UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED  MARCH 31, 2020

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______

COMMISSION FILE NUMBER 1-10596

ESCO TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)

MISSOURI	43-1554045
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
9900A CLAYTON ROAD
ST. LOUIS, MISSOURI	63124-1186
(Address of principal executive offices)	(Zip Code)

(314) 213-7200

(Registrant’s telephone number, including area code)

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

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

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

Yes ☒ No ☐

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

Yes ☒ No ☐

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

Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
Emerging growth company	☐

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

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

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

Class	Shares outstanding at April 30, 2020
Common stock, $.01 par value per share	26,037,248

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share amounts)

	Three Months Ended
	March 31,
	2020		2019
Net sales	$	180,492		171,243
Costs and expenses:
Cost of sales		113,242		103,547
Selling, general and administrative expenses		39,982		39,327
Amortization of intangible assets		5,220		4,371
Interest expense, net		1,320		1,853
Other expenses (income), net		703		2,022
Total costs and expenses		160,467		151,120
Earnings before income taxes		20,025		20,123
Income tax expense		2,203		2,301
Earnings from continuing operations		17,822		17,822
Earnings from discontinued operations, net of tax expense of $257		—		975
Gain on sale of discontinued operations		—		—
Earnings from discontinued operations		—		975
Net earnings	$	17,822		18,797
Earnings per share:
Basic - Continuing operations	$	0.69		0.69
- Discontinued operations		0.00		0.04
- Net earnings	$	0.69		0.73
Diluted - Continuing operations	$	0.68		0.68
- Discontinued operations		0.00		0.04
- Net earnings	$	0.68		0.72

See accompanying notes to consolidated financial statements.

2

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share amounts)

	Six Months Ended
	March 31,
	2020		2019
Net sales	$	352,220	334,608
Costs and expenses:
Cost of sales		219,969	206,001
Selling, general and administrative expenses		82,087	77,867
Amortization of intangible assets		11,030	8,771
Interest expense, net		3,741	3,708
Other expenses (income), net		998	(5,357)
Total costs and expenses		317,825	290,990
Earnings before income taxes		34,395	43,618
Income tax expense		5,809	8,446
Earnings from continuing operations		28,586	35,172
(Loss) earnings from discontinued operations, net of tax expense of $269 and $52		(601)	942
Gain on sale of discontinued operations, net of tax expense of $23,734		76,614	—
Earnings from discontinued operations		76,013	942
Net earnings	$	104,599	36,114
Earnings per share:
Basic - Continuing operations	$	1.10	1.36
- Discontinued operations		2.93	0.04
- Net earnings	$	4.03	1.40
Diluted - Continuing operations	$	1.09	1.34
- Discontinued operations		2.91	0.04
- Net earnings	$	4.00	1.38

See accompanying notes to consolidated financial statements.

3

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

	Three Months Ended				Six Months Ended
	March 31,				March 31,
	2020		2019		2020	2019
Net earnings	$	17,822		18,797	104,599	36,114
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments		(6,885)		677	(2,962)	(3,852)
Net unrealized gain on derivative instruments		—		126	—	100
Total other comprehensive income (loss), net of tax		(6,885)		803	(2,962)	(3,752)
Comprehensive income	$	10,937		19,600	101,637	32,362

See accompanying notes to consolidated financial statements.

4

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)

	March 31,		September 30,
	2020		2019
ASSETS
Current assets:
Cash and cash equivalents	$	100,195		61,808
Accounts receivable, net		157,050		158,715
Contract assets		96,100		110,211
Inventories, net		141,027		124,956
Other current assets		17,228		14,190
Assets of discontinued operations – current		—		25,314
Total current assets		511,600		495,194
Property, plant and equipment, net of accumulated depreciation of $122,204 and $113,520, respectively		139,248		127,843
Intangible assets, net of accumulated amortization of $118,277 and $107,247, respectively		371,779		381,605
Goodwill		389,630		390,256
Operating lease assets		18,901		—
Other assets		10,421		4,445
Assets of discontinued operations - other		—		67,377
Total assets	$	1,441,579		1,466,720
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	20,000		20,000
Accounts payable		53,617		63,800
Contract liabilities		95,382		81,177
Accrued salaries		27,062		37,194
Accrued other expenses		54,968		37,947
Liabilities of discontinued operations - current		—		11,517
Total current liabilities		251,029		251,635
Pension obligations		22,861		22,682
Deferred tax liabilities		61,690		60,856
Non-current operating lease liabilities		15,010		—
Other liabilities		34,782		36,326
Long-term debt		130,000		265,000
Liabilities of discontinued operations - other		—		3,999
Total liabilities		515,372		640,498
Shareholders’ equity:
Preferred stock, par value $.01 per share, authorized 10,000,000 shares		—		—
Common stock, par value $.01 per share, authorized 50,000,000 shares, issued 30,596,940 and 30,596,940 shares, respectively		306		306
Additional paid-in capital		294,787		292,408
Retained earnings		785,184		684,741
Accumulated other comprehensive loss, net of tax		(46,936)		(43,974)
		1,033,341		933,481
Less treasury stock, at cost: 4,607,911 and 4,615,627 common shares, respectively		(107,134)		(107,259)
Total shareholders’ equity		926,207		826,222
Total liabilities and shareholders’ equity	$	1,441,579		1,466,720

See accompanying notes to consolidated financial statements.

5

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

	Six Months Ended
	March 31,
	2020		2019
Cash flows from operating activities:
Net earnings	$	104,599		36,114
Earnings from discontinued operations		(76,013)		(942)
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		20,583		16,837
Stock compensation expense		2,896		2,557
Changes in assets and liabilities		(16,247)		(28,124)
Change in property, plant and equipment due to gain on sale of building		—		(8,922)
Pension contributions		—		(833)
Effect of deferred taxes		834		(1,431)
Net cash provided by operating activities – continuing operations		36,652		15,256
Net cash (used) provided by operating activities – discontinued operations		(14,622)		1,736
Net cash provided by operating activities		22,030		16,992
Cash flows from investing activities:
Proceeds from sale of building and land		—		17,201
Additions to capitalized software		(4,280)		(4,494)
Capital expenditures		(21,211)		(10,127)
Net cash (used) provided by investing activities – continuing operations		(25,491)		2,580
Proceeds from sale of discontinued operations		183,997		—
Capital expenditures – discontinued operations		(1,728)		(7,298)
Net cash provided (used) by investing activities – discontinued operations		182,269		(7,298)
Net cash provided (used) by investing activities		156,778		(4,718)
Cash flows from financing activities:
Proceeds from long-term debt and short-term borrowings		10,000		23,000
Principal payments on long-term debt		(145,000)		(26,000)
Dividends paid		(4,156)		(4,146)
Other		—		370
Net cash used by financing activities – continuing operations		(139,156)		(6,776)
Net cash (used) provided by financing activities – discontinued operations		(2,140)		1,091
Net cash used by financing activities		(141,296)		(5,685)
Effect of exchange rate changes on cash and cash equivalents		875		(2,111)
Net increase in cash and cash equivalents		38,387		4,478
Cash and cash equivalents, beginning of period		61,808		30,477
Cash and cash equivalents, end of period	$	100,195		34,955
Supplemental cash flow information:
Interest paid	$	3,477		3,594
Income taxes paid (including state and foreign)		23,098		13,450

See accompanying notes to consolidated financial statements.

6

ESCO TECHNOLOGIES INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.    BASIS OF PRESENTATION

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

The Company’s results for the three-month period ended March 31, 2020 are not necessarily indicative of the results for the entire 2020 fiscal year. References to the second quarters of 2020 and 2019 represent the fiscal quarters ended March 31, 2020 and 2019, respectively. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ from those estimates.

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

2.    TECHNICAL PACKAGING DIVESTITURE

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

Net sales from the Technical Packaging business were zero and $16.5 million in the second quarter and first six months of 2020, respectively, compared to $22.7 million and $41.9 million in the corresponding periods of 2019. The Company received net proceeds from the sale of approximately $184 million and recorded a $76.6 million after-tax gain on the sale in the first quarter of 2020. The Company expects to finalize the working capital adjustment during the third quarter of 2020.

7

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

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

3.    ACCOUNTING STANDARDS UPDATE

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

8

4.    EARNINGS PER SHARE (EPS)

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

	Three Months		Six Months
	Ended March 31,		Ended March 31,
	2020	2019	2020	2019
Weighted Average Shares Outstanding - Basic	25,988	25,918	25,985	25,915
Dilutive Options and Restricted Shares	100	118	141	163
Adjusted Shares - Diluted	26,088	26,036	26,126	26,078

5.    SHARE-BASED COMPENSATION

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

Performance-Accelerated Restricted Share Awards

Compensation expense related to the restricted share awards was $1.1 million and $2.3 million for the three and six-month periods ended March 31, 2020, respectively, and $0.9 million and $2.0 million for the corresponding periods in 2019. There were 175,577 non-vested shares outstanding as of March 31, 2020.

Non-Employee Directors Plan

Compensation expense related to the non-employee director grants was $0.3 million and $0.6 million for the three and six-month periods ended March 31, 2020, respectively, and $0.3 million and $0.5 million for the corresponding periods in 2019.

The total share-based compensation cost that has been recognized in the results of operations and included within selling, general and administrative expenses (SG&A) was $1.5 million and $2.9 million for the three and six-month periods ended March 31, 2020, respectively, and $1.2 million and $2.6 million for the corresponding periods in 2019. The total income tax benefit recognized in results of operations for share-based compensation arrangements was $0.3 million and $0.7 million for the three and six-month periods ended March 31, 2020, respectively, and $0.3 million and $0.6 million for the corresponding periods in 2019. As of March 31, 2020, there was $6.8 million of total unrecognized compensation cost related to share-based compensation arrangements. That cost is expected to be recognized over a remaining weighted-average period of 2.1 years.

6.    INVENTORIES

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

	March 31,		September 30,
(In thousands)	2020		2019
Finished goods	$	23,898		23,550
Work in process		39,768		26,407
Raw materials		77,361		74,999
Total inventories	$	141,027		124,956

9

7.    GOODWILL AND OTHER INTANGIBLE ASSETS

Included on the Company’s Consolidated Balance Sheets at March 31, 2020 and September 30, 2019 are the following intangible assets gross carrying amounts and accumulated amortization from continuing operations:

	March 31,		September 30,
(Dollars in thousands)	2020		2019
Goodwill	$	389,630		390,256
Intangible assets with determinable lives:
Patents
Gross carrying amount	$	2,067		1,945
Less: accumulated amortization		806		748
Net	$	1,261		1,197
Capitalized software
Gross carrying amount	$	83,243		78,962
Less: accumulated amortization		53,034		48,530
Net	$	30,209		30,432
Customer relationships
Gross carrying amount	$	226,946		227,225
Less: accumulated amortization		61,486		55,326
Net	$	165,460		171,899
Other
Gross carrying amount	$	5,081		5,441
Less: accumulated amortization		2,953		2,645
Net	$	2,128		2,796
Intangible assets with indefinite lives:
Trade names	$	172,721		175,281

The changes in the carrying amount of goodwill attributable to each business segment for the six months ended March 31, 2020 is as follows on a continuing operations basis:

					Aerospace
(Dollars in millions)	USG		Test		& Defense		Total
Balance as of September 30, 2019		254.0		34.1		102.2		390.3
Foreign currency translation		(0.6)		(0.1)		—		(0.7)
Balance as of March 31, 2020	$	253.4		34.0		102.2		389.6

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8.    BUSINESS SEGMENT INFORMATION

The Company is organized based on the products and services that it offers, and classifies its continuing business operations in three reportable segments for financial reporting purposes: Aerospace & Defense (formerly called Filtration/Fluid Flow), RF Shielding and Test (Test), and Utility Solutions Group (USG). The Aerospace & Defense segment’s operations consist of PTI Technologies Inc. (PTI), VACCO Industries (VACCO), Crissair, Inc. (Crissair), Westland Technologies Inc. (Westland), Mayday Manufacturing Co. and its affiliate Hi-Tech Metals, Inc. (collectively referred to as Mayday) and Globe Composite Solutions, LLC (Globe). The companies within this segment primarily design and manufacture specialty filtration and naval products, including hydraulic filter elements and fluid control devices used in commercial aerospace applications; unique filter mechanisms used in micro-propulsion devices for satellites and custom designed filters for manned aircraft and submarines; products and systems to reduce vibration and/or acoustic signatures and otherwise reduce or obscure a vessel’s signature, and other communications, sealing, surface control and hydrodynamic related applications to enhance U.S. Navy maritime survivability; precision-tolerance machined components for the aerospace and defense industry; and metal processing services. The Test segment’s operations consist primarily of ETS-Lindgren Inc. (ETS-Lindgren). ETS-Lindgren is an industry leader in providing its customers with the ability to identify, measure and contain magnetic, electromagnetic and acoustic energy. ETS-Lindgren also manufactures radio frequency shielding products and components used by manufacturers of medical equipment, communications systems, electronic products, and shielded rooms for high-security data processing and secure communication. The USG segment’s operations consist primarily of Doble Engineering Company (Doble), Morgan Schaffer Inc. (Morgan Schaffer), and NRG Systems, Inc. (NRG). Doble provides high-end, intelligent, diagnostic test and data management solutions for the electric power delivery industry and is a leading supplier of partial discharge testing instruments used to assess the integrity of high voltage power delivery equipment. Morgan Schaffer provides an integrated offering of dissolved gas analysis, oil testing, and data management solutions for the electric power industry. NRG designs and manufactures decision support tools for the renewable energy industry, primarily wind.

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

	Three Months				Six Months
	Ended March 31,				Ended September 30,
(In thousands)	2020		2019		2020	2019
NET SALES
Aerospace & Defense	$	95,124		79,478	172,635	145,702
Test		41,600		42,875	82,983	84,161
USG		43,768		48,890	96,602	104,745
Consolidated totals	$	180,492		171,243	352,220	334,608
EBIT
Aerospace & Defense	$	21,736		17,443	34,249	28,053
Test		5,651		5,554	10,307	8,864
USG		4,866		8,767	14,153	30,313
Corporate (loss)		(10,908)		(9,788)	(20,573)	(19,904)
Consolidated EBIT		21,345		21,976	38,136	47,326
Less: Interest expense		(1,320)		(1,853)	(3,741)	(3,708)
Earnings before income taxes	$	20,025		20,123	34,395	43,618

11

Non-GAAP Financial Measures

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

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

9.    DEBT

The Company’s debt is summarized as follows:

	March 31,		September 30,
(In thousands)	2020		2019
Total borrowings	$	150,000		285,000
Current portion of long-term debt		(20,000)		(20,000)
Total long-term debt, less current portion	$	130,000		265,000

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

At March 31, 2020, the Company had approximately $341 million available to borrow under the Credit Facility, plus the $250 million increase option, subject to lender approval, in addition to $100.2 million cash on hand. The Company classified $20.0 million as the current portion of long-term debt as of March 31, 2020, as the Company intends to repay this amount within the next twelve months; however, the Company has no contractual obligation to repay such amount during the next twelve months. The letters of credit issued and outstanding under the Credit Facility totaled $9.8 million at March 31, 2020.

Interest on borrowings under the Credit Facility is calculated at a spread over either the London Interbank Offered Rate (LIBOR ), the New York Federal Reserve Bank Rate or the prime rate, depending on various factors. The Credit Facility also requires a facility fee ranging from 10 to 25 basis points per annum on the unused portion. The Credit Facility is secured by the unlimited guaranty of the Company’s direct and indirect material U.S. subsidiaries and the pledge of 100% of the equity interests of its direct and indirect material foreign subsidiaries. The financial covenants of the Credit Facility include a leverage ratio and an interest coverage ratio. The weighted average interest rates were 3.24% and 3.21% for the three and six-month periods ending March 31, 2020, respectively , and 3.20% and 3.23% for the three and six-month periods ending March 31, 2019. As of March 31, 2020, the Company was in compliance with all covenants.

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10.  INCOME TAX EXPENSE

The second quarter 2020 effective income tax rate from continuing operations was 11.0% compared to 11.4% in the second quarter of 2019. The effective income tax rate in the first six months of 2020 was 16.9% compared to 19.4% for the first six months of 2019. The income tax expense in the second quarter of 2020 was favorably impacted by the release of a valuation allowance of $2.8 million for foreign net operating losses decreasing the second quarter and year-to-date effective tax rate by 14.3% and 8.2%, respectively. The income tax expense in the second quarter and first six months of 2019 was favorably impacted by tax planning strategies to increase the foreign tax credits claimed retrospectively. The Company reduced the valuation allowance for excess foreign tax credits by $2.3 million and recorded an amended return receivable of $0.2 million, which favorably impacted the 2019 second quarter and year-to-date effective tax rate by 12.9% and 5.9%, respectively.

11.  SHAREHOLDERS’ EQUITY

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

	Three Months Ended March 31,		Six Months Ended March 31,
	2020	2019	2020	2019
Common stock
Beginning balance	306	305	306	305
Stock plans	—	—	—	—
Ending balance	306	305	306	305
Additional paid-in-capital
Beginning balance	293,056	292,293	292,408	291,190
Stock plans	1,731	1,319	2,379	2,422
Ending balance	294,787	293,612	294,787	293,612
Retained earnings
Beginning balance	769,439	627,670	684,741	606,837
Net earnings common stockholders	17,822	18,797	104,599	36,114
Dividends paid	(2,077)	(2,074)	(4,156)	(4,147)
Adoption of accounting standards updates	—	(1,375)	—	4,214
Ending balance	785,184	643,018	785,184	643,018
Accumulated other comprehensive income (loss)
Beginning balance	(40,051)	(36,083)	(43,974)	(31,528)
Foreign currency translation	(6,885)	677	(2,962)	(3,853)
Pension	—	—	—	—
Forward exchange contracts	—	126	—	101
Ending balance	(46,936)	(35,280)	(46,936)	(35,280)
Treasury stock
Beginning balance	(107,259)	(107,394)	(107,259)	(107,394)
Issued under stock plans	125	135	125	135
Ending balance	(107,134)	(107,259)	(107,134)	(107,259)
Total equity	926,207	794,396	926,207	794,396

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12.  RETIREMENT PLANS

A summary of net periodic benefit expense for the Company’s defined benefit plans for the three and six-month periods ended March 31, 2020 and 2019 is shown in the following table. Net periodic benefit cost for each period presented is comprised of the following:

	Three Months				Six Months
	Ended March 31,				Ended March 31,
(In thousands)	2020		2019		2020	2019
Defined benefit plans
Interest cost	$	824		875	1,648	1,750
Expected return on assets		(1,041)		(1,086)	(2,082)	(2,172)
Amortization of:
Prior service cost		—		—	—	—
Actuarial loss		543		487	1,087	974
Net periodic benefit cost	$	326		276	653	552

13.  DERIVATIVE FINANCIAL INSTRUMENTS

Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign currency exchange rates. The Company is exposed to market risk related to changes in interest rates and selectively uses derivative financial instruments, including forward contracts and swaps, to manage these risks. In 2018, the Company entered into three interest rate swaps with a notional amount of $150 million to hedge some of its exposure to variability in future LIBOR-based interest payments on variable rate debt, of which one swap is outstanding as of March 31, 2020. In addition, the Company’s Canadian subsidiary Morgan Schaffer enters into foreign exchange contracts to manage foreign currency risk as a portion of their revenue is denominated in U.S. dollars. The Company expects hedging gains or losses to be essentially offset by losses or gains on the related underlying exposures. The amounts ultimately recognized may differ for open positions, which remain subject to ongoing market price fluctuations until settlement. All derivative instruments are reported in either accrued expenses or other assets on the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the gain or loss on the derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. The interest rate swaps entered into during 2018 were not designated as cash flow hedges and, therefore, the gain or loss on the derivative is reflected in earnings each period.

The following is a summary of the notional transaction amounts and fair values for the Company’s outstanding derivative financial instruments by risk category and instrument type as of March 31, 2020:

		Fair
	Notional	Value		Fix
(In thousands)	amount	(US$)		Rate
Forward contracts	6,250	USD	(381)
Interest rate swap	150,000	USD	(1,997)	2.24	%

14.  FAIR VALUE MEASUREMENTS

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

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

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

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

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Financial Assets and Liabilities

The Company has estimated the fair value of its financial instruments as of March 31, 2020 and September 30, 2019 using available market information or other appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, receivables, inventories, payables, debt and other current assets and liabilities approximate fair value because of the short maturity of those instruments.

Fair Value of Financial Instruments

The Company’s forward contracts and interest rate swaps are classified within Level 2 of the valuation hierarchy in accordance with FASB Accounting Standards Codification (ASC) 825, as presented below as of March 31, 2020:

(In thousands)	Level 1		Level 2		Level 3		Total
Assets (Liabilities):
Forward contracts and interest rate swaps	$	—		(2,378)	$	—		(2,378)

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

Nonfinancial Assets and Liabilities

The Company’s nonfinancial assets such as property, plant and equipment, and other intangible assets are not measured at fair value on a recurring basis; however they are subject to fair value adjustments in certain circumstances, such as when there is evidence that an impairment may exist. No impairments were recorded during the three and six-month periods ended March 31, 2020.

15.  REVENUES

Disaggregation of Revenues

Revenues by customer type, geographic location, and revenue recognition method for the three and six-month periods ended March 31, 2020 are presented in the tables below as the Company deems it best depicts how the nature, amount, timing and uncertainty of net sales and cash flows are affected by economic factors. The table below also include a reconciliation of the disaggregated revenue within each reportable segment on a continuing operations basis.

Three months ended March 31, 2020	Aerospace
(In thousands)	& Defense		Test		USG		Total
Customer type:
Commercial	$	51,550	$	33,952	$	43,736	$	129,238
U.S. Government		43,574		7,648		32		51,254
Total revenues	$	95,124	$	41,600	$	43,768	$	180,492
Geographic location:
United States	$	81,458	$	25,121	$	28,706	$	135,285
International		13,666		16,479		15,062		45,207
Total revenues	$	95,124	$	41,600	$	43,768	$	180,492
Revenue recognition method:
Point in time	$	46,610	$	8,009	$	32,209	$	86,828
Over time		48,514		33,591		11,559		93,664
Total revenues	$	95,124	$	41,600	$	43,768	$	180,492

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Six months ended March 31, 2020	Aerospace
(In thousands)	& Defense		Test		USG		Total
Customer type:
Commercial	$	93,417	$	69,194	$	95,971	$	258,582
U.S. Government		79,218		13,789		631		93,638
Total revenues	$	172,635	$	82,983	$	96,602	$	352,220
Geographic location:
United States	$	146,164	$	49,959	$	63,665	$	259,788
International		26,471		33,024		32,937		92,432
Total revenues	$	172,635	$	82,983	$	96,602	$	352,220
Revenue recognition method:
Point in time	$	82,897	$	17,019	$	72,524	$	172,440
Over time		89,738		65,964		24,078		179,780
Total revenues	$	172,635	$	82,983	$	96,602	$	352,220

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 ap