Good day and welcome to the ESCO First Quarter 2016 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 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 2016 and beyond EPS, EPS As Adjusted, EBIT, tax rates, future growth, profitability and revenue, operating margins, sales, acquisitions, implementation of the company's capital allocation strategy, the costs, benefits, and timing of restructuring and cost reduction activities. The results of recent acquisitions, corporate costs, 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 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 give my perspective on the quarter, I'm going to turn it over to Gary for a few financial highlights.
Thanks, Vic. As a reminder, we previously announced certain restructuring actions that are being taken related to our lower margin international operations, primarily in the test business. We described and quantified the specific actions and the resulting annual cost savings expected from these actions. The detailed restructuring costs were excluded from the FY16 guidance provided in November, and we noted we would be presenting our quarterly and annual operating results for 2016 on an EPS As Adjusted basis. Our restructuring actions are ahead of schedule and are expected to come in below the original budgeted amount. Our current view indicates the total costs will be slightly under the $9 million we originally projected, and we still expect the restructure to be substantially complete by March 31st.
We're looking forward to the completion of these actions as it eliminates the significant management distraction at the operating unit level and allows us to begin realizing the identified cost savings and operating benefits sooner. Turning to our results, I'm pleased with our Q1 performance from several perspectives, including earnings, cash flow, and entered orders, which each significantly exceeded expectations in the quarter. Starting with earnings, we reported EPS As Adjusted of $0.47 a share, which is 24% higher than Q1 of last year and 21% higher, or $0.08 above the top end of our November guidance of $0.34-$0.39. While all three operating segments came in better than planned, the primary driver of our increased earnings resulted from filtration and test outperforming our previous expectations by a considerable margin. The favorable tax rate contributed almost equally to the EPS results in both Q1 periods.
Our Q1 cash flow was several million dollars ahead of projections, and our entered orders, led by the continued strength of our commercial aerospace business and in particular the A350 program, came in better than expected, which resulted in a $10 million increase in total company backlog. I think it's worth repeating here that our strategy and our operating theme that we've communicated over the past few years is well defined and remains clearly in focus throughout the organization. Through these goals, we will strive to execute on our financial plan, deliver solid earnings results that meet or exceed expectations, position the company for sustainable long-term earnings growth, enhance our focus on returns, and follow our capital allocation plan. Here are a few highlights from the release to allow you to better understand the underlying results.
Q1 sales increased 10%, or $12 million, compared to the prior year, primarily driven by an $8 million, or 17% increase in filtration sales. Test sales increased by 9% year-over-year, and Doble sales, while increasing only $1 million, we view as a positive given that the 2015 Q1 sales mix created a challenging comp due to an unusually large quantity of our highest margin Protection Suite products being delivered in that period. Regarding EBIT, consistent with the increased sales, both filtration and test exceeded our internal earnings targets by a meaningful level, and Doble essentially came in on plan for the quarter. Corporate costs were higher than last year, primarily due to the timing and volume of spending on professional fees incurred supporting our M&A activities.
On the balance sheet front, we continue to maintain a very favorable debt level, with $30 million of net debt outstanding at December 31st. While we remain firmly committed to our capital allocation strategy, which includes share repurchases and dividends, we did not repurchase any shares in Q1. This was primarily the result of the timing of the M&A activities which were in process, coupled with management's knowledge of the pending Q1 earnings results prior to this release. We remain fully committed to our capital allocation strategy and expect to continue to opportunistically repurchase shares in the open market over the balance of 2016, as we continue to be supported by a strong balance sheet.
Our guidance and remaining outlook for 2016, while at this point in the year is unchanged from the November guide amounts for EPS As Adjusted in the range of $1.90-$2, is obviously helped by our Q1 results. Getting off to a solid start to the year certainly provides additional comfort in our ability to achieve our full-year goals. At the start of the year, we provided a somewhat wide range in our EPS guidance for the year. With the acquisition of Plastique last week, we are currently in the process of finalizing its net EPS accretion, which is impacted by purchase accounting and interest. When completed, we will determine if the net EPS impact puts us at the top end of our range or above it. Obviously, we'll have this finalized by the next earnings call in May.
Regarding our Q2 outlook, we're expecting EPS As adjusted to be in the range of $0.31-$0.36 a share. When taken together with the Q1 actuals, our current expectations for the first half of the year are above our original forecast, both from an EBIT and EPS perspective. Compared to Q1, Filtration is expected to generate higher EBIT dollars in Q2, driven by its expected increased sales volume throughout the individual operating units. The timing impact of quarterly sales volume and the related impact at Test and Doble is expected to result in lower contributions in Q2 compared to Q1. Corporate costs are expected to be lower in Q2 due to lower professional fee spending. Finally, commenting on our longer-term view, we continue to see meaningful sales, EBIT, and EPS growth across the business segments, consistent with our previous expectations and earlier communications.
I'll be happy to address any specific questions when we get to the Q&A, and now I'll turn it back over to Vic.
Thanks, Gary. As outlined in the release, as Gary commented, our Fluid Flow in Test business has performed well ahead of expectations and will deliver its Q1 financial commitments. Our strong results once again validated one of the major benefits of maintaining a multi-segment business. As Gary mentioned, the aerospace business continued to outperform with the Q1 operating results and the order book coming in stronger than expected. One of the key drivers of the continued strength and confidence in our commercial aerospace business is that we are well ahead of our near-term order plan, led by the nearly $35 million of bookings received on the A350, which continue to run higher than expected. TEQ performed well in the quarter with sales and EBIT margins up in Q1 compared to prior year, as TEQ continues to be a solid business with above-industry average operating margins.
Additionally, Fremont's first quarter contribution came in ahead of our acquisition forecast. The addition of Fremont in the first quarter certainly firms up TEQ's outlook for the balance of the year. The addition of Fremont not only provides a nice book of profitable business but also addresses and solves the capacity issue we're starting to struggle with in TEQ. As we announced last week, we acquired Plastique to further augment our technical packaging business. This addition now gives us a solid foothold in Europe, more exposure to consumer markets, and immediate access to new technology: precision-molded pulp fiber. Many of the large global medical customers want or require manufacturing capabilities in both the U.S. and Europe, and this acquisition addresses that requirement. Additionally, like many industries, the packaging market is becoming more focused on sustainability and reducing their environmental impact.
TEQ had already developed an eco-friendly plastic packaging solution for its medical products, and now with the addition of Fibre pak materials offered by Plastique, we're well positioned to lead the market in this area. Bottom line, both companies are great additions to TEQ and to ESCO. Now together, TEQ has a more sizable technical packaging platform which provides a nice return and better positions us to address this growing market. Doble reported solid operating performance in Q1 with adjusted EBIT margins of 28%. Brazil closure is on track, and the restructuring activities we described earlier are on plan. We saw a modest slowdown on the hardware side of Doble business as utilities continue to rationalize their capital budgets. We continue to see additional opportunities in our service and software applications that bode well for our outlook.
I'm pleased with the success Doble is having with their new solution offerings, which effectively augment what was already a market-leading set of products, services, and solutions. Additionally, we are hopeful that some of the new regulatory standards recently adopted by NERC and FERC will open new windows of opportunity for us to assist utilities in their compliance obligations. The test business restructure in Europe is going better than anticipated at the start of the year. We had a tight schedule and a lot of moving parts, and our teams both in the U.S. and in Europe did a very professional job of working through this challenging process. As of December, we are out of Germany, and we're nearing the exit date in the U.K. as we wind down a few remaining projects. We should start to see the normalized operating margins in test beginning in Q3.
Moving on to our outlook for the remainder of 2016, I continue to be excited about the growth prospects we're seeing materialize across the operating segments, as well as their potential impact over the balance of the year. A few items driving this perspective include the ramp-up on the A350 as it transitions from low-rate production, or LRIP, to a more meaningful run rate over the balance of the year. Test backlog today, coupled with the remaining book and ship quantities needed to meet our 2016 goals, are at the strongest level we've seen in several years at this point in the year. Additionally, we're pursuing several large chamber projects in test, which could further solidify our outlook for this year and beyond. On the cost side, we continue to see the opportunity to meet our EBIT margin goals once we fully exit the noted facilities.
Lastly, Doble continues to see solid opportunities across its global utility platform, which bodes well for their future growth. Regarding additional acquisitions, we continue to be active and will continue to be prudent. Our two recent acquisitions have come with reasonable EBIT dollar multiples, which are in the mid to upper single digits, which allows us to hit our return goals much more quickly. We anticipate solid accretion from both of these acquisitions. Our M&A strategy remains unchanged. We'll continue to take a deliberate approach looking for small to medium-sized niche players, which we can acquire for a reasonable multiple, thereby providing EPS accretion immediately and delivering an acceptable ROIC. We continue to evaluate several opportunities as we work towards supplementing our organic growth. Wrapping up, we had a strong first quarter, and our outlook for the year remains solid.
Our actions to reduce our cost structure are paying off as expected, and we're on track for a strong 2016 as we're well positioned for profitable growth in all three segments. Our focus remains constant to improve our operational performance and execute on our growth opportunities, both organically and through acquisitions. I'll now be glad to answer any questions you have.
Thank you. Ladies and gentlemen, if you have a question at this time, press the star key and the number one. If your question has been answered and you wish to remove yourself from the queue, press the pound key. Again, for questions, just press the star key and the number one. Our first question is from the line of John Tanwanteng from CJS Securities. Please go ahead.
Hi, Vic. Very nice quarter.
Hey, John. Thanks.
I know you guys are basically ahead of your expectations on a six-month basis with the last quarter and the current one you're in. But can you just clarify what's going into the sequential stepdown? I know you have some seasonality in Doble with the conference. Did you pull in some business at all in the quarter?
Yeah, there was some in that. I mean, obviously, the first quarter was pretty strong, and there was some pull-in. That wasn't the majority of it. There was some pull-in into the first quarter. As I always say, we got to take the sales when we get them. So if they were available in the first quarter, obviously, we're going to capture those. But as we mentioned, with Doble and with the test business, both, there's always some shifting from quarter to quarter. And in addition, in the first quarter in the test business, we're finishing a large project in Asia, and so that accounted for some of their upside performance in the first quarter. So we're not seeing anything that concerns us in the second quarter. We understand it.
More importantly, as we look in the second half of the year, that ramp-up that we need to make in our year, that looks very solid.
Got it. That's very helpful. We've seen a number of companies just with issues with timing or general uncertainty in the aerospace sector. I'm just wondering if you're seeing any of that at all, and why wouldn't you be exposed to that kind of volatility?
Yeah. Interestingly enough, we haven't. I think a lot of it is with the aerospace business. Well, first of all, we're a niche player, and so we're kind of far down in the supply chain in some areas. But more importantly, you have to look at the actual platforms that we're on and the things that we're on, whether it be some of the legacy projects that we're on or some of the new projects that we're on, and particularly the A350. We're just not seeing that type of slowdown. I get that question a lot because unless you hear about it, but based on the projects that we're on, the platforms that we're on, we've not seen that. We also have to remember that we do have the space projects as well. We do some work with the Navy.
I think everybody wants to paint the aerospace market as Boeing and Airbus. While certainly, they drive the add to the long-term estimate, they're a big driver of the market with our business. There's a lot more customers that we interface with. So I think that's the primary reason we haven't seen that type of impact.
Great. Thank you. And then finally, just on the tech business, are you planning to break that out eventually with the revenues approaching $100 million? What is the expected growth rate and margin profile of that once you finish integrating all the pieces?
Yeah. So two pieces. I mean, it's certainly something that we're talking with our auditors about, and when the right time, if that's the right thing to do as far as breaking it out separately. But certainly, as it's gotten this large, it's something we have to take a look at. We got to get our arms a little bit around the overall growth rate, but certainly, the growth rate in those businesses are probably in the upper single digits, I would say. And I think we have the opportunity to maybe do a little bit better than that. If you look at what we tried to accomplish by having this foothold in Europe, the products that Plastique had versus what tech had historically had, similar products, certainly, but some of the end markets are different.
So our hope is that we can take some of the expertise and some of the customers that we have in the U.S., kind of migrate that to Plastique and vice versa, as well as with this new technology, with the pulp fiber, that's something I think there's an appetite for in the U.S. as well. It's underserved now. So we got to get our arms a little bit more around exactly how that's all going to play out. But this was not just a one plus one equals two. We think by combining those businesses and then having extra capacity that we're getting with Fremont, that gives us a much better platform and should give us kind of outsized growth opportunities.
Okay. Great. And just one quick clarification. Gary, did you mean when you said that after the impact of Plastique, you'd probably see either the top end or maybe above the range? Was that before or after the 1X acquisition costs and purchase accounting?
That would be after because I used the word net because obviously, as we're going through the valuation of intangibles and all the other stuff, that has to get carved out for the pieces that are amortizable versus fixed. So my comment was on a net basis, that it would be after the purchase accounting and after the interest expenses where we will be speaking about it, but we'll also call out the pieces. But that's what I was referring to.
Okay. Great. That's very helpful. Thank you guys again.
Okay.
Our next question is from the line of Ben Hearnsberger from Stifel. Your line is now open.
Hey. Thanks for taking my question. On the test business, I think, Vic, you mentioned that you've got some large chamber projects in the pipeline. Outside of the large chamber piece of the business, can you speak to kind of the rest of the test pipeline and how it looks and maybe touch on some of the more economically sensitive areas of that business and how you feel about them?
Yeah. I'd say outside of those, the rest of the business is performing well. In fact, we were just down there last week. We had a lot been down there the last two weeks. But we sat our board meeting down last week and had our directors down. So we got a deep dive with those guys to understand it. And I'd say overall, the markets that we're addressing are pretty solid. I mean, there's some ups and downs. I'd say the medical market's a little softer than some of the others. But then the wireless is stronger. And despite all the concern about what's going on in China, that's been a really great market for us this year and looks like for the remainder of the year. So we've not seen anything that's overly concerning to us with that market.
In fact, the projections we have out there seem solid. The good thing is we don't have to get these large projects to make these things happen. But certainly, it's great to see those because we typically have one large project kind of going through the business at any given time. And so having a number of opportunities like this, I'd say, overall, that's not going to have a huge impact on this year because usually, these large projects get delivered over a couple of years. But certainly, that adds some potential upside to the business. But the underlying business, that's the outside of the medical business, is very solid.
If you're going to see some of those larger projects convert, when would the expectation be that you see them?
Well, typically, those things play out. We may enter an order, and we may get some impact in the fourth quarter. But the majority, I think that would be in 2017.
Got it. And I think you were speaking to kind of mid-teens EBIT margins for this segment. Is there kind of a revenue run rate embedded in that type of guidance that you need to be at?
Yeah. I would say, Ben, just to put math around it because the margin differentials on each of the product lines, like Vic said, with medical or the wireless or the EMC or anything around that, if you were just to peg this at roughly $43 million-$45 million revenue a quarter, you'd be at that range. And so if you look at our seasonality and we don't want to peg this as annualized, but you can see the leverage you get off of the sales increase. Historically, in our Q4, which has been our strongest quarter where we're banging around $52 million and $55 million over the past two or three fourth quarters, you can see that the margin gets up at 16%-18%. So that's kind of the band.
If you think of $44-$45 million at the target we're looking at, and then on those one-off quarters where you get the $50s and whatever, you should get three or four points of margin. So hopefully, you can kind of work around the sensitivity of that.
Okay. That's helpful. One last question on Doble and the international piece of that business. There's obviously a lot of noise internationally on a daily basis affecting the industrial economy. Can you speak to kind of what you're seeing on the ground in your Doble business?
Well, a couple of things. I mean, the first response is I'm glad that we have a dominant position in the U.S. Certainly, the U.S. market is stronger than what we're seeing in Europe right now and even in Asia. Having said that, primarily, what we do are more services, software with some hardware sales internationally. And that does not seem to be impacted quite as much. But certainly, the European market, the industrials are more challenged than they are here in the U.S. But I'd say it's great. As we look at the remainder of the year, we factor that into what we think is going to happen with the business.
Got it. Thank you.
Ladies and gentlemen, as a reminder, if you have a question, just press the star key and the number one. Our next question is from the line of Chip Moore from Canaccord. Please go ahead.
Thanks. Guys, wondering if you could maybe help us frame Plastique a little bit as we layer it in, similar EBIT margins, sort of in that 15% range for a packaging business. How should we be thinking about that as we put that in our models?
Yeah. I'm sorry. Will you say that again? I got it.
For Plastique, as you got me? Vic?
Yeah.
For Plastique, as we layer that in, how should we be thinking about EBIT margins on that business? Is that sort of similar to other packaging businesses sort of in that 15% range, or how should we think about that?
I'd say that today, they're a little bit below that. They're in the teens. They're just a little bit below 15.
Okay. That's helpful. And then on the balance sheet, after this deal, I guess, where does net debt shake out? What are you thinking for dry powder as you go after more targets?
Yeah. I'll address that. Just if you remember, right before the holidays, we re-upped our credit facility and basically extended it with a 5-year duration. We didn't increase the volume. So we start out with $450 million under a revolver, and we have $250 million under an accordion that could be used for acquisition. So if you start thinking of that in that total range and again, we don't have a $250 million acquisition in the pipeline. We have plenty of dry powder. And the other thing is the pricing that we push through. We knock anywhere from 12-25 basis points on the higher end of that borrowing, which is LIBOR-based. So that gives us a lot more flexibility if we needed to get competitive. So I think the general ballpark range of what we paid for Plastique is about 30, and we're generating cash this quarter.
And so if we were to jump ahead to March 31st, we're not in an extraordinarily different position than we are at December. And so the dry powder is plenty sufficient to handle what we have in the pipeline.
Okay. That makes sense. And just to be clear on the guidance for Q2, there's no step-up charges or anything like that in the $0.31-$0.36?
Step-up meaning purchase accounting?
Yeah. Yeah. Exactly.
No. That number there, I would say the best way to describe it is that's the operations excluding Plastique because we just bought it last week. And obviously, we know the numbers. But before we lock down, what we want to put in our commitments. So anything that Plastique flushes through, obviously, from a sales perspective and earnings perspective, will be a net positive to that depending on the purchase accounting amount, just to size that. And if you remember the release from last week, we pegged it at about $35 million on an annual basis. And so obviously, we'll have that for eight months of the year. So whatever that pro rata is, as Vic described, it's kind of a low to mid-teen, so somewhere between 12%-15% EBIT, and then would hit the purchase accounting for a few pennies off that.
That's kind of the wrap. That is not included in here. The revenue's not included in there, nor is the earnings. That's the straight-up pre-Plastique number.
Perfect. Just wanted to clarify. Appreciate it. Nice job, folks.
Thank you.
Our next question is from the line of Sean Nicholson from SDH. Please go ahead.
Yeah. Hey, Gary. Actually, my question's been answered, so thank you.
Oh. Okay, Sean. All right. Thank you.
I'm not showing any further questions in the queue. I would like to turn it back to management for final remarks.
Okay. Well, thank you, everyone. I look forward to talking to you on our next call.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful day, everyone.
Thank you.