ESCO Technologies Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2018. Unless stated otherwise, amounts below are in millions of dollars. Comparisons are with the corresponding 2017 periods.
Business context and financial performance
ESCO operates in Filtration/Fluid Flow, RF Shielding and Test, Utility Solutions Group (USG), and Technical Packaging. It acquired Manta Test Systems on March 14, 2018, adding the utility-solutions provider to USG.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $174.8 | $161.2 | $348.3 | $307.5 |
| Gross profit | $62.4 | $55.8 | $124.2 | $109.3 |
| Gross margin | 35.7% | 34.6% | 35.7% | 35.5% |
| EBIT (non-GAAP) | $15.6 | $17.7 | $30.6 | $34.5 |
| EBIT margin | 8.9% | 11.0% | 8.8% | 11.2% |
| Net earnings | $10.0 | $11.2 | $44.7 | $21.9 |
| Diluted EPS | $0.38 | $0.43 | $1.72 | $0.84 |
| Operating cash flow | Not separately reported for the quarter | $33.5 | $36.7 |
Q2 sales increased 8.4%, while net earnings fell 10.4%. Six-month sales rose 13.2%; net earnings more than doubled, principally reflecting a $24.4 million net benefit from the Tax Cuts and Jobs Act (TCJA), rather than equivalent growth in operating performance. Six-month EBIT declined 11.2%.
Segments and material changes
- USG: Q2 sales increased 42.8% to $46.7 million; six-month sales rose 50.3% to $102.5 million, mainly from NRG, Morgan Schaffer and Vanguard acquisitions and, year to date, Doble products and software. EBIT declined to $5.6 million in Q2 and $16.3 million for six months, with restructuring charges and product mix cited.
- Test: Q2 sales increased 6.3% to $40.8 million and EBIT rose to $5.3 million, primarily on U.S. project timing and higher volume.
- Filtration: Q2 sales decreased 4.5% to $65.8 million; six-month sales decreased 1.5% to $125.8 million. Lower shipments at VACCO, PTI and Westland were partly offset by Mayday growth.
- Technical Packaging: Q2 sales increased 1.4% to $21.5 million, but EBIT fell to $1.9 million, primarily due to lower-margin Plastique project mix.
- Backlog was $416.7 million at March 31, 2018, versus $377.1 million at September 30, 2017. Six-month orders increased to $387.8 million from $349.8 million.
Q2 SG&A rose to $40.7 million, or 23.3% of sales, from $34.9 million, or 21.6%. The company cited acquisition-related costs, growth-support spending and higher corporate professional fees. Q2 other expenses included $2.1 million of USG restructuring-related charges; $1.9 million related to Doble facility closures in Norway and China. PTI also recorded $0.5 million of restructuring charges to exit a low-margin market.
Cash, debt and liquidity
- Cash was $42.9 million at March 31, 2018, compared with $45.5 million at September 30, 2017. Six-month operating cash flow was $33.5 million, down from $36.7 million, primarily due to higher working-capital requirements.
- Working capital was $205.9 million, up from $197.8 million at fiscal year-end. Inventories increased $12.5 million.
- Total borrowings were $265.0 million, down from $275.0 million; $20.0 million was classified as current. The company reported approximately $176 million available under its credit facility, plus a conditional $250 million expansion option, and $9.1 million of letters of credit outstanding.
- The credit facility matures December 21, 2020. The company was in compliance with its debt covenants. Average borrowing rates were higher year over year, and six-month interest expense increased to $4.2 million from $1.5 million.
- Investing cash use was $26.1 million, including $11.4 million for business acquisitions, $10.1 million of capital expenditures and $4.6 million of capitalized software. Financing cash use was $13.6 million; dividends paid totaled $4.1 million.
Outlook, risks and unusual items
- Management said its 2018 expectations remained consistent with its February 6 outlook. It expected quarterly revenue and EPS to follow a profile similar to 2017, with EPS weighted toward the second half.
- Q3 2018 EPS guidance was $0.68–$0.73. Full-year guidance was GAAP EPS of $3.55–$3.65 and Adjusted EPS of $2.65–$2.75, with adjusted EPS excluding the first-quarter incremental net TCJA benefits and Q2 USG and Filtration cost-reduction charges.
- The six-month 2018 income tax benefit was $18.3 million, versus $11.1 million of tax expense in 2017. TCJA accounting remained provisional: management was still assessing deferred-tax effects and foreign-earnings taxes, and expected to be subject to GILTI. Repatriation may entail local withholding and state taxes and foreign-exchange effects.
- Market risks include variable interest rates and foreign exchange. The company entered into interest-rate swaps with $150 million notional to hedge some future LIBOR exposure; these swaps were not designated as cash-flow hedges, so fair-value changes affect earnings. Management reported no material change in market risks since September 30, 2017.
- The filing describes ordinary-course litigation, claims and environmental investigations/remediation; management said related costs were reserved, insured, or not expected to materially adversely affect the company. Risks also include contract/order timing, government funding, customer and supplier performance, raw-material costs, acquisition integration, tax-law changes, and environmental matters.
- Management stated that cash flow and credit-facility borrowings should meet foreseeable capital and operating needs. Access to the $250 million facility increase requires lender acceptance. The filing cautions that interim results are not necessarily indicative of the full fiscal year.
Key investor verification points
- Separate recurring operating results from the TCJA-related tax benefit when assessing six-month earnings and EPS.
- Track whether USG growth converts to improved EBIT after acquisitions, restructuring and product-mix effects.
- Review the completion of provisional TCJA accounting, including foreign-earnings tax, repatriation and GILTI treatment.
- Monitor cash conversion, inventory growth, debt repayment intentions, borrowing costs and covenant headroom.
- Assess whether backlog and orders translate into revenue and whether acquisition integration and facility closures deliver expected benefits.