Form 10-Q

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 26, 2013.

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

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  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      ¨   (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  þ

As of August 28, 2013, 31,375,484 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 26, 2013 and October 26, 2012

(In thousands, except share amounts)

 

                                           
     July 26,
2013
     October 26,
2012
 
     (Unaudited)         

ASSETS

     

Current Assets

     

Cash and cash equivalents

   $ 199,248       $ 160,675   

Cash in escrow

     4,017         5,016   

Accounts receivable, net of allowances
of $8,137 and $9,029

     332,069         383,362   

Inventories

     

Raw materials and purchased parts

     163,744         146,390   

Work in process

     184,543         174,824   

Finished goods

     97,503         88,623   
  

 

 

    

 

 

 
     445,790         409,837   

Income tax refundable

     9,084         4,832   

Deferred income tax benefits

     47,329         46,000   

Prepaid expenses

     21,524         21,340   

Other current assets

     3,774         4,631   
  

 

 

    

 

 

 

Total Current Assets

     1,062,835         1,035,693   

Property, Plant and Equipment

     746,003         701,541   

Accumulated depreciation

     382,848         345,140   
  

 

 

    

 

 

 
     363,155         356,401   

Other Non-Current Assets

     

Goodwill

     1,106,867         1,098,962   

Intangibles, net

     584,485         609,045   

Debt issuance costs, net of accumulated
amortization of $3,933 and $4,577

     6,637         8,818   

Deferred income tax benefits

     93,374         97,952   

Other assets

     7,558         20,246   
  

 

 

    

 

 

 
   $ 3,224,911       $ 3,227,117   
  

 

 

    

 

 

 

 

2


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of July 26, 2013 and October 26, 2012

(In thousands, except share amounts)

 

                                           
     July 26,
2013
     October 26,
2012
 
     (Unaudited)         

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Current Liabilities

     

Accounts payable

   $ 117,041       $ 108,689   

Accrued liabilities

     258,447         269,553   

Credit facilities

     109         0   

Current maturities of long-term debt

     21,939         10,610   

Deferred income tax liabilities

     1,215         5,125   

Federal and foreign income taxes

     1,954         2,369   
  

 

 

    

 

 

 

Total Current Liabilities

     400,705         396,346   

Long-Term Liabilities

     

Credit facilities

     170,000         240,000   

Long-term debt, net of current maturities

     562,444         598,060   

Deferred income tax liabilities

     198,809         205,198   

Pension and post-retirement obligations

     125,673         132,074   

Other liabilities

     32,616         34,904   

Shareholders’ Equity

     

Common stock, par value $.20 per share,
authorized 60,000,000 shares, issued and
outstanding 31,372,336 and 30,869,390 shares

     6,274         6,174   

Additional paid-in capital

     599,489         569,235   

Retained earnings

     1,219,227         1,120,356   

Accumulated other comprehensive loss

     (100,696      (85,284
  

 

 

    

 

 

 

Total Esterline shareholders’ equity

     1,724,294         1,610,481   

Noncontrolling interests

     10,370         10,054   
  

 

 

    

 

 

 

Total Shareholders’ Equity

     1,734,664         1,620,535   
  

 

 

    

 

 

 
   $ 3,224,911       $ 3,227,117   
  

 

 

    

 

 

 

 

3


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

For the Three and Nine Month Periods Ended July 26, 2013 and July 27, 2012

(Unaudited)

(In thousands, except per share amounts)

 

     Three Months Ended     Nine Months Ended  
     July 26,
2013
    July 27,
2012
    July 26,
2013
    July 27,
2012
 

Net Sales

   $        478,068      $        485,949      $     1,435,592      $     1,461,662   

Cost of Sales

     299,166        313,853        914,969        946,962   
  

 

 

   

 

 

   

 

 

   

 

 

 
     178,902        172,096        520,623        514,700   

Expenses

        

Selling, general & administrative

     101,822        91,869        298,711        285,516   

Research, development & engineering

     24,103        27,198        72,837        83,138   

Gain on settlement of contingency

     0        0        0        (11,891

Goodwill impairment

     3,454        52,169        3,454        52,169   

Other income

     0        (1,263     0        (1,263
  

 

 

   

 

 

   

 

 

   

 

 

 

    Total Expenses

     129,379        169,973        375,002        407,669   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Earnings from

        

Continuing Operations

     49,523        2,123        145,621        107,031   

Interest Income

     (132     (109     (381     (320

Interest Expense

     9,050        12,159        30,976        35,171   

Loss on Extinguishment of Debt

     0        0        946        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) from Continuing Operations
Before Income Taxes

     40,605        (9,927     114,080        72,180   

Income Tax Expense

     1,151        6,963        13,027        20,677   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) from Continuing Operations
Including Noncontrolling Interests

     39,454        (16,890     101,053        51,503   

Earnings Attributable to
Noncontrolling Interests

     (241     (214     (1,207     (628
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) from Continuing Operations
Attributable to Esterline

     39,213        (17,104     99,846        50,875   

Loss from Discontinued Operations Attributable
to Esterline, Net of Tax

     (975     0        (975     0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Earnings (Loss) Attributable to Esterline

   $ 38,238      $ (17,104   $ 98,871      $ 50,875   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

        

Continuing operations

   $ 1.25      $ (.55   $ 3.21      $ 1.66   

Discontinued operations

     (.03     .00        (.03     .00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable
to Esterline – Basic

   $ 1.22      $ (.55   $ 3.18      $ 1.66   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

        

Continuing operations

   $ 1.23      $ (.55   $ 3.15      $ 1.63   

Discontinued operations

     (.03     .00        (.03     .00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable
to Esterline – Diluted

   $ 1.20      $ (.55   $ 3.12      $ 1.63   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

   $ 45,201      $ (81,625   $ 83,459      $ (46,809

 

4


ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Nine Month Periods Ended July 26, 2013 and July 27, 2012

(Unaudited)

(In thousands)

 

                                         
     Nine Months Ended  
     July 26,
2013
    July 27,
2012
 

Cash Flows Provided (Used) by Operating Activities

    

Net earnings including noncontrolling interests

   $ 100,078      $ 51,503   

Adjustments to reconcile net earnings including noncontrolling
interests to net cash provided (used) by operating activities:

    

Depreciation and amortization

     87,941        79,265   

Deferred income taxes

     (12,238     (19,636

Share-based compensation

     7,667        7,686   

Gain on sale of capital assets

     (915     (1,139

Gain on settlement of contingency

     0        (11,891

Goodwill impairment

     3,454        52,169   

Working capital changes, net of effect of acquisitions:

    

Accounts receivable

     51,063        20,975   

Inventories

     (32,774     (27,494

Prepaid expenses

     (135     (5,423

Other current assets

     (836     188   

Accounts payable

     5,424        (2,339

Accrued liabilities

     4,277        16,923   

Federal and foreign income taxes

     (5,321     2,151   

Other liabilities

     (10,394     (15,074

Other, net

     (1,012     3,510   
  

 

 

   

 

 

 
     196,279        151,374   

Cash Flows Provided (Used) by Investing Activities

    

Purchases of capital assets

     (37,765     (39,456

Proceeds from sale of capital assets

     915        1,139   

Acquisition of business, net of cash acquired

     (40,689     0   
  

 

 

   

 

 

 
     (77,539     (38,317

Cash Flows Provided (Used) by Financing Activities

    

Proceeds provided by stock issuance under share-based
compensation plans

     20,450        7,331   

Excess tax benefits from stock options exercised

     2,237        221   

Proceeds from long-term credit facilities

     175,000        0   

Repayment of long-term debt

     (209,541     (44,131

Repayment of credit facilities

     (70,000     (60,000

Proceeds from government assistance

     5,114        17,203   

Dividends paid to noncontrolling interests

     (1,044     0   

Debt and other issuance costs

     (453     0   
  

 

 

   

 

 

 
     (78,237     (79,376

Effect of Foreign Exchange Rates on Cash

     (1,930     (5,643
  

 

 

   

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

     38,573        28,038   

Cash and Cash Equivalents – Beginning of Period

     160,675        185,035   
  

 

 

   

 

 

 

Cash and Cash Equivalents – End of Period

   $             199,248      $             213,073   
  

 

 

   

 

 

 

Supplemental Cash Flow Information

    

Cash Paid for Interest

   $ 25,873      $ 27,039   

Cash Paid for Taxes

     30,608        37,554   

 

5


ESTERLINE TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Nine Month Periods Ended July 26, 2013 and July 27, 2012

 

1. The consolidated balance sheet as of July 26, 2013, the consolidated statement of operations and comprehensive income (loss) for the three and nine month periods ended July 26, 2013, and July 27, 2012, and the consolidated statement of cash flows for the nine month periods ended July 26, 2013, and July 27, 2012, 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 26, 2012, 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 and restricted stock units. Common shares issuable from stock options excluded from the calculation of diluted earnings per share because they were anti-dilutive were 219,800 in the third fiscal quarter of 2013. There were no anti-dilutive shares in the third fiscal quarter of 2012. Shares used for calculating earnings per share are disclosed in the following table.

 

(In thousands)    Three Months Ended      Nine Months Ended  
     July 26,
         2013        
     July 27,
         2012        
     July 26,
         2013        
     July 27,
         2012        
 

Shares Used for Basic Earnings Per Share

     31,297         30,835         31,100         30,712   

Shares Used for Diluted Earnings Per Share

     31,870         30,835         31,663         31,266   

 

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

 

(In thousands)    Three Months Ended     Nine Months Ended  
     July 26,
         2013        
    July 27,
         2012        
    July 26,
         2013        
    July 27,
         2012        
 

Net Earnings (Loss)

   $ 38,238      $ (17,104   $ 98,871      $ 50,875   

Change in Fair Value of Derivative
Financial Instruments, Net of Tax
(1)

     (848     (5,343     (2,434     (4,958

Change in Pension and Post-retirement
Obligations, Net of Tax
(2)

     2,031        1,760        4,006        4,074   

Foreign Currency Translation Adjustment

     5,780        (60,938     (16,984     (96,800
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

   $ 45,201      $ (81,625   $ 83,459      $ (46,809
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) 

Net of tax benefit of $247 and $2,296 for the third fiscal quarter of 2013 and 2012, respectively. Net of tax benefit of $728 and $2,388 for the first nine months of fiscal 2013 and 2012, respectively.

 

  (2) 

Net of tax expense of $(1,092) and $(929) for the third fiscal quarter of 2013 and 2012, respectively. Net of tax expense of $(2,167) and $(2,341) for the first nine months of fiscal 2013 and 2012, respectively.

 

6


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

 

(In thousands)    July 26,
         2013        
     October 26,
         2012        
 

Net unrealized gain (loss) on derivative contracts

   $ (811    $ 1,623   

Pension and post-retirement obligations

     (95,173      (99,179

Currency translation adjustment

     (4,712      12,272   
  

 

 

    

 

 

 

Total accumulated other comprehensive loss

   $ (100,696    $ (85,284
  

 

 

    

 

 

 

 

6. On February 4, 2013, the Company acquired the Gamesman Group (Gamesman) for $40.8 million. Gamesman is a global supplier of input devices principally serving the gaming industry. Gamesman is included in the Avionics & Controls segment.

 

7. During the third fiscal quarter of 2013, the Company recorded a $1.5 million liability related to environmental remediation at a previously sold business for which the Company provided indemnification. A loss of $1.0 million, net of tax, is reflected in discontinued operations on the Consolidated Statement of Operations and Comprehensive Income (Loss).

 

8. During the third fiscal quarter of 2013, management performed a Step One impairment test for Racal Acoustics, Inc. (Racal Acoustics), which is included in the Avionics & Controls segment, upon identification of an indicator of impairment due to further deterioration in Racal Acoustics’ fiscal 2013 and five-year forecast resulting from further delays and reductions in global defense programs. 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 was 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 estimated impairment charge of $3.5 million. There were no impairments on Racal Acoustics’ other long-lived assets subject to amortization at July 26, 2013.

 

9. The income tax rates were 11.4% and 28.6% for the first nine months of fiscal 2013 and 2012, respectively. In the first nine months of fiscal 2013, the Company recognized $12.4 million of discrete tax benefits principally related to the following items. The first item was approximately $1.5 million of tax benefits due to the retroactive extension of the U.S. federal research and experimentation credits. The second item was approximately $2.3 million of tax benefits related to the settlement of U.S. and foreign tax examinations. The third item was a $4.3 million tax benefit related to the release of tax reserves due to the expiration of a statute of limitations. The fourth item was a $3.8 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.

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 income 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. The income tax rate differed from the statutory rate in the first nine months of fiscal 2013 and 2012, as both years benefited from various tax credits and certain foreign interest expense deductions.

 

10. As of July 26, 2013, the Company had three share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans was $7.7 million for the first nine months of fiscal 2013 and 2012. During the first nine months of fiscal 2013 and 2012, the Company issued 502,946 and 242,135 shares, respectively, under its share-based compensation plans.

 

7


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.

Employee Sharesave Scheme

Under the employee sharesave scheme for U.K. employees, participants are allowed the option to purchase shares at a discount of 5% 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 16,722 and 45,063 options in the first nine month periods ended July 26, 2013, and July 27, 2012, respectively. The weighted-average grant date fair value of options granted during the nine month periods ended July 26, 2013, and July 27, 2012, was $20.24 and $19.85 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 26,
         2013        
     July 27,
         2012        
 

Volatility

     36.97%         38.96%   

Risk-free interest rate

     0.40%         0.38%   

Expected life (years)

     3         3   

Dividends

     0         0   

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 244,700 and 343,400 options to purchase shares in the nine month periods ended July 26, 2013, and July 27, 2012, respectively. The weighted-average grant date fair value of options granted during the nine month periods ended July 26, 2013, and July 27, 2012, was $29.24 and $24.33 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 26,
2013
     July 27,
2012
 

Volatility

     41.89 – 44.25%         41.62 – 44.29%   

Risk-free interest rate

     0.79 – 1.88%         0.91 – 2.11%   

Expected life (years)

     4.5 – 9.5         4.5 – 9.5   

Dividends

     0         0   

The Company granted 32,200 restricted stock units during the nine month period ended July 26, 2013. The weighted-average grant date fair value of restricted stock units granted during the nine month period ended July 26, 2013, was $62.52 per share. The fair value of each restricted stock unit granted by the Company is equal to the fair market value of the Company’s common stock on the date of grant. There were no restricted stock units granted in the nine month period ended July 27, 2012.

 

8


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 26,    
2013
         July 27,    
2012
         July 26,    
2013
         July 27,    
2012
 

Service cost

     $ 2,832       $ 2,372       $ 9,103       $ 7,198   

Interest cost

       4,414         4,669         13,208         14,001   

Expected return on plan assets

       (5,836      (5,338      (17,142      (16,035

Amortization of prior service cost

       20         10         62         31   

Amortization of actuarial loss

       3,465         2,527         10,320         7,691   
    

 

 

    

 

 

    

 

 

    

 

 

 

Net Periodic Cost

     $ 4,895       $ 4,240       $ 15,551       $ 12,886   
    

 

 

    

 

 

    

 

 

    

 

 

 

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 26,    
2013
         July 27,    
2012
         July 26,    
2013
         July 27,    
2012
 

Service cost

     $ 956       $ 102       $ 1,470       $ 309   

Interest cost

       214         163         590         492   

Amortization of prior service cost

       (17      0         (52      0   

Amortization of actuarial loss (gain)

       8         (7      24         (21
    

 

 

    

 

 

    

 

 

    

 

 

 

Net Periodic Cost

     $ 1,161       $ 258       $ 2,032       $ 780   
    

 

 

    

 

 

    

 

 

    

 

 

 

 

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 July 26, 2013, the Company had $170.0 million outstanding under the secured credit facility at an interest rate of LIBOR plus 1.75%, which is currently 1.94%.

In July 2011, the Company amended the secured credit facility to provide for a €125.0 million term loan (Euro Term Loan). The interest rate on the Euro Term Loan ranges 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 26, 2013, the Company had €35.9 million outstanding or $47.6 million under the Euro Term Loan at an interest rate of Euro LIBOR plus 1.75%, which is currently 1.83%. The loan amortizes at 1.25% of the original principal balance quarterly through March 2016, with the remaining balance due in July 2016.

In April 2013, the Company amended the secured credit facility to provide for $175.0 million term loan (U.S. Term Loan). The interest rate on the U.S. Term Loan ranges from LIBOR plus 1.5% to LIBOR plus 2.25% depending on the leverage ratios at the time the funds are drawn. At July 26, 2013, the Company had $172.8 million outstanding under the U.S. Term Loan at an interest rate of LIBOR plus 1.75%, which is currently 1.95%. The loan amortizes at 1.25% of the original principal balance quarterly through March 2016, with the remaining balance due in July 2016.

In April 2013, the Company redeemed the $175.0 million 6.625% Senior Notes due March 2017 (2017 Notes). In connection with the redemption, the Company wrote off $1.3 million in unamortized debt issuance costs as a charge against interest expense. In addition, the Company incurred a $3.9 million redemption premium and received proceeds of $2.9 million from the termination of its $175.0 million interest rate swap agreements. As a result, the redemption of the 2017 Notes resulted in a net loss of $0.9 million on extinguishment of debt.

 

9


Based on quoted market prices, the approximate fair value of the Company’s $250.0 million 7.0% Senior Notes due August 2020 (2020 Notes) was approximately $272.5 million and $277.5 million as of July 26, 2013, and October 26, 2012, respectively. The approximate fair value of the Company’s 2017 Notes was $181.3 million as of October 26, 2012. The carrying amounts of the secured credit facility, U.S. Term Loan and Euro Term Loan approximate fair value. Estimates of fair value for the 2020 Notes are based on quoted market prices, and are considered Level 2 inputs as defined in the fair value hierarchy, described in Note 13.

Government refundable advances of $57.2 million at July 26, 2013, consist of payments received from the Canadian government to assist in research and development related to commercial aviation. The repayment of this advance is based on year-over-year commercial aviation revenue growth at CMC beginning in 2014. Imputed interest on the advance was 4.37% at July 26, 2013.

 

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 26, 2013, and October 26, 2012.

 

(In thousands)    Level 2  
     July 26,
           2013          
     October 26,
           2012          
 

Assets:

     

Derivative contracts designated as hedging instruments

   $ 1,507       $ 7,753   

Derivative contracts not designated as hedging instruments

     1,161         1,387   

Embedded derivatives

     1,215         51   

Liabilities:

     

Derivative contracts designated as hedging instruments

   $ 2,915       $ 2,143   

Derivative contracts not designated as hedging instruments

     1,480         361   

Embedded derivatives

     77         470   

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.

 

10


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 26, 2013, the Company did 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 26, 2013, and October 26, 2012, the Company had outstanding foreign currency forward exchange contracts principally to sell U.S. dollars with notional amounts of $388.0 million and $358.4 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 fiscal 2010, the Company entered into interest rate swap agreements for $175.0 million on the 2017 Notes. The swap agreements exchanged the fixed interest rate on the 2017 Notes of 6.625% for a variable interest rate. In the second quarter of fiscal 2013, the swap agreements were terminated and the Company redeemed the 2017 Notes with the proceeds from the $175.0 million U.S. Term Loan. The Company recorded a gain on the swap termination of $2.9 million. The gain is included in the Loss on Extinguishment of Debt in the Consolidated Statement of Operations and Comprehensive Income (Loss).

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.

 

11


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 26, 2013, and October 26, 2012, consisted of:

 

(In thousands)                Fair Value  
    

            Classification             

          July 26,
           2013          
       October 26,
           2012          
 

Foreign Currency Forward Exchange Contracts:

            
   Other current assets         $ 2,282         $ 3,694   
   Other assets           386           1,294   
   Accrued liabilities           2,662           2,228   
   Other liabilities           1,733           276   

Embedded Derivative Instruments:

            
   Other current assets         $ 801         $ 51   
   Other assets           414           0   
   Accrued liabilities           77           148   
   Other liabilities           0           322   

Interest Rate Swap:

            
   Long-term debt, net             
   of current maturities         $ 0         $ 4,152   

 

12


The effect of derivative instruments on the Consolidated Statement of Operations and Comprehensive Income (Loss) for the three and nine month periods ended July 26, 2013, and July 27, 2012, consisted of:

 

(In thousands)           Three Months Ended     Nine Months Ended  
   

Location of

Gain (Loss)

      July 26,
         2013        
    July 27,
         2012        
    July 26,
         2013        
    July 27,
         2012        
 

Fair Value Hedges:

           

Interest rate swap contracts

  

 

Interest Expense

    $ 0      $ 654      $ 1,058      $ 1,905   
 

Loss on Extinguishment of Debt

      0        0        2,918        0   

Embedded derivatives

         
 

Sales

      284        1,262        1,541        1,043   

Cash Flow Hedges:

           

Foreign currency forward exchange contracts:

  

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

  

 

AOCI

    $ (544   $ (7,434   $ (1,975   $ (7,553

Amount of gain (loss) reclassified from AOCI into income

  

 

Sales

      (551     (205     (1,187     207   

Net Investment Hedges:

         

Euro term loan

 

AOCI

    $ (886   $ 9,453      $ (1,310   $ 19,801   

During the first nine months of fiscal 2013 and 2012, the Company recorded losses of $1.5 million and $9.2 million, respectively, on foreign currency forward exchange contracts that have not been designated as an accounting hedge. These foreign currency exchange losses 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 2013 and 2012. 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 2013 and 2012.

Amounts included in AOCI are reclassified into earnings when the hedged transaction settles. The Company expects to reclassify approximately $0.3 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 26, 2013, is 24 months.

 

15.

The Company is subject to U.S. export laws and regulations, including the International Traffic in Arms Regulations (ITAR), that generally restrict the export of defense products, technical data, and defense services. The Company has filed voluntary disclosure reports concerning certain technical and administrative violations of the ITAR with the U.S. Department of State’s Directorate of Defense Trade Controls (DDTC) Office of Defense Trade Controls Compliance (DDTC Office of Compliance). The infractions reported by the Company were unintentional, did not result in any exports of sensitive military technology, and virtually all the reported transactions would have been allowed had the Company followed the correct regulatory procedures. To address these problems, the Company has made a number of investments in its export compliance functions, including: additional staffing; ongoing implementation of a new software system; employee training; and establishment of a regular compliance audit program and corrective action process. The DDTC Office of Compliance acknowledged the Company’s progress and continuing improvements, but nevertheless informed the Company that it intends to impose civil monetary fines and administrative sanctions based on the information it had concerning the Company’s earlier history in handling ITAR-controlled transactions, including the substance of the Company’s prior voluntary disclosures and other aspects of ITAR compliance errors. Management has been in discussions with the agency and provided supplemental information with the intent of reaching a settlement.

 

13


  On August 15, 2013, the DDTC Office of Compliance proposed a total penalty of $20 million with $10 million suspended and eligible for offset credit based on verified expenditures for past and future remedial compliance measures. Based on this proposal, the Company estimated and recorded a $10 million charge as of July 26, 2013, for this matter. The Company intends to continue discussions with the DDTC Office of Compliance on final settlement terms, and the final settlement is subject to approval by the agency. While the Company cannot be certain of the outcome, management believes that the final resolution of this matter will not be materially different from our estimated accrual.

 

16. 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 26,
2013
    July 27,
2012
    July 26,
2013
    July 27,
2012
 

Sales

        

Avionics & Controls

   $ 179,572      $ 195,059      $ 546,272      $ 569,656   

Sensors & Systems

     175,864        171,603        524,638        527,958   

Advanced Materials

     122,632        119,287        364,682        364,048   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Sales

   $       478,068      $       485,949      $     1,435,592      $     1,461,662   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) from Continuing Operations Before Income Taxes

  

Avionics & Controls

   $ 20,597  (1)    $ (25,611 (2)    $ 60,651  (1)    $ 12,703  (2) 

Sensors & Systems

     21,584        18,305        63,792        49,830   

Advanced Materials

     28,135                17,293        74,402        66,526   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment Earnings

     70,316        9,987        198,845        129,059   

Corporate expense

     (20,793     (9,127     (53,224     (35,182

Gain on settlement of contingency

     0        0        0        11,891   

Other income

     0        1,263        0        1,263   

Interest income

     132        109        381        320   

Interest expense

     (9,050     (12,159     (30,976     (35,171

Loss on extinguishment of debt

     0        0        (946     0   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $         40,605      $ (9,927   $       114,080      $         72,180   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) Includes a $3.5 million estimated impairment charge against Racal Acoustics’ goodwill.
  (2) Includes a $52.2 million impairment charge against Racal Acoustics’ goodwill.

 

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 26, 2013, and October 26, 2012, and for the applicable periods ended July 26, 2013, and July 27, 2012, for (a) Esterline Technologies Corporation (the Parent); (b) on a combined basis, the current subsidiary guarantors (Guarantor Subsidiaries) of the secured credit facility, 2017 Notes (for periods prior to the ending of the fiscal quarter ended April 26, 2013), and 2020 Notes; and (c) on a combined basis, the subsidiaries that are not guarantors of the secured credit facility, 2017 Notes (for periods prior to the ending of the fiscal quarter ended April 26, 2013), and 2020 Notes (Non-Guarantor Subsidiaries). 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 2017 Notes (for periods prior to the ending of the fiscal quarter ended April 26, 2013) and the 2020 Notes.

 

14


Condensed Consolidating Balance Sheet as of July 26, 2013.

 

(In thousands)                              
    Parent     Guarantor
     Subsidiaries
    Non-
Guarantor

     Subsidiaries
        Eliminations     Total  

Assets

         

Current Assets

         

Cash and cash equivalents

  $ 21,690      $ 1,347      $ 176,211      $                     0      $ 199,248   

Cash in escrow

    4,017        0        0        0        4,017   

Accounts receivable, net

    492        125,887        205,690        0        332,069   

Inventories

    0        177,073        268,717        0        445,790   

Income tax refundable

    0        9,084        0        0        9,084   

Deferred income tax benefits

    27,798        149        19,382        0        47,329   

Prepaid expenses

    47        5,104        16,373        0        21,524   

Other current assets

    112        119        3,543        0        3,774   

 

 

Total Current Assets

    54,156        318,763        689,916        0        1,062,835   

Property, Plant &
Equipment, Net

    1,910        168,012        193,233        0        363,155   

Goodwill

    0        313,555        793,312        0        1,106,867   

Intangibles, Net

    0        116,843        467,642        0        584,485   

Debt Issuance Costs, Net

    5,589        0        1,048        0        6,637   

Deferred Income
Tax Benefits

    33,374        (2     60,002        0        93,374   

Other Assets

    (69     1,535        6,092        0        7,558   

Amounts Due From (To)
Subsidiaries

    0        564,986        0        (564,986     0   

Investment in Subsidiaries

    2,540,780        934,953        238,493        (3,714,226     0   

 

 

Total Assets

  $     2,635,740      $     2,418,645      $     2,449,738      $ (4,279,212   $     3,224,911   

 

 

 

15


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

Liabilities and Shareholders’ Equity

  

Current Liabilities

         

Accounts payable

  $ 2,393      $ 27,967      $ 86,681      $ 0      $ 117,041   

Accrued liabilities

    26,665        85,485        146,297        0        258,447   

Credit facilities

    0        0        109        0        109   

Current maturities of
long-term debt

    8,750        173        13,016        0        21,939   

Deferred income tax
liabilities

    (94     (9     1,318        0        1,215   

Federal and foreign
income taxes

    (430     (22,441     24,825        0        1,954   

 

 

Total Current Liabilities

    37,284        91,175        272,246        0        400,705   

Credit Facilities

    170,000        0        0        0        170,000   

Long-Term Debt, Net

    414,063        55,627        92,754        0        562,444   

Deferred Income Tax
Liabilities

    61,523        (6     137,292        0        198,809   

Pension and Post-
Retirement Obligations

    19,860        41,464        64,349        0        125,673   

Other Liabilities

    10,183        194        22,239        0        32,616   

Amounts Due To (From)
Subsidiaries

    188,163        0        415,444        (603,607     0   

Shareholders’ Equity

    1,734,664        2,230,191        1,445,414        (3,675,605     1,734,664   

 

 

Total Liabilities and
Shareholders’ Equity

  $       2,635,740      $       2,418,645      $       2,449,738      $       (4,279,212   $       3,224,911   

 

 

 

16


Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) for the three month period ended July 26, 2013.

 

(In thousands)                               
     Parent     Guarantor
     Subsidiaries
    Non-
Guarantor

     Subsidiaries
        Eliminations     Total  

Net Sales

   $ 0      $ 216,949      $ 262,068      $ (949   $ 478,068   

Cost of Sales

     0        132,786        167,329        (949     299,166   

 

 
     0        84,163        94,739        0        178,902   

Expenses

          

Selling, general
and administrative

     0        38,045        63,777        0        101,822   

Research, development
and engineering

     0        12,684        11,419        0        24,103   

Gain on settlement of
contingency

     0        0        0        0        0   

Goodwill impairment

     0        0        3,454        0        3,454   

Other income

     0        0        0        0        0   

 

 

Total Expenses

     0        50,729        78,650        0        129,379   

 

 

Operating Earnings from
Continuing Operations

     0        33,434        16,089        0        49,523   

Interest Income

     (4,028     (2,028     (13,198             19,122        (132

Interest Expense

     6,489        7,052        14,631        (19,122     9,050   

Loss on Extinguishment
of Debt

     0        0        0        0        0   

 

 

Earnings (Loss) from
Continuing Operations
Before Income Taxes

     (2,461     28,410        14,656        0        40,605   

Income Tax Expense
(Benefit)

     (671     6,264        (4,442     0        1,151   

 

 

Earnings (Loss) from
Continuing Operations
Including Noncontrolling
Interests

     (1,790     22,146        19,098        0        39,454   

Earnings Attributable to
Noncontrolling Interests

     0        0        (241     0        (241

 

 

Earnings (Loss) from
Continuing Operations
Attributable to Esterline

     (1,790     22,146        18,857        0        39,213   

Loss from Discontinued
Operations Attributable
To Esterline, Net of Tax

     (975     0        0        0        (975

Equity in Net Earnings of
Consolidated Subsidiaries

     41,003        294        50        (41,347     0   

 

 

Net Earnings (Loss)
Attributable to Esterline

   $         38,238      $         22,440      $         18,907      $ (41,347   $         38,238   

 

 

Comprehensive Income
(Loss)

   $ 45,816      $ 22,610      $ 26,689      $ (49,914   $ 45,201   

 

17


Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) for the nine month period ended July 26, 2013.

 

(In thousands)                               
             Parent     Guarantor
     Subsidiaries
    Non-
Guarantor

     Subsidiaries
        Eliminations     Total  

Net Sales

   $                 0      $         653,959      $         784,389      $           (2,756   $     1,435,592   

Cost of Sales

     0        405,830        511,895        (2,756     914,969   

 

 
     0        248,129        272,494        0        520,623   

Expenses

          

Selling, general
and administrative

     0        112,881        185,830        0        298,711   

Research, development
and engineering

     0        37,448        35,389        0        72,837   

Gain on settlement of
contingency

     0        0        0        0        0   

Goodwill impairment

     0        0        3,454        0        3,454   

Other income

     0        0        0        0        0   

 

 

Total Expenses

     0        150,329        224,673        0        375,002   

 

 

Operating Earnings from
Continuing Operations

     0        97,800        47,821        0        145,621   

Interest Income

     (11,680     (5,723     (41,022     58,044        (381

Interest Expense

     23,722        20,019        45,279        (58,044     30,976   

Loss on Extinguishment
of Debt

     946        0        0        0        946   

 

 

Earnings (Loss) from
Continuing Operations

          

Before Income Taxes

     (12,988     83,504        43,564        0        114,080   

Income Tax Expense
(Benefit)

     (2,894     15,178        743        0        13,027   

 

 

Earnings (Loss) from
Continuing Operations
Including Noncontrolling
Interests

     (10,094     68,326        42,821        0        101,053   

Earnings Attributable to
Noncontrolling Interests

     0        0        (1,207     0        (1,207

 

 

Earnings (Loss) from
Continuing Operations
Attributable to Esterline

     (10,094     68,326        41,614        0        99,846   

Loss from Discontinued
Operations Attributable
To Esterline, Net of Tax

     (975     0        0        0        (975

Equity in Net Earnings of
Consolidated Subsidiaries

     109,940        677        80        (110,697     0   

 

 

Net Earnings (Loss)
Attributable to Esterline

   $ 98,871      $ 69,003      $ 41,694      $ (110,697   $ 98,871   

 

 

Comprehensive Income
(Loss)

   $ 87,090      $ 68,102      $ 35,100      $ (106,833   $ 83,459   

 

18


Condensed Consolidating Statement of Cash Flows for the nine month period ended July 26, 2013.

 

(In thousands)                               
             Parent     Guarantor
     Subsidiaries
    Non-
Guarantor

     Subsidiaries
      Eliminations             Total  

Cash Flows Provided (Used) by Operating Activities

  

Net earnings (loss) including
noncontrolling interests

   $     100,078      $     69,003      $     41,694      $     (110,697   $     100,078   

Depreciation & amortization

     0        35,547        52,394        0        87,941   

Deferred income taxes

     11,252        (332     (23,158     0        (12,238

Share-based compensation

     0        3,321        4,346        0        7,667   

Gain on sale of capital assets

     0        (322     (593     0        (915

Gain on settlement of
contingency

     0        0        0        0        0   

Goodwill impairment

     0        0        3,454        0        3,454   

Working capital changes, net
of effect of acquisitions:

          

Accounts receivable

     (311     14,744        36,630        0        51,063   

Inventories

     0        (17,500     (15,274     0        (32,774

Prepaid expenses

     29        287        (451     0        (135

Other current assets

     22        433        (1,291     0        (836

Accounts payable

     449        1,616        3,359        0        5,424   

Accrued liabilities

     9,740        7,382        (12,845     0        4,277   

Federal & foreign
income taxes

     1,607        (3,706     (3,222     0        (5,321

Other liabilities

     11,907        (13,422     (8,879     0        (10,394

Other, net

     1,284        (675     (1,621     0        (1,012

 

 
     136,057        96,376        74,543        (110,697     196,279   

Cash Flows Provided (Used) by Investing Activities

  

Purchases of capital assets

     (105     (11,949     (25,711     0        (37,765

Proceeds from sale
of capital assets

     0        322        593        0        915   

Acquisition of business,
net of cash acquired

     0        0        (40,689     0        (40,689

 

 
     (105     (11,627     (65,807     0        (77,539

 

19


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

Cash Flows Provided (Used) by Financing Activities

  

Proceeds provided by stock
issuance under share-based
compensation plans

    20,450        0        0        0        20,450   

Excess tax benefits from
stock options exercised

    2,237        0        0        0        2,237   

Proceeds from long-term 
credit facilities

    175,000        0        0        0        175,000   

Repayment of long-term debt

    (177,187     (151     (32,203     0        (209,541

Repayment of credit facilities

    (70,000     0        0        0        (70,000

Proceeds from government
assistance

    0        0        5,114        0        5,114   

Dividends paid to non-
controlling interests

    0        0        (1,044     0        (1,044

Debt and other issuance costs

    (453     0        0        0        (453

Net change in intercompany
financing

    (81,084     (84,563     54,950        110,697        0   

 

 
    (131,037     (84,714     26,817        110,697        (78,237

Effect of foreign exchange
rates on cash

    5        (12     (1,923     0        (1,930

 

 

Net increase (decrease) in
cash and cash equivalents

    4,920        23        33,630        0        38,573   

Cash and cash equivalents
– beginning of year

    16,770        1,324        142,581        0        160,675   

 

 

Cash and cash equivalents
– end of year

  $ 21,690      $ 1,347      $ 176,211      $ 0      $ 199,248   

 

 

 

20


Condensed Consolidating Balance Sheet as of October 26, 2012.

 

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

Assets

            

Current Assets

            

Cash and cash equivalents

   $ 16,770       $ 1,324      $ 142,581       $ 0      $ 160,675   

Cash in escrow

     5,016         0        0         0        5,016   

Accounts receivable, net

     181         140,631        242,550         0        383,362   

Inventories

     0         159,573        250,264         0        409,837   

Income tax refundable

     0         4,832        0         0        4,832   

Deferred income tax benefits

     22,874         105        23,021         0        46,000   

Prepaid expenses

     76         5,391        15,873         0        21,340   

Other current assets

     134         552        3,945         0        4,631   

 

 

Total Current Assets

     45,051         312,408        678,234         0        1,035,693   

Property, Plant &
Equipment, Net

     2,811         161,998        191,592         0        356,401   

Goodwill

     0         314,641        784,321         0        1,098,962   

Intangibles, Net

     0         126,142        482,903         0        609,045   

Debt Issuance Costs, Net

     7,508         0        1,310         0        8,818   

Deferred Income Tax
Benefits

     36,610         (283     61,625         0        97,952   

Other Assets

     8,082         1,561        10,603         0        20,246   

Amounts Due From (To)
Subsidiaries

     0         491,143        0         (491,143     0   

Investment in Subsidiaries

     2,457,859         1,179,938        170,223         (3,808,020     0   

 

 

Total Assets

   $     2,557,921       $     2,587,548      $     2,380,811       $     (4,299,163   $     3,227,117   

 

 

 

21


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

Liabilities and Shareholders’ Equity

           

Current Liabilities

           

Accounts payable

   $ 1,944      $ 26,351      $ 80,394       $ 0      $ 108,689   

Accrued liabilities

     17,495        79,103        172,955         0        269,553   

Credit facilities

     0        0        0         0        0   

Current maturities of 
long-term debt

     0        174        10,436         0        10,610   

Deferred income tax 
liabilities

     213        (1     4,913         0        5,125   

Federal and foreign 
income taxes

     (3,418     (23,822     29,609         0        2,369   

 

 

Total Current Liabilities

     16,234        81,805        298,307         0        396,346   

Credit Facilities

     240,000        0        0         0        240,000   

Long-Term Debt, Net

     429,152        44,107        124,801         0        598,060   

Deferred Income Tax
Liabilities

     46,730        (7     158,475         0        205,198   

Pension and Post-Retirement
Obligations

     20,507        54,886        56,681         0        132,074   

Other Liabilities

     5,189        4,194        25,521         0        34,904   

Amounts Due To (From)
Subsidiaries

     179,574        0        369,962         (549,536     0   

Shareholders’ Equity

     1,620,535        2,402,563        1,347,064         (3,749,627     1,620,535   

 

 

Total Liabilities and
Shareholders’ Equity

   $       2,557,921      $       2,587,548      $       2,380,811       $       (4,299,163   $       3,227,117   

 

 

 

22


Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) 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   

 

 

Earnings (Loss) from

          

Continuing Operations

          

Before Income Taxes

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

Income Tax Expense

          

(Benefit)

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

 

 

Earnings (Loss) from

          

Continuing Operations

          

Including Noncontrolling

          

Interests

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

Earnings Attributable to

          

Noncontrolling Interests

     0        0        (214     0        (214

 

 

Earnings (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 Earnings 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

 

 

Comprehensive Income

          

(Loss)

   $ (76,776   $ 10,140      $ (83,910   $ 68,921      $ (81,625

 

23


Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) 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   

 

 

Earnings (Loss) from

          

Continuing Operations

          

Before Income Taxes

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

Income Tax Expense

          

(Benefit)

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

 

 

Earnings (Loss) from

          

Continuing Operations

          

Including Noncontrolling

          

Interests

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

Earnings Attributable to

          

Noncontrolling Interests

     0        0        (628     0        (628

 

 

Earnings (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 Earnings 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   

 

 

Comprehensive Income

          

(Loss)

   $ (42,128   $ 74,733      $ (101,142   $ 21,728      $ (46,809

 

24


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 sale of capital assets

     0        (464     (675     0        (1,139

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     (1,981     0        (2,339

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     958        2,635        0        3,510   

 

 
     92,010        62,875        67,680        (71,191     151,374   

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   

Acquisition of business,
net of cash acquired

     0        0        0        0        0   

 

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

 

25


(In thousands)

 

                                                                                                                  
     Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminations      Total  

Cash Flows Provided (Used) by Financing Activities

  

        

Proceeds provided by stock
issuance under share-based
compensation plans

     7,331        0        0        0         7,331   

Excess tax benefits from
stock options exercised

     221        0        0        0         221   

Proceeds from long-term
credit facilities

     0        0        0        0         0   

Repayment of long-term debt

     0        (306     (43,825     0         (44,131

Repayment of credit facilities

     (60,000     0        0        0         (60,000

Proceeds from government
assistance

     0        0        17,203        0         17,203   

Dividends paid to non-
controlling interests

     0        0        0        0         0   

Debt and other issuance costs

     0        0        0        0         0   

Net change in intercompany
financing

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

 

 
     (107,051     (47,058     3,542        71,191         (79,376

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   

 

 

 

26


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 gaming industries. Communication systems designs and manufactures military audio and data products for severe battlefield environments, embedded communication intercept receivers for signal intelligence applications, as well as communication control systems to enhance security and aural clarity in military 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 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, 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 February 4, 2013, we acquired the Gamesman Group (Gamesman) for $40.8 million. Gamesman is a global supplier of input devices principally serving the gaming industry. Gamesman is included in the Avionics & Controls segment.

For the third fiscal quarter of 2013, earnings from continuing operations were $39.2 million, or $1.23 per diluted share, compared to a loss from continuing operations of $17.1 million, or $0.55 per diluted share, in the third fiscal quarter of 2012.

During the third fiscal quarter of 2013, we recorded a $3.5 million, or $0.11 per diluted share, estimated impairment charge against goodwill of Racal Acoustics, Inc. (Racal Acoustics), our military headset business, which is included in our Avionics & Controls segment, due to further deterioration in Racal Acoustics’ fiscal 2013 and five-year forecast resulting from further delays and reductions in global defense programs. In the prior-year period, we recorded a $52.2 million, or $1.69 per diluted share, impairment charge against goodwill of Racal Acoustics. The results for the third fiscal quarter of 2013 also were impacted by a $10 million charge, or $0.31 per diluted share, related to our pending matter with the DDTC as more fully discussed below.

For the third quarter of fiscal 2013, sales declined 1.6% to $478.0 million compared to the prior-year period. Gross margin for the third quarter of fiscal 2013 was 37.4% compared with 35.4% in the prior-year period. Research, development and engineering spending in the third quarter of fiscal 2013 decreased $3.1 million over the prior-year period to 5.0% of sales. Selling, general and administrative expense, as a percent of sales, in the third quarter of fiscal 2013 increased 2.4 percentage points over the prior-year period to 21.3% of sales.

 

27


The income tax rate was 2.8% compared with (70.1%) for the third fiscal quarter of 2013 and 2012, respectively. The (70.1)% income tax rate in the third fiscal quarter of 2012 reflected a $10.0 million loss from continuing operations before income taxes and income tax expense of $7.0 million. In the third quarter of fiscal 2013 and 2012, we recognized $8.7 million and $5.3 million, respectively, of discrete income tax benefits.

For the third fiscal quarter of 2013, loss from discontinued operations was $1.0 million, net of tax, or $0.03 per diluted share. The loss related to environmental remediation at a previously sold business for which we provided an environmental indemnification.

For the third fiscal quarter of 2013, net earnings were $38.2 million, or $1.20 per diluted share, compared to a net loss of $17.1 million, or $0.55 per diluted share, in the third fiscal quarter of 2012.

For the first nine months of fiscal 2013, earnings from continuing operations were $99.8 million, or $3.15 per diluted share, compared to $50.9 million, or $1.63 per diluted share, during the prior-year period. During the first nine months of fiscal 2013, earnings from continuing operations were impacted by a $3.5 million, or $0.11 per diluted share, estimated impairment charge against goodwill of Racal Acoustics, our military headset business. In the prior-year period, we were impacted by a $52.2 million, or $1.67 per diluted share, impairment charge against goodwill of Racal Acoustics. For the first nine months of fiscal 2013, earnings were also impacted by a $10 million charge, or $0.32 per diluted share, related to our pending matter with the DDTC as more fully discussed below. Earnings from continuing operations in the prior-year period benefited from an $11.9 million gain, or $9.5 million after tax, upon settlement of a contingency related to proceeds from a transaction that preceded our acquisition of CMC Electronics, Inc. (CMC).

The income tax rate was 11.4% and 28.6% for the first nine months of fiscal 2013 and 2012, respectively. In the first nine months of fiscal 2013 and 2012, we recognized $12.4 million and $7.2 million, respectively, in discrete income tax benefits.

Sales decreased by 1.8% to $1.4 billion in the first nine months of fiscal 2013, reflecting lower Avionics & Controls sales, while Sensors & Systems and Advanced Materials sales were essentially even with the prior-year period. Avionics & Controls was impacted by reductions in defense spending mainly due to the continued uncertainty of U.S. congressional budget cuts, or sequestration, on defense spending. While we believe we have adequately anticipated the impact on our financial results for fiscal 2013, the impact of sequestration is yet to be fully determined and additional reductions in defense spending over the next decade could occur.

Gross margin increased to 36.3% in the first nine months of fiscal 2013 compared with 35.2% in the prior-year period. The prior-year period included the $12.0 million effect of purchase accounting to recognize the fair value of the Souriau Group’s (Souriau) acquired inventory as expense over the first inventory turn. Advanced Materials gross profit was favorably impacted by higher sales volumes of engineered materials for defense applications.

Research, development and engineering spending in the first nine months of fiscal 2013 decreased $10.3 million over the prior-year period to 5.1% of sales. Selling, general and administrative expense, as a percent of sales, in the first nine months of fiscal 2013 increased 1.3 percentage points over the prior-year period to 20.8% of sales.

We are subject to U.S. export laws and regulations, including the International Traffic in Arms Regulations (ITAR), that generally restrict the export of defense products, technical data, and defense services. We have filed voluntary disclosure reports concerning certain technical and administrative violations of the ITAR with the U.S. Department of State’s Directorate of Defense Trade Controls (DDTC) Office of Defense Trade Controls Compliance (DDTC Office of Compliance). The infractions we reported were unintentional, did not result in any exports of sensitive military technology, and virtually all the reported transactions would have been allowed had we followed the correct regulatory procedures. To address these problems, we have made a number of investments in our export compliance functions, including: additional staffing; ongoing implementation of a new software system; employee training; and establishment of a regular compliance audit program and corrective action process. The DDTC Office of Compliance acknowledged our progress and continuing improvements, but nevertheless informed us that it intends to impose civil monetary fines and administrative sanctions based on the information it had concerning our earlier history in handling ITAR-controlled transactions, including the substance of our prior voluntary disclosures and other aspects of ITAR compliance errors. Management has been in discussions with the agency and provided

 

28


supplemental information with the intent of reaching a settlement. On August 15, 2013, the DDTC Office of Compliance proposed a total penalty of $20 million with $10 million suspended and eligible for offset credit based on verified expenditures for past and future remedial compliance measures. Based on this proposal, we estimated and recorded a $10 million charge as of July 26, 2013, for this matter. We intend to continue discussions with the DDTC Office of Compliance on final settlement terms, and the final settlement is subject to approval by the agency. While we cannot be certain of the outcome, management believes that the final resolution of this matter will not be materially different from our estimated accrual.

For the first nine months of fiscal 2013, net earnings were $98.9 million, or $3.12 per diluted share, compared to $50.9 million, or $1.63 per diluted share, during the prior-year period.

Results of Operations

Three Month Period Ended July 26, 2013, Compared with Three Month Period Ended July 27, 2012

Sales for the third fiscal quarter decreased 1.6% over the prior-year period. Sales by segment were as follows:

(In thousands)

 

                                                                                                  
     Incr./(Decr.)
from prior
year period
  Three Months Ended  
     July 26,
2013
     July 27,
2012
 

Avionics & Controls

   (7.9)%   $ 179,572       $ 195,059   

Sensors & Systems

   2.5%     175,864         171,603   

Advanced Materials

   2.8%     122,632         119,287   
    

 

 

    

 

 

 

Total Net Sales

     $ 478,068       $ 485,949   
    

 

 

    

 

 

 

The 7.9% decrease in sales of Avionics & Controls mainly reflected similarly reduced sales volumes of avionics systems and control systems totaling $7 million, and communication systems of $17 million, which were partially offset by an increase in sales of interface technologies of $8 million. The decrease in communication systems principally reflected reduced sales of embedded communication intercept receivers of $8 million and lower sales of communication systems to enhance aural clarity in military communications of $7 million. The increase in sales of interface technologies was due to high sales for medical and gaming applications, including $5 million in sales from the Gamesman acquisition.

The 2.5% increase in sales of Sensors & Systems principally reflected a $3 million increase in connection technologies due to the effects of a stronger euro relative to the U.S. dollar. Sales in the third fiscal quarter of 2013 reflected a weaker pound sterling to the U.S. dollar compared to the prior-year period and a stronger 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 1.58 in the third fiscal quarter of 2012 to 1.53 in the third fiscal quarter of 2013. The average exchange rate from the euro to the U.S. dollar increased from 1.26 in the third fiscal quarter of 2012 to 1.31 in the third fiscal quarter of 2013.

The 2.8% increase in sales of Advanced Materials principally reflected increased sales volumes of engineered materials for defense applications.

Overall, gross margin as a percentage of sales was 37.4%, compared with 35.4% in the same period a year ago. Gross profit was $178.9 million compared with $172.1 million in the same period a year ago.

Avionics & Controls segment gross margin was 39.4% and 39.0% for the third fiscal quarter of 2013 and 2012, respectively. Segment gross profit was $70.7 million compared with $76.1 million in the prior-year period. The decrease in segment gross profit was principally due to lower gross profit on communication systems of $9 million, reflecting lower sales volumes of embedded communication intercept receivers of $5 million and a decrease in gross profit on sales of communication systems to enhance security and aural clarity in military communication applications.

Sensors & Systems segment gross margin was 36.4% and 35.5% for the third fiscal quarter of 2013 and 2012, respectively. Segment gross profit was $64.0 million compared with $60.8 million in the prior-year period. The increase in gross profit was mainly due to an increase in power systems gross profit reflecting improved product mix and cost reduction actions.

 

29


Advanced Materials segment gross margin for the third fiscal quarter of 2013 was 36.1% compared with 29.5% for the prior-year period. Segment gross profit was $44.2 million compared with $35.1 million in the prior-year period. The increase in segment gross profit was principally due to strong gross margin on sales of engineered materials primarily for defense applications.

Selling, general and administrative expenses (which include corporate expenses) totaled $101.8 million, or 21.3% of sales, and $91.9 million, or 18.9% of sales, for the third fiscal quarter of 2013 and 2012, respectively. The increase in selling, general and administrative expense mainly reflects a $10 million charge related to the DDTC matter.

Research, development and engineering spending was $24.1 million, or 5.0% of sales, for the third fiscal quarter of 2013 compared with $27.2 million, or 5.6% of sales, for the third fiscal quarter of 2012. The decrease in research, development and engineering spending principally reflects similarly reduced spending on avionics systems, communication systems, and advanced sensors totaling $3 million. Fiscal 2013 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 third fiscal quarter of 2013 totaled $70.3 million, or 14.7% of sales, compared with $10.0 million, or 2.1% of sales, for the third fiscal quarter in 2012. In the third fiscal quarter of 2013 and 2012, we recorded an estimated impairment charge of $3.5 million and a $52.2 million impairment charge, respectively, against goodwill of Racal Acoustics. Excluding the impairment charge recorded in each period, segment earnings totaled $73.8 million, or 15.4% of sales, and $62.2 million, or 12.8% of sales, for the third fiscal quarter of 2013 and 2012, respectively.

Avionics & Controls segment earnings were $20.6 million, or 11.5% of sales, in the third fiscal quarter of 2013 compared with losses of $(25.6) million, or (13.1)% of sales, in the third fiscal quarter of 2012. The third fiscal quarter of 2013 and 2012 reflected an estimated impairment charge of $3.5 million and a $52.2 million impairment charge, respectively, against goodwill of Racal Acoustics. During the third fiscal quarter of 2013, management performed a Step One impairment test for Racal Acoustics upon identification of an indicator of impairment, due to further deterioration of Racal Acoustics’ fiscal 2013 and five-year forecast resulting from further delays and reductions in global defense programs. 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 the 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 estimated impairment charge of $3.5 million.

Excluding the impairment charge recorded in each period, Avionics & Controls segment earnings were $24.1 million, or 13.4% of sales, in the third fiscal quarter of 2013 compared with $26.6 million, or 13.6% of sales, in the third fiscal quarter of 2012. Avionics systems earnings benefited from improved gross margin and decreased research, development and engineering expense. Communication systems earnings were impacted by decreased gross profit on lower sales of embedded communication intercept receivers and systems to enhance security and aural clarity in military communication applications.

Sensors & Systems segment earnings were $21.6 million, or 12.3% of sales, for the third fiscal quarter of 2013 compared with $18.3 million, or 10.7% of sales, for the third fiscal quarter of 2012, principally reflecting increased earnings from sales of advanced sensors and power systems. Advanced sensors benefited from lower research, development and engineering expense. Power systems benefited mainly from improved mix and expense control.

Advanced Materials segment earnings were $28.1 million, or 22.9% of sales, for the third fiscal quarter of 2013 compared with $17.3 million, or 14.5% of sales, for the third fiscal quarter of 2012, primarily reflecting a $9 million increase in earnings from strong sales of engineered materials for defense applications.

Interest expense for the third fiscal quarter of 2013 was $9.1 million compared with $12.2 million for the third fiscal quarter of 2012, reflecting reduced borrowings.

 

30


The income tax rate was 2.8% for the third fiscal quarter of 2013 compared with (70.1)% for the third fiscal quarter of 2012. The (70.1)% income tax rate in the third fiscal quarter of 2012 reflected a $10.0 million loss from continuing operations before income taxes and income tax expense of $7.0 million. In the third fiscal quarter of 2013, we recognized $8.7 million of discrete tax benefits principally related to the following items. The first item was a $4.3 million income tax benefit related to the release of income tax reserves due to the expiration of a statute of limitations. The second item was a $3.8 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.

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. The income tax rate differed from the statutory rate in the third fiscal quarter of 2013 and 2012, as both quarters benefited from various tax credits and certain foreign interest expense deductions.

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 periods ended July 26, 2013, and July 27, 2012, are as follows:

(In thousands)

                                                                 
     Three Months Ended  
     July 26,
2013
    July 27,
2012
 

Forward foreign currency contracts – gain (loss)

   $ 237      $ (4,037

Forward foreign currency contracts reclassified
from AOCI – loss

     (551     (205

Embedded derivatives – gain

     255        1,304   

Revaluation of monetary assets/liabilities – gain

     322        1,515   
  

 

 

   

 

 

 

Total

   $ 263      $ (1,423
  

 

 

   

 

 

 

Nine Month Period Ended July 26, 2013, Compared with Nine Month Period Ended July 27, 2012

Sales for the first nine months decreased by 1.8% over the prior-year period. Sales by segment were as follows:

(In thousands)

                                                                                                  
     Incr./(Decr.)
from prior
year period
  Nine Months Ended  
     July 26,
2013
     July 27,
2012
 

Avionics & Controls

   (4.1)%   $ 546,272       $ 569,656   

Sensors & Systems

   (0.6)%     524,638         527,958   

Advanced Materials

   0.2%     364,682         364,048   
    

 

 

    

 

 

 

Total Net Sales

     $ 1,435,592       $ 1,461,662   
    

 

 

    

 

 

 

The 4.1% decrease in sales of Avionics & Controls reflected decreased sales volumes of avionics systems of $15 million and communication systems of $26 million, partially offset by increased sales volumes of interface technologies. The decrease in avionics systems reflected mainly lower cockpit integration sales for retrofits of military transport aircraft and the T-6B. The decrease in communication systems principally reflected reduced sales

 

31


of embedded communication intercept receivers of $16 million and systems to enhance security and aural clarity in military communication applications of $7 million. The $20 million increase in interface technologies mainly reflected increased sales for medical and gaming applications, including approximately $11 million in sales from the Gamesman acquisition.

The 0.6% decrease in sales of Sensors & Systems principally reflected similarly reduced sales volumes of advanced sensors and connection technologies totaling $8 million, partially offset by increased sales volumes of power systems. The decrease in advanced sensors was mainly due to lower aftermarket sales, and the decrease in connection technologies was due to reduced demand for industrial applications. The increase in power systems reflected increased demand for commercial aviation products.

The 0.2% increase in sales of Advanced Materials principally reflected increased sales volumes of engineered materials and metal finishing services, substantially offset by lower demand for defense technologies.

Overall, gross margin as a percentage of sales was 36.3% and 35.2% for the first nine months of fiscal 2013 and 2012, respectively. Gross profit was $520.6 million and $514.7 million for the first nine months of fiscal of 2013 and 2012, respectively.

Avionics & Controls segment gross margin was 37.6% and 38.5% for the first nine months of fiscal 2013 and 2012, respectively. Segment gross profit was $205.4 million compared with $219.5 million in the prior-year period, mainly reflecting a decrease in gross profit from sales of communication systems due to lower demand for embedded communication intercept receivers.

Sensors & Systems segment gross margin was 37.0% and 33.8% for the first nine months of fiscal 2013 and 2012, respectively. Segment gross profit was $194.3 million compared with $178.5 million in the prior-year period. The increase in gross profit was mainly due to increased gross profit for connection technologies, which was impacted by a $12 million charge recorded in the first quarter of fiscal 2012 due to recording Souriau’s acquired inventory at its fair value.

Advanced Materials segment gross margin was 33.2% for the first nine months of fiscal 2013 compared to 32.0% for the same period one year ago. Segment gross profit was $121.0 million compared to $116.6 million in the prior-year period. The increase in gross profit was principally due to a $5 million increase in gross profit on higher sales of elastomer materials for defense applications.

Selling, general and administrative expenses (which include corporate expenses) totaled $298.7 million, or 20.8% of sales, and $285.5 million, or 19.5% of sales, for the first nine months of fiscal 2013 and 2012, respectively. The $13.2 million increase in selling, general and administrative expenses reflects an $18.0 million increase in corporate expense and a reduction in Avionics & Controls expense. The increase in corporate expense was due to the $10.0 million loss contingency related to the DDTC matter, professional fees for regulatory compliance, the cost of opening a corporate office in France and acquisition expenses. The decrease in Avionics & Controls expense reflected a $1 million reduction of our allowance for doubtful accounts for Hawker Beechcraft; in addition, the prior-year period reflected bad debt expense of $2.3 million due to the bankruptcy of Hawker Beechcraft.

Research, development and engineering spending was $72.8 million, or 5.1% of sales, for the first nine months of fiscal 2013 compared with $83.1 million, or 5.7% of sales, for the first nine months of fiscal 2012. The decrease in research, development and engineering spending principally reflects lower spending on avionics systems. Fiscal 2013 research, development and engineering spending is expected to be approximately 5.0% of sales.

Total segment earnings (operating earnings excluding corporate expenses and other income or expense) for the first nine months of fiscal 2013 totaled $198.8 million, or 13.9% of sales, compared with $129.1 million, or 8.8% of sales, for the first nine months in fiscal 2012. The increase in segment earnings mainly reflects the $52.2 million impairment charge against goodwill of Racal Acoustics in the prior-year period. We also recorded an estimated impairment charge of $3.5 million against goodwill of Racal Acoustics in the third fiscal quarter of 2013. If the impairment charges in each period in fiscal 2013 and 2012 are excluded, segment earnings totaled $202.3 million, or 14.1% of sales, and $181.2 million, or 12.4% of sales, for the first nine months of 2013 and 2012, respectively.

 

32


Avionics & Controls segment earnings were $60.7 million, or 11.1% of sales, in the first nine months of fiscal 2013 and $12.7 million, or 2.2% of sales, in the first nine months of fiscal 2012. Excluding the impairment charges, segment earnings were $64.1 million, or 11.7% of sales, and $64.9 million, or 11.4% of sales, in the first nine months of fiscal 2013 and 2012, respectively. The decrease in segment earnings from the prior-year period mainly reflects an $11 million decrease in communication systems earnings, and an $8 million increase in avionics systems earnings. The decrease in communication systems earnings reflected the decrease in gross profit on lower sales volumes. Avionics systems earnings mainly benefited from lower research, development and engineering expense.

Sensors & Systems segment earnings were $63.8 million, or 12.2% of sales, for the first nine months of fiscal 2013 compared with $49.8 million, or 9.4% of sales, for the first nine months of fiscal 2012, which reflected the $12.0 million inventory charge due to recording Souriau’s acquired inventory at its fair value in the first three months of fiscal 2012. Sensors & Systems earnings also benefited from increased gross margin of power systems of $5 million.

Advanced Materials segment earnings were $74.4 million, or 20.4% of sales, for the first nine months of fiscal 2013 compared with $66.5 million, or 18.3% of sales, for the first nine months of fiscal 2012, primarily reflecting increased gross profit on higher sales of elastomer materials.

In the second quarter of fiscal 2012, management concluded that all contingencies relating to a dispute between CMC and a former parent company were resolved, and accordingly, we recorded a gain of approximately $11.9 million or $9.5 million after tax.

Interest expense for the first nine months of fiscal 2013 was $31.0 million compared with $35.2 million for the first nine months of fiscal 2012, reflecting reduced borrowings.

The income tax rates were 11.4% and 28.6% for the first nine months of fiscal 2013 and 2012, respectively. In the first nine months of fiscal 2013, we recognized $12.4 million of discrete tax benefits principally related to the following items. The first item was approximately $1.5 million of tax benefits due to the retroactive extension of the U.S. federal research and experimentation credits. The second item was approximately $2.3 million of tax benefits related to the settlement of U.S. and foreign tax examinations. The third item was a $4.3 million tax benefit related to the release of tax reserves due to the expiration of a statute of limitations. The fourth item was a $3.8 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.

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 income 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. The income tax rate differed from the statutory rate in the first nine months of fiscal 2013 and 2012, as both years benefited from various tax credits and certain foreign interest expense deductions.

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.

 

33


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 currency other than the functional currency of the Company for the nine month periods ended July 26, 2013, and July 27, 2012, are as follows:

(In thousands)

                                                         
     Nine Months Ended  
     July 26,
2013
    July 27,
2012
 

Forward foreign currency contracts – gain (loss)

   $ (1,512   $ (9,202

Forward foreign currency contracts reclassified
from AOCI – gain (loss)

     (1,187     207   

Embedded derivatives – gain

     1,521        1,046   

Revaluation of monetary assets/liabilities – gain (loss)

     (2,070     2,141   
  

 

 

   

 

 

 

Total

   $ (3,248   $ (5,808
  

 

 

   

 

 

 

New orders for the first nine months of fiscal 2013 were $1.43 billion compared with $1.45 billion for the same period in 2012. Backlog was $1.3 billion at July 26, 2013, compared with $1.2 billion at the end of the prior-year period and $1.3 billion at the end of fiscal 2012.

Liquidity and Capital Resources

Cash and cash equivalents at July 26, 2013, totaled $199.2 million, an increase of $38.6 million from October 26, 2012. Net working capital increased to $662.1 million at July 26, 2013, from $639.3 million at October 26, 2012. 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 $196.3 million and $151.4 million in the first nine months of fiscal 2013 and 2012, respectively, reflecting increased cash collections from customers and lower payments for income taxes, partially offset by increased payments for inventory.

Cash flows used by investing activities were $77.5 million and $38.3 million in the first nine months of fiscal 2013 and 2012, respectively. Cash flows used by investing activities in the first nine months of fiscal 2013 primarily reflected cash paid for acquisitions of $40.7 million, net of cash acquired, and capital expenditures of $37.8 million. 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 financing activities were $78.2 million and $79.4 million in the first nine months of fiscal 2013 and 2012, respectively. Cash flows used by financing activities in the first nine months of fiscal 2013 primarily reflected proceeds from our new credit facility of $175.0 million and repayment of long-term debt and credit facilities of $279.5 million. 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 and credit facilities.

Capital expenditures, consisting of machinery, equipment and computers, are anticipated to be approximately $65.0 million during fiscal 2013, compared to $49.4 million expended in fiscal 2012. Capital expenditures for the first nine months of fiscal 2013 totaled $49.3 million, including $11.6 million under capital lease obligations resulting from a lease amendment entered into during the third fiscal quarter of 2013 at a facility in our Avionics & Controls segment.

Total debt at July 26, 2013, was $754.5 million and consisted of $250.0 million of 2020 Notes, $172.8 million of the U.S. Term Loan, $47.6 million (€35.9 million) of the Euro Term Loan Facility, $170.0 million in borrowings under our secured credit facility, $57.2 million of government refundable advances, $56.3 million under capital lease obligations and $0.6 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.

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,”

 

34


“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 26, 2012, 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 any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments, except as required by law.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes in our exposure to market risk during the first nine months of fiscal 2013. 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 26, 2012.

 

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 July 26, 2013. Based upon that evaluation, they concluded as of July 26, 2013, 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 July 26, 2013, that our disclosure controls and procedures were 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 changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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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.

We are subject to U.S. export laws and regulations, including the International Traffic in Arms Regulations (ITAR), that generally restrict the export of defense products, technical data, and defense services. We have filed voluntary disclosure reports concerning certain technical and administrative violations of the ITAR with the U.S. Department of State’s Directorate of Defense Trade Controls (DDTC) Office of Defense Trade Controls Compliance (DDTC Office of Compliance). The infractions we reported were unintentional, did not result in any exports of sensitive military technology, and virtually all the reported transactions would have been allowed had we followed the correct regulatory procedures. To address these problems, we have made a number of investments in our export compliance functions, including: additional staffing; ongoing implementation of a new software system; employee training; and establishment of a regular compliance audit program and corrective action process. The DDTC Office of Compliance acknowledged our progress and continuing improvements, but nevertheless informed us that it intends to impose civil monetary fines and administrative sanctions based on the information it had concerning our earlier history in handling ITAR-controlled transactions, including the substance of our prior voluntary disclosures and other aspects of ITAR compliance errors. Management has been in discussions with the agency and provided supplemental information with the intent of reaching a settlement. On August 15, 2013, the DDTC Office of Compliance proposed a total penalty of $20 million with $10 million suspended and eligible for offset credit based on verified expenditures for past and future remedial compliance measures. Based on this proposal, we estimated and recorded a $10 million charge as of July 26, 2013, for this matter. We intend to continue discussions with the DDTC Office of Compliance on final settlement terms, and the final settlement is subject to approval by the agency. While we cannot be certain of the outcome, management believes that the final resolution of this matter will not be materially different from our estimated accrual.

 

Item 5. Other Information

Disclosure Pursuant to Section 13(r) of the Securities Exchange Act of 1934

Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 added Section 13(r) to the Securities Exchange Act of 1934, as amended. Section 13(r) requires us to disclose whether we or any of our affiliates knowingly engaged in certain activities, transactions, or dealings relating to Iran or with any person the property and interests in property of which are blocked pursuant to Executive Order Nos. 132224 or 13382 (relating to blocking property and prohibiting transactions with: (i) persons who commit, threat to commit, or support terrorism; and (ii) weapons of mass destruction proliferators and their supporters).

CMC Electronics Inc. (“CMC”), one of our Canadian subsidiaries, sells subscriptions to a navigation database that is used in the flight-management systems it manufactures and sells for use in airplanes and other aircraft. The navigation database is updated approximately once a month, and the updates are automatically made available electronically to CMC’s subscribing customers in an email notification. Customers may download the updates using instructions provided in the email.

In March 2013, CMC quoted and provided a one-year subscription to the navigation database to Ukrainian-Mediterranean Airlines (“UM Air”) for use in flight-management systems installed in UM Air’s fleet of MD-83 aircraft. CMC received $8,814 from UM Air in March 2013 for that subscription. On May 31, 2013, the Office of Foreign Assets Control of the U.S. Department of the Treasury designated UM Air as a Specially Designated Global Terrorist (“SDGT”) pursuant to Executive Order No. 132224. On June 19, 2013, in accordance with the pre-existing subscription agreement, CMC’s system automatically delivered an email notification to UM Air containing instructions on how to download the latest update to the navigation database, and UM Air downloaded the update. Within 4 days thereafter, CMC ran its periodic prohibited party screening of its customer base and discovered that UM Air had been designated as an SDGT. CMC promptly stopped UM Air from downloading further updates to its navigation database, and ceased any further transactions with UM Air. The net profit on the subscription sold to UM Air was $6,027. CMC has not engaged in any activity with UM Air since June 19, 2013, and CMC does not intend to conduct further transactions with UM Air, including under the subscription agreement. CMC has also enhanced its customer screening practices to more timely identify and address such issues in the future.

 

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Item 6. Exhibits

 

                                
     10.1      First Amendment to Lease between The Prudential Insurance Company of America and Mason Electric, Co. dated July 29, 2004.
     10.2      Second Amendment to Lease between Sylmar Cascades Properties, L.P. and Mason Electric, Co. dated January 19, 2007.
     10.3      Third Amendment to Lease between Sylmar Cascades Properties, L.P. and Mason Electric, Co. dated January 1, 2013.
     11      Schedule setting forth computation of basic and diluted earnings per common share for the three and nine month periods ended July 26, 2013, and July 27, 2012.
     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.INS      XBRL Instance Document
   101.SCH      XBRL Taxonomy Extension Schema
   101.CAL      XBRL Taxonomy Extension Calculation Linkbase
   101.DEF      XBRL Taxonomy Extension Definition Linkbase
   101.LAB      XBRL Taxonomy Extension Label Linkbase
   101.PRE      XBRL Taxonomy Extension Presentation Linkbase

 

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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: August 30, 2013   By:    

/s/ Robert D. George

    Robert D. George
    Chief Financial Officer, Vice President, and
    Corporate Development
    (Principal Financial Officer)

 

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