Business context and reporting period
ESCO Technologies Inc. filed this Form 10-Q for its fiscal second quarter ended March 31, 2016, with comparisons to the quarter and six months ended March 31, 2015. The company supplies products and services across Filtration, Technical Packaging, Test, and Utility Solutions Group (USG). Segment presentation was expanded to separately report Technical Packaging; prior periods were recast to match.
Financial performance
| Metric | Three months ended March 31, 2016 | Three months ended March 31, 2015 | Six months ended March 31, 2016 | Six months ended March 31, 2015 |
|---|---|---|---|---|
| Net sales | $138.9 million | $128.9 million | $271.8 million | $249.5 million |
| Net earnings from continuing operations | $8.6 million | $8.0 million | $17.4 million | $18.0 million |
| Diluted EPS from continuing operations | $0.33 | $0.30 | $0.67 | $0.68 |
| Consolidated EBIT | $14.0 million | $13.0 million | $27.2 million | $26.8 million |
| EBIT margin | 10.1% | 10.1% | 10.0% | 10.7% |
| Operating cash flow | Not presented quarterly | $9.1 million | $16.1 million |
Quarterly sales rose 7.7%; six-month sales rose 8.9%. Quarterly net earnings and diluted continuing-operations EPS increased, while six-month net earnings and diluted EPS declined slightly. Six-month net earnings in 2015 included a $0.4 million after-tax loss from discontinued operations; there was no such loss in 2016. SG&A was $32.5 million, or 23.4% of sales, in the quarter and $65.8 million, or 24.2% of sales, for six months, down from 25.5% and 26.6% of sales, respectively.
For the six months, sales grew most in Technical Packaging, up $16.2 million, primarily from higher TEQ shipments and the Plastique and Fremont acquisitions. USG sales increased $2.5 million; Test increased $1.9 million; Filtration increased $1.7 million. Quarterly EBIT improved at Technical Packaging and USG, while Filtration EBIT fell to $9.1 million from $11.0 million. Test six-month EBIT fell to $4.8 million from $5.1 million, including restructuring charges.
Liquidity, debt and cash flow
At March 31, 2016, cash was $38.8 million, working capital was $181.9 million, and total borrowings were $98.9 million, including $78.0 million long-term debt. Borrowings increased from $50.0 million at September 30, 2015, mainly reflecting financing needs including acquisitions. The company reported approximately $345 million available under its credit facility, plus a conditional $250 million increase option; it was in compliance with all debt covenants.
Six-month operating cash flow was $9.1 million, down from $16.1 million, primarily due to higher working-capital requirements. Investing cash outflow was $50.3 million, including $41.3 million for acquisitions; financing cash inflow was $40.7 million. Cash decreased $0.7 million from fiscal year-end. Capital expenditures were $5.3 million and capitalized software spending was $3.7 million.
Outlook, management commentary and risks
Management raised fiscal 2016 adjusted EPS guidance to $1.95–$2.02 from $1.90–$2.00, excluding ETS and Doble restructuring charges. Third-quarter adjusted EPS guidance was $0.40–$0.45, also excluding those charges. Management said its expected quarterly revenue and EPS profile and second-half weighting were unchanged. The estimated fiscal 2016 effective tax rate was approximately 35%.
ESCO acquired Plastique for approximately $31.6 million in January 2016; it reported approximately $35 million in annual sales. Fremont was acquired in October 2015 for approximately $10.5 million, plus $2 million for its operating property. Restructuring costs were $1.4 million in the quarter and $5.0 million for six months, relating principally to Test facility closures and USG restructuring. Other notable items included a UK valuation allowance that increased the six-month effective tax rate by 2.5 percentage points and foreign losses for which no tax benefit was recorded, adding 2.8 points.
Disclosure controls were deemed ineffective because a previously reported material weakness in controls over Test-segment work-in-process inventory had not been fully remediated by March 31, 2016. Remediation actions were being implemented. The company also cited uncertainty from customer orders and contract timing, market conditions, acquisitions, restructuring execution, foreign exchange and interest rates, environmental matters, litigation, and other contingencies. Management stated that claims and environmental matters were adequately reserved, insured, or not expected to have a material adverse effect.
Important facts for investors to verify
- Whether remediation of the Test-segment inventory-control material weakness is completed and disclosure controls become effective.
- Whether acquisitions deliver sustained sales and earnings contributions, and how integration costs and added debt evolve.
- Whether working-capital demands and operating cash flow improve after the reported six-month decline.
- Whether the company achieves its adjusted EPS guidance, including the excluded restructuring costs and expected second-half weighting.
- Whether restructuring costs, tax valuation allowances, foreign losses, or other contingencies materially affect subsequent results.