ESCO Technologies (NYSE: ESE) reported Q4 EPS of $1.09, $0.03 better than the analyst estimate of $1.06. Revenue for the quarter came in at $236.66 million versus the consensus estimate of $235.35 million.

Operating Highlights

• Net sales increased $41 million (5.4 percent) to $813 million in 2019 compared to $772 million in 2018.
• On a segment basis, 2019 Filtration sales increased 14 percent from 2018 (10.5 percent excluding Globe). Aerospace sales (PTI, Crissair, and Mayday) increased $32 million (19 percent) in 2019 driven by higher OEM build rates and strong after-market demand, partially offset by lower navy sales at VACCO due to revenue recognition timing on several large programs. Test sales increased $6 million (3 percent) in 2019 resulting from strong orders throughout 2019 and the completion of several large projects. USG sales from Doble increased $8 million (6 percent), while NRG’s sales to renewable energy customers decreased nearly $10 million, resulting in a net decrease in USG sales. Technical Packaging sales decreased nominally resulting from solid growth in domestic medical / pharm sales, offset by delayed new product introductions in Europe.
• SG&A expenses increased in 2019 as a result of higher spending on R&D / new product development, additional sales commissions, normal cost of living adjustments, and the addition of Globe. Both periods’ SG&A spending represents approximately 21 percent of net sales.
• Entered orders were $905 million in 2019 (book-to-bill of 1.11x) and were $279 million during Q4 2019 (book-to-bill of 1.18x) which resulted in an ending backlog of $475 million at September 30, 2019, an increase of $92 million, or 24 percent, from September 30, 2018.
• The effective income tax rate (GAAP and Adjusted) was 21 percent in 2019 and was favorably impacted by certain tax strategies implemented during 2019.
• 2019 net cash provided by operating activities was $105 million resulting in $224 million of net debt outstanding (total borrowings, less cash on hand) at September 30, 2019 with a 1.68x leverage ratio. Q4 2019 net cash provided by operating activities was $68 million resulting from strong earnings and favorable working capital management.

Chairman’s Commentary – 2019

Vic Richey, Chairman and Chief Executive Officer, commented, “I’m pleased with how we ended the year as our results once again came in above expectations and we delivered 13 percent Adjusted EPS growth over prior year. We had solid operational performance across the Company as we exceeded our sales, Adjusted EBIT, and Adjusted EPS commitments set at the beginning of the year. Our Filtration business was the clear winner in 2019 as the segment, when excluding Globe, exceeded profit expectations by 9 percent, with Test and Doble also beating profit expectations and delivering strong results.

“We improved our 2019 Adjusted EBITDA by 9 percent and increased our margins from 2018, while generating record cash flow from operations. Our entered orders were another bright spot as we booked over $900 million of new business during the year and grew our backlog by 24 percent, which sets us up nicely for growth in 2020.

“The Globe acquisition announced in early July is off to a great start as they performed better than we projected. I’m very happy with the early stages of the integration, and I’m looking forward to Globe’s continuing growth as part of ESCO. The strong leadership team, dedicated employees, and great products are an excellent addition to our portfolio and enable us to create additional avenues for meaningful sales growth across our shared customer base.

“On the M&A front we continue to evaluate a robust pipeline of opportunities and continue to work these aggressively, and I remain hopeful that we will be able to add to our portfolio. Consistent with our history, we will remain prudent and committed to our disciplined approach of balancing ROIC and protecting our balance sheet.

“The Doble headquarters relocation from Watertown to Marlborough is nearly complete and we expect to be moved in and fully operational in the next few weeks. The Doble team is looking forward to having all of its Boston area staff co-located in a single, customer-friendly facility as this will further enhance our operational efficiency and effectiveness, while lowering our facility operating costs.

“I’m pleased with the way we wrapped up 2019, and we plan to build on the successes we achieved this year and expect to continue benefitting from our disciplined operating culture heading into 2020. Our solid market positions and tangible growth opportunities across the Company provide us with a favorable view of the future with our goal remaining unchanged – to increase long-term shareholder value.”

GUIDANCE:

ESCO Technologies sees Q1 2020 EPS of $0.35-$0.40, versus the consensus of $0.75.

ESCO Technologies sees FY2020 EPS of $3.20-$3.30, versus the consensus of $3.62.

Business Outlook – 2020 Adjusted Basis

Given the pending sale of the Technical Packaging business, beginning with the Q1 2020 results of operations, the segment’s operating results, balance sheet and cash flows will be reported as Discontinued Operations, and therefore, will be excluded from the Business Outlook comparisons to 2019 described below.

The Discontinued Operations impact, as well as the expected after-tax gain on the sale of Technical Packaging will be excluded from the calculation of Adjusted EBIT, Adjusted EBITDA and Adjusted EPS in the reporting of the 2020 and 2019 results.

The net proceeds from the sale will be used to pay down debt, thereby significantly increasing liquidity and enhancing the Company’s ability to complete future acquisitions.

Additionally, later in 2020, Management plans to use a portion of the net proceeds to fully fund, terminate, and annuitize the defined benefit pension plan currently maintained by the Company. Annuitizing this non-strategic liability through an insurance company will eliminate both equity market risk and interest rate volatility, thereby reducing our costs and eliminating future cash payments. The defined benefit plan was frozen in 2003 and no additional benefits have been accrued since that date. The accounting impact of terminating and annuitizing the pension will also be excluded from the calculation of Adjusted EBITDA and Adjusted EPS.

Management continues to see meaningful net sales, Adjusted EBIT, and Adjusted EBITDA growth across each of the Company’s business segments and anticipates growth rates in 2020 and beyond that will generally exceed the broader industrial market. The growth described below is expected to be enhanced by additional M&A contributions throughout the year.

Management’s expectations for growth in 2020 compared to 2019, excluding the results of Technical Packaging in both periods, are as follows:

• Net sales from continuing operations are expected to increase 9 to 10 percent on a consolidated basis, with Filtration growing 13.5 to 14.5 percent, USG growing 7 to 8 percent and Test growing 4 to 5 percent;
• Adjusted EBIT is expected to increase approximately 11 to 12 percent with Adjusted EBIT margins at 14 to 15 percent of sales;
• Adjusted EBITDA is expected to increase approximately 12 to 13 percent with Adjusted EBITDA margins increasing nearly a full point;
• Interest expense is expected to be lower than 2019, and will be impacted by the timing (date) of closing and the amount of the final after-tax cash proceeds received on the sale of Technical Packaging;
• Non-cash depreciation and amortization of intangible assets is expected to increase approximately $5 million, or $0.15 per share after-tax, related to previous acquisitions and capital spending;
• Income tax expense is expected to increase in 2020 as Management is projecting a 23 to 24 percent effective tax rate calculated on higher pretax earnings, compared to the 20.3 percent effective tax rate used in calculating 2019 Adjusted EPS (excluding Technical Packaging). The higher effective tax rate negatively impacts 2020 Adjusted EPS by approximately ($0.10) per share;
• In summary, and excluding Technical Packaging, Management projects 2020 Adjusted EPS to be in the range of $3.20 to $3.30 per share (compared to 2019 Adjusted EPS of $2.95 per share, excluding the 2019 results of Technical Packaging). This increase reflects meaningful sales, Adjusted EBITDA and Adjusted EPS growth, partially offset by the additional depreciation and amortization charges and incremental tax expense as noted above.

On a quarterly basis and consistent with prior years, Management expects 2020 revenues and Adjusted EPS to be more back half weighted resulting in the second half of the year being stronger than the first half.

Management expects Q1 2020 Adjusted EPS to be in the range of $0.35 to $0.40 per share. The timing of quarterly sales and earnings throughout the year, coupled with the discrete charges incurred within the respective quarters will impact quarterly comparability.

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