ESCO Technologies Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended December 31, 2015; comparative period ended December 31, 2014. Dollar amounts below are in millions unless stated otherwise. The quarter is not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $132.8 | $120.5 | +10.2% |
| Gross profit | $52.8 | $48.9 | +7.9% |
| Gross margin | 39.7% | 40.6% | Down 0.9 percentage points |
| EBIT (non-GAAP) | $13.2 | $13.8 | Down 4.2% |
| EBIT margin | 9.9% | 11.4% | Down 1.5 percentage points |
| Net earnings | $8.8 | $10.0 | Down 11.9% |
| Diluted EPS | $0.34 | $0.38 | Down 10.5% |
| Operating cash flow | $1.3 | $(1.0) | Improved by $2.3 |
Sales increased in all three segments: Filtration rose 16.8% to $55.5 million, Test rose 8.6% to $42.8 million, and Utility Solutions Group (USG) rose 2.7% to $34.5 million. Filtration EBIT increased to $10.1 million from $7.1 million; Test EBIT declined to $2.3 million from $2.6 million; USG EBIT declined to $8.2 million from $10.0 million. Corporate costs increased to $7.5 million from $5.9 million.
Liquidity, debt and cash flows
- At December 31, 2015, cash was $39.8 million; working capital was $172.1 million, up from $155.0 million at September 30, 2015.
- Total debt was $70.0 million, including $20.0 million current and $50.0 million long-term, versus $50.0 million total debt at September 30. The company had $372 million available under its credit facility, plus a conditional $250 million increase option, and $7.8 million of letters of credit outstanding.
- The credit facility was amended to extend maturity to December 21, 2020 and reduce borrowing rates and commitment fees. The company reported compliance with all debt covenants; its weighted-average borrowing rate was 1.41%.
- Investing cash outflow was $16.9 million, including $12.4 million for the Fremont acquisition, $2.7 million of capital expenditures and $1.7 million of capitalized software. Financing cash inflow was $17.0 million. Cash increased $0.4 million during the quarter.
- Management said operating cash flow and credit-facility borrowings are expected to meet capital and operating needs for the foreseeable future.
Material changes and unusual items
- Other expenses were $3.6 million, compared with $0.2 million of other income in the prior-year quarter. The 2016 amount primarily included $2.3 million of Test restructuring costs and $1.3 million of USG restructuring costs.
- Test restructuring related to facility closures in Taufkirchen, Germany, and Stevenage, England; USG restructuring related to closing the Brazil office. Costs included severance, professional fees and asset impairments or write-downs.
- ESCO acquired Fremont Plastics and its Indiana real property on October 16, 2015 for a total cash purchase price of approximately $12.5 million. Fremont contributed to Filtration sales from the acquisition date; the preliminary allocation included $4.4 million of goodwill and $3.6 million of customer-relationship intangibles.
- On January 29, 2016, after quarter-end, ESCO acquired Plastique Group Limited, a packaging business with approximately $35 million in annual sales. Its effect is excluded from the stated adjusted EPS guidance, and management said the impact was still being quantified.
- The effective tax rate was 31.9%, up from 26.2%. The research credit reduced the current-period rate by 7.5%, while foreign losses for which no tax benefit was recorded increased it by 5.7%. Management estimated a fiscal 2016 effective tax rate of approximately 35%.
Orders, outlook and risks
Backlog was $337.4 million at December 31, 2015, up from $327.5 million at September 30, 2015. New orders were $142.7 million, down from $152.2 million in the prior-year quarter.
Management expected 2016 revenue and EPS to follow a profile similar to 2015, with EPS weighted toward the second half. It forecast second-quarter 2016 adjusted EPS of $0.31–$0.36 and fiscal 2016 adjusted EPS of $1.90–$2.00, excluding 2016 restructuring charges and the earnings impact of the Plastique acquisition.
Management stated that claims, litigation and environmental matters were adequately reserved, insured or not expected to materially affect results, capital expenditures or competitive position. Risks cited include order and contract timing or cancellations, market weakness, customer and supplier performance, raw-material costs, competition, litigation and environmental matters, and execution of restructuring plans. The company also reported $33.8 million of accumulated unremitted foreign earnings; estimated U.S. taxes if distributed were approximately $4.4 million.
Controls and investor verification points
- Disclosure controls were deemed ineffective because a previously reported material weakness in Test-segment work-in-process inventory controls had not been remediated by December 31, 2015. Remediation actions were underway but had not operated long enough to establish effectiveness.
- Verify whether inventory-control remediation is completed and whether any resulting adjustments or audit findings affect reported results.
- Track restructuring execution and costs, including effects on segment margins, and compare actual performance with adjusted EPS guidance.
- Assess the Plastique acquisition’s purchase accounting, integration, contribution to sales and earnings, and related financing needs.
- Monitor orders and backlog conversion, particularly given lower new orders year over year, and review liquidity and debt covenant headroom as acquisitions and operations progress.