ESCO Technologies Inc. — Q1 FY2021 Form 10-Q
Reporting period: Three months ended December 31, 2020; comparisons are with the three months ended December 31, 2019. Amounts are in U.S. dollars unless otherwise noted.
Business context and results
ESCO operates in Aerospace & Defense (A&D), Utility Solutions Group (USG), and Test. The company reported continuing operations; prior-year net earnings included a large gain on the sale of discontinued operations.
| Metric | Q1 FY2021 | Q1 FY2020 |
|---|---|---|
| Net sales | $162.9 million | $171.7 million |
| EBIT | $18.2 million | $16.8 million |
| EBIT margin | 11.2% | 9.8% |
| Earnings from continuing operations | $13.7 million | $10.8 million |
| Diluted EPS from continuing operations | $0.52 | $0.41 |
| Net earnings | $13.7 million | $86.8 million |
| Operating cash flow, continuing operations | $24.8 million | $3.3 million |
Material changes and segment performance
- Sales fell $8.8 million, or 5.1%, mainly because A&D sales declined $10.6 million (13.7%). Commercial aerospace sales at PTI, Crissair, and Mayday fell about $14 million, partly offset by $4 million of higher Navy and space sales.
- USG sales increased 3.2% to $54.5 million; segment EBIT rose to $12.7 million from $9.3 million, reflecting higher volume and favorable mix.
- Test sales were nearly flat at $41.5 million; EBIT increased to $5.3 million from $4.7 million, primarily on favorable mix and higher international sales.
- A&D EBIT declined to $9.4 million from $12.5 million as lower volumes outweighed gains elsewhere in the segment. Segment margins were 14.0% versus 16.1%.
- Continuing-operations earnings and EPS improved despite lower sales. Lower interest expense and reduced corporate pension expense contributed; interest expense was $0.5 million versus $2.4 million.
- Prior-year net earnings included $76.6 million after tax from the discontinued-operations sale. The reported year-over-year net earnings decline therefore does not reflect continuing-operations performance.
Cash, liquidity, debt, and other financial items
- Cash and equivalents were $57.4 million at December 31, 2020, up from $52.6 million at September 30, 2020. Working capital was $197.6 million, versus $190.6 million.
- Cash from continuing operations was $24.8 million. Continuing-operations capital expenditures were $6.0 million, with a further $1.6 million spent on capitalized software. Inventories rose $7.9 million from fiscal year-end.
- Total borrowings were $55.8 million, including $21.8 million classified as current; long-term debt was $34.0 million. The company stated it intended to repay $20 million within 12 months, though it had no contractual obligation to do so.
- Approximately $434 million remained available under the $500 million revolving credit facility, plus a $250 million increase option subject to lender approval. Outstanding letters of credit were $9.9 million. The company reported compliance with all credit covenants.
- Backlog was $512.1 million, down from $517.4 million at September 30, 2020. First-quarter orders were $157.6 million, compared with $220.4 million a year earlier. The company expected to recognize approximately 72% of remaining performance obligations over the next 12 months.
- ESCO acquired ATM, a precision-machining business serving aerospace, defense, and space, for approximately $6.5 million net of acquired cash. ATM has annual revenue of approximately $7 million.
- A quarterly dividend of $0.08 per share was paid in October; another $0.08 per share was paid in January after quarter-end.
Outlook, risks, and contingencies
ESCO continued to suspend specific full-year guidance because of uncertainty around COVID-19 and the timing and pace of recovery in commercial aerospace and utility markets. Management described tangible signs of recovery for the second half of fiscal 2021 and expected full-year sales, Adjusted EBITDA, and Adjusted EPS to grow versus 2020; Adjusted EBITDA and Adjusted EPS were expected to be reasonably consistent with 2019. Management expected the first half of 2021 to be slightly below the first half of 2020. These are directional expectations, not quantified guidance.
- COVID-19 adversely affected commercial aerospace demand and caused a partial shutdown of the Westland facility for several weeks. Management said supply chains had not been materially affected to date.
- No impairment was recorded in the quarter. However, Mayday’s fair value exceeded carrying value by slightly less than 10%, with $30 million of goodwill recorded; further adverse changes in estimates could trigger impairment.
- The company disclosed ordinary-course claims, litigation, and environmental investigations and remediation. Management believed related costs were reserved, insured, or not expected to materially adversely affect the company.
- Other stated risks include pandemic-related operating and supply disruptions, customer orders and government funding, economic conditions, raw-material availability and cost, interest and foreign-exchange movements, environmental matters, litigation outcomes, and integration of acquisitions.
- Disclosure controls were deemed effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether commercial aerospace demand and the Westland facility recover as assumed, and how this affects A&D sales, margins, and Mayday goodwill valuation.
- Whether the expected second-half recovery supports management’s directional full-year growth expectations, given the suspension of specific guidance.
- Whether order intake stabilizes and backlog converts to revenue as expected; first-quarter orders were substantially below the prior-year quarter.
- Whether operating cash flow remains strong as inventory increased and the company executes its planned debt repayment and ATM integration.
- How much of the prior-year earnings comparison is attributable to the discontinued-operations sale; continuing-operations results are the more comparable measure.