Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

x   

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended January 28, 2011                                                                                                                      

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

                ESTERLINE TECHNOLOGIES CORPORATION                

(Exact name of registrant as specified in its charter)

 

                                 Delaware                                                                    13-2595091                                

(State or other Jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

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                      X                                             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                      X                                             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. (Check one):

 

Large accelerated filer  

x

   Accelerated filer           ¨                 
Non-accelerated filer  

¨  (Do not check if a smaller reporting company)

   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                      X            

As of March 1, 2011, 30,475,516 shares of the issuer’s common stock were outstanding.

 

2


PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of January 28, 2011 and October 29, 2010

(In thousands, except share amounts)

 

$000,000,000.00) $000,000,000.00)
     January 28,
2011
     October 29,
2010
 
ASSETS    (Unaudited)         

Current Assets

     

Cash and cash equivalents

   $ 351,481       $ 422,120   

Cash in escrow

     14,000         0   

Accounts receivable, net of allowances

     

of $4,700 and $4,865

     263,666         309,242   

Inventories

     

Raw materials and purchased parts

     118,312         109,595   

Work in process

     121,155         99,592   

Finished goods

     64,138         53,186   
                 
     303,605         262,373   

Income tax refundable

     22,084         17,806   

Deferred income tax benefits

     38,644         37,539   

Prepaid expenses

     16,464         16,264   

Other current assets

     10,617         11,241   
                 

Total Current Assets

     1,020,561         1,076,585   

Property, Plant and Equipment

     558,241         546,004   

Accumulated depreciation

     277,892         272,234   
                 
     280,349         273,770   

Other Non-Current Assets

     

Goodwill

     806,338         739,730   

Intangibles, net

     447,644         389,017   

Debt issuance costs, net of accumulated

     

amortization of $4,934 and $4,536

     7,413         7,774   

Deferred income tax benefits

     88,866         87,622   

Other assets

     10,677         13,240   
                 
   $ 2,661,848       $ 2,587,738   
                 

 

3


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of January 28, 2011 and October 29, 2010

(In thousands, except share amounts)

 

$000,000,000.00) $000,000,000.00)
     January 28,
2011
     October 29,
2010
 
LIABILITIES AND SHAREHOLDERS’ EQUITY    (Unaudited)         

Current Liabilities

     

Accounts payable

   $ 76,225       $ 82,275   

Accrued liabilities

     228,378         215,094   

Credit facilities

     0         1,980   

Current maturities of long-term debt

     14,259         12,646   

Deferred income tax liabilities

     6,843         7,155   

Federal and foreign income taxes

     4,513         5,227   
                 

Total Current Liabilities

     330,218         324,377   

Long-Term Liabilities

     

Long-term debt, net of current maturities

     594,145         598,972   

Deferred income tax liabilities

     149,990         127,081   

Pension and post-retirement obligations

     107,047         105,333   

Other liabilities

     25,955         16,476   

Shareholders’ Equity

     

Common stock, par value $.20 per share,

     

authorized 60,000,000 shares, issued and

outstanding 30,458,741 and 30,279,509 shares

     6,092         6,056   

Additional paid-in capital

     538,634         528,724   

Retained earnings

     904,772         874,781   

Accumulated other comprehensive income

     2,315         3,235   
                 

Total Esterline shareholders’ equity

     1,451,813         1,412,796   

Noncontrolling interests

     2,680         2,703   
                 

Total Shareholders’ Equity

     1,454,493         1,415,499   
                 
   $ 2,661,848       $ 2,587,738   
                 

 

4


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

For the Three Month Periods Ended January 28, 2011 and January 29, 2010

(Unaudited)

(In thousands, except per share amounts)

 

$000,000,000.00) $000,000,000.00)
     Three Months Ended  
     January 28,
2011
    January 29,
2010
 

Net Sales

   $ 370,799      $ 335,310   

Cost of Sales

     238,677        232,639   
                
     132,122        102,671   

Expenses

    

Selling, general & administrative

     66,092        61,295   

Research, development & engineering

     19,619        16,749   

Other expense

     0        41   
                

Total Expenses

     85,711        78,085   
                

Operating Earnings from Continuing Operations

     46,411        24,586   

Interest Income

     (340     (383

Interest Expense

     9,137        7,961   
                

Income from Continuing Operations Before Income Taxes

     37,614        17,008   

Income Tax Expense

     7,654        4,569   
                

Income from Continuing Operations Including

    

Noncontrolling Interests

     29,960        12,439   

Loss (Income) Attributable to Noncontrolling Interests

     23        (54
                

Income from Continuing Operations Attributable to Esterline

     29,983        12,385   

Income from Discontinued Operations Attributable to

    

Esterline, Net of Tax

     8        340   
                

Net Earnings Attributable to Esterline

   $ 29,991      $ 12,725   
                

Earnings Per Share Attributable to Esterline – Basic:

    

Continuing operations

   $ .99      $ .42   

Discontinued operations

     .00        .01   
                

Earnings Per Share Attributable to Esterline – Basic

   $ .99      $ .43   
                

Earnings Per Share Attributable to Esterline – Diluted:

    

Continuing operations

   $ .97      $ .41   

Discontinued operations

     .00        .01   
                

Earnings Per Share Attributable to Esterline – Diluted

   $ .97      $ .42   
                

 

5


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Three Month Periods Ended January 28, 2011 and January 29, 2010

(Unaudited)

(In thousands)

 

$000,000,000.00) $000,000,000.00)
     Three Months Ended  
     January 28,
2011
    January 29,
2010
 

Cash Flows Provided (Used) by Operating Activities

    

Net earnings including noncontrolling interests

   $ 29,968      $ 12,779   

Adjustments to reconcile net earnings including

    

noncontrolling interests to net cash provided

(used) by operating activities:

    

Depreciation and amortization

     17,760        18,659   

Deferred income taxes

     1,465        (1,395

Share-based compensation

     2,070        1,472   

Working capital changes, net of effect of acquisitions:

    

Accounts receivable

     53,804        22,568   

Inventories

     (24,084     (268

Prepaid expenses

     (209     (2,093

Other current assets

     289        (239

Accounts payable

     (8,013     (4,237

Accrued liabilities

     (15,119     (20,304

Federal and foreign income taxes

     (7,139     (456

Other liabilities

     1,247        2,191   

Other, net

     (2,394     1,676   
                
     49,645        30,353   

Cash Flows Provided (Used) by Investing Activities

    

Purchases of capital assets

     (14,633     (14,120

Proceeds from sale of capital assets

     395        61   

Escrow deposit

     (14,000     0   

Acquisitions, net of cash acquired

     (103,548     (768
                
     (131,786     (14,827

 

6


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Three Month Periods Ended January 28, 2011 and January 29, 2010

(Unaudited)

(In thousands)

 

$000,000,000.00) $000,000,000.00)
     Three Months Ended  
     January 28,
2011
    January 29,
2010
 

Cash Flows Provided (Used) by Financing Activities

    

Proceeds provided by stock issuance under employee stock plans

     6,923        1,167   

Excess tax benefits from stock options exercised

     953        199   

Debt and other issuance costs

     (36     0   

Net change in credit facilities

     0        (4,442

Repayment of long-term debt

     (1,708     (178

Proceeds from government assistance

     5,285        0   
                
     11,417        (3,254

Effect of Foreign Exchange Rates on Cash and Cash Equivalents

     85        (2,016
                

Net Increase (Decrease) in Cash and Cash Equivalents

     (70,639     10,256   

Cash and Cash Equivalents – Beginning of Period

     422,120        176,794   
                

Cash and Cash Equivalents – End of Period

   $ 351,481      $ 187,050   
                

Supplemental Cash Flow Information

    

Cash paid for interest

   $ 1,653      $ 7,118   

Cash paid for taxes

     10,907        6,812   

Supplemental Non-cash Investing and Financing Activities

    

Capital asset and lease obligation additions

   $ 0      $ 5,952   

 

7


ESTERLINE TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Three Month Periods Ended January 28, 2011 and January 29, 2010

 

1. The consolidated balance sheet as of January 28, 2011, the consolidated statement of operations for the three month periods ended January 28, 2011, and January 29, 2010, and the consolidated statement of cash flows for the three month periods ended January 28, 2011, and January 29, 2010, 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 29, 2010, 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. 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 that are excluded from the calculation of diluted earnings per share because they were anti-dilutive were 222,500 and 646,901 in the first fiscal quarter of 2011 and 2010, respectively. Shares used for calculating earnings per share are disclosed in the following table.

 

$000,000,000.00) $000,000,000.00)
(In thousands)    Three Months Ended  
     January 28,
2011
     January 29,
2010
 

Shares Used for Basic Earnings Per Share

     30,349         29,789   

Shares Used for Diluted Earnings Per Share

     31,011         30,218   

 

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

 

$000,000,000.00) $000,000,000.00)
(In thousands)    Three Months Ended  
     January 28,
2011
    January 29,
2010
 

Net Earnings

   $ 29,991      $ 12,725   

Change in Fair Value of Derivative Financial Instruments,

    

Net of Tax Benefit of $590 and $671

     (1,490     (1,827

Change in Pension and Post-Retirement Obligations,

    

Net of Tax (Expense) Benefit of $(492) and $199

     728        88   

Foreign Currency Translation Adjustment

     (158     (19,272
                

Comprehensive Income (Loss)

   $ 29,071      $ (8,286
                

 

8


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

 

0000000000000 0000000000000
(In thousands)    January 28,
2011
    October 29,
2010
 

Net unrealized gain on derivative contracts

   $ 8,466      $ 9,956   

Pension and post-retirement obligations

     (64,757     (65,485

Currency translation adjustment

     58,606        58,764   
                

Total accumulated other comprehensive income

   $ 2,315      $ 3,235   
                

 

6. On December 30, 2010, the Company acquired all of the outstanding capital stock of Eclipse Electronic Systems, Inc. (Eclipse) for approximately $120.0 million, plus the change in net assets from July 31, 2010, to the actual closing balance sheet. The $120.0 million 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 is $13.4 million. Eclipse is a designer and manufacturer of embedded communications 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 preliminary purchase price includes the value of future development of exiting technologies, the introduction of new technologies, and the addition of new customers. These factors resulted in recording goodwill of $65.4 million. The amount allocated to goodwill is not deductible for income tax purposes.

 

0000000000000
(In thousands)       
As of December 30, 2010       

Current assets

   $ 30,703   

Property, plant and equipment

     2,154   

Intangible assets subject to amortization

  

Technology (9 year weighted average useful life)

     50,100   

Tradename (3 year useful life)

     1,400   

Goodwill

     65,420   
        

Total assets acquired

     149,777   

Current liabilities assumed

     33,977   

Long-term liabilities assumed

     8,350   
        

Net assets acquired

   $ 107,450   
        

 

7. On September 8, 2010, the Company sold Pressure Systems, Inc., which was included in the Sensors & Systems segment, for approximately $25.0 million, resulting in an after tax gain of $10.4 million. As a result, the consolidated income statement presents Pressure Systems, Inc. as discontinued operations. Income from discontinued operations was $8,000 in the first fiscal quarter of 2011.

The operating results of the discontinued operations for the first quarter of 2010 consisted of the following:

 

000000000000
(In thousands)    January 29,
2010
 

Sales

   $ 4,050   

Income from discontinued operations before income taxes

     540   

Income tax expense

     200   
        

Income from discontinued operations

   $ 340   
        

 

9


8. The income tax rate was 20.3% compared with 26.9% for the first fiscal quarter of 2011 and 2010, respectively. In the first fiscal quarter of 2011, the Company recognized $1.4 million of discrete tax benefits due to the retroactive extension of the U.S. federal research and experimentation tax credit. In the first fiscal quarter of 2010 the Company recognized $0.3 million of discrete tax expenses mainly the result of a change in French tax laws. The income tax rate differed from the statutory rate in the first fiscal quarter of 2011 and 2010, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next twelve months $5.9 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.

 

9. As of January 28, 2011, 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 fiscal quarter of 2011 and 2010 was $2.1 million and $1.5 million, respectively. During the first fiscal quarter of 2011 and 2010, the Company issued 179,232 and 46,482 shares, respectively, under its employee stock plans.

Employee Stock Purchase Plan

The ESPP is a “safe-harbor” designed plan whereby shares are purchased by participants at 95% 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 218,500 options and 337,800 options in the three month periods ended January 28, 2011, and January 29, 2010, respectively. The weighted-average grant date fair value of options granted during the three month periods ended January 28, 2011, and January 29, 2010, was $31.10 per share and $21.15 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.

 

0000000000000 0000000000000
     Three Months Ended  
     January 28,
2011
     January 29,
2010
 

Risk-free interest rate

     2.02 – 3.64%         2.42 – 4.0%   

Volatility

     40.8 – 42.8%         43.0 – 43.2%   

Expected life (years)

     4.5 – 9.5            4.5 – 9.5      

Dividends

     0            0      

Employee Sharesave Scheme

Under the employee sharesave scheme for U.K. employees, participants are allowed the option to purchase shares at 95% 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. No options were granted during the first fiscal quarter of 2011 and 2010.

 

10


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

 

0000000000000 0000000000000
(In thousands)    Three Months Ended  
     January 28,
2011
     January 29,
2010
 

Components of Net Periodic Pension Cost

     

Service cost

   $ 2,281       $ 1,890   

Interest cost

     4,603         4,495   

Expected return on plan assets

     (5,024      (4,373

Amortization of prior service cost

     5         5   

Amortization of actuarial loss

     1,996         1,826   
                 

Net Periodic Cost

   $ 3,861       $ 3,843   
                 
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  
     January 28,
2011
     January 29,
2010
 

Components of Net Periodic Pension Cost

     

Service cost

   $ 135       $ 78   

Interest cost

     170         174   

Amortization of actuarial gain

     (4      (19
                 

Net Periodic Cost

   $ 301       $ 233   
                 

 

11. 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 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 January 28, 2011, and October 29, 2010:

 

11


0000000000000 0000000000000
(In thousands)    Level 2  
     January 28,
2011
    October 29,
2010
 

Assets:

    

Derivative contracts designated as hedging instruments

   $ 10,398      $ 11,552   

Derivative contracts not designated as hedging instruments

   $ 1,161      $ 1,256   

Embedded derivatives

   $ 21      $ 23   

Liabilities:

    

Derivative contracts designated as hedging instruments

   $ 8,322      $ 950   

Derivative contracts not designated as hedging instruments

   $ 481      $ 782   

Embedded derivatives

   $ 1,638      $ 1,815   
(In thousands)    Level 3  
     January 28,
2011
    October 29,
2010
 

Liabilities:

    

Contingent purchase obligation

   $ 13,350      $ 0   

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 up to $14.0 million 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 objective 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.

 

12. 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 credit worthy 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

 

12


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. The Company does not have any hedges with credit-risk-related contingent features or that required the posting of collateral as of January 28, 2011. 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. As of January 28, 2011, and October 29, 2010, the Company had outstanding foreign currency forward exchange contracts principally to sell U.S. dollars with notional amounts of $237.1 million and $245.5 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 on 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 5.169% at January 28, 2011. The fair value of the Company’s interest rate swap was a $5.3 million liability at January 28, 2011, 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 on 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 4.774% at January 28, 2011. The fair value of the Company’s interest rate swap was a $2.4 million liability at January 28, 2011, and was estimated by discounting expected cash flows using market interest rates. The Company recognized a net interest receivable of $0.5 million at January 28, 2011.

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 February 2006, the Company entered into a term loan for £57.0 million. The Company designated the term loan a hedge of the investment in a certain U.K. business unit. The term loan was fully repaid in June 2009. A cumulative foreign currency loss of $4.8 million net of taxes resulting from the accounting of the term loan as a net investment hedge will remain in other comprehensive income in shareholders’ equity until the hedged investment is disposed of or sold.

Fair Value of Derivative Instruments

Fair values of derivative instruments in the Consolidated Balance Sheet at January 28, 2011, and October 29, 2010, consisted of:

 

13


0000000000000 0000000000000 0000000000000
(In thousands)       Fair Value  
   

Classification

  January 28,
2011
    October 29,
2010
 

Foreign Currency Forward

     

Exchange Contracts:

  Other current assets   $ 10,314      $ 11,218   
  Other assets     1,245        1,590   
  Accrued liabilities     1,167        1,563   
  Other liabilities     17        169   

Embedded Derivative

     

Instruments:

  Other current assets   $ 21      $ 23   
  Accrued liabilities     72        189   
  Other liabilities     1,566        1,626   

Interest Rate Swaps:

  Accrued liabilities   $ 7,619      $ 0   
The effect of derivative instruments on the Consolidated Statement of Operations for the first fiscal quarter in 2011 and 2010 consisted of:    
(In thousands)  

  Location of Gain (Loss)  

  January 28,
2011
    January 29,
2010
 

Fair Value Hedges:

     

Interest rate swap contracts

  Interest Expense   $ 479      $ 632   

Embedded derivatives

  Sales     202        (425

Cash Flow Hedges:

     

Foreign currency forward exchange contracts:

     

Amount of loss recognized
in AOCI (effective portion)

  AOCI   $ (4,748   $ (4,497

Amount of gain reclassified
from AOCI into income

  Sales     2,668        1,998   

In each of the first fiscal quarter of 2011 and 2010, the Company recorded gains of $0.1 million on foreign currency forward exchange contracts that have not been designated as an accounting hedge, respectively. 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 fiscal quarter of 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 fiscal quarter of 2011.

Amounts included in AOCI are reclassified into earnings when the hedged transaction settles. The Company expects to reclassify approximately $8.7 million of net gain into earnings over the next 12 months. The maximum duration of the Company’s foreign currency cash flow hedge contracts at January 28, 2011, is 21 months.

 

14


13. Segment information:

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

 

0000000000000 0000000000000
(In thousands)    Three Months Ended  
     January 28,
2011
    January 29,
2010
 

Sales

    

Avionics & Controls

   $ 192,467      $ 170,257   

Sensors & Systems

     77,055        70,692   

Advanced Materials

     101,277        94,361   
                

Total Sales

   $ 370,799      $ 335,310   
                

Income from Continuing Operations

    

Avionics & Controls

   $ 31,004      $ 19,432   

Sensors & Systems

     10,971        4,556   

Advanced Materials

     15,268        8,730   
                

Segment Earnings

     57,243        32,718   

Corporate expense

     (10,832     (8,091

Other expense

     0        (41

Interest income

     340        383   

Interest expense

     (9,137     (7,961
                
   $ 37,614      $ 17,008   
                

 

14. 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 January 28, 2011, and October 29, 2010, and for the applicable periods ended January 28, 2011, and January 29, 2010, 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, the Senior Notes due 2020, and the Senior Subordinated Notes (until such Senior Subordinated Notes were repurchased or otherwise redeemed in August 2010).

 

15


Condensed Consolidating Balance Sheet as of January 28, 2011

 

0000000000 0000000000 0000000000 0000000000 0000000000
(In thousands)                              
    Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

Assets

         

Current Assets

         

Cash and cash equivalents

  $ 110,527      $ 7,037      $ 233,917      $ 0      $ 351,481   

Cash in escrow

    14,000        0        0        0        14,000   

Accounts receivable, net

    423        117,495        145,748        0        263,666   

Inventories

    0        144,176        159,429        0        303,605   

Income tax refundable

    17,662        (2,338     6,760        0        22,084   

Deferred income tax benefits

    22,208        (1,230     17,666        0        38,644   

Prepaid expenses

    52        5,527        10,885        0        16,464   

Other current assets

    25        257        10,335        0        10,617   
   

Total Current Assets

    164,897        270,924        584,740        0        1,020,561   

Property, Plant &

         

Equipment, Net

    1,118        165,472        113,759        0        280,349   

Goodwill

    0        311,596        494,742        0        806,338   

Intangibles, Net

    0        138,822        308,822        0        447,644   

Debt Issuance Costs, Net

    7,413        0        0        0        7,413   

Deferred Income

         

Tax Benefits

    44,716        3,593        40,557        0        88,866   

Other Assets

    (70     1,709        9,038        0        10,677   

Amounts Due From (To)

         

Subsidiaries

    35,907        290,066        0        (325,973     0   

Investment in Subsidiaries

    1,837,906        153,466        229,041        (2,220,413     0   
   

Total Assets

  $ 2,091,887      $ 1,335,648      $ 1,780,699      $ (2,546,386   $ 2,661,848   
   

 

16


00000000000 00000000000 00000000000 00000000000 00000000000
(In thousands)                                 
     Parent      Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
     Eliminations     Total  

Liabilities and Shareholders’ Equity

  

         

Current Liabilities

            

Accounts payable

   $ 724       $ 27,674      $ 47,827       $ 0      $ 76,225   

Accrued liabilities

     29,557         79,756        119,065         0        228,378   

Credit facilities

     0         0        0         0        0   

Current maturities of

            

long-term debt

     12,500         150        1,609         0        14,259   

Deferred income tax

            

liabilities

     197         258        6,388         0        6,843   

Federal and foreign

            

income taxes

     0         (22,198     26,711         0        4,513   
   

Total Current Liabilities

     42,978         85,640        201,600         0        330,218   

Long-Term Debt, Net

     523,631         44,432        26,082         0        594,145   

Deferred Income Tax

            

Liabilities

     43,921         20,492        85,577         0        149,990   

Pension and Post-

            

Retirement Obligations

     16,586         41,577        48,884         0        107,047   

Other Liabilities

     10,278         9,103        6,574         0        25,955   

Amounts Due To (From)

            

Subsidiaries

     0         0        323,043         (323,043     0   

Shareholders’ Equity

     1,454,493         1,134,404        1,088,939         (2,223,343     1,454,493   
   

Total Liabilities and

            

Shareholders’ Equity

   $ 2,091,887       $ 1,335,648      $ 1,780,699       $ (2,546,386   $ 2,661,848   
   

 

17


Condensed Consolidating Statement of Operations for the three month period ended January 28, 2011.

 

00000000000 00000000000 00000000000 00000000000 00000000000
(In thousands)                               
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

Net Sales

   $ 0      $ 195,450      $ 175,560      $ (211   $ 370,799   

Cost of Sales

     0        128,513        110,375        (211     238,677   
   
     0        66,937        65,185        0        132,122   

Expenses

          

Selling, general

          

and administrative

     0        31,205        34,887        0        66,092   

Research, development

          

and engineering

     0        9,635        9,984        0        19,619   
   

Total Expenses

     0        40,840        44,871        0        85,711   
   

Operating Earnings from

          

Continuing Operations

     0        26,097        20,314        0        46,411   

Interest Income

     (3,482     (625     (5,410     9,177        (340

Interest Expense

     8,029        4,989        5,296        (9,177     9,137   
   

Income (Loss) from

          

Continuing Operations

          

Before Taxes

     (4,547     21,733        20,428        0        37,614   

Income Tax Expense

          

(Benefit)

     (1,073     3,871        4,856        0        7,654   
   

Income (Loss) from

          

Continuing Operations

          

Including Noncontrolling

          

Interests

     (3,474     17,862        15,572        0        29,960   

Loss Attributable to

          

Noncontrolling Interests

     0        0        23        0        23   
   

Income (Loss) from

          

Continuing Operations

          

Attributable to Esterline

     (3,474     17,862        15,595        0        29,983   

Income from Discontinued

          

Operations Attributable

          

to Esterline, Net of Tax

     8        0        0        0        8   

Equity in Net Income of

          

Consolidated Subsidiaries

     33,457        3,859        1,172        (38,488     0   
   

Net Income (Loss)

          

Attributable to Esterline

   $ 29,991      $ 21,721      $ 16,767      $ (38,488   $ 29,991   
   

 

18


Condensed Consolidating Statement of Cash Flows for the three month period ended January 28, 2011.

 

00000000000 00000000000 00000000000 00000000000 00000000000
(In thousands)                               
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

Cash Flows Provided (Used)

          

by Operating Activities

          

Net earnings (loss) including

          

noncontrolling interests

   $ 29,991      $ 21,721      $ 16,744      $ (38,488   $ 29,968   

Depreciation & amortization

     0        8,394        9,366        0        17,760   

Deferred income taxes

     4,005        22        (2,562     0        1,465   

Share-based compensation

     0        921        1,149        0        2,070   

Working capital changes, net

          

of effect of acquisitions:

          

Accounts receivable

     (149     22,200        31,753        0        53,804   

Inventories

     0        (8,936     (15,148     0        (24,084

Prepaid expenses

     (3     201        (407     0        (209

Other current assets

     (25     (213     527        0        289   

Accounts payable

     (220     (1,070     (6,723     0        (8,013

Accrued liabilities

     3,276        (4,686     (13,709     0        (15,119

Federal & foreign

          

income taxes

     (4,387     (1,704     (1,048     0        (7,139

Other liabilities

     2,352        (200     (905     0        1,247   

Other, net

     1        250        (2,645     0        (2,394
   
     34,841        36,900        16,392        (38,488     49,645   

Cash Flows Provided (Used)

          

by Investing Activities

          

Purchases of capital assets

     (11     (8,036     (6,586     0        (14,633

Proceeds from sale

          

of capital assets

     0        184        211        0        395   

Escrow deposit

     (14,000     0        0        0        (14,000

Acquisitions, net of

          

cash acquired

     0        (103,548     0        0        (103,548
   
     (14,011     (111,400     (6,375     0        (131,786

 

19


00000000000 00000000000 00000000000 00000000000 00000000000
(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

     6,923        0        0        0         6,923   

Excess tax benefits from

           

stock options exercised

     953        0        0        0         953   

Debt and other issuance costs

     (36     0        0        0         (36

Net change in credit facilities

     0        0        0        0         0   

Repayment of long-term debt

     (1,563     (83     (62     0         (1,708

Proceeds from government

           

assistance

     0        0        5,285        0         5,285   

Net change in intercompany

           

financing

     (121,628     79,305        3,835        38,488         0   
   
     (115,351     79,222        9,058        38,488         11,417   

Effect of foreign exchange

           

rates on cash and cash

           

equivalents

     (2     (2     89        0         85   
   

Net increase (decrease) in

           

cash and cash equivalents

     (94,523     4,720        19,164        0         (70,639

Cash and cash equivalents

           

– beginning of year

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

Cash and cash equivalents

           

– end of year

   $ 110,527      $ 7,037      $ 233,917      $ 0       $ 351,481   
   

 

20


Condensed Consolidating Balance Sheet as of October 29, 2010

 

00000000000 00000000000 00000000000 00000000000 00000000000
(In thousands)                                
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
     Eliminations     Total  

Assets

           

Current Assets

           

Cash and cash equivalents

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

Accounts receivable, net

     274        131,531        177,437         0        309,242   

Inventories

     0        118,567        143,806         0        262,373   

Income tax refundable

     12,548        0        5,258         0        17,806   

Deferred income tax benefits

     23,507        (1,627     15,659         0        37,539   

Prepaid expenses

     49        5,729        10,486         0        16,264   

Other current assets

     0        1        11,240         0        11,241   
   

Total Current Assets

     241,428        256,518        578,639         0        1,076,585   

Property, Plant &

           

Equipment, Net

     1,249        162,407        110,114         0        273,770   

Goodwill

     0        246,176        493,554         0        739,730   

Intangibles, Net

     0        89,812        299,205         0        389,017   

Debt Issuance Costs, Net

     7,774        0        0         0        7,774   

Deferred Income Tax

           

Benefits

     44,407        3,537        39,678         0        87,622   

Other Assets

     (69     2,004        11,305         0        13,240   

Amounts Due From (To)

           

Subsidiaries

     41,529        271,345        0         (312,874     0   

Investment in Subsidiaries

     1,710,032        149,607        227,869         (2,087,508     0   
   

Total Assets

   $ 2,046,350      $ 1,181,406      $ 1,760,364       $ (2,400,382   $ 2,587,738   
   

 

21


00000000000 00000000000 00000000000 00000000000 00000000000
(In thousands)                                
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
     Eliminations     Total  

Liabilities and Shareholders’ Equity

  

        

Current Liabilities

           

Accounts payable

   $ 944      $ 28,345      $ 52,986       $ 0      $ 82,275   

Accrued liabilities

     18,662        73,870        122,562         0        215,094   

Credit facilities

     0        0        1,980         0        1,980   

Current maturities of

           

long-term debt

     10,938        80        1,628         0        12,646   

Deferred income tax

           

liabilities

     197        278        6,680         0        7,155   

Federal and foreign

           

income taxes

     (727     (20,522     26,476         0        5,227   
   

Total Current Liabilities

     30,014        82,051        212,312         0        324,377   

Long-Term Debt, Net

     534,375        44,525        20,072         0        598,972   

Deferred Income Tax

           

Liabilities

     40,300        123        86,658         0        127,081   

Pension and Post-

           

Retirement Obligations

     16,629        42,279        46,425         0        105,333   

Other Liabilities

     9,533        251        6,692         0        16,476   

Amounts Due To (From)

           

Subsidiaries

     0        0        310,115         (310,115     0   

Shareholders’ Equity

     1,415,499        1,012,177        1,078,090         (2,090,267     1,415,499   
   

Total Liabilities and

           

Shareholders’ Equity

   $ 2,046,350      $ 1,181,406      $ 1,760,364       $ (2,400,382   $ 2,587,738   
   

 

22


Condensed Consolidating Statement of Operations for the three month period ended January 29, 2010.

 

00000000000 00000000000 00000000000 00000000000 00000000000
(In thousands)                               
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

Net Sales

   $ 0      $ 167,776      $ 167,534      $ 0      $ 335,310   

Cost of Sales

     0        114,671        117,968        0        232,639   
   
     0        53,105        49,566        0        102,671   

Expenses

          

Selling, general
and administrative

     0        29,236        32,059        0        61,295   

Research, development
and engineering

     0        5,833        10,916        0        16,749   

Other expense

     0        0        41        0        41   
   

Total Expenses

     0        35,069        43,016        0        78,085   
   

Operating Earnings from

          

Continuing Operations

     0        18,036        6,550        0        24,586   

Interest Income

     (3,880     (630     (10,113     14,240        (383

Interest Expense

     6,639        4,988        10,574        (14,240     7,961   
   

Income (Loss) from

          

Continuing Operations

          

Before Taxes

     (2,759     13,678        6,089        0        17,008   

Income Tax Expense

          

(Benefit)

     (702     3,299        1,972        0        4,569   
   

Income (Loss) from

          

Continuing Operations

          

Including Noncontrolling

          

Interests

     (2,057     10,379        4,117        0        12,439   

Income Attributable to

          

Noncontrolling Interests

     0        0        (54     0        (54
   

Income (Loss) from

          

Continuing Operations

          

Attributable to Esterline

     (2,057     10,379        4,063        0        12,385   

Income from Discontinued

          

Operations Attributable

to Esterline, Net of Tax

     0        340        0        0        340   

Equity in Net Income of

          

Consolidated Subsidiaries

     14,782        3,305        (258     (17,829     0   
   

Net Income (Loss)

          

Attributable to Esterline

   $ 12,725      $ 14,024      $ 3,805      $ (17,829   $ 12,725   
   

 

23


Condensed Consolidating Statement of Cash Flows for the three month period ended January 29, 2010.

(In thousands)

 

00000000000 00000000000 00000000000 00000000000 00000000000
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations     Total  

Cash Flows Provided (Used)
by Operating Activities

          

Net earnings (loss) including
noncontrolling interests

   $ 12,725      $ 14,024      $ 3,859      $ (17,829   $ 12,779   

Depreciation & amortization

     0        8,128        10,531        0        18,659   

Deferred income taxes

     506        28        (1,929     0        (1,395

Share-based compensation

     0        685        787        0        1,472   

Working capital changes, net
of effect of acquisitions:

          

Accounts receivable

     0        14,366        8,202        0        22,568   

Inventories

     0        1,684        (1,952     0        (268

Prepaid expenses

     0        (1,153     (940     0        (2,093

Other current assets

     0        0        (239     0        (239

Accounts payable

     (97     320        (4,460     0        (4,237

Accrued liabilities

     (4,538     1,235        (17,001     0        (20,304

Federal & foreign
income taxes

     (1,250     (940     1,734        0        (456

Other liabilities

     191        1,200        800        0        2,191   

Other, net

     0        48        1,628        0        1,676   
   
     7,537        39,625        1,020        (17,829     30,353   

Cash Flows Provided (Used)
by Investing Activities

          

Purchases of capital assets

     (13     (5,136     (8,971     0        (14,120

Proceeds from sale
of capital assets

     0        59        2        0        61   

Acquisitions, net of
cash acquired

     0        (360     (408     0        (768
   
     (13     (5,437     (9,377     0        (14,827

 

24


(In thousands)

 

00000000000 00000000000 00000000000 00000000000 00000000000
     `            Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations      Total  

Cash Flows Provided (Used)
by Financing Activities

           

Proceeds provided by stock
issuance under employee
stock plans

     1,167        0        0        0         1,167   

Excess tax benefits from
stock options exercised

     199        0        0        0         199   

Net change in credit facilities

     0        0        (4,442     0         (4,442

Repayment of long-term debt

     (162     (118     102        0         (178

Net change in intercompany
financing

     13,019        (34,619     3,771        17,829         0   
   
     14,223        (34,737     (569     17,829         (3,254

Effect of foreign exchange
rates on cash and cash
equivalents

     0        132        (2,148     0         (2,016
   

Net increase (decrease) in
cash and cash equivalents

     21,747        (417     (11,074     0         10,256   

Cash and cash equivalents

           

– beginning of year

     47,907        4,621        124,266        0         176,794   
   

Cash and cash equivalents

           

– end of year

   $ 69,654      $ 4,204      $ 113,192      $ 0       $ 187,050   
   

 

25


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. Our segments are structured around our technical capabilities.

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. In addition, communication systems designs and manufactures communication control systems to enhance security and aural clarity in military applications and embedded intercept receivers for signal intelligence applications.

The Sensors & Systems segment includes power systems and advanced sensors capabilities. Power systems develops and manufactures electrical power switching and other related systems, principally for aerospace and defense customers. 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 countermeasure devices for military customers. Sales in all segments include domestic, international, defense and commercial customers.

Our current 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 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 December 30, 2010, the Company acquired all of the outstanding capital stock of Eclipse Electronic Systems, Inc. (Eclipse). Eclipse is a designer and manufacturer of embedded communications intercept receivers for signal intelligence applications. Eclipse is included in our Avionics & Controls segment.

On September 8, 2010, we sold Pressure Systems, Inc., which was included in the Sensors & Systems segment. The results of Pressure Systems, Inc. were accounted for as a discontinued operation in the consolidated financial statements.

Income from continuing operations was $30.0 million, or $0.97 per diluted share, compared with $12.4 million, or $0.41 per diluted share, in the prior-year period. During the first fiscal quarter of 2011, our operating results benefited from solid earnings across all our segments due mainly to strong sales volumes and gross margin. Segment earnings (excluding corporate expense) as a percent of sales increased to 15.4% in the first fiscal quarter of 2011 compared to 9.8% in the prior-year period. Avionics & Controls led all segments with an $11.6 million increase in segment earnings, followed by Advanced Materials and Sensors & Systems, each with about a $6.5 million increase in segment earnings over the prior-year period. Income from continuing operations also benefited from a decrease in the income tax rate to 20.3% from 26.9% in the prior-year period, reflecting the retroactive extension of the U.S. federal research and experimentation tax credits. Income from discontinued operations was $8,000 in the first fiscal quarter of 2011 compared with $340,000 or $0.01 per diluted share in the prior-year period.

 

26


Net income was $30.0 million, or $0.97 per diluted share, compared with net income of $12.7 million, or $0.42 per diluted share, in the prior-year period.

Results of Operations

Three Month Period Ended January 28, 2011, Compared with Three Month Period Ended January 29, 2010

Sales for the first fiscal quarter increased 10.6% when compared with the prior-year period. Sales by segment were as follows:

(In thousands)

 

0000000000000 0000000000000 0000000000000
     Incr./(Decr.)      Three Months Ended  
   from prior
year period
     January 28,
2011
     January 29,
2010
 

Avionics & Controls

      13.0%       $ 192,467       $ 170,257   

Sensors & Systems

        9.0%         77,055         70,692   

Advanced Materials

        7.3%         101,277         94,361   
                    

Total Net Sales

      $ 370,799       $ 335,310   
                    

The 13.0% increase in sales of Avionics & Controls reflected increased sales volumes of avionics systems of $14.0 million, control systems of $4.4 million, and communication systems and interface technologies of approximately $3.8 million. The increase in avionics systems was principally due to strong cockpit integration and aviation products sales volumes. The increase in communication systems mainly reflected the acquisition of Eclipse on December 30, 2010. The increase in control systems was principally due to strong aftermarket demand for commercial aviation applications. The increase in interface technologies mainly reflected strong sales of input devices for medical and industrial commercial applications, partially offset by weaker demand for casino gaming applications.

The 9.0% increase in sales of Sensors & Systems reflected increased sales volume of advanced sensors of $4.3 million and power systems of $2.1 million. The increase in advanced sensors sales mainly reflected higher OEM sales of pressure sensors and strong aftermarket demand. The increase in power systems mainly reflected higher retrofit sales for commercial aviation. Sales in the first fiscal quarter of 2011 reflected a weaker pound sterling and euro relative to the U.S. dollar. The average exchange rate from the pound sterling to the U.S. dollar decreased from 1.62 in the first fiscal quarter of 2010 to 1.57 in the first fiscal quarter of 2011. The average exchange rate from the euro to the U.S. dollar decreased from 1.46 in the first fiscal quarter of 2010 to 1.34 in the first fiscal quarter of 2011.

The 7.3% increase in sales of Advanced Materials reflected decreased sales volumes of defense technologies of $2.1 million and increased sales volumes of engineered materials of $8.4 million. The decrease in defense technologies mainly reflected lower sales of flare countermeasures due to reduced demand and delayed shipments, partially offset by higher sales volumes of combustible ordnance. The increase in engineered materials primarily reflected strong demand for elastomer and insulation materials.

Overall, gross margin was 35.6% and 30.6% for the first fiscal quarter of 2011 and 2010, respectively. Gross profit was $132.1 million and $102.7 million for the first fiscal quarter of 2011 and 2010, respectively.

Avionics & Controls segment gross margin was 38.8% and 33.2% for the first fiscal quarter of 2011 and 2010, respectively. Segment gross profit was $74.6 million compared to $56.5 million in the prior-year period. Nearly 80% of the increase in segment gross profit was due to strong sales volume and improved gross margin on avionics systems reflecting increased sales volumes of cockpit integrations for the T-6B military trainer as well as aviation products. The remaining 20% increase in segment gross profit mainly reflected strong aftermarket sales of communication systems and control systems.

 

27


Sensors & Systems segment gross margin was 35.5% and 31.8% for the first fiscal quarter of 2011 and 2010, respectively. Segment gross profit was $27.4 million compared to $22.5 million in the prior-year period. The increase in gross profit mainly reflected strong demand for advanced sensors for the aftermarket as well as new OEM requirements. The increase in gross profit for advanced sensors was partially offset by a modest decline in gross profit for power systems principally due to product mix.

Advanced Materials segment gross margin was 29.7% compared to 25.1% for the same period one year ago. Segment gross profit was $30.1 million compared to $23.7 million in the prior-year period. Approximately 64% of the increase in segment gross profit was due to an increase in engineered materials and the balance was due to defense technologies. The increase in gross profit on engineered materials was due to higher sales volumes of elastomer and insulation materials. The increase in gross profit on defense technologies reflected strong demand and increased prices for combustible ordnance partially offset by lower demand and delayed shipments of flare countermeasures. Management expects that demand for countermeasures will be at reduced levels for the remainder of fiscal 2011.

Selling, general and administrative expenses (which include corporate expenses) totaled $66.1 million, or 17.8% of sales, and $61.3 million, or 18.3% of sales, for the first fiscal quarter of 2011 and 2010, respectively. The increase in selling, general and administrative expense principally reflected an increase of $2.7 million of corporate expense and a $3.0 million increase in selling, general and administrative expenses at our Avionics & Controls segment, partially offset by a $1.2 million decrease at our Advanced Materials segment. The increase in corporate expense mainly reflected higher incentive compensation expense of $1.6 million and increased charitable contributions of $0.3 million. The increase in selling, general and administrative expense at our Avionics & Controls segment principally reflected higher selling expenses and incentive compensation.

Research, development and engineering spending was $19.6 million, or 5.3% of sales, for the first fiscal quarter of 2011 compared with $16.7 million, or 5.0% of sales, for the first fiscal quarter of 2010. The increase in research, development and engineering spending principally reflects spending on avionics systems and control systems developments. Fiscal 2011 research, development and engineering spending is expected to be approximately 5.0% of sales.

Segment earnings (operating earnings excluding corporate expenses and other income or expense) for the first fiscal quarter of 2011 totaled $57.2 million, or 15.4% of sales, compared with $32.7 million, or 9.8% of sales, for the first fiscal quarter in 2010.

Avionics & Controls segment earnings were $31.0 million, or 16.1% of sales, in the first fiscal quarter of 2011 and $19.4 million, or 11.4% of sales, in the first fiscal quarter of 2010, mainly reflecting a $10.7 million increase in avionics systems. Avionics systems benefited from increased gross profit, partially offset by a $1.3 million increase in research, development and engineering and a $2.0 million increase in selling, general and administrative expense.

Sensors & Systems segment earnings were $11.0 million, or 14.2% of sales, for the first fiscal quarter of 2011 compared with $4.6 million, or 6.4% of sales, for the first fiscal quarter of 2010, principally reflecting an increase in advanced sensors gross profit.

Advanced Materials segment earnings were $15.3 million, or 15.1% of sales, for the first fiscal quarter of 2011 compared with $8.7 million, or 9.3% of sales, for the first fiscal quarter of 2010, primarily reflecting a $2.0 million increase in defense technologies and a $4.2 million increase in engineered materials. Defense technologies reflected a $3.4 million increase in combustible ordnance gross profit and a $1.4 million decrease in countermeasures gross profit. The increase in engineered materials mainly reflected increased gross profit for elastomer and insulation materials.

Interest expense for the first fiscal quarter of 2011 was $9.1 million compared with $8.0 million for the first fiscal quarter of 2010, reflecting higher borrowings during the first fiscal quarter of 2011 compared to the prior-year period.

 

28


The income tax rate was 20.3% compared with 26.9% for the first fiscal quarter of 2011 and 2010, respectively. In the first fiscal quarter of 2011, we recognized $1.4 million of discrete tax benefits due to the retroactive extension of the U.S. federal research and experimentation tax credit. In the first fiscal quarter of 2010 we recognized $0.3 million of discrete tax expenses mainly the result of a change in French tax laws. The income tax rate differed from the statutory rate in the first fiscal quarter of 2011 and 2010, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next twelve months $5.9 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 hedges qualify 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 currency other than the functional currency of the Company for the first fiscal quarter of 2011 and 2010 are as follows:

(In thousands)

0000000000000 0000000000000
     Three Months Ended  
     January 28,
2011
    January 29,
2010
 

Forward foreign currency contracts – gain

   $ 86      $ 114   

Forward foreign currency contracts – reclassified from AOCI

     2,668        1,998   

Embedded derivatives – gain (loss)

     202        (425

Revaluation of monetary assets/liabilities – loss

     (629     (800
                

Total

   $ 2,327      $ 887   
                

New orders for the first fiscal quarter of 2011 were $399.3 million compared with $338.0 million for the same period in 2010. Backlog was $1.1 billion at January 28, 2011, unchanged from the prior-year period and at the end of fiscal 2010.

 

29


Liquidity and Capital Resources

Cash and cash equivalents at January 28, 2011, totaled $351.5 million, a decrease of $70.6 million from October 29, 2010. Net working capital decreased to $690.3 million at January 28, 2011, from $752.2 million at October 29, 2010. Sources and uses of cash flows from operating activities principally consisted of cash received from the sale of products and cash payments for material, labor and operating expenses. Cash flows provided by operating activities were $49.6 million and $30.4 million in the first fiscal quarter of 2011 and 2010, respectively. The increase principally reflected higher cash receipts and lower payments for interest, offset by higher payments for inventory.

Cash flows used by investing activities were $131.8 million and $14.8 million in the first fiscal quarter of 2011 and 2010, respectively. Cash flows used by investing activities in the first fiscal quarter of 2011 primarily reflected cash paid for acquisitions of $103.5 million and capital expenditures of $14.6 million. Cash flows used by investing activities in the first fiscal quarter of 2010 primarily reflected cash paid for capital expenditures.

Cash flows provided by financing activities were $11.4 million in the first fiscal quarter of 2011 and primarily reflected cash receipts for issuance of stock and government assistance payments. Cash flows used by financing activities were $3.3 million in the first fiscal quarter of 2010 and principally reflected cash payments on our credit facilities and long-term debt.

On December 30, 2010, the Company acquired all of the outstanding capital stock of Eclipse for approximately $120.0 million, plus the change in net assets from July 31, 2010, to the actual closing balance sheet. The $120.0 million purchase price also 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 a three-year period. The estimated fair value of the contingent consideration is $13.4 million. Eclipse is a designer and manufacturer of embedded communications intercept receivers for signal intelligence applications.

Capital expenditures, consisting of machinery, equipment and computers, are anticipated to be approximately $75.0 million during fiscal 2011, compared with $53.7 million expended in fiscal 2010. Capital expenditures for fiscal 2010 included $8.1 million under a capitalized lease obligation related to our newly constructed facility for an avionics controls operation and a facility expansion for an interface technologies facility.

Total debt at January 28, 2011, was $608.4 million and consisted of $250.0 million of Senior Notes due in 2020, $167.4 million of Senior Notes due in 2017, $118.8 million of the U.S. Term Loan, $44.3 million under capital lease obligations, and $27.9 million under our 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.

Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases you can identify forward-looking statements by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risk factors set forth in “Forward-Looking Statements” and “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 29, 2010, that may cause our or the industry’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. You should not place undue reliance on these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements. Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this report are made only as of the date hereof. We do not undertake and specifically decline any obligation to update

 

30


any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes in our exposure to market risk during the first three months of fiscal 2011. A discussion of our exposure to market risk is provided in the Company’s Annual Report on Form 10-K for the fiscal year ended October 29, 2010.

 

Item 4. Controls and Procedures

Our principal executive and financial officers evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of January 28, 2011. Based upon that evaluation, they concluded as of January 28, 2011, that our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within time periods specified in Securities and Exchange Commission rules and forms. In addition, our principal executive and financial officers concluded as of January 28, 2011, that our disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

During the time period covered by this report, there were no significant changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

31


PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time we are involved in legal proceedings arising in the ordinary course of business. We believe that adequate reserves for these liabilities have been made and that there is no litigation pending that could have a material adverse effect on our results of operations and financial condition.

 

Item 6. Exhibits

 

10.1      Esterline Technologies Corporation Fiscal Year 2011 Annual Incentive Compensation Plan.
10.2      Esterline Technologies Corporation Long-Term Incentive Plan.
10.3      Stock Purchase Agreement By and Among Eclipse Electronic Systems, Inc., Its Shareholders, and Esterline Technologies Corporation dated as of December 28, 2010.
11      Schedule setting forth computation of basic and diluted earnings per common share for the three month periods ended January 28, 2011, and January 29, 2010.
31.1      Certification of Chief Executive Officer.
31.2      Certification of Chief Financial Officer.
32.1      Certification (of R. Bradley Lawrence) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2      Certification (of Robert D. George) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.XML      XBRL Instance Document
101.XSD      XBRL Taxonomy Extension Schema
101.CAL      XBRL Taxonomy Extension Calculation Linkbase
101.LAB      XBRL Taxonomy Extension Label Linkbase
101.PRE      XBRL Taxonomy Extension Presentation Linkbase

 

32


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

    ESTERLINE TECHNOLOGIES CORPORATION  
 

(Registrant)

 

Dated: March 4, 2011

    By:      

/s/ Robert D. George

 
    Robert D. George    
   

  Vice President, Chief Financial Officer,

  Secretary and Treasurer

  (Principal Financial Officer)

   

 

33