Business context and reporting period
ESCO Technologies Inc. filed this unaudited Form 10-Q for its fiscal second quarter and six months ended March 31, 2012. The company reports three segments: Utility Solutions Group (USG), RF Shielding and Test (Test), and Filtration/Fluid Flow (Filtration). Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Three months ended March 31, 2012 | Prior-year quarter | Six months ended March 31, 2012 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $173.9 | $166.7 | $326.8 | $326.7 |
| Net earnings | $10.2 | $13.2 | $15.4 | $24.0 |
| Diluted EPS | $0.38 | $0.49 | $0.57 | $0.90 |
| Consolidated EBIT | $17.1 | $21.6 | $25.9 | $38.2 |
| EBIT margin | 9.8% | 12.9% | 7.9% | 11.7% |
| Operating cash flow | Not stated by quarter | Not stated by quarter | $10.9 | $36.0 |
Sales grew 4.3% in the quarter but were essentially flat year to date. Net earnings and diluted EPS fell approximately 23% and 22% in the quarter, and 36% each for the six-month period. Gross margin, calculated from reported sales and cost of sales, was approximately 39.1% for the quarter and 39.2% year to date, versus approximately 40.9% and 40.0%, respectively, in the comparable periods. SG&A was $47.9 million (27.6% of sales) for the quarter and $96.6 million (29.6%) year to date; comparable ratios were 26.0% and 26.6%.
Segment results
| Segment | Quarter sales / EBIT | Six-month sales / EBIT | Year-over-year trend |
|---|---|---|---|
| USG | $74.5 / $9.1 | $144.8 / $14.1 | Sales down 12.4% and 18.3%; EBIT down $6.7 million and $17.1 million, respectively. |
| Test | $50.5 / $4.8 | $89.8 / $6.7 | Sales up 20.0% and 21.2%; EBIT was slightly lower in both periods. |
| Filtration | $48.9 / $9.5 | $92.1 / $17.7 | Sales up 23.2% and $16.7 million; EBIT increased $3.0 million and $5.7 million. |
At March 31, cash was $27.1 million, total debt was $126.4 million, and shareholders’ equity was $612.5 million. Current assets were $327.7 million and current liabilities $270.3 million, for working capital of approximately $57.4 million. Operating cash flow declined year over year, primarily because of lower earnings and higher working-capital needs. Six-month investing cash use was $14.2 million, including $6.2 million of capital expenditures, $6.8 million of capitalized software spending, and the $1.3 million Calico minority investment. Cash declined $7.1 million to $27.1 million.
Material changes and management commentary
USG’s lower sales reflected the wind-down or completion of Aclara AMI projects, including New York City water, PG&E gas, and Mexico CFE. Test sales benefited from large chamber projects in the U.S. and China, and Filtration growth reflected stronger aerospace, space, and other product shipments. Filtration was the only segment with substantially higher EBIT; USG’s project-related decline was the main driver of consolidated earnings deterioration. Management attributed higher SG&A to acquisition-related costs, product development and engineering investment, and SoCalGas project start-up costs.
Orders were $185.3 million for the quarter and $389.0 million for the six months, versus $167.1 million and $352.9 million, respectively. Backlog was $405.3 million at March 31, 2012, up from $343.1 million at September 30, 2011. SoCalGas project-to-date orders were approximately $53.0 million; PG&E AMI gas project-to-date orders were approximately $275.0 million as that project neared completion.
Liquidity, outlook, risks and unusual items
The credit facility was due in November 2012, so all $126.4 million of debt was classified as current. The company reported approximately $189.0 million of available borrowing capacity, plus a $50 million increase option subject to lender acceptance, and $14.7 million of letters of credit. It was in compliance with debt covenants and intended to refinance the facility before June 30, 2012. Management said cash flow and facility borrowings were expected to meet foreseeable operating and capital needs.
Management maintained its fiscal 2012 outlook from the 2011 Form 10-K: revenue growth in the low-to-mid single digits and EPS growth of 5% to 10% over the prior year. It estimated a 35% annual effective tax rate. Actual first-half performance was affected by project timing and project wind-downs and, management said, was consistent with previously communicated expectations.
Quarter and year-to-date tax rates were 38.6% and 38.2%, respectively. A $0.5 million correction to a deferred tax asset recorded in purchase accounting increased those rates; management also noted a $1.8 million expected reduction in unrecognized tax benefits over the next 12 months from a statute-of-limitations lapse. If foreign accumulated earnings of $33.2 million were distributed, estimated U.S. taxes net of credits would be approximately $5.2 million. Other income included a $0.6 million gain from revaluation of the Xtensible acquisition earnout liability. The Calico investment was acquired for $1.3 million and is accounted for under the cost method.
Management stated that ordinary-course claims and litigation were adequately reserved, insured, or not expected to materially affect the company. Disclosed risks include SoCalGas project execution, approvals and customer requirements; economic weakness and customer demand or solvency; contract timing and cancellations; supplier performance and component availability; competition, labor, regulation, environmental matters, litigation, and acquisition integration. Management cautioned that forward-looking statements are subject to these and other risks. The filing states that the quarter’s results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether the planned credit-facility refinancing was completed on the expected schedule and on what terms, given the November 2012 maturity and current classification of debt.
- How USG sales and margins evolve as major AMI projects wind down, and whether SoCalGas orders and execution offset those declines.
- Whether the higher backlog converts to revenue and cash on expected timing, and whether working-capital requirements continue to pressure operating cash flow.
- Whether fiscal 2012 revenue and EPS guidance remains achievable despite the sharp first-half earnings decline and lower EBIT margins.
- The realization of expected tax-rate and unrecognized-tax-benefit changes, and potential tax exposure if foreign earnings are repatriated.