ESCO Technologies Inc. — Q2 FY2015 Form 10-Q
Reporting period: Fiscal quarter and six months ended March 31, 2015. Unless noted, financial amounts are in millions of dollars. Results are unaudited. Aclara, sold in March 2014, is reported as discontinued operations.
Financial performance
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Net sales, continuing operations | $128.9 | $124.8 | $249.5 | $249.2 |
| Net earnings, continuing operations | $8.6 | $9.3 | $19.5 | $18.1 |
| Diluted EPS, continuing operations | $0.33 | $0.35 | $0.74 | $0.68 |
| Consolidated EBIT (non-GAAP) | $14.0 | $13.9 | $29.0 | $28.3 |
| EBIT margin | 10.9% | 11.1% | 11.6% | 11.4% |
| Operating cash flow, continuing operations | Not separately provided for quarter | $16.9 | $16.7 |
Q2 net earnings including discontinued operations were $8.3 million ($0.32 diluted EPS), compared with a net loss of $33.7 million ($1.26 diluted loss per share) a year earlier. The prior-year result included a $50.4 million after-tax loss on the Aclara sale. For the six-month periods, total net earnings were $19.1 million versus a net loss of $22.5 million, also largely reflecting that prior-year sale loss.
Q2 cost of sales was $80.1 million, implying gross margin of approximately 37.8%, versus approximately 37.9% a year earlier. For the six-month periods, implied gross margin was approximately 39.7% versus 39.1%. Tax expense was $5.1 million in Q2 and $9.1 million year to date; the effective tax rates were 37.3% and 31.8%, respectively.
Liquidity, debt, and cash flow
At March 31, 2015, cash was $34.7 million, working capital was $163.8 million, and the current ratio was approximately 2.3. Total borrowings were $73.0 million, including $20.0 million current and $53.0 million long-term, up from $40.0 million total at September 30, 2014. The company reported approximately $365 million available under its credit facility, plus a potential $250 million expansion subject to lender acceptance; it was in compliance with debt covenants.
Six-month operating cash flow was $16.5 million including discontinued operations. Investing used $31.1 million, including $20.5 million for the ENOSERV acquisition, $7.6 million of capital expenditures and $3.0 million of capitalized software. Financing provided $18.6 million; the company repurchased approximately 283,000 shares for $9.9 million and paid $4.2 million in dividends. Cash declined $0.4 million during the period.
Changes and operating drivers
- Q2 sales rose 3.3%; six-month sales were essentially flat. USG and Test drove Q2 growth. USG six-month sales increased 13.1%, while Filtration declined 7.0% and Test grew 1.2%.
- Six-month Filtration softness reflected lower VACCO space shipments, Crissair delivery timing during a facility move and lower TEQ ear-thermometer probe-cover shipments. USG growth reflected higher F and M series shipments, international revenue, and software and services.
- Q2 continuing earnings declined despite higher sales, primarily with a higher effective tax rate and lower USG EBIT. Six-month continuing earnings and diluted EPS increased.
- Backlog from continuing operations increased to $348.0 million at March 31, 2015 from $302.9 million at September 30, 2014. Six-month orders were $294.6 million versus $249.9 million.
- ESCO acquired ENOSERV for $20.5 million cash on January 28, 2015. ENOSERV had approximately $8 million annual revenue; preliminary allocation included $10.0 million goodwill and $9.0 million amortizable intangibles.
Outlook, risks, and unusual items
Management maintained its 2015 outlook, except it now expects an approximately 34% effective tax rate. It expects fiscal 2015 EPS of $1.70–$1.80 and Q3 EPS of $0.38–$0.42, with EPS more weighted to the second half, consistent with the 2014 quarterly pattern. Management said cash from operations and credit-facility borrowings should meet foreseeable capital and operating needs.
The buyer of Aclara disputes the final working-capital adjustment; the matter is in arbitration, and the filing says the buyer could prevail on some proposed adjustments. Management considered the exposure in the financial statements. The company also disclosed ordinary-course claims, litigation, and environmental investigation/remediation matters, which it believes are reserved, insured, or not expected to have a material adverse effect.
Other factors to monitor include timing of customer orders and project deliveries, market and customer conditions, supply and raw-material costs, facility-transition execution, foreign exchange and interest-rate exposure, and tax changes. The company entered forward contracts to hedge purchases of 2.1 million euros (about $2.5 million); the contracts had a $0.2 million liability fair value. Foreign subsidiaries held $29.3 million cash and $35.3 million accumulated unremitted earnings; estimated U.S. tax if distributed was approximately $4.7 million. Management noted no material change in market risk since September 30, 2014.
Investor verification points
- Track whether the $348.0 million backlog converts to revenue and cash, particularly given delivery timing and project dependencies.
- Review the outcome and financial effect of the Aclara working-capital arbitration.
- Assess progress against the $1.70–$1.80 annual EPS range, Q3 range, and 34% expected tax rate.
- Monitor debt growth, acquisition returns from ENOSERV, and the facility’s covenant headroom and availability.
- Follow elevated inventory, Filtration shipment and facility-transition issues, and USG margin performance.