ESCO Technologies Inc. — Q3 2016 Form 10-Q
Reporting period: Fiscal quarter and nine months ended June 30, 2016. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. The company reports four segments: Filtration, Technical Packaging, Test, and Utility Solutions Group (USG).
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $140.2 | $134.2 | $412.0 | $383.7 |
| Continuing-operations net earnings | $11.5 | $10.7 | $29.0 | $28.8 |
| Diluted continuing-operations EPS | $0.44 | $0.41 | $1.12 | $1.09 |
| Consolidated EBIT (non-GAAP) | $17.8 | $15.8 | $45.0 | $42.6 |
| EBIT margin | 12.7% | 11.8% | 10.9% | 11.1% |
Q3 sales increased 4.5% and nine-month sales increased 7.4%. Continuing-operations net earnings rose about 7% in Q3 and 1% for the nine-month period. Reported total net earnings were $11.5 million in Q3 and $29.0 million year to date, versus $11.9 million and $29.5 million, respectively, in 2015; prior-year results included discontinued-operation earnings.
Cost of sales was $86.6 million in Q3 and $254.8 million year to date. Gross margin was approximately 38.2% in Q3, broadly flat year over year, and approximately 38.2% year to date versus 38.6%. SG&A was $31.4 million in Q3 (22.4% of sales) and $97.2 million year to date (23.6%), down from 24.4% and 25.9% of sales, respectively. Other expenses included restructuring costs of $1.4 million in Q3 and $6.4 million year to date.
Segments and operating developments
- Filtration: Q3 sales rose 9.7% to $54.4 million; EBIT was $12.2 million. Higher VACCO space-product shipments and sales at PTI and Crissair supported results.
- Technical Packaging: Q3 sales rose 88.9% to $20.4 million; EBIT was $2.5 million. Recent acquisitions and higher TEQ shipments contributed. Plastique and Fremont contributed $9.4 million of Q3 sales and $17.5 million year to date.
- Test: Q3 sales fell 15.6% to $36.2 million, primarily due to European facility consolidation; EBIT was $3.7 million. Year-to-date EBIT included $4.7 million of incremental restructuring charges related to closures in Germany and England.
- USG: Q3 sales fell 5.5% to $29.1 million and EBIT declined to $6.1 million, reflecting lower shipments and restructuring costs, including closure of the Brazil office.
Backlog was $313.2 million at June 30, 2016, down from $327.5 million at September 30, 2015. Nine-month orders were $397.7 million versus $415.2 million a year earlier; Q3 orders increased to $125.1 million from $120.6 million.
Cash flow, liquidity, and debt
- Operating cash flow was $33.2 million for the first nine months, compared with $31.6 million in 2015. Capital expenditures were $7.8 million; capitalized software expenditures were $6.3 million.
- Cash was $40.5 million at June 30, 2016. Working capital was $178.0 million, up from $155.0 million at September 30, 2015.
- Total borrowings were $86.5 million, up from $50.0 million at September 30, 2015. The company had $361 million available under its revolving credit facility, plus a potential $250 million increase option subject to lender acceptance. It reported compliance with debt covenants.
- The amended $450 million credit facility matures December 21, 2020. Weighted-average borrowing rates were 1.50% for Q3 and 1.58% for the nine months.
- Investing cash outflow was $55.4 million, including $41.3 million for acquisitions. Financing cash inflow was $24.8 million. The company repurchased approximately 120,000 shares for $4.3 million year to date and paid $6.2 million in dividends.
Outlook, unusual items, and risks
Management said its expected quarterly revenue and EPS profile and second-half weighting for 2016 were unchanged. It forecast Q4 adjusted EPS of $0.59–$0.66 and full-year adjusted EPS of $1.95–$2.02, excluding 2016 ETS and Doble restructuring charges. Management estimated a fiscal 2016 effective tax rate of approximately 34%; the nine-month rate was 34.3%, affected by a UK valuation allowance and foreign losses without tax benefits, partly offset by the research credit.
Acquisitions included Plastique, purchased in January 2016 for approximately $31.6 million, and Fremont, acquired in October 2015 for approximately $10.5 million plus $2 million for real property. Restructuring, acquisition-related costs, and increased amortization affected reported results. No impairment charges were recorded in the reported quarter or nine-month period.
Management stated that ordinary-course claims, litigation, and environmental matters were adequately reserved, insured, or not expected to have a material adverse effect. The filing also identifies risks involving customer orders and contract timing, economic conditions, competition, acquisitions, foreign exchange and interest rates, environmental matters, and successful execution of restructuring plans. Foreign subsidiaries held $31.7 million of cash and $36.7 million of accumulated unremitted earnings; estimated U.S. tax if those earnings were distributed was approximately $5.4 million.
Control issue: Disclosure controls were deemed ineffective because of an unremediated material weakness in Test-segment work-in-process inventory accounting controls. Remediation actions were underway but had not operated long enough to establish that the weakness was fully remediated.
Important facts for investors to verify
- Progress and effectiveness of remediation of the Test inventory-control material weakness.
- Whether the adjusted EPS outlook is achieved, including the amount and timing of restructuring charges excluded from guidance.
- Backlog conversion and order trends, particularly the year-over-year decline in nine-month orders and backlog.
- Acquisition integration, contribution, and purchase-accounting impacts for Plastique and Fremont.
- Liquidity, debt levels, and availability of the optional credit-facility increase, which remains subject to lender acceptance.
- Potential effects of foreign tax matters, environmental issues, litigation, and restructuring execution.