# Esco Technologies Inc: Form 10-Q for the period ended Dec 31, 2018

- Company: [Esco Technologies Inc](/companies/ese.md) (CIK 866706)
- Form: 10-Q
- Filed: 2019-02-11
- Accepted by EDGAR: Feb 11, 2019, 14:46 ET
- Period: 2018-12-31
- Accession: 0001144204-19-006206
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/866706/000114420419006206/tv511547_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/866706/000114420419006206/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-12-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Cost of revenue | 3 months, 2018-10-01 to 2018-12-31 | $118.9m | us-gaap:CostOfRevenue |
| Selling, general and administrative | 3 months, 2018-10-01 to 2018-12-31 | $41.0m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Income tax | 3 months, 2018-10-01 to 2018-12-31 | $5.9m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2018-10-01 to 2018-12-31 | $17.3m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-10-01 to 2018-12-31 | $0.66 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2018-10-01 to 2018-12-31 | $0.67 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2018-10-01 to 2018-12-31 | 26,120,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2018-10-01 to 2018-12-31 | $8.1m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Dividends paid | 3 months, 2018-10-01 to 2018-12-31 | $2.1m | us-gaap:PaymentsOfDividends |
| Cash and equivalents | at 2018-12-31 | $36.6m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2018-12-31 | $411.9m | us-gaap:AssetsCurrent |
| Total assets | at 2018-12-31 | $1.27bn | us-gaap:Assets |
| Current liabilities | at 2018-12-31 | $194.7m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2018-12-31 | $491.4m | us-gaap:Liabilities |
| Long-term debt | at 2018-12-31 | $195.0m | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2018-12-31 | $20.3m | us-gaap:LongTermDebtCurrent |
| Shareholders' equity | at 2018-12-31 | $776.8m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 22,262 characters.

RESULTS OF OPERATIONS

References to the first quarters of 2019 and 2018 represent the three-month periods ended December 31, 2018 and 2017, respectively.

OVERVIEW

In the first quarter of 2019, sales, net earnings and diluted earnings per share were $182.6 million, $17.3 million and $0.66 per share, respectively, compared to $173.5 million, $34.7 million and $1.33 per share, respectively, in the first quarter of 2018. The decrease in net earnings and diluted earnings per share in the first quarter of 2019 as compared to the first quarter of 2018 was mainly due to the $25.1 million net tax benefit the Company recorded in the first quarter of 2018 as a result of the *Tax Cuts and Jobs Act* that was signed into law on December 22, 2017.

NET SALES

Net sales increased $9.1 million, or 5.2%, to $182.6 million in the first quarter of 2019 from $173.5 million in the first quarter of 2018. The increase in net sales in the first quarter of 2019 as compared to the first quarter of 2018 was due to a $6.2 million increase in the Filtration segment, a $3.8 million increase in the Test segment and a $0.1 million increase in the USG segment, partially offset by a $0.9 million decrease in the Technical Packaging segment.

- *Filtration*

In the first quarter of 2019, net sales of $66.2 million were $6.2 million, or 10.3%, higher than the $60.0 million in the first quarter of 2018. The sales increase in the first quarter of 2019 compared to the first quarter of 2018 was mainly due to a $3.2 million increase in net sales at Crissair due to higher aerospace shipments, a $2.3 million increase in net sales at Westland due to timing of revenue on government programs, a $1.5 million increase in net sales at PTI due to higher aerospace assembly shipments, a $1.5 million increase in net sales at Mayday due to higher aerospace shipments, partially offset by a $2.3 million decrease in net sales at VACCO due to lower revenue from its space products.

#### -Test

In the first quarter of 2019, net sales of $41.3 million were $3.8 million, or 10.0%, higher than the $37.5 million in the first quarter of 2018. The increase in the first quarter of 2019 compared to the first quarter of 2018 was primarily due to higher sales from the segment’s U.S. operations due to the timing of test and measurement chamber projects.

- *Utility Solutions Group (USG)*

In the first quarter of 2019, net sales of $55.9 million were $0.1 million, or 0.2% higher than the $55.8 million in the first quarter of 2018. The increase in the first quarter of 2019 compared to the first quarter of 2018 was mainly due to net sales increases from Morgan Schaffer and the Vanguard Instruments product line and new products and software solutions at Doble partially offset by a decrease in net sales at NRG due to softness in the renewable energy market.

#### -Technical Packaging

In the first quarter of 2019, net sales of $19.2 million were $0.9 million, or 4.7%, lower than the $20.2 million in the first quarter of 2018. The decrease in the first quarter of 2019 compared to the first quarter of 2018 was primarily due to the decrease in net sales from Plastique driven by timing of projects.

ORDERS AND BACKLOG

Backlog was $398.3 million at December 31, 2018 compared with $382.8 million at September 30, 2018. The Company received new orders totaling $198.1 million in the first quarter of 2019 compared to $200.5 million in the first quarter of 2018. Of the new orders received in the first quarter of 2019, $83.7 million related to Filtration products, $45.4 million related to Test products, $52.0 million related to USG products, and $17.0 million related to Technical Packaging products. Of the new orders received in the first quarter of 2018, $65.4 million related to Filtration products, $58.3 million related to Test products, $57.6 million related to USG products, and $19.2 million related to Technical Packaging products.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative (SG&A) expenses for the first quarter of 2019 were $41.0 million (22.4% of net sales), compared with $42.2 million (24.3% of net sales) for the first quarter of 2018. The decrease in SG&A in the first quarter of 2019 compared to the first quarter of 2018 was mainly due to a decrease in the USG segment due to the impact of the Company’s recent cost reduction actions incurred throughout 2018.

AMORTIZATION OF INTANGIBLE ASSETS

Amortization of intangible assets was $4.7 million and $4.4 million for the first quarter of 2019 and 2018, respectively. 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 first quarter of 2019 compared to the first quarter of 2018 was mainly due to an increase in amortization of intangibles related to the Manta acquisition.

OTHER (INCOME) EXPENSES, NET

Other income, net, was $7.1 million in the first quarter of 2019 compared to other expenses, net, of $0.2 million in the first quarter of 2018. The principal component in other income, net, in the first quarter of 2019 was a gain of approximately $8 million on the sale of the Doble Watertown, MA building and land. There were no individually significant items in other (income) expenses, net, in the first quarter of 2018.

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 7 to the Consolidated Financial Statements, above. EBIT was $25.1 million (13.8% of net sales) for the first quarter of 2019 compared to $15.0 million (8.6% of net sales) for the first quarter of 2018.

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

*(In thousands)*

|  | Three Months Ended December 31, 2018 | 2017 |
| --- | ---: | ---: |
| Consolidated EBIT | $25,147 | 14,986 |
| Less: Interest expense, net | (1,890) | (2,185) |
| Plus (Less): Income tax | (5,940) | 21,870 |
| Net earnings | $17,317 | 34,671 |

- *Filtration*

EBIT in the first quarter of 2019 was $10.6 million (16.0% of net sales) compared to $9.6 million (16.1% of net sales) in the first quarter of 2018. The increase in EBIT in the first quarter compared to the first quarter of 2018 was mainly due to an increase at Crissair and Westland due to higher sales volumes partially offset by a decrease in EBIT at VACCO due to the lower sales volumes mentioned above.

- *Test*

EBIT in the first quarter of 2019 was $3.3 million (8.0% of net sales) compared to $2.6 million (6.9% of net sales) in the first quarter of 2018. The increase in EBIT in the first quarter of 2019 compared to the first quarter of 2018 was primarily due to the increased sales volumes mainly from the segment’s U.S. operations.

- *Utility Solutions Group*

EBIT in the first quarter of 2019 was $21.5 million (38.6% of net sales) compared to $10.7 million (19.1% of net sales) in the first quarter of 2018. The increase in EBIT in the first quarter of 2019 compared to the first quarter of 2018 was mainly due to the gain on sale of the Doble Watertown facility of approximately $8 million as well as an increase in EBIT from Morgan Schaffer and the Vanguard Instruments and Manta product lines.

#### -Technical Packaging

EBIT in the first quarter of 2019 was $0.1 million (0.6% of net sales) compared to $1.0 million (4.8% of net sales) in the first quarter of 2018. The decrease in EBIT in the first quarter of 2019 compared to the first quarter of 2018 was mainly due to the decrease in sales volumes at Plastique. In addition, EBIT in the first quarter of 2019 included $0.3 million of restructuring charges related to the Plastique facility consolidation, which were recorded in the first quarter of 2019. These charges consisted primarily of severance and compensation benefits and asset impairment charges.

- *Corporate*

Corporate costs included in EBIT were $10.4 million and $8.9 million in the first quarter of 2019 and 2018, respectively. The increase in Corporate costs in the first quarter of 2019 compared to the first quarter of 2018 was mainly due to the $1.2 million of losses on derivative instruments recorded in the first quarter of 2019.

INTEREST EXPENSE, NET

Interest expense was $1.9 million and $2.2 million in the first quarter of 2019 and 2018, respectively. The decrease in interest expense in the first quarter of 2019 as compared to the first quarter of 2018 was mainly due to lower average outstanding borrowings ($212 million compared to $265.7 million), partially offset by higher average interest rates (3.3% vs. 2.7%).

INCOME TAX EXPENSE

Income tax expense in the first quarter of 2019 was $5.9 million compared to income tax benefit of $21.9 million in the first quarter of 2018. The first quarter 2019 effective income tax rate was 25.5% compared to (170.8%) in the first quarter of 2018. Income tax expense in the first quarter 2019 was unfavorably impacted by return to provision true-ups increasing the first quarter effective tax rate by 1.3%. H.R. 1, *Tax Cuts and Jobs Act (“*TCJA”), was signed into law on December 22, 2017. The total impact of the TCJA in the first quarter of 2018 was a net benefit of $25.1 million. The impacts were as follows: First, the Company’s 2018 federal statutory rate dropped from 35.0% to 24.5% which required an adjustment to the value of its deferred tax assets and liabilities since the first quarter of 2018 was the period that included the enactment date. This adjustment resulted in a favorable impact ($30.3 million provisional amount in the first quarter of 2018) which lowered the first quarter of 2018 effective tax rate by 236.8%. Second, the TCJA subjected the Company’s cumulative foreign earnings to federal income tax ($2.9 million provisional amount in the first quarter of 2018) which unfavorably impacted the first quarter of 2018 effective tax rate by 22.8%. The Company also recorded a $2.3 million provisional estimate of the income tax effects of the future repatriation of the cumulative earnings of its foreign subsidiaries which unfavorably impacted the first quarter of 2018 effective tax rate by 18.3%.

Staff Accounting Bulletin No. 118 (SAB 118) was issued by the SEC effective December 22, 2017. SAB 118 allows registrants to record provisional amounts of the income tax effects of the TCJA where the information necessary to complete the accounting under ASC Topic 740 is not available but the amounts are based on reasonable estimates. SAB 118 permits registrants to record adjustments to its provisional amounts during the measurement period (which cannot exceed one year).

The Company recorded a provisional charge for the Transition Tax of $3.7 million for the year ended September 30, 2018 and this charge is complete as of December 31, 2018 with minimal changes. Provisions under the TCJA that became effective for the Company in the current fiscal year include a further reduction in the U.S. statutory rate to 21%, a new minimum tax on global intangible low-taxed income (“GILTI”), the benefit of the deduction for foreign-derived intangible income (“FDII”), and changes to IRC Section 162(m) related to the deductibility of executive compensation.

The Company’s foreign subsidiaries had accumulated unremitted earnings of $4.0 million at December 31, 2018. No deferred taxes have been provided on these accumulated unremitted earnings because these funds are not needed to meet the liquidity requirements of the Company’s U.S. operations and it is the Company’s intention to indefinitely reinvest these earnings in continuing international operations. In the event these foreign entities’ earnings were distributed, it is estimated that approximately $0.4 million of foreign tax withholding would be paid. The Company does not expect that these taxes would be creditable against U.S. income tax, so they would correspondingly reduce the Company’s net earnings. No significant portion of the Company’s foreign subsidiaries’ earnings was taxed at a rate significantly less than the U.S. statutory tax rate.

CAPITAL RESOURCES AND LIQUIDITY

The Company’s overall financial position and liquidity remains strong. Working capital (current assets less current liabilities) increased to $217.3 million at December 31, 2018 from $195.5 million at September 30, 2018. Accounts receivable decreased by $17.1 million during this period mainly due to a $12.6 million decrease within the Filtration segment driven by the timing of sales and focused collection efforts. Inventories decreased by $15.8 million during this period mainly due to a $15.8 million decrease within the Filtration segment resulting primarily from the adoption of ASU No. 2014-09, *Revenue from Contracts with Customers* (ASC 606). Contract assets increased $41.0 million in the first quarter of 2019 mainly due to the adoption of ASC 606 within the Filtration segment.

Net cash provided by operating activities was $8.1 million and $17.8 million in the first quarters of 2019 and 2018, respectively. The decrease in net cash provided by operating activities in the first quarter of 2019 as compared to the first quarter of 2018 was driven by lower earnings and higher working capital requirements.

Capital expenditures were $8.9 million and $3.6 million in the first quarters of 2019 and 2018, respectively. The increase in the first quarter of 2019 was mainly due to a facility expansion at TEQ ($3.8 million). In addition, the Company incurred expenditures for capitalized software of $2.1 million in both of the first quarters of 2019 and 2018, respectively.

#### Credit Facility

At December 31, 2018, the Company had approximately $209 million available to borrow under its bank credit facility, a $250 million increase option subject to lender approval, and $36.6 million cash on hand. At December 31, 2018, the Company had $215 million of outstanding borrowings under the credit facility in addition to outstanding letters of credit of $8.2 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.

#### New Accounting Standards

In February 2016, the FASB issued ASU No. 2016-062, *Leases (Topic 842)*, which, among other things, requires an entity to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. This standard will increase an entities’ reported assets and liabilities. The standard is effective for fiscal years beginning after December 15, 2018 and mandates a modified retrospective transition period for all entities. The Company is currently assessing the impact of this standard on its consolidated financial statements and related disclosures.

In October 2016, the FASB issued ASU No. 2016-16, *Intra-Entity Transfers of Assets Other Than Inventory*, which eliminates the exception for all intra-entity sale of assets other than inventory. This standard is effective for annual periods beginning after December 15, 2017. There was no significant impact to the Company’s consolidated financial statements as a result of adopting this new standard.

#### Dividends

A dividend of $0.08 per share, totaling $2.1 million, was paid on October 17, 2018 to stockholders of record as of October 3, 2018. Subsequent to December 31, 2018, a quarterly dividend of $0.08 per share, totaling $2.1 million, was paid on January 18, 2019 to stockholders of record as of January 3, 2019.

OUTLOOK

Management’s current expectations for 2018 remain consistent with the details outlined in the Business Outlook presented in the November 15, 2018 press release. Management expects 2019 Adjusted EPS to be in the range of $2.95 to $3.05 per share reflecting meaningful organic sales growth. Management is excluding the following expected adjustments to 2019 GAAP EPS: A pre-tax gain from the October 2018 sale of Doble’s headquarters building in Watertown, Massachusetts; and pre-tax costs related to the relocation of Doble’s headquarters, the closure of Plastique’s headquarters in Tunbridge Wells, UK and the consolidation of its product design and administrative functions into its facilities in Nottingham, UK and Poznan, Poland; 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. Management expects the 2019 second quarter Adjusted EPS to be in the range of $0.58 to $0.63.

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, 2018.

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 amount and timing of future sales, revenues, cash flows, growth, Adjusted EPS and EPS; the adequacy of the Company’s credit facility and the Company’s ability to increase it; the outcome of current litigation, claims and charges; income taxation of foreign earnings and the future repatriation, reinvestment or distribution of foreign earnings; future income tax liabilities and effective tax rate; timing of the repayment of the current portion of the Company’s long-term debt; changes in the amount of unrecognized tax benefits; the recognition and timing of costs related to share-based compensation arrangements; returns on retirement plan assets; estimates or projections made in connection with the Company’s accounting policies; market risks relating to the Company’s operations and changes in interest rates; the extent to which hedging gains or losses are offset by losses or gains on related underlying exposures; the Company’s ability to hedge against or otherwise manage them through the use of derivative financial instruments; 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, 2018, and the following: 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 for convenience of Government and other customer contracts or orders; financial exposure in connection with Company guarantees of certain Aclara contracts; 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; uncertainty regarding the ultimate resolution of current disputes, claims, litigation or arbitration; and the integration of recently acquired businesses.

## Market risk

As filed, 1,621 characters.

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. 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, 2018. See Note 12 to the Consolidated Financial Statements in Item 1 of this Report for a summary of the Company’s outstanding derivative financial instruments as of December 31, 2018. Refer to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2018 for further discussion about market risk.

## Controls and procedures

As filed, 1,911 characters.

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, due to the material weakness in the Company’s internal control over financial reporting related to the ineffective design and operation of controls impacting the deferred revenue general ledger account, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were ineffective as of that date.

As previously disclosed in Part II Item 9A in the Company’s Annual Report on Form 10-K for the year ended September 30, 2018, Management concluded there was a material weakness in the Company’s internal control over financial reporting related to the ineffective design and operation of controls impacting the deferred revenue general ledger account. Remedial actions have been identified to address these controls, including enhancing our policies and procedures related to the deferred revenue reconciliation and review, and providing additional training to our segment finance department. These new procedures are in the process of being implemented but have not been in place long enough to provide sufficient assurances to support the conclusion that the above identified material weakness has been fully remediated as of December 31, 2018.

Other than the above, there have been no changes 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.

Filed Feb 11, 2019.
Source: SEC EDGAR, the filing index for accession 0001144204-19-006206. Last ingested by Listed: Nov 3, 2026, 11:19 ET. No prices; not investment advice.