ESCO Technologies Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended December 31, 2018, compared with the quarter ended December 31, 2017. Amounts below are in millions except per-share data. ESCO operates in Filtration, Test, Utility Solutions Group (USG), and Technical Packaging.
Financial results
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Net sales | $182.6 | $173.5 |
| Gross profit / margin | $63.7 / 34.9% | $61.8 / 35.6% |
| EBIT / EBIT margin | $25.1 / 13.8% | $15.0 / 8.6% |
| Earnings before income taxes | $23.3 | $12.8 |
| Income tax expense (benefit) | $5.9 | $(21.9) |
| Net earnings | $17.3 | $34.7 |
| Diluted EPS | $0.66 | $1.33 |
| Operating cash flow | $8.1 | $17.8 |
Sales increased 5.2%. SG&A declined to $41.0 million (22.4% of sales) from $42.2 million (24.3%). Interest expense was $1.9 million versus $2.2 million; average borrowings were lower, partly offset by higher average rates (3.3% versus 2.7%). The reported effective tax rate was 25.5%, compared with (170.8%) in the prior-year quarter.
Segments and material changes
- Filtration: Sales rose 10.3% to $66.2 million; EBIT was $10.6 million versus $9.6 million. Higher aerospace shipments and government-program revenue timing helped, partly offset by lower VACCO space-product revenue.
- Test: Sales increased 10.0% to $41.3 million and EBIT rose to $3.3 million from $2.6 million, mainly on U.S. project timing and volume.
- USG: Sales were essentially flat at $55.9 million. EBIT increased to $21.5 million from $10.7 million, principally reflecting an approximately $8 million gain on sale of the Doble Watertown building and land, as well as product-line contributions.
- Technical Packaging: Sales fell 4.7% to $19.2 million and EBIT declined to $0.1 million from $1.0 million, reflecting Plastique project timing and $0.3 million of restructuring charges.
- The prior-year quarter included a $25.1 million net benefit from the Tax Cuts and Jobs Act. This was the main reason net earnings and EPS fell year over year despite higher pretax earnings. The 2019 quarter also included the building-sale gain; reported EBIT therefore benefited from a nonrecurring item.
Cash, liquidity, debt, and other balance-sheet items
Cash was $36.6 million at December 31, 2018, up from $30.5 million at September 30, 2018. Working capital was $217.3 million versus $195.5 million. Operating cash flow declined to $8.1 million, which management attributed to lower earnings and higher working-capital requirements. Investing cash flow was positive $6.3 million, including $17.2 million of proceeds from the building and land sale; capital expenditures were $8.9 million and capitalized software additions were $2.1 million. Financing cash flow was negative $7.0 million, including $13.0 million of debt principal payments and $2.1 million of dividends paid.
Total borrowings were $215.3 million, including $20.3 million classified as current. The company reported approximately $209 million available under its $450 million credit facility, plus a $250 million increase option subject to lender approval, and $8.2 million of outstanding letters of credit. The facility matures December 21, 2020; ESCO said it was compliant with its covenants. Debt was variable-rate, with interest-rate swaps used to manage some exposure. The company described its financial position and liquidity as strong.
Backlog was $398.3 million, up from $382.8 million at September 30, 2018; orders were $198.1 million versus $200.5 million a year earlier. Management expected to recognize approximately 83% of remaining performance obligations within the next 12 months.
Accounting, outlook, risks, and controls
- ESCO adopted ASC 606 on October 1, 2018 using the modified retrospective method. Adoption increased opening retained earnings by $5.6 million. For the quarter, ASC 606 reduced reported sales by $4.7 million and net earnings by $0.2 million compared with prior accounting; comparative-period figures were not restated. Contract assets were $94.1 million and contract liabilities $53.3 million at quarter-end.
- Management forecast fiscal 2019 adjusted EPS of $2.95–$3.05, reflecting meaningful organic sales growth, and Q2 adjusted EPS of $0.58–$0.63. Adjusted EPS excludes the Doble property-sale gain and specified relocation, closure, consolidation, and other restructuring costs. The filing cautions that quarterly results are not necessarily indicative of the full year.
- Risks cited include government funding, contract awards or termination, market weakness, customer and supplier performance, raw-material costs, foreign exchange and interest rates, environmental matters, litigation, and integration of acquisitions. Management said claims, litigation, and environmental matters were adequately reserved, insured, or not expected to have a material adverse effect.
- Disclosure controls were deemed ineffective at quarter-end due to a previously identified material weakness involving controls over the deferred-revenue general ledger account. Remediation was underway but had not been in place long enough to establish that the weakness was fully corrected.
- The company was assessing the impact of the new lease accounting standard, which was expected to increase reported assets and liabilities.
Important facts for investors to verify
- Whether the $2.95–$3.05 adjusted EPS outlook and expected organic growth remain achievable, and how excluded restructuring costs compare with actual spending.
- Underlying USG profitability excluding the approximately $8 million property-sale gain, and whether performance in Technical Packaging and NRG improves.
- Whether operating cash flow strengthens as contract assets and other working-capital needs evolve following ASC 606 adoption.
- Progress in remediating the deferred-revenue control weakness and any related reporting or restatement developments.
- Credit-facility availability, covenant compliance, interest-rate exposure, and the timing of the company’s intended repayment of current-classified debt.
- Developments in government funding and orders, contract cost estimates, restructuring and environmental matters, and other disclosed contingencies.