Kate Lowrey - Director of IR Vic Richey - Chairman and CEO Gary Muenster - VP and CFO.

Sean Hannan - Needham & Company Jon Tanwanteng - CJS Securities Sean Nicholson - SBH.

Good day and welcome to the ESCO First Quarter 2017 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 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 2017 and beyond EPS, EBITDA, EBIT, EBIT margin, growth, profitability, sales, cash flow, orders, success of new products, success in completing additional acquisitions, the results of recent 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 the most comparable GAAP measures can be found in a 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, and good afternoon. Before I turn it over to Gary for his financial commentary, I’ll provide an update on the status of the integration and operating performance of our most recent acquisitions. Starting with technical packaging both Fremont and Plastique continue to perform ahead of our original financial expectations.

And we continue to see several meaningful opportunities to grow these businesses and expand our medical, pharma and fiber pack product offerings both domestically and internationally.

The management teams in place when we acquired both companies have proven very capable coming from a relatively small private company environment, I've been really impressed with the way the teams have adapted their skill sets so quickly into a public world - public company world which you can appreciate is not an easy task.

As a result we've been able to promote several key managers in positions of increased responsibility. With Westland, we not only acquired an outstanding company and a meaningful contributor to protection of the US naval fleet but also a solid management team who are deep on talent and solidly committed to our business and our success.

This has allowed the integration to go smoothly and efficiently. I'm pleased to see Westland outperform expectations in Q1 and anticipate continued solid performance over the balance of the year.

Wrapping on Westland, I had the opportunity to spend time with our president and I'm impressed with not only with his product knowledge and industry expertise but with the deep relationships he has established across our customer base.

I’m certain these factors will allow Westland to increase its product contributions over time as we continue to develop new products and highly engineered applications to meet our customers increasing their requirements.

Lastly, with Mayday, we not only acquired a unique set of high end process skills covering a broad range of products and applications but also their energetic and knowledgeable management team. The production workflow demands are very dynamic as they change frequently with short notice delivery schedules.

This requires a management mindset that is both agile yet highly process focused given the tight tolerances and demanding specs that leave no margin for error. Our Mayday is strong experienced and well positioned to take on any challenges on their way. the integration has gone smoothly and is on schedule.

And I’m pleased to report that our Texas teammates seem excited to be a part of ESCO as they see the growth opportunities in front of them.

So to wrap up it's always been my strongly held believe that to be successful with M&A now we have to find the right company, but more importantly you have to find the right management teams to lead the organization and take your strategic investment and vision and make it a reality.

I think we've accomplished those objectives with all of our new partners. Now I’ll turn it over to Gary for financial highlights before providing you with some operational commentary..

Thanks Vic. At the start of the year, we laid out our detailed guidance for Q1 as well as for the full year and noted that our quarterly earnings profile was backend loaded similar to years past.

Our Q1 EPS was projected to be in the range of $0.35 to $0.40 a share on a GAAP basis and additionally we indicated our GAAP earnings were impacted by some non-cash purchase accounting charges related to our recent acquisitions.

We described and quantified these incremental charges related to the inventory step-up at Mayday as well as additional incremental non-cash depreciation amortization charges that were expected to be incurred as a result of our recent M&A actions.

As noted in the release, we delivered Q1 GAAP EPS of $0.41 a share which beat the top end of our expected range despite some timing related sales headwind at Test and VACCO. We were able to beat the top end of our earnings targets as Doble’s Q1 sales and earnings came in well ahead of plan.

Coupled with the continued strength of our commercial aerospace platform, which once again delivered outstanding results. Westland and Mayday’s contributions were better than expected in Q1 as they delivered a combined 13 million in sales with EBIT margins well above their earlier commitments.

Mayday’s inventory step-up charge recorded in Q1 was approximately $1 million. And as we noted in the financial tables within the release, depreciation and amortization increased $1.7 million in Q1 compared to the comparable prior year quarter.

So on an EBITDA basis, we increased our Q1 contribution significantly despite incurring a $1 million inventory step up charge at Mayday. We are confident that the timing related shortfalls in Q1 at Test and VACCO will not impact our outlook for the year.

And it's confidence in validated by the significant level of Test orders booked in Q1 that we expect to convert the sales over the remainder of the year as well as VACCO’s legacy space and maybe business in backlog that is scheduled for completion in the next few months.

A few other Q1 highlights include the strength of our energy entered orders especially as I noted in Test which reported a 1.66 book to bill. I'm also pleased to report that each of our operating segments delivered a positive book to bill which increased our backlog by $37 million or 11% since the start of the year.

Additionally, we beat our cash flow forecast in Q1 as we delivered $16 million of net cash provided by operating activities and ended the quarter with net debt of approximately 128 million and a very reasonable leverage ratio of approximately 1.5.

Given our solid start to the year, our EPS and EBITDA outlook for the balance of ’17 remains consistent with the expectations communicated earlier.

We continue to expect ‘17’s EBITDA to increase between 21% and 23% and be in the range of $122 million to $124 million compared to 16’s adjusted EBITDA of $101 million So given today’s outlook, we remain well positioned to achieve our financial goals as we continue to see meaningful sales, EBIT and EBITDA growth across each of our business segments in ’17.

And in the longer term, we expect to exceed the growth rates of our defined peer group in the broader industrial market in total. Our Q2 EPS guidance is projected to be in the range of $0.37 to $0.42 a share on a GAAP basis.

And as a reminder this includes the remaining balance of Mayday’s inventory step-up charge and the quarterly impact of incremental depreciation and amortization as we communicated previously. So I’d be happy to address any specific financial questions when we get to the Q&A and I’ll turn it back over to Vic..

Thanks Gary. I’m pleased with our quarter one results in a lot of perspectives mainly because of the way we exceeded our earnings commitment despite the sales headwind at Test and VACCO. Exceptional performances were delivered by Doble and our aerospace businesses more than offset the timing issues noted.

I firmly believe our Q1 results once again validated one of our major benefits of maintaining our multi-segment [indiscernible] platform. Given our diversity of end markets, we can usually manage on various operational stress points given that we have several alternative paths to achieve success. In Q1, I believe what we did what we do best.

I’m proud that our collective management teams came together to deliver operating results, which again exceeded our internal expectations despite the noted challenges. Since Gary covered the financial details in his commentary, I'll focus my comments on the balance on the balance of ’17.

Looking at the business today and the opportunities and challenges in front of us, I remain confident that all of our businesses are in a solid financial condition with known and quantifiable growth opportunities and they were well positioned to deliver commitments in ’17 and the out years.

As I’d regularly commented during our earnings calls, we are not immune to economic headwinds many industrial markets are facing today.

But with that said, I firmly believe the breath and diversity of our end markets [indiscernible] that we operate to provide in continuing to provide us with protection to mitigate this pressure as was evidenced in Q1. I’ll provide a few brief comments on individual businesses.

In filtration, we continued to expect the segment to deliver solid results in sales growth, EBIT and EBITDA contributions and cash flows during ’17.

We remain well positioned on several fronts including the continued upside in commercial aerospace, contributions from Westland and Mayday growing opportunities in space on the SLS program and unparallel technology on navy submarines and surface ships which are critical to our national security.

Our technical packaging group's outlook is solid as we have meaningful scale and market leadership positions across several growth markets and geographies. We’re well positioned as a global market to provide highly engineered products to customers in the medical, pharmaceutical and consumer markets.

Given this positive outlook, we will make additional investments in this business by adding a medical clean room in UK and by expanding the manufacturing plant in Poland to capitalize on the slower manufacturing cost and adding additional capacity for fiber packaging.

I remain confident the opportunities we are seeing globally set us up nicely today in the out years. Moving on to Doble, we are seeing some easing of the spending constraints with the electric utility capital budgets and we set our growth expectations around these opportunities.

We continue to see additional outside opportunities in software and service applications which could help mitigate any slower than expected budgetary spending.

During Q1 we saw solid performance from our new products such as the M Series, doblePRIME, and DUCe coupled with the strength of our software offerings I remain enthusiastic about Doble’s future. At Test while Q1 sales performance was below planned due to time of orders from one of our key customers.

A real disappointment was at the temporarily lower sales masked the real impact of the cost savings we implemented last year. As year grasses and strong backlog converts to meaningful quarterly sales increases, we expect to deliver our EBIT margin commitments established earlier.

As I noted in the opening comments, I’m really pleased with our recent M&A activity and while we've been busy completing and integrating these deals we are not done. Acquisitions remain a key component of our ability to meet our longer term growth targets and we continue to evaluate several exciting opportunities.

We certainly have a balance sheet capacity to do more M&A and we have the management bandwidth to handle this additional growth within our current operating infrastructure. But we will continue to be disciplined in our approach and not lose focus on improvement in our returns.

Wrapping up, I’m pleased with Q2 results and I remain confident in our outlook for ’17 remains solid.

As you know in business you never get to declare a victory, so as we move forward throughout the year, our focus remains constant, continuing to improve our operational performance and to execute on our growth opportunities both organically and through acquisitions because this is how we will increase shareholder value.

I will now be glad to answer any questions you have..

[Operator Instructions] Your first question comes from line of Sean Hannan with Needham & Company. Your line is now open..

So first question I have is specific to Doble. I was looking to see if I could get a little bit more color around the momentum you're seeing. So you called out a couple of products and services.

As I first think about new products, want to get some viewpoints from you in terms of how long this momentum might be able to sustain, maybe based on product cycles you've observed in the past.

Also want to get a little bit more of color around services and in addition to that then, the software piece, the arms platform and to what degree that that's still making progress in the background. A good viewpoint beyond just the highlights that you had mentioned for the quarter, would be helpful. Thanks..

Okay. So that was a really long question..

Yes. That was. I apologize..

If I don't answer the whole thing come back and we'll try to clean it up. So the things are going well at Doble just specifically some of the new products. As you know most of the products at Doble are very long-live products. And once we implement them, get into the field going to be there for a long time.

And so the key product I specifically talked about with end product which is a product we introduced probably in the 18 months hence replacing some of our other products although not one for one but that is really off to a strong start.

I would say the sales for the product had been a little above what we thought they are going to be and that is a product that would be in the field for quite some time. It also is a product that's going to go into our lease pool, which as you know is a very good part of our business because you have some predictability in it.

Also on the software side, as you mentioned, whether the arms or some of the things we got through Enoserv. The arms is a long sales cycle, but we are starting to get some good traction there. But this Enoserv is a business [indiscernible]. It has been a real success. We won't talk a lot about it.

It's a fairly small business, but I would say it’s really exceeded expectation to give us another product to take to the market. And then with the DUC system, the Doble universal controller, we had two pretty significant sales in the first quarter on that product and we see that accelerating as we go forward.

So I would say that Doble is really doing well and that we got some traditional products that we continue to sell that's gone well. We've got new product introductions at our, kind of the early stages I would say.

And then we really emphasized in the service side, particularly international, and what we're finding is getting some of those customers, having them understand the services, as doing some work for them like we do in Saudi, it gets us ingrained with the engineers, helping them understand our capability and our capacity and then we’re able to do, take that and turn those into hardware sales as well.

So whether that be in Saudi or some other place in the Middle East where we're starting to see success. With South Africa, really kind of leading with the services and then able to follow up with the hardware sales..

Okay. That's great. And then you had mentioned Saudi. Is there any conversation at this point in the game, given you're really kind of a few years into this and on to, you know, you've completed some stages.

Is there any conversation you have with them in terms of once you get beyond the baseline testing, being able to formalize a more substantial or kind of follow-on arrangement or relationship?.

Yeah. It's been a real success story. We’re at the third year of the contract in addition to the service side, we have sold a decent amount of hardware. I don't think this is a contract that is going to just come up to end of the year and stop.

I think you really see the value of what we’re providing and I think this will be a longer-term opportunity for us, a longer term relationship that's not defined at this point.

There have been conversations about that, but it's really too early to tell, but I would say, the customer has been exceptionally appreciative of what we've been able to do and I think we've gotten them a long way, but there's a lot of work to be done there if they choose to go forward.

I’m pretty sure they’re going to be working with us because they have been very happy with the support they’ve gotten from the team..

That's great. And then another -- last question here, I'll jump back in the queue. The packaging business, I'm not sure if I caught the commentary around why the margins were a little soft there. Want to get a better understanding around that. I know obviously you're still working through some integration. But I was surprised by the margin, number one.

And then number two, if you can elaborate on, if I heard correctly, you're going to be making some additional investments within that business. At least it seemed to me that you had mentioned it was that for business. Just want to understand that a little bit better. Thanks..

Sure. As far as the margins, it's really two things. The business Plastique that we bought in Europe, their first quarter is always pretty soft, because their big quarter is kind of the second, well, second half, the second quarter and the third quarter. So theirs is a pretty seasonal business. We knew that. So this quarter's always soft.

So that's -- part of it, the other piece of it is the KAZ product, [indiscernible] covers, it was a pretty mild flu season last year. They had a good bit of inventory left.

So they pulled back on the production of that product in the first quarter, now it’s back up at full production as of January at about, we’re selling about $1 million a month there, but that was pretty significantly cut back in the first quarter.

So those are really the two things that impacted the, I don't have a concern about the margins for the year. It's just that this first quarter capping the first half of the second quarter is soft as a result, primarily the timing of the Plastique award.

And then as far as the investment, yeah, we made the acquisition, the plan always was to make an investment there because the plant they have in Poland, it’s a good plant. It's just not big enough for the work that we have in the pipeline.

So we want to get that in place so that as the business comes in, we're able to fulfill it and we've already gotten a good bit of the work, a good bit of the orders that are going to fill those new machines in the factory.

The other thing that I mentioned was, the medical clean room in the UK, one of the primary reasons we wanted to have the operation in Europe was because we were unable to effectively service the medical clients out of the US just because of the shipping cost.

And so what we committed to do was to set up a clean room, facilitate that with the same equipment that we use in our US based business. So that we would be able to service those customers, and so we’re in the process of doing that.

I think all of those investments will be completed by the middle of the summer and it will up and running in both of the locations and able to support those customers..

And hey Sean, let me put a couple of numbers around what Vic was saying relative to the seasonality. So in Q1, you'll notice in the release, I called out that Plastique did about 7 million in revenue and their annual run rate is about 36. So if you're looking at annualizing that 7m obviously it's 28.

So you can see when you're running at that lower volume, you're getting stuck with a lot of overhead, because there's a lot of manufacturing. And then on the KAZ business, it tends to be about 900,000 a month.

So say somewhere between $2.5 million or so would be the impact of that and that's almost a fully automated process so in that business, there's not coming through, there's a lot of overhead sitting on those machines that aren’t being put through. So those are the two, that's the math around Vic’s commentary..

Next question comes from Jon Tanwanteng with CJS Securities. Your line is now open..

Hi, gentleman. Thank you for answering my questions.

If you could, what was the magnitude of the timing delays you saw at VACCO and Test and are they going to fall in to the March quarter, which you saw delayed?.

It won’t. I would talk about the magnitude. I don’t think we will be pulling this out in the second quarter. I think it’s going to be really third and fourth before we’re able to get those pulled through, primarily because of the timing of the orders and customer acceptance at some of the VACCO products..

Yeah. And so Jon, numbers around that. On the VACCO side, relative to our November conversation, that goes about 2.7 million to 2.8 million light on the revenue in the test business with the order profile was about 2.2. So together, it’s about $5 million..

Got it. That's very helpful. And then could you talk a little bit more about the opportunities at Westland and at VACCO, if sub-orders or delivery schedules do increase to three a year, and how pricing may actually play into that if the orders do increase? I understand these are longer term prospects given the lead times for these submarines. .

So I think I’ll try and get the numbers right. I think we got about $6 million to $8 million of content on the submarine, on a typical submarine. So if those build rates go up, this is a type of pull through. And that’s at VACCO and then we’ve got additional at Westland. So two of them together, somewhere between $8 million and $10 million in ship set.

So you can see if they do increase production, it can have a pretty significant impact. Those are both fairly profitable businesses..

Okay. Great. And then finally, can you talk a little bit more, give us an update on your near term plans for M&A? Are you taking time to digest Mayday and Westland right now or are you still active in the market and if you are, just talk about environment evaluations you’re seeing out there? Thanks..

Sure. So I would say that the, as I mentioned at the start of the discussions, the integration I won’t say is completed, but we’re very far down the road and these three acquisitions have probably been the three of the most easily integrated that we have and as I mentioned, I was just talking about the management team to make them feel good.

And we have people that really have jumped on board with these things. We also listen internal resources to help with the integration, we’re fortunate to have finance person to put in that Mayday for a while as we made that transition. Also, we have transition service agreement with the prior owner.

So it’s been a very easy transition and I’d say we’re almost complete there. So we’re certainly back out and looking for additional acquisitions, there are several things out there that we see of interest. I’d say the valuations have not been crazy.

They’ve been and I think you’ve seen from what we’ve bought more recently that we’ve been able to get three quality companies for a reasonable, a multiple and we see that continuing at least the things we’re looking at now.

So the activity over the past 18 months has been very good for us, we were able to get four things done over the past 18 months and I hope let’s continue to do that and I think you’ll see us continue to do the type of acquisitions that we’ve done over the past 18 months.

I think the SaaS and the niche approach of those businesses is what we really do well and so we’ll continue to remain disciplined and look for opportunities like those, look through good opportunities out there..

[Operator Instructions] Our next question comes from the line of Sean Nicholson with SBH. Your line is now open..

Good afternoon. Gary, this is probably more for you. You guys obviously are disclosing more around EBITDA, which I think is great. On the EBITDA margins, though, looking at the projections, by my math it looks like FY17, margins around a little over 18% if you include corporate costs.

You know, 22%, if you kind of look at an operations basis, excluding corporate.

Is that in the ballpark?.

Yeah.

I think that’s pretty spot on when we gave the guidance range of the EBITDA, we said kind of the 123, 124 kind of number and so if you use that as the peg and put the revenue projections we're talking about, I think on a consolidated basis, you can get a little north of 18 and then on an operations basis, and I don’t mean backing stuff out, just not counting the corporate costs and that sort of thing.

And so, yeah, it's pretty close to 22..

Okay. You know, I don't know if you have this kind of a view of your recent M&A transactions at [indiscernible] and I think they traded at 16 times, Zodiac Aerospace I think went over 26 times. You guys are right around that 12, 13 times EBITDA.

Is there still opportunity to increase the EBITDA, dollars and margins? I mean, from what you guys can assume in the business today? Trajectory?.

Yeah. I’ll start with the operational side and then Vic can do the M&A side, because I think obviously as long as we keep buying stuff at less than what we’re trading for, I think it adds value.

But while we’re doing well with the integration of these business, there is still some inefficiency because we have a lot of corporate people involved and it’s just not out at the subsidiaries are doing their own thing yet. So I think once they get going through our process, isn’t that integrate those where they’re doing it.

I think there is a little bit of an upside in the longer term relative to that plus I think what I’m seeing from the numbers is when you look at the smaller companies like the Mayday and Westland that we’re standalone in private equity, no offense to private equity, but I think customers have a feel for private equity that we’re going to do business with the same folks five years from now.

And so I think being part of a bigger company is where that enthusiasm is the folks on our side at Westland and Mayday talk to me, they’re excited to be part of the big company, because now when they’re talking to customers, they know that the stake in the ground is put there and it’s going to be a part of escrow, and not be flipped six months from now or a year from now.

So I think both of those things will bode well in the longer term from what we have and then I think in Vic’s comments on the M&A, we’re not going to buy fixed rubber. .

Yeah. Just to follow-up a little bit, yeah, and the companies we bought certainly were not, and I would say that the previous owners did a nice job of investing in the business and making sure that they had what they needed.

Having said that, obviously being as part of the larger company, we can make larger investments I would say particularly in the sales and marketing side, where maybe they didn't -- they couldn't have enough people out in the field.

So we have a lot of people in the field already, I think we can capitalize on the fact that we have maybe broader customer relationships.

We have some thoughts on other markets we get into and I think just having that is probably the biggest opportunities, so I think we'll get more on the growth of these businesses and we just doing better manufacturer, certainly doing a really pretty good job.

I think we can add some things there, just because anytime you have a larger business, often, you have a larger business, it is more expertise within the organizations that help. So that [indiscernible] we don’t have the bandwidth to go fix businesses, we certainly can help manage businesses, but that’s not what we’re playing to do..

I’m showing no further questions in queue at this time. I’d like to turn the call back to Mr. Richey for closing remarks..

Okay. Well thanks everybody for your questions or comments today and look forward to talking to you at the next call..

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone, have a great day..