ESCO Technologies Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended September 30, 2017. ESCO makes engineered products and systems for utility, industrial, aerospace, defense and commercial markets through four segments: Filtration, Test, Utility Solutions Group (USG), and Technical Packaging. Unless noted otherwise, financial amounts are in U.S. dollars.
Financial performance and position
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $685.7 million | $571.5 million |
| Net earnings from continuing operations | $53.7 million | $45.9 million |
| Diluted EPS | $2.07 | $1.77 |
| EBIT (non-GAAP as defined by the company) | $84.7 million | $69.7 million |
| EBIT margin | 12.4% | 12.2% |
| Operating cash flow | $67.3 million | $73.9 million |
| Cash and cash equivalents, at year-end | $45.5 million | $53.8 million |
| Total debt, at year-end | $275.0 million | $110.0 million |
| Working capital, at year-end | $197.8 million | $165.4 million |
- Sales rose 20.0%; net earnings from continuing operations increased 17.0%. Management attributed much of the sales increase to acquisitions.
- Segment sales: Filtration $279.5 million, up 34.5%; Test $160.9 million, down 0.4%; USG $162.4 million, up 27.1%; Technical Packaging $82.9 million, up 11.4%.
- Segment EBIT: Filtration $52.2 million; Test $19.5 million; USG $36.6 million; Technical Packaging $8.5 million. Corporate charges were $32.1 million.
- Adjusted diluted EPS, a non-GAAP measure excluding specified acquisition-related charges in 2017 and restructuring charges in 2016, was $2.22 versus $2.03.
- Net cash used in investing activities was $233.9 million, including $198.6 million for acquisitions; capital expenditures were $29.7 million and capitalized software additions were $9.0 million. Financing activities provided $156.8 million, primarily reflecting acquisition-related borrowing.
- Backlog was $377.1 million, up 16% from $326.2 million; orders were $736.6 million and book-to-bill was 1.07x. About 79% of year-end backlog was expected to be completed in FY2018.
- The company declared dividends of $0.32 per share for the year. No shares were repurchased in FY2017.
Material changes versus FY2016
- FY2017 included acquisitions of Mayday and Hi-Tech, NRG, Morgan Schaffer, and Vanguard Instruments. The acquisitions contributed to reported growth and were funded substantially with cash and additional debt.
- Interest expense increased to $4.6 million from $1.3 million, reflecting higher average borrowings and interest rates. Intangible amortization increased to $16.3 million from $11.6 million.
- Operating cash flow declined by $6.5 million, principally due to working-capital changes. Receivables and inventory balances rose, in part because of acquired businesses.
- Test EBIT improved as FY2016 included $5.1 million of restructuring charges; FY2017 Test sales were essentially flat. Filtration sales benefited from acquisitions and higher VACCO shipments. USG growth reflected acquisitions and increased Doble product and software sales.
- FY2017 other income included $0.6 million from an intellectual-property sale and $0.4 million of death-benefit insurance proceeds. FY2016 other expense included restructuring charges.
Outlook, risks and unusual items
- Management forecast FY2018 sales growth of approximately 13% and diluted EPS of $2.30–$2.40, including acquisition contributions and anticipated higher interest, amortization and taxes. It expected FY2018 interest expense of about $9.5 million, an effective tax rate of 35%, and a more second-half-weighted earnings profile; Q1 EPS guidance was $0.28–$0.33.
- Management cited expected full-year acquisition contributions, higher commercial aerospace deliveries, USG organic growth and Test wins in backlog as growth drivers; Technical Packaging sales were expected to be flat. These are forward-looking estimates, not guarantees.
- Liquidity: the $450 million revolving credit facility had approximately $166 million available at year-end, plus a potential $250 million increase subject to lender consent. The facility matures December 2020; ESCO reported compliance with covenants and said cash flow and borrowing capacity should meet foreseeable needs. Management intended to repay $20 million of debt within 12 months, though it had no contractual obligation to do so.
- Key risks include dependence on government funding and contracts that may be terminated for convenience; supplier concentration and raw-material availability or price volatility; acquisition integration and execution; economic, political, currency and regulatory risks in international markets; competition and changing customer demand; and product, project, environmental and litigation exposure.
- ESCO remained guarantor of certain Aclara contracts after selling that business. Aclara nonperformance could expose ESCO to claims; recovery under indemnification would depend on Aclara’s financial position. Management said current environmental and legal matters were adequately reserved, insured or not expected to have a material adverse effect, while acknowledging uncertainty.
- Foreign subsidiaries held $48.9 million of accumulated unremitted earnings; management intended to reinvest them abroad. Repatriation was estimated to trigger about $6.9 million of U.S. tax, net of available foreign tax credits.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Management and KPMG excluded NRG, Morgan Schaffer and Vanguard Instruments from the 2017 internal-control assessment; together they represented 11.6% of consolidated assets and 3.6% of sales. ESCO adopted a share-based compensation accounting update that reduced FY2017’s effective tax rate by 1.1 percentage points.
Important facts for investors to verify
- How much FY2017 and forecast FY2018 growth is organic versus acquisition-driven, and whether acquired businesses meet expected sales, profit and cash-flow contributions.
- Debt repayment plans, covenant headroom, borrowing costs and the effect of higher interest expense on EPS and cash generation.
- Whether backlog converts to revenue as expected, particularly government-related orders subject to funding, modification or cancellation.
- Progress integrating recently acquired businesses and extending internal-control coverage to the acquired entities.
- Exposure under Aclara guarantees and the potential cost, timing and adequacy of reserves for environmental matters and litigation.
- The effects of new revenue-recognition and lease-accounting standards, and the sustainability of the forecast tax rate and dividend.