ESCO Technologies' (ESE) CEO Vic Richey on Q1 2016 Results - Earnings Call Transcript

| About: ESCO Technologies (ESE)

ESCO Technologies Inc. (NYSE:ESE)

Q1 2016 Earnings Conference Call

February 09, 2016 05:00 PM ET

Executives

Kate Lowrey - Director of Investor Relations.

Vic Richey - Chairman and Chief Executive Officer

Gary Muenster - Vice President and Chief Financial Officer

Analysts

Jon Tanwanteng - CJS Securities

Ben Hearnsberger - Stephens

Chip Moore - Canaccord

Sean Nicholson - SBH

Operator

Good day ladies and gentlemen, and welcome to ESCO First Quarter 2016 Conference Call. Today's call is being recorded.

With us today are Vic Richey, Chairman and CEO; Gary Muenster, Vice President and CFO. And now, to present the forward-looking statements, I would like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead.

Kate Lowrey

Thank you. Statements made during this call regarding 2016 and beyond EPS, EPS - As Adjusted, EBIT, tax rate, future growth, profitability in revenue, operating margin, sales, acquisitions, implementation of the Company's capital allocation strategy, the costs, benefits and timing of restructuring and cost production activities, which are results of recent acquisitions, corporate costs and other statements which are not strictly historical are forward-looking statements within the meaning in the Safe Harbor provisions of the federal securities laws.

These statements are based on current expectations and assumptions and actual results may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company's operations and business environment, including, but not limited to the risk factors referenced in the Company's press release issued today, which will be included as an exhibit to the Company's Form 8-K to be filed. We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

In addition, during this call, the Company may discuss some non-GAAP financial measures in describing the Company's operating results. A reconciliation of these measures to the most comparable GAAP measures can be found in a press release issued today and found on the Company's website at www.escotechnologies.com, under the link Investor Relations.

Now I'll turn the call over to Vic.

Vic Richey

Thanks, Kate, and good afternoon. Before I get my perspective on the quarter, I’m going to turn it over to Gary for few financial highlights.

Gary Muenster

Thanks, Vic. As a reminder, we previously announced certain restructuring actions that are being taken related to our lower margins, international operations primarily in the Test business. We described and quantified the specific actions and the resulting annual cost savings expected from these actions.

The detailed restructuring costs were excluded from the FY'16 guidance provided in November and we noted we would be presenting our quarterly and annual operating results for '16 on an EPS as adjusted basis.

Our restructuring actions are ahead of schedule and are expected to come in below the original budgeted amount. Our current view indicates the total cost to be slightly under the $9 million we originally projected and we still expect the restructuring to be substantially complete by March 31.

We are looking forward to the completion of these actions that is it eliminates the significant management distraction at the operating unit level and allows us to begin realizing the identified cost savings and operating benefits sooner.

Turning to our results, I am pleased with our Q1 performance from several perspectives, including earnings, cash flow and entered orders which each significantly exceeded expectations in the quarter.

Starting with earnings, we reported EPS as adjusted of $0.47 a share which is 24% higher than Q1 of last year and 21% higher or $0.08 above the top end of our November guidance of $0.34 to $0.39. While all three operating segments came in better than planned, the primary driver of our increased earnings resulted from filtration and test outperforming our previous expectations by a considerable margin. The favorable tax rate contributed almost equally to the EPS results in both Q1 periods.

Our Q1 cash flow was several million dollars ahead of projections and our entered orders led by the continued strength of our commercial aerospace business and in particular the A350 program came in better than expected which resulted in a $10 million increase in total company backlog.

I think it’s worth repeating here that our strategy and our operating theme that we have communicated over the past few years is well defined and remains clearly in focus throughout the organization. These goals through these goals we will strive to execute on our financial plan, deliver solid earnings, results that meet or exceed expectation, position the company for sustainable long term earnings growth, enhance our focus on returns and follow our capital allocation plan.

Here are a few highlights from the release to allow you to better understand the underlying results. Q1 sales increased 10% or $12 million compared to the prior year primarily driven by an $8 million or 17% increase in filtration sales.

Test sales increased by 9% year-over-year and Doble sales while increasing only $1 million we view as a positive given that the 2015 Q1 sales mix created a challenging comp due to an unusually large quantity of our highest margin protection suite products being delivered in that period.

Regarding EBIT, consistent with the increased sales, both filtration and test exceeded our internal earnings target by a meaningful level and Doble essentially came in on plan for the quarter.

Corporate costs were higher than last year primarily due to the timing and volume of spending on professional fees incurred supporting our M&A activities. On the balance sheet front we continue to maintain a very favorable debt level with $30 million of net debt outstanding at December 31.

While we remain firmly committed to our capital allocation strategy, which includes share repurchases and dividends we did not repurchase any shares in Q1. This was primarily the result of the timing of the M&A activities which were in process, coupled with management’s knowledge of the pending Q1 earnings results prior to this release.

We remain fully committed to our capital allocation strategy and expect to continue to opportunistically repurchase shares in the open market over the balance of 2016 as we continue to be supported by a strong balance sheet. Our guidance and remaining outlook for 2016 while at this point in the year is unchanged from the November amounts or EPS as adjusted in a range of $1.90 to $2 is obviously helped by the Q1 results.

Getting off to a solid start to the year certainly provides additional comfort in our ability to achieve our full year goals. At the start of the year we provided a somewhat wide range in our EPS guidance for the year. With the acquisition of Plastique last week, we are currently in the process of finalizing its net EPS accretion which is impacted by purchase accounting and interest.

When completed, we will determine if the net EPS impact puts us at the top end of our range or above it, obviously we’ll have this finalized by the next earnings call in May. Regarding our Q2 outlook, we are expecting EPS as adjusted to be in the range of $0.31 to $0.36 a share, and when taken together with the Q1 actuals, our current expectations for the first half of the year are above our original forecast both from an EBIT and EPS perspective.

Compared to Q1, filtration is expected to generate higher EBIT dollars in Q2 driven by its expected increased sales volume throughout the individual operating units. The timing impact of quarterly sales volume and the related impact that test in Doble is expected to result in lower contributions in Q2 compared to Q1.

Corporate costs are expected to be lower in Q2 due to lower professional fee spending. Finally, commenting on our longer term view, we continue to see meaningful sales, EBIT and EPS growth across the business segments consistent with their previous expectations in earlier communications. And I’ll be happy to address any specific questions when we get to the Q&A and I’ll turn it back over to Vic.

Vic Richey

Thanks, Gary. As outlined in the release, as Gary commented, our fully blown [ph] test business performed well ahead of expectations and over [Indiscernible]. Our strong results once again validated one of the major benefits of maintain the multi segment business. And as Gary mentioned the aerospace business continued to outperform with the Q1 operating results and the order book coming in stronger than expected.

Our key drivers have continued strength and confidence in our commercial aerospace business, and so we are well ahead of our [Indiscernible] finance led by the $35 million of bookings received on an A350 which continue to run higher than expected.

TEQ performed well in the quarter with sales and EBIT margins above the Q1 compared to prior year. As TEQ continues to be a solid business with above industry average operating margins. Additionally, pre -- first quarter contribution came in ahead of our acquisition forecast. Addition of three-month, first quarter certainly funds up tax outlook for the balance of the year. Addition to three-month not only provides a nice book of profitable business, but also addresses and solved capacity issue we starting to struggle with the TEQ.

As we announced last week, we acquired Plastique to further augment our technical packaging business. This addition now gives us a solid foothold in Europe, more exposure to consumer markets and immediate excess to the new technology, precision molded pulp fiber.

Many of the large global medical want or require manufacturing capabilities in both U.S. and Europe. And this acquisition addresses that requirement. Additionally, like many industries the packaging market become a more focus on sustainability and reducing environmental impact.

TEQ had already developed an eco-friendly Plastique packaging solution for medical product and now with the addition of fiber pack materials offer by Plastique we’re well positioned to lead the market therein.

Bottom-line, both companies have great addition to TEQ and to ASCO and now together TEQ has a more sizeable technical packaging platform which provides a nice return and better position us as to address, address the growing value [ph].

Doble reported solid operating performance in Q1 with adjusted EBITDA of 28%. Brazil closures on track, their restructuring activity as we described earlier were on plan. We saw a modest slowdown on the hardware side of Doble business as utilities continues to rationalize on capital budgets we continue to see additional opportunities on our service and software applications, they bode well for our outlook.

I’m please with the success Doble having with their new solutions offerings, which effective augment what was already a market leading set of products, services and solutions. Additionally, we are hopeful that some of the new regulatory standards recently adopted by the American firm for all the new windows of opportunity for us to assist utilities in their client’s [ph] obligations.

The test business restructure in Europe is going better than anticipated at the start of the year. We had tight schedule and a lot of moving parts and our teams both at U.S. and Europe they are very professional job working through the challenging process.

As of December, we’re out of Germany and we’re nearly exit date at U.K. that’s we want in our few remaining projects. We should start to see the normalized operating margins, the tests beginning in Q3.

Moving on to our outlook for remainder of 2016, I continue to be exciting about growth prospects we’re seeing materialize across the operating segment as well as their potential impact over the balance of the year.

A few items driving this perspective include the ramp up for the A-350 as it transition from low rate production or LRIP [ph] to more meaningful run rate over the balance of the year. Test backlog today coupled with the remaining book and ship quantities needed to meet our 16 goals, are at the strongest level we’ve seen in several years at this point for the year.

Additionally, we present several large chamber projects and test which going to further solidify our outlook for this year and beyond. On the cost side we continue to see the opportunity via EBIT margin goal plus we fully exit technology facilities.

Lastly, Doble continue to see solid opportunities across its global utility platform which bodes well for their future growth. Regarding additional acquisitions we continue to be active and we continue to be prudent.

Our two recent acquisitions have come with reasonable EBITDA multiplies which are in the mid to upper single-digit which allows us to hit our return goals much more quickly. We anticipate solid accretion from both of these acquisitions.

Our M&A strategy remain unchanged. We’ll continue to take a deliberate approach looking for small to medium sized players which we can acquire for reasonable multiple thereby providing EPS accretion immediately and delivering an acceptable ROIC.

We continue to evaluate several opportunities as we work towards supplementary our organic growth. To ramping up, we have strong first quarter and our outlook for the year remain solid.

Our actions to reduce our cost structure are same as expected and we’re on track for strong 2016 as we’re well positioned for profitable growth in all three segments. And our focus remains constant to improve our operational performance and execute on our growth opportunities both organically and through acquisitions.

I'll now be glad to answer any questions you have.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question is from the line of Jon Tanwanteng from CJS Securities. Please go ahead.

Jon Tanwanteng

Hi, Vic. Very nice quarter.

Vic Richey

Hi, Jon. Thanks.

Jon Tanwanteng

I know you guys you’re basically ahead of your expectations on a six-month basis with the last quarter and the current one you’re in. But can you just clarify what’s going on – what’s going to the sequential step down? I know you have some seasonality and dealt [ph] with the conference? Did you put on some business at all in the quarter?

Vic Richey

We have some that, I mean obviously the first quarter was very strong and there was some pull in, there wasn’t the majority of it. There was some pull in into the first quarter, hence we always says we have big sales, we get on sales if they’re available on first quarter, obviously we’re going to capture those, but as we mentioned with Doble and with the Test business there is some always some shipping from quarter to quarter and addition in the first quarter and the test business we just finished. We’re finishing a large project in Asia, so that accounted for some of their upsides performance in the first quarter, so we’re not seeing anything that concerns this in the second quarter. We understand it and more importantly as we look at the second half of the year, there were ramp up that we need to make a year that looks very solid.

Jon Tanwanteng

Got it. That’s very helpful. And we’ve seen a number of companies just with the issues with timing or general uncertainty in aerospace sector? I’m just wondering if you’re seeing that at all and why wouldn’t you be exposed to that kind of volatility?

Vic Richey

Yes. Interestingly enough, we haven’t, and I think a lot of it is with the aerospace business, we’re first of all, we’re niche player and so we’re kind of far down in the supply chain, in some area that more importantly we have to look at the actual platforms that we’re on and the things that we’re on whether it would be sort of legacy projects that we’re on or some of the new projects that we’re on. And in A-350 we’re just not seeing that type of slowdown. And I get that question lot as you hear about it, but based on the projects, that we’re on platforms, that we’re on, we’ve not seen that. We do have to remember that we do have space projects as well. We do some work for the navy. So I think everybody want to paint aerospace market as Boeing and Airbus. And while certain they drive [Indiscernible] big driver of the market. With our businesses there are lot more customers than we interface with something that’s the primary reason, we haven’t seen that type of effect.

Jon Tanwanteng

Great. Thank you. And then finally just on the TEQ business are you planning to break that out eventually with the revenues approaching $100 million. What is the expected growth rate of margin profiles that once you finished integrating all the pieces?

Vic Richey

Yes. Such a pieces I mean that certainly something that we’re talking with our partners about on the right time and that’s a right if those margin breaking out separately. And certainly as it’s got this large something we have to take a look at. We had hit our arms a little around the overall growth rate, but certainly the growth rate in that – in those businesses are probably in the upper single digits I would say, I think we have the opportunity to maybe little bit better than that.

If you’re looking at what we’re trying to accomplish by and have this foothold in Europe that the products then Plastique has what TEQ has historically had, similar product certainly but some of the end markets are different hurdle [ph] we can take some of the expertise and some of the customers we have in the U.S. kind of migrate that to Plastique and vice versa, as well as with few technology which is called fiber, something there is an appetite for an U.S. as well is under served now, so we got to hit our arms a little bit more around exactly how that all going to play out, but this is not just a one plus one equals to two. We think by combining those businesses and having extra capacity that we’re getting with Fremont, that gives us a much better platform and should give us kind of growth opportunities.

Jon Tanwanteng

Okay, great. And just one quick clarification, Gary, did you mean when you said that after the impact of Plastique you’d probably see the top end or maybe above the range, was that before and after the 1x acquisition cost and purchase accounting?

Gary Muenster

That would be after, so that I use the word net, is obviously as we’re going through the valuation of intangibles and all the other stuff that has to get carved out for the pieces that are amortizable versus fixed, so my comment was on net basis that it would be after the purchase accounting and after the interest expenses where we will be speaking about it but we’ll also call out the pieces, but that’s where I was referring to.

Jon Tanwanteng

Okay. Great. That’s very helpful. Thank you guys again.

Gary Muenster

Okay.

Operator

And our next question is from the line of Ben Hearnsberger from Stephens. Your line is now open.

Ben Hearnsberger

Hey, thanks for taking my question. On the test business I think Vic you mentioned that you’ve got some large chamber projects in the pipeline, outside of the large chamber piece of the business, can you speak to kind of the rest of the test pipeline and how it looks? Maybe touch on some of the more economically sensitive areas of that business and how you feel about them?

Vic Richey

Yes. I’d say, outside of those the rest of this is performing well, in fact we were just down there last week. We had [Indiscernible] last two weeks. But we just had our board meeting down last week and then our directors down. We got a dip dive with those guys that’s understand it and say overall the markets that we’re addressing is pretty solid. There some ups and downs, but the medical markets are little softer.

There’s somebody others that’s in a wireless is stronger and despite all the concerned about what’s going on China, it has been really great market for us this year, it looks like for the remainder of the year. So we’re not seeing anything that’s overly concerning to us for that market factor and projection. We are using seem solid. The good thing is we don’t have to get these large projects to make these things happen, but certainly it’s great to see those -- we typical up on large project that is going through at given time, so we have the number of opportunities like this and say, in fact we’re having huge impact on this year, because large project delivered over a couple of years, but certainly that’s adds them potential upside of the business, but the underlying business let’s say outside of the medical business still very settle.

Ben Hearnsberger

If you’re going to see some of those larger project convert when would the expectation that you see then?

Vic Richey

Well, typically those things play out will make [Indiscernible] and then it would make it some impact in the fourth quarter with majority of that would be in 2017.

Ben Hearnsberger

Got it. And I think you were speaking to kind of mid-teens EBIT margins for the segment. Is there a kind of a revenue run rate embedded in that type of guidance that you need to be at?

Gary Muenster

Yes. I would say, Ben, just to put math around it, because the margin differentials on each of their product lines like let’s say with medical or the wireless or the EMC or anything around that. If you were just to peg this at roughly a $43 million to $45 million revenue a quarter you’d be at that range and so if you look at our seasonality and we don’t want to peg this as annualized but you can see the leverage you get off for the sales increase. Historically, in our Q4 which is been our strongest quarter where we’re banging around 52 and 55 over the past two or three fourth quarters you can see that the margins gets up at 16% to 18%, so that’s kind of that bang if you think of 44 million or 45 million at the charge that you’re looking and then on those one-off quarters you get the 50s and whatever you should get three or four points a margin, so, that hopefully you kind of work around the sensitivity of that.

Ben Hearnsberger

Okay. That’s helpful. One last question on Doble and international piece of that business, there’s obviously lot of noise internationally on a daily basis, effect to me and industrial economy. Can you speak to kind of what you’re seeing on the ground in your Doble business?

Vic Richey

Couple of things. First response is I’m glad that we have a dominant position in the U.S, conserve less margin and strong what we’re seeing in Europe [Indiscernible] and even Asia. Having said that, primarily what do a more services, software, with some hardware sales internationally, and that does not seem to be impacted quite as much, but certainly the European market, the industrial store are more challenging in U.S. As we look at remainder of the year, we factored that in to what we think is going to happen with the business.

Ben Hearnsberger

Got it. Thank you.

Operator

[Operator Instructions] And our next question is from the line of Chip Moore from Canaccord. Please go ahead.

Chip Moore

Thanks. Guys, wondering if you could maybe help us frame Plastique a little bit as we’ve layered in, similar EBIT margin sort of in that 15% range for a packaging business. How should we be thinking about that as we put that in our model?

Vic Richey

I’m sorry. Do you say again?

Chip Moore

For Plastique, do you got me. For Plastique as we layered that in how should we be thinking about EBIT margins on that business, is that sort of similar to other packaging businesses and sort of net 15% range or how should we think about that?

Vic Richey

I’d say that today they are little bit below either or in the [Indiscernible] just below 50.

Chip Moore

Okay. That’s helpful. And then on the balance sheet after this deal, I guess where does the net debt shake out? What do you think of the dry powder as you go up to more targets?

Gary Muenster

Yes. I’ll address that, just if you remember right before the Holidays, we reups our credit facility especially extended with a five-year duration. We didn’t increase the volume, so we started with $450 million under our revolver. We have $250 million under accordion that could be use for acquisition, so if you have start thinking of that in that total range and again we don’t have a $250 million acquisition in the pipeline.

We have plenty of dry powder and the other thing is that pricing that we push through. We knock anywhere from 12 to 25 basis points on the higher end of that borrowing, which is LIBOR based selective, there’s a lot more flexibility if we need it to get competitive. So, I think the general ballpark range what we paid for Plastique is about 30 and we’re generating cash this quarter and so if we were to jump ahead to March 31st, we’re not in an extraordinarily different position than we are at December. And so the dry powder is plenty sufficient to handle to what we have in the pipeline.

Chip Moore

Okay. That’s make sense. And just to be clear on the guidance for Q2, there’s no – there are step up charges or anything like that in the $0.31 to $0.36?

Gary Muenster

Step up meaning purchasing accounting.

Chip Moore

Yes, yes, exactly.

Gary Muenster

Now, that’s number there I would say best way to describe it is that’s the operation excluding Plastique, because we just bought it last week and obviously we know the numbers, but we lock down, but we want to put in our commitment. So, anything that Plastique flushes through obviously from a sales perspective and earnings perspective will be a net positive to that depending on the purchase accounting amount just to size that and if you remember the release from last week we pegged in at about $35 million on an annual basis.

And so, obviously we’ll have that for eight months of the year so whatever that pro-rata is at as Vic described that kind of low to mid-teen. So somewhere between 12% and 15% EBIT and then we’d hit the purchase accounting for a few pennies of that, so that’s kind of the rapid. That is not included in here. The revenues not included in there nor as the earnings. That’s the straight up pre- Plastique number.

Chip Moore

Perfect. Just wanted to clarify. Appreciate. Nice job folks.

Gary Muenster

Thank you.

Operator

And our next question is from the line of Sean Nicholson from SBH. Please go ahead.

Q - Sean Nicholson

Hey, Gary, actually my questions been answered. So thank you.

Gary Muenster

Okay, Sean. All right.

Q - Sean Nicholson

Thank you.

Operator

And I’m not showing any further questions in the queue, I will like to turn it back to management for final remark.

Vic Richey

Okay. Well, thanks to everyone. I look forward to talking to you on our next call.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Have a wonderful day everyone.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!