ESCO TECHNOLOGIES INC - Quarter Report: 2021 December (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

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(MARK ONE)

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OR

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COMMISSION FILE NUMBER 1-10596

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ESCO TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)

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(314) 213-7200

(Registrant’s telephone number, including area code)

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

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

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

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share amounts)

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See accompanying notes to consolidated financial statements.

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ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

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See accompanying notes to consolidated financial statements.

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ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)

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See accompanying notes to consolidated financial statements.

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ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

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See accompanying notes to consolidated financial statements.

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ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.    BASIS OF PRESENTATION

The accompanying consolidated financial statements, in the opinion of management, include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results for the interim periods presented. The consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all the disclosures required for annual financial statements by accounting principles generally accepted in the United States of America (GAAP).

The Company’s results for the three-month period ended December 31, 2021 are not necessarily indicative of the results for the entire 2022 fiscal year. References to the first quarters of 2022 and 2021 represent the fiscal quarters ended December 31, 2021 and 2020, respectively. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ from those estimates.

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2.    EARNINGS PER SHARE (EPS)

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

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3.    ACQUISITION

On November 4, 2021, the Company acquired Networks Electronic Company, LLC (NEco) for a purchase price of approximately $15.2 million, net of cash acquired. NEco, based in Chatsworth, California, provides miniature electro-explosive devices utilized in mission-critical defense and aerospace applications. Since the date of acquisition, the operating results for the NEco business have been included as part of PTI in the A&D segment. The acquisition date fair value of the assets acquired and liabilities assumed primarily were as follows: approximately $0.6 million of accounts receivable, $1.5 million of inventory, $0.2 million of property, plant and equipment, $0.7 million of accounts payable and accrued expenses, $8.1 million of identifiable intangible assets, mainly consisting of customer relationships totaling $6.3 million. The acquired goodwill of $5.7 million related to excess value associated with opportunities to expand the services and products that the Company can offer to its customers. The Company anticipates that the goodwill will be deductible for tax purposes.

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4.    SHARE-BASED COMPENSATION

The Company provides compensation benefits to certain key employees under several share-based plans providing for performance-accelerated and/or time-vested restricted stock unit awards, and to non-employee directors under a separate compensation plan for non-employee directors.

Performance-Accelerated Restricted Stock Unit (PARS) Awards and Time-Vested Restricted Stock Unit (RSU) Awards

Compensation expense related to the PARS/RSU awards was $1.4 million and $1.1 million for the three-month periods ended December 31, 2021 and 2020, respectively. There were 208,354 non-vested shares outstanding as of December 31, 2021.

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Non-Employee Directors Plan

Compensation expense related to the non-employee director grants was $0.3 million and $0.3 million for the three-month periods ended December 31, 2021 and 2020, respectively.

The total share-based compensation cost that has been recognized in the results of operations and included within selling, general and administrative expenses (SG&A) was $1.7 million and $1.4 million for the three-month periods ended December 31, 2021 and 2020, respectively. The total income tax benefit recognized in results of operations for share-based compensation arrangements was $0.4 million and $0.3 million for the three-month periods ended December 31, 2021 and 2020, respectively. As of December 31, 2021, there was $12.2 million of total unrecognized compensation cost related to share-based compensation arrangements. That cost is expected to be recognized over a remaining weighted-average period of 2.4 years.

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5.    INVENTORIES

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

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Included on the Company’s Consolidated Balance Sheets at December 31, 2021 and September 30, 2021 are the following intangible assets gross carrying amounts and accumulated amortization from continuing operations:

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The changes in the carrying amount of goodwill attributable to each business segment for the three months ended December 31, 2021 is as follows:

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7.    BUSINESS SEGMENT INFORMATION

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

The USG segment’s operations consist primarily of Doble Engineering Company and related subsidiaries including Morgan Schaffer and Altanova (collectively, Doble), and NRG Systems, Inc. (NRG). Doble is an industry leader in the development, manufacture and delivery of diagnostic testing and data management solutions that enable electric power grid operators to assess the integrity of high voltage power delivery equipment. It combines three core elements for customers – diagnostic test and condition monitoring instruments, expert consulting, and testing services – and provides access to its large reserve of related empirical knowledge. NRG is a global market leader in the design and manufacture of decision support tools for the renewable energy industry, primarily wind and solar.

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

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

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Non-GAAP Financial Measures

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

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

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8.    DEBT

The Company’s debt is summarized as follows:

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The Credit Facility includes a $500 million revolving line of credit, as well as provisions allowing for the increase of the credit facility commitment amount by an additional $250 million, if necessary, with the consent of the lenders. The bank syndication supporting the facility is comprised of a diverse group of eight banks led by JP Morgan Chase Bank, N.A., as Administrative Agent. The Credit Facility matures September 27, 2024.

At December 31, 2021, the Company had approximately $291 million available to borrow under the Credit Facility, plus the $250 million increase option, in addition to $55.7 million cash on hand. The Company classified $20 million as the current portion of long-term debt as of December 31, 2021, as the Company intends to repay this amount within the next twelve months; however, the Company has no contractual obligation to repay such amount during the next twelve months. The letters of credit issued and outstanding under the Credit Facility totaled $10.7 million at December 31, 2021.

Interest on borrowings under the Credit Facility is calculated at a spread over either the New York Federal Reserve Bank Rate, the prime rate, or the London Interbank Offered Rate (LIBOR), depending on various factors. The Credit Facility also requires a facility fee ranging from 10 to 25 basis points per annum on the unused portion. The Credit Facility is secured by the unlimited guaranty of the Company’s direct and indirect material U.S. subsidiaries and the pledge of 100% of the equity interests of its direct and indirect material foreign subsidiaries. The financial covenants of the Credit Facility include a leverage ratio and an interest coverage ratio. The weighted average interest rates were 1.17% and 1.45% for the three-month periods ending December 31, 2021 and 2020, respectively. As of December 31, 2021, the Company was in compliance with all covenants.

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9.    INCOME TAX EXPENSE

The first quarter 2022 effective income tax rate was 22.3% compared to 22.5% in the first quarter of 2021. Income tax expense in the first quarter of 2022 was favorably impacted by excess tax benefit related to the vesting of share based compensation, decreasing the effective tax rate for the quarter by 1.7%.

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10.  SHAREHOLDERS’ EQUITY

The change in shareholders’ equity for the first three months ended December 31, 2021 and 2020 is shown below (in thousands):

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11.  FAIR VALUE MEASUREMENTS

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

Financial Assets and Liabilities

The Company has estimated the fair value of its financial instruments as of December 31, 2021 and September 30, 2021 using available market information or other appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, receivables, inventories, payables, and other current assets and liabilities approximate fair value because of the short maturity of those instruments.

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Fair Value of Financial Instruments

The Company’s forward contracts and interest rate swaps are classified within Level 2 of the valuation hierarchy in accordance with FASB Accounting Standards Codification (ASC) 825, and are immaterial.

Nonfinancial Assets and Liabilities

The Company’s nonfinancial assets such as property, plant and equipment, and other intangible assets are not measured at fair value on a recurring basis; however they are subject to fair value adjustments in certain circumstances, such as when there is evidence that an impairment may exist. No impairments were recorded during the three-month period ended December 31, 2021.

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12.  REVENUES

Disaggregation of Revenues

Revenues by customer type, geographic location, and revenue recognition method for the three-month period ended December 31, 2021 are presented in the table below as the Company deems it best depicts how the nature, amount, timing and uncertainty of net sales and cash flows are affected by economic factors. The table below also includes a reconciliation of the disaggregated revenue within each reportable segment.

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Revenues by customer type, geographic location, and revenue recognition method for the three-month period ended December 31, 2020 are presented in the table below:

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Revenue Recognition

Payment terms with our customers vary by the type and location of the customer and the products or services offered. Arrangements with customers that include payment terms extending beyond one year are not significant. The transaction price for these contracts reflects our estimate of returns and discounts, which are based on historical, current and forecasted information to determine the expected amount to which we will be entitled in exchange for transferring the promised goods or services to the customer. The realization of variable consideration occurs within a short period of time from product delivery; therefore, the time value of money effect is not significant. We primarily provide standard warranty programs for products in our commercial businesses for periods that typically range from one to two years. These assurance-type programs typically cannot be purchased separately and do not meet the criteria to be considered a performance obligation. Under the typical payment terms of our long term fixed price contracts, the customer pays us either performance-based or progress payments. Performance-based payments represent interim payments based on quantifiable measures of performance or on the achievement of specified events or milestones. Progress payments are interim payments of costs incurred as the work progresses.

For our overtime revenue recognized using the output method of costs incurred, contract cost is estimated utilizing current contract specifications and expected engineering requirements. Contract costs typically are incurred over a period of several months to one or more years, and the estimation of these costs requires judgment. Our cost estimation process is based on the professional knowledge and experience of engineers and program managers along with finance professionals. We review and update our projections of costs quarterly or more frequently when circumstances significantly change. In addition, in the USG segment, we recognize revenue as a series of distinct services based on each day of providing services (straight-line over the contract term) for certain of our USG segment contracts. Under the typical payment terms of our service contracts, the customer pays us in advance of when services are performed. In addition, in the Test segment, we use milestones to measure progress for our Test segment contracts because it best depicts the transfer of control to the customer that occurs as we incur costs on our contracts.

Remaining Performance Obligations

Remaining performance obligations, which is the equivalent of backlog, represent the expected transaction price allocated to contracts that the Company expects to recognize as revenue in future periods when the Company performs under the contracts. These remaining obligations include amounts that have been formally appropriated under contracts with the U.S. Government, and exclude unexercised contract options and potential orders under ordering-type contracts such as Indefinite Delivery, Indefinite Quantity contracts. At December 31, 2021, the Company had $639.4 million in remaining performance obligations of which the Company expects to recognize revenues of approximately 77% in the next twelve months.

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Contract assets and liabilities

Assets and liabilities related to contracts with customers are reported on a contract-by-contract basis at the end of each reporting period. Because of the timing difference of revenue recognition and customer billing, these contracts will often result in revenue recognized in excess of billings and billings in excess of costs incurred. At December 31, 2021, contract assets and liabilities totaled $100.9 million and $111.6 million, respectively. During the first quarter of 2022, the Company recognized approximately $29 million in revenues that were included in the contract liabilities balance at September 30, 2021. The increase in net contract assets in the first quarter of 2022 was due to revenue being recognized for performance completed during the period that exceeded customer billings. Other factors that impacted the change in net contract liabilities were immaterial. At October 1, 2020, contract assets and liabilities totaled $94.3 million and $100.6 million, respectively.

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13.  LEASES

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

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

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

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

The components of lease costs are shown below:

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Additional information related to leases are shown below:

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The following is a reconciliation of future undiscounted cash flows to the operating and finance lease liabilities, and the related ROU assets, presented on the Consolidated Balance Sheet on December 31, 2021:

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Operating lease liabilities are included on the Consolidated Balance Sheet in accrued other expenses (current portion) and as a caption on the Consolidated Balance Sheet (long-term portion). Finance lease liabilities are included on the Consolidated Balance Sheet in accrued other expenses (current portion) and other liabilities (long-term portion). Operating lease ROU assets are included as a caption on the Consolidated Balance Sheet and finance lease ROU assets are included in Property, plant and equipment on the Consolidated Balance sheet.

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14.  ADJUSTED QUARTERLY FINANCIAL INFORMATION

During 2021, the Company identified immaterial errors in the historical consolidated financial statements of Westland, within the A&D segment, that are being corrected as an immaterial revision of those financial statements. Specifically, the adjustments include net sales being overstated by $0.3 million in the first quarter of 2021, along with inventory being overstated and cost of goods sold being understated by $0.8 million in the first quarter of 2021. The tax impact of correcting these errors was a reduction in tax expense of $0.2 million in the first quarter of 2021. The table below shows the impact of these adjustments to the first quarter of 2021. Management has determined that these adjustments are not material to the prior year period.

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

RESULTS OF OPERATIONS

References to the first quarters of 2022 and 2021 represent the three-month periods ended December 31, 2021 and 2020, respectively.

COVID-19 TRENDS AND UNCERTAINTIES

The COVID-19 global pandemic has continued to create significant and unprecedented challenges, and during these highly uncertain times, our top priority remains the health and safety of our employees, customers and suppliers, thereby securing the financial well-being of the Company and supporting business continuity. The economic uncertainty, changes in the propensity for the general public to travel by air, and reductions in demand for commercial aircraft as a result of the COVID-19 pandemic have adversely impacted net sales and operating results in certain of our A&D reporting units. Additionally, the electric utility market has been impacted by reduced domestic electricity consumption related to the pandemic, which in turn impacts utility spending on investments in grid maintenance and testing.

Throughout 2021 and the first quarter of 2022, our Navy, defense aerospace, space and Test segment end-markets have remained solid and now we are beginning to see recovery in our core markets most affected by the pandemic. We are encouraged by the growing strength of our entered orders across the commercial aerospace, electric utility and renewable energy end-markets. While there is still uncertainty as to the timing and pace of recovery in the commercial aerospace and electric utility markets, we have seen these markets begin to stabilize and expect strong growth in the second half of fiscal 2022.

We are also monitoring the impacts of COVID-19 on the fair value of assets. We do not currently anticipate any material asset impairments as a result of the COVID-19 global pandemic. We determined that there was no impairment for the three months ended December 31, 2021. We will continue to monitor the impacts of COVID-19 on the fair value of assets. For further discussion, refer to Management’s Discussion and Analysis contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2021.

OVERVIEW

Sales, net earnings and diluted earnings per share were $177.0 million, $11.5 million and $0.44 per share, respectively, in the first quarter of 2022 compared to $162.7 million, $12.8 million and $0.49 per share, respectively, in the first quarter of 2021.

NET SALES

Net sales increased $14.3 million, or 8.8%, to $177.0 million in the first quarter of 2022 from $162.7 million in the first quarter of 2021. The increase in net sales in the first quarter of 2022 as compared to the first quarter of 2021 was due to an $8.9 million increase in the USG segment, a $3.6 million increase in the Aerospace & Defense segment, and a $1.8 million increase in the Test segment.

-Aerospace & Defense (A&D)

Net sales of $70.2 million in the first quarter of 2022 were $3.6 million, or 5.4%, higher than the $66.6 million in the first quarter of 2021. The sales increase in the first quarter of 2022 compared to the first quarter of 2021 was primarily due to an approximately $6.1 million increase in aerospace shipments at PTI and Mayday and a $2.6 million increase in navy sales at Westland, partially offset by a $4.5 million decrease in navy and space sales from VACCO and Globe due to supply chain issues and a $0.6 million decrease in aerospace shipments at Crissair.

-USG

Net sales of $63.5 million in the first quarter of 2022 were $8.9 million, or 16.4% higher than the $54.5 million in the first quarter of 2021. The increase in the first quarter of 2022 compared to the first quarter of 2021 was mainly due to the recent acquisitions of Altanova and Phenix which contributed $14.5 million in sales partially offset by lower sales of core Doble products, and a $1.7 million increase in net sales at NRG driven by solar products.

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-Test

Net sales of $43.3 million in the first quarter of 2022 were $1.8 million, or 4.2%, higher than the $41.5 million in the first quarter of 2021. The increase in the first quarter of 2022 compared to the first quarter of 2021 was primarily due to $5.3 million of higher sales from the segment’s Asian operations partially offset by $3.5 million of lower sales from the segment’s U.S. and European operations, both due to the timing of test and measurement chamber projects.

ORDERS AND BACKLOG

Backlog was $639.4 million at December 31, 2021 compared with $592.0 million at September 30, 2021. The Company received new orders totaling $224.4 million in the first quarter of 2022 compared to $157.6 million in the first quarter of 2021. Of the new orders received in the first quarter of 2022, $90.2 million related to Aerospace & Defense products, $66.2 million related to USG products, and $68.0 million related to Test products. Of the new orders received in the first quarter of 2021, $65.4 million related to Aerospace & Defense products, $48.7 million related to USG products, and $43.5 million related to Test products.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative (SG&A) expenses were $46.6 million (26.3% of net sales) for the first quarter of 2022, compared with $41.0 million (25.2% of net sales) for the first quarter of 2021. The increase in SG&A in the first quarter of 2022 compared to the first quarter of 2021 was mainly due to higher expenses at Doble as a result of the SG&A contribution from the Altanova and Phenix acquisitions and higher expenses at Corporate due to acquisition related costs and professional fees.

AMORTIZATION OF INTANGIBLE ASSETS

Amortization of intangible assets was $6.5 million and $4.9 million for the first quarter of 2022 and 2021, respectively. Amortization expenses consist of amortization of acquired intangible assets from acquisitions and other identifiable intangible assets (primarily software). The increase in amortization expense in the first quarter of 2022 compared to the first quarter of 2021 was mainly due to the Company’s recent acquisitions of Phenix, Altanova and NEco.

OTHER EXPENSES, NET

Other expenses, net, were $0.1 million in the first quarter of 2022 compared to other expenses, net, of $0.1 million in the first quarter of 2021. There were no individually significant items in other expenses (income), net, in the first quarter of 2022. The principal component of other expenses, net, in the first quarter of 2021 included approximately $0.7 million of facility consolidation charges for the Doble Manta facility, including employee severance and lease termination charges.

EBIT

The Company evaluates the performance of its operating segments based on EBIT, and provides EBIT on a consolidated basis, which is a non-GAAP financial measure. Please refer to the discussion of non-GAAP financial measures in Note 7 to the Consolidated Financial Statements, above. EBIT was $15.6 million (8.8% of net sales) for the first quarter of 2022 compared to $17.1 million (10.5% of net sales) for the first quarter of 2021.

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The following table presents a reconciliation of EBIT to a GAAP financial measure:

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– Aerospace & Defense

EBIT was $10.0 million (14.2% of net sales) in the first quarter of 2022 compared to $8.3 million (12.4% of net sales) in the first quarter of 2021. The increase in EBIT in the first quarter of 2022 compared to the first quarter of 2021 was mainly due to higher sales volumes at PTI, Westland and Mayday partially offset a decrease in EBIT at VACCO, Crissair and Globe due to the lower sales volumes mentioned above. In addition, EBIT in the first quarter of 2022 was negatively impacted by a $0.1 million inventory step-up charge related to the NEco acquisition.

– USG

EBIT was $13.4 million (21.1% of net sales) in the first quarter of 2022 compared to $12.7 million (23.3% of net sales) in the first quarter of 2021. The increase in EBIT in the first quarter of 2022 compared to the first quarter of 2021 was mainly due to the higher sales volumes in the first quarter of 2022. EBIT in the first quarter of 2022 was negatively impacted by approximately $0.5 million of inventory step-up charges related to the Altanova acquisition.

– Test

EBIT was $4.0 million (9.2% of net sales) in the first quarter of 2022 compared to $5.3 million (12.9% of net sales) in the first quarter of 2021. The decrease in EBIT in the first quarter of 2022 compared to the first quarter of 2021 was primarily due to lower sales volumes from the segment’s U.S. and European operations and higher material and labor costs which have negatively impacted EBIT.

– Corporate

Corporate costs included in EBIT were $11.7 million and $9.3 million in the first quarter of 2022 and 2021, respectively. The increase in Corporate costs in the first quarter of 2022 compared to the first quarter of 2021 was mainly due to the increase in amortization expense of acquired intangible assets related to the Company’s recent acquisitions of Phenix, Altanova and NEco.

INTEREST EXPENSE, NET

Interest expense was $0.7 million and $0.5 million in the first quarter of 2022 and 2021, respectively. The increase in interest expense in the first quarter of 2022 as compared to the first quarter of 2021 was mainly due to higher average outstanding borrowings ($183 million compared to $70 million).

INCOME TAX EXPENSE

The effective income tax rate was 22.3% in the first quarter of 2022 compared to 22.5% in the first quarter of 2021. Income tax expense in the first quarter of 2022 was favorably impacted by excess tax benefit related to the vesting of share based compensation, decreasing the effective tax rate for the quarter by 1.7%.

CAPITAL RESOURCES AND LIQUIDITY

The Company’s overall financial position and liquidity remain strong. Working capital from continuing operations (current assets less current liabilities) increased to $218.9 million at December 31, 2021 from $188.4 million at September 30, 2021. Inventories increased by $17.9 million during this period mainly due to an $8.8 million increase within the Test segment, a $4.6 million increase within the Aerospace & Defense segment and a $4.5 million increase within the USG segment resulting primarily from the timing of receipt of raw materials to meet anticipated demand and an increase in work in process inventories due to timing of manufacturing existing orders.

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Net cash provided by operating activities was $1.9 million and $24.8 million in the first quarters of 2022 and 2021, respectively. The decrease in net cash provided by operating activities in the first quarter of 2022 as compared to the first quarter of 2021 was driven by higher working capital requirements.

Capital expenditures were $14.1 million and $6.0 million in the first quarters of 2022 and 2021, respectively. The increase in the first quarter of 2022 was mainly due to the purchase of the NRG building of approximately $10 million in the first quarter of 2022. In addition, the Company incurred expenditures for capitalized software of approximately $2.0 million and $1.6 million in the first quarters of 2022 and 2021, respectively.

Acquisition

On November 4, 2021, the Company acquired Networks Electronic Company, LLC (NEco) for a purchase price of approximately $15.2 million, net of cash acquired. NEco, based in Chatsworth, California, provides miniature electro-explosive devices utilized in mission-critical defense and aerospace applications. Since the date of acquisition, the operating results for the NEco business have been included as part of PTI in the A&D segment.

Credit Facility

At December 31, 2021, the Company had approximately $291 million available to borrow under its bank credit facility, a $250 million increase option subject to lender approval, and $55.7 million cash on hand. At December 31, 2021, the Company had $198 million of outstanding borrowings under the credit facility and short-term borrowings in addition to outstanding letters of credit of $10.7 million. Cash flow from operations and borrowings under the Company’s credit facility are expected to meet the Company’s capital requirements and operational needs for the foreseeable future. The Company’s ability to access the additional $250 million increase option of the credit facility is subject to acceptance by participating or other outside banks.

Share Repurchases

During the first quarter of 2022, the Company repurchased approximately 116,000 shares for $10.0 million. For further information on the share repurchases during the first quarter of 2022, see Part II, Item 2 of this Report.

Dividends

A dividend of $0.08 per share, totaling $2.1 million, was paid on October 15, 2021 to stockholders of record as of October 1, 2021. Subsequent to December 31, 2021, a quarterly dividend of $0.08 per share, totaling $2.1 million, was paid on January 19, 2022 to stockholders of record as of January 4, 2022.

CRITICAL ACCOUNTING POLICIES

Management has evaluated the accounting policies used in the preparation of the Company’s financial statements and related notes and believes those policies to be reasonable and appropriate. Certain of these accounting policies require the application of significant judgment by Management in selecting appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, trends in the industry, information provided by customers and information available from other outside sources, as appropriate. The most significant areas involving Management judgments and estimates may be found in the Critical Accounting Policies section of Management’s Discussion and Analysis and in Note 1 to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2021.

OTHER MATTERS

Contingencies

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

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FORWARD LOOKING STATEMENTS

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

Investors are cautioned that such statements are only predictions and speak only as of the date of this Form 10-Q, and the Company undertakes no duty to update them except as may be required by applicable laws or regulations. The Company’s actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company’s operations and business environment, including but not limited to those described in Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2021, and the following: the continuing impact of the COVID-19 pandemic including the effects of known or unknown COVID-19 variants, labor shortages, facility closures, shelter in place policies or quarantines, material shortages, transportation delays, termination or delays of Company contracts and the inability of our suppliers or customers to perform; the impacts of natural disasters on the Company’s operations and those of the Company’s customers and suppliers; the timing and content of future contract awards or customer orders; the appropriation, allocation and availability of Government funds; the termination for convenience of Government and other customer contracts or orders; weakening of economic conditions in served markets; the success of the Company’s competitors; changes in customer demands or customer insolvencies; competition; intellectual property rights; technical difficulties; the availability of selected acquisitions; delivery delays or defaults by customers; performance issues with key customers, suppliers and subcontractors; material changes in the costs and availability of certain raw materials; labor disputes; changes in U.S. tax laws and regulations; other changes in laws and regulations including but not limited to changes in accounting standards and foreign taxation; changes in interest rates; costs relating to environmental matters arising from current or former facilities; uncertainty regarding the ultimate resolution of current disputes, claims, litigation or arbitration; and the integration of recently acquired businesses.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign currency exchange rates. The Company is exposed to market risk related to changes in interest rates and selectively uses derivative financial instruments, including forward contracts and swaps, to manage these risks. The Company’s Canadian subsidiary Morgan Schaffer enters into foreign exchange contracts to manage foreign currency risk as a portion of their revenue is denominated in U.S. dollars. All derivative instruments are reported on the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the gain or loss on the respective derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. There has been no material change to the Company’s market risks since September 30, 2021. Refer to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2021 for further discussion about market risk.

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ITEM 4. CONTROLS AND PROCEDURES

The Company carried out an evaluation, under the supervision and with the participation of Management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of that date. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

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As previously disclosed in Part II Item 9A in the Company’s Annual Report on Form 10-K for the year ended September 30, 2021, Management concluded there were material weaknesses in the Company’s internal control over financial reporting at a reporting unit within the Company’s Aerospace & Defense (A&D) segment, related to an ineffective design and implementation of certain controls over revenue recognition and the accumulation of inventory costs and the determination of inventory carrying values. Remedial actions have been identified and implemented to address these controls including the following: a) Dedicated additional resources to improve the Company’s risk assessment process to ensure that it is comprehensive, continuous, and designed to identify and assess changes that could significantly impact internal control over financial reporting; b) Improved Company policies, procedures and system and process controls related to inventory costing and revenue recognition; and c) Provided additional risk assessment training to the A&D segment finance department on the applicable financial reporting requirements and related accounting policies. During the first quarter of 2022, 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 weaknesses have been remediated as of December 31, 2021.

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 period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES*

*     On August 5, 2021, the Company’s Board of Directors approved a new common stock program, which was announced on August 9, 2021, authorizing us to repurchase shares of our stock from time to time at our discretion, in the open market or otherwise, up to a maximum total repurchase amount equal to $200 million (or such lesser amount as may be permitted under the Company’s bank credit agreements). This program is scheduled to expire September 30, 2024. The Company has not determined whether or when it will make additional repurchases under the program.

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ITEM 6. EXHIBITS

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

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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