ESCO Technologies Inc. — Fiscal 2015 Form 10-K
Business context and period. This annual report covers the fiscal year ended September 30, 2015. ESCO supplies engineered products and systems through Filtration/Fluid Flow, RF Shielding and Test, and Utility Solutions Group (USG). Figures below generally refer to continuing operations; former subsidiary Aclara is presented as discontinued operations.
Financial performance and position
| Metric | FY2015 | FY2014 |
|---|---|---|
| Net sales | $537.3 million | $531.1 million |
| Net earnings from continuing operations | $41.7 million | $42.6 million |
| Diluted continuing-operations EPS | $1.59 | $1.60 |
| EBIT / EBIT margin | $62.3 million / 11.6% | $63.8 million / 12.0% |
| Operating cash flow, continuing operations | $65.0 million | $44.9 million |
| Cash and total debt at year-end | $39.4 million / $50.0 million | $35.1 million / $40.0 million |
| Working capital | $155.0 million | $148.9 million |
- Sales increased 1.2%. Segment sales were Filtration $236.1 million (+1.0%), Test $177.6 million (-2.3%), and USG $123.6 million (+6.9%).
- Gross margin, calculated from reported sales and cost of sales, was approximately 37.7%, down from 39.0%. SG&A declined to $130.2 million, or 24.2% of sales, from $134.9 million, or 25.4%.
- Segment EBIT diverged: Filtration rose to $46.6 million from $41.4 million; Test fell to $9.5 million from $21.1 million; USG rose to $29.6 million from $26.6 million. Test’s decline reflected lower volume, product mix, inventory write-downs and patent-defense legal costs.
- Net cash from continuing operations rose primarily because of lower operating working-capital requirements. Capital expenditures were $12.4 million; capitalized software spending was $6.9 million.
- The $450 million revolving credit facility had approximately $392 million available, in addition to cash; the company was in covenant compliance. The $20 million classified as current debt was intended to be repaid within 12 months, but was not contractually due then.
- Backlog increased 8% to $327.5 million; orders were $561.9 million and book-to-bill was 1.05x. Management estimated 81.5% of backlog would be completed in FY2016.
Changes, outlook and management commentary
- FY2015 continuing-operations earnings and diluted EPS were slightly below FY2014 despite modest sales growth. Total net earnings were $42.5 million versus $0.4 million in FY2014, largely because FY2014 included a $52.1 million after-tax loss on the Aclara sale; FY2015 included a $0.8 million discontinued-operations gain.
- Test revenue declined amid softness in U.S. shielding and European operations. Filtration growth at PTI and TEQ was partly offset by lower VACCO Space shipments, including Boeing Space Launch System work. USG benefited from services, product shipments and the Enoserv acquisition.
- Management’s FY2016 outlook: adjusted EPS of $1.90–$2.00, excluding approximately $9 million, or $0.24 per share, of restructuring charges. Actions include closing Test facilities in Germany and the U.K., streamlining Test product lines and U.S. headcount, and closing Doble’s Brazil office. Expected savings are more than $6 million in FY2016 and $8 million annually from FY2017 onward.
- For FY2016, Filtration sales were expected to grow at a high-single-digit rate; Test sales were expected to be flat to slightly higher; and Doble sales were expected to rise more than 10%, with adjusted EBIT margin above 26%. The expected effective tax rate was approximately 35%. Management’s longer-term goals through 2017 were 10% compound annual sales growth and 15% compound annual EPS growth.
- Acquisitions: Enoserv was purchased for $20.5 million in January 2015. In October 2015, after year-end, ESCO acquired Fremont Plastics for $10.5 million and bought its facility for $2 million. The Aclara sale adjustment resulted in a $2.3 million cash payment to ESCO in 2015.
Risks, contingencies and unusual items
- Material internal-control weakness: Management and KPMG identified ineffective controls over Test segment work-in-process inventory reconciliations and communication with corporate. KPMG gave an adverse opinion on internal control over financial reporting, while issuing an unqualified opinion on the financial statements. Management said it was implementing remediation.
- FY2015 included $4.3 million of Test inventory and cost-of-sales charges related to incorrect capitalization in earlier periods: $1.2 million assigned to Q1, $1.0 million to Q2, and $2.1 million recorded in Q4 for prior-year amounts. The filing states prior-period amounts were not material; quarterly results were adjusted.
- Other exposures include government funding and contract termination risk, supplier concentration (one supplier makes more than 75% of Doble products), raw-material availability and pricing, international and currency risks, contract-estimate uncertainty, product liability, environmental remediation, and guarantees of certain Aclara contracts. Management did not expect litigation and environmental matters, in aggregate, to materially affect results, but estimates remain uncertain.
- Foreign earnings of $35.3 million were intended to remain indefinitely invested abroad; repatriation was estimated to trigger approximately $4.9 million of U.S. tax. No goodwill impairment was recorded in FY2015.
Important facts for investors to verify
- Progress and effectiveness of remediation of the Test inventory-control material weakness, and whether future filings report it resolved.
- Test segment recovery and the operational, cash and earnings effects of the restructuring versus stated savings and FY2016 guidance.
- Quality and conversion timing of backlog, particularly exposure to government programs and VACCO Space orders.
- Cash generation, working-capital and inventory trends, and repayment plans for the $20 million current debt classification.
- Performance and integration of Enoserv and Fremont, and any remaining liabilities or claims under ESCO’s Aclara guarantees.