ESCO Technologies Inc (ESE) 2013 Q3 法說會逐字稿

Good day and welcome to the third quarter 2013 ESCO Technologies Incorporated earnings 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'd like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead.

Thank you. Statements made during this call regarding the success, timing, and results of the Aclara divestiture process, the timing, amounts, and sources of fiscal 2013 and beyond expected results, both on a GAAP, operational, and an as adjusted basis, future sales, cash flow, orders, backlog, margins, EBIT, EPS, EPS from continuing operations as adjusted, liquidity, growth, profits, new opportunities, past and future acquisition efforts and results, the schedule, costs, savings, and margin improvement resulting from previously-announced restructuring and cost reduction initiatives, 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 today.

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 their 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.

Thanks, Kate. Good afternoon. Given the actions we announced today in our press release we obviously have a lot to cover. The decision to divest Aclara was difficult, but after a comprehensive review of our options and thorough, extensive discussions with our board, we came to the conclusion that this is the right decision for the company and our shareholders.

It is no secret that the nature of Aclara's business, relative to our other businesses, had a significant impact on our ability to accurately forecast quarterly earnings. Our plan is to refocus on our core businesses, fluid flow, test and utility solutions where we enjoy steady growth driven by our market leading positions along with predictable earnings and strong profitability.

I will talk in more detail about the Aclara process in a moment, but I think our real focus should be on how the rest of the business is performing and what our future plans are. As Gary will detail in a few minutes, the rest of the business is performing very well. We are growing backlog and remain solidly profitable. The restructuring activities that we initiated this year in test and in Doble will allow us to show additional bottom line improvement next year. And the organic growth we expect across the company will be augmented by the recent acquisition of Canyon Engineering along with any additional acquisitions we make.

The sale of Aclara and the resulting cash proceeds will result in a very strong balance sheet which will provide us with a significant amount of liquidity to grow the business inorganically. While we don't feel pressure to immediately make acquisitions to replace the revenue lost in this divestiture, I'm very pleased that we will have plenty of financial capacity to fund good opportunities as they become available.

I think it would be helpful to detail the characteristics of the companies we're looking to add to ESCO. Our initial focus will be on expanding our core businesses and end markets, but we are comfortable in opening apertures a bit without straying too far from the core. We will continue to search for companies with expertise in niche markets. We will seek out businesses with technology driven products and services. We'll focus on companies with strong market positions and with reasonably predictable revenue streams. And finally, we expect to add companies that are solidly profitable with clearly defined growth opportunities.

If you think about these criteria, you can see our remaining businesses meet all of these criteria. So the reality is, we plan to build on what is already a strong, profitable base. I'll now talk about what's going on in our remaining businesses.

The filtration business continues to hit on all cylinders and integration of Canyon Engineering and Crissair is well underway. We remain very excited about this business and anticipate seeing the same type of growth and profitability in Canyon as we saw at Crissair after their acquisition. Doble is maintaining their 20% EBIT margin and gaining traction with the new products and solutions they recently introduced. The shutdown of the Lemke operation is on track and will be completed by the end of the fiscal year.

The restructure of our domestic test business was completed on time and budget and we are seeing the anticipated savings from this action flowing to the bottom line which will result in improved profitability next year. TEQ, our thermoforming business, is performing well with an EBIT margin in the mid-teens. We have received strong orders across the company this year resulting in significant backlog growth at June 30th which gives us good insight into next year where we're expecting solid growth.

Now back to Aclara. Obviously I am very limited in what I can say because this is happening in real time. I can tell you that we have made significant progress to date with the sales process and that we anticipate completing the process in the next 60 to 90 days. We are moving quickly to a successful conclusion. We don't anticipate this activity or the transaction itself to have any negative impact on our ongoing support of our customers.

With that, I'll turn it over to Gary.

Thanks, Vic. With the decision to divest Aclara, our financial statement presentation has been changed to reflect Aclara as discontinued operations in the P&L and assets held for sale on the balance sheet. I realize there are a lot of moving parts here, so I will call out the unique items throughout the release to allow you to better understand the underlying results of the business going forward on a continuing operations basis.

Starting at the top, Q3 sales were generally consistent with the prior year and year to date sales decreased a modest 3%, primarily due to the test business's project timing. Despite the sales fluctuations, we are pleased to see the gross margin percentages increase in 2013 over 2012 in both the quarter and the nine months.

As a result of our ongoing cost containment initiatives, SG&A decreased as well in both the quarter and year to date periods. Other income and expense in 2013 includes the test and Doble Lemke restructuring charges and in 2012 other income and expense includes the noncash earnings from the revaluation of the ostensible purchase accounting earn out. Absent these charges in both 2013 and the gain in 2012, other income and expense was generally consistent in the comparable periods noted.

The tax rate in 2013 was higher than normal as a result of the Doble Lemke deferred tax asset write-off resulting from the shutdown of that facility. The tax rate in 2012 was lower than normal due to the decrease in certain tax accruals where the liability statute expired.

So at the bottom line, in Q3 of this year we reported $0.33 of EPS from continuing operations as adjusted which compares to $0.43 in Q3 of 2012. And again, the $0.43 from the prior year includes the $0.09 per share from the gain on the ostensible earn out as well as the favorable tax rate which improved prior year Q3 EPS by an additional $0.07 a share.

To recap the 2013 restructuring adjustments, which are defined in the release, for Q3 the total restructuring costs from continuing operations were $2.7 million pretax or $0.09 a share. The $2.7 million is comprised of Doble - $700,000 of costs related to the Lemke shutdown, corporate - $1.5 million of write-offs related to the Lemke trade name, and test - $500,000 of the final restructuring costs.

For the nine months, total restructuring charges were $0.23 a share which includes pretax charges of $5.6 million along with the $1.8 million deferred tax asset write-off from Doble Lemke which was recorded in Q2. So from an operational basis, filtration continues to outperform expectations and again delivered a 20% EBIT margin in the quarter. We expect our fiscal year sales growth and profit contributions to come in as previously communicated.

Test sales and EBIT were lower than our earlier expectations due to the timing of several large chamber projects which slipped out of Q3 and the majority are now expected to be completed in Q4. We are pleased to see the test business's profit contributions for the balance of fiscal '13 remaining on track.

Doble continues to perform well as Q3 sales increased from prior year but came in slightly lower than planned as a few customers continued to push their expected deliveries to Q4. Doble's EBIT margin, excluding the Lemke charges, remains around 20%.

On the cash flow and balance sheet front, we ended the quarter with a strong balance sheet, as our net debt balance was $155 million which includes the recently announced acquisition of Canyon Engineering. Our leverage ratio was 2.6 with continued favorable pricing on our outstanding debt.

During Q3 on a continuing operations basis, we recorded $141 million in orders for a 1.21 book to bill. And for the first nine months, our backlog grew across all three operating segments as we reported a 1.12 book to bill. June 30th ending backlog was $289 million which is up 17% from the start of the year. For the balance of fiscal '13, our guidance is based on EPS from continuing operations as adjusted which excludes Aclara and backs out the nonrecurring costs associated with the test business restructure and the Doble Lemke shutdown announced and quantified in previous announcements.

As noted in the release, we expect 2013 EPS from continuing operations as adjusted in the range of $1.35 to $1.45 per share. And this adjustment from our earlier guidance basically reflects the removal of Aclara's results from the earlier guidance. I'll be happy to address any specific financial questions in the Q&A, and I'll turn it over to Vic for some closing comments.

Okay. Well, we'll open it up to questions now. I just do want to remind you that we are going to be very limited on what we can say today and really in the future until the transaction is completed, about either the potential sale or the sale of Aclara. So I hope you indulge me there, but there will be very little we can say about that. With that, I'll open it up to questions.

(Operator Instructions). Kevin Maczka, BB&T Capital Markets.

Hi. Thanks. Gary, first question I guess, the way the company is configured now going forward, can you give a little more color around the Q4 guidance? It looks like again we always have a heavily backend loaded year and I guess it's no different with the configuration we're in now. But you're talking about going from $0.33 to $0.52 and it looks like to do that you probably need a really strong ramp in both filtration and test. I know you mentioned some push outs, but can you give a little bit more color there on why exactly that ramp should be so steep?

Yeah, let's start with the test side. Obviously we're still very comfortable with our year and we had a few things like I mentioned that moved out of Q3 into Q4. So we are expecting and we're pretty confident, Vic and I were just down at the test business in July, and we're pretty confident in what the fourth quarter looks like. Because about $10 million of revenue moved from Q3 to Q4 specifically related to timing which were site related where the customer wasn't ready to begin construction and things like that. So that $10 million adds a significant amount of tailwind into the Q4, so we're very comfortable with what that looks like.

And then back to the filtration side, generally while it hasn't been as skewed as heavily as the Aclara business contributed to us, but the filtration group's fourth quarter has always been their strongest. There's some things at VACCO, like the Virginia class submarine which has a relatively large valve contribution which ships once a year, and that revenue is in the fourth quarter. We will get a quarter contribution from Canyon which I think we said in the release is about $12 million on an annual basis, so you can count tailwind there of $3 million to $4 million in Q4. And then just the balance of the filtration companies will have their normal fourth quarter pop.

Doble, some of the things we talked about earlier in the year, you remember in the first half we talked about some things moving to the back half of the year from the super storm that hit and caused some delays in redeployment of service business there. Doble is expecting a fourth quarter as well. So you're right, the math plays out the way exactly as you said it, but when you take the pieces of it, we're comfortable with where we see the guidance coming in.

Yeah, if I can add one thing, the other piece is we completed the reorganization at the test business a month ago, or I should say the last month of the third quarter. So as we look at the fourth quarter, we're going to see all the benefit for the full quarter of being in one less facility.

Got it. Gary, so you said the guidance reduction is all about Aclara and nothing about the remaining business units. Did I hear that correctly, first of all? And if so, on the filtration piece, that's still performing very well, but we did have margins down 200 basis points roughly year over year there even as sales were higher. So can you maybe talk about that and if that did not factor into any of the guidance cut?

Yes, well to the first part of your question, yes, the step down from the earlier guidance of I think it's $0.25 or something like that, was clearly related to Aclara's contribution in the fourth quarter which was going to be or for them is still their heaviest quarterly contribution because of the catch-up on some things there. So the step down is 100% related to Aclara.

Relative to the continuing operations perspective, I'd say our comfort is enhanced. And Vic's exactly right on the test business contribution, we're very pleased with the way that margin should play out in Q4. And then Canyon as a profitable entity with $3 million or $4 million in sales should throw off several hundred thousand dollars of profit. And then the strength of VACCO which continues.

So what really drove the margin a little bit down in Q3 relative to what we've consistently done is, within the VACCO business they do a lot of development work which is a really high margin, and as they move from development of product, or development of new products into the manufacturing, the margin changes from a high margin development profile to a slightly lower production profile which is what they started in Q3.

So VACCO's been banging out 23% to 25% EBIT margins for the last 5 or 6 quarters and they were down a couple of points just as the transition of their product mix which moved out. In Q4 they have a little higher, like I said, on the Virginia class hardware which is very profitable stuff for us. So in Q4 they'll be back up in the 24% to 25% EBIT margin which will get us back in the aggregate to the numbers we were used to seeing.

John Quealy, Canaccord Genuity.

Good afternoon, guys. So just in terms of thinking about the transaction, Vic, in terms of why now, and I know you can only comment so much, but feels like a lot of the business is troughed. And it seems like the multiple could be better if you sold it maybe a little bit down the road. So is it your sort of impatience with the business or you think that's where the end market is, is where we are? And then I just have a follow-up.

Okay. Yes, it's always difficult to kind of time these things perfectly, but what we see -- I mean I think we need to think of it in a broader base than just whether it's this quarter or next quarter or last quarter for that matter. But we just have determined that it's the right thing to do. We've got good positions that we can monetize, we can reinvest in the business, to get the profile that we're comfortable with and more predictable going forward.

And then in terms of what, if anything, you're responsible for, so SoCal is sort of right about to launch. Do you have to fund, or is there a carve out for any more R&D or how does that factor in? And is the customer happy now or comfortable on the transition of ownership?

Yeah, we're in a very good spot with SoCal. I think they're not impacted at all by this. Fortunately we're at the point where we're in full, essentially a full deployment. We're getting 100,000 units deployed a month, so it's really blowing and going if you will. The customer is not tipped over about this and so we'll ensure that it's a smooth transition with the new owner. I don't anticipate any problems at all there.

And Gary, maybe how do we think about the run rate of Aclara? I know you guys have been very transparent on this, but is this $200 million-ish and $0.25 of earnings power when we play with this? Or how do we look at it?

It's larger than that. If we were to retain it, it's probably 10% or 15% higher than that. So $230 million to $250 million is kind of the run rate, but this year it's a little lower than that, but SoCal is the big driver for next year. So if you were using $230 million, you'd be okay.

My last one, and I'll jump back, in terms of on the accretive side now, have you gone through a couple of different books in terms of companies you'd like to see? Or you want cash in hand and then go ahead and take your time? I would imagine you guys are already seeing stuff you like.

We are. We are seeing some things out there. I hesitate to get too far ahead of ourselves because we've had that happen before where we thought we had something in hand and it kind of got away from us. But we are looking hard at some businesses now and we'll continue to do that. As I said, we're going to make the right decisions, we're going to be disciplined about this, we're going to make -- really make those businesses that we acquire fit the criteria that we have. Because as I said, as I wrote down that criteria, I kind of was thinking, well, that's what everybody is looking for in a business, right? But the facts are, that's what we have. If you look at the remainder of our business, that's kind of the composition of the business. So our view is we need to get more of those and we'll work hard to make those happen at the appropriate time.

Paul Coster, JPMorgan.

Thanks for taking my question. What's the rationale for retaining Doble which doesn't look like it's really posted much growth? Is it that it's predictable? And then is there any sort of loss of -- is there a sort of cross selling opportunity forgone by retaining that and not the Aclara business?

Yeah, they are very different businesses. If you look at the Doble business, it's much more like our other business than it is Aclara in that it's a sell or a lease of a product and services. It is a more predictable business. It's a highly profitable business. So we really like that business. And for that matter, we like the utility space. And so I don't want people to think we'll we're just going to walk away from the utility space, because we think it remains a solid growth opportunity for us because of the infrastructure and because of the expertise we have, our understanding of how to deal with those kind of customers.

And we've just recently invested a lot of money in Doble in refreshing their products and developing some new products. And so we certainly want to take advantage of that opportunity. I would say the sum of that is what's maybe muted the growth that we maybe anticipated there. We have grown the business since we've owned it. I think with these products and services in some of the international initiatives that we have underway, we'll be able to get a little more significant growth there than we have historically.

Okay, and then I may have missed this from earlier on, but the test business is really -- it's experienced year on year decline now for about 4 or 5 quarters in a row. I know it's very lumpy so things change quickly, but what gives you comfort that it's back on the growth trajectory?

Well two things from a top line and the backlog. We've been able to grow the backlog and I would say that the most exciting thing to me, just because we do want a more predictable business, is if you look at the orders that they entered this past quarter, they were pretty high level. And the good thing is, there were no large projects in there. Typically, if we have a high level of orders in a quarter at Aclara, I mean at the test business, there would be a $10 million order in there. This time I think the largest order we had was somewhere between $1.5 million and $2 million.

So that, from a sales perspective, we're seeing good growth there. From an EBIT perspective what gives us confidence is this activity that we've just completed on restructuring the business and taking some of the cost structure out so that we can better handle some of the lumpiness. Part of the problem that we had was if you had a light quarter, we had so much infrastructure that it kind of quickly brought the margins down. So by resetting the cost structure, it's going to give us a lot more flexibility to handle some of that.

(Operator Instructions). Richard Eastman, Robert W. Baird & Company, Inc.

Gary or Vic, could you just kind of talk for a second or two about the orders on the filtration side? Just curious maybe what the composition is there. Is that VACCO or is it more on the aerospace side or TEQ pack or just -- a little bit of the composition of the orders and how they may flow out.

Yeah, well let me just go with the Q3 because it's generally the same story for the nine months. Obviously with different numbers. But when you look at the growth we had in filtration of let's call it $8 million or $9 million, it's kind of evenly spread across the board with a slightly disproportionately higher at TEQ. And the reason is the big project we have with the ear probe covers for the thermometer system that -- CAS is the company, that order comes in once a year. So we had the next year buy basically, the '14 buy is in the quarter. And so I'd peg that at a pretty decent unique item.

But the rest of it, at PTI the orders are up and that's generally with [Avi-all] and kind of the normal cycle of their restocking. Crissair gets pulled into that same thing. VACCO's orders were a little higher than we had expected because the space business just continues to exceed expectations there. So the orders that we had there were probably $2 million higher than expected. So I wouldn't say it's any unique. It's not some change in the market dynamic as much as it is just the right timing and the continued acceleration of the aerospace uptick with the unique item being the TEQ CAS order which is about $6 million to $7 million.

Okay. So when you look at the backlog as it stands in filtration, it seems we have pretty good backlog there and it feels like -- can that flow, that mix of business flow out of there with an incremental of 25% or maybe 30% at the conversion EBIT line?

We don't want to get too far ahead of ourselves, but I would say certainly at VACCO and PTI. Crissair is still -- once they get in the new facility with Canyon, I think it's absolutely yes. But I'd say for the next three, two to three quarters while we are doing the consolidation at Cris, it's probably a little lighter. But the nice part of the facilities and the heavy infrastructure that we have there, it's we're where we need to be. So every dollar of incremental revenue at PTI is 40% to 42%.

At Crissair, or I'm sorry, at VACCO, we're kind of bursting at the seams. We expanded so quickly, so the incremental dollars there are probably in the 45 range. Where you don't get the same leverage is at the TEQ pack business which is close to $40 million a year. So that kind of mutes your number a little bit just because that $40 million as a subset of the total is lower than that. Their incremental direct margin is probably in the 25 range if that helps.

Yes, it does. And then can I just ask just a small detail? Gary, do you have the restated EPS from continuing ops adjusted for Q1 and Q2? I know the sum is $0.55, but I'm just curious how that splits? It looks like Aclara must have lost about $0.11 in the first half. I mean that's just the math.

Yeah, I would say Aclara on an EBIT basis in Q1 the loss was about $7.5 million. So you can just kind of tax effect that and divide it by the shares. They're negative EBIT.

I can do the rest. That must have been about -- yeah, I can do the rest. Just one last thought. Maybe, Vic, when you look at the business here post sale of Aclara, how does this change the growth profile? It's maybe a silly question on a looking in the rearview mirror on the volatility in Aclara's revenue, but as you move forward, is the filtration business maybe like a 6% type of core growth business secular? But the test business, that's jumped all over the place but essentially has really not been a growth business. So how do you look at the mix here going forward?

Well I would say that we're probably going to be more in the mid to high single digits on organic growth rate. I'd say we're going to be a lot more predictable and more profitable. And as we look to add businesses, I think we're in a much better position as I mentioned in our introductory remarks, to make acquisitions to get that inorganic growth.

Okay. And just maybe the last question, with Aclara, again, post-sale, does your corporate -- when you look at the corporate expense number, does anything change there?

In fact we've been looking at that and obviously as a smaller business, at least in the interim, some of the professional fees and audit fees and legal fees, some of those kind of things certainly will come down as a result, some of our insurance. So we haven't gotten that far into that yet, but I would certainly think there would be some trimming of that corporate cost.

Jim Giannakouros, Oppenheimer & Co.

Good afternoon, guys. Just quick one on your -- I know we're probably a few quarters away or maybe just couple of quarters away of acquisitions or cash deployment post Aclara disposition, but do you envision, I'm sorry if I missed this, do you envision acquisitions to be multiple smaller acquisitions? Or do you have in your pipeline or in sight maybe one or two kind of big splash type of acquisitions that would replace the revenue stream that you'll be losing when you sell Aclara?

Well we'll be looking for both. I mean honestly, it's going to be whatever the best fits are. Our preference would probably be to do something larger rather than smaller. And larger is a relative term, but I don't see us doing $10 million and $15 million or $20 million acquisitions. I think the time and effort that goes into making those acquisitions and integration is probably not worth the effort. So we would be looking at larger acquisitions, I would think at least $50 million acquisitions going forward. Having said that, I mean if they were a perfect drop in like we had with Crissair, I mean certainly we would evaluate that. But that's not the focus as we go out and actively look for potential acquisitions. That would not be our focus.

And is it fair to assume that these acquisitions are predominantly domestic or not a fair assumption?

That's not a fair assumption. I think we've made international acquisitions and we would continue to be willing to do that to expand our business. If you look at the business post this divestiture, I think we're going to be close to 40% international, so we have a good, solid international business. So we do have experience doing that and we would be interested in doing that, particularly in the specific businesses we have today where we don't have a big international presence like with our test business.

And we have no final questions at this time.

Okay. Well I appreciate everybody's interest today. I look forward to talking with you over the next coming months. I did have the opportunity to talk to all the Aclara employees earlier today and I wanted to reiterate my gratitude to all of them for the contributions they've made to Aclara's successes over the years and I'm convinced they'll provide the same level of passion and dedication to the new parents as they have to ESCO. Thank you.

Thank you, ladies and gentlemen, This concludes today's conference. Thank you for participating, and you may now disconnect.