ESCO Technologies Inc. — Q3 FY2017 Form 10-Q
Reporting period: Fiscal third quarter and nine months ended June 30, 2017; comparisons are with the corresponding 2016 periods. Amounts are in U.S. dollars unless noted.
Business context
ESCO supplies products and services through four segments: Filtration/Fluid Flow, RF Shielding and Test, Utility Solutions Group (USG), and Technical Packaging. FY2017 results include acquisitions of Westland and Mayday in Filtration and NRG Systems and Morgan Schaffer in USG; acquired businesses contributed to revenue growth and increased debt, amortization, and acquisition-related costs.
Financial performance and position
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Net sales | $171.2 million | $140.2 million | $478.7 million | $412.0 million |
| Net earnings | $12.6 million | $11.5 million | $34.5 million | $29.0 million |
| Diluted EPS | $0.49 | $0.44 | $1.33 | $1.12 |
| Consolidated EBIT | $18.6 million; 10.9% of sales | $17.8 million; 12.7% of sales | $53.1 million; 11.1% of sales | $45.0 million; 10.9% of sales |
- Sales grew 22.1% in Q3 and 16.2% year to date. Q3 growth was led by Filtration (+$16.8 million) and USG (+$12.9 million). For nine months, Filtration rose $53.1 million and USG $16.6 million, while Test declined $9.9 million.
- Q3 EBIT margin declined year over year despite higher sales. Filtration’s Q3 EBIT margin fell to 16.8% from 22.4%, reflecting lower shipments at PTI and development-contract cost growth at VACCO. Nine-month EBIT margin improved overall; Test benefited from the absence of prior-year restructuring charges.
- Operating cash flow was $33.5 million for nine months, essentially unchanged from $33.2 million. Investing cash outflow was $188.0 million, including $162.3 million for acquisitions and $23.1 million of capital expenditures. Financing provided $148.8 million, primarily from net debt borrowing; cash declined $5.3 million to $48.5 million.
- At June 30, cash was $48.5 million and total borrowings were $265.0 million, up from $110.0 million at September 30, 2016. The company reported $178 million available under its credit facility, plus a potential $250 million increase option subject to lender acceptance; it was in compliance with debt covenants. Working capital was $205.0 million, versus $165.4 million at fiscal year-end.
Material changes, outlook, and other matters
- Backlog increased to $385.6 million at June 30 from $332.4 million at September 30, 2016. Nine-month orders were $532.0 million versus $397.7 million a year earlier.
- Management forecast FY2017 GAAP EPS of $2.05–$2.10. The outlook reflects acquisition contributions and costs, purchase-accounting inventory step-up charges, added depreciation and amortization, and customer-driven program pushouts from 2017 into 2018. The filing does not provide a clear prior-guidance range for comparison.
- Management estimated a FY2017 effective tax rate of approximately 33%. Adoption of share-based-payment accounting guidance reduced the reported effective tax rate by 5.1 percentage points in Q3 and 1.8 points year to date. Foreign subsidiaries held $50.4 million of unremitted earnings; estimated U.S. tax if distributed was approximately $8.8 million.
- Acquisition accounting remains preliminary. Inventory step-up charges were $1.9 million for Mayday year to date and $0.7 million for NRG and Morgan Schaffer in Q3. Amortization and acquisition-related costs also increased.
- Management said liquidity was strong and expected operating cash flow and credit-facility borrowings to meet foreseeable needs. It reported no material change in market risk and no impairment charges. Routine litigation, claims, and environmental investigations/remediation were described as adequately reserved, insured, or not expected to have a material adverse effect.
- Key risks cited include acquisition integration, order and contract timing, customer program delays or cancellations, government funding, market conditions, competition, supplier and material availability, interest and foreign-exchange movements, and environmental matters.
Important facts for investors to verify
- Whether the higher backlog and order intake convert into revenue on schedule, particularly given customer-driven pushouts.
- Acquired-business contribution to organic growth, segment margins, integration costs, and the final purchase-price allocations.
- Cash conversion and working-capital needs, alongside the sharp increase in borrowings and remaining facility capacity.
- Progress toward the $2.05–$2.10 FY2017 EPS outlook, including purchase-accounting effects and the estimated tax rate.
- Potential U.S. tax exposure if foreign earnings are repatriated, and developments in litigation or environmental matters.