Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

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

 

For the quarterly period ended  

January 29, 2010

OR

 

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

For the transition period from                                      to                                     

Commission file number 1-6357

      ESTERLINE TECHNOLOGIES CORPORATION      

(Exact name of registrant as specified in its charter)

 

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

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

(Address of principal executive offices)(Zip Code)

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes             X                              No                       

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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                                              No                       


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

 

Large accelerated filer    x    Accelerated filer    ¨
Non-accelerated filer      ¨ (Do not check if a smaller reporting company)    Smaller reporting company    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes                                              No            X        

As of March 2, 2010, 29,827,637 shares of the issuer’s common stock were outstanding.

 

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PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of January 29, 2010 and October 30, 2009

(In thousands, except share amounts)

 

     January 29,
2010
  October 30,
2009

ASSETS

     (Unaudited)  

Current Assets

    

Cash and cash equivalents

   $ 187,050   $ 176,794

Accounts receivable, net of allowances

of $5,105 and $5,297

     245,527     270,976

Inventories

    

Raw materials and purchased parts

     113,082     115,215

Work in process

     98,618     98,340

Finished goods

     60,289     61,727
            
     271,989     275,282

Income tax refundable

     7,581     7,638

Deferred income tax benefits

     31,059     31,434

Prepaid expenses

     19,291     17,425

Other current assets

     11,635     17,048
            

Total Current Assets

     774,132     796,597

Property, Plant and Equipment

     522,037     515,828

Accumulated depreciation

     251,670     252,577
            
     270,367     263,251

Other Non-Current Assets

    

Goodwill

     731,792     736,808

Intangibles, net

     409,204     422,082

Debt issuance costs, net of accumulated

amortization of $8,319 and $7,842

     6,659     7,136

Deferred income tax benefits

     79,593     79,114

Other assets

     12,307     9,259
            
   $     2,284,054   $     2,314,247
            

 

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ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEET

As of January 29, 2010 and October 30, 2009

(In thousands, except share amounts)

 

     January 29,
2010
    October 30,
2009

LIABILITIES AND SHAREHOLDERS’ EQUITY

     (Unaudited)      

Current Liabilities

    

Accounts payable

   $ 76,980      $ 82,304

Accrued liabilities

     172,636        191,667

Credit facilities

     1,439        5,896

Current maturities of long-term debt

     6,816        5,409

Deferred income tax liabilities

     5,932        7,294

Federal and foreign income taxes

     936        1,669
              

Total Current Liabilities

     264,739        294,239

Long-Term Liabilities

    

Long-term debt, net of current maturities

     525,737        520,158

Deferred income tax liabilities

     127,571        130,456

Pension and post-retirement obligations

     93,665        93,615

Other liabilities

     21,984        20,027

Shareholders’ Equity

    

Common stock, par value $.20 per share,
authorized 60,000,000 shares, issued and
outstanding 29,820,112 and 29,773,630 shares

     5,964        5,955

Additional paid-in capital

     507,378        504,549

Retained earnings

     745,586        732,861

Accumulated other comprehensive income (loss)

     (11,355     9,656
              

Total Esterline shareholders’ equity

     1,247,573        1,253,021

Noncontrolling interests

     2,785        2,731
              

Total Shareholders’ Equity

     1,250,358        1,255,752
              
   $     2,284,054      $     2,314,247
              

 

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ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF OPERATIONS

For the Three Month Periods Ended January 29, 2010 and January 30, 2009

(Unaudited)

(In thousands, except per share amounts)

 

     Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Net Sales

   $    339,360      $    309,717   

Cost of Sales

     234,831        207,565   
                
     104,529        102,152   

Expenses

    

Selling, general & administrative

     62,315        59,725   

Research, development & engineering

     17,047        17,398   

Other expense

     41        5,014   
                

Total Expenses

     79,403        82,137   
                

Operating Earnings From Continuing Operations

     25,126        20,015   

Interest income

     (383     (411

Interest expense

     7,961        6,736   
                

Income From Continuing Operations Before Income Taxes

     17,548        13,690   

Income Tax Expense

     4,769        2,168   
                

Income From Continuing Operations Including
Noncontrolling Interests

     12,779        11,522   

Income Attributable to Noncontrolling Interests

     (54     (35
                

Income From Continuing Operations Attributable to Esterline

     12,725        11,487   

Income From Discontinued Operations Attributable to
Esterline, Net of Tax

            15,456   
                

Net Earnings Attributable to Esterline

   $ 12,725      $ 26,943   
                

Earnings Per Share Attributable to Esterline – Basic:

    

Continuing operations

   $ .43      $ .39   

Discontinued operations

            .52   
                

Earnings Per Share Attributable to Esterline – Basic

   $ .43      $ .91   
                

Earnings Per Share Attributable to Esterline – Diluted:

    

Continuing operations

   $ .42      $ .38   

Discontinued operations

            .52   
                

Earnings Per Share Attributable to Esterline – Diluted

   $ .42      $ .90   
                

 

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ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Three Month Periods Ended January 29, 2010 and January 30, 2009

(Unaudited)

(In thousands)

 

     Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Cash Flows Provided (Used) by Operating Activities

    

Net earnings including noncontrolling interests

   $         12,779      $         26,978   

Adjustments to reconcile net earnings including

    

noncontrolling interests to net cash provided

    

(used) by operating activities:

    

Depreciation and amortization

     18,659        14,491   

Deferred income taxes

     (1,395     (1,121

Share-based compensation

     1,472        1,972   

Gain on sale of discontinued operations

            (26,379

Working capital changes, net of effect of acquisitions:

    

Accounts receivable

     22,568        31,646   

Inventories

     (268     (13,219

Prepaid expenses

     (2,093     (2,460

Other current assets

     (239     446   

Accounts payable

     (4,237     (14,810

Accrued liabilities

     (20,304     (19,349

Federal and foreign income taxes

     (456     7,771   

Other liabilities

     2,191        4,712   

Other, net

     1,676        (6,510
                
     30,353        4,168   

Cash Flows Provided (Used) by Investing Activities

    

Purchases of capital assets

     (14,120     (7,521

Proceeds from sale of discontinued operations,

    

net of cash

            62,944   

Proceeds from sale of capital assets

     61        94   

Acquisitions, net of cash acquired

     (768     (250,777
                
     (14,827     (195,260

 

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ESTERLINE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

For the Three Month Periods Ended January 29, 2010 and January 30, 2009

(Unaudited)

(In thousands)

 

     Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Cash Flows Provided (Used) by Financing Activities

    

Proceeds provided by stock issuance under

    

employee stock plans

     1,167        1,575   

Excess tax benefits from stock options exercised

     199          

Net change in credit facilities

     (4,442     113,705   

Repayment of long-term debt

     (178     (1,315
                
     (3,254     113,965   

Effect of Foreign Exchange Rates on Cash

     (2,016     (2,287
                

Net Increase (Decrease) in Cash and Cash Equivalents

     10,256        (79,414

Cash and Cash Equivalents – Beginning of Period

     176,794            160,645   
                

Cash and Cash Equivalents – End of Period

   $     187,050      $ 81,231   
                

Supplemental Cash Flow Information

    

Cash Paid for Interest

   $ 7,118      $ 6,493   

Cash Paid for Taxes

     6,812        7,011   

 

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ESTERLINE TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Three Month Periods Ended January 29, 2010 and January 30, 2009

 

1. The consolidated balance sheet as of January 29, 2010, the consolidated statement of operations for the three month periods ended January 29, 2010, and January 30, 2009, and the consolidated statement of cash flows for the three month periods ended January 29, 2010, and January 30, 2009, 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 30, 2009, provide a summary of significant accounting policies and additional financial information that should be read in conjunction with this Form 10-Q.

 

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

 

4. Basic earnings per share is computed on the basis of the weighted average number of shares outstanding during the year. Diluted earnings per share includes the dilutive effect of stock options. Common shares issuable from stock options that are excluded from the calculation of diluted earnings per share because they were anti-dilutive were 646,901 and 1,250,960 in the first fiscal quarter of 2010 and 2009, respectively. Shares used for calculating earnings per share are disclosed in the following table.

 

(In thousands)    Three Months Ended
     January 29,
2010
   January 30,
2009

Shares Used for Basic Earnings Per Share

   29,789    29,664

Shares Used for Diluted Earnings Per Share

   30,218    29,865

 

5. Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board issued a standard that significantly changes the way companies account for business combinations. The standard will generally require more assets acquired and more liabilities assumed to be measured at fair value on the date of acquisition. Under the standard, acquisition-related transaction costs

 

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are expensed when incurred and are no longer included in goodwill as a cost of acquiring the business. The standard also requires acquirers to estimate the acquisition-date fair value of any contingent consideration and to recognize any subsequent changes in the fair value of the contingent consideration in earnings. In addition, restructuring costs the acquirer expects, but is not obligated to incur, will be recognized separately from the business acquisition. The Company adopted this standard in the first quarter of fiscal 2010. The new standard is applied prospectively to all business combinations with an acquisition date on or after October 31, 2009. No business combination transactions occurred in the three months ended January 29, 2010.

In December 2007, the Financial Accounting Standards Board issued a standard that changes the way companies account for and report noncontrolling interests (minority interests) of consolidated subsidiaries. The Company adopted this standard in the first quarter of fiscal year 2010 with no impact to the Company’s financial statements other than the Company has changed the presentation of noncontrolling interests on the Consolidated Balance Sheet and Consolidated Statement of Operations. Noncontrolling interests of $2.8 million at January 29, 2010, and $2.7 million of noncontrolling interests at October 30, 2009, are now included within Equity.

 

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

 

(In thousands)    Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Net Earnings

   $     12,725      $     26,943   

Change in Fair Value of Derivative Financial Instruments,
    Net of Tax (Expense) Benefit of $671 and $(331)

     (1,827     525   

Adjustment for Minimum Pension Liability, Net of Tax
    (Expense) Benefit of $199 and $(182)

     88        424   

Foreign Currency Translation Adjustment

     (19,272     (27,055
                

Comprehensive Income (Loss)

   $ (8,286   $ 837   
                

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

 

(In thousands)    January 29,
2010
    October 30,
2009
 

Currency translation adjustment

   $     33,886      $     53,158   

Net unrealized gain on derivative contracts

     9,538        11,365   

Employee benefit plans

     (54,779     (54,867
                

Total accumulated other comprehensive income (loss)

   $ (11,355   $ 9,656   
                

 

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7. On January 26, 2009, the Company acquired all of the outstanding capital stock of Racal Acoustics Global Ltd. (Racal Acoustics) for approximately £122.6 million or $171.3 million in cash, including acquisition costs. Racal Acoustics develops and manufactures high technology ruggedized personal communication equipment for the defense and avionics segment. The acquisition expands the scale of the Company’s existing avionics and controls business. Racal Acoustics is included in the Avionics & Controls segment.

The following summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition. The Company recorded goodwill of $94.0 million. The amount allocated to goodwill is not expected to be deductible for income tax purposes.

 

(In thousands)     

As of January 26, 2009

  

Current assets

   $ 30,319

Property, plant and equipment

     2,931

Intangible assets subject to amortization

  

Programs (15 year weighted average useful life)

     90,045

Goodwill

     93,986
      

Total assets acquired

     217,281

Current liabilities assumed

     20,747

Deferred tax liabilities

     25,213
      

Net assets acquired

   $     171,321
      

On December 15, 2008, the Company acquired all of the outstanding capital stock of NMC Group, Inc. (NMC) for approximately $90.1 million in cash, including acquisition costs. NMC designs and manufactures specialized light-weight fasteners principally for commercial aviation applications. The acquisition expands the scale of the Company’s existing advanced materials business. NMC is included in the Advanced Materials segment.

The following summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition. The Company recorded goodwill of $40.8 million. The amount allocated to goodwill is expected to be deductible for income tax purposes.

 

10


(In thousands)     

As of December 15, 2008

  

Current assets

   $ 7,925

Property, plant and equipment

     3,246

Intangible assets subject to amortization

  

Programs (15 year weighted average useful life)

     39,580

Goodwill

     40,796

Other assets

     19
      

Total assets acquired

     91,566

Current liabilities assumed

     1,427
      

Net assets acquired

   $     90,139
      

 

8. On November 3, 2008, the Company sold U.K.-based Muirhead Aerospace Limited and Traxsys Input Products Limited, which were included in the Sensors & Systems segment, for approximately U.K. £40.0 million or $63.4 million, resulting in an after-tax gain of $15.5 million. As a result, the consolidated financial statements present Muirhead Aerospace Limited and Traxsys Input Products Limited as a discontinued operation.

The operating results of the discontinued operations for the first quarter of 2009 consisted of the following:

 

(In thousands)    January 30,
2009

Sales

   $

Income from discontinued operations
    before income taxes

     26,379

Income tax expense

     10,923
      

Income from discontinued operations

   $     15,456
      

 

9. The effective income tax rate for the first fiscal quarter of 2010 was 25.5% (before a $0.3 million tax expense) compared with 18.9% (before a $0.4 million tax benefit) for the prior-year period. The $0.3 million tax expense in the first fiscal quarter of 2010 was the result of a change in the tax law of France. The $0.4 million tax benefit in the first fiscal quarter of 2009 was the result of two events. The first event was a $2.0 million reduction of previously recorded withholding tax liabilities as a result of the enactment of a U.S.-Canadian tax treaty. The second event was the recording of a $1.6 million penalty due to a development with regard to certain foreign tax laws. The effective tax rate differed from the statutory rate in the first fiscal quarters of 2010 and 2009, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next 12 months, $6.7 million of unrecognized foreign tax benefits associated with losses on the disposition of assets could decrease as a result of the expiration of a statute of limitations and be recognized in net income.

 

11


10.

  As of January 29, 2010, the Company had three share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans for the first fiscal quarters of 2010 and 2009 was $1.5 million and $2.0 million, respectively. During the first fiscal quarters of 2010 and 2009, the Company issued 46,482 and 52,972 shares, respectively, under its employee stock plans.

Employee Stock Purchase Plan

The Company converted the ESPP to a “safe harbor” design on December 16, 2008. Under the safe harbor design, shares are purchased by participants at 95% of the market value on the purchase date and, therefore, compensation cost is no longer recorded under the ESPP.

Equity Incentive Plan

Under the equity incentive plan, option exercise prices are equal to the fair market value of the Company’s common stock on the date of grant. The Company granted 337,800 options and 378,800 options in the three-month periods ended January 29, 2010, and January 30, 2009, respectively. The weighted-average grant date fair value of options granted during the three-month periods ended January 29, 2010, and January 30, 2009, was $21.15 per share and $15.92 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.

 

     Three Months Ended  
     January 29,
    2010     
    January 30,
    2009     
 

Risk-free interest rate

   2.42 – 4.0   1.43 – 3.12

Volatility

   43.0 – 43.2   36.8 – 43.1

Expected life (years)

   4.5 – 9.5      4.5 – 9.5   

Dividends

          

Employee Sharesave Scheme

In April 2009, the Company offered shares under its employee sharesave scheme for U.K. employees. This plan allows participants the option to purchase shares at 95% of the market price of the stock as of the beginning of the offering period. The term of these options is three years. The sharesave scheme is not a “safe-harbor” design, and therefore, compensation cost is recognized on this plan.

Under the sharesave scheme, option exercise prices are equal to the fair market value of the Company’s common stock on the date of grant. The Company granted 164,199 options in fiscal 2009, with a weighted-average grant date fair value of $7.49 per share.

 

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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 the grant.

 

     January 29,
    2010     
 

Risk-free interest rate

   0.58

Volatility

   50.08

Expected life (years)

   3   

Dividends

     

 

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. Components of periodic pension cost consisted of the following:

 

(In thousands)    Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Components of Net Periodic Pension Cost

    

Service cost

   $ 1,890      $ 1,475   

Interest cost

     4,495        4,575   

Expected return on plan assets

     (4,373     (3,509

Amortization of prior service cost

     5          

Amortization of actuarial loss

     1,826        998   
                

Net Periodic Cost

   $     3,843      $     3,539   
                

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

 

(In thousands)    Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Components of Net Periodic Pension Cost

    

Service cost

   $ 78      $ 82   

Interest cost

     174        161   

Amortization of actuarial gain

     (19     (19
                

Net Periodic Cost

   $     233      $     224   
                

 

12. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy has been established that prioritizes the inputs to valuation techniques used to measure fair value. An asset or liability’s level within the fair value hierarchy is

 

13


based on the lowest level of input that is significant to the fair value measurement. The hierarchy of fair value measurements is described below:

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

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

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

The following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis by level within the fair value hierarchy at January 29, 2010 and October 30, 2009:

 

(In thousands)

   Level 2
         January 29,    
2010
       October 30,    
2009

Assets:

     

Derivative contracts designated as

     

hedging instruments

   $     14,213    $     16,590

Derivative contracts not designated as

     

hedging instruments

   $ 537    $ 442

Embedded derivatives

   $ 10    $

Liabilities:

     

Derivative contracts designated as

     

hedging instruments

   $ 1,866    $ 181

Derivative contracts not designated as

     

hedging instruments

   $ 1,377    $ 1,405

Embedded derivatives

   $ 1,009    $ 588

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.

 

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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.

 

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

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

The fair values of derivative instruments are presented on a gross basis, as the Company does not have any derivative contracts which are subject to master netting arrangements. The Company does not have any hedges with credit-risk-related contingent features or that required the posting of collateral as of January 29, 2010. The cash flows from derivative contracts are recorded in operating activities in the Consolidated Statement of Cash Flows.

Foreign Currency Forward Exchange Contracts

The Company transacts business in various foreign currencies which subjects the Company’s cash flows and earnings to exposure related to changes in foreign currency exchange rates. These exposures arise primarily from purchases or sales of products and services from third parties. Foreign currency forward exchange contracts provide for the purchase or sale of foreign currencies at specified future dates at specified exchange rates and are used to offset changes in the fair value of certain assets or liabilities or forecasted cash flows resulting from transactions denominated in foreign currencies. As of January 29, 2010, and October 30, 2009, the Company had outstanding foreign currency forward exchange contracts principally to sell U.S. dollars with notional amounts of $251.1 million and $275.3 million, respectively.

 

15


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 June 2009, the Company entered into an interest rate swap agreement on the $175.0 million Senior Subordinated Notes due in 2013. The swap agreement exchanged the fixed interest rate of 7.75% for a variable interest rate on the $175.0 million principal amount outstanding. The variable interest rate is based upon LIBOR plus 5.37% and was 5.60% at January 29, 2010. The fair value of the Company’s interest rate swap was an $859,000 asset at January 29, 2010, and was estimated by discounting expected cash flows using market interest rates. The Company records interest receivable and interest payable on interest rate swaps on a net basis. The Company recognized a net interest receivable of $471,000 at January 29, 2010. A $2.9 million deferred gain on a terminated interest rate swap is being amortized in proportion to the repayment of the underlying debt. The unamortized balance at January 29, 2010, was $2.2 million. The gain will be amortized through 2013.

Embedded Derivative Instruments

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

Net Investment Hedge

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

Fair Value of Derivative Instruments

Fair values of derivative instruments in the Consolidated Balance Sheet at January 29, 2010, and October 30, 2009, consisted of:

 

16


(In thousands)   

Classification

   Fair Value  
        January 29,
2010
   October 30,
2009
 

Foreign currency forward

        

  exchange contracts

   Other current assets    $ 12,019    $ 17,032   

Foreign currency forward

        

  exchange contracts

   Other assets    $ 2,731    $   

Foreign currency forward

        

  exchange contracts

   Accrued liabilities    $ 2,644    $ 1,586   

Foreign currency forward

        

  exchange contracts

   Other liabilities    $ 599    $   

Embedded derivative

        

  instruments

   Other current assets    $ 10    $   

Embedded derivative

        

  instruments

   Accrued liabilities    $ 1,009    $ 588   

Interest rate swap

   Long-term debt, net of current maturities    $ 859    $ (269

The effect of derivative instruments on the Consolidated Statement of Operations for the first fiscal quarter in 2010 and 2009 consisted of:

 

(In thousands)    Location of
Gain (Loss)
   January 29,
2010
    January 30,
2009
 

Fair Value Hedges:

       

Interest rate swap contracts

   Interest Expense    $ 632      $   

Embedded derivatives

   Sales    $ (425   $ 711   

Cash Flow Hedges:

       

Foreign currency forward exchange contracts:

       

Amount of gain (loss) recognized

       

  in AOCI (effective portion)

   AOCI    $ (4,497   $ 6,279   

Amount of gain (loss) reclassified

       

  from AOCI into income

   Sales    $ 1,998      $ (5,422

Net Investment Hedges:

       

U.K. term loan

   AOCI    $      $ 3,450   

During the first fiscal quarter of 2010, the Company recorded gains of $0.1 million on foreign currency forward exchange contracts that have not been designated as an accounting hedge. These foreign currency exchange gains are included in selling, general and administrative expense.

There was no significant impact to the Company’s earnings related to the ineffective portion of any hedging instruments during the first fiscal quarter of 2010. In addition, there was no significant impact to the Company’s earnings when a hedged firm commitment no longer

 

17


qualified as a fair value hedge or when a hedged forecasted transaction no longer qualified as a cash flow hedge during the first fiscal quarter of 2010.

Amounts included in AOCI are reclassified into earnings when the hedged transaction settles. The Company expects to reclassify approximately $10.2 million of net gain into earnings over the next 12 months. The maximum duration of the Company’s foreign currency cash flow hedge contracts at January 29, 2010, is 26 months.

 

14. Segment information:

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

 

(In thousands)    Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Sales

    

Avionics & Controls

   $        170,257      $        128,468   

Sensors & Systems

     74,742        84,555   

Advanced Materials

     94,361        96,694   
                

Total Sales

   $ 339,360      $ 309,717   
                

Income from Continuing Operations

    

Avionics & Controls

   $ 19,432      $ 14,475   

Sensors & Systems

     5,096        10,252   

Advanced Materials

     8,730        9,974   
                

Segment Earnings

     33,258        34,701   

Corporate expense

     (8,091     (9,672

Other expense

     (41     (5,014

Interest income

     383        411   

Interest expense

     (7,961     (6,736
                
   $ 17,548      $ 13,690   
                

 

15. The acquisition of Racal Acoustics was funded from cash proceeds from the sale of U.K.-based Muirhead and Traxsys and the Company’s line of credit. To facilitate the acquisition of Racal Acoustics, the Company executed a $159.7 million U.S. dollar-denominated intercompany loan with a wholly owned subsidiary, of which its functional currency is the pound sterling. Due to holding of pounds sterling to fund the acquisition during a period of foreign exchange volatility, the Company incurred a $7.9 million foreign currency transaction loss in January 2009, which was recorded in other expense.

 

16.

The following schedules set forth condensed consolidating financial information as required by Rule 3-10 of Securities and Exchange Commission Regulation S-X as of January 29,

 

18


 

2010, and October 30, 2009, and for the applicable periods ended January 29, 2010, and January 30, 2009, for (a) Esterline Technologies Corporation (the Parent); (b) on a combined basis, the subsidiary guarantors (Guarantor Subsidiaries) of the Credit Agreement, Senior Subordinated Notes due 2013 (Senior Subordinated Notes) and Senior Notes due 2017 (Senior Notes) which include Advanced Input Devices, Inc., Angus Electronics Co., Armtec Countermeasures Co., Armtec Countermeasures TNO Co., Armtec Defense Products Co., AVISTA, Incorporated, BVR Technologies Co., CMC DataComm Inc., CMC Electronics Acton Inc., CMC Electronics Aurora Inc., EA Technologies Corporation, Equipment Sales Co., Esterline Canadian Holding Corporation, Esterline International Company, Esterline Sensors Services Americas, Inc., Esterline Technologies Holdings Limited, Esterline Technologies Ltd. (England), H.A. Sales Co., Hauser Inc., Hytek Finishes Co., Janco Corporation, Kirkhill-TA Co., Korry Electronics Co., Leach Holding Corporation, Leach International Corporation, Leach International Mexico S. de R.L. de C.V. (Mexico), Leach Technology Group, Inc., Mason Electric Co., MC Tech Co., Memtron Technologies Co., NMC Group, Inc., Norwich Aero Products, Inc., Palomar Products, Inc., Pressure Systems, Inc., Pressure Systems International, Inc., Racal Acoustics Inc., UMM Electronics Inc., and (c) on a combined basis, the subsidiary non-guarantors (Non-Guarantor Subsidiaries), which include Acoustics Holdco Limited, Auxitrol S.A., BAE Systems Canada/Air TV LLC, CMC Electronics Inc., CMC Electronics ME Inc., Darchem Engineering Ltd., Darchem Holding Ltd., Esterline Acquisition Ltd., Esterline Canadian Acquisition Corporation, Esterline Canada Limited Partnership, Esterline Foreign Sales Corporation, Esterline Input Devices Asia Ltd., Esterline Input Devices (Shanghai) Ltd., Esterline Mexico S. de R.L. de C.V., Esterline Sensors Services Asia PTE Ltd., Esterline Technologies Acquisition Ltd., Esterline Technologies Denmark ApS, Esterline Technologies Europe Limited, Guizhou Leach-Tianyi Aviation Electrical Company Ltd., Leach International Asia-Pacific Ltd., Leach International Europe S.A., Leach International Germany GmbH, Leach International U.K. Ltd., Leach Italia Srl., LRE Medical GmbH, Pressure Systems International Ltd., Rag Newco Ltd., Racal Acoustics Global Ltd., Racal Acoustics Group Ltd., Racal Acoustics Holdings Limited, Racal Acoustics Limited, TA Mfg. Ltd., UKCI Limited, Wallop Defence Systems Ltd., Wallop Industries Ltd., Weston Aero 2003, and Weston Aerospace Ltd. Muirhead Aerospace Limited (Muirhead), Norcroft Dynamics Ltd. (Norcroft), and Traxsys Input Products Ltd. (Traxsys), were Non-Guarantor Subsidiaries as of October 31, 2008. As explained in Note 8, Muirhead, Norcroft, and Traxsys were sold on November 3, 2008, and, accordingly, Muirhead, Norcroft, and Traxsys were excluded from the Condensed Consolidating Balance Sheet at January 30, 2009, and accounted for as a discontinued operation in the Condensed Consolidating Statement of Operations and Cash Flows for the three-month period ended January 30, 2009. The Guarantor Subsidiaries are direct and indirect wholly-owned subsidiaries of Esterline Technologies Corporation and have fully and unconditionally, jointly and severally, guaranteed the Credit Agreement, Senior Notes and Senior Subordinated Notes.

 

19


Condensed Consolidating Balance Sheet as of January 29, 2010

 

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

Assets

            

Current Assets

            

Cash and cash equivalents

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

Accounts receivable, net

          105,334        140,193             245,527

Inventories

          120,162        151,827             271,989

Income tax refundable

                 7,581             7,581

Deferred income tax benefits

     19,507      (1,624     13,176             31,059

Prepaid expenses

          6,102        13,189             19,291

Other current assets

                 11,635             11,635
 

Total Current Assets

     89,161      234,178        450,793             774,132

Property, Plant &
Equipment, Net

     1,424      165,702        103,241             270,367

Goodwill

          249,495        482,297             731,792

Intangibles, Net

          98,074        311,130             409,204

Debt Issuance Costs, Net

     6,659                         6,659

Deferred Income Tax Benefits

     43,994      3,443        32,156             79,593

Other Assets

     787      1,603        9,917             12,307

Amounts Due (To) From Subsidiaries

          189,384             (189,384    

Investment in Subsidiaries

     1,771,192      248,365        248,417      (2,267,974    
 

Total Assets

   $ 1,913,217    $ 1,190,244      $ 1,637,951    $ (2,457,358   $ 2,284,054
 

 

20


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

Liabilities and Shareholders’ Equity

  

        

Current Liabilities

           

Accounts payable

   $ 481      $ 23,264      $ 53,235    $      $ 76,980

Accrued liabilities

     8,640        62,983        101,013             172,636

Credit facilities

                   1,439             1,439

Current maturities of
long-term debt

     6,250        226        340             6,816

Deferred income tax liabilities

     424        279        5,229             5,932

Federal and foreign
income taxes

     (13,748     (2,326     17,010             936
 

Total Current Liabilities

     2,047        84,426        178,266             264,739

Long-Term Debt, Net

     471,788        42,218        11,731             525,737

Deferred Income Tax Liabilities

     34,370        32        93,169             127,571

Pension and Post-Retirement Obligations

     12,636        52,732        28,297             93,665

Other Liabilities

     8,467        293        13,224                      —        21,984

Amounts Due To (From) Subsidiaries

     136,336               141,027      (277,363    

Shareholders’ Equity

     1,247,573        1,010,543        1,172,237      (2,179,995     1,250,358
 

Total Liabilities and Shareholders’ Equity

   $     1,913,217      $     1,190,244      $     1,637,951    $   (2,457,358   $     2,284,054
 

 

21


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

 

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

Net Sales

   $      $     171,826      $     167,534      $      $     339,360   

Cost of Sales

            116,863        117,968               234,831   
   
            54,963        49,566               104,529   

Expenses

          

Selling, general and administrative

            30,256        32,059               62,315   

Research, development
and engineering

            6,131        10,916               17,047   

Other expense

                   41               41   
   

Total Expenses

            36,387        43,016               79,403   
   

Operating Earnings From Continuing Operations

            18,576        6,550               25,126   
Interest income      (3,880     (630     (10,113     14,240        (383
Interest expense      6,639        4,988        10,574        (14,240     7,961   
   

Income (Loss) From
Continuing Operations
Before Taxes

     (2,759     14,218        6,089               17,548   

Income Tax Expense (Benefit)

     (702     3,499        1,972               4,769   
   

Income (Loss) From
Continuing Operations
Including Noncontrolling
Interests

     (2,057     10,719        4,117                    —        12,779   

Income Attributable to Noncontrolling Interests

                   (54            (54
   

Income (Loss) From
Continuing Operations

          

Attributable to Esterline

     (2,057     10,719        4,063               12,725   

Equity in Net Income of Consolidated Subsidiaries

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

Net Income (Loss)
Attributable to Esterline

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

 

22


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

 

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

Cash Flows Provided (Used)
by Operating Activities

   

Net earnings (loss) including noncontrolling interests

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

Depreciation & amortization

            8,128        10,531               18,659   

Deferred income taxes

     506        28        (1,929            (1,395

Share-based compensation

            685        787               1,472   

Working capital changes, net of effect of acquisitions:

          

Accounts receivable

            14,366        8,202               22,568   

Inventories

            1,684        (1,952            (268

Prepaid expenses

            (1,153     (940            (2,093

Other current assets

                   (239            (239

Accounts payable

     (97     320        (4,460            (4,237

Accrued liabilities

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

Federal & foreign
income taxes

     (1,250     (940     1,734               (456

Other liabilities

     191        1,200        800               2,191   

Other, net

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

Cash Flows Provided (Used)
by Investing Activities

   

Purchases of capital assets

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

Proceeds from sale of
capital assets

            59        2               61   

Acquisitions of businesses,
net of cash acquired

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

 

23


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

Cash Flows Provided (Used)
by Financing Activities

   

Proceeds provided by stock issuance under employee stock plans

     1,167                           1,167   

Excess tax benefits from stock options exercised

     199                           199   

Net change in credit facilities

                   (4,442          (4,442

Repayment of long-term debt

     (162     (118     102             (178

Net change in intercompany financing

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

Effect of foreign exchange rates on cash

            132        (2,148          (2,016
   

Net increase (decrease) in
cash and cash equivalents

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

Cash and cash equivalents
– beginning of year

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

Cash and cash equivalents
– end of year

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

 

24


Condensed Consolidating Balance Sheet as of October 30, 2009

 

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

Assets

         

Current Assets

         

Cash and cash equivalents

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

Accounts receivable, net

           119,700        151,276            270,976

Inventories

           121,846        153,436            275,282

Income tax refundable

                  7,638            7,638

Deferred income tax benefits

    21,417        (2,172     12,189            31,434

Prepaid expenses

           4,949        12,476            17,425

Other current assets

                  17,048            17,048
 

Total Current Assets

    69,324        248,944        478,329            796,597

Property, Plant & Equipment, Net

    1,527        160,099        101,625            263,251

Goodwill

           249,134        487,674            736,808

Intangibles, Net

           100,185        321,897            422,082

Debt Issuance Costs, Net

    7,136                          7,136

Deferred Income Tax Benefits

    43,514        3,623        31,977            79,114

Other Assets

    (72     1,650        7,681                      —        9,259

Amounts Due To (From) Subsidiaries

           159,482            (159,482    

Investment in Subsidiaries

    1,751,705        245,060        248,675     (2,245,440    
 

Total Assets

  $     1,873,134      $       1,168,177      $     1,677,858   $ (2,404,922   $     2,314,247
 

 

25


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

Liabilities and Shareholders’ Equity

  

        

Current Liabilities

           

Accounts payable

   $ 578      $ 22,944      $ 58,782    $      $ 82,304

Accrued liabilities

     13,446        61,748        116,473             191,667

Credit facilities

                   5,896             5,896

Current maturities of
long-term debt

     4,688        351        370             5,409

Deferred income tax liabilities

     1,455        227        5,612             7,294

Federal and foreign
income taxes

     (12,498     (1,386     15,553             1,669
 

Total Current Liabilities

     7,669        83,884        202,686             294,239

Long-Term Debt, Net

     472,385        36,259        11,514             520,158

Deferred Income Tax Liabilities

     34,263        (312     96,505             130,456

Pension and Post-Retirement

Obligations

     11,892        51,825        29,898             93,615

Other Liabilities

     9,020               11,007                     —        20,027

Amounts Due To (From) Subsidiaries

     84,884               136,864      (221,748    

Shareholders’ Equity

     1,253,021        996,521        1,189,384      (2,183,174     1,255,752
 

Total Liabilities and Shareholders’ Equity

   $     1,873,134      $     1,168,177      $     1,677,858    $ (2,404,922   $   2,314,247
 

 

26


Condensed Consolidating Statement of Operations for the three month period ended January 30, 2009.

 

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

Net Sales

  $      $ 187,180      $ 122,814      $ (277   $ 309,717   

Cost of Sales

           125,145        82,697        (277     207,565   
   
           62,035        40,117               102,152   

Expenses

         

Selling, general and administrative

           32,380        27,345               59,725   

Research, development
and engineering

           7,667        9,731               17,398   

Other expense (income)

    1,250        10,687        (6,923            5,014   
   

Total Expenses

    1,250        50,734        30,153               82,137   
   

Operating Earnings From Continuing Operations

    (1,250     11,301        9,964               20,015   
Interest income     (5,224     (1,107     (7,372     13,292        (411
Interest expense     6,324        5,123        8,581        (13,292     6,736   
   

Income (Loss) From
Continuing Operations
Before Taxes

    (2,350     7,285        8,755               13,690   

Income Tax Expense (Benefit)

    (443     (667     3,278               2,168   
   

Income (Loss) From
Continuing Operations
Including Noncontrolling
Interests

    (1,907     7,952        5,477               11,522   

Income Attributable to Noncontrolling Interests

                  (35            (35
   

Income (Loss) From
Continuing Operations
Attributable to Esterline

    (1,907     7,952        5,442               11,487   

Income From Discontinued
Operations Attributable to
Esterline, Net of Tax

           15,456                             —        15,456   

Equity in Net Income of Consolidated Subsidiaries

    28,850        1,279        6,346        (36,475       
   

Net Income (Loss)
Attributable to Esterline

  $     26,943      $ 24,687      $ 11,788      $ (36,475   $ 26,943   
   

 

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Condensed Consolidating Statement of Cash Flows for the three month period ended January 30, 2009.

 

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

Cash Flows Provided (Used)
by Operating Activities

   

     

Net earnings (loss) including noncontrolling interests

   $     26,943      $       24,687      $       11,823      $ (36,475   $     26,978   

Depreciation & amortization

            7,267        7,224                    —        14,491   

Deferred income taxes

     (612     (285     (224            (1,121

Share-based compensation

            1,130        842               1,972   

Gain on sale of
discontinued operations

            (26,379                   (26,379

Working capital changes, net of effect of acquisitions:

          

Accounts receivable

     (123     12,295        19,474               31,646   

Inventories

            (3,217     (10,002            (13,219

Prepaid expenses

            (425     (2,035            (2,460

Other current assets

                   446               446   

Accounts payable

     (302     (5,604     (8,904            (14,810

Accrued liabilities

     (4,158     (7,482     (7,709            (19,349

Federal & foreign
income taxes

     41        7,108        622               7,771   

Other liabilities

     3,086        (108     1,734               4,712   

Other, net

     2,915        186        (9,611            (6,510
   
     27,790        9,173        3,680        (36,475     4,168   

Cash Flows Provided (Used)
by Investing Activities

   

     

Purchases of capital assets

            (4,498     (3,023            (7,521

Proceeds from sale of
discontinued operations,
net of cash

            62,944                 62,944   

Proceeds from sale of
capital assets

            30        64               94   

Acquisitions of businesses,
net of cash acquired

            (89,519     (161,258            (250,777
   
            (31,043     (164,217            (195,260

 

28


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

Cash Flows Provided (Used)
by Financing Activities

   

      

Proceeds provided by stock issuance under employee stock plans

     1,575                           1,575   

Net change in credit facilities

     115,000               (1,295          113,705   

Repayment of long-term debt

     (4,047     (254     2,986             (1,315

Net change in intercompany financing

     (198,381     2,697        159,209        36,475        
   
     (85,853     2,443        160,900            36,475      113,965   

Effect of foreign exchange rates on cash

            (134     (2,153          (2,287
   

Net decrease in cash
and cash equivalents

     (58,063     (19,561     (1,790          (79,414

Cash and cash equivalents
– beginning of year

     80,884        21,913        57,848             160,645   
   

Cash and cash equivalents
– end of year

   $       22,821      $       2,352      $       56,058      $    $       81,231   
   

 

29


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

Overview

We operate our businesses in three segments: Avionics & Controls, Sensors & Systems and Advanced Materials. Our segments are structured around our technical capabilities.

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

The Sensors & Systems segment includes power systems and advanced sensors capabilities. Power systems develops and manufactures electrical power switching and other related systems, principally for aerospace and defense customers. Advanced sensors develops and manufactures high precision temperature and pressure sensors for aerospace and defense customers.

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

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

On November 3, 2008, we sold Muirhead Aerospace Limited (Muirhead) and Traxsys Input Products Limited (Traxsys), which were included in the Sensors & Systems segment. The results of Muirhead and Traxsys were accounted for as a discontinued operation in the consolidated financial statements.

 

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On December 15, 2008, we acquired NMC Group, Inc. (NMC), which designs and manufactures specialized light-weight fasteners principally for commercial aviation applications. NMC is included in our Advanced Materials segment.

On January 26, 2009, we acquired Racal Acoustics Global Ltd. (Racal Acoustics), which develops and manufactures high technology ruggedized personal communication equipment for the defense and avionics segment. Racal Acoustics is included in our Avionics & Controls segment.

Income from continuing operations was $12.7 million, or $0.42 per diluted share, compared with $11.5 million, or $0.38 per diluted share, in the prior-year period, reflecting expected performance in a down commercial aviation market and a 25.5% effective income tax rate compared to an 18.9% effective income tax rate in the prior-year period. During the first fiscal quarter of 2010, our operating results benefited from solid earnings from our Avionics & Controls segment, which were substantially offset by lower earnings of our Sensors & Systems and Advanced Materials segments. Avionics & Controls earnings reflected increased sales and earnings from defense programs and incremental earnings from the Racal Acoustics acquisition. Sensors & Systems earnings were impacted by lower sales and gross margins due to competitive pressures and the commercial aviation downturn in particular. Advanced Materials earnings were principally impacted by lower gross margins at our combustible ordnance operations. Income from continuing operations in the first fiscal quarter of 2009 was impacted by a foreign currency loss of $7.9 million relating to the pound sterling-denominated funding of Racal Acoustics. The increase in the effective income tax rate from the prior-year period reflected a change in tax law in France, the expiration of U.S. research and development credits and changes in U.S. and Canada Tax Treaty. In addition, the prior-year period’s effective income tax rate reflected tax benefits associated with the $7.9 million foreign currency loss.

Income from discontinued operations for the first fiscal quarter of 2009 was $0.52 per diluted share reflecting the gain on sale of our U.K.-based Muirhead and Traxsys subsidiaries in November 2008. Net income was $12.7 million, or $0.42 per diluted share, compared with net income of $26.9 million, or $0.90 per diluted share, in the prior-year period.

 

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Results of Operations

Three Month Period Ended January 29, 2010 Compared with Three Month Period Ended January 30, 2009

Sales for the first fiscal quarter increased 9.6% when compared with the prior-year period. Sales by segment were as follows:

(In thousands)

     Incr./(Decr.)
from prior
    year period    
  Three Months Ended
       January 29,
2010
   January 30,
2009

Avionics & Controls

            32.5%   $ 170,257    $ 128,468

Sensors & Systems

          (11.6)%     74,742      84,555

Advanced Materials

            (2.4)%     94,361      96,694
               

Total Net Sales

     $ 339,360    $ 309,717
               

The 32.5% increase in sales of Avionics & Controls was principally due to strong sales at our avionics systems and interface technologies operations and $16.9 million in incremental sales from the Racal Acoustics acquisition. Avionics systems sales increases were mainly due to production shipments of the T-6B military trainer and a military transport cockpit retrofit, which aggregated approximately $19.0 million. Sales at our interface technologies operations increased due to higher sales of our custom input systems for casino gaming machines. These increases were partially offset by lower control systems sales for aerospace applications.

The 11.6% decrease in sales of Sensors & Systems mainly reflected lower OEM sales of temperature sensors and certain power systems devices for regional and business jets. These decreases were partially offset by the effect of exchange rates at our non-U.S. operations. Sales in the first fiscal quarter of 2010 reflected a stronger pound sterling and euro relative to the U.S. dollar. The average exchange rate from the pound sterling to the U.S. dollar increased from 1.51 in the first fiscal quarter of 2009 to 1.62 in the first fiscal quarter of 2010. The average exchange rate from the euro to the U.S. dollar increased from 1.32 in the first fiscal quarter of 2009 to 1.46 in the first fiscal quarter of 2010.

The 2.4% decrease in sales of Advanced Materials principally reflected lower sales of combustible ordnance, thermally engineered components, and elastomer components. These decreases were partially offset by higher sales of flare countermeasure devices at our U.K. operation.

Avionics & Controls segment gross margin was 33.2% and 35.7% for the first fiscal quarter of 2010 and 2009, respectively. The decrease in Avionics & Controls segment gross margin mainly reflected sales mix and a lower recovery of fixed costs at our control systems operations. These decreases were partially offset by incremental gross profit from the Racal Acoustics acquisition.

Sensors & Systems segment gross margin was 32.6% and 35.2% for the first fiscal quarter of 2010 and 2009, respectively. The decrease in gross margin was due to our advanced sensors

 

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operations, which were impacted by a lower recovery of fixed costs and competitive pricing pressures. Additionally, gross margin in the prior-year period benefited from retroactive price agreements. In the first fiscal quarter of 2010 these decreases to gross margin were partially offset by sales of power systems for military applications with a higher gross margin.

Advanced Materials segment gross margin was 25.1% compared to 27.4% for the same period one year ago. The decrease in Advanced Materials gross margin principally reflected lower gross margins at our combustible ordnance operations due to enhanced quality control requirements on certain mortar increments. Additionally, gross margin was impacted by lower pricing options under a certain combustible ordnance contract with the U.S. government. These decreases were partially offset by improved gross margins at our U.K. flare operations. Gross margins at our engineered material operations increased slightly compared to the prior-year period.

Selling, general and administrative expenses (which include corporate expenses) totaled $62.3 million, or 18.4% of sales, and $59.7 million, or 19.3% of sales, for the first fiscal quarter of 2010 and 2009, respectively. The increase in selling, general and administrative expense principally reflected incremental selling, general and administrative expense from the acquisition of Racal Acoustics and NMC.

Research, development and engineering spending was $17.0 million, or 5.0% of sales, for the first fiscal quarter of 2010 compared with $17.4 million, or 5.6% of sales, for the first fiscal quarter of 2009. The decrease in research, development and engineering reflected the completion of the development of the integrated cockpit for the T-6B military trainer and other programs, partially offset by development spending on advanced sensors for the A-350. Fiscal 2010 research, development and engineering spending is expected to be approximately 5.0% of sales.

Segment earnings (operating earnings excluding corporate expenses and other income or expense) for the first fiscal quarter of 2010 totaled $33.3 million, or 9.8% of sales, compared with $34.7 million, or 11.2% of sales, for the first fiscal quarter in 2009.

Avionics & Controls segment earnings were $19.4 million, or 11.4% of sales, in the first fiscal quarter of 2010 and $14.5 million, or 11.3% of sales, in the first fiscal quarter of 2009, principally reflecting higher earnings of our avionics systems unit on increased sales volume and gross profit on our integrated cockpit for the T-6B military trainer and a military transport cockpit retrofit, and lower research, engineering and development. Additionally, earnings of our technology interface systems operations were strong compared with the prior-year period due to higher sales and improved profitability of our custom input systems for casino gaming machines. These increases were partially offset by lower earnings from our control systems operations. We incurred $1.2 million in lease termination costs resulting from a facilities move. In addition, gross profit decreased from the prior-year period due to a lower recovery of fixed overhead costs.

Sensors & Systems segment earnings were $5.1 million, or 6.8% of sales, for the first fiscal quarter of 2010 compared with $10.3 million, or 12.1% of sales, for the first fiscal quarter of 2009. The decrease in segment earnings principally reflects lower sales and gross margins at our temperature and pressure sensor operations and start-up costs incurred to set up a manufacturing

 

33


operation in Mexico. Our temperature and pressure sensors operations have been impacted by a very competitive market and the downturn in commercial aviation. Earnings at our power systems operations were solid and slightly better than the prior-year period.

Advanced Materials segment earnings were $8.7 million, or 9.3% of sales, for the first fiscal quarter of 2010 compared with $10.0 million, or 10.3% of sales, for the first fiscal quarter of 2009, principally reflecting lower earnings from our combustible ordnance operations and partially offset by improved earnings at our U.K. flare countermeasure operations. Earnings at our U.K. flare countermeasure operations benefited from international shipments, which had been delayed at October 30, 2009. Our engineered materials operations improved their profitability as a percentage of sales compared with the prior-year period with lower sales volumes due to strong cost control.

On January 26, 2009, we acquired Racal Acoustics for £122.6 million or $171.3 million. Racal Acoustics develops and manufactures high technology ruggedized personal communication equipment for the defense and avionics market segment. The acquisition was funded with cash proceeds from the sale of U.K.-based Muirhead and Traxsys and our line of credit. To facilitate the acquisition of Racal Acoustics, we executed a $159.7 million U.S. dollar-denominated intercompany loan with a wholly owned subsidiary, for which its functional currency is the pound sterling. Due to our holding of pounds sterling to fund the acquisition during a period of foreign exchange volatility, we incurred a $7.9 million foreign currency transaction loss in January 2009, which was recorded in other expense.

Interest expense for the first fiscal quarter of 2010 was $8.0 million compared with $6.7 million for the first fiscal quarter of 2009, reflecting higher borrowings during most of the first fiscal quarter of 2010.

The effective income tax rate for the first fiscal quarter of 2010 was 25.5% (before a $0.3 million tax expense) compared with 18.9% (before a $0.4 million tax benefit) for the prior-year period. The $0.3 million tax expense in the first fiscal quarter of 2010 was the result of a change in the tax law of France. The $0.4 million tax benefit in the first fiscal quarter of 2009 was the result of two events. The first event was a $2.0 million reduction of previously recorded withholding tax liabilities as a result of the enactment of a U.S.-Canadian tax treaty. The second event was the recording of a $1.6 million penalty due to a development with regard to certain foreign tax laws. The effective tax rate differed from the statutory rate in the first fiscal quarters of 2010 and 2009, as both years benefited from various tax credits and certain foreign interest expense deductions.

It is reasonably possible that within the next 12 months, $6.7 million of unrecognized foreign tax benefits associated with losses on the disposition of assets could decrease as a result of the expiration of a statute of limitations and be recognized in net income.

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.

 

34


We use forward contracts to hedge our foreign currency exchange risk. To the extent that these hedges qualify under U.S. GAAP, the amount of gain or loss is deferred in Accumulated Other Comprehensive Income (AOCI) until the related sale occurs. Also, we are subject to foreign currency gains or losses from embedded derivatives on backlog denominated in a currency other than the functional currency of our operating companies or its customers. Gains and losses on forward contracts, embedded derivatives, and revaluation of assets and liabilities denominated in currency other than the functional currency of the Company for the first fiscal quarter of 2010 and 2009 are as follows:

 

(In thousands)    Three Months Ended  
     January 29,
2010
    January 30,
2009
 

Forward foreign currency contracts – gain (loss)

   $         114      $ (3,844

Forward foreign currency contracts – reclassified

from AOCI

     1,998        (5,422

Embedded derivatives – gain (loss)

     (425               711   

Revaluation of monetary assets/liabilities – loss

     (800     (9,130
                

Total

   $ 887      $ (17,685
                

New orders for the first fiscal quarter of 2010 were $342.8 million compared with $370.2 million for the same period in 2009. The decrease in orders principally reflected approximately $65.2 million in backlog acquired from the Racal Acoustics and NMC acquisitions in the first fiscal quarter of 2009. Backlog was $1.1 billion compared with $1.2 billion at the end of the prior-year period and $1.1 billion at the end of fiscal 2009.

 

35


Liquidity and Capital Resources

Cash and cash equivalents at January 29, 2010, totaled $187.1 million, an increase of $10.3 million from October 30, 2009. Net working capital increased to $509.4 million at January 29, 2010, from $502.4 million at October 30, 2009. 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 $30.4 million and $4.2 million in the first fiscal quarter of 2010 and 2009, respectively. The increase principally reflected higher cash receipts and lower payments for inventory.

Cash flows used by investing activities were $14.8 million and $195.3 million in the first fiscal quarter of 2010 and 2009, respectively. Cash flows used by investing activities in the first fiscal quarter of 2010 primarily reflected cash paid for capital expenditures. Cash flows used by investing activities in the prior-year period reflected approximately $250.8 million for the acquisitions of NMC and Racal Acoustics, and $7.5 million in purchases of capital assets, partially offset by proceeds from the sale of Muirhead and Traxsys of $62.9 million.

Cash flows used by financing activities were $3.3 million in the first fiscal quarter of 2010 and principally reflected cash payments on our credit facilities and long-term debt. Cash flows provided by financing activities were $114.0 million in the first fiscal quarter of 2009 and principally reflected a $113.7 million increase in our credit facility to finance the Racal Acoustics acquisition.

On December 15, 2008, the Company acquired all of the outstanding capital stock of NMC Group, Inc. (NMC) for approximately $90.1 million in cash, including acquisition costs. The acquisition was funded from existing cash. NMC designs and manufactures specialized light-weight fasteners principally for commercial aviation applications.

On January 26, 2009, the Company acquired all of the outstanding capital stock of Racal Acoustics Global Ltd. (Racal Acoustics) for approximately $171.3 million in cash, including acquisition costs. Racal Acoustics develops and manufactures high technology ruggedized personal communication equipment for the defense and avionics segment. The acquisition was funded from proceeds from the sale of Muirhead and Traxsys and our credit facility.

Capital expenditures, consisting of machinery, equipment and computers, are anticipated to be approximately $50.0 million during fiscal 2010, compared with $87.4 million expended in fiscal 2009. Capital expenditures for fiscal 2009 included $28.2 million under a capitalized lease obligation related to our newly constructed facility for an avionics controls operation and a facility expansion for an interface technologies facility. Capital expenditures for the first fiscal quarter of 2010 totaled $20.1 million, primarily for machinery and equipment, building, construction in process, and enhancements to information systems. Capital expenditures for the first quarter of 2010 included $6.0 million under capitalized lease obligations for our newly constructed avionics and controls facility and facility expansion noted above.

 

36


Total debt at January 29, 2010, was $534.0 million and consisted of $175.0 million of Senior Notes due in 2017, $175.9 million of Senior Subordinated Notes due in 2013, $125.0 million of the U.S. Term Loan, $2.2 million of deferred gain on a terminated interest rate swap, $42.0 million under capital lease obligations, and $13.9 million under our credit facility and 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 fiscal 2010.

Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases you can identify forward-looking statements by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risk factors set forth in “Forward-Looking Statements” and “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 30, 2009, 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.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes in our exposure to market risk during the first three months of fiscal 2010. 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 30, 2009.

 

Item 4. Controls and Procedures

Our principal executive and financial officers evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of January 29, 2010. Based upon that evaluation, they concluded as of January 29, 2010, that our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within time periods specified in Securities and Exchange Commission rules and forms. In addition, our principal executive and financial officers concluded as of January 29, 2010, that our

 

37


disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

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

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

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

Item 6.                 Exhibits

10.1      Esterline Technologies Corporation Fiscal Year 2010 Annual Incentive Plan.
10.2      Esterline Technologies Corporation Long-Term Incentive Plan.
10.3      Summary of Non-Employee Director Compensation for Services on the Board of Directors of Esterline Technologies Corporation.
10.4      Lease Extension Agreement between Weir Redevelopment Company and Kirkhill TA Corporation dated October 30, 2009.
11      Schedule setting forth computation of basic and diluted earnings per common share for the three month periods ended January 29, 2010, and January 30, 2009.
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.

 

38


SIGNATURES

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

 

    ESTERLINE TECHNOLOGIES CORPORATION
    (Registrant)            
Dated: March 4, 2010     By:    /s/ Robert D. George
     

Robert D. George                 Vice President, Chief Financial Officer,                 Secretary and Treasurer                

(Principal Financial Officer)                

 

39