Good day, and welcome to the ESCO Q4 2017 Earnings Conference Call. Today's call is being recorded. With us today are Vic Richey, Chairman and Chief Executive Officer. Gary Muenster, Vice President and Chief Financial Officer. 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 2018 and beyond EPS, Adjusted EBITDA, EBITDA, EBIT, EBIT margin, growth, non-cash depreciation and amortization from recent acquisitions, tax rate, profitability, sales, cash flow, orders, success of new products, success in completing additional acquisitions, the results of recent acquisitions and cost reduction activities, and other statements which are not strictly historical, are forward-looking statements within the meaning of the safe harbor provisions of the Federal Securities Law. 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 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. As noted in the release, we're wrapping up 2017 in a strong fashion, which Gary will describe in a moment. I have to report we delivered on our earlier expectations of EBITDA and EPS. Setting aside the numbers for a second, I'm most satisfied with our recent, recent M&A activities, as we've added four great companies this year, supplementing the three we acquired in 2016. With these new partners, we've not only added great companies to our portfolio, we also added strong management teams who share our vision and our values. As we look toward the future, we plan to build on both the organic and acquisition successes we achieved over the past two years, and we will continue to aggressively address the normal market challenges we face every day.
This gives me a favorable view of our future, and our goal remains unchanged, and that is to increase long-term shareholder value. Before I give my perspective on our outlook for 2018, I'll turn it over to Gary to wrap up 2017 with a few financial comments and to summarize our 2018 outlook.
Thanks, Vic. I'm pleased with the 2017 financial results and very proud of what we accomplished this year in the way of acquisitions, which better positions the company for achieving our long-term growth objectives across the portfolio. At the start of the year, we set our financial goals centered around EBITDA, which we expected to be in the range of $122-$124 million, and with GAAP EPS expected in the range of $2.16-$2.26 a share. We also described several non-cash items that would be impacting our GAAP results. Given our additional M&A activities completed late in the fiscal year, coupled with the corresponding GAAP-required non-cash purchase accounting charges from these acquisitions, our GAAP earnings became less comparable as the year progressed. As a result, adjusted EBITDA and adjusted EPS became more important operating performance measures when looking at our comparative results.
This adjusted approach is consistent with our view of 2016's operating performance. So touching on a few financial highlights from 2017, for the year, we reported $123 million of adjusted EBITDA, which is slightly better than our previous expectations of $122 million communicated in August. This represents a $22 million and 22% increase over 2016's adjusted EBITDA of $101 million. During Q4, we reported a record high quarterly adjusted EBITDA of $43 million, which reflects a 34% increase over the comparable 2016 EBIT margin. Of special note, over the past six months, we successfully with $89 million in sales at a 15% EBIT margin, reflecting our lower cost structure. Our adjusted EPS of 2.22, $2.22 a share in 17 cents a share increased 18% compared to Q4 2016's adjusted EPS of 67 cents.
Sales increased to $115 million, or 20% year-over-year, with organic sales increasing about 4.5%, supplemented by an M&A sales contribution of about $90 million. Entered orders were $737 million, reflecting a book-to-bill of 1.07, and increasing our end-of-the-year backlog by $51 million, or 16% from the start of the year. Our orders increased to $161 million, or 28%, over the $576 million in orders received last year. All four operating segments also had positive book-to-bills for the year, led by the test business, which recorded nearly $200 million in orders. I'm pleased to report that this strong order trend continued into the first six weeks of fiscal 2018, which Vic will discuss later in his commentary.
And finally, cash provided by operating activities was $67 million, resulting in net debt of $229 million and a reasonable two point two leverage ratio. Our significant credit capacity and available liquidity have us well positioned to execute our long-term strategy. As we enter 2018, I'm confident that our current backlog and our expected order profile, given the significant increase in our recent M&A activities, comparative GAAP EPS amounts become a bit more complicated. As an example, non-cash depreciation and amortization from the recent acquisitions is expected to increase over $7 million, or $0.18 a share, as we believe this is more relevant metric to be considered when measuring operating performance on an ongoing basis, and is a better measure for determining ESCO's enterprise value.
For 2018, we expect adjusted EBITDA to increase between 15%-17%, resulting in $141 million-$143 million of adjusted EBITDA, which compares to the $123 million we reported in 2017. To bridge our expected adjusted EBITDA to our GAAP EPS, in the release, I've called out a few items, including higher non-cash depreciation amortization charges, which I mentioned at $0.18, additional interest expense impacting GAAP EPS by $0.12, and the estimated tax rate differential, which impacts GAAP EPS by $0.07. These result in a total EPS impact of $0.37 in 2018 compared to 2017. As a result of these incremental charges, 2018, 2018's EPS profile is expected to be back-half weighted, but with a more pronounced second half earnings contribution when compared to 2017.
So when comparing 2018's guidance to last year, we're expecting meaningful increases in sales at USG and Test, along with higher sales of aerospace products at PTI, Crissair, and Mayday within the Filtration group. Filtration continues to benefit from the strong commercial aerospace market, but its growth in 2018 is muted by PTI's reduced sales of a low-margin industrial automotive product, driven by a specific customer's desire to move to a foreign competitor, offering a substantial price reduction. And by the timing of VACCO, VACCO's SLS sales, as this program transitions from design and development revenue to production hardware. VACCO's future margin will benefit significantly once the SLS program begins its launches, where our content is over $13 million per launch. Test sales are expected to increase in the mid-teens, with a projected EBIT margin at 13%.
This view is supported by Test's ongoing and strong opening balance sheet, the catch-up of the 2017 program delays, recent large program wins, as well as its lower cost structure, which we validated in the last six months of its performance. USG sales are expected to grow over 37%, with EBIT margins over 21%. This is despite our continuing investment in new products and solutions, as well as an increased focus on international sales and marketing when compared to 2017. The sales increase reflects the full year impact of USG's recent M&A activities, coupled with growth from recent new product introductions, such as the DUC, protection hardware, software applications, and the rationalization of our sales channels.
Lastly, corporate costs are expected to be significantly higher in 2018 due to the additional non-cash amortization of the identifiable purchase accounting assets recognized on the corporate books. I'll be happy to address any specific financial questions when we get to the Q&A. And so now I'll turn it back over to Vic.
Thanks, Gary. In our fiscal 2018, I'm confident all of our businesses are in a solid financial condition, with known and quantifiable growth opportunities. We're well positioned to deliver our projected results in 2018 and in the out years. As I've noted previously, we're not immune to the economic headwinds that many industrial markets face. But with that said, I strongly believe the breadth and diversity of our end markets, and the specific niches which we operate in, provide us with the protection to mitigate a lot of these pressures. While we're not without challenges, I like the position we're in across our various businesses and anticipate that we can achieve growth rates in 2018 and beyond that exceed those of our defined peer group, as well as the broader industrial markets. I'll provide a couple of specific thoughts and comments on individual businesses entering 2018.
In Filtration, we expect to deliver solid results in 2018, and I'm comfortable with our outlook for 6%-7% growth in the EBITDA in this segment. We're well positioned on several fronts in Filtration, including the continued upcycle in commercial aerospace, as well as additional technology we're providing for submarines and surface ships, which are critical for the U.S. Navy. We recently won a large multi-year contract at Westland to supply mission-critical proprietary hardware for surface ships. At VACCO, we were awarded a follow-on order for the next lot of Virginia-class submarines. So taken together with our Westland outlook, we have tangible and profitable growth embedded in our naval product offering, growth in a market we only recently entered. Several existing customers have already placed meaningful MRO orders, which we can build upon.
Our Technical Packaging group's future has improved given our scale and leadership positions across several growth markets and geographies. We recently expanded our production capacity at our facilities in Poland and England. This provides the capability to deliver highly engineered products to customers in the medical, pharmaceutical, and consumer markets throughout Europe. In USG, we see solid growth opportunities across the global platform, including hardware, software, and services. We also see numerous opportunities for our expanded product offerings, both internally developed and acquired. Our rep and distribution network rationalization is nearly complete, and I'm really impressed with the quality of our sales channel partners. This process is very key as we integrate our new partners into Doble. We need to ensure that we are able to service our customers in the most effective and efficient manner possible.
Our entry into the renewable energy market with the acquisition of NRG was an important move in 2017. We look forward to enhancing our position in this fast-growing market in 2018 and beyond. At Test, we're seeing the results of our past cost reductions materialize as anticipated. Our reduced cost structure and ongoing operational improvement initiatives support our 13% EBIT margin expectations. Test sales growth, while appearing a bit aggressive given our history, is supported by several metrics, such as opening backlog and the nearly $30 million of new business awards in October and through today. I feel good about the growth opportunities we have across all of our businesses in 2018, and I can see tangible avenues for additional growth in future years. Regarding our recent M&A, I'm pleased with the integration process across the board.
This complex process is nearly complete and is showing favorable sales and earnings opportunities. Within USG, I like our ability to enhance our overall growth strategy, sales and EBIT growth across our business, consistent with our previous communications. Acquisitions remain a key component of our ability to meet our longer-term growth targets, and we continue to evaluate additional opportunities. We certainly have the 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 remain disciplined in our approach. Our focus remains constant, that to continue to improve our operational performance and to execute on our growth opportunities, both organically and through acquisitions. I'd be glad to answer any questions you have now.
Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone lines, please press star, then one. Our first question will come from the line of Jonathan Tanwanteng with CJS Securities. Please proceed.
Good afternoon, guys. Thank you for taking my questions.
Good morning.
You mentioned that you have more capacity for more M&A after doing quite a lot of business, or transactions in the past year. One, just helpful.
Yeah, it's remained pretty active. Honestly, we've obviously had a lot of success over the past two years, and we see, you know, ample opportunities going forward. You know, we think a lot about why that is, because, you know, probably before two years ago, we weren't seeing as much traffic. I think it's a matter of a lot more things coming to market, and then I think we have proven our ability to be successful in some of these acquisitions. So I think we're getting on more people's radar screens and getting access to more of those acquisitions. Plus, we have a focused, you know, activity here to go out and seek, you know, competitors, partners, people that we're aware of in the market. So it remains pretty robust.
I think, John, from the valuation side, you know, if you look at our last five, six or seven deals, you know, it certainly doesn't feel like we overpaid for those relative to the multiples we paid. I'd say the things in the pipeline today are generally within that bandwidth. You know, there, there's not things we're looking at that are 12x and 13x EBITDA. I think the future performance will look like the past, and then the sizes, you know, certainly appear digestible.
Great. Thank you. And then, just in terms of the expectations you have for both cost and sales synergies in USG and in Filtration, what are you building into expectations for next year?
We've not built a lot of synergies just because, you know, it usually takes a year to kind of figure that out. You know, so we don't want to build something in there kind of betting on the come. We're still in a process of doing that. But I would say there's no hard numbers assumed in what we have in the forecast. It's probably the most succinct way to answer that.
Okay, got it. And then, any color on the packaging space and that segment, and why you expect that to be flat going forward?
Yeah. So I would say that the flatness that we're seeing this year is probably not gonna be long term. What I would say is the attrition rate in what we saw in the European acquisition was a little higher than what we'd anticipated. You know, just some simple things, you know, like the razor market, which we did have participate with our Plastique acquisition there. It's amazing that the internet razor business has really forced, and you see it with the razor manufacturers and how they're all struggling as a result of that, where they were maybe using a higher-end package historically, they're basically competing on price now, and one place they can take out price is in packaging. So we've seen a little more attrition in some of those areas, like Plastique, than what we'd anticipated.
Great. Thank you very much. I'll jump back in queue.
Thank you. Our next question will come from the line of Liam Burke with B. Riley. Please proceed.
Thank you. Good afternoon, Vic. Good afternoon, Gary.
Good afternoon.
Vic, on the Filtration side of the business, you're looking for beginning to catch up, or is there other things in that expectation?
I'd say the biggest thing we have is a pretty big pickup at our Mayday business, both as a result of getting them on board fully now, you know, 11 months versus 12, or 12 months versus 11 months. I think the efficiencies are going to be higher there. And then, as I mentioned, this MRO business has tripled, you know, year-over-year. I'd say that's the biggest piece. And then Westland as well, we have been waiting on a contract there, which, as I mentioned, earlier in the call, we did get that. So that had some impact on us in 2017, and now we have that contract in place. We'll be able to deliver that in 2018. So I'd say those are the two biggest impacts year to year.
Okay. And then on the NRG and Morgan Schaffer acquisitions, those businesses, as I understand it, carry lower operating margins. Part of the cost synergies were presumably to integrate those businesses. Looks like fourth quarter, you were better sequentially, but still lower year-over-year. Do you expect to make continued progress on those two acquisitions, or have you pretty much got as much cost out as you can?
Well, I'd say that... Well, let me talk separately about the two businesses. I mean, NRG is not really going to be integrated within Doble. It's a freestanding business. I think where we'll see margins improve there is as we continue to grow that business, and, you know, maybe we can help with some of the efficiencies. So we're not going to get the same type of synergies that we would with the company we're going to integrate. With Morgan Schaffer, as you know, we had bought their product historically and integrated it with a system of their new product at a little higher production rate into the field. I think that will help as well.
And then we're also finishing up, as I mentioned, in fact, we were in the process of looking for somebody for Doble to run the European sales operation. Fortunately, there was somebody at Morgan Schaffer that filled that role for us, so it allowed us to have, you know, an internal candidate to fill a role like that. There's a couple other places where we're able to do that as well.
Great. Thank you, Vic.
You bet.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question over the phone at this time, please press star then one on your telephone keypad. Once again, that is star then one. Our next question will come from the line of Ethan Potasnick with Needham and Company. Please proceed.
Yeah. Hi, this is Ethan Potasnick , filling in for Sean Hannan. Similar to a previous question, I'm wondering about the mix of revenues in USG. Could you maybe share how much is coming from service and software? And I guess how that is trending, and, you know, is that part of 2018 expectations?
Well, I'll let Gary put some, some tight numbers or tighter numbers on it. Obviously, we're going to get specifics, but I'd say both with sales and software, that's trending up. The acquisition we made a couple of years ago, software business, that business has grown pretty significantly. I mean, it's a fairly small business, but grown pretty significantly. And then we've had a, a focus on, on software at Doble as well, and services. So we see both of those areas trending up.
Yeah. So Ethan, I'd ask you to think about the pieces that we add. So if we just split them into individually what they are, Morgan Schaffer is generally a hardware business. They supply products, so there's not, I mean, there is it. On NRG, they have a better mix of services and some software applications, so that's probably about 60% hardware and 40% in the other bucket. And then the Vanguard piece is almost nearly all hardware. So as you think about that, added to what Doble's historical mix was between those allocated pieces, you will see hardware becomes a bigger piece of it because we added the Vanguard and Morgan Schaffer piece to that.
So but it doesn't, you know, it doesn't dominate it, you know, to the point or, or to the expense, or if you will, of, of the software and its favorable margin. So, as Vic said, the software business organically is growing faster, you know, but it's a lot of small numbers, and then you're going to see a disproportionate growth in hardware just because of the acquisitions.
Okay. Then I know you guys talked about this a little bit in the prepared remarks, but I was wondering if you could possibly share, you know, what kind of growth should we see percentage-wise within each segment, and then also kind of at the EBITDA level for 2018?
Yeah, I would say, you know, if you look across the, you know, the sales platforms there, let's start with, with filtration. You know, like we did mention a little bit of headwind. We have about $7-$8 million of product that, we're not going to go forward with because of some extraordinary pricing conditions that, you know, it's already a low-margin business. We're not going to give the stuff away. So, you know, that part of the business goes away. So let's call that $7-$8 million bucks as we go into 2018, and that's that PTI. The good part is, like I said, it's not aerospace. It's, it's low margin industrial and automotive.
So I'd say the way I would look at as a group in filtration, you're probably talking somewhere in the neighborhood of 2%-3% because of that headwind there, and because of the timing on the VACCO transition from about two full points of margin at VACCO. So you're actually going to see, despite the kind of flattish sales, you're going to actually improved operating performance there, operating profit margin there. So, you know, if you were to use that as a group at 2%-3%, I'd hold the packaging group flat. As Vic alluded to, there's some attrition there, so, you know, holding that, give or take $1 million around where they're at.
And then the test really comes from, you know, if you think of the large technology program that we talked about last year, that had some construction-related timing things from its headquarters, we pick up that, plus we pick up the momentum from the backlog, significant backlog growth. So I would think of the test business, as I mentioned in there, you know, high teens to 15%, validated by those two metrics. And then on the USG side, you know, the growth is gonna be north of $60 million, combination of the dollars, the combination of the acquisitions for the full year, but then the inherent organic growth in there is attractive as well. So hopefully, you can follow all those pieces of that.
Okay. And then, finally, maybe if you could discuss contribution assumptions for growth internationally in 2018?
If you look at Morgan Schaffer, obviously, they're based in Canada, so I'd say about 50% of their business happens in the U.S. and 50% happens around the world. So if you peg them at, you know, $23-$24 million, you could take half of that in that regard. Vanguard at, you know, $11-$12 million is almost predominantly U.S. So, you know, I'd say 20% of that is international. And then on NRG, it's probably a little closer to 50/50. So if you peg them at, you know, $45 million or something like that, and put that in that relationship, that should help. Within the aerospace business, there's not a whole lot, or within the filtration business, there's not a whole lot of international content.
Then in Packaging, it's about 50/50 because, you know, Plastique is a big chunk of that $80+ million we have there. Then Test is probably 50/50 as well.
At this time. So now it's my pleasure to hand the conference back over to Mr. Vic Richey, Chairman and Chief Executive Officer for some closing comments and remarks.
Okay, well, thanks, everybody. I look forward to talking to you in the next call. Thank you.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and we may all disconnect. Everybody, have a wonderful day.