ESCO Technologies Inc. — Fiscal 2018 First-Quarter 10-Q
Reporting period: Three months ended December 31, 2017, compared with the three months ended December 31, 2016. The filing describes these as the first quarters of fiscal 2018 and 2017. Amounts below are in U.S. dollars unless noted.
Financial performance
| Metric | Q1 FY2018 | Q1 FY2017 | Change / context |
|---|---|---|---|
| Net sales | $173.5 million | $146.4 million | Up 18.5% |
| Gross profit / gross margin | $61.8 million / 35.6% | $53.5 million / 36.5% | Margin down about 0.9 percentage points |
| Consolidated EBIT / EBIT margin | $15.0 million / 8.6% | $16.8 million / 11.5% | Down 10.8% in dollars |
| Earnings before taxes | $12.8 million | $16.1 million | Down 20.6% |
| Income tax benefit (expense) | $21.9 million benefit | $5.4 million expense | FY2018 benefit includes $25.1 million net benefit from U.S. tax reform |
| Net earnings | $34.7 million | $10.7 million | Up substantially, primarily due to the tax benefit |
| Diluted EPS | $1.33 | $0.41 | Increase primarily tax-driven |
| Operating cash flow | $17.8 million | $15.7 million | Up $2.1 million |
Revenue growth was led by Utility Solutions Group (USG), up $20.2 million to $55.8 million, largely reflecting the NRG, Morgan Schaffer and Vanguard acquisitions and Doble products and software. Test sales rose 10.9% to $37.5 million; Technical Packaging rose 10.9% to $20.2 million; Filtration rose 2.1% to $60.0 million, including Mayday acquisition sales. Management attributed some segment movements to project timing and order timing.
Segment EBIT was $9.6 million for Filtration (versus $10.7 million), $2.6 million for Test (versus $2.4 million), $10.7 million for USG (versus $9.7 million), and $1.0 million for Technical Packaging (approximately flat). Corporate costs increased to $8.9 million from $7.0 million. USG’s EBIT margin declined to 19.1% from 27.1%, primarily due to acquisition-related product mix; Filtration and Technical Packaging margins also declined.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $41.6 million at December 31, 2017, down from $45.5 million at September 30, 2017. Working capital was $195.0 million, versus $197.8 million.
- Total borrowings were $260.0 million, down from $275.0 million at September 30; $20.0 million was classified as current and $240.0 million as long-term debt. The company reported approximately $181 million available under its credit facility, plus a potential $250 million facility increase subject to lender consent.
- The credit facility matures December 21, 2020. Average borrowing rates were 2.74% versus 1.61% a year earlier; the company said it complied with all debt covenants.
- Investing cash outflow was $5.9 million, including $3.6 million of capital expenditures and $2.1 million of capitalized software spending. Financing cash outflow was $17.1 million; the company paid $2.1 million in dividends and made $30.0 million of debt principal payments while borrowing $15.0 million.
- Operating cash flow less capital expenditures and capitalized software spending was approximately $12.1 million, compared with approximately $7.3 million in the prior-year quarter; this is a simple calculation, not a company-reported measure.
Material changes and unusual items
- Sales increased, but EBIT declined and EBIT margin compressed. SG&A rose to $42.2 million from $33.8 million, partly due to acquisitions and increased Doble sales and marketing spending. Interest expense rose to $2.2 million from $0.7 million, reflecting higher average debt and interest rates following 2017 acquisitions.
- The Tax Cuts and Jobs Act generated a provisional $25.1 million net tax benefit. The principal favorable item was a $30.3 million provisional reduction in deferred tax liabilities/assets following the federal rate change; foreign-earnings and repatriation-related estimates partly offset it. The effective tax rate was (170.8%), versus 33.5% a year earlier.
- Tax accounting remained incomplete under SEC Staff Accounting Bulletin 118. The company expected to refine estimates relating to deferred taxes and taxation of cumulative foreign earnings during the measurement period. It also expected to be subject to GILTI and had not yet selected its related accounting policy.
- The company entered into three interest-rate swaps with a $150 million notional amount during the quarter. These swaps were not designated as cash-flow hedges, so changes in their fair value are reflected in earnings.
- Backlog was $404.1 million at December 31, up from $377.1 million at September 30. Quarterly orders were $200.5 million, compared with $182.9 million a year earlier.
Outlook, risks and contingencies
Management projected fiscal 2018 GAAP EPS of $3.55–$3.65 and adjusted EPS of $2.65–$2.75. Adjusted EPS is a non-GAAP measure. The outlook reflects acquisition contributions, added depreciation and amortization, higher interest costs, specified cost-reduction charges, and adjustment for the first-quarter tax benefit and cost-reduction charges. For fiscal Q2, management forecast GAAP EPS of $0.30–$0.35, including approximately $2–$3 million of pretax USG and Filtration cost-reduction charges, and adjusted EPS of $0.38–$0.43.
Management said operating cash flow and credit-facility borrowings should meet capital and operating needs for the foreseeable future. It cautioned that results are not necessarily indicative of the full fiscal year. Disclosed risks include order and contract timing, government funding and contract termination, economic conditions, customer and supplier performance, raw-material availability and cost, acquisition integration, interest and foreign-exchange rates, tax-law and tax-accounting uncertainty, environmental matters, litigation and claims. Management stated that the costs of ongoing claims, litigation and environmental investigations or remediation were adequately reserved, insured, or not expected to have a material adverse effect.
Key facts for investors to verify
- How much of reported sales and EBIT growth is sustainable and organic, versus attributable to acquisitions, timing, or product mix.
- Whether the provisional $25.1 million tax benefit, deferred-tax adjustments, foreign-earnings estimates and GILTI accounting will change as the tax analysis is completed.
- Whether management’s full-year and second-quarter EPS outlook is achieved, including the effect of stated cost-reduction charges and the distinction between GAAP and adjusted EPS.
- Debt repayment plans, borrowing costs, covenant headroom and availability of the facility increase option; assess exposure to variable interest rates and the swaps’ earnings effects.
- Backlog conversion into sales and cash flow, and the progress and costs of integrating recent acquisitions.
- Potential outcomes and financial exposure from litigation, environmental matters and guarantees identified in the filing.