ESCO Technologies Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2019; comparative periods ended March 31, 2018. Amounts below are in U.S. dollars. ESCO operates in Filtration/Fluid Flow, RF Shielding and Test, Utility Solutions Group (USG), and Technical Packaging.
Financial performance
| Metric | Three months ended March 31, 2019 | Prior year | Six months ended March 31, 2019 | Prior year |
|---|---|---|---|---|
| Net sales | $193.9 million | $174.8 million | $376.5 million | $348.3 million |
| Net earnings | $18.8 million | $10.0 million | $36.1 million | $44.7 million |
| Diluted EPS | $0.72 | $0.38 | $1.38 | $1.72 |
| Consolidated EBIT | $23.3 million | $15.6 million | $48.4 million | $30.6 million |
| EBIT margin | 12.0% | 8.9% | 12.9% | 8.8% |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $17.0 million | $33.5 million |
Quarterly sales increased 10.9%; six-month sales increased 8.1%. Calculated gross margin was approximately 37.1% for the quarter versus 35.7% a year earlier, and 36.0% for the six months versus 35.7%. Quarterly SG&A was $41.7 million, or 21.5% of sales, compared with $40.7 million, or 23.3%; six-month SG&A was $82.7 million, or 22.0%, versus $82.9 million, or 23.8%.
Quarterly net earnings rose despite higher other expense, supported by sales growth, improved EBIT, and a lower effective tax rate. Six-month net earnings and EPS declined from 2018, whose results included a substantial tax benefit related primarily to the Tax Cuts and Jobs Act (TCJA). The 2019 six-month effective tax rate was 19.0%, versus a 2018 rate of negative 69.3%. The 2019 second-quarter rate was 12.0%, versus 26.4%; 2019 benefited from tax-planning actions involving foreign tax credits.
Segments and material changes
- Filtration: Second-quarter sales rose 20.8% to $79.5 million and EBIT increased to $17.4 million from $11.1 million. Higher aerospace shipments and defense spares were cited.
- Test: Sales increased 5.1% to $42.9 million; EBIT was $5.6 million versus $5.3 million. Management cited timing of U.S. test-chamber projects.
- USG: Sales increased 4.7% to $48.9 million; EBIT was $8.8 million versus $5.6 million. Six-month EBIT also included an approximately $8 million gain on the sale of the Doble Watertown building and land; NRG was affected by market softness.
- Technical Packaging: Sales rose 5.6% to $22.7 million, while EBIT declined to $1.6 million from $1.9 million, partly due to restructuring charges.
- Second-quarter orders were $231.7 million versus $187.3 million. Backlog was $436.1 million at March 31, 2019, up from $382.8 million at September 30, 2018; management expected to recognize 83% of remaining performance obligations as revenue within the next twelve months.
- ESCO adopted ASC 606 on October 1, 2018 using the modified retrospective method. The company recorded a $4.2 million increase to opening retained earnings. The filing’s reconciliation shows adoption reduced reported 2019 net earnings by $0.7 million for the quarter and $1.0 million for the six-month period versus prior accounting; prior-year figures were not restated.
Cash flow, liquidity, and debt
For the six months, operating cash flow was $17.0 million, down from $33.5 million, with management attributing the decrease to higher working-capital needs. Capital expenditures were $17.4 million, including a facility expansion at TEQ; capitalized software additions were another $4.5 million. Proceeds from the Doble property sale were $17.2 million. Cash increased to $35.0 million from $30.5 million at September 30, 2018.
Working capital was $234.0 million, compared with $195.5 million at September 30, 2018. Current assets were $436.0 million and current liabilities $201.9 million. Contract assets increased to $100.5 million from $53.0 million at September 30, primarily reflecting ASC 606 adoption and related contract accounting.
Total debt was $217.0 million, including $20.0 million classified as current; long-term debt, excluding the current portion, was $197.0 million. The company reported $207.0 million available under its credit facility, plus a conditional $250 million increase option, and $8.3 million in outstanding letters of credit. The facility matures December 2020. ESCO reported compliance with its debt covenants. Weighted-average borrowing rates were 3.20% for the quarter and 3.23% for the six months.
Outlook, risks, and unusual items
- Management raised fiscal 2019 adjusted EPS guidance to $3.05–$3.10 from $2.95–$3.05 and forecast third-quarter adjusted EPS of $0.75–$0.80. Adjusted EPS excludes the Doble property-sale gain and specified relocation, closure, consolidation, and other restructuring costs; it is not GAAP EPS.
- Second-quarter other expense included $1.3 million of restructuring charges and derivative losses. Six-month other income included the approximately $8 million Doble property-sale gain, partly offset by restructuring and derivative losses.
- Management said liquidity remained strong and expected operating cash flow and credit-facility borrowings to meet foreseeable capital and operating needs. Access to the additional $250 million facility option requires lender acceptance.
- Risks identified include changes in customer orders and government funding, contract termination, economic and market weakness, customer or supplier performance, raw-material availability and cost, interest and foreign-exchange movements, environmental matters, litigation, tax-law changes, and integration of acquired businesses. Management said existing claims, litigation, and environmental matters were adequately reserved, insured, or not expected to have a material adverse effect.
- Controls: Disclosure controls were deemed ineffective at March 31, 2019 because of an unresolved material weakness in 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.
Important facts for investors to verify
- Whether the improved sales and segment EBIT trends continue, particularly in Filtration, and how much growth reflects shipment timing.
- How much of the $436.1 million backlog converts to sales and cash, and whether contract assets and working-capital requirements moderate.
- The composition and timing of items excluded from adjusted EPS guidance, including restructuring costs and the Doble sale gain.
- The sustainability of the favorable 2019 tax rate and the comparability of earnings with 2018’s TCJA-related tax benefit.
- Progress in remediating the deferred-revenue control weakness and any effects on reporting reliability.
- Debt repayment plans, credit-facility availability and covenants, and the outcome of disclosed litigation and environmental matters.