ESCO Technologies Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2021. Unaudited results; dollar amounts below are in millions unless stated otherwise. ESCO reports Aerospace & Defense (A&D), Utility Solutions Group (USG), and Test segments.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $181.4 | $172.7 | $510.0 | $524.9 |
| Net earnings from continuing operations | $14.9 | $18.7 | $43.1 | $47.3 |
| Diluted EPS from continuing operations | $0.57 | $0.72 | $1.65 | $1.81 |
| EBIT, non-GAAP | $19.4 | $23.3 | $57.1 | $61.5 |
| EBIT margin | 10.7% | 13.5% | 11.2% | 11.7% |
- Q3 sales rose 5.0%, while net earnings fell about 20% and diluted EPS declined to $0.57. Higher SG&A and lower EBIT contributed to the earnings decline.
- Nine-month sales fell 2.8%, principally due to lower A&D sales. Nine-month 2020 net earnings of $123.3 million included a $76.6 million after-tax gain on the sale of discontinued operations; continuing-operations earnings are the more comparable measure.
- Q3 segment sales: A&D $85.6 million, up 1.8%; USG $47.7 million, up 12.0%; Test $48.1 million, up 4.6%. Nine-month A&D sales declined 8.6%, while USG and Test sales increased 1.9% and 3.4%, respectively.
- Q3 segment EBIT was $16.7 million for A&D, $8.2 million for USG, and $6.8 million for Test. A&D EBIT was pressured by Westland charges and lower Mayday volumes; USG EBIT improved, while Test EBIT declined year over year in the quarter.
- Gross margin, calculated from reported sales and cost of sales, was approximately 37.4% in Q3 2021 versus 37.6% in Q3 2020, and 37.9% for the first nine months versus 37.6% a year earlier. SG&A was 23.6% of Q3 sales versus 21.4%; nine-month SG&A was 24.0% versus 22.7%.
- Effective tax rates were 21.3% for Q3 and 22.5% for the first nine months of 2021, compared with 14.3% and 15.9%, respectively, in 2020. Prior-year rates benefited from tax-credit and valuation-allowance items.
Cash flow, debt and liquidity
- For the first nine months, operating cash flow from continuing operations was $75.4 million, versus $53.8 million a year earlier. Capital expenditures were $17.9 million and capitalized software additions were $6.5 million. Investing cash flow was negative $29.1 million and financing cash flow was negative $22.3 million.
- Cash was $78.4 million at June 30, 2021, up from $52.6 million at September 30, 2020. Working capital was $217.5 million, versus $187.3 million at fiscal year-end.
- Total borrowings were $48.0 million, including $20.0 million classified as current; the company said it intended to repay that amount within 12 months but had no contractual obligation to do so. The $500 million credit facility matures in September 2024. Approximately $444 million remained available, in addition to cash; letters of credit were $8.4 million. The company was in compliance with its covenants.
Backlog, outlook and management commentary
- Backlog/remaining performance obligations were $539.0 million at June 30, 2021, unchanged from September 30, 2020. Management expected approximately 70% to be recognized as revenue in the next 12 months. Q3 orders were $203.8 million, compared with $157.8 million in Q3 2020; nine-month orders were $537.7 million versus $623.9 million.
- The filing provides no specific earnings or revenue guidance. Management described liquidity as strong and said operating cash flow and the credit facility were expected to meet capital and operating needs for the foreseeable future.
- COVID-19 continued to affect commercial aerospace demand and certain A&D businesses; Westland had a partial facility shutdown for several weeks in Q1. Management said supply chains had not been materially affected to date. Mayday and Westland goodwill reporting units had fair values less than 10% above carrying value; no impairment was recorded. A negative change in estimates could require a write-down.
- Subsequent to quarter-end, the company closed its acquisition of Altanova on July 29 and acquired Phenix assets on August 9; both are intended for USG. Their 2020 annual sales were approximately $30 million and $25 million, respectively. The filing does not state transaction consideration.
- Other notable items: Q3 included $0.5 million of Doble Morgan Schaffer facility consolidation charges; year-to-date other income included an approximately $2 million final settlement related to the sale of the Doble Watertown building. A new share repurchase program, authorized August 5, permits purchases up to the lesser of $200 million or credit-agreement limits through September 30, 2024; it does not require repurchases.
- Management said ordinary-course claims, litigation, and environmental matters were adequately reserved, insured, or not expected to have a material adverse effect. The filing identifies risks including COVID-19 effects, customer orders and government funding, supply and labor constraints, acquisition integration, and potential environmental costs.
Controls and unusual reporting matters
- Disclosure controls were deemed ineffective as of June 30, 2021 because of material weaknesses at an A&D reporting unit involving controls over revenue recognition and inventory costing and valuation. Remediation actions include enhanced procedures, training, and additional risk-assessment resources; the weaknesses will not be considered remediated until controls operate effectively for a sufficient period.
- The company identified and corrected immaterial Westland errors: $3.5 million of sales had been overstated and $2.1 million of inventory overstated/cost of sales understated across specified 2020 and 2021 quarters. Management said the revisions were not material to prior periods or the current fiscal year and did not change total operating cash flow.
Important facts for investors to verify
- Progress and demonstrated effectiveness of remediation for the A&D internal-control material weaknesses, and any further revisions or disclosures.
- Westland’s operating performance, production and quality issues, and the valuation cushion for Westland and Mayday goodwill.
- Whether backlog converts to revenue as expected, alongside order trends and recovery in commercial aerospace and COVID-affected services.
- Integration, funding, and results of the Altanova and Phenix acquisitions; the filing gives no purchase price.
- Debt repayment plans, liquidity needs, and any actual share repurchases under the new authorization.