPTEMBER 24, 2005 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ Net Sales $132,178 $304,555 $22,054 $(10,283) $448,504 Costs and expenses: Cost of sales 108,874 222,573 15,348 (10,283) 336,512 Selling, general and administrative 11,230 45,892 4,806 -- 61,928 Research and development 3,701 7,547 742 -- 11,990 Environmental cost provision, Deer Park facility 1,538 -- -- -- 1,538 -------- -------- ------- -------- -------- 125,343 276,012 20,896 (10,283) 411,968 -------- -------- ------- -------- -------- Operating earnings 6,835 28,543 1,158 -- 36,536 Non-operating income (expense) Interest income 1,060 44 98 -- 1,202 Interest expense (6,873) -- -- -- (6,873) Other, net 5 52 (135) -- (78) -------- -------- ------- -------- -------- (5,808) 96 (37) -- (5,749) Earnings before income taxes 1,027 28,639 1,121 -- 30,787 Income tax benefit (expense) 495 (11,836) (608) -- (11,949) -------- -------- ------- -------- -------- Earnings after income taxes 1,522 16,803 513 -- 18,838 Equity in undistributed earnings of subsidiaries 17,316 -- -- (17,316) -- -------- -------- ------- -------- -------- Net earnings $ 18,838 $ 16,803 $ 513 $(17,316) $ 18,838 ======== ======== ======= ======== ========
EDO CORPORATION CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 24, 2005 (IN THOUSANDS)
EDO Corporation Parent Subsidiary Company Only Guarantors Non-Guarantors Eliminations Consolidated ------------ ---------- -------------- ------------ ------------ OPERATING ACTIVITIES: Earnings from continuing operations $ 18,838 $ 16,803 $ 513 $(17,316) $ 18,838 Adjustments to earnings to arrive at cash provided by continuing operations: Depreciation 3,205 3,616 417 -- 7,238 Amortization -- 3,568 751 -- 4,319 Bad debt expense 244 755 -- -- 999 Loss on sale of property, plant and equipment -- 3 -- -- 3 Environmental cost provision, Deer Park facility 1,538 -- -- -- 1,538
17 Long-term Incentive Plan compensation expense 1,298 -- -- -- 1,298 Employee Stock Ownership Plan compensation expense 3,771 -- -- -- 3,771 Dividends on unallocated Employee Stock Ownership Plan shares 191 -- -- -- 191 Common shares issued for directors' fees 148 -- -- -- 148 Changes in operating assets and liabilities, excluding effects of acquisitions: Equity in earnings of subsidiaries (17,316) -- -- 17,316 -- Intercompany 22,997 (22,855) (142) -- -- Accounts receivable (6,730) (15,064) (420) -- (22,214) Inventories (1,491) (8,843) 201 -- (10,133) Prepayments and other assets 4,234 (608) (12) -- 3,614 Accounts payable, accrued liabilities and other (12,044) 12,674 (1,250) -- (620) Contribution to defined benefit pension plan (6,000) -- -- -- (6,000) Contract advances and deposits (3,168) 20,276 -- -- 17,108 -------- -------- ------- -------- -------- Cash provided by operations 9,715 10,325 58 -- 20,098 -------- -------- ------- -------- -------- INVESTING ACTIVITIES: Purchase of Property, plant and equipment (11,778) (6,434) (192) -- (18,404) Payments received on notes receivable 225 -- -- -- 225 Cash paid for acquisitions, net of cash acquired (45,180) -- -- -- (45,180) -------- -------- ------- -------- -------- Cash used by investing activities (56,733) (6,434) (192) -- (63,359) -------- -------- ------- -------- -------- FINANCING ACTIVITIES: Proceeds from exercise of stock options 839 -- -- -- 839 Excess income tax benefit from stock options and Long-term Incentive Plan 661 -- -- -- 661 Proceeds from management group receivables 11 -- -- -- 11 Repayments of acquired debt (6,931) -- (6,931) Payment of common share cash dividends (1,815) -- -- -- (1,815) -------- -------- ------- -------- -------- Cash used by financing activities (7,235) -- -- -- (7,235) -------- -------- ------- -------- -------- Net (decrease) increase in cash and cash equivalents (54,253) 3,891 (134) -- (50,496) Cash and cash equivalents at beginning of period 93,129 1,314 4,441 -- 98,884 -------- -------- ------- -------- -------- Cash and cash equivalents at end of period $ 38,876 $ 5,205 $ 4,307 $ -- $ 48,388 ======== ======== ======= ======== ========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The Company designs and manufactures a diverse range of products with core competencies in critical defense areas. We are a leading supplier of sophisticated, highly engineered products and systems for defense, aerospace and intelligence applications. We believe our advanced systems are mission-critical on a wide range of military programs and are at the core of transforming defense capabilities. We have two reporting segments: Engineered Systems and Services and Electronic Systems and Communications. Our Engineered Systems and Services segment comprises of aircraft armament systems, integrated composite structures, undersea warfare sonar systems, and professional engineering services. Our Electronic Systems and Communications segment provides highly-engineered electronic systems and equipment including electronic warfare systems, reconnaissance and surveillance systems, signal intelligence systems, command, control, communications, and computers (C4) products and systems, Information and Intelligence Warfare Markets. The Company has a disciplined acquisition program which is diversifying its 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. 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 18 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 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 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. To determine the fair value of our reporting units, we generally use a present value technique (discounted cash flow) corroborated by market multiples when available and as appropriate, for all of the reporting units. The discounted cash flow method measures intrinsic value by reference to an enterprise's or an asset's expected annual free cash flows. We applied what we believe to be the 19 most appropriate valuation methodology for each of the reporting units. If we had established different reporting units or utilized different valuation methodologies, the impairment test results could differ. PENSION AND POST-RETIREMENT BENEFITS 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. 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. RESULTS OF OPERATIONS The following information should be read in conjunction with the Consolidated Financial Statements as of September 30, 2006. THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 24, 2005 Net sales by segment were as follows:
THREE MONTHS ENDED INCREASE/ ----------------------------- (DECREASE) SEPTEMBER 30, SEPTEMBER 24, FROM SEGMENT 2006 2005 PRIOR PERIOD ------- ------------- ------------- ------------ (IN THOUSANDS) Engineered Systems & Services ......... $ 77,648 $ 57,325 35.5% Electronic Systems & Communications ... 106,745 118,559 (10.0%) -------- -------- ----- Total ................................. $184,393 $175,884 4.8% ======== -------- -----
In the Engineered Systems and Services segment, the increase in sales was attributable to the acquisition of Fiber Innovations which was acquired on September 19, 2005 and CAS which was acquired on September 6, 2006 plus increased sales of undersea warfare products, flight line test products and professional services. These increases were partially offset by lower sales in aircraft armament systems. In the Electronic Systems and Communications segment, the decrease in sales was attributable to continued lower sales volume of electronic force protection systems resulting from lack of follow-on orders for systems in previous periods and a delay in delivery for those systems on order. This decrease was partially offset by increased sales of C4 products and systems, including the Transition Switch Module (TSM), in addition to sales contributed by NexGen, which was acquired on December 20, 2005, and the sales contributed by IST which was acquired on September 15, 2006. Operating earnings by segment were as follows:
THREE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, SEGMENT 2006 2005 ------- ------------- ------------- (IN THOUSANDS) Engineered Systems & Services ......... $ 674 $ 3,005 Electronic Systems & Communications ... 1,730 14,577 Environmental cost provision, Deer Park facility ...................... $ -- (288) ------ ------- Total ................................. $2,404 $17,294 ====== =======
Operating earnings for the three months ended September 30, 2006 were $2.4 million or 1.3% of net sales. This compares to operating earnings for the three months ended September 24, 2005 of $17.3 million or 9.8% of net sales. Items of note affecting operating earnings are summarized here to help clarify the comparison of results. 20
THREE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, 2006 2005 ------------- ------------- (IN THOUSANDS) Pension ............................... $1,194 $1,070 ESOP Compensation expense ............. $ 975 $1,221 Other intangible asset amortization ... $1,707 $1,698 ------ ------ $3,876 $3,989 ====== ======
The increase in pension expense in 2006 compared to 2005 is attributable to changes in actuarial assumptions such as discount rate and return on plan assets. The lower ESOP compensation expense for the three months ended September 30, 2006 is attributable to our lower average stock price compared to the three months ended September 24, 2005. Pension and ESOP compensation expense are allocated between cost of sales and selling, general and administrative expense. The Engineered Systems and Services segment's operating earnings for the three months ended September 30, 2006 were $0.7 million or 0.9% of this segment's net sales compared to operating earnings of $3.0 million or 5.2% of this segment's net sales for the three months ended September 24, 2005. Operating earnings for the three months ended September 30, 2006, were negatively impacted by a $2.2 million cost growth on an aircraft armament systems program and a $0.4 million cost growth on an undersea warfare program as well as lower margins due to lower sales volume of composite structures, primarily the Joint Air to Surface Standoff Missile units (JASSM) and the attendant higher absorption of overhead costs. We believe that, based on our most current estimates, we have accounted for all future costs necessary to complete these programs. In addition, operating earnings for Engineered Systems and Services were impacted by a write-down of unamortized other intangible assets of $1.5 million related to the Company's rugged computer product line. As sales and orders were not materializing to expected levels, the Company tested for impairment and it was determined that the future undiscounted cash flows associated with these assets were insufficient to recover their carrying values. These assets were written down to zero, which was determined on the basis of future discounted cash flows. These negative impacts were partially offset by performance improvements on other undersea warfare programs and by the acquisition of CAS on September 6, 2006. For the three months ended September 24, 2005 the Engineered Systems and Services segment's operating earnings were negatively impacted by $1.0 million for the same undersea warfare systems program noted above and a $1.4 million impact on several sonar array/depth sounder programs. The Electronic Systems and Communications segment's operating earnings for the three months ended September 30, 2006 were $1.7 million or 1.6% of this segment's net sales compared to operating earnings of $14.6 million or 12.3% of this segment's net sales for the three months ended September 24, 2005. Operating earnings were negatively impacted by the significantly lower sales volume of electronic force protection systems. For the three months ended September 30, 2006, sales of Warlock force protection systems represented 2.1% of our total sales compared to 32.7% for the three months ended September 24, 2005. In addition, earnings were negatively impacted by a charge of approximately $2.1 million related to the settlement of a contract dispute during the third quarter of 2006. This was partially offset by higher earnings due to the above mentioned TSM sales and performance improvements on other programs. For the three months ended September 30, 2006, sales of TSM represented 13.9% of our total sales compared to less than 1% for the three months ended September 24, 2005. Selling, general and administrative expenses for the three months ended September 30, 2006 of $30.2 million increased as a percent of net sales to 16.4% from 12.3% for the three months ended September 24, 2005. The increase is attributable to the three acquisitions made in 2005, which resulted in an increase in other intangible asset amortization expense and costs accrued for stay pay agreements. The acquisitions of CAS and IST also contributed to the increase. In addition, the aforementioned legal settlement is reflected in selling, general and administrative costs for the three months ended September 30, 2006. Research and development expense for the three months ended September 30, 2006 increased to $4.7 million or 2.5% of net sales from $3.6 million or 2.0% of net sales for the three months ended September 24, 2005. The increase is attributable to higher than usual spending on advanced communications detections technologies partially offset by lower spending on force protection. Interest expense, net of interest income, for the three months ended September 30, 2006 increased to $2.5 million from $2.0 million for the three months ended September 24, 2005. Interest expense for the three months ended September 30, 2006 is associated primarily with our 4.0% Convertible Subordinated Notes ("Notes") due 2025 and recent borrowings under our revolving credit facility. Also included in interest expense is the amortization of deferred debt issuance costs associated with the offering of the Notes and amortization of deferred financing costs associated with our credit facility. Interest expense for the three months ended September 24, 2005 included the costs of our $138.0 million 5.25% Convertible Subordinated Notes. 21 For the three months ended September 30, 2006, we recorded a discrete income tax benefit of $2.3 million related primarily to claims for the federal research and development credit and extraterritorial income (ETI) exclusion tax benefits not previously claimed. In the third quarter of 2005, the Company recorded an income tax benefit of $0.8 million resulting from the reversal of income tax contingencies which were determined to be no longer needed. For the three months ended September 30, 2006, net earnings were $2.1 million or $0.11 per diluted common share on 18.6 million diluted shares compared to net earnings of $9.8 million or $0.48 per diluted common share on 22.8 million diluted shares for the three months ended September 24, 2005. The convertible notes were anti-dilutive for the third quarter 2006 and dilutive in the third quarter of 2005. NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 24, 2005 Net sales by segment were as follows:
NINE MONTHS ENDED INCREASE/ ----------------------------- (DECREASE) SEPTEMBER 30, SEPTEMBER 24, FROM SEGMENT 2006 2005 PRIOR PERIOD ------- ------------- ------------- ------------ (IN THOUSANDS) Engineered Systems & Services ......... $199,078 $169,986 17.1% Electronic Systems & Communications ... 257,422 278,518 (7.6%) -------- -------- ---- Total ................................. $456,500 $448,504 1.8% ======== ======== ----
In the Engineered Systems and Services segment, the increase in sales was attributable to higher sales of aircraft armament systems relating to the F-22 missile launcher program, higher sales in composite structures which include Fiber Innovations which was acquired on September 19, 2005 and the acquisition of CAS on September 6, 2006. In addition, sales increased in undersea warfare products and in professional services and were slightly offset by sales decline in the flight line test systems due to delayed orders in the early part of the period. The award was originally expected in the first quarter of 2006, but was not received until August 2006. In the Electronic Systems and Communications segment, the decrease in sales was attributable to lower sales due to lack of orders this year for our electronic force protection systems and a delay in delivery of those systems on order. These lower sales were partially offset by sales of EVI, NexGen and CAS, which were acquired in the second and fourth quarter of 2005 and the third quarter of 2006, respectively. Additional offset to the lower force protection sales resulted from the increase in sales of the TSM units for the Marine Corps and higher sales in B-1B spares, as well as radar and RF products. Operating earnings by segment were as follows:
NINE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, SEGMENT 2006 2005 ------- ------------- ------------- (IN THOUSANDS) Engineered Systems & Services ......... $3,891 $ 9,168 Electronic Systems & Communications ... 4,246 28,906 Environmental cost provision, Deer Park facility ........................... -- (1,538) ------ ------- Total ................................. $8,137 $36,536 ====== =======
Operating earnings for the nine months ended September 30, 2006 were $8.1 million or 1.8% of net sales. This compares to operating earnings for the nine months ended September 24, 2005 of $36.5 million or 8.1% of net sales. Items of note affecting operating earnings are summarized here to help clarify the comparison of results.
NINE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 24, 2006 2005 ------------- ------------- (IN THOUSANDS) Pension ............................... $ 3,582 $ 3,209 ESOP Compensation expense ............. $ 3,310 $ 3,771 Other intangible asset amortization ... $ 5,121 $ 4,319 Stock-based compensation expense for options ............................ $ 838 $ -- ------- ------- $12,851 $11,299 ======= =======
The increase in pension expense in 2006 compared to 2005 is attributable to changes in actuarial assumptions such as discount rate and return on plan assets. The lower ESOP compensation expense for the first nine months of 2006 is attributable 22 to our lower average stock price compared to the first nine months of 2005. Pension and ESOP compensation expense are allocated between cost of sales and selling, general and administrative expense. The increase in other intangible asset amortization expense is attributable to the three acquisitions made in 2005. The increase in Stock-Based Compensation Expense relates to the implementation of Financial Accounting Standards Board Statement No. 123(R), Accounting for Stock-Based Compensation, (FAS 123(R)). With respect to FAS 123(R), no further costs are anticipated in 2006 related to non-vested stock options. Prior to adoption of FAS 123(R) as of January 1, 2006, we accounted for our 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 was recognized and pro-forma disclosure information was provided. In 2006, we issued options only to Directors. Those options were 100% vested at issuance and, therefore, accounted for most of the $0.8 million of expense recorded in the first quarter. The Engineered Systems and Services segment's operating earnings for the nine months ended September 30, 2006 were $3.9 million or 2.0% of this segment's net sales compared to operating earnings of $9.2 million or 5.4% of this segment's net sales for the nine months ended September 24, 2005. Operating earnings were negatively impacted by a $2.5 million cost growth on an undersea warfare program, $1.4 million and $2.2 million on two aircraft armament systems programs. We believe that, based on our most current estimates, we have accounted for all future costs necessary to complete these programs. In addition, operating earnings were negatively impacted by $1.2 million in respect of the conclusion of a legal action as well as a write-off of unamortized other intangible assets of $1.5 million related to the Company's rugged computer product line. Sales and orders were not materializing to expected levels. Consequently, the related other intangible assets were deemed impaired. These reductions were partially offset by performance improvement on other jobs, release of a $0.9 million reserve on a completed aircraft armament program and a $0.5 million reserve release on a sonar systems program, both due to program completion under anticipated cost, and by earnings from the recently acquired CAS. For the nine months ended September 24, 2005, the Engineered Systems and Services segment's operating earnings were negatively impacted by a cost growth of approximately $3.2 million on an undersea warfare sonar program. This was offset by a positive impact to operating earnings of approximately $1.6 million due to performance improvements on an aircraft armament program. In the Electronic Systems and Communications segment, operating earnings for the nine months ended September 30, 2006 were $4.2 million or 1.6% of this segment's net sales compared to operating earnings of $28.9 million or 10.4% of this segment's net sales for the nine months ended September 24, 2005. Operating earnings were negatively impacted by less recovery of overhead expenses due to lower sales volume of electronic force protection systems, cost growth of $2.5 million on an interference cancellation program, lower milestone achievements of reconnaissance and surveillance systems and acquisition-related costs for stay pays associated with the acquisitions in 2005 and 2006. For the nine months ended September 30, 2006, sales of warlock force protection systems represented 2.9% of our total sales compared to 21.4% for the nine months ended September 24, 2005. Operating earnings were additionally impacted by $3.8 million relating to the settlement of the above-mentioned contract dispute. This was partially offset by higher earnings relating to our RF products, B-1B support and radar products. Legal costs and provisions for liabilities for the concluded legal matters referred to above had an adverse effect on the results of operations for the nine months ended September 30, 2006 of approximately $5.0 million. Selling, general and administrative expenses for the nine months ended September 30, 2006 of $79.0 million increased as a percent of net sales to 17.3% from 13.8% for the nine months ended September 24, 2005. The increase is attributable to the three acquisitions made in 2005 and the two in the current year, the aforementioned legal matters and the effect of the implementation of FAS 123(R). Other intangible asset amortization also increased due to an increase in other intangibles from the acquisitions of EVI, Fiber Innovations, and NexGen. Research and development expense for the nine months ended September 30, 2006 decreased to $11.0 million or 2.4% of net sales from $12.0 million or 2.7% of net sales for the nine months ended September 24, 2005, during which time there was higher spending on electronic force protection, aircraft armament and composite munitions. Interest expense, net of interest income, for the nine months ended September 30, 2006 decreased to $5.1 million from $5.7 million for the nine months ended September 24, 2005 primarily due to higher interest income on a higher average cash balance and a lower interest rate on our 4.0% Convertible Notes issued in November 2005. These decreases were partially offset by interest expense associated with borrowings under the revolver. Also included in interest expense is the amortization of deferred debt issuance costs associated with the offering of the Notes and amortization of deferred financing costs associated 23 with our credit facility. Income tax expense reflects a benefit of 153% for the nine months ended September 30, 2006 and an expense of 38.8% for the nine months ended September 24, 2005. For the nine months ended September 30, 2006, we recorded a discrete income tax benefit during the third quarter of $2.3 million related primarily to claims for the federal research and development credit and extraterritorial income (ETI) exclusion tax benefits not previously claimed and an income tax benefit of $3.7 million due to the reversal of income tax contingency reserves related to the resolution of an outstanding tax matter which was determined during the second quarter to be no longer needed. In the nine months ended September 24, 2005, the Company recorded an income tax benefit of $0.8 million resulting from the reversal of income tax contingencies which were determined during the third quarter to be no longer needed. For the nine months ended September 30, 2006, net earnings were $7.4 million or $0.40 per diluted common share on 18.6 million diluted shares compared to net earnings of $18.8 million or $0.97 per diluted common share on 22.7 million diluted shares for the nine months ended September 24, 2005. The convertible notes were anti-dilutive for the nine months ended September 30, 2006 and dilutive for the nine months ended September 24, 2005. LIQUIDITY AND CAPITAL RESOURCES BALANCE SHEET Our cash and cash equivalents decreased 60.6% to $42.8 million at September 30, 2006 from $108.7 million at December 31, 2005. This decrease was due primarily to the acquisition of CAS and IST in the third quarter of 2006, as well as $14.2 million used for the purchase of capital equipment and $1.8 million for the payment of common share dividends. Accounts receivable increased 12.5% to $212.8 million at September 30, 2006 from $189.2 million at December 31, 2005 due in part to timing of collections of billed receivables, increased sales, and the aforementioned acquisitions. At September 30, 2006 approximately 85% of billed receivables were in the under-60 days aging category compared with 81% at December 31, 2005. Inventories increased 31.2% to $74.2 million at September 30, 2006 from $56.6 million at December 31, 2005 due primarily to the efforts expended on work-in-process on major programs and the delays in milestone achievements which would have generated sales and reduced inventories. The note receivable of $7.0 million at September 30, 2006 relates to the sale of our facility in Deer Park in 2003. The Deer Park facility note was due on the later of October 9, 2005 or the date EDO achieved "Material Closure" as defined as the note of certain environmental conditions. Subsequent to the end of the quarter, we received a payment in respect of this note. There is an on-going dispute between the Company and purchaser of the Deer Park facility relating to the date of Material Closure. In the nine months ended September 30, 2006, capital expenditures were $14.2 million. This compares to $18.4 million for the nine months ended September 24, 2005. For the nine months ended September 24, 2005 the higher expenditures were attributable to new facility capital for our Antenna Products business unit which was relocated to a new leased facility, as well as expansion and upgrades at several other facilities. FINANCING ACTIVITIES Credit Facility We have a five-year credit facility with a consortium of banks, led by Citibank, N.A., as the administrative agent, Bank of America as the syndication agent and Wachovia Bank, N.A. as the documentation agent. The facility expires in November 2010. The credit agreement provides for a revolving credit facility in an aggregate amount equal to $300 million with sub-limits of $20 million for short-term swing loans and $100 million for letters of credit. The potential cash borrowing under the facility is reduced by the amount of outstanding letters of credit. The Company has the option to select Base Rate or Eurodollar Rate loans under the terms of the Credit Agreement. Any borrowings under the facility would be priced initially at LIBOR plus a predetermined amount depending on our consolidated leverage ratio at the time of the borrowing. At September 30, 2006, LIBOR was approximately 5.3% and the applicable adjustment to LIBOR was 2.5%. 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%. In addition, the agreement provides for potential incremental credit extensions in the form of term loans or revolving credit commitment increases of up to $300 million. 24 Letters of credit outstanding at September 30, 2006 pertaining to the credit facility were $38.7 million, resulting in $261.3 million available for borrowings. As at September 30, 2006, there were $200 million direct borrowings outstanding under the credit facility. There were no direct borrowings outstanding under the credit facility at December 31, 2005. Accrued interest payable was $0.9 million at September 30, 2006. 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, leverage ratio, fixed charge coverage ratio, and senior secured leverage ratio. As of September 30, 2006, the Company was in compliance with its covenants. The credit facility is secured by the Company's accounts receivable, inventory and machinery and equipment. 4.0% Convertible Subordinated Notes due 2025 ("4.0% Notes") In November 2005, we completed the offering of $201.2 million principal of 4.0% Notes and received proceeds of $195.7 million, net of $5.5 million of commissions. Interest payments are due May 15 and November 15 of each year commencing on May 15, 2006. Accrued interest payable was $3.1 million at September 30, 2006. 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 $34.19 per share, subject to adjustment in certain events. As of September 30, 2006, there had been no such conversions. Shelf Registration At September 30, 2006, our remaining capacity under the universal shelf registration statement that became effective in January 2004 was approximately $298.8 million. 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 September 30, 2006, we have included the following table. We are obligated under building and equipment leases expiring between 2006 and 2019. The aggregate future minimum lease commitments under those obligations with non-cancellable terms in excess of one year are included in the table 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 (IN MILLIONS): ---------------------------------------------------------- 2011 AND COMMITMENTS AND CONTRACTUAL OBLIGATIONS: TOTAL 2006 2007 2008 2009 2010 BEYOND ---------------------------------------- ------ ------ ----- ----- ----- ----- -------- Borrowings Under Revolver ........................... $200.0 $200.0 $ -- $ -- $ -- $ -- $ -- Notes payable ....................................... 24.3 2.0 7.8 8.8 5.7 -- -- 4.0% Convertible Subordinated Notes due 2025 (1) .... 201.2 -- -- -- -- -- 201.2 Operating leases .................................... 159.3 5.7 22.7 21.6 19.9 17.4 72.0 Letters of credit ................................... 38.6 2.4 21.6 0.6 13.4 -- 0.6 Projected pension contributions ..................... 17.0 -- 6.0 6.0 5.0 -- -- Advance payment and performance bonds ............... 1.9 0.2 -- -- 1.7 -- -- ------ ------ ----- ----- ----- ----- ------ Total ............................................... $642.3 $210.3 $58.1 $37.0 $45.7 $17.4 $273.8 ====== ====== ===== ===== ===== ===== ======
(1) Excludes interest of approximately $8 million annually. 25 During the third quarter of 2006, the Company contributed $6.0 million to the pension plan. Actual pension contributions may differ from amounts presented above and are contingent on cash flow and liquidity. Additionally, the Company is 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 is unlikely to have a material adverse effect on our consolidated financial position, results of operations or liquidity. However, certain legal matters did adversely impact results of operations for the nine months ended September 30, 2006, as noted above. CONCENTRATION OF SALES We conduct a significant amount of our business with the United States Government. 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. For the three and nine months ended September 30, 2006, sales of Warlock force protection systems represented 2.1% and 2.9% of net sales compared to 32.7% and 21.4% for the three and nine months ended September 24, 2005, respectively. In addition, for the three and nine months ended September 30, 2006, sales of TSM represented 13.9% and 7.3% of net sales compared to less than 1% of net sales for the same periods ended September 24, 2005. BACKLOG The funded backlog of unfilled orders at September 30, 2006 increased to $771.6 million from $558.7 million at December 31, 2005. Our backlog consists primarily of current orders under long-lived, mission-critical programs on key defense platforms. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The statements in this Quarterly Report and in oral statements that may be made by representatives of the Company relating to plans, strategies, economic performance and trends and other statements that are not descriptions of historical facts may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27(a) of the Securities Act of 1933 and Section 21(e) of the Securities Exchange Act of 1934. Forward looking statements are inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to the following for each of the types of information noted below. U.S. and international military program sales, follow-on procurement, contract continuance, and future program awards, upgrades and spares support are subject to: U.S. and international military budget constraints and determinations; U.S. congressional and international legislative body discretion; U.S. and international government administration policies and priorities; changing world military threats, strategies and missions; competition from foreign manufacturers of platforms and equipment; NATO country determinations regarding participation in common programs; changes in U.S. and international government procurement timing, strategies and practices, the general state of world military readiness and deployment; and the ability to obtain export licenses. 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 and IPR&D acquired in a stock purchase business combination and the non-deductibility of our non-cash ESOP compensation expense. The Company has no obligation to update any forward-looking statements. 26 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS For quantitative and qualitative disclosures about market risk, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our annual report on Form 10-K for the year ended December 31, 2005. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of the end of the period covered by this Quarterly Report on Form 10-Q the Company carried out an evaluation, under the supervision and with the participation of the Company's senior management, including the Chief Executive Officer and the Chief Financial Officer, as well the audit committee of the Board of Directors, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on their evaluation, the Chief Executive Officer and the Chief Financial Officer of the Company have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC 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 II - OTHER INFORMATION ITEM 1A. RISK FACTORS None. ITEM 4. Submission of Matters to a Vote of Security Holders None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS 10* 2004 Non-Executive Director Stock Ownership Plan, as amended. 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. (B) REPORTS ON FORM 8-K The following report on Form 8-K was filed during the three months ended September 30, 2006:
DATE OF REPORT ITEMS REPORTED -------------- -------------- July 26, 2006 Item 1.01. Entry into a material definitive agreement. Item 5.02. Departures of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers.
27 July 27, 2006 Item 2.02. Results of Operations and Financial Condition. August 31, 2006 Item 1.01. Entry into a material definitive agreement. September 6, 2006 Item 1.01. Entry into a material definitive agreement. Item 2.01. Completion of Acquisition or Disposition of Assets. September 15, 2006 Item 2.01. Completion of Acquisition or Disposition of Assets.
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 financial officer, thereunto duly authorized. EDO CORPORATION (Registrant) Dated: November 6, 2006 By: /s/ FREDERIC B. BASSETT ------------------------------------ Frederic B. Bassett Senior Vice President Finance, Treasurer and Chief Financial Officer 28