ESCO Technologies Inc (ESE) 2014 Q2 法說會逐字稿

Good day, and welcome to the ESCO second quarter 2014 conference call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO ; and Gary Muenster, Vice President and CFO. 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.

Thank you. Statements made during this call regarding the total cash to be received in connection with the Aclara sale, 2014 EPS from continuing operations as adjusted, future growth, profitability and revenue, the schedule and cost of the Crissair move 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 we 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 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 will turn the call over to Vic.

Thanks, Kate, and good afternoon. Let me start with a brief comment on the sell of Aclara which we wrapped up at the end of March. I am pleased with cash proceeds resulting from the transaction. As the total cash generated is expected to be north of $155 million and result in a very favorable liquidity position. Completing the transaction positions us for a more stable and predictable future, and combined with the strength of our balance sheet creates additional opportunities for growth given our financial flexibility.

Our remaining businesses continue to present us with long-term organic growth opportunities, that when supplemented with our M&A strategy create an exciting outlook for ESCO over the next several years. As we reported in a separate release today, I am pleased to announce that we have added two new independent Board members. We are fortunate to have experienced and seasoned Board, and these additions further enhance our depth. Lee and Bob bring a wealth of industry perspective to ESCO and we are excited to capitalize on their experience.

Moving onto our Q2 performance. For the third consecutive quarter we have exceeded our profit and cash flow commitments compared to earlier guidance. This was a result of another strong quarter in filtration segment and lower than expected SG&A spending across the Company. Within the filtration segment we remain bullish on our growth and profitability which is being driven by the recently announced aerospace program wins coupled with having some sizable programs moving toward production. The consolidation of Crissair Canyon Engineering is progressing on schedule and on budget. And through the first six months of this year Canyon continues to beat its initial acquisition forecast. Looking forward to next year we are excited to see the projections coming out of the combined Crissair Canyon operation.

The Test business recovered some of the order softness we saw in the first quarter and for the first six months at a book-to-bill north of one. The second half of the year revenue outlook contains several large projects which are on track and expected to deliver solid profitability. While we do see some lingering order softness in certain end markets of the Test business, we feel we have adequately addressed this risk with other program opportunities and ongoing cost saving initiatives.

Doble had another solid quarter as they delivered 22% EBIT on increased sales. We continue to see a significant uptick in the market interest related to Doble's recently introduced products and solution including Doble ARMS. On the international front we are excited about the momentum we are seeing around several opportunities we are currently pursuing. Our recent Doble conference held in Boston again set attendance records with over 1,200 utility representatives attended this week long meeting.

So to wrap up, the remainder of the year is on track, and based on our recent midyear planning meetings, I remain optimistic about our growth prospects both short term and longer term. Our priorities remain simple and straight forward; execute and deliver our commitments in the core business, maintain our focus on new product developments supporting organic growth and supplement our existing plan with accretive acquisitions around our core business. This will be supported by our strong balance sheet, our rigorous planning process and our attention to the allocation of capital.

I will now turn it over to Gary to discuss the financials, and we would be glad to answer any questions you have.

Thanks, Vic. With the sale of Aclara being completed in Q2 Aclara's financials are presented as discontinued operations in the attached release. I will remind you that once Aclara was put into discontinued operations last year depreciation and amortization were no longer expensed.

On the cash side through March 31st, we have collected approximately $140 million in proceeds related to the transaction, and we expect another $15 million in cash to be received within the next 60 days related to the specific Aclara receivables and other working capital adjustments. Additionally we generated $15 million of cash from continuing operations during the first six months of the year. Consistent with our previous communication the Q2 and year-to-date results are being reported based on EPS from continuing operations as adjusted, and therefore my commentary will follow as such.

As a reminder the 2014 results discussed here exclude the nonrecurring charges to complete the exit and relocation of Crissair Palmdale, California operation into the Canyon Engineering facility in Valencia. As Vic said, the move is on track and expected to be completed by the end of the year at a cost of approximately $2 million or $0.05 a share and to date we have spent about $500,000. The 2013 adjusted items were identified throughout the prior year on a quarterly basis and are noted in the financial tables attached to the release.

During the February call we expected Q2 EPS from continuing operations as adjusted in the range of $0.27 to $0.32 a share. We beat the top end of our range by $0.04 as we delivered$0.36 a share on a comparable basis. As Vic noted, the increased earnings were the result of better than expected filtration performance and lower SG&A spending.

I will call out a few highlights from the release to allow you to better understand the underlying results. Q2 sales increases $7 million or 6% over prior year with all three segments contributing. Filtration increased 9%, Test and Doble both increased 3%. When calling out our Q2 highlights we are pleased to see the $1.6 million increase in our adjusted EBIT, and the related increase in EBIT margins to 11.4% from 10.7% in the prior year. Doble's margin of 22% was significantly higher than Q2 of the prior year and was impacted by a favorable sales mix between hardware and services.

On the Test side the adjusted EBIT margin decreased from prior year, and this is reflecting the increase in a larger number of large chamber projects which carry a lower margin due to a significant portion of pass through content from third parties. Filtration came in slightly below prior year due to the additional engineering startup costs being occurred at PTI as several new aerospace programs are moving into the early stages of development and/or production. These nonrecurring engineering costs coupled with the additional cost of currently operating in the two facilities at Crissair and Canyon, which are being consolidated into one.

So at the bottom line in Q2 of this year we reported $0.36 of EPS from continuing operations as adjusted, which compares to $0.31 in Q2 of 2013. This reflects a 16% increase in EPS on a 6% increase in sales.

On the cash flow and balance sheet front along with the cash proceeds from the Aclara sale we continue to be supported by a strong balance sheet as out net debt was approximately $4 million at March 31. During Q2 we recorded a $136 million in orders for a 1.1 book-to-bill and resulting backlog of $273 million. Our order profile for the balance of 2014 remains strong and continues to support our growth expectations.

Management continues to see strong growth across the Company in the second half of the year, and as noted in the release are expectations for 2014 are consistent with the guidance presented at the start of the year which was EPS from continuing operations in the range of $1.50 to $1.60 per share with Q3 expected to be in the range of $0.36 to $0.41 per share.

Now I will be happy to address any specific financial questions during the Q&A. I'll turn it back over to Vic.

Okay. We would be happy to answer questions you have.

Thank you. (Operator Instructions). Our first question is going to come from Jon from CJS Securities. Please go ahead your line is open.

Good afternoon guys. Nice job on the EPS.

Thanks.

Corporate expenses in SG&A were pretty low in the quarter. Can you give us a little more detail in what went into that and the run rate we can expect going forward?

I think John, with the effort we were expending on the Aclara transaction we pretty well had everything else on hold. So normally we are looking at some M&A opportunities and we have some diligence activities going on and things like that. And I would say normal ordinary course of business where we are spending money on certain things, I would say we were all pretty well on lock down getting the Aclara transaction done, so that is why it was a little lighter than one would expect. I think if you look at the first quarter that would be what I refer to as a little bit more normalized run rate relative to what you should be able to see there. I think if you use that in the neighborhood of $5.5 million to $6 million would probably be the right way to think about that. So it was more of a timing thing than anything.

Okay. Thanks. And then just on the new capital return strategy, on a relative basis can you give us more color on how much you have actually spent in the past as a percentage of free cash flow just on dividends or buy backs that kind of thing?

The dividend has been pretty well fixed since we initiated in its ballpark $8 million. I think it is about $8.4 million, and so we expect that to remain the same. So if you look historically we have been in and out of the buy back scenario. We bought back $15 million over the last two years. Going forward I think really the [solve for] aspect of it is if you look at free cash flow going forward and if we were to use a number of $40 million to $50 million and you put 40% against that and you have $8 million on dividends the balance would be how you should think about share repurchases going forward. So $40 million, 40%,$16 million so you would be somewhere in the neighborhood of $8 million to $10 million on that math.

Just so you know, this is not that different than what we have done historically based on what Gary said. We just thought it would be helpful for people to kind of understand how we were thinking about that. Of course, the wild card will be what we do on the M&A side. Obviously you can say 60% for the other piece of it. And I would say the real consistent pieces are going to be the dividend and what we make as far as investment in new product development and the rest of it is kind of driven by what is available in the market from an M&A perspective that would augmented with share repurchases as appropriate.

Got it. That is very helpful. And then can you just give us an update on the M&A pipeline and what you are seeing out there?

As Gary mentioned earlier, we pretty much had everybody on lock down until 30 days to 60 days ago, but there are opportunities out there, those are starting to filter in. We have kind of formal approaches in each of the operating units as well as getting aggressive here at corporate again. There are opportunities out there. As you know things are expensive these days, so we are going to make sure that we take a very disciplined approach as we start to add to the Company through M&A, but there are good opportunities out there.

Okay. Thank you very much.

Thank you. Our next question is going to come from John Quealy out of Canaccord Genuity. Please go ahead your line is open.

Good afternoon. Nice job here on the EPS. First question, so the two new independent directors was the motivation more internally just sort of best practice or was there some active [ISS/activist] pressure or how did that come about with the first --

This is a process that started -- I didn't mean to cut you off, John.

That is all right. That is okay. You got it.

This was a process we actually started before we had decide sell Aclara, so we started down the path because we had a pretty small Board. We thought it was time to start adding to the Board as a lot of folks we have on Board have been on the Board for a long time which is great thing. We just felt it was time to bring on some additional people with additional experiences, and particularly we wanted to have some with utility experience because while we sold Aclara we still are very interested in the utility space, and thought have some expertise was good there. Now once we made the decision to sell Aclara, we put that on hold because we thought it was unfair to bring people on board in the middle of that process. So once we got closer to the finish line we were energized to add and were able to bring these guys on. I would say it is more we wanted to have a broader Board with some additional experiences, so that is what really drove that decision. And then as you may remember we unfortunately lost a Board member about a year ago now, so that really accelerated the fact where we were looking at one initially maybe two we really needed to add two. Even with these guys on we still have a reasonably small Board.

Okay. That is fair. Looking at filtration it continues to do really well, you mentioned the secular uptick. Talk to us qualitatively if you would, Vic, do you think the macro has longer legs than you thought before? I could imagine that potentially influences M&A decisions at the right price. But just give us a Litmus Test on aerospace filtration especially at this point.

I would say it does continue to improve over the last couple of years. As you know both the (Inaudible) Airbus have the biggest backlog that they have had in quite some time. The thing that is encouraging to me is we already have a couple of programs moving to production and with the recent wins,that we have talked about before, that gives us more legs. And as you know with this business with the aerospace business it is a matter of getting on new air frames because once you get on an air frame unless you really screw it up, you get to keep that position. So you really do need a good mix of the legacy programs as well as new programs. We have been able to do that, we will continue to do that. So it is a good business. It is just really a long-term good business, and we see that. We were just out there a couple of weeks ago and as some of these programs start to go into productions that is where we will see some better growth than what we have seen over the last couple of years. As these programs go into production that is really where you start getting an incremental growth.

Okay. Lastly, so the remaining small debt on the balance sheet now pushed to the current aisle do you wait for an acquisition to do something with that debt or do you just pay it down. Gary, how should we think about that? You are clearly under levered here.

Right. This is not the ideal capital structure, we acknowledge that and that is why we are being aggressive on the M&A side. As Vic said we are looking at a lot of opportunities. We are going to generate cash in the back half of the year. So the reason it has moved up to current we do not have a mandatory payment due, it is really more just the accounting to reflect it. So we do not really have to write any checks to pay that $40 million off. But between the buy back and the M&A activity we would expect free cash flow to pay that down and then acquisitions and buy backs to bump it back up and over time, again we are not looking to just blow the balance sheet with a tremendous amount of debt, but I think over time we are going to maintain a very prudent capital structure. For right now I assume jump ahead to the next quarter. If we don't have an acquisition done by the next quarter, you will just see that debt lower than it is today.

Great. Thanks guys.

Thank you. And then our next question is going to come from Nick Prendergast from BB&T Capital Markets . Please go ahead your line is open.

Good afternoon. I had a question on your test margins. They came in lower expected and you gave a pretty good explanation on that. I know that segment is typically pretty volume sensitive and it is usually backend loaded. So do you see volumes sequentially increasing here in Q3 and Q4 and maybe margins recovering to a more normalized level or is there going to be some carry over of these low margin projects?

I think what you are going to see is a nice uptick. If you look at the profile back in fiscal 2013, it is going to very be very similar to that. So we did $41 million in revenue in Q2, that should be north of $46 million in Q3, and there will be fewer of the large chambers in there that have all the construction pass through content. So you should see margins getting up in to the low to mid teens there with that volume in the mix change favorably. And than in Q4 you will see a big pop from some of these orders that we booked in Q2 where the order profile will be in the low to mid $50 million in Q4 and with that kind of volume you will have very similar margins to what you had in Q4 of 2013 which were 17%. So you can expect 17% of the that volume come through, and we have demonstrated that last year that the volume will pull that overhead absorption through. It will be backend loaded as it was in the past, and I think if you go back a couple of years it is the same kind of profile and the mix is favorable as well.

Got it. That is extremely helpful. Obviously your debt profile would play a large part in any of your M&A. How much do you have available under your revolver?

The gross revolver is 450 and then we have the accordion which is 250. So on the piece that we are actually carrying in the revolving side we have $40 million of debt against that and then we have about $7 million or $8 million of letters of credit outstanding that count against that. In round terms counting the domestic cash we have on hand I would comfortable say we have 400 immediately available, and then if we were to do an acquisition that is what the accordion is for so we can draw against that if we choose to. Just hypothetically if we had a $250 million deal we could pull the accordion into it and keep the revolver in tact, so we have a lot of flexibility.

Got it. Okay, appreciate that. Thank you --

(Inaudible) sitting in the checkbook.

I appreciate that. Thank you.

Thank you. And then our next question is going to come from Jim Giannakouros from Oppenheimer. Please go ahead your line is open.

Thank you. Good afternoon, gentlemen. I would like to tack on to that margin question, basically for the USGfiltration segment. I know on filtration you are tracking a little lower than I think what I had anticipate 19.5%, 20% or so normalized given some startup costs, et cetera, in the first half of this year. How should we be thinking about the second half run rates for USG and Filtration filtration.

On the USGside you will see a little bit of an uptick relative to the volumes there. So if you look at Q2 we did about $25 million. I think we are comfortable in Q3 putting that up at about $28 million to $29 million in revenue and keeping the EBIT margin in the low 20%, somewhere between 20% and 22%, again themix influences that, so comfortable with that,. And if you remember last year in Q4 we had a step up to about $30 million in Q4. We expect to be pretty close to that. So should be pretty comparable looking both on dollars of revenue and percentage of margins at the EBIT side. So I think Q4 is going to look a lot like Q4 last year in the Doble business.

And then on the filtration side again with the announcement we put on the four or five new program wins we have we are expending a lot of startup money on that to get some of the engineering wrapped up in the development stage net to burn through so you won't have that same level of costs hitting in Q3 and Q4. There will still be some there but not in the magnitude it is at. So you will see the margins step up greater than a point there. So I think we did about 17% , 18% there. You will see that go up a full point. And then in Q4 you will see it north of 20% with a nice pop in revenue there. And that is really going to be a function of catching up on some of the commercial aerospace products we are going to be selling as well as VACCO delivering a big piece of the Virginia class submarine valve that we do every year and that will pull through some favorable margins in filtration. So we feel pretty good about the back half of the year. As Vic said, we are (Inaudible) operating units within the last month. And we took a hard scrub of that in advance of this call and we feel pretty comfortable with the back half of the year.

Great, thanks. That is all I had. See you next week.

Thanks, Jim.

(Operator Instructions).

Okay. It looks like we are finished. I appreciate everybody's interest today, and we will talk to you next quarter.

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