ESCO Technologies Inc (ESE) 2014 Q4 法說會逐字稿

Good day and welcome to the ESCO fourth-quarter 2014 conference call. Today's call is being recorded. With us today are Victor Richey, Chairman and CEO; 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 2015 and beyond EPS, EBIT, tax rates, revenue from the SLS and [KAZ] programs, future growth, profitability and revenue, margin, sales, market share, product development, acquisitions, share repurchases and other statement 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 to the most comparable GAAP measures can be found in the press release issued today and found in the Company's website at www.escotechnologies.com under the link, Investor Relations. And as a note, there's an error in the press release that states the dividend paid and record dates as being in January of 2014. And obviously those will be in January 2015.

Now I'd like to turn the call over to Vic.

Thanks, Kate. Good afternoon. I'll make a few comments about fiscal 2014 before I turn it over to Gary.

As mentioned in the release, we had four specific goals as we entered into the year: sell Aclara, pay down debt, execute our operating plan and deliver solid EPS performance. I'm proud to say we accomplished all four and, in addition, have positioned ourselves for solid growth over the next several years. I'm also encouraged that our out performance versus plan was the result of contributions from across the Company. Additionally, given our strange cash generation, we finished the year essentially debt free. We were also able to increase our backlog about 11%, which bodes well for our future.

To mention a few speck highlights from the year. Delivering adjusted EPS of $1.65 was a clear win for us. We completed a consolidation of Crissair into the Canyon facility on time and on budget and are excited about the future profit contributions resulting from the significantly lower cost structure. As part of Doble's international growth strategy, we entered the Middle Eastern market in a meaningful way by establishing an office in Dubai, which contributed to us winning an initial contract which Saudi National Grid. We believe this local presence and large reference customer will allow us direct access to other utility customers in the region.

From a capital allocation perspective, we returned nearly $21 million of cash to shareholders during the year through dividends and share buybacks. And in September, we held our first analyst investor day in New York City, which given the investor interaction and feedback, we think was a success. Our only major disappointment during the year was we were not able to close any acquisitions. As I mentioned in the press release, we look at a number of opportunities, passed on a few, lost some on price and continue to work several others. While acquisitions are key to supplement our organic growth, we will remain disciplined in our approach and [insure] we can generate an appropriate and attractive return on these investments.

Bottom line, we had a very good year from a lot of perspectives. Our focus now is clearly on the future.

I'll now turn the over to Gary for a recap of the financials, after which I will give you some insight into our outlook.

Thanks, Vic. I'll provide a few comments on the 2014 results and then turn it back over to Vic for his thoughts on 2015 and then come back around to wrap up a few financial thoughts on my perspective on 2015.

Consistent with our previous communications, the Q4 and full-year results were reported on the basis of EPS from continuing operations as adjusted and my commentary will follow that format. The 2014 results presented exclude the non-recurring charges related to the exit and relocation of Crissair's Palm Dale facility into the Canyon Engineering facility in Valencia, California. As Vic noted, the move was completed on time and on budget at a cost of approximately $2 million, or $0.05 a share. The 2013 adjusted items were identified on a quarterly basis throughout the prior year and are described in the financial tables attached to this release. During our August call, we expected Q4 EPS from continuing operations as adjusted in the range of $0.44 to $0.48 a share and I'm pleased to report that we beat these expectations and exceeded the top end of our range by delivering $0.51 a share on a comparable basis. The increase in earnings was a result of solid operating performance, infiltration in Doble along with effective cost management across the Company.

I'll call out a few highlights from the release to allow you to better understanding the underlying results. Q4 sales increased 5% over prior year with all three segments contributing. Doble lead the group with a 10% sales increase in Q4 followed by test in filtration. Doble's Q4 EBIT margin of 23.4% was a highlight of the quarter as it significantly exceeded our earlier expectations. While EBIT margin was below Q4 the prior year, it was primarily due to last years unique sales mix, which included several million dollars of revenue related to legacy hardware, which when sold, carries an unusually high gross margin. Doble's Q4 2014 margin was especially strong despite their additional sales and marketing spend related to several new products, which are now in the market. Filtration's Q4 EBIT came in above plan and increased from prior year, despite higher engineering start up costs being incurred at PTI this fiscal year as several of our new aerospace program wins are in the early stages of development and/or low rate initial production.

We are excited with the completion of the Crissair consolidation and we look forward to the margin enhancements expected to be realized. Despite the disruption that naturally occurs during a move of this magnitude, Crissair's adjusted EBIT was north of 20%. Tests EBIT came in a little short of plan due to a few program timing issues on foreign projects that were expected to close out in September and moved out of the year. These projects give us some tailwind as we enter the first quarter of 2015.

Q4 adjusted tax rate was 35.2% compared to 29.2 in Q4 of 2013. So for the year, we increased sales by 8.4%, increased adjusted EBIT dollars by 9.5%, increased our adjusted EBIT margin by 0.1 of a point and increased adjusted EPS by 12.2% to $1.65. The $1.65 topped our earlier expectations by $0.05 a share and I'm happy to report that all three segments contributed to this with increased sales and increased EBIT dollars.

On the cash flow and balance sheet front, we generated $45 million of cash from continuing operations during 2014, which reduced our net borrowing position to approximately $5 million at September 30. As Vic noted, we remain committed to our capital allocation strategy, which includes share repurchases and dividends. As such, we return nearly $21 million to shareholders during 2014. We launched the current stock buyback program earlier this year and have spent over $13 million to repurchase nearly 400,000 shares through today. We expect to continue to opportunistically repurchase shares in the open market during 2015 as we continue to be supported by a very strong balance sheet.

A significant highlight of both Q4 and the full-year was the strength of our inner orders. We booked $162 million in Q4 and $562 million for the year, reflecting an 11% increase in backlog and an ending backlog of $303 million. We are most proud of the fact that from a sales, EBIT, EPS, cash flow and orders perspective, fiscal 2014 played out at or above our expectations set at the beginning of the year.

I'll be happy to address any specific 2014 related questions when we get to the Q&A and I'll turn it over to Vic for a few 2015 thoughts.

Thank you, Gary. As we discussed at our investor day, our three year outlook reflects growing our top line, 10% and EPS 15% on a compound basis. While we're not getting out of the blocks as quickly as I'd like in 2015, we still believe these goals are reasonable and achievable. Our 2015 outlook is muted by the two items highlighted in the press release. VACCO's SLS program re-plan and the temporary production break in the KAZ line at TEQ. Also projecting an annual tax rate of 35% in 2015 makes a year-over-year comparison a bit challenging compared to the 31.6% in 2014. Having said that, we also see a lot of improvements across the business in 2015, which are reflected in a 10% increase in EBIT dollars compared to 2014.

Much of the investment we made in 2014 was to position us for growth in 2015 and beyond. We made significant investments at Doble necessary to accelerate their growth, both domestically with new products and solutions as well as internationally by entering new markets. Over the past two years, we've worked the overall cost structure in both filtration and test to improve their margins and to further protect our market leading positions. We will continue to work on improving our expected 2015 performance while preparing for additional acceleration in 2016 and 2017. We are well positioned for solid organic growth and have the capacity, both from a financial and management bandwidth perspective, to augment our growth with appropriate acquisitions. We look forward to an exciting and successful year.

I'll now turn it back over to Gary to walk through the 2015 outlook.

Based on our recent financial planning meetings, I firmly believe our core 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.

Starting with the filtration segment. Despite the short-term timing issues presented at VACCO and TEQ, I want to point out that both of these programs have recently increased in overall value by a meaningful amount. The impact of VACCO resulting from the level loading of the SLS revenues is expected to deliver several million dollars of additional project content over the next three years. At TEQ, the $30 million KAZ extension provides tremendous visibility and predictability for the next three to four years. Also worth mentioning, the core aerospace business at PTI and Crissair are showing solid growth in sales and EBIT and in 2015 and beyond. We remain bullish on our underlying growth and profitability, driven by the recent aerospace wins, coupled with having some sizeable programs such as the A350 moving toward production.

The test business remains in growth mode from top line and bottom line perspective as the outlook contains several large projects, which are on track and are expect to deliver solid profitability in 2015. The EMP market continues to gain momentum and we are bidding on several large opportunities, both domestically and internationally. Doble is expecting another solid year as we expect high single digit top line growth with a significant EBIT contribution expecting to deliver around 24% margins. This growth is driven by a significant uptick in market interest related to Doble's recently introduced products and solutions, including the M7 test set and Doble ARMS. The recent wins at Saudi and SoCal Edison support our outlook. We also see the Saudi win as a potential catalyst for several other pending opportunities in the region.

So when you roll this up, we expect top line growth in the low single digits, EBIT growth in the high single digits, and with the headwind of a 35% tax rate, we project EPS in the range of $1.70 to $1.80 a share. On a quarterly basis we expect EPS profile to be similar to 2014 with a bit more second half weighting.

And now I'll turn it back to Vic.

Okay. Well that's our prepared comments. We'll be glad to answer any questions you now have.

(Operator Instructions)

Our first question comes from [Jon Tanwanteng].

Hi guys nice job in the quarter.

Thank, Jon.

I'm just curious as to what's driving the sequential decline near EPS expectations in the Q1. Is that mostly the switch into gen-2 product in TEQ or are there other factors going into that?

No, that's a big part of it. When you look across the platform, I think our test business is going to be a little bit stronger. Doble had a very strong first quarter. They are going to be more normalized. And then the absence of some of the sales at TEQ, which are -- that's high margin stuff on the KAZ program that's pulling it back a little bit, plus we're trying to maintain a little conservative posture as well.

Okay. Got it. And then can you update us on the progress Doble has made in the Middle East? Is that what's driving most of the margin improvement there?

They started the project about two months ago now. And it's a high margin project because it's really more of a service contract, if you will, where they're going in and identifying the health of the current infrastructure. So it's a nice project, high margin business. It's gone well. We're pretty sure we'll get the next follow on for this year. And then we won a small contract and another utility in Saudi within the last couple of weeks. So I think that that bodes well for what we're going to be able to do in the Middle East.

Okay thanks. And then can you just give us a little bit more color on the pipeline for M&A and what your target leverage might be if you are successful?

Yes. You know, it's tough out there right now to be honest. We've got a couple things that we're going after, but as you know, there's a lot of cash out there and we're fighting with, not only the strategics, but even some PE firms that are bidding a lot higher numbers. But that is a primary focus for myself and, obviously, our director of development, VP of development. We're working that from a lot of different angles. So we think now that we've got the sale behind us and we're able to focus more on that. We'll be able to make some more head way here in the next three to six months and identify and bring us (inaudible).

Okay thanks. And then just regarding the share repurchases, would you expect to be more aggressive there if you aren't successful in M&A? And could you just remind me how much is remaining on the current authorization?

I think we have about $8 million left on the current authorization. We want to give a little time for this to play out before we get more aggressive and we're going to do it opportunistically in the near term and then we'll see how some of the acquisition things play out.

And, Jon, just to clarify, on the original authorization, which was put in place a couple years ago, it was about $100 million. And we've picked off about $30 million against that. So Vic's $8 million is relative to the most recent update to that where the Board basically looks at $10 million increments of this thing. So the $8 million is what we have against the $10 million the Board authorized. But from a broad scope perspective, we have about $60 million left should things turn where it turns into a situation where that's attractive.

The next question comes from [Nick Pendergrast].

Good evening. I just had a quick question here on the guidance shift you're doing in filtration. There's two buckets here. You have the space launch system. You're very clear about what the effects are there. There's $10 million pushed out of 2015 -- sounds like 2016 becomes $10 million higher and then you've got $5 million additional in 2017. So my question really is on the TEQ side -- now it sounds like they bumped this up from a $50 million contract to an $80 million contract and now it extends all the way through 2018, I believe, if I'm doing the math right there. I'm just curious as to the cadence of that $30 million if $3 million is pushing out of 2015.

I'd say generally, and give or take $200,000 around this, it's essentially a $10 million a year expected revenue profile. So in 2015, we'll call it $7 million because of this $3 million delay. So what you basically do is if you just divide that into a monthly profile, it's not exactly $1 million a month but you just -- we're just basically adding tail to it. And it obviously covers a tremendous amount of overhead there as well. So it will be $7 million this year and $10 million-plus next year and then continue at that profile.

Understood. Thank you very much.

(Operator Instructions)

The next question comes from Sean Hannan.

Hi, folks. Can you hear me?

Yes.

Sure.

Okay. Alright so just wanted to see if I could push a little bit more or ask a little bit more around the longer term view points for the model. When you think about that 10% CAGR in the top line, 15% in terms of earnings, as we all start to extend our models into 2016, clearly some of the items that you talked about that push out from 2015 contribute to that 2016 number now more so. But it still would line up that you'd have to have a pretty material year in order to keep up with that expected strategic plan and the pace. So just trying to get a better understanding of what else might be behind some of the business? What might drive that acceleration as we get into fiscal 2016? If there's anything that you can detail there would be great. Thanks.

Sure. So a couple things and then you picked up on the first one, obviously, with the SLS. Some of that goes into next year. So that helps next year. The other two things are we do think we're going to have a good bit of acceleration at Doble as a result of two things. Number one, the new products and services that are now complete and going into the field. And then the other one is just some further international penetration, which I think what we're seeing in Saudi, what we're seeing in South Africa really bodes well for our ability to be able to do that. The other large one is we do have a number of projects that are going into production at filtration, particularly the largest one being the A350. And if you remember, when you get to full production there that's going to be about $10 million a year, in and of itself. So that's -- and then we got some of the smaller programs like [Commack] and [Emberair] that are also going to be going into production here in that same time frame. So I think that's key.

And then on the test side, we talked a good bit about the ENP market. We had some good success there and that's one of those where it can really take off and make a difference. We're not planning on that in the -- in our current plan that that's going to get to be a huge number but it certainly is going to be a contributor. So it's not just hoping that we're going to get there. We've got very specific projects that are already in house, are close to being in house, that are going to take place in 2016. And then always, even though as we talked about it at the investors conference, we think we're going to get 80% of the growth through acquisition. And so then the other piece I was going to come through acquisitions for the other 20%. And obviously if we have more success than that, then that could accelerate the growth as well.

That's very helpful.

Sean, one thing I'll add to that just to supplement Vic's comments on the Doble side is comment earlier on the 2014 comments relative to Saudi. And that kind of business model is that service component picks up, you are going to see the big step up in revenue in 2016 but it's going to pull through an even higher margin at a meaningful level because there's no additional infrastructure cost or no additional G&A of substance that supports that. So the incremental margin at the point we're at now when you go into fiscal 2016, it's -- you're talking at 60% plus incremental margin falling through on those dollars of sales.

That's great. That partially gets at the next question I had here, Gary. The project that you've got there in Dubai, the relationship, obviously -- you're now active. And so want to see if we can get a little bit more feedback in terms of how that is working at present -- the feedback that you're getting from customer. And then any elaboration you could provide in terms of expansion opportunities on that business in relationship that you have with them. Thanks.

Sure. So a couple things, number one, it is going very well. We had a team prepared to go in there and they've been there since the day we signed the contract. They started the activity -- a good relationship with the customer. Obviously with us already winning a second contract, I think that bodes well. We're in discussions with several other, I think about five or six other, utilities in the region, which we think can turn into something. And then the thing that we haven't talked a lot about is I think the real prize here is that at some point is utilities you're going to get past the assessment phase and everyone will want to do this themselves. And so then that gives the opportunity to sell the hardware. And obviously that's -- those can be more significant dollars than what we're seeing on the service side. So we think this will be a good long term opportunity for us. And getting into the Saudi grid first was the best thing that could happen because a lot of the other utilities in the region follow what they do.

That's great. Alright. Thank you so much.

Thank you, Sean.

And at this time, I'm showing no further questions.

Okay. So to wrap up, our three year financial goals remain on track and I'm optimistic about our growth prospects, both short-term and long term. Our priorities remain simple and straightforward: execute and deliver our commitments in our core business; maintain our focus on new product development; supporting organic growth and supplement our existing plan with accretive acquisitions around our core business. So thank you, everyone, and look forward to talking to you on the next call.

Thank you.

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