ESCO 10Q 2020 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)


	☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2020


	☐	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 1-10596

ESCO TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)


MISSOURI	43-1554045
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

9900A CLAYTON ROAD
ST. LOUIS, MISSOURI	63124-1186
(Address of principal executive offices)	(Zip Code)

(314) 213-7200

(Registrant’s telephone number, including area code)

Securities registered pursuant to section 12(b) of the Act:

		Name of each exchange
Title of each class	Trading Symbol(s)	on which registered
Common Stock, par value $0.01 per share	ESE	New York Stock Exchange

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒	Accelerated filer	☐

Non-accelerated filer	☐	Smaller reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class		Shares outstanding at July 31, 2020
Common stock, $.01 par value per share		26,037,714

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share amounts)


	Three Months Ended
	June 30,
	2020		2019

Net sales	$	172,665	178,259
Costs and expenses:
Cost of sales		107,686	105,036
Selling, general and administrative expenses		36,936	41,226
Amortization of intangible assets		5,535	4,445
Interest expense, net		1,523	1,878
Other (income) expenses, net		(824)	2,007
Total costs and expenses		150,856	154,592

Earnings before income taxes		21,809	23,667
Income tax expense		3,122	4,622
Earnings from continuing operations		18,687	19,045
Earnings from discontinued operations, net of tax expense of $203		—	1,022

Net earnings	$	18,687	20,067

Earnings per share:
Basic - Continuing operations	$	0.72	0.73
- Discontinued operations		—	0.04
- Net earnings	$	0.72	0.77

Diluted - Continuing operations	$	0.72	0.73
- Discontinued operations		—	0.04
- Net earnings	$	0.72	0.77

See accompanying notes to consolidated financial statements.

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share amounts)


	Nine Months Ended
	June 30,
	2020		2019
Net sales	$	524,885	512,867
Costs and expenses:
Cost of sales		327,655	311,037
Selling, general and administrative expenses		119,023	119,093
Amortization of intangible assets		16,565	13,216
Interest expense, net		5,264	5,586
Other expenses (income), net		174	(3,350)
Total costs and expenses		468,681	445,582

Earnings before income taxes		56,204	67,285
Income tax expense		8,931	13,068
Earnings from continuing operations		47,273	54,217
(Loss) earnings from discontinued operations, net of tax expense of $269 and $255		(601)	1,964
Gain on sale of discontinued operations, net of tax expense of $23,734		76,614	—
Earnings from discontinued operations		76,013	1,964

Net earnings	$	123,286	56,181

Earnings per share:
Basic - Continuing operations	$	1.82	2.09
- Discontinued operations		2.92	0.08
- Net earnings	$	4.74	2.17

Diluted - Continuing operations	$	1.81	2.07
- Discontinued operations		2.91	0.08
- Net earnings	$	4.72	2.15

See accompanying notes to consolidated financial statements.

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)


	Three Months Ended			Nine Months Ended
	June 30,			June 30,
	2020		2019	2020		2019
Net earnings	$	18,687	20,067		123,286	56,181
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments		2,802	1,840		(160)	(2,013)
Net unrealized (loss) gain on derivative instruments		—	(7)		—	94
Total other comprehensive income (loss), net of tax		2,802	1,833		(160)	(1,919)
Comprehensive income	$	21,489	21,900		123,126	54,262

See accompanying notes to consolidated financial statements.

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)


	June 30,		September 30,
	2020		2019
ASSETS
Current assets:
Cash and cash equivalents	$	104,739		61,808
Accounts receivable, net		138,080		158,715
Contract assets		101,533		110,211
Inventories, net		152,264		124,956
Other current assets		16,868		14,190
Assets of discontinued operations – current		—		25,314
Total current assets		513,484		495,194
Property, plant and equipment, net of accumulated depreciation of $127,311 and $113,520, respectively		141,461		127,843
Intangible assets, net of accumulated amortization of $123,812 and $107,247, respectively		370,100		381,605
Goodwill		389,942		390,256
Operating lease assets		18,351		—
Other assets		11,247		4,445
Assets of discontinued operations - other		—		67,377
Total assets	$	1,444,585		1,466,720

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt and short-term borrowings	$	21,577		20,000
Accounts payable		54,305		63,800
Contract liabilities		87,421		81,177
Accrued salaries		29,137		37,194
Accrued other expenses		49,975		37,947
Liabilities of discontinued operations - current		—		11,517
Total current liabilities		242,415		251,635
Pension obligations		13,114		22,682
Deferred tax liabilities		65,954		60,856
Non-current operating lease liabilities		14,357		—
Other liabilities		35,288		36,326
Long-term debt		130,000		265,000
Liabilities of discontinued operations - other		—		3,999
Total liabilities		501,128		640,498
Shareholders’ equity:
Preferred stock, par value $.01 per share, authorized 10,000,000 shares		—		—
Common stock, par value $.01 per share, authorized 50,000,000 shares, issued 30,645,625 and 30,596,940 shares, respectively		307		306
Additional paid-in capital		292,631		292,408
Retained earnings		801,787		684,741
Accumulated other comprehensive loss, net of tax		(44,134)		(43,974)
		1,050,591		933,481
Less treasury stock, at cost: 4,607,911 and 4,615,627 common shares, respectively		(107,134)		(107,259)
Total shareholders’ equity		943,457		826,222
Total liabilities and shareholders’ equity	$	1,444,585		1,466,720

See accompanying notes to consolidated financial statements.

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)


	Nine Months Ended
	June 30,
	2020		2019
Cash flows from operating activities:
Net earnings	$	123,286	56,181
Earnings from discontinued operations		(76,013)	(1,964)
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		31,066	25,802
Stock compensation expense		4,184	3,685
Changes in assets and liabilities		(20,926)	(42,528)
Change in property, plant and equipment due to gain on sale of building		—	(8,922)
Pension contributions		(10,000)	(2,500)
Effect of deferred taxes		2,155	1,983
Net cash provided by operating activities – continuing operations		53,752	31,737
Net cash (used) provided by operating activities – discontinued operations		(14,737)	5,304
Net cash provided by operating activities		39,015	37,041

Cash flows from investing activities:
Proceeds from sale of building and land		—	17,201
Additions to capitalized software		(6,564)	(6,207)
Capital expenditures		(28,291)	(15,280)
Net cash used by investing activities – continuing operations		(34,855)	(4,286)
Proceeds from sale of discontinued operations		183,812	—
Acquisition of business – discontinued operations		—	(937)
Capital expenditures – discontinued operations		(1,728)	(11,177)
Net cash provided (used) by investing activities – discontinued operations		182,084	(12,114)
Net cash provided (used) by investing activities		147,229	(16,400)
Cash flows from financing activities:
Proceeds from long-term debt and short-term borrowings		11,577	32,000
Principal payments on long-term debt		(145,000)	(35,000)
Dividends paid		(6,240)	(6,227)
Other		(3,127)	(3,230)
Net cash used by financing activities – continuing operations		(142,790)	(12,457)
Net cash (used) provided by financing activities – discontinued operations		(2,140)	921
Net cash used by financing activities		(144,930)	(11,536)
Effect of exchange rate changes on cash and cash equivalents		1,617	(626)
Net increase in cash and cash equivalents		42,931	8,479
Cash and cash equivalents, beginning of period		61,808	30,477
Cash and cash equivalents, end of period	$	104,739	38,956

Supplemental cash flow information:
Interest paid	$	4,669	5,556
Income taxes paid (including state and foreign)		23,435	18,513

See accompanying notes to consolidated financial statements.

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying consolidated financial statements, in the opinion of management, include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results for the interim periods presented. The consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all the disclosures required for annual financial statements by accounting principles generally accepted in the United States of America (GAAP). For further information, refer to the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019. Certain 2019 amounts have been reclassified to conform with the 2020 presentation.

The Company’s results for the three-month period ended June 30, 2020 are not necessarily indicative of the results for the entire 2020 fiscal year. References to the third quarters of 2020 and 2019 represent the fiscal quarters ended June 30, 2020 and 2019, respectively. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ from those estimates.

Beginning in the first quarter of 2020, Management has renamed the Filtration / Fluid Flow (Filtration) segment as Aerospace & Defense (A&D) to better reflect the composition of the segment’s products, end markets and customer characteristics. The A&D segment’s individual legal and operating entities, historical financial results, and management structure are unchanged from what was formerly presented as Filtration.

2. TECHNICAL PACKAGING DIVESTITURE

On December 31, 2019, the Company completed the sale of its Technical Packaging business segment, consisting of the Company's wholly-owned subsidiaries Thermoform Engineered Quality LLC, Plastique Ltd. and Plastique sp. z o.o. (the "Technical Packaging Business"), to Sonoco Plastics, Inc. and Sonoco Holdings, Inc. ("Buyers"), 2 wholly-owned subsidiaries of Sonoco Products Company, pursuant to the Equity Purchase Agreement entered into on November 15, 2019. The companies within this segment provide innovative solutions to the medical and commercial markets for thermoformed packages and specialty products using a wide variety of thin gauge plastics and pulp. Results of operations, financial position and cash flows for the Technical Packaging business is reflected as discontinued operations in the consolidated financial statements and related notes for all periods presented.

Net sales from the Technical Packaging business were 0 and $16.5 million in the third quarter and first nine months of 2020, respectively, compared to $21.5 million and $63.4 million in the corresponding periods of 2019. The Company received net proceeds from the sale of approximately $184 million and recorded a $76.6 million after-tax gain on the sale in the first quarter of 2020. The Company finalized the working capital adjustment and paid $0.2 million to the buyer during the third quarter of 2020.

The major classes of assets and liabilities of the Technical Packaging business included in the Consolidated Balance Sheet at September 30, 2019 are shown below (in millions).


	September 30, 2019
Assets:
Accounts receivable, net	$	15.7
Contract assets, net		5.1
Inventories		3.9
Other current assets		0.6
Current assets		25.3
Property, plant & equipment, net		33.6
Intangible assets, net		11.4
Goodwill		19.0
Other assets		3.4
Total assets	$	92.7
Liabilities:
Accounts payable	$	7.6
Accrued expenses and other current liabilities		3.9
Current liabilities		11.5
Other liabilities		4.0
Total liabilities	$	15.5

3. ACCOUNTING STANDARDS UPDATE

In February 2016, the FASB issued ASU No. 2016-062, "Leases" (ASU 2016-062) which supersedes ASC 840, "Leases" and creates a new topic, ASC 842, "Leases." Subsequent to the issuance of ASU 2016-062, ASC 842 was amended by various updates that amend and clarify the impact and implementation of the aforementioned update. Effective October 1, 2019, the Company adopted these updates using the optional transition method. These updates require lessees to recognize a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months on its balance sheet. Upon initial application, the provisions of these updates are required to be applied using the modified retrospective method, which requires retrospective adoption to each prior reporting period presented with the cumulative effect of adoption recorded to the earliest reporting period presented. An optional transition method can be utilized which requires retrospective adoption beginning on the date of adoption with the cumulative effect of initially applying these updates recognized at the date of initial adoption. The standard also provided several optional practical expedients for use in transition. The Company elected to use what the FASB has deemed the “package of practical expedients,” which allowed the Company not to reassess previous conclusions regarding lease identification, lease classification and the accounting treatment for initial direct costs. These updates also expand the required quantitative and qualitative disclosures surrounding leases. The adoption resulted in the addition of "right of use" assets and lease liabilities of approximately $20 million in the consolidated balance sheet, with no significant change to the Company’s consolidated statements of operations or cash flows. Refer to Note 16 for further discussion.

4. EARNINGS PER SHARE (EPS)

Basic EPS is calculated using the weighted average number of common shares outstanding during the period. Diluted EPS is calculated using the weighted average number of common shares outstanding during the period plus shares issuable upon the assumed exercise of dilutive common share options and vesting of performance-accelerated restricted shares (restricted shares) by using the treasury stock method. The number of shares used in the calculation of earnings per share for each period presented is as follows (in thousands):


	Three Months Ended		Nine Months Ended
	June 30,		June 30,
	2020	2019	2020	2019
Weighted Average Shares Outstanding - Basic	26,031	25,971	26,002	25,935
Dilutive Options and Restricted Shares	103	138	128	155
Adjusted Shares - Diluted	26,134	26,109	26,130	26,090

5. SHARE-BASED COMPENSATION

The Company provides compensation benefits to certain key employees under several share-based plans providing for performance-accelerated restricted shares (restricted shares), and to non-employee directors under a non-employee directors compensation plan.

Performance-Accelerated Restricted Share Awards

Compensation expense related to the restricted share awards was $1.0 million and $3.2 million for the three and nine-month periods ended June 30, 2020, respectively, and $1.1 million and $3.1 million for the corresponding periods in 2019. There were 221,024 non-vested shares outstanding as of June 30, 2020.

Non-Employee Directors Plan

Compensation expense related to the non-employee director grants was $0.3 million and $1.0 million for the three and nine-month periods ended June 30, 2020, respectively, and $0.3 million and $0.8 million for the corresponding periods in 2019.

The total share-based compensation cost that has been recognized in the results of operations and included within selling, general and administrative expenses (SG&A) was $1.3 million and $4.2 million for the three and nine-month periods ended June 30, 2020, respectively, and $1.3 million and $3.9 million for the corresponding periods in 2019. The total income tax benefit recognized in results of operations for share-based compensation arrangements was $0.2 million and $0.9 million for the three and nine-month periods ended June 30, 2020, respectively, and $0.2 million and $0.8 million for the corresponding periods in 2019. As of June 30, 2020, there was $9.2 million of total unrecognized compensation cost related to share-based compensation arrangements. That cost is expected to be recognized over a remaining weighted-average period of 2.2 years.

6. INVENTORIES

Inventories, net, from continuing operations consist of the following:


	June 30,		September 30,
(In thousands)	2020		2019
Finished goods	$	26,706	23,550
Work in process		43,569	26,407
Raw materials		81,989	74,999
Total inventories	$	152,264	124,956

7. GOODWILL AND OTHER INTANGIBLE ASSETS

Included on the Company’s Consolidated Balance Sheets at June 30, 2020 and September 30, 2019 are the following intangible assets gross carrying amounts and accumulated amortization from continuing operations:


	June 30,		September 30,
(Dollars in thousands)	2020		2019
Goodwill	$	389,942	390,256

Intangible assets with determinable lives:
Patents
Gross carrying amount	$	2,079	1,945
Less: accumulated amortization		832	748
Net	$	1,247	1,197

Capitalized software
Gross carrying amount	$	85,528	78,962
Less: accumulated amortization		55,315	48,530
Net	$	30,213	30,432

Customer relationships
Gross carrying amount	$	227,095	227,225
Less: accumulated amortization		64,562	55,326
Net	$	162,533	171,899

Other
Gross carrying amount	$	5,129	5,441
Less: accumulated amortization		3,105	2,645
Net	$	2,024	2,796
Intangible assets with indefinite lives:
Trade names	$	174,083	175,281

The changes in the carrying amount of goodwill attributable to each business segment for the nine months ended June 30, 2020 is as follows on a continuing operations basis:


				Aerospace
(Dollars in millions)	USG		Test	& Defense	Total
Balance as of September 30, 2019	$	254.0	34.1	102.2	390.3
Foreign currency translation		(0.3)	(0.1)	—	(0.4)
Balance as of June 30, 2020	$	253.7	34.0	102.2	389.9

The economic uncertainty, changes in the propensity for the general public to travel by air, and reductions in demand for commercial aircraft as a result of the COVID-19 pandemic have adversely impacted net sales and operating results in certain of our Aerospace and Defense reporting units and was determined to be an event and change in circumstances that required a quantitative review of goodwill and other intangible assets for impairment. The determination of the fair value of reporting units is based, among other things, on estimates of future operating performance of the reporting unit being valued. The Company's methodology includes the use of an income approach that discounts future net cash flows to their present value at a rate that reflects the Company's cost of capital. These estimated fair values are based on estimates of future cash flows of the businesses. Factors affecting these future cash flows include the continued market demand for, and acceptance of, the products and services offered by the businesses, the development of new products and services by the businesses and the underlying cost of development, the future cost structure of the businesses and future technological changes. The Company also incorporates market multiples for comparable companies in determining the fair value of its reporting units where applicable. The quantitative review determined that there was 0 impairment during the three and nine months ended June 30, 2020. Due to similar and other challenges in our NRG reporting unit, a quantitative review of goodwill and other intangible assets for impairment was performed. The Company determined that there was no impairment during the three and nine months ended June 30, 2020.

8. BUSINESS SEGMENT INFORMATION

The Company is organized based on the products and services that it offers, and classifies its continuing business operations in three reportable segments for financial reporting purposes: Aerospace & Defense (formerly called Filtration/Fluid Flow), RF Shielding and Test (Test), and Utility Solutions Group (USG). The Aerospace & Defense segment’s operations consist of PTI Technologies Inc. (PTI), VACCO Industries (VACCO), Crissair, Inc. (Crissair), Westland Technologies Inc. (Westland), Mayday Manufacturing Co. and its affiliate Hi-Tech Metals, Inc. (collectively referred to as Mayday) and Globe Composite Solutions, LLC (Globe). The companies within this segment primarily design and manufacture specialty filtration and naval products, including hydraulic filter elements and fluid control devices used in commercial aerospace applications; unique filter mechanisms used in micro-propulsion devices for satellites and custom designed filters for manned aircraft and submarines; products and systems to reduce vibration and/or acoustic signatures and otherwise reduce or obscure a vessel’s signature, and other communications, sealing, surface control and hydrodynamic related applications to enhance U.S. Navy maritime survivability; precision-tolerance machined components for the aerospace and defense industry; and metal processing services.

The Test segment’s operations consist primarily of ETS-Lindgren Inc. (ETS-Lindgren). ETS-Lindgren is an industry leader in providing its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy. ETS-Lindgren also manufactures radio frequency shielding products and components used by manufacturers of medical equipment, communications systems, electronic products, and shielded rooms for high-security data processing and secure communication.

The USG segment’s operations consist primarily of Doble Engineering Company (Doble), Morgan Schaffer Inc. (Morgan Schaffer), and NRG Systems, Inc. (NRG). Doble provides high-end, intelligent, diagnostic test and data management solutions for the electric power delivery industry and is a leading supplier of partial discharge testing instruments used to assess the integrity of high voltage power delivery equipment. Morgan Schaffer provides an integrated offering of dissolved gas analysis, oil testing, and data management solutions for the electric power industry. NRG designs and manufactures decision support tools for the renewable energy industry, primarily wind.

Management evaluates and measures the performance of its reportable segments based on “Net Sales” and “EBIT”, which are detailed in the table below. EBIT is defined as earnings from continuing operations before interest and taxes. The table below is presented on the basis of continuing operations and excludes discontinued operations.


	Three Months Ended			Nine Months Ended
	June 30,			June 30,
(In thousands)	2020		2019	2020	2019
NET SALES
Aerospace & Defense	$	84,072	83,067	256,707	228,769
Test		46,016	42,298	128,999	126,459
USG		42,577	52,894	139,179	157,639
Consolidated totals	$	172,665	178,259	524,885	512,867

EBIT
Aerospace & Defense	$	17,409	19,039	51,658	47,092
Test		7,177	5,927	17,483	14,791
USG		6,156	10,148	20,310	40,461
Corporate (loss)		(7,410)	(9,569)	(27,983)	(29,473)
Consolidated EBIT		23,332	25,545	61,468	72,871
Less: Interest expense		(1,523)	(1,878)	(5,264)	(5,586)
Earnings before income taxes	$	21,809	23,667	56,204	67,285

Non-GAAP Financial Measures

The financial measure “EBIT” is presented in the above table and elsewhere in this Report. EBIT on a consolidated basis is a non-GAAP financial measure. Management believes that EBIT is useful in assessing the operational profitability of the Company’s business segments because it excludes interest and taxes, which are generally accounted for across the entire Company on a consolidated basis. EBIT is also one of the measures used by management in determining resource allocations within the Company as well as incentive compensation. A reconciliation of EBIT to net earnings from continuing operations is set forth in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations – EBIT.

The Company believes that the presentation of EBIT provides important supplemental information to investors to facilitate comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results. However, the Company’s non-GAAP financial measures may not be comparable to other companies’ non-GAAP financial performance measures. Furthermore, the use of non-GAAP financial measures is not intended to replace any measures of performance determined in accordance with GAAP.

9. DEBT

The Company’s debt is summarized as follows:


	June 30,		September 30,
(In thousands)	2020		2019
Total borrowings	$	151,577	285,000
Current portion of long-term debt and short-term borrowings		(21,577)	(20,000)
Total long-term debt, less current portion	$	130,000	265,000

On September 27, 2019, the Company entered into a new five-year credit facility (“the Credit Facility”), modifying its previous credit facility which would have matured December 21, 2020. The Credit Facility includes a $500 million revolving line of credit, as well as provisions allowing for the increase of the credit facility commitment amount by an additional $250 million, if necessary, with the consent of the lenders. The bank syndication supporting the facility is comprised of a diverse group of eight banks led by JP Morgan Chase Bank, N.A., as Administrative Agent. The Credit Facility matures September 27, 2024.

At June 30, 2020, the Company had approximately $340 million available to borrow under the Credit Facility, plus the $250 million increase option, subject to lender approval, in addition to $104.7 million cash on hand. The Company classified $20.0 million as the current portion of long-term debt as of June 30, 2020, as the Company intends to repay this amount within the next twelve months; however, the Company has no contractual obligation to repay such amount during the next twelve months. The letters of credit issued and outstanding under the Credit Facility totaled $9.9 million at June 30, 2020.

Interest on borrowings under the Credit Facility is calculated at a spread over either the London Interbank Offered Rate (LIBOR ), the New York Federal Reserve Bank Rate or the prime rate, depending on various factors. The Credit Facility also requires a facility fee ranging from 10 to 25 basis points per annum on the unused portion. The Credit Facility is secured by the unlimited guaranty of the Company’s direct and indirect material U.S. subsidiaries and the pledge of 100% of the equity interests of its direct and indirect material foreign subsidiaries. The financial covenants of the Credit Facility include a leverage ratio and an interest coverage ratio. The weighted average interest rates were 3.24% and 3.22% for the three and nine-month periods ending June 30, 2020, respectively , and 3.21% and 3.22% for the three and nine-month periods ending June 30, 2019. As of June 30, 2020, the Company was in compliance with all covenants.

10. INCOME TAX EXPENSE

The third quarter 2020 effective income tax rate from continuing operations was 14.3% compared to 19.5% in the third quarter of 2019. The effective income tax rate in the first nine months of 2020 was 15.9% compared to 19.4% for the first nine months of 2019. The income tax expense in the third quarter and first nine months of 2020 was favorably impacted by the following items: 1) additional tax benefits on share-based compensation that vested during the quarter decreasing the third quarter and year-to-date effective tax rate by 1.4% and 0.6%, respectively; 2) research credits and other 2019 tax return to provision true-ups decreasing the third quarter and year-to-date effective tax rate by 1.6% and 0.6%, respectively; and 3) an increase in the available 2019 and 2020 foreign tax credit which was attributable to new information and tax planning strategies, for which the combined effect was a 6.3% reduction in the third quarter effective tax rate and a 2.4% reduction in the year-to-date effective tax rate. The income tax expense was favorably impacted in the second quarter of 2020 by the release of a valuation allowance of $2.8 million for foreign net operating losses decreasing the year-to-date effective tax rate by 5.1%.

The income tax expense in the third quarter and first nine months of 2019 was favorably impacted by tax planning strategies to increase the foreign tax credits claimed retrospectively. The Company reduced the valuation allowance for excess foreign tax credits by $2.4 million ($2.3 million in the second quarter of 2019 and $0.1 million in the third quarter of 2019) and recorded an amended return receivable of $0.3 million ($0.2 million in the second quarter of 2019 and $0.1 million in the third quarter of 2019) which favorably impacted the third quarter and year-to-date effective tax rate of 2019 by 1.4% and 4.3%, respectively. Income tax expense in the third quarter and first nine months of 2019 was also favorably impacted by additional tax benefits on share-based compensation that vested during the quarter decreasing the effective tax rate by 1.8% and 0.6%, respectively. A non-automatic accounting method change filed with the 2018 tax return was approved by the Internal Revenue Service during the third quarter of 2019 and favorably impacted the third quarter and year-to-date effective tax rate by 1.1% and 0.4%, respectively.

11. SHAREHOLDERS’ EQUITY

The change in shareholders’ equity for the first three and nine months of 2020 and 2019 is shown below (in thousands):


	Three Months Ended June 30,		Nine Months Ended June 30,
	2020	2019	2020	2019

Common stock
Beginning balance	306	305	306	305
Stock plans	1	1	1	1
Ending balance	307	306	307	306

Additional paid-in-capital
Beginning balance	294,787	293,612	292,408	291,190
Stock plans	(2,156)	(2,408)	223	14
Ending balance	292,631	291,204	292,631	291,204

Retained earnings
Beginning balance	785,184	643,018	684,741	606,836
Net earnings common stockholders	18,687	20,067	123,286	56,181
Dividends paid	(2,084)	(2,082)	(6,240)	(6,227)
Adoption of accounting standards updates	—	—	—	4,213
Ending balance	801,787	661,003	801,787	661,003

Accumulated other comprehensive income (loss)
Beginning balance	(46,936)	(35,280)	(43,974)	(31,528)
Foreign currency translation	2,802	1,840	(160)	(2,013)
Pension	—	—	—	—
Forward exchange contracts	—	(7)	—	94
Ending balance	(44,134)	(33,447)	(44,134)	(33,447)

Treasury stock
Beginning balance	(107,134)	(107,259)	(107,259)	(107,394)
Issued under stock plans	—	—	125	135
Ending balance	(107,134)	(107,259)	(107,134)	(107,259)

Total equity	943,457	811,807	943,457	811,807

12. RETIREMENT PLANS

A summary of net periodic benefit expense for the Company’s defined benefit plans for the three and nine-month periods ended June 30, 2020 and 2019 is shown in the following table. Net periodic benefit cost for each period presented is comprised of the following:


	Three Months Ended			Nine Months Ended
	June 30,			June 30,
(In thousands)	2020		2019	2020		2019
Defined benefit plans
Interest cost	$	616	875		2,264	2,626
Expected return on assets		(1,067)	(1,086)		(3,149)	(3,259)
Amortization of:
Prior service cost		—	—		—	—
Actuarial loss		715	487		1,801	1,461
Net periodic benefit cost	$	264	276		916	828

13. DERIVATIVE FINANCIAL INSTRUMENTS

Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign currency exchange rates. The Company is exposed to market risk related to changes in interest rates and selectively uses derivative financial instruments, including forward contracts and swaps, to manage these risks. In 2018, the Company entered into three interest rate swaps with a notional amount of $150 million to hedge some of its exposure to variability in future LIBOR-based interest payments on variable rate debt, of which one swap is outstanding as of June 30, 2020. In addition, the Company’s Canadian subsidiary Morgan Schaffer enters into foreign exchange contracts to manage foreign currency risk as a portion of their revenue is denominated in U.S. dollars. The Company expects hedging gains or losses to be essentially offset by losses or gains on the related underlying exposures. The amounts ultimately recognized may differ for open positions, which remain subject to ongoing market price fluctuations until settlement. All derivative instruments are reported in either accrued expenses or other assets on the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the gain or loss on the derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. The interest rate swaps entered into during 2018 were not designated as cash flow hedges and, therefore, the gain or loss on the derivative is reflected in earnings each period.

The following is a summary of the notional transaction amounts and fair values for the Company’s outstanding derivative financial instruments by risk category and instrument type as of June 30, 2020:


	Notional		Fair Value
(In thousands)	amount		(US$)	Fix Rate
Forward contracts	5,000	USD	(106)
Interest rate swap	150,000	USD	(1,485)	2.24	%

14. FAIR VALUE MEASUREMENTS

The accounting guidance establishes a three-level hierarchy for disclosure of fair value measurements, based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, as follows:

●

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

●

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

●

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Financial Assets and Liabilities

The Company has estimated the fair value of its financial instruments as of June 30, 2020 and September 30, 2019 using available market information or other appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, receivables, inventories, payables, debt and other current assets and liabilities approximate fair value because of the short maturity of those instruments.

Fair Value of Financial Instruments

The Company’s forward contracts and interest rate swaps are classified within Level 2 of the valuation hierarchy in accordance with FASB Accounting Standards Codification (ASC) 825, as presented below as of June 30, 2020:


(In thousands)	Level 1		Level 2		Level 3	Total
Assets (Liabilities):
Forward contracts and interest rate swaps	$	—	(1,591)	$	—	(1,591)

Valuation was based on third party evidence of similarly priced derivative instruments.

Nonfinancial Assets and Liabilities

The Company’s nonfinancial assets such as property, plant and equipment, and other intangible assets are not measured at fair value on a recurring basis; however they are subject to fair value adjustments in certain circumstances, such as when there is evidence that an impairment may exist. As more fully described in note 7, events and changes in circumstances for the NRG reporting unit and certain reporting units in our Aerospace & Defense segment resulting from the COVID-19 pandemic required that the property, plant and equipment, and other intangible assets of those businesses be reviewed for impairment. No impairments were recorded during the three and nine-month periods ended June 30, 2020.

15. REVENUES

Disaggregation of Revenues

Revenues by customer type, geographic location, and revenue recognition method for the three and nine-month periods ended June 30, 2020 are presented in the tables below as the Company deems it best depicts how the nature, amount, timing and uncertainty of net sales and cash flows are affected by economic factors. The table below also include a reconciliation of the disaggregated revenue within each reportable segment on a continuing operations basis.


Three Months Ended June 30, 2020	Aerospace
(In thousands)	& Defense		Test		USG		Total
Customer type:
Commercial	$	37,485	$	38,737	$	39,740	$	115,962
U.S. Government		46,587		7,279		2,837		56,703
Total revenues	$	84,072	$	46,016	$	42,577	$	172,665

Geographic location:
United States	$	73,476	$	19,441	$	26,499	$	119,416
International		10,596		26,575		16,078		53,249
Total revenues	$	84,072	$	46,016	$	42,577	$	172,665

Revenue recognition method:
Point in time	$	36,461	$	9,138	$	27,765	$	73,364
Over time		47,611		36,878		14,812		99,301
Total revenues	$	84,072	$	46,016	$	42,577	$	172,665


Nine Months Ended June 30, 2020	Aerospace
(In thousands)	& Defense		Test		USG		Total
Customer type:
Commercial	$	130,817	$	107,931	$	135,711	$	374,459
U.S. Government		125,890		21,068		3,468		150,426
Total revenues	$	256,707	$	128,999	$	139,179	$	524,885

Geographic location:
United States	$	219,640	$	69,399	$	90,155	$	379,194
International		37,067		59,600		49,024		145,691
Total revenues	$	256,707	$	128,999	$	139,179	$	524,885

Revenue recognition method:
Point in time	$	118,660	$	26,157	$	100,289	$	245,106
Over time		138,047		102,842		38,890		279,779
Total revenues	$	256,707	$	128,999	$	139,179	$	524,885

Remaining Performance Obligations

Remaining performance obligations, which is the equivalent of backlog, represent the expected transaction price allocated to contracts that the Company expects to recognize as revenue in future periods when the Company performs under the contracts. These remaining obligations include amounts that have been formally appropriated under contracts with the U.S. Government, and exclude unexercised contract options and potential orders under ordering-type contracts such as Indefinite Delivery, Indefinite Quantity contracts. At June 30, 2020, the Company had $550.5 million in remaining performance obligations of which the Company expects to recognize revenues of approximately 72% in the next twelve months.

Contract assets and liabilities

Assets and liabilities related to contracts with customers are reported on a contract-by-contract basis at the end of each reporting period. At June 30, 2020, contract assets and liabilities totaled $101.5 million and $87.4 million, respectively. During the first nine months of 2020, the Company recognized approximately $47.1 million in revenues that were included in the contract liabilities balance at the adoption date.

16. LEASES

As described in Note 3, effective October 1, 2019, the Company adopted ASC 842, Leases. The Company determines at lease inception whether an arrangement that provides control over the use of an asset is a lease. The Company recognizes at lease commencement a right-of-use (ROU) asset and lease liability based on the present value of the future lease payments over the lease term. The Company has elected not to recognize a ROU asset and lease liability for leases with terms of 12 months or less. Certain of the Company’s leases include options to extend the term of the lease for up to 20 years. When it is reasonably certain that the Company will exercise the option, Management includes the impact of the option in the lease term for purposes of determining total future lease payments. As most of the Company’s lease agreements do not explicitly state the discount rate implicit in the lease, Management uses the Company’s incremental borrowing rate on the commencement date to calculate the present value of future payments based on the tenor of each arrangement.

The Company’s leases for real estate commonly include escalating payments. These variable lease payments are included in the calculation of the ROU asset and lease liability. In addition to the present value of the future lease payments, the calculation of the ROU asset also includes any deferred rent, lease pre-payments and initial direct costs of obtaining the lease.

In addition to the base rent, real estate leases typically contain provisions for common-area maintenance and other similar services, which are considered non-lease components for accounting purposes. Non-lease components are excluded from our ROU assets and lease liabilities and expensed as incurred.

The Company’s leases are for office space, manufacturing facilities, and machinery and equipment.

The components of lease costs are shown below:


	Three Months Ended		Nine Months Ended
	June 30,		June 30,
(Dollars in thousands)	2020		2020
Finance lease cost
Amortization of right-of-use assets	$	540	$	1,622
Interest on lease liabilities		319		970
Operating lease cost		1,474		4,399
Total lease costs	$	2,333	$	6,991

Additional information related to leases are shown below:


	Three Months Ended		Nine Months Ended
	June 30,		June 30,
(Dollars in thousands)	2020		2020
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	1,452	$	4,334
Operating cash flows from finance leases		319		655
Financing cash flows from finance leases		418		1,145
Right-of-use assets obtained in exchange for lease liabilities
Operating leases	$	53	$	22,072
Weighted-average remaining lease term
Operating leases				6.64	years
Finance leases				12.76	years
Weighted-average discount rate
Operating leases				3.14	%
Finance leases				4.29	%

The following is a reconciliation of future undiscounted cash flows to the operating and finance lease liabilities, and the related ROU assets, presented on our Consolidated Balance Sheet on June 30, 2020:


(Dollars in thousands)		Operating	Finance
Years Ending September 30:	Leases		Leases
2020 (excluding the nine months ended June 30, 2020)	$	1,294		718
2021		4,664		2,930
2022		4,005		3,011
2023		3,057		3,094
2024 and thereafter		7,633		31,416
Total minimum lease payments		20,653		41,169
Less: amounts representing interest		2,021		10,502
Present value of net minimum lease payments	$	18,632		30,667
Less: current portion of lease obligations		4,275		1,908
Non-current portion of lease obligations		14,357		28,759
ROU assets	$	18,351		27,535

Operating lease liabilities are included in the Consolidated Balance Sheet in accrued other expenses and operating lease liabilities. Finance lease liabilities are included in accrued other expenses and other liabilities. Operating lease ROU assets are included as a caption on the Consolidated Balance Sheet and finance lease ROU assets are included in Property, plant and equipment on the Consolidated Balance sheets.

As the Company has not restated prior-year information for the adoption of ASC 842, the following presents the Company’s future minimum lease payments for operating and capital leases under ASC 840 for continuing operations as of September 30, 2019:


(Dollars in thousands)	Operating		Finance
Years Ending September 30:	Leases		Leases
2020	$	5,574		2,518
2021		4,558		2,930
2022		3,950		3,012
2023		3,270		3,094
2024 and thereafter		8,443		31,499
Total minimum lease payments	$	25,795		43,053
Less: amounts representing interest		*		11,241
Present value of net minimum lease payments		*		31,812
Less: Current portion of lease obligations		*		1,832
Non-current portion of lease obligations		*		29,980

* Not applicable for operating leases

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COVID-19 TRENDS AND UNCERTAINTIES

The COVID-19 global pandemic has created significant and unprecedented challenges, and during these highly uncertain times, our top priority remains the health and safety of our employees, customers and suppliers, thereby securing the financial well-being of the Company and supporting business continuity. Our businesses have been deemed essential and are currently operational, supplying our customers with vital and necessary products. To date, our global supply chains have not been materially affected by the global pandemic. Given our diverse portfolio of strong, durable businesses serving non-discretionary end-markets, the strength and resilience of our business model positions us to continue to support our long-term outlook.

Recognizing the uncertainty presented by this global pandemic, we are suspending our full-year 2020 financial guidance. Our businesses are facing varying levels of pressure depending on the markets they serve as outlined below and the impact on our business cannot be reasonably estimated at this time. In response to COVID-19, we have taken decisive actions to enhance our financial condition, while continuing to execute our long-term strategy for profitable growth. Some of the actions we have taken include: deferring a portion of executive compensation, reducing discretionary spending, minimizing capital spending, implementing hiring and salary freezes, and increasing our focus on optimizing free cash flow. These operational measures are prudent steps to maintain our liquidity and will help manage our financial flexibility as we work through near-term volatility. As of June 30, 2020, we had nearly $700 million of liquidity, with $105 million in cash, net debt of approximately $47 million. Additionally, we have no debt maturities nor repayment obligations coming due and payable until September 2024. The Company has made no changes to its dividend plan. We are also monitoring the impacts of COVID-19 on the fair value of assets. We do not currently anticipate any material impairments on assets as a result of COVID-19. A portion of our workforce has worked from home at times due to COVID-19, however we have not had to redesign or design new internal controls over financial reporting at this time. Depending on the duration of COVID-19, it may become necessary for us to redesign or design new internal controls over financial reporting in a future period. We do not believe such an event will have a material impact on our business. Further details by operating segment are outlined below.

In our A&D segment, our third quarter revenues were negatively impacted by a decrease of approximately $4 million as compared to our expectations in April 2020 and we continue to see a slowdown in commercial aerospace deliveries and revenues over the remainder of the year. For the quarter ended June 30, 2020, the economic uncertainty, changes in the propensity for the general public to travel by air, and reductions in demand for commercial aircraft as a result of the COVID-19 pandemic have adversely impacted net sales and operating results in certain of our Aerospace and Defense reporting units and was determined to be an event and change in circumstances that required a quantitative review of goodwill and other intangible assets for impairment. We determined that there was no impairment during the three and nine months ended June 30, 2020 and the fair value of each reporting unit reviewed substantially exceeded carrying value, with the exception of Mayday where fair value exceeded carrying value by 8%. At June 30, 2020, we had $30 million of goodwill recorded for Mayday. The valuation methodology we use involves estimates of discounted cash flows, which are subject to change, and if they change negatively it could result in the need to write down those assets to fair value. We will continue to monitor the impacts of COVID-19 on the fair value of assets. The defense portion of A&D, both military aerospace and navy products is expected to remain at approximately historical business levels given its backlog coupled with the timing of expected platform deliveries.

In our Test segment, our third quarter revenues were negatively impacted by a decrease of approximately $6 million as compared to our expectations in April 2020 due to the China facility’s temporary three-week shutdown in February, and delayed timing of installation projects caused by access limitations to customer sites due to COVID-19. We expect the Test segment to remain at relatively normal business levels over the remainder of the year given the strength of its backlog and its served markets, primarily related to new communications technologies such as 5G.

In our USG segment, our third quarter revenues were negatively impacted by approximately $7 million as compared to our expectations in April 2020 as several utility customers continued to defer purchase orders and maintenance-related project deliveries so they could divert resources to other issues such as critical power delivery given their concerns around COVID-19. Additionally, Doble’s service business continued to largely be on hold during the pandemic. We expect USG’s customer spending softness to continue for the next few quarters before returning to normal levels. We reviewed the long-lived assets, including goodwill, of our NRG business for impairment that had $8 million of goodwill as of June 30, 2020. While the quantitative review determined that there was no impairment, the fair value of that reporting unit exceeded carrying value by 10%. The valuation methodology we use involves estimates of discounted cash flows, which are subject to change, and if they change negatively it could result in the need to write down those assets to fair value. We will continue to monitor the impacts of COVID-19 on the fair value of assets.

See the “Outlook” and “Part II – Other Information, Item 1A, Risk Factors” sections below for additional details.

RESULTS OF OPERATIONS

References to the third quarters of 2020 and 2019 represent the three-month periods ended June 30, 2020 and 2019, respectively.

OVERVIEW

In the third quarter of 2020, sales, net earnings and diluted earnings per share from continuing operations were $172.7 million, $18.7 million and $0.72 per share, respectively, compared to $178.3 million, $19.0 million and $0.73 per share, respectively, in the third quarter of 2019. In the first nine months of 2020, sales, net earnings and diluted earnings per share from continuing operations were $524.9 million, $47.3 million and $1.81, respectively, compared to $512.9 million, $54.2 million and $2.07 per share, respectively, in the first nine months of 2019. The decrease in net earnings and diluted earnings per share in the first nine months of 2020 as compared to the first nine months of 2019 was mainly due to the gain of approximately $8 million on the sale of the Doble Watertown property in the first quarter of 2019.

NET SALES

In the third quarter of 2020, net sales of $172.7 million were $5.6 million, or 3.1%, lower than the $178.3 million in the third quarter of 2019. In the first nine months of 2020, net sales of $524.9 million were $12.0 million, or 2.3%, higher than the $512.9 million in the first nine months of 2019. The decrease in net sales in the third quarter of 2020 as compared to the third quarter of 2019 was due to a $10.3 million decrease in the USG segment, partially offset by a $3.7 million increase in the Test segment and a $1.0 million increase in the Aerospace & Defense segment. The increase in net sales in the first nine months of 2020 as compared to the first nine months of 2019 was due to a $27.8 million increase in the Aerospace & Defense segment and a $2.7 million increase in the Test segment, partially offset by an $18.5 million decrease in the USG segment.

-Aerospace & Defense (A&D)

In the third quarter of 2020, net sales of $84.1 million were $1.0 million, or 1.2%, higher than the $83.1 million in the third quarter of 2019. In the first nine months of 2020, net sales of $256.7 million were $27.9 million, or 12.2%, higher than the $228.8 million in the first nine months of 2019. The sales increase in the third quarter of 2020 compared to the third quarter of 2019 was mainly due to the addition of $7.9 million in net sales from Globe, a $2.4 million increase in net sales at VACCO due to increased revenue from space products and a $0.5 million increase in net sales at Westland, partially offset by a $4.2 million decrease in net sales at PTI due to lower aerospace assembly shipments, a $3.5 million decrease in net sales at Crissair, and a $2.1 million decrease in net sales at Mayday all due to the impacts of COVID-19. The sales increase in the first nine months of 2020 compared to the first nine months of 2019 was due to the addition of $25.7 million in net sales from Globe, a $7.8 million increase in net sales at VACCO due to increased revenue from space products, partially offset by $2.2 million decrease in net sales at Crissair, a $1.6 million decrease in net sales at Westland due to timing of revenue on government programs, a $1.6 million decrease in net sales at Mayday, and a $0.2 million decrease in net sales at PTI.

-Test

In the third quarter of 2020, net sales of $46.0 million were $3.7 million, or 8.7%, higher than the $42.3 million in the third quarter of 2019. In the first nine months of 2020, net sales of $129.0 million were $2.5 million, or 2.0%, higher than the $126.5 million in the first nine months of 2019. The increase in the third quarter and first nine months of 2020 compared to the corresponding periods of 2019 was primarily due to higher sales from the segment’s Asian operations due to the catch up in shipments as the China facility had a temporary three-week shutdown during the second quarter due to COVID-19 and higher sales from the segment’s European operations due to the timing of test and measurement chamber projects.

-USG

In the third quarter of 2020, net sales of $42.6 million were $10.3 million, or 19.5% lower than the $52.9 million in the third quarter of 2019. In the first nine months of 2020, net sales of $139.2 million were $18.4 million, or 11.7%, lower than the $157.6 million in the first nine months of 2019. The decrease in the third quarter and first nine months of 2020 compared to the corresponding periods of 2019 was mainly due to lower product and software sales at Doble primarily driven by the impact of COVID-19 as customers delayed orders and on-site testing.

ORDERS AND BACKLOG

Backlog from continuing operations was $550.5 million at June 30, 2020 compared with $451.6 million at September 30, 2019. The Company received new orders totaling $157.8 million in the third quarter of 2020 compared to $170.7 million in the third quarter of 2019. Of the new orders received in the third quarter of 2020, $65.9 million related to Aerospace & Defense products, $41.5 million related to Test products, and $50.4 million related to USG products. Of the new orders received in the third quarter of 2019, $71.2 million related to Aerospace & Defense products, $44.1 million related to Test products, and $55.4 million related to USG products.

The Company received new orders totaling $623.9 million in the first nine months of 2020 compared to $561.3 million in the first nine months of 2019. Of the new orders received in the first nine months of 2020, $350.9 million related to Aerospace & Defense products, $121.8 million related to Test products, and $151.2 million related to USG products. Of the new orders received in the first nine months of 2019, $255.7 million related to Aerospace & Defense products, $147.1 million related to Test products, and $158.5 million related to USG products.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative (SG&A) expenses from continuing operations for the third quarter of 2020 were $36.9 million (21.4% of net sales), compared with $41.2 million (23.1% of net sales) for the third quarter of 2019. For the first nine months of 2020, SG&A expenses were $119.0 million (22.7% of net sales) compared to $119.1 million (23.2% of net sales) for the first nine months of 2019. The decrease in SG&A in the third quarter and first nine months of 2020 compared to the corresponding periods of 2019 was mainly due to lower discretionary spending related to travel and other discretionary expenses due to the COVID-19 pandemic; partially offset by the addition of Globe.

AMORTIZATION OF INTANGIBLE ASSETS

Amortization of intangible assets from continuing operations was $5.5 million and $16.6 million for the third quarter and first nine months of 2020, respectively, compared to $4.4 million and $13.2 million for the corresponding periods of 2019. Amortization expenses consist of amortization of acquired intangible assets from acquisitions and other identifiable intangible assets (primarily software). The increase in amortization expense in the third quarter and first nine months of 2020 compared to the corresponding periods of 2019 was mainly due to an increase in amortization of intangible assets related to the Globe acquisition and an increase in amortization of capitalized software at Doble.

OTHER (INCOME) EXPENSES, NET

Other income, net, was ($0.8) million in the third quarter of 2020 compared to other expenses, net, of $2.0 million in the third quarter of 2019. The principal component of other income, net, in the third quarter of 2020 was a gain on derivative instruments of $0.5 million. The principal component of other expenses, net, in the third quarter of 2019 was $0.8 million of restructuring charges related to the consolidation of VACCO’s aircraft/aerospace business into PTI’s aerospace facility in Oxnard, California and the completion of other restructuring activities begun in 2018; and losses on derivative instruments.

Other expenses, net, was $0.2 million in the first nine months of 2020 compared to other income, net, of ($3.4) million in the first nine months of 2019. There were no individually significant items in other expenses (income), net, in the first nine months of 2020. The principal component of other income, net, in the first nine months of 2019 was a gain of approximately $8 million on the sale of the Doble Watertown, MA building and land, partially offset by certain restructuring activities at Doble, PTI and VACCO and losses on derivative instruments.

EBIT

The Company evaluates the performance of its operating segments based on EBIT, and provides EBIT on a consolidated basis, which is a non-GAAP financial measure. Please refer to the discussion of non-GAAP financial measures in Note 8 to the Consolidated Financial Statements, above. EBIT was $23.3 million (13.5% of net sales) for the third quarter of 2020 compared to $25.5 million (14.3% of net sales) for the third quarter of 2019. For the first nine months of 2020, EBIT was $61.5 million (11.7% of net sales) compared to $72.9 million (14.2% of net sales) for the first nine months of 2019.

The following table presents a reconciliation of EBIT to net earnings from continuing operations.


	Three Months Ended				Nine Months Ended
	June 30,				June 30,
(In thousands)	2020		2019		2020	2019
Consolidated EBIT	$	23,332		25,545	61,468	72,871
Less: Interest expense, net		(1,523)		(1,878)	(5,264)	(5,586)
Less: Income tax		(3,122)		(4,622)	(8,931)	(13,068)
Net earnings from continuing operations	$	18,687		19,045	47,273	54,217

-Aerospace & Defense

EBIT in the third quarter of 2020 was $17.4 million (20.7% of net sales) compared to $19.0 million (22.9% of net sales) in the third quarter of 2019. EBIT in the first nine months of 2020 was $51.7 million (20.1% of net sales) compared to $47.1 million (20.6% of net sales) in the first nine months of 2019. The decrease in EBIT in the third quarter of 2020 compared to the third quarter of 2019 was mainly due to a $1.8 million decrease at Crissair due to lower sales volumes, a $1.0 million decrease at VACCO due to product mix, an $0.8 million decrease at PTI due to lower sales volumes; partially offset by the $1.8 million contribution from Globe. The increase in EBIT in the first nine months of 2020 compared to the first nine months of 2019 was mainly due to the $6.4 million contribution from Globe; partially offset by a $1.5 million decrease at Crissair due to lower sales volumes. In addition, EBIT in the third quarter of 2020 was negatively impacted by $0.8 million of incremental costs associated with the COVID-19 pandemic.

-Test

EBIT in the third quarter of 2020 was $7.2 million (15.6% of net sales) compared to $5.9 million (14.0% of net sales) in the third quarter of 2019. EBIT in the first nine months of 2020 was $17.5 million (13.6% of net sales) compared to $14.8 million (11.7% of net sales) in the first nine months of 2019. The increase in EBIT in the third quarter and first nine months of 2020 compared to the corresponding periods of 2019 was primarily due to higher sales volumes from the segment’s Asian and European operations as mentioned above.

-USG

EBIT in the third quarter of 2020 was $6.2 million (14.5% of net sales) compared to $10.1 million (19.2% of net sales) in the third quarter of 2019. EBIT in the first nine months of 2020 was $20.3 million (14.6% of net sales) compared to $40.5 million (25.7% of net sales) in the first nine months of 2019. The decrease in EBIT in the third quarter of 2020 compared to the third quarter of 2019 was mainly due to a decrease in EBIT from Doble due to lower sales volumes of higher margin products and software mentioned above. The decrease in EBIT in the first nine months of 2020 as compared to the first nine months of 2019 was mainly due to the gain on sale of the Doble Watertown facility of approximately $8 million in the first quarter of 2019 as well as a decrease in EBIT from Doble due to lower sales volumes in the first nine months of 2020. In addition, EBIT in the third quarter of 2020 was negatively impacted by approximately $0.2 million of incremental costs associated with the COVID-19 pandemic and EBIT in the first quarter of 2020 was negatively impacted by approximately $0.6 million of facility move costs at Doble.

-Corporate

Corporate costs included in EBIT were $7.4 million and $28.0 million in the third quarter and first nine months of 2020, respectively, compared to $9.6 million and $29.5 million in the corresponding periods of 2019. The decrease in Corporate costs in the third quarter of 2020 and first nine months of 2020 compared to the corresponding periods of 2019 was mainly due to lower professional services and lower compensation expense.

INTEREST EXPENSE, NET

Interest expense was $1.5 million and $5.3 million in the third quarter and first nine months of 2020, respectively, and $1.9 million and $5.6 million in the corresponding periods of 2019. The decrease in interest expense in the third quarter of 2020 as compared to the third quarter of 2019 was mainly due to lower average outstanding borrowings ($151 million compared to $218 million) at relatively consistent average interest rates of 3.2%.

INCOME TAX EXPENSE

The third quarter 2020 effective income tax rate from continuing operations was 14.3% compared to 19.5% in the third quarter of 2019. The effective income tax rate in the first nine months of 2020 was 15.9% compared to 19.4% for the first nine months of 2019. The income tax expense in the third quarter and first nine months of 2020 was favorably impacted by the following items: 1) additional tax benefits on share-based compensation that vested during the third quarter and year-to-date quarter decreasing the effective tax rate by 1.4% and 0.6%, respectively; 2) research credits and other 2019 tax return to provision true-ups decreasing the third quarter and year-to-date effective tax rate by 1.6% and 0.6%, respectively; and 3) an increase in the available 2019 and 2020 foreign tax credit which was attributable to new information and tax planning strategies; for which the combined effect was a 6.3% reduction in the third quarter effective tax rate and a 2.4% reduction in the year-to-date effective tax rate. The income tax expense was favorably impacted in the second quarter of 2020 by the release of a valuation allowance of $2.8 million for foreign net operating losses decreasing the year-to-date effective tax rate by 5.1%.

CAPITAL RESOURCES AND LIQUIDITY

The Company’s overall financial position and liquidity remains strong. The effects of COVID-19 have not materially affected liquidity. Working capital from continuing operations (current assets less current liabilities) increased to $271.1 million at June 30, 2020 from $229.8 million at September 30, 2019. Inventories increased by $27.3 million during this period due to a $12.3 million increase within the Aerospace & Defense segment, a $7.2 million increase within the Test segment and a $7.8 million increase within the USG segment, resulting primarily from the timing of receipt of raw materials and work-in-process due to timing of projects.

Net cash provided by operating activities from continuing operations was $53.8 million and $30.8 million in the first nine months of 2020 and 2019, respectively. The increase in net cash provided by operating activities from continuing operations in the first nine months of 2020 as compared to the first nine months of 2019 was driven by lower working capital requirements.

Capital expenditures from continuing operations were $28.3 million and $15.3 million in the first nine months of 2020 and 2019, respectively. The increase in the first nine months of 2020 was mainly due to the building improvement additions at the new Doble headquarters facility of approximately $7 million and a $2.7 million increase in capital expenditures at VACCO primarily for construction of a new parking lot and certain machinery and equipment. In addition, the Company incurred expenditures for capitalized software of $6.6 million and $6.2 million in the first nine months of 2020 and 2019, respectively.

Credit Facility

At June 30, 2020, the Company had approximately $340 million available to borrow under its bank credit facility, a $250 million increase option subject to lender approval, and $104.7 million cash on hand. At June 30, 2020, the Company had $150 million of outstanding borrowings under the credit facility, and $1.6 million of short-term borrowings in addition to outstanding letters of credit of $9.9 million. Cash flow from operations and borrowings under the Company’s credit facility are expected to meet the Company’s capital requirements and operational needs for the foreseeable future. The Company’s ability to access the additional $250 million increase option of the credit facility is subject to acceptance by participating or other outside banks.

Pension contributions

The Company paid $10 million of pension contributions during the third quarter of 2020. During the first quarter of 2020, the Company announced that it plans to terminate and annuitize the defined benefit pension plan during the fourth quarter of 2020.

Dividends

A dividend of $0.08 per share, totaling $2.1 million, was paid on April 17, 2020 to stockholders of record as of April 2, 2020. Subsequent to June 30, 2020, a quarterly dividend of $0.08 per share, totaling $2.1 million, was paid on July 16, 2020 to stockholders of record as of July 2, 2020.

OUTLOOK

During the second and third quarters of 2020, business disruptions related to the COVID-19 pandemic affected the Company’s operations. Given the considerable uncertainty regarding the extent and duration of these economic circumstances, it is difficult to predict how our future operations will be affected using our normal forecasting methodologies, therefore, the Company is suspending its previously issued fiscal year 2020 guidance.

CRITICAL ACCOUNTING POLICIES

Management has evaluated the accounting policies used in the preparation of the Company’s financial statements and related notes and believes those policies to be reasonable and appropriate. Certain of these accounting policies require the application of significant judgment by Management in selecting appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, trends in the industry, information provided by customers and information available from other outside sources, as appropriate. The most significant areas involving Management judgments and estimates may be found in the Critical Accounting Policies section of Management’s Discussion and Analysis and in Note 1 to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019.

OTHER MATTERS

Contingencies

As a normal incident of the business in which the Company is engaged, various claims, charges and litigation are asserted or commenced against the Company. Additionally, the Company is currently involved in various stages of investigation and remediation relating to environmental matters. In the opinion of Management, the aggregate costs involved in the resolution of these matters, and final judgments, if any, which might be rendered against the Company, are adequately reserved, are covered by insurance, or would not have a material adverse effect on the Company’s results from operations, capital expenditures, or competitive position.

FORWARD LOOKING STATEMENTS

Statements contained in this Form 10-Q regarding future events and the Company’s future results that reflect or are based on current expectations, estimates, forecasts, projections or assumptions about the Company’s performance and the industries in which the Company operates are considered “forward-looking statements” within the meaning of the safe harbor provisions of the Federal securities laws. These include, but are not necessarily limited to, statements about: the effects of the COVID-19 pandemic including any impairment to the Company’s assets, impacts to commercial aerospace, military and navy markets which the Company serves, and the strength of the markets served by the Company’s Test and USG segments; the adequacy of the Company’s credit facility and the Company’s ability to increase it; the outcome of current litigation, claims and charges; timing of the repayment of the current portion of the Company’s long-term debt; future revenues from remaining performance obligations; fair values of reporting units; the Company’s ability to hedge against or otherwise manage market risks through the use of derivative financial instruments; the extent to which hedging gains or losses will be offset by losses or gains on related underlying exposures; and any other statements contained herein which are not strictly historical. Words such as expects, anticipates, targets, goals, projects, intends, plans, believes, estimates, variations of such words, and similar expressions are intended to identify such forward-looking statements.

Investors are cautioned that such statements are only predictions and speak only as of the date of this Form 10-Q, and the Company undertakes no duty to update them except as may be required by applicable laws or regulations. The Company’s actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company’s operations and business environment, including but not limited to those described in Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019 and this Quarterly Report on Form 10-Q, and the following: the impact of the COVID-19 pandemic including labor shortages, facility closures, material shortages, transportation delays, termination or delays of Company contracts, the inability of our suppliers or customers to perform, and weakening of economic conditions in served markets; the impacts of natural disasters on the Company’s operations and those of the Company’s customers and suppliers; the timing and content of future contract awards or customer orders; the appropriation, allocation and availability of Government funds; the termination of Government and other customer contracts or orders; weakening of economic conditions in served markets; the success of the Company’s competitors; changes in customer demands or customer insolvencies; competition; intellectual property rights; technical difficulties; the availability of selected acquisitions; delivery delays or defaults by customers; performance issues with key customers, suppliers and subcontractors; material changes in the costs and availability of certain raw materials; labor disputes; changes in U.S. tax laws and regulations; other changes in laws and regulations including but not limited to changes in accounting standards and foreign taxation; changes in interest rates; costs relating to environmental matters arising from current or former facilities; and uncertainty regarding the ultimate resolution of current disputes, claims, litigation or arbitration.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign currency exchange rates. The Company is exposed to market risk related to changes in interest rates and selectively uses derivative financial instruments, including forward contracts and swaps, to manage these risks. In 2018, the Company entered into three interest rate swaps with a notional amount of $150 million to hedge some of its exposure to variability in future interest payments on variable rate debt, of which one swap is outstanding as of June 30, 2020. In addition, the Company’s Canadian subsidiary Morgan Schaffer enters into foreign exchange contracts to manage foreign currency risk as a portion of their revenue is denominated in U.S. dollars. All derivative instruments are reported on the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the gain or loss on the respective derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. The interest rate swaps entered into during 2018 were not designated as cash flow hedges and, therefore, the gain or loss on the derivative is reflected in earnings each period. There has been no material change to the Company’s market risks since September 30, 2019. See Note 13 to the Consolidated Financial Statements in Item 1 of this Report for a summary of the Company’s outstanding derivative financial instruments as of June 30, 2020. Refer to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019 for further discussion about market risk.

ITEM 4. CONTROLS AND PROCEDURES

The Company carried out an evaluation, under the supervision and with the participation of Management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of that date. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

“Item 1A. Risk Factors” of our most recent Form 10-K, filed November 29, 2019, includes a discussion of our risk factors. The information presented below updates, and should be read in conjunction with, the risk factors and information disclosed in our Form 10-K.

The COVID-19 pandemic and its widespread effects on the United States and global economies may have a material adverse effect on our business which could continue for an unknown period of time.

The rapid spread of the COVID-19 virus, as well as the measures governments and private organizations have implemented in order to stem the spread of this pandemic, is resulting in significant worldwide disruptions and contractions in economic activity, including those resulting from “shelter in place” and similar orders, restrictions on non-essential business operations and travel, and increased unemployment. Significant governmental and business resources are being reallocated from normal governmental and business expenditures toward COVID-19 prevention and treatment as well as toward attempting to mitigate the effects of the pandemic on individuals physically or economically harmed by these disruptions.

The Company may be subject to postponement or cancellation of certain contracts to which it is a party, including a substantial number of government contracts which may be delayed or terminated for convenience without penalty. Current restrictions and conditions may also prevent or delay the Company in accessing customer facilities to deliver products and provide services, and may disrupt or delay the Company’s supply chain. While the Company's businesses have been classified as essential businesses and allowed to remain in operation in jurisdictions in which facility closures have been mandated, the Company can give no assurance that this will not change in the future or that the Company's businesses will be classified as essential in each of the jurisdictions in which it operates. Further, although the Company has implemented prevention procedures at its own facilities, including enhanced cleaning procedures, social distancing efforts and working from home where feasible, and substantially all of its facilities have so far remained in business, due to the nature of the COVID-19 pandemic, there can be no assurance that the Company will not suffer facility closures or other adverse effects on its business operations in the future.

These facts and circumstances may have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows. The extent to which the COVID-19 pandemic will impact the Company’s business, results of operations, financial condition and cash flows in the future, and the length of time these impacts may continue, will depend on future developments that are highly uncertain and cannot be predicted at this time, including new information that may emerge concerning the severity of COVID-19, the longevity of COVID-19 and the actions to contain its impact.

ITEM 6. EXHIBITS


Exhibit Number	Description	Document Location

3.1(a)	Restated Articles of Incorporation	Exhibit 3(a) to the Company’s Form 10-K for the fiscal year ended September 30, 1999

3.1(b)	Amended Certificate of Designation, Preferences and Rights of Series A Participating Cumulative Preferred Stock of the Registrant	Exhibit 4(e) to the Company’s Form 10-Q for the fiscal quarter ended March 31, 2000

3.1(c)	Articles of Merger effective July 10, 2000	Exhibit 3(c) to the Company’s Form 10-Q for the fiscal quarter ended June 30, 2000

3.1(d)	Amendment of Articles of Incorporation effective February 5, 2018	Exhibit 3.1 to the Company’s Form 8-K filed February 7, 2018

3.2	Bylaws	Exhibit 3.1 to the Company’s Form 8-K filed November 19, 2019

31.1	Certification of Chief Executive Officer	Filed herewith

31.2	Certification of Chief Financial Officer	Filed herewith

32	Certification of Chief Executive Officer and Chief Financial Officer	Filed herewith

101.INS	XBRL Instance Document*	Submitted herewith
101.SCH	XBRL Schema Document*	Submitted herewith
101.CAL	XBRL Calculation Linkbase Document*	Submitted herewith
101.DEF	XBRL Definition Linkbase Document*	Submitted herewith
101.LAB	XBRL Label Linkbase Document*	Submitted herewith
101.PRE	XBRL Presentation Linkbase Document*	Submitted herewith

104	Cover Page Interactive Data File (contained in Exhibit 101)	Submitted herewith

* Exhibit 101 to this report consists of documents formatted in XBRL (Extensible Business Reporting Language). The financial information contained in the XBRL – related documents is “unaudited” or “unreviewed”.

SIGNATURE

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 thereunto duly authorized.


	ESCO TECHNOLOGIES INC.

	/s/ Gary E. Muenster
	Gary E. Muenster
	Executive Vice President and Chief Financial Officer
	(As duly authorized officer and principal accounting and
	financial officer of the registrant)

Dated: August 10, 2020

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ESCO (ESE) 10-Q2020 Q3 Quarterly report

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