ESCO Technologies Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2020. Dollar amounts are in U.S. dollars. The filing is unaudited.
Business context and reporting period
ESCO reports three continuing segments: Aerospace & Defense (A&D), Test, and Utility Solutions Group (USG). Its Technical Packaging business was sold on December 31, 2019 and is presented as discontinued operations. The company renamed its Filtration/Fluid Flow segment A&D; its operations and historical results were unchanged.
Financial results and key metrics
| Metric | Three months ended June 30, 2020 | Nine months ended June 30, 2020 |
|---|---|---|
| Net sales, continuing operations | $172.7 million; down 3.1% year over year | $524.9 million; up 2.3% |
| EBIT and EBIT margin | $23.3 million; 13.5% | $61.5 million; 11.7% |
| Earnings from continuing operations | $18.7 million; diluted EPS $0.72 | $47.3 million; diluted EPS $1.81 |
| Net earnings, including discontinued operations | $18.7 million | $123.3 million; diluted EPS $4.72 |
Quarterly continuing-operations earnings were $19.0 million and diluted EPS was $0.73 in the prior-year quarter. Nine-month continuing-operations earnings and diluted EPS declined from $54.2 million and $2.07. The 2020 nine-month total net earnings included a $76.6 million after-tax gain on the Technical Packaging sale; the 2019 comparison included discontinued-operation earnings.
For the nine months, continuing-operations operating cash flow was $53.8 million, versus $31.7 million in 2019. Total operating cash flow, including discontinued operations, was $39.0 million. Capital expenditures were $28.3 million and capitalized software additions were $6.6 million. Sale proceeds from the divested business were $183.8 million. Cash increased to $104.7 million from $61.8 million at September 30, 2019.
At June 30, total borrowings were $151.6 million, including $130.0 million of long-term debt; net debt was approximately $46.8 million. The company had approximately $340 million available under its revolving credit facility and $104.7 million in cash. An additional $250 million facility increase is subject to lender approval. The company reported covenant compliance and no contractual debt repayment obligation before the facility matures in September 2024.
Working capital from continuing operations was $271.1 million, up from $229.8 million at September 30, 2019. The company paid $10 million in pension contributions during the quarter. Dividends remained $0.08 per share per quarter.
Material changes versus the prior comparable period
- Third-quarter sales decreased by $5.6 million, primarily because USG sales fell $10.3 million; A&D and Test sales increased $1.0 million and $3.7 million, respectively.
- Nine-month sales increased by $12.0 million, led by A&D growth of $27.9 million, partly offset by an $18.4 million USG decline.
- Quarterly EBIT declined to $23.3 million from $25.5 million. A&D EBIT fell to $17.4 million from $19.0 million, Test EBIT rose to $7.2 million from $5.9 million, and USG EBIT declined to $6.2 million from $10.1 million.
- Nine-month USG EBIT was $20.3 million versus $40.5 million, reflecting weaker Doble sales and the prior-year period’s approximately $8 million gain on a property sale. Nine-month A&D and Test EBIT increased.
- SG&A declined to $36.9 million for the quarter, mainly due to lower discretionary spending; amortization increased, mainly due to the Globe acquisition and capitalized software.
- Total borrowings declined from $285.0 million at September 30, 2019, following $145 million of principal payments during the nine-month period.
Outlook, management commentary, risks, and unusual items
- ESCO suspended its fiscal 2020 financial guidance, citing uncertainty about the extent and duration of COVID-19 disruptions. Management said businesses remained operational and supply chains had not been materially affected to date.
- COVID-19 effects varied by segment: commercial aerospace was weakening; Test faced delayed customer-site installations and a temporary China facility shutdown; and USG customers deferred orders, maintenance work, and Doble services. Management expected USG softness to continue for several quarters, while it expected A&D defense and Test activity to be supported by backlog and served markets.
- Management cited approximately $4 million, $6 million, and $7 million of third-quarter revenue shortfalls versus April expectations in A&D, Test, and USG, respectively. It also reported cost-control steps, including reduced discretionary spending, hiring and salary freezes, and lower planned capital spending.
- Remaining performance obligations were $550.5 million at June 30; the company expected to recognize approximately 72% as revenue within twelve months. Third-quarter orders were $157.8 million, versus $170.7 million a year earlier; nine-month orders rose to $623.9 million from $561.3 million.
- COVID-19 prompted impairment reviews of certain A&D and NRG reporting units; no impairment was recorded. Mayday’s estimated fair value exceeded carrying value by 8%, with $30 million of goodwill, and NRG’s by 10%, with $8 million of goodwill. Changes in cash-flow estimates could result in future impairment charges.
- The Technical Packaging divestiture generated approximately $184 million in net proceeds and a $76.6 million after-tax gain. The company finalized the working-capital adjustment and paid the buyer $0.2 million in the quarter.
- The filing describes ordinary-course litigation, claims, and environmental matters; management said the expected aggregate costs were reserved, insured, or not expected to have a material adverse effect. COVID-19, customer or government contract delays or cancellations, supply-chain disruption, and uncertainty in served markets remain key risks.
- ESCO adopted lease accounting standard ASC 842 on October 1, 2019, recording approximately $20 million of right-of-use assets and lease liabilities at adoption, with no significant effect on earnings or cash flows.
Important facts for investors to verify
- Whether COVID-19-related demand weakness, especially in commercial aerospace and USG, persists or worsens, and how it affects margins and cash generation.
- Whether the Mayday and NRG valuation cushions remain adequate as forecasts change, and whether any impairment is recorded in later periods.
- How much of the $550.5 million performance-obligation balance converts to revenue on the expected schedule, and whether order trends remain strong.
- Reconcile reported nine-month net earnings with continuing-operations performance: the $76.6 million divestiture gain substantially increased total net earnings.
- Confirm available borrowing capacity and covenant headroom; the additional $250 million facility option requires lender approval.