Commission file number: 1-10596
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ⌧ 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 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Aggregate market value of the Common Stock held by non-affiliates of the registrant as of the close of trading on March 29, 2019, the last business day of the registrant’s most recently completed second fiscal quarter: approximately $1,698,000,000. *
* Based on the New York Stock Exchange closing price on March 29, 2019. For purpose of this calculation only, without determining whether the following are affiliates of the registrant, the registrant has assumed that (i) its directors and executive officers are affiliates, and (ii) no party who has filed a Schedule 13D or 13G is an affiliate.
Number of shares of Common Stock outstanding at November 22,2019: 25,981,313
Part III of this Report incorporates by reference certain portions of the registrant’s definitive Proxy Statement for its 2020 Annual Meeting of Shareholders, which the registrant currently anticipates first sending to shareholders on or about December 11, 2019 (hereinafter, the “2019 Proxy Statement”).
Statements contained in this Form 10-K regarding future events and the Company’s future results that are based on current expectations, estimates, forecasts and projections 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, without limitation, statements about: the adequacy of the Company’s buildings, machinery and equipment; the adequacy of the Company’s credit facilities and future cash flows; the outcome of litigation, claims and charges; future costs relating to environmental matters; repayment of debt within the next twelve months; the outlook for 2020 and beyond, including amounts, timing and sources of 2020 sales, revenues, sales growth, Adjusted EBIT, EBITDA, Adjusted EBITDA and Adjusted EPS; interest on Company debt obligations; the ability of expected hedging gains or losses to be offset by losses or gains on related underlying exposures; the Company’s ability to increase shareholder value; acquisitions; income tax expense and the Company’s expected effective tax rate; minimum cash funding required by, expected benefits payable from, and Management’s assumptions about future events which could affect liability under, the Company’s defined benefit plans and other postretirement benefit plans; the recognition of unrecognized compensation costs related to share-based compensation arrangements; the Company’s exposure to market risk related to interest rates and to foreign currency exchange risk; the likelihood of future variations in the Company’s assumptions or estimates used in recording contracts and expected costs at completion under the percentage of completion method; the Company’s estimates and assumptions used in the preparation of its financial statements; cost and estimated earnings on long-term contracts; valuation of inventories; estimates of uncollectible accounts receivable; the risk of goodwill impairment; the Company’s estimates utilized in software revenue recognition, non-cash depreciation and the amortization of intangible assets; the valuation of deferred tax assets; estimates of future cash flows and fair values in connection with the risk of goodwill impairment; amounts of NOL not realizable and the timing and amount of the reduction of unrecognized tax benefits; the effects of implementing recently issued accounting pronouncements; the sale of the Technical Packaging business segment and the Company’s use of the expected proceeds from the sale; 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-K, and the Company undertakes no duty to update the information in this Form 10-K 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 herein under “Item 1A, Risk Factors,” and the following: the impacts of labor disputes, civil disorder, wars, elections, political changes, tariffs and trade disputes, terrorist activities or natural disasters on the Company’s operations and those of the Company’s customers and suppliers; the timing and content of future customer orders; the appropriation and allocation of government funds; the termination for convenience of government and other customer contracts; the timing and magnitude of future contract awards; 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 of certain raw materials; material changes in the cost of credit; changes in laws and regulations including but not limited to changes in accounting standards and taxation requirements; costs relating to environmental matters; litigation uncertainty; the Company’s inability to successfully execute internal restructuring and other plans; and the Company’s inability to complete the sale of its Technical Packaging business segment.
The Registrant, ESCO Technologies Inc. (ESCO), is a global provider of highly engineered products and solutions to diverse and growing end-markets that include the commercial and military aerospace, space, healthcare, wireless, consumer electronics, electric utility and renewable energy industries. ESCO is focused on generating predictable and profitable long-term growth through continued innovation and expansion of its product offerings across each of its business segments. ESCO conducts its business through a number of wholly-owned direct and indirect subsidiaries. ESCO and its subsidiaries are referred to in this Report as “the Company.”
ESCO was incorporated in Missouri in August 1990 as a wholly owned subsidiary of Emerson Electric Co. (Emerson) to be the indirect holding company for several Emerson subsidiaries, which were primarily in the defense business. Ownership of the Company was spun off by Emerson to its shareholders on October 19, 1990, through a special distribution. Since that time, through a series of acquisitions and divestitures, the Company has shifted its primary focus from defense contracting to the production and supply of engineered products and systems marketed to utility, industrial, aerospace and commercial users. ESCO’s corporate strategy is centered on a multi-segment approach designed to enhance the strength and sustainability of sales and earnings growth by providing lower risk through diversification. Its stock is listed on the New York Stock Exchange, where its ticker symbol is “ESE”.
The Company’s fiscal year ends September 30. Throughout this Annual Report, unless the context indicates otherwise, references to a year (for example 2019) refer to the Company’s fiscal year ending on September 30 of that year, and references to the “Consolidated Financial Statements” refer to the Consolidated Financial statements included in the Financial Information section of this Annual Report beginning on page F-1, an Index to which is provided on page F-1.
The Company is organized based on the products and services it offers, and classifies its business operations in segments for financial reporting purposes. The Company’s four reportable segments during 2019, together with the significant domestic and foreign operating subsidiaries within each segment, are as follows:
Filtration/Fluid Flow (Filtration):
PTI Technologies Inc. (PTI)
VACCO Industries (VACCO)
Crissair, Inc. (Crissair)
Westland Technologies, Inc. (Westland)
Mayday Manufacturing Co. (Mayday)
Hi-Tech Metals, Inc. (Hi-Tech)
Globe Composite Solutions, LLC (Globe)
Utility Solutions Group (USG):
Morgan Schaffer Ltd. (Morgan Schaffer)
NRG Systems, Inc. (NRG)
Except as the context otherwise indicates, the term “Doble” as used herein includes Doble Engineering Company and the Company’s other USG subsidiaries except Morgan Schaffer and NRG.
RF Shielding and Test (Test):
Except as the context otherwise indicates, the term “ETS-Lindgren” as used herein includes ETS-Lindgren Inc. and the Company’s other Test segment subsidiaries.
Thermoform Engineered Quality LLC (TEQ)
Plastique Limited and Plastique Sp. z o.o. are referred to together herein as “Plastique.” The Company has entered into an agreement to sell the entities comprising this segment. See “Subsequent Event” on page 7.
The Company’s operating subsidiaries are engaged primarily in the research, development, manufacture, sale and support of the products and systems described below. Their respective businesses are subject to a number of risks and uncertainties, including without limitation those discussed in Item 1A, “Risk Factors.” See also Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Forward-Looking Information.”
ESCO is continually seeking ways to reduce overall operating costs, streamline business processes and enhance the branding of its products and services. During 2018, the Company undertook several restructuring actions involving the closure of Doble’s sales offices in Norway, China, Mexico and Dubai as part of its consolidation of the global distribution channels of Doble and Morgan Schaffer. During 2019, Doble sold its headquarters facility in Watertown, Massachusetts and is in the process of consolidating its headquarters operations into a single, more cost-efficient facility in Marlborough, Massachusetts. Also during fiscal 2019, Plastique reduced its operating costs and gained efficiencies through a restructuring that involved closing its administrative and product development center in Tunbridge Wells, UK and integrating those activities into its existing manufacturing locations in Nottingham, UK and Poznan, Poland.
ESCO is also continually seeking opportunities to supplement its growth by making strategic acquisitions. During 2017, the Company acquired Mayday, Hi-Tech, NRG, the assets of Morgan Schaffer Inc., and the assets of Vanguard Instruments Company (Vanguard Instruments); in March 2018 the Company acquired the assets of Manta Test Systems Ltd. (Manta); and in July 2019 the Company acquired Globe. More information about these acquired businesses is provided in the following section, “Products,” and in Note 2 to the Consolidated Financial Statements.
In November 2019, the Company entered into an agreement to sell the businesses comprising its Technical Packaging segment. See “Subsequent Event” on page 7.
The Company’s principal products are described below. See Note 13 to the Consolidated Financial Statements for financial information regarding business segments and 10% customers.
The Filtration segment accounted for approximately 40%, 37% and 41% of the Company’s total revenue in 2019, 2018 and 2017, respectively.
PTI is a leading supplier of filtration and fluid control products serving the commercial aerospace, military aerospace and various industrial markets. Products include filter elements, manifolds, assemblies, modules, indicators and other related components, all of which must meet stringent qualification requirements and withstand severe operating conditions. Product applications include hydraulic, fuel, cooling and air filtration systems for fixed wing and rotary aircraft, mobile transportation and construction equipment, aircraft engines and stationary plant equipment. PTI supplies products worldwide to OEMs and the U.S. government under long-term contracts, and to the commercial and military aftermarket through distribution channels.
VACCO supplies filtration and fluid control products including valves, manifolds, filters, regulators and various other components for use in the space, military aerospace, defense missile systems, U.S. Navy and commercial industries. Applications include aircraft fuel and de-icing systems, missiles, satellite propulsion systems, satellite launch vehicles and other space transportation systems such as the Space Launch System, the Orion Multi-Purpose Crew Vehicle and the European Service Module. VACCO also utilizes its multi-fab technology and capabilities to produce products for use in space and U.S. Navy applications.
Crissair supplies a wide variety of custom and standard valves, actuators, manifolds and other various components to the aerospace, defense, automotive and commercial industries. Product applications include hydraulic, fuel and air filtration systems for commercial and military fixed wing and rotary aircraft, defense missile systems and commercial engines. Crissair supplies products worldwide to OEMs and to the U.S. Government under long-term contracts and to the commercial aftermarket through distribution channels.
Westland is a leading designer and manufacturer of elastomeric-based signature reduction solutions to enhance U.S. Navy maritime survivability. Westland’s products include complex tiles and other shock and vibration dampening systems that reduce passive acoustic signatures and/or modify signal (radar, infrared, acoustical, sonar) emission and reflection to reduce or obscure a vessel’s signature. Westland’s products are used on the majority of the U.S. Naval fleet including the U.S. submarine fleet and various surface ships including aircraft carriers.
Mayday is a leading manufacturer of mission-critical bushings, pins, sleeves and precision-tolerance machined components for landing gear, rotor heads, engine mounts, flight controls, and actuation systems for the aerospace and defense industries.
Hi-Tech is a full-service metal processor offering aerospace OEMs and Tier 1 suppliers a large portfolio of processing services including anodizing, cadmium and zinc-nickel plating, organic coatings, non-destructive testing, and heat treatment. Its portfolio includes over 100 OEM processing approvals.
Globe is a well-established, vertically integrated supplier of mission-critical composite-based products and solutions for navy, defense, and industrial customers; it works directly with the U.S. Navy and also through prime contractors to cost-effectively and efficiently produce parts that meet rigid military-grade specifications through its internally developed expertise. Its products are utilized for acoustic, signature-reduction, communications, sealing, vibration-reducing, surface control, and hydrodynamic-related applications.
The USG segment accounted for approximately 26%, 28% and 24% of the Company’s total revenue in 2019, 2018 and 2017, respectively.
Doble develops, manufactures, and delivers diagnostic testing solutions for electrical equipment comprising the electric power grid, and enterprise management systems, that are designed to optimize electrical power assets and system performance, minimize risk and improve operations. It combines three core elements for customers – diagnostic test and monitoring instruments, expert consulting, and testing services – and provides access to its large reserve of related empirical knowledge.
Doble has seven offices in the United States and five international offices.
Morgan Schaffer designs, develops, manufactures and markets an integrated offering of dissolved gas analysis, oil testing, and data management solutions which have been combined with doblePrime™ to create a comprehensive online monitoring solution including bushing monitoring, DGA and partial discharge.
NRG is a global market leader in the design and manufacture of decision support tools for the renewable energy industry, primarily wind.
The Test segment accounted for approximately 23%, 24% and 23% of the Company’s total revenue in 2019, 2018 and 2017, respectively.
ETS-Lindgren designs and manufactures products to measure and contain magnetic, electromagnetic and acoustic energy. It supplies customers with a broad range of isolated environments and turnkey systems, including RF test facilities, acoustic test enclosures, RF and magnetically shielded rooms, secure communication facilities, RF measurement systems and broadcast and recording studios. Many of these facilities include proprietary features such as shielded doors and windows. ETS-Lindgren also provides the design, program management, installation and integration services required to successfully complete these types of facilities.
ETS-Lindgren also supplies customers with a broad range of components including RF absorptive materials, RF filters, active compensation systems, antennas, antenna masts, turntables and electric and magnetic probes, RF test cells, proprietary measurement software and other test accessories required to perform a variety of tests. ETS-Lindgren offers a variety of services including calibration for antennas and field probes, chamber certification, field surveys, customer training and a variety of product tests. ETS-Lindgren’s test labs are accredited by the following organizations: American Association for Laboratory Accreditation, National Voluntary Laboratory Accreditation Program and CTIA-The Wireless Association Accredited Test Lab. ETS-Lindgren serves the acoustics, medical, health and safety, electronics, wireless communications, automotive and defense markets. ETS-Lindgren has four offices in the United States and nine international offices.
The Technical Packaging segment accounted for approximately 11%, 11% and 12% of the Company’s total revenue in 2019, 2018 and 2017, respectively.
TEQ produces highly engineered thermoformed products and packaging materials for medical, pharmaceutical, retail, food and electronic applications. Through its alliance partner program, TEQ also provides its clients with a total packaging solution including engineering services and testing, sealing equipment and tooling, contract manufacturing, and packing.
Plastique, with locations in the UK and Poland, designs and manufactures plastic and pulp fibre packaging for customers in the personal care, household products, pharmaceutical, food and broader retail markets. Through its Fibrepak brand, Plastique became the first European manufacturer of smooth-surfaced press-to-dry pulp packaging, a sustainable alternative to plastic packaging.
The Company’s products generally are distributed to customers through a domestic and foreign network of distributors, sales representatives, direct sales teams and in-house sales personnel.
The Company’s sales to international customers accounted for approximately 28%, 30% and 27% of the Company’s total revenue in 2019, 2018 and 2017, respectively. See Note 13 to the Consolidated Financial Statements for financial information by geographic area. See also Item 1A, “Risk Factors,” for a discussion of risks of the Company’s international operations.
Some of the Company’s products are sold directly or indirectly to the U.S. Government under contracts with the Army, Navy and Air Force and subcontracts with prime contractors of such entities. Direct and indirect sales to the U.S. Government, primarily related to the Filtration segment, accounted for approximately 19%, 20% and 20% of the Company’s total revenue in 2019, 2018 and 2017, respectively.
The Company owns or has other rights in various forms of intellectual property (i.e., patents, trademarks, service marks, copyrights, mask works, trade secrets and other items). As a major supplier of engineered products to industrial and commercial markets, the Company emphasizes developing intellectual property and protecting its rights therein. However, the scope of protection afforded by intellectual property rights, including those of the Company, is often uncertain and involves complex legal and factual issues. Some intellectual property rights, such as patents, have only a limited term. Also, there can be no assurance that third parties will not infringe or design around the Company’s intellectual property. Policing unauthorized use of intellectual property is difficult, and infringement and misappropriation are persistent problems for many companies, particularly in some international markets. In addition, the Company may not elect to pursue an unauthorized user due to the high costs and uncertainties associated with litigation. Further, there can be no assurance that courts will ultimately hold issued patents or other intellectual property valid and enforceable. See Item 1A, “Risk Factors.”
A number of products in the Filtration segment are based on patented or otherwise proprietary technology that sets them apart from the competition, such as VACCO’s proprietary quieting technology and Westland’s signature reduction solutions. In addition, Globe has developed significant manufacturing and logistics capability useful for special hull treatments for submarines. Globe has also obtained patent protection in the U.S. and Europe for a novel shielding curtain to be used with electromagnetic radiation scanning systems.
In the USG segment, the segment policy is to seek patent and/or other forms of intellectual property protection on new and improved products, components of products and methods of operation for its businesses, as such developments are made. Doble is pursuing patent protection on improvements to its line of diagnostic equipment and NERC CIP compliance tools. Doble also holds an extensive library of apparatus performance information useful to Doble employees and to entities that generate, distribute or consume electric energy. Doble makes part of this library available to registered users via an Internet portal. NRG is pursuing patent protection on its upcoming line of bat deterrent systems, which are expected to reduce bat mortality at windfarms. In 2018, NRG acquired patented direct detect LIDAR technology from Pentalum Technologies Ltd. with uses in wind resource assessment, wind farm operation, forecasting and research.
In the Test segment, patent protection has been sought for significant inventions. Examples of such inventions include novel designs for window and door assemblies used in shielded enclosures and anechoic chambers, improved acoustic techniques for sound isolation and a variety of unique antennas. In addition, the Test segment holds a number of patents, and has patents pending, on products used to perform wireless device testing.
The Technical Packaging segment emphasizes advanced manufacturing technology and methods. For example, the TEQ 3-in-1 tooling system, with an added stacking tool, provides a competitive edge over traditional thermoform tooling; and Plastique’s “Cure-In-The-Mold” technology produces high-quality, smooth-surface, thin-wall packaging products which may be made from sustainable virgin crop fibers or virgin pulp. The segment’s intellectual property consists chiefly of trade secrets and proprietary technology embodied in products for which the Company is the only approved source, such as the TEQconnexTM and TEQethelyeneTM single polymer sterile barrier medical packaging systems for which TEQ owns the validation studies required to register the package with the FDA.
The Company considers its patents and other intellectual property to be of significant value in each of its segments.
Total Company backlog of firm orders at September 30, 2019 was $475.1 million, representing an increase of $92.3 million (24.1%) from the backlog of $382.8 million on September 30, 2018. By segment, the backlog at September 30, 2019 and September 30, 2018, respectively, was $288.4 million and $204.2 million for Filtration; $41.7 million and $40.7 million for USG; $133.6 million and $122.3 million for Test; and $11.4 million and $15.5 million for Technical Packaging. The Company estimates that as of September 30, 2019 domestic customers accounted for approximately 73% of the Company’s total firm orders and international customers accounted for approximately 27%. Of the total Company backlog at September 30, 2019, approximately 90% is expected to be completed in the fiscal year ending September 30, 2020.
The Company’s products require a wide variety of components and materials. Although the Company has multiple sources of supply for most of its materials requirements, certain components and raw materials are supplied by sole source vendors, and the Company’s ability to perform certain contracts depends on their performance. In the past, these required raw materials and various purchased components generally have been available in sufficient quantities. However, the Company does have some risk of shortages of materials or components due to reliance on sole or limited sources of supply. See Item 1A, “Risk Factors.”
The Filtration segment purchases supplies from a wide array of vendors. In most instances, multiple vendors of raw materials are screened during a qualification process to ensure that there will not be an interruption of supply should one of them underperform or discontinue operations. Nonetheless, in some situations, there is a risk of shortages due to reliance on a limited number of suppliers or because of price fluctuations due to the nature of the raw materials. For example, aerospace-grade titanium and gaseous helium, important raw materials for our Filtration segment subsidiaries, may at times be in short supply.
The USG segment manufactures electronic instrumentation through a network of regional contract manufacturers under long-term contracts. In general, USG purchases the same kinds of component parts as do other electronic products manufacturers, and it purchases only a limited amount of raw materials.
The Test segment is a vertically integrated supplier of electro-magnetic (EM) shielding and RF absorbing products, producing most of its critical RF components. This segment purchases significant quantities of raw materials such as polyurethane foam, polystyrene beads, steel, aluminum, copper, nickel and wood. Accordingly, it is subject to price fluctuations in the worldwide raw materials markets. While ETS-Lindgren has long-term contracts with a number of its suppliers, it is vulnerable to changes in trade policies.
The Technical Packaging segment selects suppliers initially on the basis of their ability to meet requirements, and then conducts ongoing evaluations and ratings of the supplier’s performance based on a documented evaluation process. The segment purchases raw materials according to a documented and controlled process assuring that purchased materials meet defined specifications. Thermoplastics represent the largest percentage of raw material spend, with purchase prices subject to fluctuation depending on petrochemical industry pricing and capacity in the plastic resin market.
Competition in the Company’s major markets is broadly based and global in scope. Competition can be particularly intense during periods of economic slowdown, and this has been experienced in some of the Company’s markets. Although the Company is a leading supplier in several of the markets it serves, it maintains a relatively small share of the business in many of the other markets it serves. Individual competitors range in size from annual revenues of less than $1 million to billion-dollar enterprises. Because of the specialized nature of the Company’s products, its competitive position with respect to its products cannot be precisely stated. In the Company’s major served markets, competition is driven primarily by quality, technology, price and delivery performance. See also Item 1A, “Risk Factors.”
Primary competitors of the Filtration segment include Pall Corporation, Moog, Inc., Safran (Sofrance), CLARCOR Inc., TransDigm (PneuDraulics), Marotta Controls, and Parker Hannifin.
Significant competitors of the USG segment include OMICRON electronics Corp., Megger Group Limited, Vaisala, and Qualitrol Company LLC (a subsidiary of Danaher Corporation).
The Test segment is a global leader in EM shielding. Significant competitors in this market include Rohde & Schwarz GMBH, Microwave Vision SA (MVG), TDK RF Solutions Inc., Albatross GmbH, IMEDCO AG, and Universal Shielding Corp..
Significant competitors of the Technical Packaging segment include Nelipak Corporation, Prent Corporation, Placon Corporation, and Poli Marian Holz.
Research and development and the Company’s technological expertise are important factors in the Company’s business. Research and development programs are designed to develop technology for new products or to extend or upgrade the capability of existing products, and to enhance their commercial potential. The Company performs research and development at its own expense, and also engages in research and development funded by customers. See Note 1 to the Consolidated Financial Statements for financial information about the Company’s research and development expenditures.
The Company is involved in various stages of investigation and cleanup relating to environmental matters. It is difficult to estimate the potential costs of such matters and the possible impact of these costs on the Company at this time due in part to: the uncertainty regarding the extent of pollution; the complexity and changing nature of Government laws and regulations and their interpretations; the varying costs and effectiveness of alternative cleanup technologies and methods; the uncertain level of insurance or other types of cost recovery; the uncertain level of the Company’s responsibility for any contamination; the possibility of joint and several liability with other contributors under applicable law; and the ability of other contributors to make required contributions toward cleanup costs. Based on information currently available, the Company does not believe that the aggregate costs involved in the resolution of any of its environmental matters will have a material adverse effect on the Company’s financial condition or results of operations.
The Company contracts with the U.S. Government and subcontracts with prime contractors of the U.S. Government. Although VACCO and Westland have a number of “cost-plus” Government contracts, the Company’s Government contracts also include firm fixed-price contracts under which work is performed and paid for at a fixed amount without adjustment for the actual costs experienced in connection with the contracts. All Government prime contracts and virtually all of the Company’s Government subcontracts provide that they may be terminated at the convenience of the Government or the customer. Upon such termination, the Company is entitled to receive equitable compensation from the customer. See “Marketing and Sales” in this Item 1, and Item 1A, “Risk Factors,” for additional information regarding Government contracts and related risks.
As of September 30, 2019, the Company employed 3,239 persons, including 3,012 full time employees. Of the Company’s full-time employees, 2,440 were located in the United States and 572 were located in 15 foreign countries.
For information about the Company’s credit facility, see Note 8 to the Consolidated Financial Statements, which is incorporated into this Item by reference.
The information set forth in Item 1A, “Risk Factors,” is incorporated in this Item by reference.
The Company makes available free of charge on or through its website, www.escotechnologies.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Information contained on the Company’s website is not incorporated into this Report.
On November 15, 2019 the Company, through its wholly owned subsidiaries ESCO Technologies Holding LLC and ESCO UK Holding Company I Ltd., entered into an agreement to sell its Technical Packaging business segment, consisting of Thermoform Engineered Quality LLC, Plastique Ltd. and Plastique sp. z o.o., to subsidiaries of Sonoco Products Company (NYSE: SON) for a cash purchase price of $187 million, plus or minus certain customary adjustments based on working capital and other typical post-closing adjustments specified in the sale agreement. Closing of the trasaction is subject to specified representations, warranties, covenants and conditions customary in agreements of this kind and scope. The buyers have agreed to waive any post-closing claims against the sellers for indennity under the representations and warranties in the sale agreement (except in the event of fraud) and intend to obtain a Representation and Warranty Insurance policy to provide coverage in the event of a breach by the sellers.
The Company expects to finalize the sale upon receipt of regulatory clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and similar foreign regulations, and upon satisfaction or waiver of the conditions to Closing specified in the Agreement. The Company expects the Closing to occur in late 2019 or early 2020.
The Technical Packaging business segment will be reported as discontinued operations in 2020.
The Company intends to use the proceeds from the sale to pay down debt and for other corporate purposes, including funding, terminating and annuitizing the Company’s defined benefit pension plan, which has been frozen since 2003, during fiscal 2020.
The following sets forth certain information as of November 1, 2019 with respect to the Company’s executive officers. These officers are elected annually to terms which expire at the first meeting of the Board of Directors after the next Annual Meeting of Stockholders.
Chairman of the Board of Directors and Chief Executive Officer since April 2003; President since October 2006 *
Executive Vice President and Chief Financial Officer since February 2008; Director since February 2011
Senior Vice President, Secretary and General Counsel since November 2008
* Mr. Richey also serves as Chairman of the Executive Committee of the Board of Directors.
This Form 10-K, including Item 1, “Business,” Item 2, “Properties,” Item 3, “Legal Proceedings,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 7A, “Quantitative and Qualitative Disclosures About
Market Risk,” contains “forward-looking statements” within the meaning of the safe harbor provisions of the federal securities laws, as described under “Forward-Looking Statements” above.
In addition to the risks and uncertainties discussed in that section and elsewhere in this Form 10-K, the following important risk factors could cause actual results and events to differ materially from those contained in any forward-looking statements, or could otherwise adversely affect the Company’s business, operating results or financial condition:
Our sales of products to the Government depend upon continued Government funding.
Sales to the U.S. Government and its prime contractors and subcontractors represent a significant portion of our business. Over the past three fiscal years, from 19% to 20% of our revenues have been generated from sales to the U.S. Government or its contractors, primarily within our Filtration segment. These sales are dependent on government funding of the underlying programs, which is generally subject to annual Congressional appropriations. There could be reductions or terminations of, or delays in, the government funding on programs which apply to us or our customers. These funding effects could adversely affect our sales and profit, and could bring about a restructuring of our operations, which could result in an adverse effect on our financial condition or results of operations. A significant portion of VACCO’s, Westland’s and Globe’s sales involve major U.S. Government programs such as NASA’s Space Launch System (SLS) and U.S. Navy submarines. A reduction or delay in Government spending on these programs could have a significant adverse impact on our financial results which could extend for more than a single year.
Negative worldwide economic conditions and related credit shortages could result in a decrease in our sales and an increase in our operating costs, which could adversely affect our business and operating results.
If there is a worsening of global and U.S. economic and financial market conditions and additional tightening of global credit markets, many of our customers may further delay or reduce their purchases of our products. Uncertainties in the global economy may cause the utility industry and commercial market customers to experience shortages in available credit, which could limit capital spending. To the extent this problem affects our customers, our sales and profits could be adversely affected. Likewise, if our suppliers face challenges in obtaining credit, they may have to increase their prices or become unable to continue to offer the products and services we use to manufacture our products, which could have an adverse effect on our business, results of operations and financial condition.
We have experienced variability in quarterly results and believe our quarterly results will continue to fluctuate as a result of many factors, including the size and timing of customer orders, governmental approvals and funding levels, changes in existing taxation rules or practices, the gain or loss of significant customers, timing and levels of new product developments, shifts in product or sales channel mix, increased competition and pricing pressure, and general economic conditions.
A significant part of our manufacturing operations depends on a small number of third-party suppliers.
A significant part of our manufacturing operations relies on a small number of third-party manufacturers to supply component parts or products. For example, Doble has arrangements with six manufacturers which produce and supply a substantial portion of its end-products, and one of these suppliers produces approximately 35% of Doble’s products from a single location within the United States. As another example, PTI has a single supplier of critical electronic components for a significant aircraft production program, and if this supplier were to discontinue producing these components the need to secure another source could pose a risk to the production program. A significant disruption in the supply of those products or others provided by a small number of suppliers could negatively affect the timely delivery of products to customers as well as future sales, which could increase costs and reduce margins.
Certain of our other businesses are dependent upon sole source or a limited number of third-party manufacturers of parts and components. Many of these suppliers are small businesses. Since alternative supply sources are limited, there is an increased risk of adverse impacts on our production schedules and profits if our suppliers were to default in fulfilling their price, quality or delivery obligations. In addition, some of our customers or potential customers may prefer to purchase from a supplier which does not have such a limited number of sources of supply.
Increases in prices of raw material and components, and decreased availability of such items, could adversely affect our business.
The cost of raw materials and product components is a major element of the total cost of many of our products. For example, our Test segment’s critical components rely on purchases of raw materials from third parties. Increases in the prices of raw materials (such as steel, copper, nickel, zinc, wood and petrochemical products) could have an adverse impact on our business by, among other things, increasing costs and reducing margins. Aerospace-grade titanium and gaseous helium, important raw materials for our Filtration segment, may at times be in short supply. Further, many of Doble’s items of equipment which are provided to its customers for their use are in the maturity of their life cycles, which creates the risk that replacement components may be unavailable or available only at increased costs.
In addition, our reliance on sole or limited sources of supply of raw materials and components in each of our segments could adversely affect our business, as described in the preceding Risk Factor. Weather-created disruptions in supply, in addition to affecting costs, could impact our ability to procure an adequate supply of these raw materials and components, and delay or prevent deliveries of products to our customers.
Increases in tariffs or other changes in trade policies could adversely affect our ability to compete.
In addition to the effects of increases in market prices, increases in domestic import tariffs could increase the prices to us of our foreign-sourced raw materials and product components and thereby require us to either increase our selling prices or accept reduced margins. In the case of ETS-Lindgren, for example, tariffs on imports of Chinese goods have raised the costs of components purchased by it either from its China facility or from other Chinese suppliers, and its margins in China have been impacted by the increased costs of its products made in the U.S. and sold through its Chinese business.
In addition, increases in foreign-country tariffs applicable to our exported products could increase the effective prices of our products to our customers in those countries unless we were able to offset the tariffs by reducing our selling prices. Any or all of these factors could decrease the demand for our products, reduce our profitability, and/or make our products less competitive than those of other manufacturers that are not subject to the same tariffs. For example, during 2018 and 2019 increased tariffs imposed by China on US origin goods have adversely affected sales of NRG’s products in China by increasing their prices to Chinese customers.
In addition, trade restrictions against certain foreign-made products or entities may adversely affect our business. For example, because ETS-Lindgren sells wireless test solutions to Huawei in China the proposed trade ban against Huawei would adversely impact ETS-Lindgren’s Chinese business.
Our international operations expose us to fluctuations in currency exchange rates that could adversely affect our results of operations and cash flows.
We have significant manufacturing and sales activities in foreign countries, and our domestic operations have sales to foreign customers. Our financial results may be affected by fluctuations in foreign currencies and by the translation of the financial statements of our foreign subsidiaries from local currencies into U.S. dollars, and we may not be able to adequately or successfully hedge against these risks. In addition, a rise in the dollar against foreign currencies could make our products more expensive for foreign customers and cause them to reduce the volume of their purchases.
Economic, political and other risks of our international operations, including terrorist activities, could adversely affect our business.
In 2019, approximately 28% of our net sales were to customers outside the United States. Increases in international tariffs resulting from changes in domestic or foreign trade policies could increase the costs of the raw materials used in our products and/or the costs of our products. In addition, an economic downturn or an adverse change in the political situation in certain foreign countries in which we do business could cause a decline in revenues and adversely affect our financial condition. For example, our Test segment does significant business in Asia, and changes in the Asian political climate or political changes in specific Asian countries could negatively affect our business; several of our subsidiaries are based in Europe and could be negatively impacted by weakness in the European economy; Doble’s and Plastique’s UK-based businesses could be adversely affected by Brexit; and Doble’s future business in the Middle East could be adversely affected by continuing political unrest, wars and terrorism in the region.
Our international sales are also subject to other risks inherent in foreign commerce, including currency fluctuations and devaluations, differences in foreign laws, uncertainties as to enforcement of contract or intellectual property rights, and difficulties in negotiating and resolving disputes with our foreign customers.
Our governmental sales and our international and export operations are subject to special U.S. and foreign government laws and regulations which may impose significant compliance costs, create reputational and legal risk, and impair our ability to compete in international markets.
The international scope of our operations subjects us to a complex system of commercial and trade regulations around the world, and our foreign operations are governed by laws and business practices that often differ from those of the U.S. In addition, laws such as the U.S. Foreign Corrupt Practices Act and similar laws in other countries increase the need for us to manage the risks of improper conduct not only by our own employees but by distributors and contractors who may not be within our direct control. Many of our exports are of products which are subject to U.S. Government regulations and controls such as the U.S. International Traffic in Arms Regulations (ITAR), which impose certain restrictions on the U.S. export of defense articles and services, and these restrictions are subject to change from time to time, including changes in the countries into which our products may lawfully be sold.
If we were to fail to comply with these laws and regulations, we could be subject to significant fines, penalties and other sanctions including the inability to continue to export our products or to sell our products to the U.S. Government or to certain other customers. In addition, some of these regulations may be viewed as too restrictive by our international customers, who may elect to develop their own domestic products or procure products from other international suppliers which are not subject to comparable export restrictions; and the laws, regulations or policies of certain other countries may also favor their own domestic suppliers over foreign suppliers such as the Company.
Our inability to timely develop new products could reduce our future sales.
Much of our business is dependent on the continuous development of new products and technologies to meet the changing needs of our markets on a cost-effective basis. Many of these markets are highly technical from an engineering standpoint, and the relevant technologies are subject to rapid change. If we fail to timely enhance existing products or develop new products as needed to meet market or competitive demands, we could lose sales opportunities, which would adversely affect our business. In addition, in some existing contracts with customers, we have made commitments to develop and deliver new products. If we fail to meet these commitments, the default could result in the imposition on us of contractual penalties including termination. Our inability to enhance existing products in a timely manner could make our products less competitive, while our inability to successfully develop new products may limit our growth opportunities. Development of new products and product enhancements may also require us to make greater investments in research and development than we now do, and the increased costs associated with new product development and product enhancements could adversely affect our operating results. In addition, our costs of new product development may not be recoverable if demand for our products is not as great as we anticipate it to be.
Changes in testing standards could adversely impact our Test and USG segments’ sales.
A significant portion of the business of our USG and Test segments involves sales to technology customers who need to have a third party verify that their products meet specific international and domestic test standards. If regulatory agencies were to eliminate or reduce certain domestic or international test standards, or if demand for product testing from these customers were to decrease for some other reason, our sales could be adversely affected. For example, if Wi-Fi technology in mobile phones were to be superseded by a new communications technology, then there might be no need for certain testing on mobile phones; or if a regulatory authority were to relax the test standards for certain electronic devices because they were determined not to interfere with the broadcast spectrum, our sales of certain testing products could be significantly reduced.
The end of customer product life cycles could negatively affect our Filtration segment’s results.
Many of our Filtration segment products are sold to be components in our customers’ end-products. If a customer discontinues a certain end-product line, our ability to continue to sell those components will be reduced or eliminated. The result could be a significant decrease in our sales. For example, a substantial portion of PTI’s revenue is generated from commercial aviation aftermarket sales. As certain aircraft are retired and replaced by newer aircraft, there could be a corresponding decrease in sales associated with our current products. Such a decrease could adversely affect our operating results.
Product defects could result in costly fixes, litigation and damages.
Our business exposes us to potential product liability risks that are inherent in the design, manufacture and sale of our products and the products of third-party vendors which we use or resell. If there are claims related to defective products (under warranty or otherwise), particularly in a product recall situation, we could be faced with significant expenses in replacing or repairing the product. For example, the Filtration segment obtains raw materials, machined parts and other product components from suppliers who provide certifications of quality which we rely on. Should these product components be defective and pass undetected into finished products, or should a finished product contain a defect, we could incur significant costs for repairs, re-work and/or removal and replacement of the defective product. In addition, if a dispute over product claims cannot be settled, arbitration or litigation may result, requiring us to incur attorneys’ fees and exposing us to the potential of damage awards against us.
We may not be able to identify suitable acquisition candidates or complete acquisitions successfully, which may inhibit our rate of growth.
As part of our growth strategy, we plan to continue to pursue acquisitions of other companies, assets and product lines that either complement or expand our existing business. However, we may be unable to implement this strategy if we are unable to identify suitable acquisition candidates or consummate future acquisitions at acceptable prices and terms. We expect to face competition for acquisition candidates which may limit the number of acquisition opportunities available to us and may result in higher acquisition prices. As a result, we may be limited in the number of acquisitions which we are able to complete and we may face difficulties in achieving the profitability or cash flows needed to justify our investment in them.
Our acquisitions of other companies carry risk.
Acquisitions of other companies involve numerous risks, including difficulties in the integration of the operations, technologies and products of the acquired companies, the potential exposure to unanticipated and undisclosed liabilities, the potential that expected benefits or synergies are not realized and that operating costs increase, the potential loss of key personnel, suppliers or customers of acquired businesses and the diversion of Management’s time and attention from other business concerns. Although we attempt to identify and evaluate the risks inherent in any acquisition, we may not properly ascertain or mitigate all such risks, and our failure to do so could have a material adverse effect on our business.
We may incur significant costs, experience short-term inefficiencies, or be unable to realize expected long-term savings from facility consolidations and other business reorganizations.
We periodically assess the cost and operational structure of our facilities in order to manufacture and sell our products in the most efficient manner, and based on these assessments, we may from time to time reorganize, relocate or consolidate certain of our facilities. These actions may require us to incur significant costs and may result in short term business inefficiencies as we consolidate and close facilities and transition our employees; and in addition, we may not achieve the expected long-term benefits. Any or all of these factors could result in an adverse impact on our operating results, cash flows and financial condition.
The trading price of our common stock continues to be volatile and may result in investors selling shares of our common stock at a loss.
The trading price of our common stock is volatile and subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including those described in this section and including but not limited to actual or anticipated variations in our quarterly operating results, changes in financial estimates by securities analysts that cover our stock or our failure to meet those estimates, substantial sales of our common stock by our existing shareholders, and general stock market conditions. In recent years, the stock markets in general have experienced dramatic price and volume fluctuations, which may continue indefinitely, and changes in industry, general economic or market conditions could harm the price of our stock regardless of our operating performance.
We may not realize as revenue the full amounts reflected in our backlog.
As of September 30, 2019, our twelve-month backlog was approximately $428 million, which represents confirmed orders we believe will be recognized as revenue within the next twelve months. There can be no assurance that our customers will purchase all the orders represented in our backlog, particularly as to contracts which are subject to the U.S. Government’s ability to modify or terminate major programs or contracts, and if and to the extent that this occurs, our future revenues could be materially reduced.
The Company has guaranteed certain Aclara contracts.
During 2014, the Company sold that portion of the Company’s USG segment represented by Aclara Technologies LLC and two related entities (together, Aclara), a leading supplier of data communications systems and related software used by electric, gas and water utilities in support of their advanced metering infrastructure (AMI) deployments, typically encompassing the utility’s entire service area. Aclara’s largest contracts, such as those with Pacific Gas & Electric Company and Southern California Gas Co. (SoCal Gas), each involve several million end points. In the normal course of business during the time that Aclara was our subsidiary, we agreed to provide guarantees of Aclara’s performance under certain real property leases, certain vendor contacts, and certain large, long-term customer contracts for the delivery, deployment and performance of AMI systems. In connection with the sale of Aclara, we agreed to remain a guarantor of Aclara’s performance of these contracts. Although the Company, Aclara and Aclara’s parent company Hubbell Inc. are working together to obtain the release of the Company under these guarantees and have obtained some releases, including from SoCal Gas¸ other guarantees have not yet been released and still remain in effect. If Aclara were to fail to perform any of the remaining guaranteed contracts, the other party to the contract could seek damages from us resulting from the non-performance, and if we were determined to be liable for these damages, they could have a material adverse effect on our business, operating results or financial condition. Although we would be entitled to seek indemnification from Aclara for these damages, our ability to recover would be subject to Aclara’s financial position at that time.
Despite our efforts, we may be unable to adequately protect our intellectual property.
Much of our business success depends on our ability to protect and freely utilize our various intellectual properties, including both patents and trade secrets. Despite our efforts to protect our intellectual property, unauthorized parties or competitors may copy or otherwise obtain and use our products and technology, particularly in foreign countries such as China where the laws may not protect our proprietary rights as fully as in the United States. Our current and future actions to enforce our proprietary rights may ultimately not be successful; or in some cases we may not elect to pursue an unauthorized user due to the high costs and uncertainties associated with litigation. We may also face exposure to claims by others challenging our intellectual property rights. Any or all of these actions may divert our resources and cause us to incur substantial costs.
Disputes with contractors could adversely affect our Test segment’s results.
A major portion of our Test segment’s business involves working in conjunction with general contractors to produce complex building components constructed on-site, such as electronic test chambers, secure communication rooms and MRI facilities. If there are performance problems caused by either us or a contractor, they could result in cost overruns and may lead to a dispute as to which party is responsible. The resolution of such disputes can involve arbitration or litigation, and can cause us to incur significant expense including attorneys’ fees. In addition, these disputes could result in a reduction in revenue, a loss on a particular project, or even a significant damages award against us.
Environmental or regulatory requirements could increase our expenses and adversely affect our profitability.
Our operations and properties are subject to U.S. and foreign environmental laws and regulations governing, among other things, the generation, storage, emission, discharge, transportation, treatment and disposal of hazardous materials and the clean-up of contaminated properties. These regulations, and changes to them, could increase our cost of compliance, and our failure to comply could result in the imposition of significant fines, suspension of production, alteration of product processes, cessation of operations or other actions which could materially and adversely affect our business, financial condition and results of operations.
We are currently involved as a responsible party in several ongoing investigations and remediations of contaminated third-party owned properties. In addition, environmental contamination may be discovered in the future on properties which we formerly owned or operated and for which we could be legally responsible. Future costs associated with these situations, including ones which may be currently unknown to us, are difficult to quantify but could have a significant effect on our financial condition. See Item 1, “Business – Environmental Matters” for a discussion of these factors.
We are or may become subject to legal proceedings that could adversely impact our operating results.
We are, and will likely be in the future, a party to a number of legal proceedings and claims involving a variety of matters, including environmental matters such as those described in the preceding risk factor and disputes over the ownership or use of intellectual property. Given the uncertainties inherent in litigation, including but not limited to the possible discovery of facts adverse to our position, adverse rulings by a court or adverse decisions by a jury, it is possible that such proceedings could result in a liability that we may have not adequately reserved for, that may not be adequately covered by insurance, or that may otherwise have a material adverse effect on our financial condition or results of operations.
The loss of specialized key employees could affect our performance and revenues.
There is a risk of our losing key employees having engineering and technical expertise. For example, our USG segment relies heavily on engineers with significant experience and reputation in the utility industry to furnish expert consulting services and support to customers. Despite our active recruitment efforts, there remains a shortage of these qualified engineers because of hiring competition from other companies in the industry. Loss of these employees to other employers or for other reasons could reduce the segment’s ability to provide services and negatively affect our revenues.
Our decentralized organizational structure presents certain risks.
We are a relatively decentralized company in comparison with some of our peers. This decentralization necessarily places significant control and decision-making powers in the hands of local management, which present various risks, including the risk that we may be slower or less able to identify or react to problems affecting a key business than we would in a more centralized management environment. We may also be slower to detect or react to compliance related problems (such as an employee undertaking activities prohibited by applicable law or by our internal policies), and Company-wide business initiatives may be more challenging and costly to implement, and the risks of noncompliance or failures higher, than they would be under a more centralized management structure. Depending on the nature of the problem or initiative in question, such noncompliance or failure could have a material adverse effect on our business, financial condition or result of operations.
Provisions in our articles of incorporation, bylaws and Missouri law could make it more difficult for a third party to acquire us and could discourage acquisition bids or a change of control, and could adversely affect the market price of our common stock.
Our articles of incorporation and bylaws contain certain provisions which could discourage potential hostile takeover attempts, including: a limitation on the shareholders’ ability to call special meetings of shareholders; advance notice requirements to nominate candidates for election as directors or to propose matters for action at a meeting of shareholders; a classified board of directors, which means that approximately one-third of our directors are elected each year; and the authority of our board of directors to issue, without shareholder approval, preferred stock with such terms as the board may determine. In addition, the laws of Missouri, in which we are incorporated, require a two-thirds vote of outstanding shares to approve mergers or certain other major corporate transactions, rather than a simple majority as in some other states such as Delaware. These provisions could impede a merger or other change of control not approved by our board of directors, which could discourage takeover attempts and in some circumstances reduce the market price of our common stock.
The Company believes its buildings, machinery and equipment have been generally well maintained, are in good operating condition and are adequate for the Company’s current production requirements and other needs.
At September 30, 2019, the Company’s physical properties, including those described in the table below, comprised approximately 1,903,800 square feet of floor space, of which approximately 852,200 square feet were owned and approximately 1,051,600 square feet were leased. The table below includes the Company’s principal physical properties. The Company does not believe any of the omitted properties, consisting primarily of office and/or warehouse space, are individually or collectively material to its operations or business. See also Notes 14 and 15 to the Consolidated Financial Statements.
Owned / Leased (with
M, E, O
Leased (9/30/2029, plus options)
M, O, W
M, E, O, W
Leased (various term ends)
LaSalle (Montreal), Quebec
Leased (8/31/2020) plus options
* Property was sold in October 2018 and leased back pending consolidation into Marlborough facility (expected Q1 2020).
As a normal incident of the businesses in which the Company is engaged, various claims, charges and litigation are asserted or commenced from time to time against the Company. With respect to claims and litigation currently asserted or commenced against the Company, it is the opinion of Management that final judgments, if any, which might be rendered against the Company are adequately reserved for, are covered by insurance, or are not likely to have a material adverse effect on the Company’s financial condition or results of operations. Nevertheless, given the uncertainties of litigation, it is possible that such claims, charges and litigation could have a material adverse impact on the Company; see Item 1A, “Risk Factors.”
Holders of Record. As of November 22, 2019, there were approximately 1,827 holders of record of the Company’s common stock.
Price Range of Common Stock and Dividends. The Company’s common stock is listed on the New York Stock Exchange; its trading symbol is “ESE”. For information about the price range of the common stock and dividends paid on the common stock in the last two fiscal years, please refer to Note 16 to the Company’s Consolidated Financial Statements.
Company Purchases of Equity Securities. The Company did not repurchase any shares of its common stock during the fourth quarter of fiscal 2019.
Securities Authorized for Issuance Under Equity Compensation Plans. For information about securities authorized for issuance under the Company’s equity compensation plans, please refer to Item 12 of this Form 10-K and to Note 10 to the Company’s Consolidated Financial Statements.
Performance Graph. The graph and table on the following page present a comparison of the cumulative total shareholder return on the Company’s common stock as measured against the Russell 2000 index and two customized peer groups whose individual component companies are listed below. Because the Company changed the composition of the peer group for 2019, as described below, the peer group used for the corresponding disclosures in 2018 is also shown for comparison. The Company is not a component of either the 2019 peer group or the 2018 peer group, but it is a component of the Russell 2000 Index. The measurement period begins on September 30, 2014 and measures at each September 30 thereafter. These figures assume that all dividends, if any, paid over the measurement period were reinvested, and that the starting values of each index and the investments in the Company’s common stock were $100 at the close of trading on September 30, 2014.
Among ESCO Technologies Inc., the Russell 2000 Index,
and the 2019 and 2018 Peer Groups
The 2019 peer group was composed of ten companies that corresponded to the Company’s four industry segments used for financial reporting purposes during 2019, as follows: Filtration/Fluid Flow segment (40% of the Company’s 2019 total revenue): CIRCOR International, Inc., Donaldson Company, Inc. and Moog Inc.; USG segment (26% of the Company’s 2019 total revenue): Aegion Corporation, Ameresco, Inc. and Thermon Group Holdings, Inc.; Test segment (23% of the Company’s 2019 total revenue): EXFO Inc. and FARO Technologies, Inc.; and Technical Packaging segment (11% of the Company’s 2019 total revenue): AptarGroup, Inc. and Berry Global Group, Inc.
The 2018 peer group was composed of nine companies that corresponded to the Company’s four industry segments used for financial reporting purposes during 2018, as follows: Filtration/Fluid Flow segment (37% of the Company’s 2018 total revenue): CIRCOR International, Inc., Donaldson Company, Inc. and Moog Inc.; USG segment (28% of the Company’s 2018 total revenue): Aegion Corporation, Ameresco, Inc. and Thermon Group Holdings, Inc.; Test segment (24% of the Company’s 2018 total revenue): EXFO Inc. and FARO Technologies, Inc.; and Technical Packaging Segment (11% of the Company’s 2018 total revenue): AptarGroup, Inc. and Bemis Company, Inc. Bemis Company, Inc. was originally a member of the 2018 peer group, but it was acquired during 2019 and is therefore not included in the total return calculations.
In calculating the composite return of the 2019 and 2018 peer groups, the return of each company comprising the peer group was weighted by (a) its market capitalization in relation to the other companies in its corresponding Company industry segment, and (b) the percentage of the Company’s total revenue represented by its corresponding Company industry segment.
The following selected consolidated financial data of the Company and its subsidiaries should be read in conjunction with the Company’s Consolidated Financial Statements, the Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, as of the respective dates indicated and for the respective periods ended thereon.
For years ended September 30:
See also Notes 1 and 2 to the Consolidated Financial Statements for discussion of the Company’s adoption of ASU 2014-09, Revenue from Contracts with Customers (ASC 606) and acquisition activity which affect comparability between years.
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto and refers to the Company’s results from continuing operations, except where noted.
This section includes comparisons of certain 2019 financial information to the same information for 2018. Year-to-year comparisons of the 2018 financial information to the same information for 2017 are contained in Item 7 of the Company’s Form 10-K for 2018 filed with the Securities and Exchange Commission on November 29, 2018 and available through the SEC’s website at https://www.sec.gov/edgar/searchedgar/companysearch.html.
ESCO Technologies Inc. and its wholly owned subsidiaries (the Company) are organized into four reportable operating segments for financial reporting purposes: Filtration/Fluid Flow (Filtration), RF Shielding and Test (Test), Utility Solutions Group (USG), and Technical Packaging. The Company’s business segments are comprised of the following primary operating entities:
● Filtration: PTI Technologies Inc. (PTI); VACCO Industries (VACCO); Crissair, Inc. (Crissair); Westland Technologies, Inc. (Westland); Mayday Manufacturing Co. (Mayday), Hi-Tech Metals, Inc. (Hi-Tech); and Globe Composite Solutions, LLC (Globe).
● USG: Doble Engineering Company (Doble); Morgan Schaffer Ltd. (Morgan Schaffer); and NRG Systems, Inc. (NRG).
● Test: ETS-Lindgren Inc. (ETS-Lindgren).
● Technical Packaging: Thermoform Engineered Quality LLC (TEQ); Plastique Limited and Plastique Sp. z o.o. (together, Plastique). In November 2019 the Company entered into an agreement to sell the businesses comprising this segment. See “Subsequent Event” on page 7.
Filtration. PTI, VACCO and Crissair primarily design and manufacture specialty filtration 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. Westland designs, develops and manufactures elastomeric-based signature reduction solutions for U.S. naval vessels. Mayday designs and manufactures mission-critical bushings, pins, sleeves and precision-tolerance machined components for landing gear, rotor heads, engine mounts, flight controls, and actuation systems for the aerospace and defense industries. Hi-Tech is a full-service metal processor serving aerospace suppliers. Globe is a vertically integrated supplier of composite-based products and solutions for acoustic, signature-reduction, communications, sealing, vibration-reducing, surface control, and hydrodynamic-related applications.
USG. Doble provides high-end, intelligent diagnostic test solutions for the electric power delivery industry and is a leading supplier of power factor and 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 which enhance the ability of electric utilities to accurately monitor the health of critical power transformers. NRG designs and manufactures decision support tools for the renewable energy industry, primarily wind.
Test. ETS-Lindgren is an industry leader in providing its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy.
Technical Packaging. The companies within this segment provide innovative solutions to the medical and commercial markets for thermoformed and precision molded pulp fiber packages and specialty products using a wide variety of thin gauge plastics and pulp.
Selected financial information for each of the Company’s business segments is provided in the discussion below and in Note 13 to the Company’s Consolidated Financial Statements.
The Company continues to operate with meaningful growth prospects in its primary served markets and with considerable financial flexibility. The Company continues to focus on new products that incorporate proprietary design and process technologies. Management is committed to delivering shareholder value through organic growth, ongoing performance improvement initiatives, and acquisitions.
Highlights of 2019 Operations
● Sales, net earnings and diluted earnings per share in 2019 were $813.0 million, $81.0 million and $3.10 per share, respectively, compared to sales, net earnings and diluted earnings per share in 2018 of $771.6 million, $92.1 million and $3.54 per share, respectively.
● Diluted EPS – As Adjusted for 2019 was $3.13 and excludes $0.6 million of pretax charges (or $0.03 per share after tax) consisting primarily of purchase accounting charges related to the Globe acquisition and certain restructuring charges related to facility consolidations at Doble, Plastique, PTI and VACCO partially offset by the gain on the Doble Watertown building sale. Diluted EPS – As Adjusted for 2018 was $2.77 and excludes $4.8 million of pretax charges (or $0.17 per share after tax) consisting primarily of charges related to closing the Doble offices in Norway, China, Dubai and Mexico, consisting of employee severance and compensation benefits, professional fees, and asset impairment charges; and restructuring charges at PTI related to the exit of the low margin industrial/automotive market. Also excluded for 2018 was a $24.4 million (or $0.94 per share) of net tax benefit recorded resulting from the implementation of U.S. Tax Reform.
● Net cash provided by operating activities was approximately $105.1 million in 2019 compared to $93.3 million in 2018.
● At September 30, 2019, cash on hand was $61.8 million and outstanding debt was $286.3 million, for a net debt position (total debt less net cash) of approximately $224.5 million.
● Entered orders for 2019 were $905.3 million resulting in a book-to-bill ratio of 1.11x. Backlog at September 30, 2019 was $475.1 million compared to $382.8 million at September 30, 2018.
● In July 2019, the Company acquired Globe for a purchase price of approximately $95 million, net of cash acquired. Since the date of acquisition, the operating results for Globe have been included within the Company’s Filtration segment.
● The Company declared dividends of $0.32 per share during 2019, totaling $8.3 million in dividend payments.
Net sales increased $41.4 million, or 5.4%, to $813.0 million in 2019 from $771.6 million in 2018. The increase in net sales in 2019 as compared to 2018 was due to a $39.0 million increase in the Filtration segment and a $5.5 million increase in the Test segment, partially offset by a $2.1 million decrease in the USG segment and a $1.0 million decrease in the Technical Packaging segment.
The $39.0 million, or 13.6%, increase in net sales in 2019 as compared to 2018 was mainly due to a $14.3 million increase in net sales at PTI due to higher aerospace and assembly element shipments, a $11.1 million increase in net sales at Crissair due to higher aerospace shipments, an $8.9 million sales contribution from Globe (acquired in July 2019), a $6.8 million increase in net sales at Mayday due to higher aerospace shipments, and a $1.1 million increase in net sales at Westland, partially offset by a $3.2 million decrease in net sales at VACCO due to lower shipments of defense spares.
The $2.1 million, or 1.0%, decrease in net sales in 2019 as compared to 2018 was mainly due to a $9.5 million decrease in net sales at NRG due to continued softness in the renewable energy market, partially offset by a $7.4 million increase in net sales at Doble driven by a full year of Manta’s sales and higher F series product shipments.
The $5.5 million, or 3.0%, increase in net sales in 2019 as compared to 2018 was mainly due to a $7.7 million increase in net sales from the segment’s U.S. and Asian operations partially offset by a $2.2 million decrease in net sales from the segment’s European operations, both due to the timing of test and measurement chamber projects.
The $1.0 million, or 1.1%, decrease in net sales in 2019 as compared to 2018 was mainly due to a $5.5 million decrease in net sales from Plastique due to lower shipments to commercial customers partially offset by a $4.5 million increase in net sales at TEQ.
New orders received in 2019 were $905.3 million as compared to $777.2 million in 2018, resulting in order backlog of $475.1 million at September 30, 2019 as compared to order backlog of $382.8 million at September 30, 2018. Orders are entered into backlog as firm purchase order commitments are received.
In 2019, the Company recorded orders of $409.9 million related to Filtration products, $212.9 million related to USG products, $199.6 million related to Test products and $82.9 million related to Technical Packaging products. In 2018, the Company recorded orders of $287.9 million related to Filtration products, $219.1 million related to USG products, $190.4 million related to Test products and $79.8 million related to Technical Packaging products.
Selling, general and administrative (SG&A) expenses were $172.1million, or 21.2% of net sales, in 2019, and $162.4 million, or 21.0% of net sales, in 2018.
The increase in SG&A expenses in 2019 as compared to 2018 was mainly due to an increase in the USG segment due to higher sales commissions including additional sales and marketing expenses to support future revenue growth.
Amortization of intangible assets was $19.5 million in 2019 and $18.3 million in 2018. Amortization of intangible assets included $11.8 million and $10.9 million of amortization of acquired intangible assets in 2019 and 2018, respectively, related to the Company’s acquisitions. The amortization of acquired intangible assets related to the Company’s acquisitions is included in the Corporate operating segment’s results. The remaining amortization expenses relate to other identifiable intangible assets (primarily software, patents and licenses), which are included in the respective segment’s operating results. The increase in amortization expense in 2019 as compared to 2018 was mainly due to an increase in amortization of intangible assets related to the Company’s recent acquisitions.
Other Expenses or Income, Net
Other expenses, net, were $2.2 million in 2019, compared to other expenses, net, of $3.7 million in 2018. The principal components of other expenses, net, in 2019 included $3 million of purchase accounting charges related to the Globe acquisition; $1.4 million of restructuring charges incurred related to the Plastique facility consolidation in 2019 consisting primarily of severance and compensation benefits and asset impairment charges; $0.9 million of restructuring charges related to the consolidation of VACCO’s aircraft/aerospace business into PTI’s aerospace facility in Oxnard, California; approximately $1 million of charges at Doble related to facility consolidations begun in 2018; and approximately $3 million of losses on derivative instruments; partially offset by a net gain of approximately $8 million on the sale of the Doble Watertown, MA building and land. The principal components of other expenses, net, in 2018 included $3 million of charges related to the USG segment restructuring activities, including the Doble facility consolidations in Norway, China, Dubai and Mexico; and $0.8 million of charges within the Filtration segment due to the exit of the low margin industrial/automotive market. There were no other individually significant items included in other expenses, net, in 2019 or 2018.
The information reported herein includes the financial measures EPS – As Adjusted, which the Company defines as EPS excluding the per-share net impact of the purchase accounting charges related to the Globe acquisition and the restructuring charges incurred at Doble, Plastique, PTI and VACCO during fiscal 2019, partially offset by the gain on the Doble Watertown, MA property sale; and restructuring charges related to the Company’s restructuring actions in 2018 and the net recorded per-share tax benefit resulting from the implementation of U.S. Tax Reform in 2018; EBIT, which the Company defines as earnings before interest and taxes; and EBIT margin, which the Company defines as EBIT expressed as a percentage of net sales. EPS – As Adjusted, EBIT on a consolidated basis, and EBIT margin on a consolidated basis are not recognized in accordance with U.S. generally accepted accounting principles (GAAP). However, the Company believes that EBIT and EBIT margin provide investors and Management with valuable information for assessing the Company’s operating results. Management evaluates the performance of its operating segments based on EBIT and believes that EBIT is useful to investors to demonstrate the operational profitability of the Company’s business segments by excluding interest and taxes, which are generally accounted for across the entire company on a consolidated basis. EBIT is also one of the measures Management uses to determine resource allocations and incentive compensation. The Company believes that the presentation of EBIT, EBIT margin and EPS – As Adjusted provides important supplemental information to investors by facilitating comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results. The use of non-GAAP financial measures is not intended to replace any measures of performance determined in accordance with GAAP.
The reconciliation of EBIT to a GAAP financial measure is as follows:
Add (less): Income taxes
The $11.4 million increase in EBIT in 2019 as compared to 2018 was primarily due to the EBIT contribution from higher sales volumes at PTI, Crissair, Mayday and Westland and Globe (acquired July 2019). EBIT in 2019 was negatively impacted by $0.9 million of restructuring charges related to the consolidation of VACCO’s aircraft/aerospace business into PTI’s aerospace facility in Oxnard, California and $0.3 million of purchase accounting charges at Globe related to the inventory step-up charge.
The $9.0 million increase in EBIT in 2019 as compared to 2018 was primarily due to a $12.0 million increase in EBIT at Doble (which included a net gain on the sale of the Doble Watertown facility of approximately $8.0 million partially offset by certain charges to close the Doble facilities in Dubai and Mexico), and also due to higher sales volumes at Doble; partially offset by a $3.0 million decrease in EBIT from NRG due to softness in the renewable energy market.
The $1.8 million increase in EBIT in 2019 as compared to 2018 was primarily due to the increased sales volumes from the segment’s U.S. and Asian operations.
The $2.2 million decrease in EBIT in 2019 as compared to 2018 was primarily due to the $1.4 million of restructuring charges incurred related to the Plastique facility consolidation in 2019. These charges consisted primarily of severance and compensation benefits and asset impairment charges.
Corporate operating charges included in 2019 consolidated EBIT increased to $43.2 million as compared to $37.0 million in 2018 due to purchase accounting charges related to the Globe acquisition, higher professional fees and acquisition costs.
The “Reconciliation to Consolidated Totals (Corporate)” in Note 13 to the Consolidated Financial Statements represents Corporate office operating charges.
Interest expense was $8.4 million in 2019 compared to $8.8 million in 2018, due to lower average outstanding borrowings ($236.4 million compared to $258.8 million) partially offset by higher average interest rates (3.2% vs. 3.0%) as a result of the additional borrowings to fund the Company’s recent acquisitions.
On December 22, 2017, President Trump signed into law new tax legislation commonly referred to as the Tax Cut and Jobs Act (the “TCJA”). Provisions under the TCJA affecting the Company 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 effective tax rates for 2019, 2018 and 2017 were 20.7%, (4.7)% and 33.0%, respectively. The increase in the 2019 effective tax rate as compared to 2018 was primarily due to the enactment of the TCJA. The specific impacts of the TCJA in 2018 were primarily as follows:
● The Company’s 2018 federal statutory rate decreased from 35.0% to 24.5%, which required an adjustment to the value of its deferred tax assets and liabilities. This adjustment of $30.6 million (complete as of September 30, 2018) favorably impacted the 2018 effective tax rate by 34.8%.
● The TCJA subjected the Company’s cumulative foreign earnings to $3.7 million (complete as of December 31, 2018) of federal income tax which unfavorably impacted the 2018 effective tax rate by 4.2%. In addition to the impacts from the TCJA, the Company recorded $2.4 million (complete as of September 30, 2018) for the income tax effects of the current and future repatriation of the cumulative earnings of its foreign subsidiaries which unfavorably impacted the 2018 effective tax rate by 2.8%.
● The Company approved an additional $7.5 million pension contribution for the 2017 plan year during the second quarter of 2018 resulting in a favorable adjustment to the 2018 effective tax rate of 0.9%.
● An accounting method change was filed with the 2017 tax return which resulted in a favorable adjustment to the 2018 effective tax rate of 0.7%.
The 2019 effective tax rate was favorably impacted by tax planning strategies to increase foreign tax credits claimed retrospectively. The Company reduced the valuation allowance for excess foreign tax credits by $2.4 million and recorded an amended return benefit of $0.3 million, which favorably impacted the 2019 effective tax rate by 2.8%.
The TJCA made comprehensive changes to U.S. federal income tax laws by moving from a global to a modified territorial tax regime. As a result, cash repatriated to the U.S. is generally no longer subject to U.S. federal income tax. No provision is made for foreign withholding any applicable U.S. income taxes on the undistributed earnings of non-U.S. subsidiaries where these earnings are considered indefinitely invested or otherwise retained for continuing international operations. Determination of the amount of taxes that might be paid on these undistributed earnings if eventually remitted is not practicable.
Information regarding the Company’s acquisitions during 2019, 2018 and 2017 is set forth in Note 2 to the Company’s Consolidated Financial Statements, which Note is incorporated by reference herein.
All of the Company’s acquisitions have been accounted for using the purchase method of accounting, and accordingly, the respective purchase prices were allocated to the assets (including intangible assets) acquired and liabilities assumed based on estimated fair values at the date of acquisition. The financial results from these acquisitions have been included in the Company’s financial statements from the date of acquisition.
Subsequent to the end of fiscal 2019 the Company entered into an agreement to sell the business comprising its Technical Packaging segment. See “Subsequent Event” on page 7.
The Company’s overall financial position and liquidity are strong. Working capital (current assets less current liabilities) increased to $243.6 million at September 30, 2019 from $195.5 million at September 30, 2018. Contract assets increased $62.3 million in 2019 mainly within the Filtration segment due to the adoption of ASU No. 2014-09, Revenue from Contracts with Customers (ASC 606). Inventories decreased by $6.6 million during 2019 mainly due to a 9.5 million decrease within the Filtration segment resulting primarily from the adoption of ASC 606. The $8.3 million increase in accounts payable at September 30, 2019 was mainly due to a $4.9 million increase within the Test segment and a $4.0 million increase within the Technical Packaging segment both due to the timing of payments.
Net cash provided by operating activities was $105.1 million and $93.3 million in 2019 and 2018, respectively.
Net cash used in investing activities was $125.1 million and $41.6 million in 2019 and 2018, respectively. The increase in net cash used in investing activities in 2019 as compared to 2018 was due to the Globe acquisition and higher capital expenditures. Capital expenditures were $37.2 million and $20.6 million in 2019 and 2018, respectively. The increase in capital expenditures in 2019 as compared to 2018 was mainly due to the facility expansion at TEQ in 2019. There were no commitments outstanding that were considered material for capital expenditures at September 30, 2019. In addition, the Company incurred expenditures for capitalized software of $8.4 million and $9.6 million in 2019 and 2018, respectively.
The Company made pension contributions of $2.5 million and $10.0 million in 2019 and 2018, respectively.
Net cash provided by financing activities was $53.5 million in 2019, compared to net cash used by financing activities of $66.4 million in 2018. The change in 2019 as compared to 2018 was primarily due to additional borrowings in 2019 related to the Globe acquisition.
A description of the Company’s credit facility (the “Credit Facility”) is set forth in Note 8 to the Company’s Consolidated Financial Statements, which Note is incorporated by reference herein.
Cash flow from operations and borrowings under the Credit Facility is expected to provide adequate resources to meet the Company’s capital requirements and operational needs for the foreseeable future.
Since 2010, the Company has paid a regular quarterly cash dividend at an annual rate of $0.32 per share. The Company paid dividends of $8.3 million and $8.3 million in 2019 and 2018, respectively.
The following table shows the Company’s contractual obligations as of September 30, 2019:
(1) Estimated interest payments for the Company’s debt obligations were calculated based on Management’s determination of the estimated applicable interest rates and payment dates.
(2) A purchase obligation is defined as a legally binding and enforceable agreement to purchase goods and services that specifies all significant terms. Since the majority of the Company’s purchase orders can be cancelled, they are not included in the table above.
The Company had no off-balance-sheet arrangements outstanding at September 30, 2019.
Information about the Company’s common stock repurchases is provided in Note 9 to the Consolidated Financial Statements.
The minimum cash funding requirements related to the Company’s defined benefit pension plans are estimated to be approximately $0 in 2020, $0 in 2021, and $1.4 million in 2022. Additional information about the Company’s pension plans is provided in Note 11 to the Consolidated Financial Statements.
As a normal incident of the business in which the Company is engaged, various claims, charges and litigation are asserted or commenced from time to time against the Company. Additionally, the Company is currently involved in various stages of investigation and remediation relating to environmental matters. It is the opinion of Management that 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 for, are covered by insurance or are not likely to have a material adverse effect on the Company’s results of operations, capital expenditures or competitive position.
Management continues to see meaningful organic sales, Adjusted EBIT and Adjusted EBITDA growth across each of the Company’s business segments, and anticipates that growth rates in 2020 and beyond will generally exceed the broader industrial market. Given the pending sale of the Technical Packaging business expected to be completed in the first half of 2020 (see “Subsequent Event” on page 7), this business will be reported as discontinued operations in 2020 and is excluded from the Outlook section and comparisons to 2019 described below. The details of Management’s growth expectations for 2020 compared to 2019 are as follows:
● Sales from continuing operations are expected to increase 9 to 10 percent on a consolidated basis, with Filtration growing 13.5 to 14.5 percent, USG growing 7 to 8 percent and Test growing 4 to 5 percent;
● Interest expense is expected to be lower than 2019, and will be impacted by the timing of the final after-tax cash proceeds received on the sale of the Technical Packaging business;
● Non-cash depreciation and amortization of intangible assets is expected to increase approximately $5 million, or $0.15 per share after-tax, related to previous acquisitions and capital spending;
● Income tax expense is expected to increase as Management is expecting a 23 to 24 percent effective tax rate calculated on higher pretax earnings;
● In summary, excluding Technical Packaging and the accounting impact of terminating and annuitizing the Company’s defined benefit pension plan, Management projects 2020 Adjusted EPS to be in the range of $3.20 to $3.30 per share (compared to 2019 Adjusted EPS of $2.95 per share, excluding the 2019 results of Technical Packaging).
On a quarterly basis and consistent with prior years, Management expects 2020 revenues and Adjusted EPS to be more second-half weighted. Management expects Q1 2020 Adjusted EPS to be in the range of $0.35 to $0.40 per share.
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 entered 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 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 Company is also subject to foreign currency exchange rate risk inherent in its sales commitments, anticipated sales, anticipated purchases and assets and liabilities denominated in currencies other than the U.S. dollar. The foreign currencies most significant to the Company’s operations are the Canadian Dollar and the Euro. The Company occasionally hedges certain foreign currency commitments by purchasing foreign currency forward contracts. The Company does not have material foreign currency market risk; net foreign currency transaction gain/loss was less than 2% of net earnings for 2019 and 2018.
The Company has determined that the market risk related to interest rates with respect to its variable debt is not material. The Company estimates that if market interest rates averaged one percentage point higher, the effect would have been less than 3% of net earnings for the year ended September 30, 2019.
For more information about the Company’s derivative financial instruments, see Note 12 to the Company’s Consolidated Financial Statements included herein.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires Management to make estimates and assumptions in certain circumstances that affect amounts reported in the Consolidated Financial Statements. In preparing these financial statements, Management has made its best estimates and judgments of certain amounts included in the Consolidated Financial Statements, giving due consideration to materiality. The Company does not believe there is a great likelihood that materially different amounts would be reported under different conditions or using different assumptions related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. The Company’s senior Management discusses the critical accounting policies described below with the Audit and Finance Committee of the Company’s Board of Directors on a periodic basis.
The following discussion of critical accounting policies is intended to bring to the attention of readers those accounting policies which Management believes are critical to the Consolidated Financial Statements and other financial disclosure. It is not intended to be a comprehensive list of all significant accounting policies that are more fully described in Note 1 to the Consolidated Financial Statements.
Information regarding the recognition of revenue by the entities in each of the Company’s business segments is set forth in Note 1.E to the Company’s Consolidated Financial Statements.
The Company operates in numerous taxing jurisdictions and is subject to examination by various U.S. Federal, state and foreign jurisdictions for various tax periods. The Company’s income tax positions are based on research and interpretations of the income tax laws and rulings in each of the jurisdictions in which the Company does business. Due to the subjectivity of interpretations of laws and rulings in each jurisdiction, the differences and interplay in tax laws between those jurisdictions, as well as the inherent uncertainty in estimating the final resolution of complex tax audit matters, Management’s estimates of income tax liabilities may differ from actual payments or assessments.
On December 22, 2017, the U.S. government enacted the TCJA, which, among other things, lowered the U.S. corporate statutory income tax rate and established a modified territorial system requiring a mandatory deemed repatriation on undistributed earnings of foreign subsidiaries. The Company completed its analysis of the impact of the TCJA during the first quarter of 2019.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets may be reduced by a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance when Management believes it is more likely than not such assets will not be recovered, taking into consideration historical operating results, expectations of future earnings, tax planning strategies, and the expected timing of the reversals of existing temporary differences.
Management annually reviews goodwill and other long-lived assets with indefinite useful lives for impairment or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. If the Company determines that the carrying value of the long-lived asset may not be recoverable, a permanent impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value. Fair value is measured based on a discounted cash flow method using a discount rate determined by Management to be commensurate with the risk inherent in each of our reporting units’ current business models. The estimates of cash flows and discount rate are subject to change due to the economic environment, including such factors as interest rates, expected market returns and volatility of markets served. Management believes that the estimates of future cash flows and fair value are reasonable; however, changes in estimates could result in impairment charges. At September 30, 2019, the Company has determined that no reporting units are at risk of goodwill impairment as the fair value of each reporting unit exceeded its carrying value.
Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable.
As a normal incident of the businesses in which the Company is engaged, various claims, charges and litigation are asserted or commenced from time to time against the Company. Additionally, the Company is currently involved in various stages of investigation and remediation relating to environmental matters. It is the opinion of Management that the aggregate costs involved in the resolution of these matters, and final judgments, if any, which might be rendered against the Company are adequately accrued, are covered by insurance or are not likely to have a material adverse effect on the Company’s results from continuing operations, capital expenditures, or competitive position.
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 has entered 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 derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. See further discussion regarding the Company’s market risks in “Market Risk Analysis,” above.
For a description of the Company’s evaluation of its disclosure controls and procedures, see Item 9A, “Controls and Procedures.”
Information regarding new and updated accounting standards which affect the content and/or presentation of the Company’s financial information is set forth in Note 1.V to the Company’s Consolidated Financial Statements included herein.
See “Market Risk Exposure” and “Other Matters – Quantitative and Qualitative Disclosures about Market Risk” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are incorporated into this Item by reference.
The information required by this Item is incorporated by reference to the Consolidated Financial Statements of the Company, the Notes thereto, and the related “Report of Independent Registered Public Accounting Firm” of KPMG LLP, as set forth in the Financial Information section of this Annual Report; an Index is provided on page F-1.
For 2019, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act). The evaluation was conducted under the supervision and with the participation of the Company’s Management, including the Company’s Chief Executive Officer and Chief Financial Officer, using the Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. 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 September 30, 2019.
As disclosed in Item 9A, Controls and Procedures, in our Annual Report on Form 10-K for the fiscal year ended September 30, 2018, during the fourth quarter of 2018 we identified a material weakness in internal control related to the ineffective design and operation of controls impacting the deferred revenue general ledger account. During 2019, Management implemented our previously disclosed remediation plan that included: enhancing our policies and procedures related to the deferred revenue reconciliation and review and providing additional training to certain personnel in our finance department. During the fourth quarter of 2019, we completed our testing of the operating effectiveness of the implemented controls and found them to be effective. As a result we have concluded the material weakness has been remediated as of September 30, 2019.
Except for the changes in connection with our implementation of the remediation plan discussed above, there have been no other changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
For the remainder of the information required by this item, see “Management’s Report on Internal Control over Financial Reporting” and the related “Report of Independent Registered Public Accounting Firm” of KPMG LLP, in the Financial Information section beginning on page F-1 of this Annual Report, which are incorporated into this Item by reference.
Information regarding directors, nominees and nominating procedures, the Company’s Code of Ethics, its Audit and Finance Committee, and non-compliance (if any) with Section 16(a) of the Securities Exchange Act of 1934 is hereby incorporated by reference to the sections captioned “Proposal 1: Election of Directors,” “Board of Directors – Governance Policies and Management Oversight,” “Committees” and “Securities Ownership” in the 2019 Proxy Statement.
Information regarding the Company’s executive officers is set forth in Item 1, “Business – Information about our Executive Officers,” above.
Information regarding the Company’s compensation committee and director and executive officer compensation is hereby incorporated by reference to the sections captioned “Committees – Compensation Committee Interlocks and Insider Participation,” “Director Compensation” and “Executive Compensation Information” in the 2019 Proxy Statement.
Information regarding the beneficial ownership of shares of the Company’s common stock by nominees and directors, by executive officers, by directors and executive officers as a group and by any known five percent stockholders is hereby incorporated by reference to the section captioned “Securities Ownership” in the 2019 Proxy Statement.
The following table summarizes certain information regarding shares of Company common stock that may be issued by the Company pursuant to its equity compensation plans existing as of September 30, 2019:
securities reflected in column (a)) (1)
(1) The number of shares is subject to adjustment for future changes in capitalization by stock splits, stock dividends and similar events.
(2) Consists of the Company’s 2013 Incentive Compensation Plan and 2018 Omnibus Incentive Plan.
(3) Consists of 96,322 and 184,682 shares issuable in connection with the vesting and distribution of outstanding performance-accelerated restricted share units awarded under the 2013 Incentive Compensation Plan and 2018 Omnibus Incentive Plan, respectively.
(4) The securities outstanding at September 30, 2019 have no exercise price.
(5) Represents shares currently available for awards under the 2018 Omnibus Incentive Plan. No shares remain available for issuance under the 2013 Incentive Compensation Plan.
(6) Does not include shares that may be purchased on the open market pursuant to the Company’s Employee Stock Purchase Plan (ESPP). Under the ESPP, participants may elect to have up to 10% of their current salary or wages withheld and contributed to one or more independent trustees for the purchase of shares. At the discretion of an officer of the Company, the Company or a domestic subsidiary or division may contribute cash in an amount not to exceed 20% of the amounts contributed by participants; however, the total number of shares purchased with the Company’s matching contributions after October 15, 2003 may not exceed 275,000. As of September 30, 2019, 611,833 shares had been purchased with the Company’s matching funds of which 199,811 were purchased after October 15, 2003.
(7) Represents shares issuable pursuant to the Company’s Compensation Plan for Non-Employee Directors (Director Compensation Plan). The Director Compensation Plan provides for each director to be paid an annual retainer fee payable in shares of Company stock as well as an annual retainer fee and certain other fees payable in cash, all as determined periodically by the Human Resources and Compensation Committee of the Board of Directors. Directors may elect to defer receipt of their stock and/or cash compensation. The maximum number of shares available for issuance under the Director Compensation Plan is 400,000 shares; as of September 30, 2019, 277,805 shares had been issued and four directors had elected to defer the issuance of a total of approximately 70,362 shares. Deferred amounts are credited to the director’s deferred compensation account in stock equivalents and are distributed at a future date or dates specified by the director unless distribution is accelerated in certain circumstances, including a change in control of the Company. Deferred cash compensation may be distributed in shares or cash, but any deferred stock portion may only be distributed in shares.
Information regarding transactions with related parties and the independence of the Company’s directors, nominees for directors and members of the committees of the board of directors is hereby incorporated by reference to the sections captioned “Board of Directors” and “Committees” in the 2019 Proxy Statement.
Information regarding the Company’s independent registered public accounting firm, its fees and services, and the Company’s Audit and Finance Committee’s pre-approval policies and procedures regarding such fees and services, is hereby incorporated by reference to the section captioned “Audit-Related Matters” in the 2019 Proxy Statement.
(1)Financial Statements. The Consolidated Financial Statements of the Company, and the Report of Independent Registered Public Accounting Firm thereon of KPMG LLP, are included in this Report beginning on page F-1; an Index thereto is set forth on page F-1.
(2)Financial Statement Schedules. Financial Statement Schedules are omitted because either they are not applicable or the required information is included in the Consolidated Financial Statements or the Notes thereto.
(3)Exhibits. The following exhibits are filed with this Report or incorporated herein by reference to the document location indicated:
Amended Certificate of Designation, Preferences and Rights of Series A Participating Cumulative Preferred Stock
Articles of Merger, effective July 10, 2000
Amendment to Articles of Incorporation, effective February 5, 2018
Specimen revised Common Stock Certificate
Exhibit 4.1 to the Company’s Form 10-Q for the fiscal quarter ended March 31, 2010
Credit Agreement dated September 27, 2019, incorporated by reference to Exhibit 10.1 hereto
Exhibit 10.1 to the Company’s Form 8-K filed September 30, 2019
Credit Agreement dated as of September 27, 2019 among the Registrant, the Foreign Subsidiary Borrowers party thereto, the Lenders party thereto, JPMorgan Chase Bank, N.A. as Administrative Agent, BMO Harris Bank N.A. as Syndication Agent, and Bank of America, N.A., SunTrust Bank, U.S. Bank National Association and Wells Fargo Bank, National Association as Co-Documentation Agents
Securities Purchase Agreement dated March 14, 2014 between ESCO Technologies Holding LLC and Meter Readings Holding LLC
Exhibit 10.1 to the Company’s Form 8-K filed March 28, 2014
Form of Indemnification Agreement with each of ESCO’s non-employee directors
Exhibit 10.1 to the Company’s Form 10-K for the fiscal year ended September 30, 2012
First Amendment to the ESCO Electronics Corporation Supplemental Executive Retirement Plan, effective August 2, 1993 (comprising restatement of entire Plan)
Exhibit 10.2(a) to the Company’s Form 10-K for the fiscal year ended September 30, 2012
Second Amendment to Supplemental Executive Retirement Plan, effective May 1, 2001
Exhibit 10.4 to the Company’s Form 10-K for the fiscal year ended September 30, 2001
Form of Supplemental Executive Retirement Plan Agreement
Exhibit 10.28 to the Company’s Form 10-K for the fiscal year ended September 30, 2002
Directors’ Extended Compensation Plan, adopted effective October 11, 1993, restated to include all amendments through August 7, 2013 (current as of November 2019)
Compensation Plan For Non-Employee Directors, as amended and restated November 8, 2017
Exhibit 10.3 to the Company’s Form 8-K filed November 14, 2017
Appendix A to the Company’s Schedule 14A Proxy Statement filed December 19, 2012
Form of Award Agreement under 2013 Incentive Compensation Plan, effective November 11, 2015
Exhibit 10.1 to the Company’s Form 8-K filed November 12, 2015
Form of Amendment to 2012-2014 Awards under 2004 and 2013 Incentive Compensation Plans, effective November 11, 2015
Exhibit 10.2 to the Company’s Form 8-K filed November 12, 2015
Exhibit 10.1 to the Company’s Form 8-K filed February 6, 2018
Form of Award Agreement for Performance-Accelerated Restricted Shares under 2018 Omnibus Incentive Plan (revised August 29, 2018)
Exhibit 10.6(f) to the Company’s Form 10-K for the fiscal year ended September 30, 2018
Form of Award Agreement for Performance-Accelerated Restricted Shares under 2018 Omnibus Incentive Plan (revised May 1, 2019)
Exhibit 10.1 to the Company’s Form 8-K filed May 7, 2019
Eighth Amendment and Restatement of Employee Stock Purchase Plan, effective August 2, 2018
Exhibit 10.7 to the Company’s Form 10-K for the fiscal year ended September 30, 2018
Ninth Amendment and Restatement of Employee Stock Purchase Plan, effective February 5, 2019
Exhibit 10.1 to the Company’s Form 8-K filed February 7, 2019
Performance Compensation Plan for Corporate, Subsidiary and Division Officers and Key Managers, adopted August 2, 1993, as amended and restated through February 4, 2019
Exhibit 10.1 to the Company’s Form 8-K filed November 19, 2019
Compensation Recovery Policy, adopted effective February 4, 2010
Exhibit 10.6 to the Company’s Form 8-K filed February 10, 2010
Severance Plan adopted as of August 10, 1995, as Amended and Restated November 11, 2015
Exhibit 10.1 to the Company’s Form 8-K/A filed November 30, 2015
Employment Agreement with Victor L. Richey, effective November 3, 1999
Exhibit 10(bb) to the Company’s Form 10-K for the fiscal year ended September 30, 1999
(Note: Agreement with Victor L. Richey is substantially identical to the referenced Exhibit and is therefore omitted as a separate exhibit pursuant to Rule 12b-31)
Second Amendment to Employment Agreement with Victor L. Richey, effective May 5, 2004
Exhibit 10.1 to the Company’s Form 10-Q for the fiscal quarter ended June 30, 2004
Third Amendment to Employment Agreement with Victor L. Richey, effective December 31, 2007
Exhibit 10.1 to the Company’s Form 8-K filed January 7, 2008
Employment Agreement with Gary E. Muenster, effective November 3, 1999
(Note: Agreement with Gary E. Muenster is substantially identical to the referenced Exhibit except that it provides a minimum base salary of $108,000, and is therefore omitted as a separate exhibit pursuant to Rule 12b-31)
Second Amendment to Employment Agreement with Gary E. Muenster, effective May 5, 2004
Exhibit 10.2 to the Company’s Form 10-Q for the fiscal quarter ended June 30, 2004
Third Amendment to Employment Agreement with Gary E. Muenster, effective December 31, 2007
(Note: Third Amendment with Gary E. Muenster is substantially identical to the referenced Exhibit except that (i) the termination amounts payable under Paragraph 9.a(1) are equal to base salary for 12 months and (ii) under Paragraph 9.a(1)(B), such termination amounts may be paid in biweekly installments equal to 1/26th of such amounts, and is therefore omitted as a separate exhibit pursuant to Rule 12b-31)
Fourth Amendment to Employment Agreement with Gary E. Muenster, effective February 6, 2008
Exhibit 10.1 to the Company’s Form 8-K filed February 12, 2008
Employment Agreement with Alyson S. Barclay, effective November 3, 1999
(Note: Agreement with Alyson S. Barclay is substantially identical to the referenced Exhibit except that it provides a minimum base salary of $94,000, and is therefore omitted as a separate exhibit pursuant to Rule 12b-31)
Second Amendment to Employment Agreement with Alyson S. Barclay, effective May 5, 2004
(Note: Second Amendment with Alyson S. Barclay is substantially identical to the referenced Exhibit, and is therefore omitted as a separate exhibit pursuant to Rule 12b-31)
Third Amendment to Employment Agreement with Alyson S. Barclay, effective December 31, 2007
(Note: Third Amendment with Alyson S. Barclay is substantially identical to the referenced Exhibit except that (i) the termination amounts payable under Paragraph 9.a(1) are equal to base salary for 12 months and (ii) under Paragraph 9.a(1)(B), such termination amounts may be paid in biweekly installments equal to 1/26th of such amounts, and is therefore omitted as a separate exhibit pursuant to Rule 12b-31)
Fourth Amendment to Employment Agreement with Alyson S. Barclay, effective July 29, 2010
Exhibit 10.1 to the Company’s Form 8-K filed August 3, 2010
Cover Page Inline Interactive Data File (contained in Exhibit 101)
** Furnished (and not filed) with the Commission pursuant to Item 601(b)(32)(ii) of Regulation S-K.
*** Exhibits 101 and 104 to this report consist of documents formatted in XBRL (Extensible Business Reporting Language).
Executive Vice President, Chief Financial Officer (Principal Accounting Officer) and Director
/s/ Patrick M. Dewar
/s/ Leon J. Olivier
/s/ Robert J. Phillippy
/s/ Larry W. Solley
/s/ James M. Stolze
/s/ Gloria L. Valdez
Management’s Statement of Financial Responsibility
We have audited the accompanying consolidated balance sheets of ESCO Technologies Inc. and subsidiaries (the Company) as of September 30, 2019 and 2018, the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended September 30, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of September 30, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated November 29, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for revenue from contracts with customers as of October 1, 2018 due to the adoption of ASU No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606).
Assessment of the estimation of total contract costs at completion for contracts in the Filtration segment for which revenue is recognized over time using a cost-to-cost model
As discussed in Notes 2 and 14 to the consolidated financial statements, the Company’s Filtration segment enters into certain long-term fixed price contracts with aerospace and defense customers to produce various products. These products do not have an alternative use and the Company has an enforceable right to payment for costs incurred plus a reasonable margin. Revenue for these contracts is recognized over time using a cost-to-cost model. Under such model, the Company measures the extent of progress towards completion of these contracts based on the ratio of contract costs incurred to date to the estimate of total contract costs at completion. The estimation of these costs requires judgment by the Company given the unique product specifications and requirements for contracts related to the design, development, and manufacture of complex products.
We identified the assessment of the estimation of total contract costs at completion for contracts in the Filtration segment for which revenue is recognized over time using a cost-to-cost model as a critical audit matter. Complex auditor judgment was required in evaluating expected engineering and production requirements of the contracts and the associated cost estimates for labor hours and materials.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s revenue recognition process, including controls over the accumulation and estimation of labor hours and costs of materials. We compared the Company’s historical estimated costs and profit margin to the actual costs and profit margin for completed contracts to assess the Company’s ability to accurately estimate costs. We challenged the Company’s assumptions for labor hours and materials to be incurred for a sample of contracts by:
● Reading the underlying contract documents to obtain an understanding of the contractual requirements and deliverables;
● Comparing the costs incurred to date, as a percentage of the estimated costs at completion, to the Company’s physical production to date under the contract;
● Comparing actual incurred and remaining estimated material costs to the original estimated amount of material costs at the beginning of the project plus incremental material costs due to modifications;
● Comparing actual incurred and remaining estimated labor hours to the original estimate of labor hours at the beginning of the project plus incremental labor hours due to modification;
● Comparing the estimated costs at completion, which includes costs incurred to date plus estimated costs to complete, to actual costs incurred for similar products previously developed and produced, if applicable; and
● Inspecting correspondence between the Company and the customer regarding actual and expected contract performance to date and comparing to the estimate to complete.
Evaluation of the sufficiency of audit evidence obtained over net sales
As discussed in Notes 1 and 16 to the consolidated financial statements, and disclosed in the consolidated statements of operations, the Company recorded $813.0 million of net sales in 2019. Net sales are recognized primarily from the sale of highly engineered products and systems across various industries and through multiple Company divisions and locations around the world.
We identified the evaluation of the sufficiency of audit evidence obtained over net sales as a critical audit matter. Evaluating the sufficiency of audit evidence obtained over net sales required especially subjective auditor judgment because of the disaggregated nature of the Company’s operations, including revenue recognition accounting policies and procedures that differ among the various divisions and locations. This included determining the Company divisions and locations at which procedures were performed.
The primary procedures we performed to address this critical audit matter included the following. We applied auditor judgment to determine the nature and extent of procedures to be performed over net sales, including the determination of the Company divisions and locations at which those procedures were to be performed. At each Company division and location where procedures were performed, we:
● Tested certain internal controls over the Company’s net sales process at the applicable division and location; and
● Assessed the recorded net sales by selecting a sample of transactions and compared the amount recognized for consistency with underlying documentation, including contracts with customers and shipping documentation, if applicable, and the Company’s revenue recognition policies.
After completion of these procedures, we evaluated the overall sufficiency of audit evidence obtained over net sales.
Evaluation of initial measurement of customer relationship and trade name intangible assets acquired in the Globe Composite Solutions, LLC business combination
As discussed in Note 2 to the consolidated financial statements, the Company acquired Globe Composite Solutions, LLC (Globe) on July 2, 2019. As a result of the transaction, the Company acquired a customer relationship intangible asset associated with the generation of future income from Globe’s existing customers and a trade name intangible asset associated with the Globe Composite Solutions trade name (collectively, the intangible assets).
We identified the evaluation of the initial measurement of these intangible assets acquired in the Globe business combination as a critical audit matter. There was a high degree of subjectivity in evaluating the discounted cash flow model used to calculate the acquisition-date fair value of the intangible assets. In addition, auditor judgment was required to evaluate the following assumptions used by the Company in valuing the intangible assets:
● Forecasted revenues and revenue growth rates;
● Forecasted revenues from existing customer contracts, inclusive of attrition;
● Forecasted earnings before interest, taxes, depreciation, and amortization (EBITDA);
● Royalty rate; and
● Estimated discount rate.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s acquisition-date valuation process, including controls related to the development of the relevant assumptions, as listed above. We compared the Company’s estimates of forecasted revenues and EBITDA to Globe’s historical results. We evaluated the Company’s forecasted revenues from existing customers, exclusive of attrition, and forecasted EBITDA by comparing forecasted revenue growth and EBITDA assumptions to those of the Company’s peers and trends in the industry. We tested the Company’s determination of the weighted average cost of capital (WACC) by comparing it to the WACCs of comparable peer companies. In addition, we involved valuation professionals with specialized skills and knowledge, who assisted in:
● Comparing the valuation approaches used by the Company to calculate the fair value of the intangible assets to standard valuation approaches for comparable types of assets;
● Comparing customer attrition to an independent estimate developed based on historical attrition rates for Globe and certain qualitative market factors;
● Evaluating the Company’s royalty rate, by comparing it to royalty rates used for similar assets in the same industry;
● Evaluating the Company’s discount rate, by comparing it against a discount rate range that was independently developed using publicly available market data for comparable peers;
● Developing an estimate of the fair value of the customer relationship intangible asset using the Company’s cash flow forecast and an independently developed discount rate; and
● Developing an estimate of the fair value of the trade name intangible asset using the Company’s forecasted revenues and estimated royalty rate and an independently developed discount rate.
Amortization of prior service costs and actuarial (losses) gains
Accounts receivable, less allowance for doubtful accounts of $1,505 and $1,683 in 2019 and 2018, respectively