Esterline Outlook: Edge of the Cliff

By John N. Simon

Esterline Technologies (ESL) reported not-so-bad results for its second quarter of fiscal 2009. What was shocking to some, however, was its outlook for the balance of the fiscal year.

Before we get into the details of the quarter, let me explain what was disturbing about the Company’s latest pronouncement. Last quarter, ESL’s management opined that fiscal 2009 earnings would probably be in a range of $3.70 to $3.90 per share. This quarter, ESL’s management lowered its EPS range estimate for the year to $3.00 to $3.20. The decline between the mid-point of those projections is over 18%.

One reason for the reduction: Incoming orders in first quarter amounted to $370.2 million, while incoming orders in the second quarter totaled $306.1 million, a sequential decline of over 17%. Put another way, organic incoming orders in Q2-09 were off by $152.8 million, which is a year-over-year decline of over 19% from the $788.1 million booked in Q2-08. Any way you look at it, business is softening.

Now, onto the quarter: Total Net Sales of $359.5 million were off by just 0.4%; however, the change within ESL’s three segments was much more dramatic. Avionics & Controls Sales -- aided by an acquisition -- rose by 14.9% to $169.1 million, while Sensors & Systems Sales declined by 10.9% to $86.8 million and Advanced Materials Sales were off by 8.7% to $103.6 million.

Gross Profit declined by 7.2% to $112.6 million and the Gross Margin slipped from 33.9% to 31.3%. The weakness was attributed to currency-related accounting requirements, adjustments to the profitability of long-term contracts and the start-up costs associated with a Mexican facility.

S,G&A Expense declined by 5.3% to $54.6 million and went from 16.1% of Sales to 15.2%. R,D,T&E was significantly reduced by 27.0% to $18.3 million -- and went from 7.0% of Sales to 5.1% -- probably, in part, because the 787 is finally about ready to make its first flight. Operating Income -- ostensibly impacted by a $2.7 million charge for currency effect -- was down by 4.1% to just under $37.0 million and the Operating Margin dropped from 10.8% to 10.3%.

Interest Expense of $7.6 million was 4.6% higher. The Income Tax Rate went down from 25.2% last year to 14.5% this year for a variety of reasons. The result of all these perturbations was that Net Income from Continuing Operations was up by 5.8% to $25.3 million, which engendered diluted EPS of 85¢ - versus 80¢- up 6.3% on a 0.2% decline in shares.

Based on summary data from the conference call, Segment Operating Profit was as follows: Avionics & Controls = $21.7 million, up 24.7%, with Operating Margin of 12.8% versus 11.8%; Sensors & Systems = $9.9 million, down 5.7%, with Operating Margin of 11.4% versus 10.8%; and Advanced Materials = $14.4 million, off 27.6%, with Operating Margin of 13.9% versus 17.5%.

Turning to the Balance Sheet, the Number of Days in Accounts Receivable soured from 63 to 68, while the Number of Days in Inventory improved from 112 to 106. The Current Ratio was off just a tad from 2.6:1 to 2.5:1. Goodwill + Intangibles as a percent of Equity rose from 86.2% to 100.6%, and Net Long-Term Debt went from 23.5% of Equity to 36.4%.

Some other tidbits from the conference call: Organic Sales in Q2-09 were off by 6%; for the second half of the year, Net Sales are estimated to be in a range of $360 to $380 million per quarter and the Tax Rate will be around 15%.