Good day, and welcome to the ESCO Fourth Quarter 2019 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, timing of the divestiture, tax rates, shareholder value, 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, and good afternoon. Gary will describe our fourth quarter and full year financial results in detail after my comments. So I'm going to take a few minutes to discuss the sale of our Technical Packaging business and share our thinking around the strategic aspect of this divestiture.

Five or six months ago, we were not contemplating selling our packaging assets, as we saw a clear path for this business to expand its contribution within ESCO. Given their identified prospects for growth, we made some meaningful capital investments in 2019, both domestically and internationally to support this outlook.

But given the robust valuations we were seeing in the market, coupled with our strong presence in the medical -- medical device and pharmaceutical markets, we knew we had an attractive set of packaging assets that would command a solid valuation, if offered for sale. And yesterday's announcement of the transaction proved we were right.

After a thoughtful analysis of our options, we came to the conclusion that monetizing our Technical Packaging assets had a strong valuation was strategically positive and financially prudent. This transaction makes a lot of sense for a lot of reasons.

It allows us to delever by paying down our outstanding debt, which creates additional debt capacity and liquidity for future M&A spending in our other segments.

The transaction also streamlines our business and simplifies our portfolio, which allows us to focus on our remaining core operating segments, both on organic growth and continued M&A around this core.

On a personal note, I would like to thank Randy Loga and the entire management team and the dedicated employees around the world, who worked so hard to make the packaging business to success and I wish everyone all the best in the future with Sonoco. Now I'll turn it over to Gary for the financial discussion..

Thanks, Vic. We wrapped up the year in a strong fashion compared to fiscal 2018 by delivering solid top line growth coupled with 9% growth in adjusted EBITDA, 13% growth in adjusted EPS, strong cash flow and record entered orders. As all of these items exceeded our previous expectations set earlier.

Similar to the past, our sales, adjusted EBITDA and adjusted EPS not only exceeded our expectations but they beat the consensus estimate driven by continued strength across all three core segments. On a segment basis, Filtration sales increased 14% over prior year or 11% excluding Globe.

This growth was led by our aerospace businesses, where sales increased $32 million or 19%, resulting from continued strong demand across our extensive aero platforms both OEM and aftermarket and both commercial and defense.

This growth was partially offset by VACCO's Navy business, which had lower sales in 2019, resulting from revenue recognition timing items on several large programs. Globe added approximately $9 million of sales in the three months that we own them. Test and Doble both grew sales at better-than-expected amounts.

And our renewable energy business decreased in 2019, which mitigated our USG sales growth. Our 2019 adjusted EBITDA was $151 million compared to $139 million in 2018 and our adjusted EPS was $3.13 a share compared to $2.77 a share in 2018 which reflects 13% growth.

These increases were accomplished through a combination of meaningful sales growth, a favorable sales mix, rigorous cost management, coupled with solid execution across the company and topped-off with solid tax planning strategies.

Additionally, I think the strength of our 2019 results continues to demonstrate the earnings power that we can generate at higher sales volumes and continues to support our multi-segment, multi-industry strategy.

Our cash flow provided by operating activities for the year was $105 million which resulted in $224 million of debt outstanding which reflects an extremely comfortable leverage ratio of 1.68 at September 30. Q4 cash from operating activities was $68 million reflecting our strongest -- our strongest quarterly cash flow in history.

This was driven by solid earnings and enhanced focus on working capital management and strong cash collections. I'm also really pleased with our entered orders both in Q4 and for the year, where we set a record by exceeding $900 million of new business for the first time.

It was also great to see how our order growth was spread nicely across the operating segments. This order level resulted in an increase ending backlog of $92 million or 24% from the start of the year. This gives us some comfort supporting our fiscal 2020 growth outlook.

Looking forward to fiscal 2020, I'll provide a backdrop for our outlook that was detailed in the press release and point out that all comparisons between fiscal 2020 and fiscal 2019 are done excluding technical packaging from both periods.

We expect to grow our top line 9% to 10% on a consolidated basis led by Filtration which is centered around 14% growth followed by USG at 7% to 8% with Test growing 4% to 5%. We expect adjusted EBITDA to increase 12% to 13% with the corresponding margins increasing nearly a full point.

Non-cash depreciation and amortization is expected to increase approximately $5 million which negatively impacts projected EPS by $0.15 a share.

We are projecting a 23% to 24% effective tax rate which is higher than our 2019 rate which I noted earlier was favorably impacted by various tax strategies which generated both cash and earnings benefits which we do not expect to repeat in 2020 at the same level.

This higher tax rate differential negatively impacts 2020 projected EPS by $0.10 a share. So when bringing all these together, we expect our 2020 adjusted EPS to be in the range of $3.20 to $3.30 a share when excluding the packaging business. This reflects a meaningful increase over the pro forma adjusted EPS of $2.95 a share for fiscal 2019.

So in closing, given our new and expanded credit facility and available liquidity, we are well positioned to effectively execute on our M&A strategy and support future growth both organically and through acquisitions across our core businesses. All of these, while remaining focused on ROIC and increasing shareholder value.

And with that, I'll turn it back over to Vic for a few additional comments..

Thanks Gary. I'll update you on a few items that were in process when we last spoke. We officially moved into the Doble headquarters facility last week and everyone is really pleased to have this disruption behind them and have settled into their new office.

I'm really happy to have all of our Boston area employees in one location as I'm certain this will enhance collaboration and productivity and will certainly benefit our employee recruitment, given its favorable location.

Also within USG, we continue to see solid progress in customer acceptance within NRG's bad return product and given a strong support from all the stakeholders and the positive test results being documented, we see this solution as a growth opportunity for the company. I'm excited about Globe's future as they're off to a great start.

The fit with us is obvious as synergies with a shared customer base are already paying off with expanded order flow.

As Gary mentioned, our Aerospace and Space businesses continue to see an uptick in order and sales activity and I'm pleased to see the Block V awards on the Virginia-class subs being released, which will benefit VACCO, Westland and Globe. Our Test business outlook for 2020 is solid and we expect to see continued order strength throughout the year.

Among other end markets, 5G continued to gain momentum. We continue to look for additional acquisitions to support our organic growth and we plan to deliver on our commitments in both these areas to support longer-term growth objectives. In closing, we remain focused on successfully executing our strategy and we're planning for a successful 2020.

Now I'll be happy to take any questions..

[Operator Instructions] Our first question comes from the line of Jon Tanwanteng with CJS Securities. Your line is now open..

Good afternoon, guys. Thanks for taking my questions..

Thank you, Jon..

Gary, could you give us the adjusted EBITDA number and margins that you're working off of, or basing the 12% to 13% and EBITDA margin expansion growth level for next year?.

Yes. When we look at where we're looking to go.

If we pro forma 2019 is that what you're referring to?.

Yes..

Yes. I would say, it's about $139 million for 2019. And then we're seeing the 12% to 13% growth off of that number and that $139 million is what correlates to the 295 of pro forma -- adjusted pro forma EPS for 2019..

Okay, great. Thank you.

And then, can you give us a bit more color in terms of the timing of your backlog and the dip of your forecast in Q1 into Q2?.

Yes. Let me do it from the bottom and I'll refer to Vic if he wants to talk about the business side of it. So one thing I want to make sure everyone is aware is, kind of, what the profile of the year looks like. We tend to have significantly back half-weighted years.

It seems like every other year, this year, in fiscal 2020, it looks a little bit more like fiscal 2018. And so, just to give you a couple of statistics to saving the map, in fiscal 2018, in the first half of the year we did about 29% of our annual EPS, which means 71% came in the second half.

Fiscal 2020 -- I'm sorry, fiscal 2019 was a little flatter, we did 40% in the first half and 60% in the second half. And fiscal 2020 Cadence will look a little bit more like 18 where we'll have somewhere between 30% and 33% of our EPS -- adjusted EPS will hit in the first half which means 67% will hit in the second half.

So while the quarterly profile is back-end weighted again, it looks pretty similar to the achievements that we realized in fiscal 2018 on that kind of weighting.

And that's really just a function of the bigger programs we have across the Test business, across the submarine platforms, Doble has some things in the back half of the year on some larger projects that impact that across the aerospace business. It's usually a function of distributor restocking orders that come in and fits and starts.

So there's nothing really unique to this year, again, because what we've done is profile in the past and it's very achievable for us. So hopefully that answered your question from a financial perspective. And Vic --.

Yes. Let me just add, I mean, I think the thing that gives me a lot of confidence is the backlog. We have grown the backlog pretty significantly over this past year. So these timing issues quarter-to-quarter are frustrating, but that's how they are. I don't think there's any issue at all..

Great. Thanks for that color. Appreciate it. And then just a question on the backlog.

How much of the backlog today is part of the packaging business that's going to be divested?.

I'm going to go back to the last page of the press release. So we had -- at the end of the year, we were at about $11 million..

Okay, great.

And then finally, just what's in the M&A pipeline now? And is it appropriate to think about you guys relatively quickly replacing the EBITDA that you're divesting with other assets that you may be pursuing that are more synergistic with your USG and filtration businesses?.

It's certainly our hope. We are working a number of issues right now. I mean, the M&A pipelines, but as full as it's been for us, I mean, it doesn't mean something's going to happen right away, but certainly there are a number of really good opportunities that we're pursuing currently..

Okay. Thanks Vic.

And, finally, if I could, from a global and geopolitical risk standpoint, have you seen any changes in the risk or headwinds that might be out there or maybe from a large individual program standpoint?.

Not really. I mean, I would say that, we probably are far enough than the food chain where we participate it's not really been an issue. We watch China closely just because we do some business there particularly with the Test business somewhat Doble although not that much at Doble these days.

But the Test business certainly, I mean, we do have a location there, so that helps us a lot. And we're actually, a net exporter rather than imported from China. So we don't actually bring anything back here from our Chinese operations. So we don't have any tariff issues coming in this direction..

Great. Thanks. And congrats on the sales again..

Thank you..

Thank you..

Our next question comes from Robert McCarthy with Stephens. Your line is now open..

Good afternoon.

Can you hear me?.

Hey, Rob. Yes we can..

Great. Well, first, I want to just go on record as saying this is a tremendous quarter really good strength. And obviously, the divestiture activity you should be applauded for the price you got.

So I just want to make sure that I'm on record on that, okay? So with that being said, could we talk about the bridge a little bit that was very helpful in terms of the incremental guidance but maybe we could just kind of run through the math one more time to just kind of level set everybody where we are.

Because fundamentally, the outlook looks – remains very strong, right? But I want to just make sure I'm getting the bridging aspects correct..

Okay. And from a top line obviously, it really just impacts the packaging business.

So the results that we've included on that last page of the segment page of the press release, I don't have the page number here, but you can see that from a revenue perspective, we're talking about $86 million, $87 million for the packaging business, and then we're taking out adjusted EBIT thereof about $7.3 million, there's about $4 million of D&A in that so you add that big in.

So that kind of takes you down to the number that I referenced at about $139 million to $140 million, there is a little bit of corporate that goes away where we carry a little bit of amortization of some purchase accounting stuff. So that will reconcile you back to the $139 million $140 million of EBITDA..

Okay..

And then so kind of stepping across on the top line, we kind of referred to each of that as we level said, it's obviously filtration's growing at a very solid amount obviously Globe's in there for 12 months versus three, but absent that, we're still growing in the high-single digits there. So we're really pleased with that.

The packaging business – I'm sorry, the Test business. It's kind of at the higher end of our historical range working out kind of in that 4% or 5%. And USG is getting a little of a rebound effect. The renewable space was soft to be polite in 2019. And so we're kind of at the bottom of the V, and it's just a matter of how wide the bottom of that V is.

But we're seeing pretty decent growth there as Vic alluded to in his comments on the Bat Deterrence situation and a few other new products we've put out. So that's going to be adding its low small numbers but that's 8% to 10% growth in that business again coming off of the base of the V.

Does that help?.

No, that's very helpful.

And I was actually just – if you wouldn't mind just indulging me and just walking through that bridge again the EPS bridge, which is basically level setting as to what should be the comparable number year-over-year, which you did allude to? And then just highlighting the incremental tax and the incremental the other adjustment just so we understand what the bridge was at the outset?.

Yeah, it equates back to about like I said $2.95 a share. The tax rate on a consolidated basis was impacted. Our consolidated rate was lower because a lot of the tax strategies we put in place were incurred domestically.

And so the rate that we level set for the packaging business being excluded is back to our statutory rate of essentially 23%, 23.5%, so as you look at that EBIT and you back that out and then you take a tax effect of what that would be that should bring you right down to $2.95 a share. We try to keep it as simple as possible.

Obviously, when we do discounts hopefully at the end of Q1 when that closes, we will have a very comprehensive bridge in those financials. But hopefully that gets you enough information to get you back to the $2.95..

Yeah. I think the other things maybe you were talking about with the tax rate. And the number you referenced is about $0.15. And then the other thing was amortization intangibles is another 10% -- $0.10..

Yes year-over-year..

That's very helpful. Now in terms of the cash and association with the deal.

First of all when do you expect to close on this?.

Yes, I hope. We have two regulatory approvals HSR and then we have to get an approval in Poland, because we both have operations there. And that one is a little bit unknown just because we've not done that before. But certainly our target is to try to get this done by the end of fiscal -- end of the calendar year..

Okay. And then in terms of the cash generation of the existing Technical Packaging business help us kind of square that circle? Because obviously, I'm concerned about the free cash flow generation, but it sounds like you're selling a business that has been a bit of a cash drain.

So going forward given what we're seeing actually this will probably be pretty material benefit fundamentally and optically to your free cash flow generation?.

Yes. And I think it will Rob. And just to take that kind of conversion of the EBIT number I gave you at about $7.3 million they generally run in the 85% to 90% conversion of cash. So in that case that would be somewhere in the neighborhood of $5 million or $6 million this past year.

But I want to point out as Vic mentioned in his prepared remarks during 2019, we made substantial capital investments that we garner the facility, put some extrusion lines in place which created value and we put clean rooms in a couple of places. So we made about 13 -- $12 million, $13 million of capital investment.

So the packaging group in total is a negative cash, but it's because of that one-off we're not going to spend 30%. We wouldn't have spent $13 million over the year. And so that's the kind of way you ought to think about the cash when you're looking at 2019....

I guess that raises the question around CapEx as a company for 2019.

You may not guide to that, but maybe does that obviously govern that or inform what you think CapEx is going to be at the corporate level for 2020?.

Yes. I would say if you look at the CapEx of the cash, so you can take 13 out of that right away, because that won't repeat obviously because we don't know -- we won't own the business for the year. And I would say we had a couple of other kind of one-off things where we did some things on some facilities that won't repeat.

So I would think if you started with what we reported back off 13% and then back off maybe another two to three that should give optics of generally what CapEx looks like as we step forward into 2020..

Do you expect core CapEx to be flat or to increase slightly or tough to know?.

Generally flat. We're very generous. We do focus on ROIC. And if one of the operating guys brings us a plan to put some additional automation in. We're big fans of that because it improves efficiency. So I would say and again we don't repeat these things.

If we go to Chris here and put in $1 million piece of equipment there may or may not be another $1 million next year. We've kind of deferred to the operating guys there.

So I would say if you held it flat and I don't mean flat like we're constraining it, it's flat because we've been making a sizable amount of capital investments both in the hard capital and the software over the past five years..

Yes. I mean one of the issues we're running into days and I think it's -- you probably hear this from our other company that we cover that you talked to just difficult designing qualified people particularly machine tax and things like that.

And so we have been working very hard to automate as much as we can just because it's hard to find qualified employees. And so we're working outside, but we agree with Gary and we're probably kind of flattish on capital equipment because we have been fairly aggressive where we past several years..

And help me on the filtration side. I mean obviously you had a very good quarter there aided by the recent acquisition. But level set us to what your expectation is for acquired revenues for 2020? Because I think well I'm not a math major so probably I just was laziness and slough. But my number for filtration was way off.

And you really handily beat it.

So maybe just any kind of color around acquisition contribution for 2020 would be helpful?.

Yes. And really what we do is we don't -- we have a lot of things in the works as Vic said, but we don't put those in because obviously the success rate is in this. So just to give you the one that's in there when we announced Globe in July, we pegged it at roughly $37 million in revenue on an annual basis.

And so we did about nine in round terms so if you use that $37 million for 2020 because, again that's what we are guiding towards, so 37 versus the nine is the net differential of $28 million is the acquisition growth would be in '20 and then the balance of it comes from a combination of the strength of arrow, the strength of submarines because the order profile is picking up to some of the block five and some other legacy things are coming through.

So that's where the inorganic growth comes from a onetime pop..

I guess the last question and then I'll take more of the questions offline. Your guidance looks very sound. The backlog is there. You have great line of sight. You're executing well.

Where is the biggest area of maybe incremental concern or opportunity even just in thinking about your kind of forecasting? I mean obviously on the utility side one could speculate that obviously off a low base with some concerns around alternative energy you're well positioned? And obviously there's been at least on a top down view a lot more interest in grid hardening and transmission and distribution investment.

Now, I know you don't do grid, you're a -- distribution excuse me your transmission transformers more of that in terms of the spend and testing.

But thinking about the prevailing environment where could we see more upside surprise in '20 or more risk in terms of how you're thinking about the outlook versus something on the Navy side where you probably have pretty good line of sight..

So, I would say, the area if you're going to force me to have a concern which I tried not to on days that we issue earnings, but they forced me to have a concern, really the capital budgets in utilities are always a little tenuous.

And I think, we're broad enough now between the number of companies that we own in that space and renewables and non renewables and all of that that I think we're going to be okay. I mean. We obviously took a hard look and do a bottoms-up review of the forecast that we have in that business.

But that's one thing that always the utilities come back also. So again I think we're in enough utilities that it would have to be something dramatic to have a big issue there. But there's probably more risk there than some of the other businesses.

I think the thing that we haven't gotten our arms around yet from an upset perspective is with our Navy business. We're working really hard at Globe obviously to be successful on the surface hall treatment. They're off to a great start with that.

I think there's more opportunities within the Navy because the vendor base within the Navy is not as robust I think is what a lot of people might expect or what the Navy would want. And so we've developed almost $100 million of business in that area now. So, we're seen as a larger contributor, larger vendor than we had been historically.

And so, we're looking for opportunities to take advantage of having Globe and having Westland and having VACCO, so we really think we can go to the customer and say look, we're here. Our Navy business is part of a larger corporation and we really want to be a big vendor for you, so let's work together and figure out what else we can do for you.

So I think there's some real upside there, but we just haven't had an opportunity to flush that out completely..

Well, I'll take care of the rest of my questions offline, but congratulations again on a very successful transaction, great valuation and a very strong quarter..

Okay, Rob. Thanks very much..

I was going to say, I'm showing no further questions in queue..

Okay. Thanks so much. We appreciate everybody's interest and we'll talk to you next quarter..

Thank you..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..