ESCO Technologies Inc.
Q3 2017 Earnings Call Transcript

Published: 15 Nov 2017

[Operator:]

Good day, and welcome to the ESCO Q4 2017 Earnings Conference Call. Today’s call is being recorded. With us today are Vic Richey, Chairman and Chief Executive Officer; Gary Muenster, Vice President and Chief Financial Officer. And now to present the forward-looking statement, 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 amounts and timing of 2018 and beyond EPS, adjusted EBITDA, EBITDA, EBIT, EBIT margin, non-cash depreciation and amortization from recent acquisitions, tax rate, profitability, sales, cash flow, orders, success of new products, success in completing additional acquisitions, the results of recent acquisitions and cost reduction activity and other statements which are not strictly historical are forward-looking statements within the meaning of 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 that are most comparable GAAP measures can be found in the 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. As noted in the release we were adding up ‘17 with strong passion which Gary will describe in a moment. In that report we delivered some earlier expectations of EBITDA and EPS. Turning side that numbers for a second, I’m most satisfied with the recent M&A activities as we’ve added four great companies this year, three we acquired in 2016. With these partners we’ve not only added great companies to our portfolio, we’ve also added strong management teams to share our vision and our values. As we look forward to future, we plan to goal on both the organic and acquisition successes we’ve achieved over the past few years, and we’ll continue to aggressively address the normal market challenges we face every day. This gives me a favorable view on our future and our goal remains unchanged in order to increase the long-term shareholder value. For a perspective on our outlook for ‘18, I’ll turn it over Gary to wrap up ‘17 with the two financial comments and summarize our ‘18 outlook.

[Gary Muenster:]

Thanks Vic. I’m pleased with the ‘17 financial results and very proud of what we accomplished this year in way of acquisitions, which better positions the company for achieving our long-term growth objectives across the portfolio. At the start of the year we set our financial goal centered around EBITDA which we expected to be in the range of 122 million to 124 million and with GAAP EPS expected in the range of 216 to 266 a share and we also described several non-cash items that would be impacting our GAAP results. Given our additional M&A activities completed late in the fiscal year coupled with the corresponding GAAP required non-cash purchase accounting charges from these acquisitions our GAAP earnings became less comparable as the year progress. As a result, adjusted EBITDA and adjusted EPS became more important operating performance measures and looking at our competitive results. This adjusted approach is consistent with our view of '16 operating performance. So, touching on a few financial highlights from '17. For the year we reported a 123 million of adjusted EBITDA which is slightly better than our previous expectations of 122 communicated in August. This represents a 22 million and 22% increase over '16s adjusted EBITDA of 101 million. During Q4 we recorded a record high quarterly adjusted EBITDA of 43 million which reflects a 34% increase over the comparable 32 million noted in Q4 of last year. our full operating segments contributed to the Q4 earnings increase as follows

[Vic Richey:]

Thanks Gary. In fiscal ‘18 I’m confident all of our businesses are on a solid financial addition with no one to quantify our growth opportunities. We’re all positioned to move our trajectories in ‘18 and in the out years. As I’ve noted previously we’re not immune to economic headwinds in many industrial markets space. With that said, I strongly believe the breadth and diversity of our end markets and the specific niches in which we operate in provides the protection to mitigate a lot these pressures. While we’re not without challenges I’d like to position we’re in across various businesses and anticipate that we can achieve growth rates in ‘18 and beyond that see those of us in a time period as well as broader industrial markets. I’ll provide a couple of specific thoughts economists of individual businesses entering ’18. In filtration, we expect to deliver solid results in ‘18 and I’m comfortable with our outlook for 67% growth in EBITDA in the segment. We’re well positioned on several fronts in filtration including we continue to up cycle in commercial aerospace as well as additional technology we’ve provided for submarines and surface jets which occur. We recently won a large multi-year contract for Westland mission critical proprietary hardware for surface ships. And back home we were awarded a follow-on order to the nationalized Virginia Class submarines. So, taking together with our Westland outlook we have tangible and profitable growth in better than enabled product offerings for many years to come. Mayday continues to expand its product offerings including its entry into the aerospace MRO markets where we see strong growth in a market we only recently entered. Several existing customers have already placed MRO orders, which we can build upon. Our Technical Packaging group’s future has improved given our scale and leadership positions across several growth markets and geographies. We recently expanded our production capacities at our facilities in Poland and England. This provides capability to deliver highly-engineered products to customers in the medical, pharmaceutical and consumer markets throughout Europe. And USG, which is solid growth opportunities for us to global platform including the hardware, software and services. We also see numerous opportunities for our expanded product offerings both internally developed and acquired. Our distribution network rationalization is nearly complete and I'm really impressed with the quality of our sell channel partners. This process is very key as we integrate our new partners into Doble. We need to ensure that we are able to service our customers in the most effective and efficient manner possible. Our entry into the renewable energy market with the acquisition of NRG was an important move in ‘17. We look forward at enhancing our position in this fast-growing market in ‘18 and beyond. At Test we are seeing the results of our past cost reductions materializes anticipate. Our reduced cost structure and ongoing operational improvement initiatives support our 13% EBIT margin expectations. Test sales growth while appeared a bit aggressive given our history is supported by several metrics such as opening backlog in the nearly $30 million of new business awards in October and through today. I tell you about the growth opportunities we have across all our businesses in ‘18 and tangible avenues for additional growth of future years. Regarding our recent M&A, I’m pleased the immigration process across the board. This complex process is nearly complete and has shown favorable sales in areas opportunities. Within USG I like our ability to enhance our overall gross strategies and past customer relationships where applicable. Commenting on my longer-term view for the total business we continue to see meaningful sales and EBIT growth across our business consistent with our previous communications. Acquisitions remain a key component of our growth to meet our longer-term growth target and we continue to evaluate additional opportunities. We certainly have a balance sheet capacity to more than M&A and we have management bandwidth that handles this additional growth with our current operating infrastructure. But we will continue to remain disciplined in our approach. Our focus remains constant that we continue to improve our operational performance and to execute on our growth opportunities both organically and through acquisitions. I will be glad to answer any questions you have now.

[Operator:]

[Operator Instructions] And our first question will come from the line of Jon Tanwanteng with CJS Securities. Please proceed.

[Jon Tanwanteng:]

You mentioned that you have more capacity for more M&A after doing quite a lot of business or transactions in the past year. How much timing are you guys actually spending on that, are there a lot of opportunities what evaluations look like, anymore color on just the whole M&A process and pipeline will be helpful?

[Vic Richey:]

Its remains pretty active, honestly as we had a lot of success over the past two years and we see ample opportunities going forward. We think a lot of that what that is probably before two years ago we weren’t seeing this much traffic, and I think it’s a matter of a lot more things coming to market, and I think we have proven our ability to be successful in some of these acquisitions. So, I think we will get on more people's radar screen to get access to more those acquisitions. Plus, we have a focused activity here to go out and seek competitors, partners, people who are aware of the market so it remains pretty robust. And I think Jon from the valuation side if you look at our last five., six or seven deals certainly doesn't feel like we overpaid for those relative to the multiples we paid. And I'd say the things in the pipeline today are generally within that bandwidth, there's nothing we are looking at that are 12 and 13-time EBITDA so I think future performance will look like the past and the sizes certainly appear digestible.

[Jon Tanwanteng:]

And then just in terms of the expectations you have for both cost and sales synergies and USG and filtration what you're building into expectations for next year?

[Vic Richey:]

We have built a lot of synergies just because it takes a year to figure that out. So, we don’t want to build something in there begging on to come. We are still in the process of doing that. But I would say it's no hard numbers assumed and what we have in our forecast probably is the sustained way to answer that.

[Jon Tanwanteng:]

And then any color on the packaging space in that segment why you expected that to be flat going forward?

[Vic Richey:]

I would say the flatness that we are seeing this year is probably not going to be long term, what I will say is the attrition rate and what we saw in European acquisitions we hired than what had anticipated. Some simple things like the razor market, which we did -- have participate with our Plastique acquisition there. It's amazing that the internet raised your business really forced and you see it with the through manufacturers and how they are all struggling as a result of that. They would maybe using a higher package historically, they're basically competing on price now and one place they can take their prices and packaging, so we're seeing a little more attrition in some of those areas like Plastique than what we anticipated.

[Operator:]

Thank you. And our next question will come from the line of Liam Burke with B. Riley. Please proceed.

[Liam Burke:]

Vic, on the Filtration side of the business, you're looking for a significant step up in EBITDA of growth in '18. Is it primarily the absorption of upfront investments on the contracts beginning to catch up? Or is there other things in that expectation?

[Vic Richey:]

The biggest thing we have is a pretty big pickup at our Mayday business both as a result of getting them onboard fully now, 11 months versus -- our 12 months versus 11 months, I think the efficiencies are going to be higher there, and then as I mentioned MRO business has tripled year-over-year, as they had the biggest piece, and then Westland as well, we've been waiting on a contract there which as I mentioned earlier in the call we'd get that, so that had some impact on us in '17, and now we have a contract in place to deliver that in '18, so I'll say those are the two biggest impacts year-to-year.

[Liam Burke:]

And then on the NRG and mortgage acquisitions, those businesses as I understand carry lower operating margins, part of the cost synergies were presumably to integrate those businesses, looks like fourth quarter, you're better sequentially but still lower year-over-year, do you expect to make continued progress on those two acquisitions, or have you pretty much got as much cost out as you can?

[Vic Richey:]

I'd say that well, let me talk separately about the two businesses. I mean, NRG is not really going to be integrated within Doble. It's a freestanding business. I think we'll see margins improve there as we continue to grow that business and we're going to have some of those efficiencies. So, we're not going to get the same type of synergies that we would with the company we're going to integrate. With Morgan Schaffer, as you know we had bought their product historically and integrate it with a system of ours. So just having that lack of a second markup if you will I think will be helpful there, and then as we get their new product, with higher production rate into the field I think will help as well. I think also finishing up as I mentioned the integration of the sales channels and so that has an inherent cost savings as well. And we're fortunate we get some really strong people there, in fact we were in the process of looking for somebody for Doble to run the European sales operations, fortunately there were somebody at Morgan Schaffer that filled that role for us, so it allowed us have an internal [key entity that could fill] a role like that, there's couple of other [place] that we were able to do that as well.

[Operator:]

Thank you. [Operator Instructions] And our next question will come from the line of Ethan Potasnick with Needham and Company. Please proceed.

[Ethan Potasnick:]

Yes, hi this is Ethan Potasnick on in for Sean Hannan, similar to previous question I'm wondering about the mix of revenues in USG, could you maybe share how much is coming from service and software and I guess how that is trending and is that part of 2018 expectations?

[Vic Richey:]

Well, I’ll let Gary put some side numbers and specifics that I’d say sales and software that’s trending up the acquisition we made couple of years ago software business, that business has grown pretty significantly. And its very small business current pretty significantly and then we’ve had a focus on software Doble as well and services. And we see both of those areas trending up.

[Gary Muenster:]

Yes, I would ask you think about the pieces that we had. So just split them individually what they are. Morgan Schaffer is generally a hardware business. They supply products. So, there is not -- I mean, there is some services there and there is some software, but it’s predominantly 90% plus would be added into the product bucket. On NRG they have a better mix of services and some software applications, so that's probably about 60% hardware and 40% in the other bucket, and then the Vanguard piece is almost nearly all hardware. So, as you think about that added to what Doble’s historical mix was between those allocated pieces, you will see hardware becomes a bigger piece of it because we added the Vanguard and Morgan Schaffer piece of that, so it doesn't dominate to the point or to the expense or if you will of the software and its favorable margin. So as Vic said, the software business organically is growing faster but it's loss more numbers and you're going to see a disproportionate growth in hardware just because of the acquisitions.

[Ethan Potasnick:]

Okay. And then I know you guys talked about this a little bit in the prepared remarks but I was wondering if you could possibly share what kind of growth should we see percentage wise within each segment and then also kind of at the EBITDA level for 2018?

[Gary Muenster:]

Yes, I would say if you looked across the sales platforms there, let’s start with Filtration, we didn’t mention all of that headwind wheel about $7 million or $8 million of product that we're not going to go forward with because of some extraordinary pricing conditions that it's already a low margin business we’re all going to get the stuff away. So that part of the business goes away. So, let’s call that $7 million or $8 million as we go into ‘18 and that’s a PTI part like I said it’s not aerospace, it’s low margin industrial and automotive. So, I’d say the way I would look as a group in Filtration, you're probably talking somewhere in the neighborhood of 2% or 3% because of that headwind there and because of the timing on the VACCO transition from development into production. The nice part is there is a significant margin trade to the positive amount that's worth about two full points margins at VACCO so you are actually going to see despite the flattish sales, you’re going to actually see improved operating performance that our operating profit margin there. So to use that as a group that 2% or 3% on hold the packaging group flat as Vic alluded to there is some attrition there. So, holding that give or take a $1 million around where we are at and then Test really comes from, if you think of the large technology program that we talked about last year that had some more construction related timing things from its headquarters. We picked up that plus we picked up some momentum from the significant backlog growth. So, I would think of the Test business as I mentioned in there high teens the 15% validated by those two metrics. And then on the USG side the growth is going to be north of 60 million combinations of dollars, the combination of the acquisitions for the full year but then the inherent organic growth in there is attractive as well. So hopefully you follow on those pieces of that.

[Ethan Potasnick:]

And then finally, maybe you could discuss contribution assumptions for growth internationally in 2018?

[Gary Muenster:]

On the revenue side or profit or what?

[Ethan Potasnick:]

Yes, revenue and profit please.

[Gary Muenster:]

So, if you look at Morgan Schafer obviously they are based in Canada, so I would say about 50% of their business happens in the U.S. and 50% happens around the world so if you take them at 23 million 24 million you could take half of that. In that regard Vanguard at 11 million or $12 million is almost predominantly U.S. I would say 20% of that is international. And then on NRG it's probably a little closer to 50-50. So, if you take them at 45 million or something like that and put that net relationship that should help. Within aerospace business there is not a whole lot and within the filtration business there is not a whole lot international content. And then that in packaging it's about 50-50 because Plastique is a big chunk of that $80 plus million we have there. And then Test is probably 50-50 as well. And I can't do all that math in my head at the same time but I would be comfortable saying about 30% or 33%. And Kate mentioned that historically we would be in the upper 20s and that will be in the low 30s as a percentile or a percent of international content.

[Operator:]

Thank you. And I'm showing no further questions at this time. So now I'll present the conference back over to Mr. Vic Richey, Chairman and Chief Executive Officer for some closing comments or remarks.

[Vic Richey:]

Okay, well, thanks everybody I look forward talking to you in the next call. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference, this does conclude the program. And you may all disconnect. Everybody have a wonderful day.