ESCO Technologies Inc. — Q3 FY2015 Form 10-Q
Reporting period: Fiscal quarter and nine months ended June 30, 2015. Unless otherwise noted, dollar amounts below are in millions. The filing presents unaudited consolidated results; continuing-operations results exclude Aclara, sold in March 2014.
Financial performance
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Net sales | $134.2 | $130.5 | $383.7 | $379.7 |
| EBIT from continuing operations | $15.8 | $15.4 | $44.8 | $43.7 |
| EBIT margin | 11.8% | 11.8% | 11.7% | 11.5% |
| Net earnings from continuing operations | $10.7 | $11.6 | $30.2 | $29.7 |
| Diluted EPS from continuing operations | $0.41 | $0.43 | $1.15 | $1.11 |
| Net earnings (loss), including discontinued operations | $11.9 | $11.6 | $31.0 | $(10.9) |
Q3 sales grew 2.8%; continuing-operations EBIT rose 2.6%, while continuing net earnings declined 7.3%, primarily reflecting a higher effective tax rate. Q3 gross margin was approximately 38.2%, versus 39.0% a year earlier, based on reported sales and cost of sales. Nine-month continuing sales increased about 1.0%; diluted continuing EPS rose from $1.11 to $1.15.
Segment trends: Q3 Filtration sales rose 4.7% to $60.4 and EBIT increased to $12.3 from $10.3. Test sales fell 4.7% to $42.9 and EBIT declined to $2.0 from $5.8, with lower-margin project mix, inventory write-downs, and patent-defense legal costs cited. USG sales rose 11.2% to $30.8 and EBIT increased to $7.4 from $5.7, supported by volume and product mix. For the nine months, USG sales increased 12.5%, while Filtration and Test sales decreased 3.0% and 0.9%, respectively.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $31.6, including $30.4 from continuing operations, compared with $21.0 and $22.6, respectively, in the prior-year period.
- Continuing-operations capital expenditures were $10.6 and capitalized software expenditures were $4.4. The company paid $6.3 in dividends and repurchased approximately 283,000 shares for $9.9 during the nine months.
- Cash was $36.9 at June 30, 2015, versus $35.1 at September 30, 2014. Working capital increased to $169.7 from $148.9. Inventories rose $15.8 to $110.1; management cited project timing, production-location transition requirements, and support for anticipated growth.
- Total debt was $65.4, including $20.4 current and $45.0 long-term, compared with $40.0 at September 30, 2014. Approximately $376 of the $450 revolving facility remained available; $8.7 of letters of credit were outstanding. The company reported compliance with all debt covenants.
Material changes, outlook and risks
- ESCO acquired Enoserv on January 28, 2015, for $20.5 cash. Enoserv, a utility software provider with approximately $8 in annual revenue, is included in USG. The preliminary allocation recorded approximately $10.0 of goodwill and $9.0 of amortizable intangibles.
- Q3 orders were $120.6 versus $150.4 in Q3 FY2014; nine-month orders increased to $415.2 from $400.3. Continuing-operations backlog was $334.5 at June 30, compared with $302.9 at September 30, 2014.
- Management expected FY2015 revenue and EPS to follow a profile similar to FY2014, with EPS weighted toward the second half. It forecast Q4 EPS of $0.55–$0.60 and FY2015 EPS of $1.70–$1.75. The estimated FY2015 effective tax rate was approximately 33%.
- The Aclara working-capital adjustment dispute was resolved by arbitration in June 2015, resulting in a $2.3 cash payment to ESCO. Aclara-related results remain classified as discontinued operations; the prior-year nine-month loss included a $50.4 after-tax loss on sale.
- Management described liquidity as strong and said operating cash flow and the credit facility should meet foreseeable needs. Key risks disclosed include order and contract timing or cancellations, economic weakness in served markets, customer and supplier performance, competition and intellectual property disputes, raw-material costs, environmental matters, litigation, and execution of restructuring plans. Management stated that existing claims and environmental matters were adequately reserved, insured, or not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the lower Q3 order intake and Test segment profitability recover, and how backlog converts to revenue.
- Whether higher inventory levels unwind as expected, particularly inventory tied to project timing and the Filtration facility transition.
- Whether Enoserv contributes as expected and whether acquisition-related costs or amortization materially affect earnings.
- Whether management achieves FY2015 EPS guidance, including the Q4 range, and whether the effective tax rate approaches the forecast.
- Future cash generation, debt levels, and covenant headroom; the additional $250 credit-facility expansion option is subject to lender acceptance.
- Potential exposure from patent litigation, environmental matters, Aclara-related guarantees, and the estimated $6.4 of U.S. tax that could arise if foreign earnings were distributed.