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 statement, I would like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead.
Thank you. Statements are 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 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. 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 set so quickly into the public company world, which you can appreciate is not an easy task. As a result, we've been able to promote several key managers into positions of increased responsibility.
With Westland, we not only acquired an outstanding company and a meaningful contributor to the protection of the U.S. 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 I anticipate continued solid performance over the balance of the year. Wrapping up on Westland, I had the opportunity to spend time with our president, and I'm impressed not only with his product knowledge and industry expertise but with the deep relationships he's established across our customer base. I'm certain these factors will allow Westland to increase his product contributions over time as we continue to develop new products and highly engineered applications to meet our customers' increasing 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 a very 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 team is strong, experienced, and well-positioned to take on any challenges thrown 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.
To wrap up, it's always been my strongly held belief that to be successful with M&A, you not only 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 a few 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 back-end loaded similar to years past. Our Q1 EPS was projected to be in the range of $0.35-$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 or incremental non-cash depreciation and 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 this confidence is validated by the significant level of test orders booked in Q1 that we expect to convert to sales over the remainder of the year as well as VACCO's legacy space and Navy business in backlog that is scheduled for completion in the next few months. A few other Q1 highlights include the strength of our 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 2017 remains consistent with the expectations communicated earlier. We continue to expect 2017's EBITDA to increase between 21% and 23% and be in the range of $122-$124 million compared to 2016's adjusted EBITDA of $101 million.
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 2017, and in the longer term, we expect to exceed the growth rates of our defined peer group and the broader industrial market in total. Our Q2 EPS guidance is projected to be in the range of $0.37-$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'll 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 am pleased with our quarter one results from a lot of perspectives, mainly because of the way we exceeded our earnings commitment despite the sales headwind at Test and VACCO. The exceptional performance is delivered by Doble and our aerospace business is 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 business platform. Given our diversity of end markets, we can usually manage around various operational stress points given that we have several alternative paths to achieve success. In Q1, I believe 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 of 2017.
Looking at the business today and the opportunities and challenges in front of us, I remain confident that all of our businesses are in solid financial condition with known and quantifiable growth opportunities, and that we're well-positioned to deliver commitments in 2017 and the out years. As I've 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 breadth and diversity of our end markets and specific initiatives that we operate in continue to provide us with the protection to mitigate this pressure, as was evidenced in Q1. I'll provide a few brief comments on individual businesses. In filtration, we continue to expect this segment to deliver solid results in sales growth, EBIT, and EBITDA contributions and cash flows during 2017.
We remain well-positioned on several fronts, including the continued upcycle in commercial aerospace, contributions from Westland and Mayday, growing opportunities in space on the SLS program, and unparalleled 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 in this global market to provide highly engineered products to customers in the medical, pharmaceutical, and consumer markets. Given this positive outlook, we are making additional investments in this business by adding a medical cleanroom in the U.K. and by expanding the manufacturing plant in Poland to capitalize on the slower manufacturing costs and adding additional capacity for fiber packaging. I remain confident the opportunities we're seeing globally set us up nicely today and in the out years.
Moving on to Doble, we are seeing some easing of the spending constraints within the electric utility capital budgets, and we set our growth expectations around these opportunities. We continue to see additional upside opportunities in our software and service applications which can help mitigate any slower-than-expected budgetary spending. During Q1, we saw solid performance from our new products such as the M- Series, Doble Prime, and our DUC. Coupled with the strength of our software offerings, I remain enthusiastic about Doble's future. At Test, while Q1 sales performance was below plan due to the timing of orders from one of our key customers, our real disappointment was that the temporarily lower sales masked the real impact of the cost savings we implemented last year. As the year progresses and a strong backlog converts to meaningful quarterly sales increases, we expect to deliver our EBIT margin commitments established earlier.
As I noted in my opening comments, I'm really pleased with our recent M&A activity, and while we've been busy completing and integrating these deals, we're 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 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 be disciplined in our approach and not lose focus on improving in our returns. Wrapping up, I'm pleased with Q1 results, and I remain confident that our outlook for 2017 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: to continue to improve our operational performance and to execute on our growth opportunities both organic and through acquisitions because this is how we'll increase year-over-year value. I'll now be glad to answer any questions you have.
Ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, you may do so by pressing the pound key. Again, if you'd like to ask a question at this time, that's star, then 1. Your first question comes from a line of Sean Hannan with Needham & Company. Your line is now open.
Thanks. Good evening, folks. Can you hear me?
Yeah. Yes.
Okay. Great. Thanks for taking my question here. 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've called out a couple of products and services. As I first think about new products, I 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. I also want to get a little bit more color around services, and in addition to that, then the software piece of 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 one really long question. So if I don't answer the whole.
Yeah. That was. I apologize.
If I don't answer the whole thing, come back and we'll try to clean it up. 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-lived products. Once we implement them, get them into the field, they're going to be there for a long time. The three products I specifically talked about were the M product, which is a product we introduced probably in the last 18 months, and it's replacing some of our other products, although not one-for-one. That is really off to a strong start. I'd say the sales for that product have been a little above what we thought they were 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, which you mentioned, whether it be ARMS or some of the things we got through ENOSERV, I think that's been going well. The ARMS is a long sales cycle, but we are starting to get some good traction there. But this ENOSERV is a business we bought in Tulsa, the software business. It has been a real success. We don't talk a lot about it. It's a fairly small business, but I'd 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 in that we've got the traditional products that we continue to sell. That's gone well. We've got new product introductions that are kind of the early stages, I would say. And then we really emphasize the service side, particularly internationally. And what we're finding is getting some of those customers, having them understand the services, us doing some work for them like we're doing in Saudi, really gets us ingrained with the engineers, helping them understand our capability and our capacity. And then what we're able to do then is take that and turn those into hardware sales as well.
So whether that be in Saudi, we have some other places in the Middle East where we're starting to see some success, or South Africa, we're 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 onto you've completed some stages? Is there any conversation that 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 with them. In addition to the service side, we have sold a decent amount of hardware. I don't think this is a contract that's going to just come up to the end of the year and stop. I think they 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'll 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 or 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. I 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 for that business. So I just want to understand that a little bit better. Thanks.
Sure. So as far as the margins, it's really two things. The Plastique business that we bought in Europe, their first quarter's always pretty soft because their big quarter is kind of the second, big quarter, kind of the second half of 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, the thermal scan thermometer 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. And 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 it. I don't have a concern about the margins for the year. It's just that this first quarter, probably the first half of the second quarter, is soft as a result, primarily the timing of the Plastique work. And then as far as investment, yeah, when we made the acquisition, the plan always was to make the investment there because the plant they have in Poland is 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 that 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 and the factory.
The other thing that I mentioned was the medical cleanroom in the U.K. One of the primary reasons we wanted to have the operation in Europe was because we weren't able to effectively service the medical clients out of the U.S. just because of the shipping costs. And so what we committed to do was to set up a cleanroom, facilitate that with the same equipment that we use in our U.S.-based business so that we'd 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 will be up and running in both of those locations and able to support those customers.
Hey, Sean, let me put a couple of numbers around what Victor's saying there relative to the seasonality. So in Q1, you'll notice in the release, I called out the Plastique did about $7 million in revenue, and their annual run rate's about $36 million. So if you're looking at annualizing that $7 million, obviously, that's $28 million. 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-$2.5 million or so would be the impact of that. And that's almost a fully automated process. So when that business is not coming through, there's a lot of overhead sitting around those machines that aren't being put through.
So those are the two. That's the math around Victor's commentary.
Very helpful. Thanks so much.
You bet.
Next question comes from John Tanwanteng with CJS Securities. Your line is now open.
Hi, gentlemen. Thank you, Frank, for 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 into the March quarter, what you saw delayed?
I'll let Gary talk about the magnitude. I don't think we'll be fully recovered in the second quarter. I think it's going to be really the third and fourth quarter before we're able to get those pulled through, primarily because of the timing of the orders and customer acceptance of some of the VACCO products.
Yeah. John, numbers around that. On the VACCO side relative to our November conversation, VACCO was about $2.7 million or $2.8 million light on the revenue, and the Test business with the order profile was about $2 million-$2.2 million. 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 suborders or delivery schedules do increase to 3 a year and how pricing may actually play into that if the orders do increase? And I understand these are longer-term prospects given the lead times for these submarines.
So I think I'm going to try to get the numbers right. I think we've got about $6 million-$8 million of content on a submarine, on a typical submarine. So if those build rates go up, you can see that type of pull-through. And that's at VACCO. And then we've got additional at Westland. So I think two of them together are somewhere between $8 million-$10 million a ship set. So you can see if they do increase production, it can have a pretty significant impact because 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 the environment, the valuations you're seeing out there. Thanks.
Sure. So I would say that, as I mentioned at the start of the discussion, the integration, I won't say it's completed, but we're very far down the road. These three acquisitions have probably been the three of the most easily integrated that we've had. As I mentioned, I wasn't just talking about the management team to make it feel good. I mean, we've got people that really have jumped on board with these things. We also use some internal resources to help with the integration. We're fortunate to have a finance person to put in at Mayday for a while as we made that transition. Also, we had a 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 are 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. Obviously, they've been and I think you've seen from what we bought more recently that we've been able to get pre-quality companies for 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're happy we were able to get four things done over the past 18 months, and our hope is to 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 size and the niche approach of those businesses are what we really do well. And so we'll continue to remain disciplined and look for opportunities like this.
I think there are good opportunities out there.
Great. Thank you very much.
You bet.
Again, ladies and gentlemen, if you'd like to ask a question at this time, that's star, then one. Our next question comes from the line of Sean Nicholson with SBH. Your line is now open.
Yeah. 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 FY 2017 margins around a little over 18% if you include corporate costs and 22% if you kind of look at an operations basis exceeding 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 a $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, now I mean backing stuff out, just not counting the corporate costs and that sort of thing, yeah, it's pretty close to 22%.
Okay. I didn't know if you had kind of a view. Recent M&A transactions at Clarcor, 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. I mean, is there still opportunity to increase the EBITDA dollars and margins? I mean, from what you guys kind of see in the business today trajectory?
Yeah. I'll start with the operational side, and then Victor 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 adds value. But while we're doing well with the integration of these businesses, there's still some inefficiency because we have a lot of corporate people involved, and they're just not out at the subsidiaries doing their own thing yet. So I think once they get going through our processes and integrate those where they're doing it, I think there's a little bit of upside in the longer term relative to that.
Plus, I think what I'm seeing from the numbers is when you look at these smaller companies like Mayday and Westland that were 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 talked to me. They're excited to be part of a 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 ESCO 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 Victor's comments on the M&A, we're not going to buy fixer-uppers, so. I don't know if you want to. Yeah. Just to follow up a little bit, yeah, the companies that 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 part of a larger company, we can make larger investments, I would say, particularly in the sales and marketing side where maybe they couldn't put 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 that we can get into. I think just having that is probably our biggest opportunity. So I think we'll get more on the growth of these businesses than we will just doing better manufacturing because they already do a really pretty good job. I think we can add some things there just because anytime you have a larger business or often you have a larger business, there's more expertise within the organizations that help. But we didn't buy fixer-uppers, and we're not going to in the future. That's just not who we are. We don't have the bandwidth to go fix businesses. We certainly can help manage businesses, but that's not what we're planning to do.
Okay. That's helpful. Thank you very much.
Thanks, Sean.
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 and comments today. I 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.