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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the ESCO Technologies Q1 2020 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 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 amounts and timing of 2020 and beyond, revenues, EPS, adjusted EPS, EBITDA, adjusted EBITDA, debt, growth, profitability, ROIC, shareholder value, future orders, success in completing additional acquisitions 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 to their 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.
Now I'll turn the call over to Vic.
Thanks, Kate. Before I had it over to Gary to discuss the first quarter financials, I'll make a few comments. Clearly the highlight of Q1 was completing the sale of the packaging business and receiving $191 million in cash before the quarter end. Gary will discuss the gain from the sale as well as other accounting matters related to the discontinued operations noted in the financials.
As you saw in the release, we renamed our corporation for the flow group Aerospace and Defense, which we'll refer to as A&D going forward. Following the global acquisition last July and the conjunction with the divestiture of the Packaging segment, we decided to make this change. Aerospace and Defense better reflects the products, end markets and customers in this segment.
Additionally, we believe this is a more direct comparison to some of our peers in these markets. We've now changed the group's legal entities, reporting structure or manager relationships from what was previously presented at filtration
Moving on to our operations, I am pleased with our start to the year as we delivered a solid first-quarter being expectations on sales, adjusted EBITDA and adjusted EPS, which beat the top of our guidance. We did better than planned in A&D and test as both businesses delivered higher sales volumes along with a favorable sales mix, which drove increased profits.
USG sales were impacted by the monthly timing of orders, which moved some of the expected Q1 sales into Q2. USG orders in December were strong and we expect this trend to continue which support our outlook for the balance of the year. I think it's safe to assume that the disruption and inefficiency surrounding to the Q1 move to global headquarters building also contributed to the shortfall.
Within A&D, the summary market continues its our solid outlook and we expect to show meaningful growth over the balance of the year, a significant amount of orders have been received as reflected in our Q1 orders, with more expected over the balance of the year.
VACCO, Westland and Globe benefit from these orders as the class continues to expand it's filled rate and our content continues to expand. We anticipate orders for the Columbia class subs in the back half of the year.
On the headwind side, we call that the impact of 737 Max production issue and how it impacts us in total. While certainly that's good news given our relatively modest dollar content in that platform, we can absorb the earnings impact with other fine opportunities within A&D. While our outlook for the year remains the same as communicated in November, it was good to start the year with a stronger than expected as that takes a little pressure off of our second half ramp up.
On an M&A front, we continue to evaluate several actual deals and there's a lot of activity underway in this area. The news of the pack of the sale also brought us few new opportunities from investment bankers and we continue to pursue ideas that we've identified to our operating units.
We continue to look for complementary businesses to acquire in the Aerospace and Defense and USG segment, where we can add to our global distribution network. Additionally, we'll look to expand our USG Solutions offerings into adjacent markets through a combination of internally developed products and software, supplemented with acquisitions. Our Board is very supportive of our M&A strategy and our current balance sheet provides us with plenty of liquidity to allow us to add to our existing portfolio.
So in summary, we delivered a strong first quarter, the balance of the year looks solid and we're working hard for some M&A upside.
I'll now turn it over to Gary.
Thanks Vic. I'll briefly mention that accounting from discontinued operations is noted in the financial statements related to the packaging sale where we recognized a $100 million pretax gain on the sale and we received gross proceeds of approximately $191 million at closing.
We expect to pay approximately $26 million in cash taxes on the gain plus some other fees and expenses related to the transaction thereby netting us approximately $161 million after all this. Since the Q1 results of both periods present were impacted by several unique non-operating items noted in the release, such as the gain on the sale the packaging business this year, the gain on the Doble building sale last year coupled with the specific identified cost reduction actions that we've undertaken. I will focus my prepared remarks on the adjusted numbers as these are more relevant measures of our operating performance.
Also using adjusted numbers is consistent with our previous financial statement presentations and related management commentary. As noted in the release we reported Q1 of adjusted EPS of $0.43 a share which as Vic mentioned was $0.03 above the top of our guidance range of $0.35 to $0.40 a share and is also above the analyst consensus estimate of $0.40.
Comparing Q1 of 2020 to Q1 of last year on an adjusted basis, we increased our sales 5% to $172 million led by A&B with growth contributing nicely to that growth together with PTI, Crissair and VACCO. We also increased our adjusted EBITDA by 5% led by Test and A&D which increased 30% and 18% respectively.
With the proceeds from the divestiture we paid down our net debt to $53 million and lower the leverage ratio to $0.92 million. This level of debt is well below where we believe an idea of capital structure should be and we are working hard to utilize our low cost liquidity to grow our portfolio through additional M&A.
Our cash flow from operating activities was below expectations primarily due to the timing of several large cash receipts on a few of our major contracts where the cash came in shortly after quarter end. We continue to focus on this area and I remain comfortable that our current initiatives are showing progress which will be reflected in enhanced cash conversion ratio for the year in total.
Since the earnings release lays out other key points and highlights of the quarter I’ll dispense with repeating them here so we can get to the Q&A. So for my final comment on the quarter, I remain confident with our fiscal year outlook and our ability to generate cash flow from operating activities to fund our future. Given our significant liquidity from the divestiture along with our recently expanded credit facility we are well-positioned to effectively execute our M&A strategy and support further growth. All of this while remaining focused on ROIC and increasing shareholder value.
So with that, I'll turn it over the operator to begin the Q&A.
Thank you. [Operator Instructions] Our first question comes from the line of Tanwanteng with CJS Securities. Your line is now open.
Good afternoon, gentlemen. Thank you for taking my questions and nice quarter.
Thank you.
Just wanted to start with the quarter itself and kind of the outlook that you've given for Q2 both of which were above the consensus, you didn't raise your annual guidance, Just wondering if there is any shift from the second half and the first half in terms of profitable expectation or future [indiscernible]
Yeah. I'll start out with the - on the numbers, John, and then I’ll let Gary give his overview on the thinking kind of in the aggregate. I think what we started out with a little better expectations in Q1, we think we're going to have that same kind of treatment across the balance of the year. But sitting here this early and only three months after we put the year’s guidance, we just felt it'd be a little premature.
We didn't want to get out ahead of ourselves for the year, but as we alluded to and we pick out the one pretty decent sized headwind of the MAX that we can overcome that with some other things, I think just the balance of the portfolio, our risk in total is balanced, but with 10 months left in the year, I just think it's more prudent to kind of hold our position till we get - till we get further through the year. So that's my view of the numbers.
And I'd very you seem very consistent with that. And again we have our best guess at what's going to happen with Boeing and the USG. It's going to be a fluid situation. So there always is a potential for additional downside there. And so I just think it's prudent to kind of stay we're at this point but certainly we're working to improve on that.
Okay. Great. Thank you. And just remind us what the content per plane is on the MAX? And if you have any other risks that you see in front of you whether it's coronavirus or anything that might be on your horizon or radar?
On the MAX, on the OEM side obviously it's not in the aftermarket yet. It's about $15,000 per plane. And what we feel comfortable about is obviously they're not producing and putting those into service. So what that really means for the Airlines that are flying other 737 they’re trying to cover the routes with the stretching the points a little longer.
So, what we’re seeing is a little bit of uptick in the aftermarket, but not – but the airlines not having the fleet fully staffed with the max that we are seeing a little bit of benefit. But 15,000 per plane is why we called it modest is the revenue contribution and that's why I think regardless of it, they can't go below zero. So, it's really as big as that. So, it's a time or duration thing and so I think we've captured it in our risk profile. We have enough other identifiable opportunities.
Hey I don't know of any other significant risk if we did. We'd be talking about and I did talk to our ever test segment today and asked him specifically about Coronavirus and he said as long as it gets resolved in the next 60 days or so he doesn't think of be any impact. I mean, it gets much beyond that issue you really have is installation because we do installations in different parts of China. And so at some point if it drags out forever could have some impact. I don't think it's anything major. There's something we're going to track very closely.
Okay great. Thanks for the color. I wanted to talk a little bit more about Globe. You mentioned the increase in content in your submarines. Can you talk about what your full content is per Virginia and per Colombia and how many of those are expected each year for the next year - for the foreseeable future versus what is actually in your backlog?
Yeah. I'll go with the content side of that question, John. Let me give you the overview of the build rates and all that sort of thing. So, I'm on the Colombia class today and this is across the platforms. So it's globe obviously, but it's also Westland excuse me in [indiscernible].
So it's right around $29 million per a vote on Virginia. And then once the Colombia comes online which current thinking on that is we should start getting orders in the back half of the year with some advanced deliveries in 2021 because that’s when they’re supposed to start whole construction on that. And it’s a little bit north of 4D on the Columbia Class and just as a reminder they're going to do one of those every other year. So that calibrated as if one use round numbers 30 on Virginia Class and 40 on Columbia.
Yeah. In the Virginia class, the current plan is two-year going forward. There's some talk of increasing it to three, but that we certainly don't have it in our forecast. And she had to be saying it was going to happen in a couple of years. They'll start to retrofit of some of the existing submarines that are out there. And again, we don't have that in our forecast yet. But that's something that we certainly think we're well-positioned when they start that process to participate in.
Okay, great. That just on the backlog question, do you have a specific number of boats in your backlog?
The answer is. Yes. But I don't have that readily available. I know in the backlog, they haven't fully funded. Block V is 9 boats with an option for a 10 in the orders that we receive. So the way we treated kind of be conservative is you get the contract for the full allotment, but we don't put them into backlog until we actually get the purchase order.
That's boat specific. And so the backlog today reflects the boats that we have POs for. And normally what they do is they release the POs to us in a two or three-boat configuration. So the conceptual backlog relative to contract value is substantially larger. And again our prudence in doing this is just booking the orders specific to appeal release. So I would…
Got it.
…say and again let me just point out one more thing. It's not just Block V and we're still delivering product for Block IV, okay. So there're several more boats in Block IV that they’re going to hit the water over the next few years. So the beauty of our positioning is we're well out of head. Our stuff is getting delivered to the boat builders, electric boat in Huntington Angles, and those boats well in advance of the boat hitting the water. So you see the backlog coming in, but what we're really shipping a lot of this stuff what we're shipping is still for boats number, not a block four.
Got it. Thanks for the color. I believe you've been tracking a high number of M&A opportunities. Can you give us an update on the number and size of targets out of their valuations and kind of relative closest transaction happening?
Yes. We probably are - not probably, more attracted about a different – potential acquisitions now, they're in various stages. Everything from pretty far down the road to start to take a look at some things, it's something that we've just done a board meeting last week, and there was still lot of time reviewing those with the board because obviously this big opportunity for us going forward, and it seems like more and more things are popping up. So we feel really good about the pipeline that's out there now. We're being prudent as always on these things, but we do think we'll be able to have some success this year.
Okay. Great. And then Gary just one last question. I think you've completed the move for the Delta headquarters some other restructuring programs. Just remind us how much you’re expecting to save on a year-over-year as a result of this?
Yes. I see. We're trading dollars obviously when you own the building and that sort of thing you have a cost, but some of it is depreciation on the facility versus now it's cash rent. I think the net savings will be upper hundreds of thousands maybe just a hair less than $1 million just on the facility aspect of it.
And then, the intangible savings that come along which really it's too early to quantify just the efficiency of having everyone in one building and having a more state-of-the-art building that has – the workflow is a lot more efficient and that sort of thing plus the next intangibles retention of people plus hiring of people. Those intangible values I think will benefit us in the future where we can't assign a dollar value to that other than say they're greater than zero.
Okay. Got it. Hope to see you soon. Thank you, Kate. Appreciate the questions.
Thank you. Our next question comes from the line of Robert McCarthy of Stephens. Your line is open.
I guess first the USG, could you just talk a little bit about the timing and I guess presumably of revenues and do you expect kind of that the hit in 2Q and that that informs kind of a particular guide or how do we think about that in some of the volume and profitable – profitability shortfall and how that plays out?
Yeah, I'd say, as we look at the cadence of the order and the conversion of that into revenue, some of the stuff comes in and ships the same way, but for the most part when we get an order it's in the 30 day to 60 day kind of delivery window unless it's a large project like an arms or a double-prime or something like that.
And that's why the comment in Vic's remarks about December being strong and the order profile gives us confidence that the Q2 revenue has a step function up from where we were here and again the disruption of moving, you're physically doing things back and forth, so there's a little distraction aspect.
So those two things you set aside and I think we have a pretty good profile for the year. And again if you go back to the November guidance when we talked about the relationship of this year versus last year on a quarterly profile it's more steeply backend loaded that more closely resembles fiscal 2018 if you remember where we had a pretty predominant greater than 60% relationship of back half EPS to front half. It's driven by the boats.
The Virginia Class stuff we just talked about so across A&D, we got strength there but then Doble is really strong in the back half of the year because there are several large projects that come across the P&L there. And then the Test business is just we tried forever to try to figure out why the fourth quarters what it always is, but it is again this year a dominant player. So that's why the cadence of the profile is the way it is. And our confidence level is supported at USG by the orders we booked so far.
Yeah, I'd just say just one more comment on USG specific that I think that's what we're focused on. As you know we just had a – we had a soft month in November and the Doble products here I’d say it turned pretty quick. And so if you have a soft month it does turn into an issue fairly quickly. But again, we had a strong month in December and a solid month in January. So I think it’s going to be fine. I mean it's hard to predict the exact timing with that business.
That makes sense. And in terms of the re-segmentation or renaming of the segment aerospace to defense, just remind the layman in the room namely me, what is your relative mix now between defense I guess commercial aerospace, submarine, defense aerospace rather in terms a relative mix of the overall segment. Do you have any kind of breakdown of that?
Certainly the Navy business now is about $100 million of sales specific. And that was really a big driver on this because it's kind of hard to talk about filtration and when we're not really filtering anything in those products. If you look at a broader sense you get some specific numbers –
Yeah, up 35%.
On that segment. This is military. So about like 35% of that segment is military. So that’s the naval as well as some products at PGI and Crissair that also go on defense side. Everything else is aerospace – commercial aerospace.
Commercial aerospace. Okay. That's great. And then do you think you are in terms of your opportunity set in terms of those eight acquisitions or are you kind of getting the word out or maybe this is the naive and my point from my standpoint, but are you being starting to see being seen as a strategic acquirer of a certain size of choice in the submarine space?
Certainly. I think we've made it to the top of a lot of people's list, you of a certain size I would say. So we’ve gotten more attention from a couple of those folks and maybe we have in the past and a lot of it’s just getting in with the right investment bank. So when things are going to come to the market whether it be on the Navy side or their aerospace side to make sure that we get it in the queue on those that I think we've been more successful in cultivate those relationships to make sure that we do.
Fair enough. And then I guess in terms of level setting your from the cash proceeds that you have in the state of your balance sheet and your comfort level, I mean what would be your outer bound for M&A appetite in the aggregate? How many deals could you reasonably do maybe over the next year or two without really issuing equity or taking making up at the company or of a debt laden type scenario?
I'll let Gary talk about specific numbers because we just went through this exercise again with our board and I’ll talk a little bit more about timing and numbers and those kind of things, because they really are two different things.
Yeah. And so, not to get into a math exercise, but the beauty of the way the credit facility works is when you buy something you get to pull along their trailing EBITDA as part of the leverage ratio. So to help level set this with the board, and again we have no expectations to complete all eight of these things that we’re looking at. But if you just pick a random sample of those three and pick a large one and medium and small, hypothetically let's say we spent $500 million to $600 million we would pull along something in the neighborhood of $60 million of EBITDA with a 10 multiple. That would bring us up to a leverage ratio of about 2.6. And that's basically that is not uncomfortable.
Right.
Our capacity can go up 3.5 and then we get a holiday for a year should we find something extraordinary. But the beauty of the math is for us to get ourselves north of three we would have to pay a pretty outsized multiples. So if you just kind of think of our history as we kind of pay 8 to 10 times, and if we did a small, medium and large or we spent $500 million we’d be right in the sweet spot of a capital structure that makes sense if you’re levered 2.5, 2.6 times set the match.
And that would be over the 12 months period, right?
Yeah, that be at point in time…
Yeah.
Hypothetical if you three of them at the same time and…
Right.
… keep all those in and then obviously you would deliver off the cash all those operations.
Right.
So as far as what we could do would do are different things. And I think it really depend so much on what businesses you buy as far as what you could do? So if you're buying a larger business with a good management team that are comfortable. They can run that without a tremendous amount of oversight we get integrated and that's one thing for bond smaller businesses.
You really need to put systems in place. Sometimes that can be more complicated than a larger business. So it really depends, I mean, I hate that answer, but that’s a fact on what the business is, where it is, what size it is, what state it's and we never buy fixer uppers, we always say. So we're not nagging about business, where we’re going to drop a team in there and go run it. But some businesses are going to be easier to integrate than others.
So it really depends on what those businesses are and where they are and we're very fortunate that we've got people that can help us with the integration that we've talked before. We usually send the finance person in to help with the integration of this usually, the most difficult part. And then with – so the taxi business, we've got a more senior person that can help on in that regard as well.
So I feel comfortable that we could integrate several businesses, maybe at same exact, but probably at the same time or very close to each other. So it's really going to depend on what business we’re going to be successful moving forward with.
And Rob, let me add one more thing just to the math that you might need for your modeling. Again, this is theoretical in the example that I gave. If we were to spend $500 million or so, with that, we would be adding about $175 million in revenue, if again with multiples. Again, this is all theoretical math right now.
And then just again I want to point everyone to the focus within USG and individual contribution margins are greater than the sum. So what that would mean is if we're targeting those areas that would inherently raise the consolidated operating margins by buying companies that are above more consistent with our A&D, our A&D margins and our USG margins as well. So as you care that across your model it has a nice uplift to it on an even based EBITDA basis – EBIT and EBITDA basis.
Now, to go back to the backlog – go back to the backlog of M&A, would you say that it's pretty level least set between aerospace defense opportunities and utility opportunities or is there a skew to where the opportunity set is?
Well, it's always the point time. So, the point time today, there are more opportunities on the utility side.
No, interesting. Okay. And then in terms of – if you indulge me for a couple more, in terms of op tempo or association with maybe a conflict with Iran or a limited one, could you just remind us from history and maybe what your new portfolio would be, what – how stimulative that could be to your aftermarket within – with infiltration?
Yeah. I don't think it would be a real near-term issue there. I mean obviously the outside of the Navy which wouldn't be impacted at all. Outside of the Navy, you're really talking about replacement parts for aircraft and so it might accelerate it some, but you – probably that's something you'd see six months from that point rather than the next quarter.
And then the last question, could you talk a little bit about where you are in terms of how your journey around the cash and cash conversion, particularly with this divestiture and kind of level setting for what we should be thinking about cash conversion going forward, because the portfolio has changed a bit with the sale of Technical Packaging and some of these M&A opportunities? How are you thinking about kind of free cash flow generation and conversion going forward?
Well, it certainly will improve and again this isn't disparaging to the packaging business, but it inherently had a lower cash conversion percentage than the whole. So, it will move favorably just by the absence of that. So that’s one. Second is the initiatives that we've undertaken have very finite goals and very tangible processes that we're implementing across. Again it's not a digital thing, it's just overnight.
We flip the switch and off it goes because this goes from a sales cycle, when the sales people we have to write contracts better, we have to get better terms, and they're all the way to paying attention to collections and payments. So it's everything in between.
So I'd never want to say we can't get to 100%, but it'll be a challenge to get to 100% because within the Test business, we have processes in the contracts where you get milestones along the way where you might be recognizing revenue and profit faster than you're collecting catch against milestones.
So that's why reference it on a yearly basis, not a quarterly basis because it is going to have peaks and valleys on the quarter. And then kind of the same thing on the Virginia Glass, you'll get a big cash down payment as we did in Q4 at VACCO last year. And then you burn that off. Then we're spending the money against that in Q1 and Q2. And so you're going to have the earnings there for the percentage of completion stuff, but you're not going to have the cash because you already received the cash.
Now you do an outflow. So our goal is a lot of words around to say. Our goal is to get us into the mid-90s. I think last year Kate we were in the upper 80s, I would say 87%, 88%, and our goal is to get to 95%. And I think we have a clear path to that. But it's not going to be by Q2. It's a process that I think as we get to the end of fiscal 2020, we'll be in a lot better shape. By 2021, well be an even better shape than that conversion.
And remind me this is the last housekeeping item just how much amortization should we expect for full year 2020?
Bear with me a second. $42 million will be a good round number.
Really appreciate the time.
Hey, Rob, just to be clear, that’s depreciation and amortization.
Oh! That is, okay. Right. Well, we'll drink a double espresso and figure it out and then take it offline.
Thank you. [Operator Instructions]
Okay. It doesn't look like we have any further questions. So thank you everybody for joining us. Look forward to talking to you in the next call. Thank you.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.