XNYS:ESL Esterline Technologies Quarterly Report 10-Q Filing - 7/27/2012

Effective Date 7/27/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 27, 2012.

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  1-6357

 

LOGO

ESTERLINE TECHNOLOGIES CORPORATION

(Exact name of registrant as specified in its charter)

 

  Delaware   13-2595091     
  (State or other Jurisdiction   (I.R.S. Employer     
  of incorporation or organization)   Identification No.)     

500  108th Avenue N.E., Bellevue, Washington 98004

(Address of principal executive offices)(Zip Code)

Registrant’s telephone number, including area code (425) 453-9400

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  þ      No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   þ      No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  þ        Accelerated filer  ¨        Non-accelerated filer  ¨        Smaller reporting company  ¨

                                             (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨     No  þ

As of August 28, 2012, 30,857,658 shares of the issuer’s common stock were outstanding.


PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of July 27, 2012 and October 28, 2011

(In thousands, except share amounts)

 

 

 

     July 27,
2012
     October 28,
2011
 

ASSETS

     (Unaudited)        

Current Assets

     

Cash and cash equivalents

   $ 213,073       $ 185,035   

Cash in escrow

     5,014         5,011   

Accounts receivable, net of allowances

     

of $9,397 and $7,063

     333,815         369,826   

Inventories

     

Raw materials and purchased parts

     145,446         130,445   

Work in process

     175,504         187,922   

Finished goods

     89,565         84,181   
  

 

 

    

 

 

 
     410,515         402,548   

Income tax refundable

     10,409         2,857   

Deferred income tax benefits

     46,078         48,251   

Prepaid expenses

     23,872         19,245   

Other current assets

     2,651         6,540   
  

 

 

    

 

 

 

Total Current Assets

     1,045,427         1,039,313   

Property, Plant and Equipment

     685,259         669,920   

Accumulated depreciation

     330,208         301,504   
  

 

 

    

 

 

 
     355,051         368,416   

Other Non-Current Assets

     

Goodwill

     1,076,874         1,163,725   

Intangibles, net

     608,416         693,915   

Debt issuance costs, net of accumulated

     

amortization of $4,108 and $2,700

     9,294         10,695   

Deferred income tax benefits

     88,208         79,605   

Other assets

     18,756         22,917   
  

 

 

    

 

 

 
   $           3,202,026       $           3,378,586   
  

 

 

    

 

 

 

 

2


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of July 27, 2012 and October 28, 2011

(In thousands, except share amounts)

 

 

 

     July 27,
2012
    October 28,
2011
 

LIABILITIES AND SHAREHOLDERS’ EQUITY

     (Unaudited)       

Current Liabilities

    

Accounts payable

   $ 109,936      $ 119,888   

Accrued liabilities

     268,889        270,422   

Credit facilities

     127        5,000   

Current maturities of long-term debt

     12,521        11,595   

Deferred income tax liabilities

     3,503        9,538   

Federal and foreign income taxes

     13,713        1,918   
  

 

 

   

 

 

 

Total Current Liabilities

     408,689        418,361   

Long-Term Liabilities

    

Credit facilities

     300,000        360,000   

Long-term debt, net of current maturities

     619,753        660,028   

Deferred income tax liabilities

     208,702        238,709   

Pension and post-retirement obligations

     89,770        107,877   

Other liabilities

     34,180        19,693   

Shareholders’ Equity

    

Common stock, par value $.20 per share,

    

authorized 60,000,000 shares, issued and

outstanding 30,855,583 and 30,613,448 shares

     6,171        6,123   

Additional paid-in capital

     566,893        551,703   

Retained earnings

     1,058,696        1,007,821   

Accumulated other comprehensive loss

     (100,496     (2,812
  

 

 

   

 

 

 

Total Esterline shareholders’ equity

     1,531,264        1,562,835   

Noncontrolling interests

     9,668        11,083   
  

 

 

   

 

 

 

Total Shareholders’ Equity

     1,540,932        1,573,918   
  

 

 

   

 

 

 
   $           3,202,026      $           3,378,586   
  

 

 

   

 

 

 

 

3


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

For the Three and Nine Month Periods Ended July 27, 2012 and July 29, 2011

(Unaudited)

(In thousands, except per share amounts)

 

           Three Months Ended                 Nine Months Ended        
         July 27,    
    2012    
        July 29,    
    2011    
        July 27,    
    2012    
        July 29,    
    2011    
 

Net Sales

   $    485,949      $  409,512      $  1,461,662      $    1,215,588   

Cost of Sales

     313,853        265,973        946,962        778,980   
  

 

 

   

 

 

   

 

 

   

 

 

 
     172,096        143,539        514,700        436,608   

Expenses

        

Selling, general & administrative

     91,869        76,418        285,516        214,919   

Research, development

        

& engineering

     27,198        23,075        83,138        63,945   

Gain on settlement of contingency

     0        0        (11,891     0   

Goodwill impairment

     52,169        0        52,169        0   

Other income

     (1,263     (6,366     (1,263     (6,366
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

     169,973        93,127        407,669        272,498   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Earnings from

        

Continuing Operations

     2,123        50,412        107,031        164,110   

Interest Income

     (109     (658     (320     (1,428

Interest Expense

     12,159        10,286        35,171        28,381   

Loss on Extinguishment of Debt

     0        0        0        831   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) from Continuing Operations

        

Before Income Taxes

     (9,927     40,784        72,180        136,326   

Income Tax Expense

     6,963        2,821        20,677        22,323   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) from Continuing Operations

        

Including Noncontrolling Interests

     (16,890     37,963        51,503        114,003   

Income Attributable to

        

Noncontrolling Interests

     (214     (222     (628     (328
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) from Continuing Operations

        

Attributable to Esterline

     (17,104     37,741        50,875        113,675   

Loss from Discontinued Operations

        

Attributable to Esterline, Net of Tax

     0        (46     0        (75
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Earnings (Loss) Attributable to Esterline

   $ (17,104   $ 37,695      $ 50,875      $ 113,600   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable to Esterline – Basic:

        

Continuing operations

   $ (.55   $ 1.23      $ 1.66      $ 3.73   

Discontinued operations

     .00        .00        .00        .00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable

        

to Esterline – Basic

   $ (.55   $ 1.23      $ 1.66      $ 3.73   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable to Esterline – Diluted:

        

Continuing operations

   $ (.55   $ 1.21      $ 1.63      $ 3.65   

Discontinued operations

     .00        .00        .00        .00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable

        

to Esterline – Diluted

   $ (.55   $ 1.21      $ 1.63      $ 3.65   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

4


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Nine Month Periods Ended July 27, 2012 and July 29, 2011

(Unaudited)

(In thousands)

 

     Nine Months Ended  
     July 27,
2012
    July 29,
2011
 

Cash Flows Provided (Used) by Operating Activities

    

Net earnings including noncontrolling interests

   $                51,503      $              113,928   

Adjustments to reconcile net earnings including

    

noncontrolling interests to net cash provided

    

(used) by operating activities:

    

Depreciation and amortization

     79,265        56,738   

Deferred income taxes

     (19,636     823   

Share-based compensation

     7,686        5,781   

Gain on settlement of contingency

     (11,891     0   

Goodwill impairment

     52,169        0   

Working capital changes, net of effect of acquisitions

    

Accounts receivable

     20,975        34,625   

Inventories

     (27,494     (34,924

Prepaid expenses

     (5,423     (1,528

Other current assets

     188        (1,565

Accounts payable

     (2,466     383   

Accrued liabilities

     16,923        1,773   

Federal and foreign income taxes

     2,151        3,577   

Other liabilities

     (15,074     (20,112

Other, net

     2,371        (1,040
  

 

 

   

 

 

 
     151,247        158,459   

Cash Flows Provided (Used) by Investing Activities

    

Purchases of capital assets

     (39,456     (35,227

Proceeds from sale of capital assets

     1,139        913   

Escrow deposit

     0        (14,000

Acquisitions, net of cash acquired

     0        (811,914
  

 

 

   

 

 

 
     (38,317     (860,228

 

5


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Nine Month Periods Ended July 27, 2012 and July 29, 2011

(Unaudited)

(In thousands)

 

     Nine Months Ended  
     July 27,
2012
    July 29,
2011
 

Cash Flows Provided (Used) by Financing Activities

    

Proceeds provided by stock issuance under

    

employee stock plans

     7,331        13,244   

Excess tax benefits from stock options exercised

     221        1,830   

Dividends paid to noncontrolling interests

     0        (238

Debt and other issuance costs

     0        (5,374

Proceeds from credit facilities

     127        395,000   

Proceeds from issuance of long-term debt

     0        179,975   

Repayment of long-term debt and credit facilities

     (104,131     (118,158

Proceeds from government assistance

     17,203        14,950   
  

 

 

   

 

 

 
     (79,249     481,229   

Effect of Foreign Exchange Rates on Cash

     (5,643     6,258   
  

 

 

   

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

     28,038        (214,282

Cash and Cash Equivalents – Beginning of Period

     185,035        422,120   
  

 

 

   

 

 

 

Cash and Cash Equivalents – End of Period

   $              213,073      $              207,838   
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Cash Paid for Interest

   $ 27,039      $ 21,722   

Cash Paid for Taxes

     37,554        25,407   

 

6


ESTERLINE TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Nine Month Periods Ended July 27, 2012 and July 29, 2011

 

1. The consolidated balance sheet as of July 27, 2012, the consolidated statement of operations for the three and nine month periods ended July 27, 2012, and July 29, 2011, and the consolidated statement of cash flows for the nine month periods ended July 27, 2012, and July 29, 2011, are unaudited but, in the opinion of management, all of the necessary adjustments, consisting of normal recurring accruals, have been made to present fairly the financial statements referred to above in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the above statements do not include all of the footnotes required for complete financial statements. The results of operations and cash flows for the interim periods presented are not necessarily indicative of results that can be expected for the full year.

 

2. The notes to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended October 28, 2011, provide a summary of significant accounting policies and additional financial information that should be read in conjunction with this Form 10-Q.

 

3. The timing of the Company’s revenues is impacted by the purchasing patterns of customers and, as a result, revenues are not generated evenly throughout the year. Moreover, the Company’s first fiscal quarter, November through January, includes significant holiday periods in both Europe and North America.

 

4. In June 2011 the Financial Accounting Standards Board (FASB) amended requirements for the presentation of other comprehensive income (OCI), requiring presentation of comprehensive income in either a single, continuous statement of comprehensive income or on separate but consecutive statements, the statement of operations and the statement of OCI. The amendment is effective for the Company at the beginning of fiscal year 2013, with early adoption permitted. The adoption of this guidance will not impact the Company’s financial position, results of operations or cash flows and will only impact the presentation of OCI on the financial statements.

 

5. Basic earnings per share is computed on the basis of the weighted average number of shares outstanding during the year. Diluted earnings per share includes the dilutive effect of stock options. Common shares issuable from stock options excluded from the calculation of diluted earnings per share because they were anti-dilutive were 303,100 in the third fiscal quarter of 2011. Shares used for calculating earnings per share are disclosed in the following table.

 

(In thousands)    Three Months Ended      Nine Months Ended  
         July 27,    
2012
         July 29,    
2011
         July 27,    
2012
         July 29,    
2011
 

Shares Used for Basic Earnings Per Share

     30,835         30,579         30,712         30,475   

Shares Used for Diluted Earnings Per Share

     30,835         31,260         31,266         31,144   

 

7


6. The Company’s comprehensive income (loss) is as follows:

 

(In thousands)    Three Months Ended     Nine Months Ended  
       July 27,  
2012
    July 29,
2011
    July 27,
2012
    July 29,
2011
 

Net Earnings (Loss)

   $ (17,104   $ 37,695      $ 50,875      $ 113,600   

Change in Fair Value of Derivative

        

Financial Instruments, Net of Tax (1)

     (5,343     (5,370     (4,958     (325

Pension and Post-retirement

        

Obligations, Net of Tax (2)

                 1,760        1,248                    4,074        1,940   

Foreign Currency Translation

        

Adjustment

     (60,938     (26,247     (96,800     47,521   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

   $ (81,625   $             7,326      $ (46,809   $         162,736   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) 

Net of tax benefit of $2,296 and $2,201 for the third fiscal quarter of 2012 and 2011, respectively. Net of tax (expense) benefit of $2,388 and $(4) for the first nine months of fiscal 2012 and 2011, respectively.

 

  (2) 

Net of tax expense of $(929) and $(714) for the third fiscal quarter of 2012 and 2011, respectively. Net of tax expense of $(2,341) and $(1,406) for the first nine months of fiscal 2012 and 2011, respectively.

The Company’s accumulated other comprehensive loss is comprised of the following:

 

(In thousands)            July 27,        
2012
    October 28,
2011
 

Net unrealized gain (loss) on derivative contracts

   $ (936   $                 4,022   

Pension and post-retirement obligations

     (71,397     (75,471

Currency translation adjustment

     (28,163     68,637   
  

 

 

   

 

 

 

Total accumulated other comprehensive loss

   $ (100,496   $ (2,812
  

 

 

   

 

 

 

 

7. On July 26, 2011, the Company acquired the Souriau Group (Souriau) for approximately $726.7 million, including cash of $17.8 million. Souriau is a leading global supplier of highly engineered connectors for harsh environments serving aerospace, defense & space, power generation, rail, and industrial equipment markets. Souriau is included in the Sensors & Systems segment.

The following summarizes the allocation of the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition. The fair value adjustment for inventory was $41.7 million, which has been recognized as cost of goods sold over 4.5 months, the estimated inventory turnover. The purchase price includes the value of future development of existing technologies, the introduction of new technologies, and the addition of new customers. These factors resulted in recording goodwill of $376.9 million. The amount allocated to goodwill is not deductible for income tax purposes.

 

8


(In thousands)       

As of July 26, 2011

  

Current assets

   $ 228,694   

Property, plant and equipment

     91,843   

Intangible assets subject to amortization

  

Programs (15 year weighted average useful life)

     224,296   

Trade name (10 year weighted average useful life)

     45,709   

Goodwill

     376,902   

Other assets

     6,900   
  

 

 

 

Total assets acquired

     974,344   

Current liabilities assumed

     110,596   

Long-term liabilities assumed

     128,674   

Noncontrolling interest

     8,369   
  

 

 

 

Net assets acquired

   $             726,705   
  

 

 

 

Pro Forma Financial Information

The following pro forma financial information shows the results of continuing operations for the three and nine months ended July 29, 2011, as though the acquisition of Souriau had occurred at the beginning of the fiscal year. The pro forma financial information includes, where applicable, adjustments for: (i) the amortization of acquired intangible assets, (ii) additional interest expense on acquisition-related borrowings and (iii) the income tax effect on the pro forma adjustments. The pro forma financial information below is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have been achieved had the acquisition been completed as of the date indicated above or the results that may be obtained in the future.

 

(In thousands, except per share amounts)        Three Months Ended    
July 29, 2011
       Nine Months Ended    
July 29, 2011
 

Pro forma net sales

   $ 504,498       $ 1,473,427   

Pro forma net income

   $ 44,498       $ 128,222   

Basic earnings per share as reported

   $ 1.23       $ 3.73   

Pro forma basic earnings per share

   $ 1.46       $ 4.21   

Diluted earnings per share as reported

   $ 1.21       $ 3.65   

Pro forma diluted earnings per share

   $ 1.42       $ 4.12   

On December 30, 2010, the Company acquired Eclipse Electronic Systems, Inc. (Eclipse) for $123.8 million. The purchase price includes cash of $14.0 million in contingent consideration, which was deposited in an escrow account and will be paid to the seller if certain performance objectives are met over the three-year period. The estimated fair value of the contingent consideration was $13.4 million at the date of acquisition. On February 2, 2012, the Company paid the initial $5.0 million of three installments totaling $14.0 million of contingent consideration. As of July 27, 2012, the estimated fair value of the contingent consideration was $8.4 million. Eclipse is a designer and manufacturer of embedded communication intercept receivers for signal intelligence applications. Eclipse is included in the Avionics & Controls segment.

The following summarizes the allocation of the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition. The purchase price includes the value of future development of existing technologies, the introduction of new technologies, and the addition of new customers. These factors resulted in recording goodwill of $67.9 million. The amount allocated to goodwill is not deductible for income tax purposes.

 

9


(In thousands)       

As of December 30, 2010

  

Current assets

   $ 31,827   

Property, plant and equipment

     2,154   

Intangible assets subject to amortization

  

Technology (10 year weighted average useful life)

     53,200   

Goodwill

     67,878   
  

 

 

 

Total assets acquired

     155,059   

Current liabilities assumed

     36,240   

Long-term liabilities assumed

     8,350   
  

 

 

 

Net assets acquired

   $             110,469   
  

 

 

 

 

8. During the third fiscal quarter of 2012, management performed a Step One impairment test for Racal Acoustics, included in the Avionics & Controls segment, upon identification of an indicator of impairment. Racal Acoustics’ third quarter forecast projected an operating loss for fiscal 2012. Additionally, management determined that requirements for hearing protection devices for the U.S. Army would not recover in the five-year planning horizon in light of the cancellation of certain programs that include Racal Acoustics’ products, and the expected decline in demand for Racal Acoustics’ products from the U.S. armed forces, as well as a global slowdown in defense spending. As required under U.S. GAAP, a Step Two impairment test was required because the current fair value of the business using a discounted cash flow and market approach was less than its carrying amount of the business. Under Step Two, the fair value of all of Racal Acoustics’ assets and liabilities were estimated, including tangible assets, existing technology, and trade names, for the purpose of deriving an estimate of the implied fair value of goodwill. The implied fair value of the goodwill was then compared to the recorded goodwill to determine the amount of the impairment. Assumptions used in measuring the value of these assets and liabilities included the discount rates, royalty rates, and obsolescence rates used in valuing the intangible assets, and pricing of comparable transactions in the market in valuing the tangible assets. The excess of the carrying amount of goodwill over the implied fair value of goodwill resulted in an impairment charge of $52.2 million. There were no impairments on Racal Acoustics’ other long-lived assets subject to amortization at July 27, 2012.

 

9. The income tax rate (before the goodwill impairment charge) was 16.6% and 16.4% for the first nine months of fiscal 2012 and 2011, respectively. The income tax rate for the first nine months of fiscal 2012 (after the goodwill impairment charge) was 28.6%. In the first nine months of fiscal 2012, the Company recognized $7.2 million of discrete tax benefits principally related to three items. The first item was a $2.3 million tax benefit due to a change in French tax laws associated with the holding company structure and the financing of the Souriau acquisition. The second item was a $2.9 million reduction of net deferred tax liabilities as a result of the enactment of tax laws reducing the U.K. statutory income tax rate. The third item was a $1.7 million tax benefit as a result of reconciling the prior year’s income tax return to the U.S. income tax provision.

In the first nine months of fiscal 2011, the Company recognized $11.0 million of discrete tax benefits principally related to three items. The first item was approximately $3.3 million of tax benefits due to the retroactive extension of the U.S. federal research and experimentation credits and the release of a valuation allowance related to a net operating loss of an acquired subsidiary. The second item was approximately $5.6 million of tax benefits associated with net operating losses of an acquired subsidiary as a result of concluding a tax examination. The third item was approximately $3.2 million of net reduction of deferred tax liabilities as a result of the enactment of tax laws reducing the U.K. statutory income tax rate.

The income tax rate differed from the statutory rate in the first nine months of fiscal 2012 and 2011, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next twelve months approximately $5.6 million of tax benefits associated with research and development tax credits, capital and operating losses that are currently unrecognized could be recognized as a result of settlement of examinations and/or the expiration of a statute of limitations.

 

10


10. As of July 27, 2012, the Company had three share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans for the first nine months of fiscal 2012 and 2011 was $7.7 million and $5.8 million, respectively. During the first nine months of fiscal 2012 and 2011, the Company issued 242,135 and 333,128 shares, respectively, under its employee stock plans.

Employee Stock Purchase Plan (ESPP)

The ESPP is a “safe-harbor” designed plan whereby shares are purchased by participants at a discount of 5% of the market value on the purchase date and, therefore, compensation cost is not recorded under the ESPP.

Equity Incentive Plan

Under the equity incentive plan, option exercise prices are equal to the fair market value of the Company’s common stock on the date of grant. The Company granted 343,400 and 316,300 options to purchase shares in the nine month periods ended July 27, 2012, and July 29, 2011, respectively. The weighted-average grant date fair value of options granted during the nine month periods ended July 27, 2012, and July 29, 2011, was $24.33 and $32.58 per share, respectively.

The fair value of each option granted by the Company was estimated using a Black-Scholes pricing model which uses the assumptions noted in the following table. The Company uses historical data to estimate volatility of the Company’s common stock and option exercise and employee termination assumptions. The risk-free rate for the contractual life of the option is based on the U.S. Treasury zero coupon issues in effect at the time of the grant.

 

     Nine Months Ended  
         July 27,    
2012
         July 29,    
2011
 

Volatility

         41.62 – 44.29%             40.80 – 42.78%   

Risk-free interest rate

     0.91 – 2.11%         2.02 – 3.64%   

Expected life (years)

     4.5 – 9.5             4.5 – 9.5       

Dividends

     0             0       

Employee Sharesave Scheme

The Company offers shares under its employee sharesave scheme for U.K. employees. This plan allows participants the option to purchase shares at a 5% discount of the market price of the stock as of the beginning of the offering period. The term of these options is three years. The sharesave scheme is not a “safe-harbor” design, and therefore, compensation cost is recognized on this plan. Under the sharesave scheme, option exercise prices are equal to the fair market value of the Company’s common stock on the date of grant. The Company granted 45,063 and 9,956 options in the first nine month periods ended July 27, 2012, and July 29, 2011, respectively. The weighted-average grant date fair value of options granted during the nine month periods ended July 27, 2012, and July 29, 2011, were $19.85 and $26.14 per share, respectively.

The fair value of the awards under the employee sharesave scheme was estimated using a Black-Scholes pricing model which uses the assumptions noted in the following table. The risk-free rate for the contractual life of the option is based on the U.S. Treasury zero coupon issues in effect at the time of grant.

 

     Nine Months Ended  
     July 27,
2012
     July 29,
2011
 

Volatility

                      38.96%                          51.10%   

Risk-free interest rate

     0.38%         0.98%   

Expected life (years)

     3             3       

Dividends

     0             0       

 

11


11. The Company’s pension plans principally include a U.S. pension plan maintained by Esterline and a non-U.S. plan maintained by CMC Electronics, Inc. (CMC). Components of periodic pension cost consisted of the following:

 

(In thousands)    Three Months Ended     Nine Months Ended  
         July 27,    
2012
        July 29,    
2011
        July 27,    
2012
        July 29,    
2011
 

Components of Net Periodic Pension Cost

        

Service cost

   $ 2,372      $ 2,359      $ 7,198      $ 6,913   

Interest cost

     4,669        4,705        14,001        13,945   

Expected return on plan assets

     (5,338     (5,096     (16,035     (15,207

Amortization of prior service cost

     10        4        31        14   

Amortization of actuarial loss

     2,527        2,091        7,691        6,097   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Periodic Cost

   $ 4,240      $ 4,063      $ 12,886      $ 11,762   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s principal post-retirement plans include non-U.S. plans, which are non-contributory healthcare and life insurance plans. The components of expense of these other retirement benefits consisted of the following:

 

(In thousands)    Three Months Ended     Nine Months Ended  
         July 27,    
2012
        July 29,    
2011
        July 27,    
2012
        July 29,    
2011
 

Components of Net Periodic

        

Post-Retirement Plans Cost

        

Service cost

   $ 102      $ 141      $ 309      $ 416   

Interest cost

     163        178        492        524   

Amortization of actuarial gain

     (7     (4     (21     (12
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Periodic Cost

   $    258      $    315      $      780      $      928   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

12. In March 2011, the Company entered into a secured credit facility for $460 million made available through a group of banks. The credit facility is secured by substantially all of the Company’s assets and interest is based on standard inter-bank offering rates. The credit facility expires in March 2016. The spread ranges from LIBOR plus 1.5% to LIBOR plus 2.25% depending on the leverage ratios at the time the funds are drawn. At the same time as the Company entered into the $460 million secured credit facility, the Company repaid its U.S. Term Loan for $118.8 million. At July 27, 2012, the Company had $300.0 million outstanding under the secured credit facility at an initial interest rate of LIBOR plus 2.0% or currently 2.25%.

In July 2011, the Company amended the secured credit facility to provide for a €125.0 million term loan (Euro Term Loan) to Esterline Technologies Europe Limited. The interest rate spread on the Euro Term Loan will range from Euro LIBOR plus 1.5% to Euro LIBOR plus 2.25% depending on the leverage ratios at the time the funds are drawn. At July 27, 2012, the Company had €83.0 million outstanding or $102.3 million under the Euro Term Loan at an interest rate of Euro LIBOR plus 2.0% or currently 2.33%. The loan amortizes at 1.25% of the outstanding balance quarterly through March 2016, with the remaining balance due in July 2016.

Based on quoted market prices, the fair value of the Company’s $250.0 million 7.0% Senior Notes due August 2020 was $276.6 million and $263.1 million as of July 27, 2012, and October 28, 2011, respectively. The fair value of the Company’s $175.0 million 6.625% Senior Notes due March 2017 was $181.3 million and $175.0 million as of July 27, 2012, and October 28, 2011, respectively. The carrying amounts of the secured credit facility and Euro Term Loan due 2016 approximate fair value. Estimates of fair value for the Senior Notes are based on Level 2 inputs as defined in the fair value hierarchy.

 

12


13. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy has been established that prioritizes the inputs to valuation techniques used to measure fair value. An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The hierarchy of fair value measurements is described below:

Level 1 – Valuations are based on quoted prices that the Company has the ability to obtain in actively traded markets for identical assets and liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market or exchange traded market, a valuation of these instruments does not require a significant degree of judgment.

Level 2 – Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuations are based on model-based techniques for which some or all of the assumptions are obtained from indirect market information that is significant to the overall fair value measurement and which require a significant degree of management judgment.

The following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis by level within the fair value hierarchy at July 27, 2012, and October 28, 2011.

 

(In thousands)    Level 2  
             July 27,        
2012
           October 28,      
2011
 

Assets:

     

Derivative contracts designated as hedging instruments

   $ 6,607       $ 7,553   

Derivative contracts not designated as hedging instruments

   $ 350       $ 2,214   

Embedded derivatives

   $ 569       $ 38   

 

Liabilities:

     

Derivative contracts designated as hedging instruments

   $ 5,293       $ 1,632   

Derivative contracts not designated as hedging instruments

   $ 2,422       $ 1,070   

Embedded derivatives

   $ 39       $ 895   

 

 

(In thousands)

   Level 3  
     July 27,
2012
     October 28,
2011
 

Liabilities:

     

Contingent purchase obligation

   $ 8,350       $ 13,350   

The Company’s embedded derivatives are the result of entering into sales or purchase contracts that are denominated in a currency other than the Company’s functional currency or the supplier’s or customer’s functional currency. The fair value is determined by calculating the difference between quoted exchange rates at the time the contract was entered into and the period end exchange rate. These contracts are categorized as Level 2 in the fair value hierarchy.

The Company’s derivative contracts consist of foreign currency exchange contracts and interest rate swap agreements. These derivative contracts are over the counter and their fair value is determined using modeling techniques that include market inputs such as interest rates, yield curves, and currency exchange rates. These contracts are categorized as Level 2 in the fair value hierarchy.

The Company’s contingent purchase obligation consists of additional consideration in connection with the acquisition of Eclipse. The contingent consideration will be paid to the seller if certain performance objectives are met over the three-year period. The value recorded on the balance sheet was derived from the estimated probability that the performance objectives will be met by the end of the three-year period. The contingent purchase obligation is categorized as Level 3 in the fair value hierarchy. The Company paid $5.0 million of the contingent purchase consideration in the second fiscal quarter of 2012.

 

13


14. The Company uses derivative financial instruments in the form of foreign currency forward exchange contracts and interest rate swap contracts for the purpose of minimizing exposure to changes in foreign currency exchange rates on business transactions and interest rates, respectively. The Company’s policy is to execute such instruments with banks the Company believes to be creditworthy and not to enter into derivative financial instruments for speculative purposes. These derivative financial instruments do not subject the Company to undue risk, as gains and losses on these instruments generally offset gains and losses on the underlying assets, liabilities, or anticipated transactions that are being hedged.

All derivative financial instruments are recorded at fair value in the Consolidated Balance Sheet. For a derivative that has not been designated as an accounting hedge, the change in the fair value is recognized immediately through earnings. For a derivative that has been designated as an accounting hedge of an existing asset or liability (a fair value hedge), the change in the fair value of both the derivative and underlying asset or liability is recognized immediately through earnings. For a derivative designated as an accounting hedge of an anticipated transaction (a cash flow hedge), the change in the fair value is recorded on the Consolidated Balance Sheet in Accumulated Other Comprehensive Income (AOCI) to the extent the derivative is effective in mitigating the exposure related to the anticipated transaction. The change in the fair value related to the ineffective portion of the hedge, if any, is immediately recognized in earnings. The amount recorded within AOCI is reclassified into earnings in the same period during which the underlying hedged transaction affects earnings.

The fair values of derivative instruments are presented on a gross basis, as the Company does not have any derivative contracts which are subject to master netting arrangements. At July 27, 2012, the Company does not have any hedges with credit-risk-related contingent features or that required the posting of collateral. The cash flows from derivative contracts are recorded in operating activities in the Consolidated Statement of Cash Flows.

Foreign Currency Forward Exchange Contracts

The Company transacts business in various foreign currencies which subjects the Company’s cash flows and earnings to exposure related to changes in foreign currency exchange rates. These exposures arise primarily from purchases or sales of products and services from third parties. Foreign currency forward exchange contracts provide for the purchase or sale of foreign currencies at specified future dates at specified exchange rates and are used to offset changes in the fair value of certain assets or liabilities or forecasted cash flows resulting from transactions denominated in foreign currencies. At July 27, 2012, and October 28, 2011, the Company had outstanding foreign currency forward exchange contracts principally to sell U.S. dollars with notional amounts of $414.0 million and $431.2 million, respectively. These notional values consist primarily of contracts for the European euro, British pound sterling and Canadian dollar, and are stated in U.S. dollar equivalents at spot exchange rates at the respective dates.

Interest Rate Swaps

The Company manages its exposure to interest rate risk by maintaining an appropriate mix of fixed and variable rate debt, which over time should moderate the costs of debt financing. When considered necessary, the Company may use financial instruments in the form of interest rate swaps to help meet this objective. In November 2010, the Company entered into an interest rate swap agreement for $100.0 million of the $175.0 million Senior Notes due in 2017. The swap agreement exchanged the fixed interest rate of 6.625% for a variable interest rate on the $100.0 million of the principal amount outstanding. The variable interest rate is based upon LIBOR plus 4.865% and was 5.312% at July 27, 2012. The fair value of the Company’s interest rate swap was a $2.1 million asset at July 27, 2012, and was estimated by discounting expected cash flows using market interest rates. The Company records interest receivable and interest payable on interest rate swaps on a net basis. In December 2010, the Company entered into an interest rate swap agreement for $75.0 million of the $175.0 million Senior Notes due in 2017. The swap agreement exchanged the fixed interest rate of 6.625% for a variable interest rate on the $75.0 million of the principal amount outstanding. The variable interest rate is based upon LIBOR plus 4.47% and was 4.917% at July 27, 2012. The fair value of the Company’s interest rate swap was a $2.1 million asset at July 27, 2012, and was estimated by discounting expected cash flows using market interest rates. The Company recognized a net interest receivable of $1.1 million at July 27, 2012.

 

14


Embedded Derivative Instruments

The Company’s embedded derivatives are the result of entering into sales or purchase contracts that are denominated in a currency other than the Company’s functional currency or the supplier’s or customer’s functional currency.

Net Investment Hedge

In July 2011, the Company entered into a Euro Term Loan for €125.0 million under the secured credit facility. The Company designated the Euro Term Loan a hedge of the investment in a certain French business unit. The foreign currency gain or loss that is effective as a hedge is reported as a component of other comprehensive income in shareholders’ equity. To the extent that this hedge is ineffective, the foreign currency gain or loss is recorded in earnings. There was no ineffectiveness since inception of the hedge.

Fair Value of Derivative Instruments

Fair values of derivative instruments in the Consolidated Balance Sheet at July 27, 2012, and October 28, 2011, consisted of:

 

(In thousands)              Fair Value  
               Classification                            July 27,        
2012
           October 28,      
2011
 

Foreign currency forward

           

exchange contracts:

   Other current assets       $ 1,512       $ 7,092   
   Other assets         1,263         1,321   
   Accrued liabilities         6,797         1,606   
   Other liabilities         918         1,096   

 

Embedded derivative instruments:

   Other current assets       $ 569       $ 38   
   Accrued liabilities         16         82   
   Other liabilities         23         813   

 

Interest rate swap:

   Long-term debt, net         
   of current maturities       $ 4,182       $ 1,354   

The effect of derivative instruments on the Consolidated Statement of Operations for the three and nine month periods ended July 27, 2012, and July 29, 2011, consisted of:

 

(In thousands)         Three Months Ended     Nine Months Ended  
     Location of
     Gain (Loss)     
        July 27,     
2012
         July 29,     
2011
         July 27,     
2012
         July 29,     
2011
 

Fair Value Hedges:

           

Interest rate
swap contracts

   Interest
Expense
   $ 654      $ 737      $ 1,905      $ 1,934   

Embedded
derivatives

   Sales    $ 1,304      $ 1,413      $ 1,046      $ 533   

 

Cash Flow Hedges:

           

Foreign currency forward exchange contracts:

  

     

Amount of gain
(loss) recognized
in AOCI (effective
portion)

   AOCI    $ (7,434   $ (10,285   $ (7,553   $ (8,652

Amount of gain
(loss) reclassified
from AOCI
into income

   Sales    $ (205   $ 2,716      $ 207      $ 8,331   

 

Net Investment Hedges:

           

Euro term loan

   AOCI    $ 9,453      $ (1,413   $ 19,801      $ 0   

 

15


During the first nine months of fiscal 2012 and 2011, the Company recorded a loss of $9.2 million and a gain of $3.1 million, respectively, on foreign currency forward exchange contracts that have not been designated as an accounting hedge. These foreign currency exchange gains are included in selling, general and administrative expense.

There was no significant impact to the Company’s earnings related to the ineffective portion of any hedging instruments during the first nine months of fiscal 2012 and 2011. In addition, there was no significant impact to the Company’s earnings when a hedged firm commitment no longer qualified as a fair value hedge or when a hedged forecasted transaction no longer qualified as a cash flow hedge during the first nine months of fiscal 2012 and 2011.

Amounts included in AOCI are reclassified into earnings when the hedged transaction settles. The Company expects to reclassify approximately $3.6 million of net loss into earnings over the next 12 months. The maximum duration of the Company’s foreign currency cash flow hedge contracts at July 27, 2012, is 23 months.

 

15. Segment information:

Business segment information for continuing operations includes the segments of Avionics & Controls, Sensors & Systems and Advanced Materials.

 

(In thousands)    Three Months Ended     Nine Months Ended  
     July 27,
2012
    July 29,
2011
    July 27,
2012
    July 29,
2011
 

Sales

        

Avionics & Controls

   $ 195,059      $ 208,021      $ 569,656      $ 632,020   

Sensors & Systems

     171,603        88,605        527,958        250,841   

Advanced Materials

     119,287        112,886        364,048        332,727   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Sales

   $ 485,949      $ 409,512      $ 1,461,662      $ 1,215,588   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Income (Loss) from Continuing Operations

        

Avionics & Controls

     (25,611 (1)      28,604           $ 12,703  (1)    $ 104,523   

Sensors & Systems

     18,305        10,764        49,830        33,403   

Advanced Materials

     17,293        18,797        66,526        57,044   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment Earnings

     9,987        58,165        129,059        194,970   

 

Corporate expense

     (9,127     (14,119     (35,182     (37,226

Gain on settlement of contingency

     0        0        11,891             0   

Other income

     1,263        6,366        1,263        6,366   

Interest income

     109        658        320        1,428   

Interest expense

     (12,159     (10,286     (35,171     (28,381

Loss on extinguishment of debt

     0        0        0        (831
  

 

 

   

 

 

   

 

 

   

 

 

 
   $          (9,927   $         40,784      $         72,180      $       136,326   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) Includes a $52.2 million impairment charge against Racal Acoustics’ goodwill.

 

16. Prior to the March 2007 acquisition of CMC, CMC was involved in a transaction in which CMC shareholders had a limited amount of time in which to tender their shares in exchange for cash. In May 2008, after the prescribed time period had expired, CAD $11.8 million remained unclaimed. As a result, the paying agent returned the unclaimed amount to CMC in accordance with Canadian law. In December 2008, CMC’s former parent company instituted a legal action against the paying agent, alleging negligence and breached contract terms by returning the funds to CMC. The plaintiff lost at trial and appealed. In the second quarter of fiscal 2012, CMC received notice that the plaintiff abandoned its appeal. In addition, CMC and the paying agent settled all remaining issues. Management concluded that all contingencies relating to this matter were resolved, and accordingly, the Company recorded a gain of approximately CAD $11.8 million or $11.9 million, or $9.5 million after tax, in the second fiscal quarter of 2012.

 

16


17. The following schedules set forth condensed consolidating financial information as required by Rule 3-10 of Securities and Exchange Commission Regulation S-X as of July 27, 2012, and October 28, 2011, and for the applicable periods ended July 27, 2012, and July 29, 2011, for (a) Esterline Technologies Corporation (the Parent); (b) on a combined basis, the current subsidiary guarantors (Guarantor Subsidiaries) of the secured credit facility, Senior Notes due 2017, and Senior Notes due 2020; and (c) on a combined basis, the subsidiaries that are not guarantors of the secured credit facility, Senior Notes due 2017, and Senior Notes due 2020 (Non-Guarantor Subsidiaries). The Guarantor Subsidiaries previously guaranteed the Senior Subordinated Notes due 2013 that were repurchased or otherwise redeemed in August 2010. The Guarantor Subsidiaries are direct and indirect wholly-owned subsidiaries of Esterline Technologies Corporation and have fully and unconditionally, jointly and severally, guaranteed the secured credit facility, the Senior Notes due 2017 and the Senior Notes due 2020.

Condensed Consolidating Balance Sheet as of July 27, 2012.

 

(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

 

Assets

         

 

Current Assets

         

Cash and cash equivalents

  $ 33,326      $ 11,010      $ 168,737      $ 0      $ 213,073   

Cash in escrow

    5,014        0        0        0        5,014   

Accounts receivable, net

    146        121,839        211,830        0        333,815   

Inventories

    0        160,973        249,542        0        410,515   

Income tax refundable

    0        10,409        0        0        10,409   

Deferred income tax benefits

    23,342        714        22,022        0        46,078   

Prepaid expenses

    95        5,399        18,378        0        23,872   

Other current assets

    131        439        2,081        0        2,651   

 

 

Total Current Assets

    62,054        310,783        672,590        0        1,045,427   

 

Property, Plant &
Equipment, Net

    3,026        162,959        189,066        0        355,051   

Goodwill

    0        315,127        761,747        0        1,076,874   

Intangibles, Net

    0        129,742        478,674        0        608,416   

Debt Issuance Costs, Net

    7,895        0        1,399        0        9,294   

Deferred Income
Tax Benefits

    28,051        (150     60,307        0        88,208   

Other Assets

    8,209        1,616        8,931        0        18,756   

Amounts Due From (To)
Subsidiaries

    0        509,512        0        (509,512     0   

Investment in Subsidiaries

    2,411,673        1,134,042        248,315        (3,794,030     0   

 

 

Total Assets

  $      2,520,908      $      2,563,631      $      2,421,029      $     (4,303,542   $      3,202,026   

 

 

 

17


(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

Liabilities and Shareholders’ Equity

         

 

Current Liabilities

         

Accounts payable

  $ 863      $ 26,116      $ 82,957      $ 0      $ 109,936   

Accrued liabilities

    26,557        77,588        164,744        0        268,889   

Credit facilities

    0        0        127        0        127   

Current maturities of
long-term debt

    0        184        12,337        0        12,521   

Deferred income tax
liabilities

    200        (1     3,304        0        3,503   

Federal and foreign
income taxes

    9,075        (16,067     20,705        0        13,713   

 

 

Total Current Liabilities

    36,695        87,820        284,174        0        408,689   

 

Credit Facilities

    300,000        0        0        0        300,000   

Long-Term Debt, Net

    429,182        44,152        146,419        0        619,753   

Deferred Income Tax
Liabilities

    50,056        (8     158,654        0        208,702   

Pension and Post-
Retirement Obligations

    17,246        25,392        47,132        0        89,770   

Other Liabilities

    4,655        3,794        25,731        0        34,180   

Amounts Due To (From)
Subsidiaries

    142,142        0        475,782        (617,924     0   

Shareholders’ Equity

    1,540,932        2,402,481        1,283,137        (3,685,618     1,540,932   

 

 

Total Liabilities and
Shareholders’ Equity

  $      2,520,908      $      2,563,631      $      2,421,029      $     (4,303,542   $      3,202,026   

 

 

 

 

18


Condensed Consolidating Statement of Operations for the three month period ended July 27, 2012.

 

(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

 

Net Sales

  $ 0      $ 227,022      $ 260,229      $ (1,302   $ 485,949   

Cost of Sales

    0        144,787        170,368        (1,302     313,853   

 

 
    0        82,235        89,861        0        172,096   

Expenses

         

Selling, general
and administrative

    0        35,862        56,007        0        91,869   

Research, development
and engineering

    0        13,062        14,136        0        27,198   

Gain on settlement of
contingency

    0        0        0        0        0   

Goodwill impairment

    0        0        52,169        0        52,169   

Other income

    0        0        (1,263     0        (1,263

 

 

Total Expenses

    0        48,924        121,049        0        169,973   

 

 

 

Operating Earnings from
Continuing Operations

    0        33,311        (31,188     0        2,123   

Interest Income

    (3,574     (5,090     (14,319     22,874        (109

Interest Expense

    8,648        7,396        18,989        (22,874     12,159   

Loss on Extinguishment
of Debt

    0        0        0        0        0   

 

 

Income (Loss) from
Continuing Operations
Before Taxes

    (5,074     31,005        (35,858     0        (9,927

Income Tax Expense
(Benefit)

    (4,058     22,476        (11,455     0        6,963   

 

 

Income (Loss) from
Continuing Operations
Including Noncontrolling
Interests

    (1,016     8,529        (24,403     0        (16,890

Income Attributable to
Noncontrolling Interests

    0        0        (214     0        (214

 

 

Income (Loss) from
Continuing Operations
Attributable to Esterline

    (1,016     8,529        (24,617     0        (17,104

Loss from Discontinued
Operations Attributable
to Esterline, Net of Tax

    0        0        0        0        0   

Equity in Net Income of
Consolidated Subsidiaries

    (16,088     2,080        (50     14,058        0   

 

 

Net Earnings (Loss)
Attributable to Esterline

  $         (17,104   $           10,609      $         (24,667   $           14,058      $         (17,104

 

 

 

19


Condensed Consolidating Statement of Operations for the nine month period ended July 27, 2012.

 

(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

 

Net Sales

  $ 0      $ 670,767      $ 793,626      $ (2,731   $ 1,461,662   

Cost of Sales

    0        419,969        529,724        (2,731     946,962   

 

 
    0        250,798        263,902        0        514,700   

Expenses

         

Selling, general
and administrative

    0        107,639        177,877        0        285,516   

Research, development
and engineering

    0        38,080        45,058        0        83,138   

Gain on settlement of
contingency

    0        0        (11,891     0        (11,891

Goodwill impairment

    0        0        52,169        0        52,169   

Other income

    0        0        (1,263     0        (1,263

 

 

Total Expenses

    0        145,719        261,950        0        407,669   

 

 

 

Operating Earnings from
Continuing Operations

    0        105,079        1,952        0        107,031   

Interest Income

    (10,559     (12,468     (47,717     70,424        (320

Interest Expense

    26,311        20,613        58,671        (70,424     35,171   

Loss on Extinguishment
of Debt

    0        0        0        0        0   

 

 

 

Income (Loss) from
Continuing Operations
Before Taxes

    (15,752     96,934        (9,002     0        72,180   

Income Tax Expense
(Benefit)

    (6,087     32,840        (6,076     0        20,677   

 

 

Income (Loss) from
Continuing Operations
Including Noncontrolling
Interests

    (9,665     64,094        (2,926     0        51,503   

Income Attributable to
Noncontrolling Interests

    0        0        (628     0        (628

 

 

Income (Loss) from
Continuing Operations
Attributable to Esterline

    (9,665     64,094        (3,554     0        50,875   

Loss from Discontinued
Operations Attributable
to Esterline, Net of Tax

    0        0        0        0        0   

Equity in Net Income of
Consolidated Subsidiaries

    60,540        10,791        (140     (71,191     0   

 

 

Net Earnings (Loss)
Attributable to Esterline

  $           50,875      $           74,885      $            (3,694   $         (71,191   $           50,875   

 

 

 

20


Condensed Consolidating Statement of Cash Flows for the nine month period ended July 27, 2012.

 

(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

 

Cash Flows Provided (Used) by Operating Activities

  

     

Net earnings (loss) including
noncontrolling interests

  $           51,503      $           74,885      $           (3,694   $         (71,191   $           51,503   

Depreciation & amortization

    0        28,556        50,709        0        79,265   

Deferred income taxes

    19,199        (20,844     (17,991     0        (19,636

Share-based compensation

    0        3,344        4,342        0        7,686   

Gain on settlement of
contingency

    0        0        (11,891     0        (11,891

Goodwill impairment

    0        0        52,169        0        52,169   

Working capital changes, net
of effect of acquisitions
Accounts receivable

    12        16,088        4,875        0        20,975   

Inventories

    0        (17,107     (10,387     0        (27,494

Prepaid expenses

    (36     (393     (4,994     0        (5,423

Other current assets

    9        (95     274        0        188   

Accounts payable

    51        (409     (2,108     0        (2,466

Accrued liabilities

    7,489        (2,201     11,635        0        16,923   

Federal & foreign
income taxes

    8,148        (1,745     (4,252     0        2,151   

Other liabilities

    5,718        (17,698     (3,094     0        (15,074

Other, net

    (83     494        1,960        0        2,371   

 

 
    91,010        62,875        67,553        (71,191     151,247   

 

Cash Flows Provided (Used) by Investing Activities

  

     

Purchases of capital assets

    (1,466     (18,728     (19,262     0        (39,456

Proceeds from sale
of capital assets

    0        464        675        0        1,139   

Escrow deposit

    0        0        0        0        0   

Acquisitions, net of
cash acquired

    0        0        0        0        0   

 

 
    (1,466     (18,264     (18,587     0        (38,317

 

21


(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

 

Cash Flows Provided (Used) by Financing Activities

  

     

Proceeds provided by stock
issuance under employee
stock plans

    7,331        0        0        0                  7,331   

Excess tax benefits from
stock options exercised

    221        0        0        0        221   

Dividends paid to non-
controlling interests

    0        0        0        0        0   

Debt and other issuance costs

    0        0        0        0        0   

Proceeds from credit facilities

    0        0        127        0        127   

Proceeds from issuance of
long-term debt

    0        0        0        0        0   

Repayment of long-term debt
and credit facilities

    (60,000     (306     (43,825     0        (104,131

Proceeds from government
assistance

    0        0        17,203        0        17,203   

Net change in intercompany
financing

    (54,603     (46,752               30,164        71,191        0   

 

 
    (107,051     (47,058     3,669              71,191        (79,249

 

Effect of foreign exchange
rates on cash

    (4     7        (5,646     0        (5,643

 

 

 

Net increase (decrease) in
cash and cash equivalents

    (16,511     (2,440     46,989        0        28,038   

Cash and cash equivalents
– beginning of year

    49,837        13,450        121,748        0        185,035   

 

 

Cash and cash equivalents
– end of year

  $           33,326      $           11,010      $ 168,737      $ 0      $ 213,073   

 

 

 

22


Condensed Consolidating Balance Sheet as of October 28, 2011.

 

(In thousands)                              
                Non-              
          Guarantor     Guarantor              
    Parent         Subsidiaries         Subsidiaries       Eliminations     Total  

Assets

         

 

Current Assets

         

Cash and cash equivalents

  $ 49,837      $ 13,450      $ 121,748      $ 0      $ 185,035   

Cash in escrow

    5,011        0        0        0        5,011   

Accounts receivable, net

    158        137,927        231,741        0        369,826   

Inventories

    0        143,866        258,682        0        402,548   

Income tax refundable

    0        0        2,857        0        2,857   

Deferred income tax benefits

    25,585        1,574        21,092        0        48,251   

Prepaid expenses

    59        5,006        14,180        0        19,245   

Other current assets

    140        344        6,056        0        6,540   

 

 

Total Current Assets

    80,790        302,167        656,356        0        1,039,313   

Property, Plant &

         

Equipment, Net

    1,109        161,297        206,010        0        368,416   

Goodwill

    0        313,788        849,937        0        1,163,725   

Intangibles, Net

    0        140,590        553,325        0        693,915   

Debt Issuance Costs, Net

    9,033        0        1,662        0        10,695   

Deferred Income Tax

         

Benefits

    27,925        125        51,555        0        79,605   

Other Assets

    10,307        2,321        10,289        0        22,917   

Amounts Due From (To)

         

Subsidiaries

    350,407        482,330        0        (832,737     0   

Investment in Subsidiaries

    1,953,823        624,856        321,170        (2,899,849     0   

 

 

Total Assets

  $      2,433,394      $      2,027,474      $      2,650,304      $     (3,732,586   $      3,378,586   

 

 

 

23


(In thousands)                              
                Non-              
          Guarantor     Guarantor              
    Parent         Subsidiaries         Subsidiaries       Eliminations     Total  

Liabilities and Shareholders’ Equity

  

       

 

Current Liabilities

         

Accounts payable

  $ 812      $ 26,525      $ 92,551      $ 0      $ 119,888   

Accrued liabilities

    18,587        79,524        172,311        0        270,422   

Credit facilities

    0        0        5,000        0        5,000   

Current maturities of

         

long-term debt

    0        211        11,384        0        11,595   

Deferred income tax

         

liabilities

    238        (1     9,301        0        9,538   

Federal and foreign

         

income taxes

    (1,326     (25,185     28,429        0        1,918   

 

 

Total Current Liabilities

    18,311        81,074        318,976        0        418,361   

Credit Facilities

    360,000        0        0        0        360,000   

Long-Term Debt, Net

    426,354        44,289        189,385        0        660,028   

Deferred Income Tax

         

Liabilities

    32,959        21,971        183,779        0        238,709   

Pension and Post-

         

Retirement Obligations

    17,849        38,335        51,693        0        107,877   

Other Liabilities

    4,003        8,549        7,141        0        19,693   

Amounts Due To (From)

         

Subsidiaries

    0        0        444,820        (444,820     0   

Shareholders’ Equity

    1,573,918        1,833,256        1,454,510        (3,287,766     1,573,918   

 

 

Total Liabilities and

         

Shareholders’ Equity

  $      2,433,394      $      2,027,474      $      2,650,304      $     (3,732,586   $      3,378,586   

 

 

 

24


Condensed Consolidating Statement of Operations for the three month period ended July 29, 2011.

 

(In thousands)                              
                Non-              
          Guarantor     Guarantor              
    Parent         Subsidiaries         Subsidiaries       Eliminations     Total  

Net Sales

  $ 0      $ 215,058      $ 195,162      $ (708   $ 409,512   

Cost of Sales

    0        141,994        124,687        (708     265,973   

 

 
    0        73,064        70,475        0        143,539   

Expenses

         

Selling, general

         

and administrative

    0        35,803        40,615        0        76,418   

Research, development

         

and engineering

    0        8,973        14,102        0        23,075   

Gain on settlement of

         

contingency

    0        0        0        0        0   

Goodwill impairment

    0        0        0        0        0   

Other income

    0        0        (6,366     0        (6,366

 

 

Total Expenses

    0        44,776        48,351        0        93,127   

 

 

Operating Earnings from

         

Continuing Operations

    0        28,288        22,124        0        50,412   

Interest Income

    (3,748     (794     (6,908     10,792        (658

Interest Expense

    8,628        5,326        7,124        (10,792     10,286   

Loss on Extinguishment

         

of Debt

    0        0        0        0        0   

 

 

Income (Loss) from

         

Continuing Operations

         

Before Taxes

    (4,880     23,756        21,908        0        40,784   

Income Tax Expense

         

(Benefit)

    (1,250     1,640        2,431        0        2,821   

 

 

Income (Loss) from

         

Continuing Operations

         

Including Noncontrolling

         

Interests

    (3,630     22,116        19,477        0        37,963   

Income Attributable to

         

Noncontrolling Interests

    0        0        (222     0        (222

 

 

Income (Loss) from

         

Continuing Operations

         

Attributable to Esterline

    (3,630     22,116        19,255        0        37,741   

Loss from Discontinued

         

Operations Attributable

         

to Esterline, Net of Tax

    0        (46     0        0        (46

Equity in Net Income of

         

Consolidated Subsidiaries

    41,325        9,492        (1,365     (49,452     0   

 

 

Net Earnings (Loss)

         

Attributable to Esterline

  $           37,695      $           31,562      $           17,890      $          (49,452   $           37,695   

 

 

 

25


Condensed Consolidating Statement of Operations for the nine month period ended July 29, 2011.

 

(In thousands)                              
                Non-              
          Guarantor     Guarantor              
    Parent         Subsidiaries         Subsidiaries        Eliminations     Total  

Net Sales

  $ 0      $ 640,539      $ 576,745      $ (1,696   $ 1,215,588   

Cost of Sales

    0        410,499        370,177        (1,696     778,980   

 

 
    0        230,040        206,568        0        436,608   

Expenses

         

Selling, general

         

and administrative

    0        99,909        115,010        0        214,919   

Research, development

         

and engineering

    0        26,891        37,054        0        63,945   

Gain on settlement of

         

contingency

    0        0        0        0        0   

Goodwill impairment

    0        0        0        0        0   

Other income

    0        0        (6,366     0        (6,366

 

 

Total Expenses

    0        126,800        145,698        0        272,498   

 

 

Operating Earnings from

         

Continuing Operations

    0        103,240        60,870        0        164,110   

Interest Income

    (10,770     (2,053     (18,007     29,402        (1,428

Interest Expense

    24,348        15,413        18,022        (29,402     28,381   

Loss on Extinguishment

         

of Debt

    831        0        0        0        831   

 

 

Income (Loss) from

         

Continuing Operations

         

Before Taxes

    (14,409     89,880        60,855        0        136,326   

Income Tax Expense

         

(Benefit)

    (3,527     12,635        13,215        0        22,323   

 

 

Income (Loss) from

         

Continuing Operations

         

Including Noncontrolling

         

Interests

    (10,882     77,245        47,640        0        114,003   

Income Attributable to

         

Noncontrolling Interests

    0        0        (328     0        (328

 

 

Income (Loss) from

         

Continuing Operations

         

Attributable to Esterline

    (10,882     77,245        47,312        0        113,675   

Loss from Discontinued

         

Operations Attributable

         

to Esterline, Net of Tax

    0        (75     0        0        (75

Equity in Net Income of

         

Consolidated Subsidiaries

    124,482        22,354        1,127        (147,963     0   

 

 

Net Earnings (Loss)

         

Attributable to Esterline

  $         113,600      $        99,524      $        48,439      $     (147,963   $         113,600   

 

 

 

26


Condensed Consolidating Statement of Cash Flows for the nine month period ended July 29, 2011.

 

(In thousands)                              
                Non-              
          Guarantor     Guarantor              
    Parent         Subsidiaries         Subsidiaries        Eliminations     Total  

Cash Flows Provided (Used) by Operating Activities

  

     

Net earnings (loss) including

         

noncontrolling interests

  $         113,928      $           99,524      $           48,439      $        (147,963   $         113,928   

Depreciation & amortization

    0        26,389        30,349        0        56,738   

Deferred income taxes

    8,727        (18     (7,886     0        823   

Share-based compensation

    0        2,643        3,138        0        5,781   

Gain on settlement of

         

contingency

    0        0        0        0        0   

Goodwill impairment

    0        0        0        0        0   

Working capital changes, net

         

of effect of acquisitions

         

Accounts receivable

    262        9,055        25,308        0        34,625   

Inventories

    0        (16,564     (18,360     0        (34,924

Prepaid expenses

    (71     355        (1,812     0        (1,528

Other current assets

    (26     (96     (1,443     0        (1,565

Accounts payable

    (95     833        (355     0        383   

Accrued liabilities

    5,399        (318     (3,308     0        1,773   

Federal & foreign

         

income taxes

    3,477        (4,591     4,691        0        3,577   

Other liabilities

    (632     (17,956     (1,524     0        (20,112

Other, net

    1,539        (12,165     9,586        0        (1,040

 

 
    132,508        87,091        86,823        (147,963     158,459   

Cash Flows Provided (Used) by Investing Activities

  

     

Purchases of capital assets

    (102     (17,202     (17,923     0        (35,227

Proceeds from sale

         

of capital assets

    0        262        651        0        913   

Escrow deposit

    (14,000     0        0        0        (14,000

Acquisitions, net of

         

cash acquired

    0        (103,039     (708,875     0        (811,914

 

 
    (14,102     (119,979     (726,147     0        (860,228

 

27


(In thousands)                              
                Non-              
          Guarantor     Guarantor              
    Parent         Subsidiaries         Subsidiaries        Eliminations     Total  

Cash Flows Provided (Used) by Financing Activities

  

     

Proceeds provided by stock

         

issuance under employee

         

stock plans

    13,244        0        0        0        13,244   

Excess tax benefits from

         

stock options exercised

    1,830        0        0        0        1,830   

Dividends paid to non-

         

controlling interests

    0        0        (238     0        (238

Debt and other issuance costs

    (3,616     0        (1,758     0        (5,374

Proceeds from credit facilities

    395,000        0        0        0        395,000   

Proceeds from issuance of

         

long-term debt

    0        0        179,975        0        179,975   

Repayment of long-term debt

         

and credit facilities

    (120,313     (255     2,410        0        (118,158

Proceeds from government

         

assistance

    0        0        14,950        0        14,950   

Net change in intercompany

         

financing

    (534,804     35,232        351,609        147,963        0   

 

 
    (248,659     34,977        546,948        147,963        481,229   

Effect of foreign exchange

         

rates on cash

    1        (4     6,261        0        6,258   

 

 

Net increase (decrease) in

         

cash and cash equivalents

    (130,252     2,085        (86,115     0        (214,282

Cash and cash equivalents

         

– beginning of year

    205,050        2,317        214,753        0        422,120   

 

 

Cash and cash equivalents

         

– end of year

  $           74,798      $             4,402      $         128,638      $                     0      $         207,838   

 

 

 

28


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We operate our businesses in three segments: Avionics & Controls, Sensors & Systems and Advanced Materials.

The Avionics & Controls segment includes avionics systems, control systems, interface technologies and communication systems capabilities. Avionics systems designs and develops cockpit systems integration and avionics solutions for commercial and military applications. Control systems designs and manufactures technology interface systems for military and commercial aircraft and land- and sea-based military vehicles. Interface technologies manufactures and develops custom control panels, input systems for medical, industrial, military and casino gaming industries. Communication systems designs and manufactures military audio and data products for severe battlefield environments, as well as communication control systems to enhance security and aural clarity in military applications. In addition, communication systems designs and manufactures embedded communication intercept receivers for signal intelligence applications.

The Sensors & Systems segment includes power systems, connection technologies and advanced sensors capabilities. Power systems develops and manufactures electrical power switching and other related systems, principally for aerospace and defense customers. Connection technologies develops and manufactures highly engineered connectors for harsh environments and serves the aerospace, defense & space, power generation, rail, and industrial equipment markets. Advanced sensors develops and manufactures high precision temperature and pressure sensors for aerospace and defense customers.

The Advanced Materials segment includes engineered materials and defense technologies capabilities. Engineered materials develops and manufactures thermally engineered components and high-performance elastomer products used in a wide range of commercial aerospace and military applications. Defense technologies develops and manufactures combustible ordnance components and warfare countermeasures for military customers. Sales in all segments include domestic, international, defense and commercial customers.

Our business and strategic plan focuses on the continued development of our products principally for aerospace and defense markets. We are concentrating our efforts to expand our capabilities in these markets and to anticipate the global needs of our customers and respond to such needs with comprehensive solutions. These efforts focus on continuous research and new product development, acquisitions and strategic realignments of operations to expand our capabilities as a more comprehensive supplier to our customers across our entire product offering.

On July 26, 2011, we acquired the Souriau Group (Souriau). Souriau is a leading global supplier of highly engineered connection technologies for harsh environments. Souriau is included in our Sensors & Systems segment.

On December 30, 2010, we acquired Eclipse Electronic Systems, Inc. (Eclipse). Eclipse is a designer and manufacturer of embedded communication intercept receivers for signal intelligence applications. Eclipse is included in our Avionics & Controls segment.

During the third fiscal quarter of 2012, we recorded a $52.2 million, or $1.69 per diluted share, impairment charge against goodwill of Racal Acoustics, our military headset business, which is included in our Avionics & Controls segment. Including this charge, we incurred a net loss of $17.1 million or $0.55 per diluted share compared to net income of $37.7 million or $1.21 per diluted share during the prior-year period.

Sales increased 18.7% to $485.9 million in the third fiscal quarter of 2012, principally reflecting increased Sensors & Systems segment sales, which benefited from incremental sales from the Souriau acquisition and a 5.7% increase in Advanced Materials segment sales. These sales increases were partially offset by lower Avionics & Controls segment sales, which declined 6.2% compared to the prior-year period, principally due to lower sales of avionics systems for military aircraft.

Segment earnings as a percent of sales were 2.1% in the third fiscal quarter of fiscal 2012 compared to 14.2% in the prior-year period. Excluding the impairment charge, segment earnings as a percentage of sales were 12.8%. Avionics & Controls segment sales and earnings declined principally due to lower sales and earnings of avionics

 

29


systems. Sensors & Systems segment sales and earnings increased compared to the prior-year period, principally reflecting incremental sales and operating earnings from the Souriau acquisition and strong sales and earnings of power systems, partially offset by lower earnings of advanced sensors. Advanced Materials earnings declined compared to the prior-year period due to lower earnings on sales of engineered materials for military aircraft and commercial aviation and lower sales and earnings of combustible ordnance and non-U.S. countermeasures.

The income tax rate (before the goodwill impairment charge) was 16.5% for the third fiscal quarter of 2012 compared to 6.9% for the prior-year period.

Cash flows from operating activities were $151.2 million in the first nine months of fiscal 2012 compared to $158.5 million in the prior-year period. We paid down our revolving credit facility and Euro Term Loan by $104.1 million during the first nine months of fiscal 2012.

Results of Operations

Three Month Period Ended July 27, 2012, Compared with Three Month Period Ended July 29, 2011

Sales for the third fiscal quarter increased 18.7% over the prior-year period. Sales by segment were as follows:

 

(In thousands)            
         Incr./(Decr.)    
from prior
year period
   Three Months Ended  
                July 27,        
2012
             July 29,        
2011
 

Avionics & Controls

       (6.2)%    $ 195,059       $ 208,021   

Sensors & Systems

       93.7%        171,603         88,605   

Advanced Materials

       5.7%      119,287         112,886   
     

 

 

    

 

 

 

Total Net Sales

      $ 485,949       $ 409,512   
     

 

 

    

 

 

 

The 6.2% decrease in sales of Avionics & Controls mainly reflected decreased sales volumes of avionics systems, reflecting lower sales of cockpit integration for military transport aircraft.

The 93.7% increase in sales of Sensors & Systems principally reflected incremental sales from the Souriau acquisition of $78 million and increased sales of power systems, reflecting higher demand for commercial aviation products. Sales in the third fiscal quarter of 2012 reflected a weaker pound sterling and euro relative to the U.S. dollar compared to the prior-year period. The average exchange rate from the pound sterling to the U.S. dollar decreased from 1.63 in the third fiscal quarter of 2011 to 1.58 in the third fiscal quarter of 2012. The average exchange rate from the euro to the U.S. dollar decreased from 1.44 in the third fiscal quarter of 2011 to 1.26 in the third fiscal quarter of 2012. If Souriau’s sales were translated at 1.44 versus 1.26, Souriau’s incremental sales would have been $89 million in the third quarter of fiscal 2012.

The 5.7% increase in sales of Advanced Materials principally reflected higher sales volumes of engineered materials for commercial aviation applications.

Overall, gross margin as a percentage of sales was 35.4%, compared to 35.1% in the same period a year ago. Gross profit was $172.1 million compared to $143.5 million in the same period a year ago.

Avionics & Controls segment gross margin was 39.0% and 37.4% for the third fiscal quarter of 2012 and 2011, respectively. Segment gross profit was $76.1 million compared to $77.9 million in the prior-year period. A $7 million decrease in gross profit on sales of avionics systems was substantially offset by higher gross profit on sales of control systems, communication systems and interface technologies.

Sensors & Systems segment gross margin was 35.5% and 34.1% for the third fiscal quarter of 2012 and 2011, respectively. Segment gross profit was $60.8 million compared to $30.2 million in the prior-year period. The increase in gross profit mainly reflected incremental gross profit from the Souriau acquisition.

 

30


Advanced Materials segment gross margin was 29.5% compared to 31.4% for the prior-year period. Segment gross profit was $35.1 million compared to $35.5 million in the prior-year period. The change in gross margin primarily reflects lower gross profits on decreased sales of elastomer materials for the F-35 fighter aircraft due to the requirement of the prime contractor to rebalance its inventories. Sales and gross profit of air duct assemblies for the A-380 also declined due to the temporary production slowdown of such aircraft.

Selling, general and administrative expenses (which include corporate expenses) totaled $91.9 million, or 18.9% of sales, and $76.4 million, or 18.7% of sales, for the third fiscal quarter of 2012 and 2011, respectively. The increase in selling, general and administrative expense principally reflected incremental selling, general and administrative expenses from the Souriau acquisition of $19 million, partially offset by a $5 million decrease in corporate expense, mainly attributable to acquisition expense incurred in the prior-year period due to the Souriau acquisition.

Research, development and engineering spending was $27.2 million, or 5.6% of sales, for the third fiscal quarter of 2012 compared with $23.1 million, or 5.6% of sales, for the third fiscal quarter of 2011. The increase in research, development and engineering spending principally reflects higher spending on control systems and communication systems of $3.0 million, and incremental spending as a result of the Souriau acquisition of $3 million, partially offset by lower spending for avionics systems. Fiscal 2012 research, development and engineering spending is expected to be approximately 5.5% to 6.0% of sales.

Segment earnings (operating earnings excluding corporate expenses and other income or expense) for the third fiscal quarter of 2012 totaled $10.0 million, or 2.1% of sales, compared with $58.2 million, or 14.2% of sales, for the third fiscal quarter in 2011. The decrease in segment earnings mainly reflects the $52.2 million impairment charge against goodwill of Racal Acoustics. Excluding the impairment charge, segment earnings totaled $62.2 million, or 12.8% of sales, for the third fiscal quarter of 2012. Results of operations for the third fiscal quarter of 2012 did not meet our expectations due to decreased sales and gross profit from lower cockpit integration sales for the T-6B military trainer and retrofits of military transport aircraft, as well as air duct assemblies for the A-380 aircraft and radar absorbing material for the F-35 fighter aircraft. The decrease in sales for the T-6B was due to its manufacturer, Hawker Beechcraft, filing for bankruptcy. The decrease in sales for retrofits of military transport was due to delayed orders, and the decrease in sales for air duct assemblies for the A-380 was due to the temporary production slowdown of such aircraft. The decrease in sales of radar absorbing material for the F-35 fighter aircraft was due to the requirement of the prime contractor to rebalance its inventories.

Avionics & Controls segment losses were $(25.6) million, or (13.1)% of sales, in the third fiscal quarter of 2012 compared to earnings of $28.6 million, or 13.8% of sales, in the third fiscal quarter of 2011, mainly reflecting the $52.2 million impairment charge against goodwill of Racal Acoustics, our military headset business. During the third fiscal quarter of 2012, management performed a Step One impairment test for Racal Acoustics upon identification of an indicator of impairment, since Racal Acoustics’ third quarter forecast projected an operating loss for fiscal 2012. Additionally, management determined that requirements for hearing protection devices for the U.S. Army would not recover in our five-year planning horizon in light of the cancellation of Humvee retrofits, delays in VIS-X and the slowdown in operational tempo of the U.S. armed forces as well as a global slowdown in defense spending. As required under U.S. GAAP, a Step Two impairment test was required because the current fair value of the business using a discounted cash flow and market approach was less than its carrying amount of the business. Under the Step Two impairment test, all assets and liabilities were valued at fair value. The excess of the carrying amount of goodwill over the implied fair value of goodwill resulted in an impairment charge of $52.2 million.

Excluding the impairment charge, Avionics & Controls segment earnings were $26.6 million, or 13.6% of sales, in the third fiscal quarter of 2012 compared to $28.6 million, or 13.8% of sales, in the third fiscal quarter of 2011. The $2.0 million decrease in segment earnings from the prior-year period principally reflected lower sales volumes and earnings of avionics systems for military transport aircraft, partially offset by a $1 million increase in earnings from sales of input systems for casino gaming applications due to improved gross margin.

Sensors & Systems segment earnings were $18.3 million, or 10.7% of sales, for the third fiscal quarter of 2012 compared with $10.8 million, or 12.1% of sales, for the third fiscal quarter of 2011. The increase in segment earnings principally reflected incremental earnings from the Souriau acquisition in July 2011. The decrease in

 

31


segment earnings as a percent of sales was due to lower operating margins of Souriau compared to our power systems business and reduced earnings of our advanced sensors business due to lower aftermarket sales in North America. Souriau’s earnings met our expectations and reflected solid sales and earnings from commercial aviation operations.

Advanced Materials segment earnings were $17.3 million, or 14.5% of sales, for the third fiscal quarter of 2012 compared with $18.8 million, or 16.7% of sales, for the third fiscal quarter of 2011, primarily reflecting a decrease in engineered materials gross profit on lower sales of elastomer material for the F-35 due to a re-balancing of inventory by Lockheed Martin and lower sales of air duct assemblies for the A-380 due to the temporary production slowdown of such aircraft.

Interest expense for the third fiscal quarter of 2012 was $12.2 million compared with $10.3 million for the third fiscal quarter of 2011, reflecting higher borrowings as a result of the Souriau acquisition.

The income tax rate (before the goodwill impairment charge) was 16.5% compared with 6.9% for the third fiscal quarter of 2012 and 2011, respectively. In the third fiscal quarter of 2012, we recognized $5.3 million of discrete tax benefits principally related to the following items. The first item was a $2.9 million reduction of net deferred income tax liabilities as a result of the enactment of tax laws reducing the U.K. statutory income tax rate. The second item was a $1.7 million tax benefit as a result of reconciling the prior year’s U.S. income tax return to the U.S. income tax provision.

In the third fiscal quarter of 2011, we recognized $7.7 million of tax benefits principally related to the following two items. The first item was approximately $5.6 million of tax benefits associated with net operating losses of an acquired subsidiary as a result of concluding a tax examination. The second item was approximately $3.2 million of net reduction of deferred tax liabilities as a result of the enactment of tax laws reducing the U.K. statutory income tax rate.

The income tax rate differed from the statutory rate in the third fiscal quarter of 2012 and 2011, as both quarters benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next twelve months approximately $5.6 million of tax benefits associated with research and development tax credits, capital and operating losses that are currently unrecognized could be recognized as a result of settlement of examinations and/or the expiration of a statute of limitations.

To the extent that sales are transacted in a currency other than the functional currency of the operating unit, we are subject to foreign currency fluctuation risk.

We use forward contracts to hedge our foreign currency exchange risk. To the extent that these contracts qualify as hedges under U.S. GAAP, the amount of gain or loss is deferred in Accumulated Other Comprehensive Income (AOCI) until the related sale occurs. Also, we are subject to foreign currency gains or losses from embedded derivatives on backlog denominated in a currency other than the functional currency of our operating companies or its customers. Gains and losses on forward contracts, embedded derivatives, and revaluation of assets and liabilities denominated in a currency other than the functional currency of the Company for the three-month period ended July 27, 2012, and July 29, 2011, are as follows:

 

(In thousands)    Three Months Ended  
             July 27,        
2012
            July 29,        
2011
 

Forward foreign currency contracts – gain (loss)

   $ (4,037   $ 1,028   

Forward foreign currency contracts reclassified from AOCI

     (205     2,716   

Embedded derivatives – gain

     1,304        1,443   

Revaluation of monetary assets/liabilities – gain

     1,507        5,464   
  

 

 

   

 

 

 

Total

   $ (1,431   $ 10,651   
  

 

 

   

 

 

 

 

32


Nine Month Period Ended July 27, 2012, Compared with Nine Month Period Ended July 29, 2011

Sales for the first nine months increased 20.2% over the prior-year period, principally reflecting the Souriau acquisition in July 2011. Sales by segment were as follows:

 

(In thousands)                   
         Incr./(Decr.)    
from prior
year period
   Nine Months Ended  
                July 27,        
2012
             July 29,        
2011
 

Avionics & Controls

       (9.9)%    $ 569,656       $ 632,020   

Sensors & Systems

       110.5%          527,958         250,841   

Advanced Materials

       9.4%      364,048         332,727   
     

 

 

    

 

 

 

Total Net Sales

      $ 1,461,662       $ 1,215,588   
     

 

 

    

 

 

 

The 9.9% decrease in sales of Avionics & Controls reflected decreased sales volumes of avionics systems of $59 million. The $59 million decrease in avionics systems was principally due to lower cockpit integration sales volumes for the T-6B military trainer and retrofits of military transport aircraft. The decrease in sales for the T-6B was due the financial difficulties of Hawker Beechcraft. On May 3, 2012, Hawker Beechcraft, the manufacturer of the T-6B military trainer, filed for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. Management expects that cockpit integration sales for military transport aircraft will resume in fiscal 2013. The decrease in segment sales also reflected a $13 million decrease in sales of hearing protection headsets due to reduced demand and order delays, of which about 50% was offset by strong sales of communication intercept receivers for signal intelligence applications. Additionally, interface technologies sales decreased due to lower demand for input systems for casino gaming applications.

The 110.5% increase in sales of Sensors & Systems principally reflected incremental sales from the Souriau acquisition of $248 million and increased sales volume of advanced sensors and power systems of $29 million. About 70% of the increase in advanced sensors and power systems sales reflected increased sales of power systems due to higher demand for commercial aviation products. The increase in advanced sensors reflected higher OEM sales and strong aftermarket demand in Asia and weaker demand in North America. Sales in the first nine months of fiscal 2012 reflected a weaker euro relative to the U.S. dollar compared to the prior-year period. The average exchange rate from the euro to the U.S. dollar decreased from 1.39 in the first nine months of fiscal 2011 to 1.31 in the first nine months of fiscal 2012.

The 9.4% increase in sales of Advanced Materials principally reflected increased sales volumes of engineered materials of $39 million, partially offset by decreased sales volumes of defense technologies of $9 million. The $39 million increase in engineered materials primarily reflected strong demand for elastomer and insulation materials for commercial aviation products. The $9 million decrease in defense technologies principally reflected a decrease in sales of non-U.S. countermeasure flares due to reduced demand and order delays as well as lower demand for combustible ordnance.

Overall, gross margin as a percentage of sales was 35.2% and 35.9% for the first nine months of fiscal 2012 and 2011, respectively. Gross profit was $514.7 million and $436.6 million for the first nine months of fiscal of 2012 and 2011, respectively.

 

33


Avionics & Controls segment gross margin was 38.5% and 38.6% for the first nine months of fiscal 2012 and 2011, respectively. Segment gross profit was $219.5 million compared to $244.1 million in the prior-year period. The decrease in gross profit was mainly due to lower sales volumes of cockpit integrations for the T-6B military trainer and retrofits of military aircraft. A $4 million increase in communication systems gross profit reflected increased gross profit from strong sales of communication intercept receivers for signal intelligence applications, partially offset by a $6 million decrease in gross profit from sales of hearing protection devices.

Sensors & Systems segment gross margin was 33.8% and 34.7% for the first nine months of fiscal 2012 and 2011, respectively. Segment gross profit was $178.5 million compared to $87.1 million in the prior-year period. Approximately 10% of the increase in gross profit reflected strong demand for power systems for commercial aviation applications. Approximately 90% of the increase in gross profit was due to incremental gross profit from the Souriau acquisition. Souriau’s gross profit was impacted by a $12 million charge in the first fiscal quarter of 2012 due to recording Souriau’s acquired inventory at its fair value.

Advanced Materials segment gross margin was 32.0% for the first nine months of fiscal 2012 compared to 31.7% for the same period one year ago. Segment gross profit was $116.6 million compared to $105.4 million in the prior-year period. The increase in gross profit was principally due to higher sales of elastomer materials and insulation materials primarily for commercial aviation applications. Gross profit on defense technologies decreased $3 million, principally reflecting decreased gross profit and margin on combustible ordnance due to sales mix as well as lower gross profit on non-U.S. flare countermeasures reflecting decreased demand and delayed shipments.

Selling, general and administrative expenses (which include corporate expenses) totaled $285.5 million, or 19.5% of sales, and $214.9 million, or 17.7% of sales, for the first nine months of fiscal 2012 and 2011, respectively. The increase in selling, general and administrative expense principally reflected a $61.6 million increase in selling, general and administrative expense at our Sensors & Systems segment due to incremental selling, general and administrative expense from the Souriau acquisition. Selling, general and administrative expense increased $11.1 million at Avionics & Controls and Advanced Materials. This increase reflects a $2.8 million increase in bad debt due to the bankruptcy filing of Hawker Beechcraft, $3.5 million in incremental selling, general and administrative expense from the Eclipse acquisition, and $2.4 million in severance costs.

Research, development and engineering spending was $83.1 million, or 5.7% of sales, for the first nine months of fiscal 2012 compared with $63.9 million, or 5.3% of sales, for the first nine months of fiscal 2011. The increase in research, development and engineering spending principally reflects expense on control systems, communication systems, and incremental expense as a result of the Souriau acquisition of $9 million. Fiscal 2012 research, development and engineering spending is expected to be approximately 5.5% to 6.0% of sales.

Total segment earnings (operating earnings excluding corporate expenses and other income or expense) for the first nine months of fiscal 2012 totaled $129.1 million, or 8.8% of sales, compared with $195.0 million, or 16.0% of sales, for the first nine months in fiscal 2011. The decrease in segment earnings mainly reflects the $52.2 million impairment charge against goodwill of Racal Acoustics. If the impairment charge is excluded, segment earnings totaled $181.2 million or 12.4% of sales for the first nine months of 2012.

Avionics & Controls segment earnings were $12.7 million, or 2.2% of sales, in the first nine months of fiscal 2012 and $104.5 million, or 16.5% of sales, in the first nine months of fiscal 2011. Excluding the $52.2 million impairment charge, segment earnings were $64.9 million, or 11.4% of sales, in the first nine months of fiscal 2012. The decrease in segment earnings from the prior-year period mainly reflects a $27 million decrease in avionics systems earnings and a $9 million decrease in control systems earnings. Avionics systems earnings were impacted by decreased gross profit and a $2.3 million bad debt expense due to the bankruptcy of Hawker Beechcraft. Control systems earnings were impacted by lower gross margin, a $7 million increase in research, development and engineering expense, and $0.5 million in bad debt expense related to the Hawker Beechcraft bankruptcy filing. The prior-year period gross margin benefited from a $4.4 million retroactive price settlement due to product scope changes recognized in the second quarter of fiscal 2011. Additionally, the second fiscal quarter of 2011 benefited from a $1.1 million recovery of non-recurring engineering expense upon settlement with a customer of control systems.

 

34


Sensors & Systems segment earnings were $49.8 million, or 9.4% of sales, for the first nine months of fiscal 2012 compared with $33.4 million, or 13.3% of sales, for the first nine months of fiscal 2011, reflecting $12 million in incremental earnings from the Souriau acquisition and a $4 million increase in power systems. Power systems benefited from increased gross profits, partially offset by higher non-recurring engineering expenses principally related to the A400M program. The decrease in segment earnings as a percent of sales reflects the inclusion of Souriau in the segment, which has lower earnings as a percentage of sales than our advanced sensors and power systems businesses, and the $12 million charge in the first fiscal quarter of 2012 due to recording Souriau’s acquired inventory at its fair value.

Advanced Materials segment earnings were $66.5 million, or 18.3% of sales, for the first nine months of fiscal 2012 compared with $57.0 million, or 17.1% of sales, for the first nine months of fiscal 2011, primarily reflecting increased gross profit on higher sales of elastomer and insulation materials, particularly in the first six months of fiscal 2012.

Prior to our March 2007 acquisition of CMC, CMC was involved in a transaction in which CMC shareholders had a limited amount of time in which to tender their shares in exchange for cash. In May 2008, after the prescribed time period had expired, CAD $11.8 million remained unclaimed. As a result, the paying agent returned the unclaimed amount to CMC in accordance with Canadian law. In December 2008, CMC’s former parent company instituted a legal action against the paying agent, alleging negligence and breached contract terms by returning the funds to CMC. The plaintiff lost at trial and appealed. In the second quarter of fiscal 2012, CMC received notice that the plaintiff abandoned its appeal. In addition, CMC and the paying agent settled all remaining issues. Management concluded that all contingencies relating to this matter were resolved, and accordingly, the Company recorded a gain of approximately CAD $11.8 million or $11.9 million, or $9.5 million after tax, in the second fiscal quarter of 2012.

Interest expense for the first nine months of fiscal 2012 was $35.2 million compared with $28.4 million for the first nine months of fiscal 2011, reflecting higher borrowings as a result of the Souriau acquisition.

The income tax rate (before the goodwill impairment charge) was 16.6% compared with 16.4% for the first nine months of fiscal 2012 and 2011, respectively. In the first nine months of fiscal 2012, we recognized $7.2 million of discrete tax benefits principally related to three items. The first item was a $2.3 million tax benefit due to a change in French tax laws associated with the holding company structure and the financing of the Souriau acquisition. The second item was a $2.9 million reduction of net deferred tax liabilities as a result of the enactment of tax laws reducing the U.K. statutory income tax rate. The third item was a $1.7 million tax benefit as a result of reconciling the prior year’s income tax return to the U.S. income tax provision.

In the first nine months of fiscal 2011, we recognized $11.0 million of discrete tax benefits principally related to the following items. The first item was approximately $3.3 million of tax benefits due to the retroactive extension of the U.S. federal research and experimentation credits and the release of a valuation allowance related to a net operating loss of an acquired subsidiary. The second item was approximately $5.6 million of tax benefits associated with net operating losses of an acquired subsidiary as a result of concluding a tax examination. The third item was approximately $3.2 million of net reduction of deferred tax liabilities as a result of the enactment of tax laws reducing the U.K. statutory income tax rate.

The income tax rate differed from the statutory rate in the first nine months of fiscal 2012 and 2011, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next twelve months approximately $5.6 million of tax benefits associated with research and development tax credits, capital and operating losses that are currently unrecognized could be recognized as a result of settlement of examinations and/or the expiration of a statute of limitations.

To the extent that sales are transacted in a currency other than the functional currency of the operating unit, we are subject to foreign currency fluctuation risk.

We use forward contracts to hedge our foreign currency exchange risk. To the extent that these contracts qualify as hedges under U.S. GAAP, the amount of gain or loss is deferred in Accumulated Other Comprehensive Income (AOCI) until the related sale occurs. Also, we are subject to foreign currency gains or losses from embedded

 

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derivatives on backlog denominated in a currency other than the functional currency of our operating companies or its customers. Gains and losses on forward contracts, embedded derivatives, and revaluation of assets and liabilities denominated in currency other than the functional currency of the Company for the nine month period ended July 27, 2012, and July 29, 2011, are as follows:

 

                                         
(In thousands)    Nine Months Ended  
             July 27,        
2012
            July 29,        
2011
 

Forward foreign currency contracts – gain (loss)

   $ (9,202   $ 3,116   

Forward foreign currency contracts reclassified from AOCI

     207        8,331   

Embedded derivatives – gain

     1,046        491   

Revaluation of monetary assets/liabilities – gain

     2,141        957   
  

 

 

   

 

 

 

Total

   $ (5,808   $ 12,895   
  

 

 

   

 

 

 

New orders for the first nine months of fiscal 2012 were $1.45 billion compared with $1.38 billion for the same period in 2011. Backlog was $1.24 billion at July 27, 2012, compared with $1.26 billion at the end of the prior-year period and $1.25 billion at the end of fiscal 2011.

Liquidity and Capital Resources

Cash and cash equivalents at July 27, 2012, totaled $213.1 million, an increase of $28.0 million from October 28, 2011. Net working capital increased to $636.7 million at July 27, 2012, from $621.0 million at October 28, 2011. Sources and uses of cash flows from operating activities principally consist of cash received from the sale of products and cash payments for material, labor and operating expenses. Cash flows provided by operating activities were $151.2 million and $158.5 million in the first nine months of fiscal 2012 and 2011, respectively, reflecting decreased income from continuing operations, cash collections from customers, and increased payments for income taxes and interest, partially offset by decreased payments for inventory.

Cash flows used by investing activities were $38.3 million and $860.2 million in the first nine months of fiscal 2012 and 2011, respectively. Cash flows used by investing activities in the first nine months of fiscal 2012 primarily reflected cash paid for capital expenditures. Cash flows used by investing activities in the first nine months of fiscal 2011 primarily reflected cash paid for acquisitions of $811.9 million and capital expenditures of $35.2 million.

Cash flows used by financing activities were $79.2 million in the first nine months of fiscal 2012. Cash flows provided by financing activities were $481.2 million in the first nine months of fiscal 2011. Cash flows used by financing activities in the first nine months of fiscal 2012 primarily reflected $104.1 million in cash repayments of long-term debt. Cash flows provided by financing activities in the first nine months of fiscal 2011 primarily reflected a $395.0 million increase in our credit facility, $180.0 million in proceeds for the issuance of long-term debt and $118.2 million in cash repayments of long-term debt.

Capital expenditures, consisting of machinery, equipment and computers, are anticipated to be approximately $65.0 million during fiscal 2012, compared to $49.5 million expended in fiscal 2011.

Total debt at July 27, 2012, was $932.4 million and consisted of $179.2 million of Senior Notes due in 2017, $250.0 million of Senior Notes due in 2020, $102.3 million (€83.0 million) under our Euro Term Loan Facility, $300.0 million under our credit facility, $44.9 million under capital lease obligations and $56.0 million of various foreign currency debt agreements and other debt agreements.

We believe cash on hand and funds generated from operations are adequate to service operating cash requirements and capital expenditures through the next twelve months.