ITEM 1. FINANCIAL STATEMENTS
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, 2018.
The Company’s results for the three-month period
ended December 31, 2018 are not necessarily indicative of the results for the entire 2019 fiscal year. References to the first
quarters of 2019 and 2018 represent the fiscal quarters ended December 31, 2018 and 2017, 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.
|
2.
|
SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES UPDATE
|
Our significant accounting policies are included
in Note 1 of our Annual Report on Form 10-K for the year ended September 30, 2018. On October 1, 2018, we adopted ASU No. 2014-09,
Revenue from Contracts with Customers (ASC 606)
. Significant changes to our policies resulting from the adoption are provided
below. We adopted ASC 606 using the modified retrospective transition method applied to contracts that were not substantially complete
at the end of fiscal year 2018. We recorded a $5.5 million adjustment to increase retained earnings to reflect the cumulative impact
of adopting this standard at the beginning of fiscal year 2019, primarily related to certain long-term contracts our Filtration
and Technical Packaging segments have that converted to the cost-to-cost method for revenue recognition. The comparative information
has not been restated and is reported under the accounting standards in effect for those periods. A reconciliation of the financial
statement line items impacted for the three months ended December 31, 2018 under ASC 606 to the prior accounting standards is provided
in Note 14.
Revenue Recognition
Revenue is recognized when control of the goods
or services promised under the contract is transferred to the customer either at a point in time (e.g., upon delivery) or over
time (e.g., as we perform under the contract). We account for a contract when it has approval and commitment from both parties,
the rights and payment terms of the parties are identified, the contract has commercial substance and collectability of consideration
is probable. Contracts are reviewed to determine whether there is one or multiple performance obligations. A performance obligation
is a promise to transfer a distinct good or service to a customer and represents the unit of accounting for revenue recognition.
For contracts with multiple performance obligations, the expected consideration, or the transaction price, is allocated to each
performance obligation identified in the contract based on the relative standalone selling price of each performance obligation.
Revenue is then recognized for the transaction price allocated to the performance obligation when control of the promised goods
or services underlying the performance obligation is transferred.
Payment terms with customers vary by the type and
location of the customer and the products or services offered. The Company does not adjust the promised amount of consideration
for the effects of significant financing components based on the expectation that the period between when the Company transfers
a promised good or service to a customer and when the customer pays for that good or service will be one year or less. Arrangements
with customers that include payment terms extending beyond one year are not significant.
Filtration:
Within the Filtration segment,
approximately 48% of revenues (approximately 18% of consolidated revenues) are recognized at a point in time when products are
shipped (when control of the goods transfers) to unaffiliated customers. The related contracts are with commercial and military
customers and have a single performance obligation as there is only one good promised or the promise to transfer the goods or services
is not distinct or separately identifiable from other promises in the contract. The transaction price for these contracts reflects
our estimate of returns, rebates and discounts, which are based on historical, current and forecasted information to determine
the expected amount to which the Company will be entitled in exchange for transferring the promised goods or services to the customer.
The realization of variable consideration occurs within a short period of time from product delivery; therefore, the time value
of money effect is not significant. Amounts billed to customers for shipping and handling are included in the transaction price
as the related activities are performed prior to customer obtaining control of the products. They generally are not treated as
separate performance obligations as these costs fulfill a promise to transfer the product to the customer and are expensed in selling,
general, and other costs in the period they are incurred. Taxes collected from customers and remitted to government authorities
are recorded on a net basis. We primarily provide standard warranty programs for products in our commercial businesses for periods
that typically range from one to two years. These assurance-type programs typically cannot be purchased separately and do not meet
the criteria to be considered a performance obligation.
Approximately 52% of the segment’s revenues (approximately 19% of consolidated revenues) are accounted
for over time as the products do not have alternative use and the Company has an enforceable right to payment for costs incurred
plus a reasonable margin or the inventory is owned by the customer. The related contracts are primarily cost-plus or fixed price
contracts related to the design, development and manufacture of complex fluid control products, quiet valves, manifolds, shock
and vibration dampening, thermal insulation and systems primarily for the commercial aerospace and military (U.S. Government) markets.
The contracts may contain multiple products, which are capable of being distinct as the customer could benefit from each product
on its own or together with other readily available resources. Each product is separately identifiable from the other products
in the contract. Therefore, each product is distinct in context of the contract and will be accounted for as a separate performance
obligation. Our contracts are frequently modified for changes in contract specifications and requirements. Most of our contract
modifications are for products that are not distinct from the existing contract and are accounted for as part of that existing
contract.
Contracts with the U.S. Government
generally contain clauses that provide lien rights to work-in-process along with clauses that allow the customer to unilaterally
terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work-in-process.
Due to the continuous transfer of control to the U.S. Government, we recognize revenue over the time that we perform under the
contract.
Selecting the method to measure progress towards completion for the commercial and military contracts
requires judgment and is based on the nature of the products or service to be provided. We generally use the cost-to-cost method
to measure progress for our Filtration segment contracts the rate at which costs are incurred to fulfill a contract best depicts
the transfer of control to the customer. Under this measure, the extent of progress towards completion is measured based on the
ratio of costs incurred to date to the estimated costs at completion of the performance obligation, and revenue is recorded proportionally
as costs are incurred based on an estimated profit margin.
The transaction price for
our contracts represents our best estimate of the consideration we will receive and includes assumptions regarding variable
consideration as applicable. Certain of our long-term contracts contain incentive fees that can increase the transaction
price. These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones or
cost targets and can be based upon customer discretion. We include estimated amounts in the transaction price to the
extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty
associated with the variable consideration is resolved. Our estimates of variable consideration and determination of
whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated
performance and all other information that is reasonably available to us.
Total contract cost is estimated utilizing
current contract specifications and expected engineering requirements. Contract costs typically are incurred over a period of
several months to one or more years, and the estimation of these costs requires substantial judgment. Our cost estimation
process is based on the professional knowledge and experience of engineers and program managers along with finance
professionals. We review and update our projections of costs quarterly or more frequently when circumstances significantly
change.
Under the typical payment terms of our long term fixed price contracts, the customer pays us either performance-based
or progress payments. Performance-based payments represent interim payments based on quantifiable measures of performance or on
the achievement of specified events or milestones. Progress payments are interim payments of costs incurred as the work progresses.
Because of the timing difference of revenue recognition and customer billing, these contracts will often result in revenue recognized
in excess of billings and billings in excess of costs incurred, which we present as contract assets and contract liabilities, respectively,
in the Consolidated Balance Sheets. Amounts billed and due from our customers are classified in Accounts receivable, net. For short
term fixed price and cost-type contracts, we are generally paid within a short period of time.
For contracts where revenue is recognized over time,
we generally recognize changes in estimated contract revenues, costs and profits using the cumulative catch-up method of accounting. This
method recognizes the cumulative effect of changes on current and prior periods with the impact of the change from inception-to-date
recorded in the current period. Anticipated losses on contracts are recognized in full in the period in which the losses become
probable and estimable.
Test:
Within
the Test segment, approximately 25% of revenues (approximately 6% of consolidated revenues) are recognized at a point in time
when products such as, antennas and probes are shipped (when control of the goods transfers) to unaffiliated customers. The related
contracts are with commercial customers. The contracts may contain multiple products which are capable of being distinct as the
customer could benefit from each product on its own or together with other readily available resources. Each product is separately
identifiable from the other products in the contract. Therefore, each product is distinct in context of the contract and will
be accounted for as a separate performance obligation. The transaction price for these contracts reflects our estimate of variable
consideration in the form of returns, rebates and discounts, which are based on historical, current and forecasted information
to determine the expected amount to which the Company will be entitled in exchange for transferring the promised goods or services
to the customer. The realization of variable consideration occurs within a short period of time from product delivery; therefore,
the time value of money effect is not significant. Amounts billed to customers for shipping and handling are included in the transaction
price as the related activities are performed prior to customer obtaining control of the products. They generally are not treated
as separate performance obligations as these costs fulfill a promise to transfer the product to the customer and are expensed
in selling, general, and other costs in the period they are incurred. Taxes collected from customers and remitted to government
authorities are recorded on a net basis. We primarily provide standard warranty programs for products in our commercial businesses
for periods that typically range from one to two years. These assurance-type programs typically cannot be purchased separately
and do not meet the criteria to be considered a performance obligation.
Approximately 75% of the segment’s revenues (approximately 17% of consolidated revenues) are recorded
over time as the product does not have an alternative use and the Company has an enforceable right to payment for costs incurred
plus a reasonable margin. Products accounted for under this guidance include the construction and installation of complex test
chambers to a buyer’s specifications that provide its customers with the ability to measure and contain magnetic, electromagnetic
and acoustic energy. The goods and services related to each installed test chamber are not distinct due to the significant amount
of integration provided and each installed chamber is accounted for as a single performance obligation. Selecting the method to
measure progress towards completion for these contracts requires judgment and is based on the nature of the products and service
to be provided. We use milestones to measure progress for our Test segment contracts because it best depicts the transfer
of control to the customer that occurs as we incur costs on our contracts. For arrangements that are accounted for under this guidance,
the Company estimates profit as the difference between total revenue and total estimated cost of a contract and recognizes these
revenues and costs based primarily on contract milestones. The transaction price for our contracts represents our best estimate
of the consideration we will receive and includes assumptions regarding variable consideration as applicable.
Total contract cost is estimated utilizing
current contract specifications and expected engineering requirements. Contract costs typically are incurred over a period of
several months to a year, and the estimation of these costs requires substantial judgment. Our cost estimation process is
based on the professional knowledge and experience of engineers and program managers along with finance professionals. We
review and update our projections of costs quarterly or more frequently when circumstances significantly change.
Under the typical payment terms
of our fixed price contracts, the customer pays us either performance-based or progress payments. Performance-based payments represent
interim payments based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress
payments are interim payments of costs incurred as the work progresses. Because of the timing difference of revenue recognition
and customer billing, these contracts result in revenue recognized in excess of billings and billings in excess of costs incurred,
which we present as contract assets and contract liabilities, respectively, in the Consolidated Balance Sheets. Amounts billed
and due from our customers are classified in Accounts receivable, net.
For contracts where revenue is recognized over time,
we generally recognize changes in estimated contract revenues, costs and profits using the cumulative catch-up method of accounting.
This method recognizes the cumulative effect of changes on current and prior periods with the impact of the change from inception-to-date
recorded in the current period. Anticipated losses on contracts are recognized in full in the period in which the losses
become probable and estimable.
USG
:
Within the USG segment, approximately 80% of revenues (approximately
24% of consolidated revenues) are recognized at a point in time when products are shipped (when control of the goods transfers)
to unaffiliated customers. The related contracts are with commercial customers. The contracts may contain multiple products which
are capable of being distinct as the customer could benefit from each product on its own or together with other readily available
resources. Each product is separately identifiable from the other products in the contract. Therefore, each product is distinct
in context of the contract and will be accounted for as a separate performance obligation. The transaction price for these contracts
reflects our estimate of variable consideration in the form of returns, rebates and discounts, which are based on historical,
current and forecasted information to determine the expected amount to which the Company will be entitled in exchange for transferring
the promised goods or services to the customer. The realization of variable consideration occurs within a short period of
time from product delivery; therefore, the time value of money effect is not significant. Amounts billed to customers for shipping
and handling are included in the transaction price as the related activities are performed prior to customer obtaining control
of the products. They generally are not treated as separate performance obligations as these costs fulfill a promise to transfer
the product to the customer and are expensed in selling, general, and other costs in the period they are incurred. Taxes
collected from customers and remitted to government authorities are recorded on a net basis. We primarily provide standard warranty
programs for products in our commercial businesses for periods that typically range from one to two years. These assurance-type
programs typically cannot be purchased separately and do not meet the criteria to be considered a performance obligation.
Approximately 20% of the segment’s revenues (approximately 6% of consolidated revenues) are recognized
over time as services are performed. The services accounted for under this method include an obligation to provide testing services
using hardware and embedded software, software maintenance, training, lab testing, and consulting services. The related contracts
contain a bundle of goods and services that are integrated in the context of the contract. Therefore, the goods and services are
not distinct and the Company has a single performance obligation. Selecting the method to measure progress towards completion for
these contracts requires judgment and is based on the nature of the products and service to be provided. We will recognize
revenue as a series of distinct services based on each day of providing services (straight-line over the contract term) for our
USG segment contracts. The transaction price for our contracts represents our best estimate of the consideration we will receive
and includes assumptions regarding variable consideration as applicable. Under the typical payment terms of our service contracts,
the customer pays us in advance of when services are performed. Because of the timing difference of revenue recognition and customer
payment, which is typically received upon commencement of the contract, these contracts result in deferred revenue, which we present
as contract liabilities, in the Consolidated Balance Sheets.
Included in this category, approximately 8% of the segment’s revenues (approximately 2% of consolidated
revenues) are recognized based on the terms of the software contract. For contracts that transfer a software license to the customer,
revenue will be recognized at a point in time. These type of software contracts represent a right to use the software, or a functional
license, in which revenue should be recognized upon transfer of the license. For contracts in software as a service (SaaS) arrangements,
revenue will be recognized over time. The customer receives and consumes the benefits of the SaaS arrangement through access to
the system which is for a stated period. We will recognize revenue based on each day of providing access (straight-line over the
contract term). The transaction price for our contracts represent our best estimate of the consideration we will receive and includes
assumptions regarding variable consideration as applicable. Under the typical payment terms of our software contracts, the customer
pays us in advance of when services are performed. Because of the timing difference of revenue recognition and customer payment,
these contracts result in deferred revenue, which we present as contract liabilities, in the Consolidated Balance Sheets.
Technical Packaging:
Within
the Technical Packaging segment, 100% of the revenues (approximately 10% of consolidated revenues) are recognized over time as
the product does not have an alternative use and the Company has an enforceable right to payment. Selecting the method to measure
progress towards completion for the contracts requires judgment and is based on the nature of the products to be provided. We
use the cost-to-cost method to measure progress for our Technical Packaging segment contracts because it best depicts the transfer
of control to the customer that occurs as we incur costs on our contracts. Under this measure, the extent of progress towards
completion is measured based on the ratio of costs incurred to date to the estimated costs at completion of the performance obligation,
and revenue is recorded proportionally as costs are incurred. The transaction price for our contracts reflects our estimate of
variable consideration in the form of returns, rebates and discounts, which are based on historical, current and forecasted information
to determine the expected amount to which the Company will be entitled in exchange for transferring the promised goods or services
to the customer. The realization of variable consideration occurs within a short period of time from product delivery; therefore,
the time value of money effect is not significant.
Total contract cost is
estimated utilizing current contract specifications and expected engineering requirements. Contract costs typically are
incurred over a period of weeks, minimizing the amount of judgment in developing the cost estimate. Our cost estimation
process is based on the professional knowledge and experience of engineers and program managers along with finance
professionals. We review and update our projections of costs quarterly or more frequently when circumstances significantly
change.
Under the typical payment terms
of our contracts, the customer is billed upon shipment of product. Amounts billed and due from our customers are classified in
Accounts receivable, net. Because of the timing difference of revenue recognition and customer billing, these contracts result
in revenue recognized in excess of billings, which we present as contract assets in the Consolidated Balance Sheets.
For contracts where revenue
is recognized over time, we generally recognize changes in estimated contract revenues, costs and profits using the
cumulative catch-up method of accounting. This method recognizes the cumulative effect of changes on current and prior
periods with the impact of the change from inception-to-date recorded in the current period. Anticipated losses on
contracts are recognized in full in the period in which the losses become probable and estimable.
Contract Assets and Liabilities
Contract assets arise from contracts when revenue is recognized over time and the amount of revenue recognized,
including our estimate of variable consideration that has been included in the transaction price, exceeds the amount billed to
the customer. These amounts are included in contract assets until the right to payment is no longer conditional on events other
than the passage of time. These contract assets are reclassified to receivables when the right to consideration becomes unconditional.
Contract liabilities include deposits, deferred revenue, upfront payments and billings in excess of revenue recognized. Liabilities
for customer rebates and discounts are included in other current liabilities in the accompanying balance sheet.
|
3.
|
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 December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Weighted Average Shares Outstanding - Basic
|
|
|
25,911
|
|
|
|
25,836
|
|
Dilutive Options and Restricted Shares
|
|
|
209
|
|
|
|
244
|
|
Adjusted Shares - Diluted
|
|
|
26,120
|
|
|
|
26,080
|
|
|
4.
|
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 $1.1 million and $1.1 million for the three-month periods ended December 31, 2018 and 2017, respectively. There were
316,794 non-vested shares outstanding as of December 31, 2018.
Non-Employee Directors Plan
Compensation expense related to the non-employee
director grants was $0.3 million and $0.3 million for the three-month periods ended December 31, 2018 and 2017, respectively.
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 $1.4
million and $1.4 million for the three-month periods ended December 31, 2018 and 2017, respectively. The total income tax benefit
recognized in results of operations for share-based compensation arrangements was $0.3 million and $0.4 million for the three-month
periods ended December 31, 2018 and 2017, respectively. As of December 31, 2018, there was $6.8 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 1.4 years.
Inventories consist of the following:
(In thousands)
|
|
December 31,
2018
|
|
|
September 30,
2018
|
|
|
|
|
|
|
|
|
Finished goods
|
|
$
|
19,125
|
|
|
|
26,678
|
|
Work in process
|
|
|
39,636
|
|
|
|
47,765
|
|
Raw materials
|
|
|
60,898
|
|
|
|
60,973
|
|
Total inventories
|
|
$
|
119,659
|
|
|
|
135,416
|
|
|
6.
|
GOODWILL AND OTHER INTANGIBLE
ASSETS
|
Included on the Company’s Consolidated Balance
Sheets at December 31, 2018 and September 30, 2018 are the following intangible assets gross carrying amounts and accumulated amortization:
(Dollars in thousands)
|
|
December 31,
2018
|
|
|
September 30,
2018
|
|
Goodwill
|
|
$
|
381,198
|
|
|
|
381,652
|
|
|
|
|
|
|
|
|
|
|
Intangible assets with determinable lives:
|
|
|
|
|
|
|
|
|
Patents
|
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
1,833
|
|
|
|
1,833
|
|
Less: accumulated amortization
|
|
|
818
|
|
|
|
791
|
|
Net
|
|
$
|
1,015
|
|
|
|
1,042
|
|
|
|
|
|
|
|
|
|
|
Capitalized software
|
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
73,355
|
|
|
|
71,294
|
|
Less: accumulated amortization
|
|
|
43,480
|
|
|
|
41,624
|
|
Net
|
|
$
|
29,875
|
|
|
|
29,670
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
184,915
|
|
|
|
185,333
|
|
Less: accumulated amortization
|
|
|
50,415
|
|
|
|
47,802
|
|
Net
|
|
$
|
134,500
|
|
|
|
137,531
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
5,368
|
|
|
|
5,468
|
|
Less: accumulated amortization
|
|
|
2,211
|
|
|
|
2,056
|
|
Net
|
|
$
|
3,157
|
|
|
|
3,412
|
|
Intangible assets with indefinite lives:
|
|
|
|
|
|
|
|
|
Trade names
|
|
$
|
171,648
|
|
|
|
173,698
|
|
The changes in the carrying amount of goodwill attributable
to each business segment for the three months ended December 31, 2018 is as follows:
(Dollars in millions)
|
|
USG
|
|
|
Test
|
|
|
Filtration
|
|
|
Packaging
|
|
|
Total
|
|
Balance as of September 30, 2018
|
|
|
254.1
|
|
|
|
34.1
|
|
|
|
73.7
|
|
|
|
19.8
|
|
|
|
381.7
|
|
Foreign currency translation
|
|
|
(0.3
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(0.2
|
)
|
|
|
(0.5
|
)
|
Balance as of December 31, 2018
|
|
$
|
253.8
|
|
|
|
34.1
|
|
|
|
73.7
|
|
|
|
19.6
|
|
|
|
381.2
|
|
|
7.
|
BUSINESS SEGMENT INFORMATION
|
The Company is organized based on the products and
services that it offers, and classifies its business operations in four reportable segments for financial reporting purposes: Filtration/Fluid
Flow (Filtration), RF Shielding and Test (Test), Utility Solutions Group (USG) and Technical Packaging. The Filtration 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). The companies
within this segment primarily design and manufacture specialty filtration products, including hydraulic filter elements used in
commercial aerospace applications, unique filter mechanisms used in micro-propulsion devices for satellites and custom designed
filters for manned and unmanned aircraft; manufacture elastomeric-based signature reduction solutions for the U.S. Navy; and manufacture
landing gear components for the aerospace and defense industry. 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. 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
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. The Technical Packaging segment’s operations consist of Thermoform Engineered
Quality LLC (TEQ) and Plastique Limited and Plastique Sp. z o.o. (together, Plastique). 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.
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 before interest and taxes.
|
|
Three Months
Ended December 31,
|
|
(In thousands)
|
|
2018
|
|
|
2017
|
|
NET SALES
|
|
|
|
|
|
|
|
|
Filtration
|
|
$
|
66,224
|
|
|
|
60,035
|
|
Test
|
|
|
41,286
|
|
|
|
37,530
|
|
USG
|
|
|
55,855
|
|
|
|
55,754
|
|
Technical Packaging
|
|
|
19,232
|
|
|
|
20,176
|
|
Consolidated totals
|
|
$
|
182,597
|
|
|
|
173,495
|
|
|
|
|
|
|
|
|
|
|
EBIT
|
|
|
|
|
|
|
|
|
Filtration
|
|
$
|
10,610
|
|
|
|
9,645
|
|
Test
|
|
|
3,310
|
|
|
|
2,596
|
|
USG
|
|
|
21,546
|
|
|
|
10,651
|
|
Technical Packaging
|
|
|
106
|
|
|
|
965
|
|
Corporate (loss)
|
|
|
(10,425
|
)
|
|
|
(8,871
|
)
|
Consolidated EBIT
|
|
|
25,147
|
|
|
|
14,986
|
|
Less: Interest expense
|
|
|
(1,890
|
)
|
|
|
(2,185
|
)
|
Earnings before income taxes
|
|
$
|
23,257
|
|
|
|
12,801
|
|
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 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.
The Company’s debt is summarized as follows:
(In thousands)
|
|
December 31,
2018
|
|
|
September 30,
2018
|
|
Total borrowings
|
|
$
|
215,273
|
|
|
|
220,000
|
|
Short-term borrowings and current portion of long-term debt
|
|
|
(20,273
|
)
|
|
|
(20,000
|
)
|
Total long-term debt, less current portion
|
|
$
|
195,000
|
|
|
|
200,000
|
|
The Company’s existing credit facility (“the
Credit Facility”) matures December 21, 2020. The Credit Facility includes a $450 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 nine banks led by JPMorgan
Chase Bank, N.A., as Administrative Agent.
At December 31, 2018, the Company had approximately
$209 million available to borrow under the Credit Facility, and a $250 million increase option subject to lender approval, in addition
to $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. The Company classified $20.0 million as the current portion of long-term
debt as of December 31, 2018, as the Company intends to repay this amount within the next twelve month period; however, the Company
has no contractual obligation to repay such amount during the next twelve month period.
The Credit Facility requires, as determined by certain
financial ratios, a facility fee ranging from 12.5 to 27.5 basis points per year on the unused portion. The terms of the facility
provide that interest on borrowings may be calculated at a spread over the London Interbank Offered Rate (LIBOR) or based on the
prime rate, at the Company’s election. The facility is secured by the unlimited guaranty of the Company’s material
domestic subsidiaries and a 65% pledge of the material foreign subsidiaries’ share equity. The financial covenants of the
Credit Facility include a leverage ratio and an interest coverage ratio. The weighted average interest rates were 3.25% and 2.74%
for the three-month periods ending December 31, 2018 and 2017, respectively. At December 31, 2018, the Company was in compliance
with all debt covenants.
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 change in shareholders’ equity for the
first three months of 2019 is shown below (in thousands):
Balance at September 30, 2018
|
|
$
|
759,410
|
|
Net earnings
|
|
|
17,317
|
|
Other comprehensive (loss)
|
|
|
(4,554
|
)
|
Cash dividends
|
|
|
(2,073
|
)
|
Impact of ASC 606, Revenue Recognition
|
|
|
5,588
|
|
Stock compensation plans
|
|
|
1,104
|
|
Balance at December 31, 2018
|
|
$
|
776,792
|
|
A summary of net periodic benefit expense for the
Company’s defined benefit plans for the three-month periods ended December 31, 2018 and 2017 is shown in the following table.
Net periodic benefit cost for each period presented is comprised of the following:
|
|
Three Months
Ended December 31,
|
|
(In thousands)
|
|
2018
|
|
|
2017
|
|
Defined benefit plans
|
|
|
|
|
|
|
|
|
Interest cost
|
|
$
|
875
|
|
|
|
820
|
|
Expected return on assets
|
|
|
(1,086
|
)
|
|
|
(975
|
)
|
Amortization of:
|
|
|
|
|
|
|
|
|
Prior service cost
|
|
|
-
|
|
|
|
-
|
|
Actuarial loss
|
|
|
487
|
|
|
|
549
|
|
Net periodic benefit cost
|
|
$
|
276
|
|
|
|
394
|
|
|
12.
|
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 $150 million
to hedge some of its exposure to variability in future LIBOR-based interest payments on variable rate debt. In addition, the Company’s
Canadian subsidiary Morgan Schaffer enters into foreign exchange contracts to manage foreign currency risk as a portion of their
revenue is denominated in U.S. dollars. The Company expects hedging gains or losses to be essentially offset by losses or gains
on the related underlying exposures. All derivative instruments are reported in either accrued expenses or other receivables on
the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the gain or loss on the derivative
is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. The interest
rate swaps entered into during 2018 were not designated as cash flow hedges and, therefore, the gain or loss on the derivative
is reflected in earnings each period.
The following is a summary of the notional transaction
amounts and fair values for the Company’s outstanding derivative financial instruments by risk category and instrument type
as of December 31, 2018:
(In thousands)
|
|
Notional
amount
|
|
|
Fair
Value
(US$)
|
|
|
Float
Rate
|
|
|
Fix
Rate
|
|
Forward contracts
|
|
|
700
|
|
|
GBP
|
(119
|
)
|
|
|
|
|
|
|
|
|
Forward contracts
|
|
|
8,500
|
|
|
USD
|
(416
|
)
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
|
150,000
|
|
|
USD
|
599
|
|
|
|
2.48
|
%
|
|
|
2.09
|
%
|
Interest rate swap *
|
|
|
150,000
|
|
|
USD
|
308
|
|
|
|
N/A
|
|
|
|
2.24
|
%
|
*This swap represents a forward
contract and will be effective in November 2019.
|
13.
|
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 December 31, 2018 and September 30, 2018 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 December 31, 2018:
(In thousands)
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets (Liabilities):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forward contracts and interest rate swaps
|
|
$
|
-
|
|
|
|
372
|
|
|
$
|
-
|
|
|
|
372
|
|
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. No impairments
were recorded during the three-month period ended December 31, 2018.
Disaggregation of Revenues
Our revenues by customer type, geographic location, and revenue recognition method for the three-month
period ended December 31, 2018 are presented in the table 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 includes a reconciliation
of the disaggregated revenue within our reportable segments.
(In thousands)
|
|
Filtration
|
|
|
Test
|
|
|
USG
|
|
|
Technical
Packaging
|
|
|
Total
|
|
Customer type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
$
|
37,523
|
|
|
$
|
36,297
|
|
|
$
|
54,662
|
|
|
$
|
19,114
|
|
|
$
|
147,596
|
|
U.S. Government
|
|
|
28,701
|
|
|
|
4,989
|
|
|
|
1,193
|
|
|
|
118
|
|
|
|
35,001
|
|
Total revenues
|
|
$
|
66,224
|
|
|
$
|
41,286
|
|
|
$
|
55,855
|
|
|
$
|
19,232
|
|
|
$
|
182,597
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geographic location:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
54,847
|
|
|
$
|
28,453
|
|
|
$
|
40,228
|
|
|
$
|
9,849
|
|
|
$
|
133,377
|
|
International
|
|
|
11,377
|
|
|
|
12,833
|
|
|
|
15,627
|
|
|
|
9,383
|
|
|
|
49,220
|
|
Total revenues
|
|
$
|
66,224
|
|
|
$
|
41,286
|
|
|
$
|
55,855
|
|
|
$
|
19,232
|
|
|
$
|
182,597
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue recognition method:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Point in time
|
|
$
|
32,054
|
|
|
$
|
10,382
|
|
|
$
|
44,303
|
|
|
$
|
-
|
|
|
$
|
86,739
|
|
Over time
|
|
|
34,170
|
|
|
|
30,904
|
|
|
|
11,552
|
|
|
|
19,232
|
|
|
|
95,858
|
|
Total revenues
|
|
$
|
66,224
|
|
|
$
|
41,286
|
|
|
$
|
55,855
|
|
|
$
|
19,232
|
|
|
$
|
182,597
|
|
Remaining Performance Obligations
Our remaining performance obligations, which is the equivalent of our backlog, represent the expected
transaction price allocated to our contracts that we expect to recognize as revenue in future periods when we perform 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 December 31, 2018, we had $398.3 million in remaining performance obligations of which we expect
to recognize revenues of approximately 83% in the next twelve months.
Contract assets and liabilities
Assets and liabilities related to our contracts with customers are reported on a contract-by-contract
basis at the end of each reporting period. At December 31, 2018, contract assets and liabilities totaled $94.1 million
and $53.3 million, respectively. Upon adoption of ASC 606 on October 1, 2018, contract assets and liabilities related
to our contracts with customers were $87 million and $51 million, respectively. During the first quarter of 2019, we recognized
approximately $20 million in revenues that were included in the contract liabilities balance at the adoption date.
Reconciliation of ASC 606 to Prior Accounting
Standards
The amount by which each financial statement line
item is affected in 2019 as a result of applying the new accounting standard as discussed in Note 2 is presented below:
|
|
December 31, 2018
|
|
(In thousands)
|
|
As Reported
|
|
|
Effect of the
adoption of
ASC 606
|
|
|
Under Prior
Accounting
|
|
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract assets (1)
|
|
$
|
94,082
|
|
|
$
|
(41,836
|
)
|
|
$
|
52,246
|
|
Inventories
|
|
|
119,659
|
|
|
|
34,697
|
|
|
|
154,356
|
|
Total current assets
|
|
|
411,919
|
|
|
|
(7,139
|
)
|
|
|
404,780
|
|
Total assets
|
|
|
1,268,211
|
|
|
|
(7,139
|
)
|
|
|
1,261,072
|
|
Contract liabilities (2)
|
|
|
53,251
|
|
|
|
1,423
|
|
|
|
54,674
|
|
Total current liabilities
|
|
|
194,668
|
|
|
|
1,423
|
|
|
|
196,091
|
|
Deferred tax liabilities
|
|
|
61,536
|
|
|
|
226
|
|
|
|
61,762
|
|
Total liabilities
|
|
|
491,419
|
|
|
|
1,423
|
|
|
|
492,842
|
|
Retained earnings
|
|
|
627,670
|
|
|
|
(8,562
|
)
|
|
|
619,108
|
|
Total shareholders’ equity
|
|
|
776,792
|
|
|
|
(8,562
|
)
|
|
|
768,230
|
|
Total liabilities and shareholders’ equity
|
|
$
|
1,268,211
|
|
|
|
(7,139
|
)
|
|
|
1,261,072
|
|
|
(1)
|
Previously “cost and estimated earnings on long-term
contracts”
|
|
(2)
|
Previously “advance payments on long-term contracts”
and “current portion of deferred revenue”
|
|
|
Three Months Ended
December 31, 2018
|
|
(In thousands, except per share amounts)
|
|
As Reported
|
|
|
Effect of the
adoption of
ASC 606
|
|
|
Under Prior
Accounting
|
|
Consolidated Statements of Operations
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
182,597
|
|
|
$
|
(4,746
|
)
|
|
$
|
177,851
|
|
Cost of sales
|
|
|
118,908
|
|
|
|
(4,448
|
)
|
|
|
114,460
|
|
Total costs and expenses
|
|
|
159,340
|
|
|
|
(4,448
|
)
|
|
|
154,892
|
|
Earnings before income tax
|
|
|
23,257
|
|
|
|
(297
|
)
|
|
|
22,960
|
|
Income tax (benefit) expense
|
|
|
5,940
|
|
|
|
(64
|
)
|
|
|
5,876
|
|
Net earnings
|
|
|
17,317
|
|
|
|
(234
|
)
|
|
|
17,083
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
0.67
|
|
|
$
|
(0.01
|
)
|
|
$
|
0.66
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
0.66
|
|
|
$
|
(0.01
|
)
|
|
$
|
0.65
|
|
Consolidated Statements of Comprehensive Income
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
17,317
|
|
|
$
|
(234
|
)
|
|
$
|
17,083
|
|
Comprehensive income
|
|
|
12,763
|
|
|
|
(234
|
)
|
|
|
12,529
|
|
Consolidated Statements of Cash flows
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
17,317
|
|
|
$
|
(234
|
)
|
|
$
|
17,083
|
|
Adjustments to reconcile net earnings to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in assets and liabilities
|
|
$
|
(7,912
|
)
|
|
|
234
|
|
|
$
|
(7,678
|
)
|
Net cash provided by operating activities
|
|
|
8,102
|
|
|
|
-
|
|
|
|
8,102
|
|
|
15.
|
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.