ESCO Technologies Inc.

Good day and welcome to the Q2 2020 ESCO Technologies Conference call. Today's call is being recorded. With us today are Vic Ritchie, Chairman and CEO, Gary Monster, Vice President and CFO, and now to present the forward-looking statement, I would like to turn the call over to Kaye Lowry, Director of Investor Relations. Please go ahead.

Thank you. We issued a press release earlier today that will be referenced during the prepared remarks from this call. You can find a copy of our press release and our safe harbor statement regarding forward-looking statements made during this call in the Investor Center of ESCO's website at www.escotechnologies.com. During this call, the company may make forward-looking statements which are inherently subject to risk and uncertainty, particularly given the unknown impact of the current COVID-19 pandemic and the company's response to these evolving circumstances. Actual results may differ materially from those projected in forward-looking statements, and the company does not assume any duty to update forward-looking statements. Please refer to the company's press release for risk factors which may impact any forward-looking statements and for a reconciliation of any non-GAAP financial measures to their most comparable GAAP measures. Now I'll turn the call over to Vic.

Thanks, Kate. Before I hand it over to Gary to discuss the second quarter financials, I'll make a few comments on the current state of the company. as well as our outlook for the future in light of the COVID-19 crisis. Given how much the world has changed since our last earnings call three months ago, I think it's important to share with you the details of how we're managing the business through this interesting time. As the pandemic spread across the globe during February and March, as economic impacts started being felt in some of our businesses, we did what we do best. We took decisive action. The actions we've taken have a clear and precise focus, which is to protect our strong financial condition, to secure the financial well-being of the company, and to support business continuity. These measures will allow us to weather the storm while continuing to support our long-term strategy for profitable growth. In the past, we've shown our operational excellence and our ability to effectively manage costs to meet challenging market demands. The challenging time will be no different as we are actively addressing today's business pressures by using all the tools at our disposal. The beauty of these current cost reduction initiatives is they're being done and implemented with minimal cost to achieve, thereby maintaining our flexibility to ramp up quickly should demand increases, customers, communities, and countries reopen their economies. Bottom line, we're controlling what is within our control and focusing on the near term without losing our vision for the future. I hope our comments today will leave investors with three clear messages about ESCO going forward. Our diverse portfolio of strong, durable businesses serving a wide range of non-discretionary end markets provides us with the strength and resilience to continue to support our long-term growth outlook. Number two, our strong balance sheet and significant financial liquidity will allow us to effectively manage through this crisis and maintain the company's financial health and well-being. And finally, our deep and experienced leadership team has managed through and overcome many challenges in our 30-year history, and I'm confident it will emerge from this extraordinary time as an even stronger company. Today, we have very clearly defined priorities. First and foremost is the health and safety of our employees and their families, followed by a commitment to meet the needs of our customers and suppliers. Both of these will help support the business today and secure our future during this uncertain time. Esco will benefit from the fact that we have developed leading positions in various niche markets with a set of unique and highly technical products and solutions specifically designed to meet our customers' needs, which makes it difficult to be replaced by alternative sources. Our continued investment in new products across all three segments and our staff of highly skilled engineering talent will continue to create new opportunities to provide value to our customers, which will drive our long-term growth. I firmly believe that our future will arise as our customers' communities recover and spending returns to more normal levels. To close out my comments before I hand it over to Gary, as we face the immediate and ensuing economic fallout of COVID-19, I believe we are well positioned to navigate the short-term challenges in front of us. I'm confident that our fundamental approach to operating our business and our solid liquidity will be the cornerstone of our continued long-term success. Our employees are our most important asset, and I want to say thank you to our manufacturing employees, leadership teams, and staff around the world for their hard work and dedication during this trying time. As you have all demonstrated, an extraordinary commitment to the success of ESCO. Now I'll turn it over to Gary.

Thank you, Vic. I'll briefly cover the Q2 and year-to-date operating results, which we've laid out in the press release. Then I'll share some comments on the guidance for the balance of the year. And Vic will close out today's call with his current view related to our future and our end markets. As Vic noted in his comments, a liquidity position is of the utmost importance to us during this challenging time. I'm extremely pleased with where we stand today by having nearly $700 million of dry powder at our disposal between cash on hand and available credit capacity, while carrying a modest leverage ratio of 0.92. I wish I could tell you that we saw this economic crisis coming late in 2019 when we extended our five-year credit facility out to the year 2024. and we increased their debt capacity by an additional $50 million at lower rates. Or when we sold a technical packaging business and generated over $190 million of gross proceeds to significantly improve our cash and debt positions, but we didn't see it coming. We did not anticipate a pandemic as we executed both of these liquidity enhancements as these were part of our normal financial strategy. I'm sure glad we did these things as they have bolstered our current financial position. I'll touch on a few Q2 highlights from the release. Sales increased 5%, led by our aerospace and defense segment, growing $16 million, or 20%, driven by the addition of GLOBE's submarine businesses, coupled with strong aerospace sales at PTI and Chris Air, and higher space sales at Vacco. Q2 A&D sales came in approximately $3 million ahead of plan. Test sales were relatively flat as a result of a three-week shutdown of our Chinese manufacturing facility in February, coupled with the timing delays of several installation sites where personnel access was restricted due to COVID. Domestic chamber sales were relatively strong and on plan during the quarter, which nearly offset the installation site issues. USG sales were down due to the timing of various project deliverables as several large utility customers, both domestic and international, realigned their short-term maintenance and spending protocol to focus on uninterrupted power delivery during the global crisis. Entered orders clearly were a bright spot in both Q2 and year-to-date, where we booked $466 million of new business and ended March with a record backlog of $565 million, which is up 25%, from the start of the year. Our DOD business, led by our participation on the Block 5 contract for additional Virginia-class submarines, was the clear winner. During Q2, we generated $34 million of cash from continuing operations with free cash flow of $23 million, which is 127% free cash flow conversion to net earnings during the quarter. Q2 and year-to-date adjusted EBITDA improved from prior year, with Q2 reflecting a 17.4% margin, despite the lower contribution from USG, which is our highest margin segment. And finally, Q2 adjusted EPS was 68 cents a share, down slightly from the 71 cents a share delivered in Q2 of 2019, which resulted from the noted COVID impact. To set the table for the balance of 2020, the COVID-19 global pandemic has introduced considerable uncertainty around the extent and duration of today's economic circumstances, which makes it difficult to predict how our future operations will be affected using our normal forecasting methodologies. And as a result of this uncertainty, we're withdrawing our previously issued full-year guidance and will not provide guidance for Q3 at this time. To add some color to Vic's comments on our cost savings actions, We are clearly focused on the right things, and we are pulling on all reasonable cost levers to maintain and optimize our cash flow and liquidity. Our focus is to prudently cut or defer costs in the short term and focus on those costs which do not have a negative outcome impacting our ability to meet increasing demand or growth in the future. And I'll turn it back over to Vic.

Thanks, Gary. I will offer some qualitative comments about our end markets. I will emphasize that today's situation is very fluid and there are many unknowns, so my comments today may change materially in the future. We recently completed a thorough review of our individual businesses as part of our April planning meetings to better frame our expectations of the impact of COVID-19 across and within our various operating units. Starting with the aerospace and defense segment, we expect to see a slowdown in commercial aerospace deliveries over the balance of the year. It's too early in the cycle to determine the sales and even impact from the current industry downturn as it relates to future build rates and airline passenger miles. We are working with all of our aerospace customers to get a better picture of their demand requirements over the coming quarters, but the situation continues to evolve daily. Our defense contract within Aerospace and Defense, both military aerospace and Navy products, is expected to remain strong given its current backlog and the urgency of expected platform deliveries. Our aerospace supply chain partners continue to deliver necessary parts and services to us, and in some cases where we see some weakness, we are working on bringing some of these products and services back in-house, such as machining and other capabilities we can replicate as a safety net. We also see this weakness in the aerospace market as an opportunity for ESCO. Should we find suppliers or competitors experiencing financial or operational stress during this crisis, we may be able to provide assistance, value partnering, or through an acquisition at a reasonable price. Our test business is expected to remain relatively solid over the balance of the year, given the strength of its backlog and the strength of its served markets, including medical shielding, and 5G industry-related communications technologies. We expect USG's customer spending softness to continue for the next few months as they come out of their summer testing protocols and return to their more normal buying patterns. Once some of the social distancing guidelines get sorted out and utility service personnel can return to their normal site visit routines, we expect our service business to return to normal as it has been essentially on hold for the past few months. Utilities have money to spend, and I'm certain spending will return in the near future, as maintenance spending cannot be delayed indefinitely without creating significant risk to grid safety, efficiency, or regulatory compliance. The critical need to maintain, repair, and improve the utility's aging infrastructure is not reduced by this pandemic crisis. On a positive note, I'm really pleased with USG's pipeline of new products and solutions, especially related to software security and related asset hardening solutions. We introduced several new solutions at the Doble Conference in March, and from customer feedback, both during and after the show, these products are being enthusiastically received. Moving on to M&A, prior to COVID, we had a couple of actionable opportunities well down the path to completion. and we're continuing to evaluate several other actionable deals in the pipeline. When the time is right, we'll take actionable opportunities to grow our businesses when we happen to pass. Our board is supportive of our M&A strategy, and our current balance sheet provides us with plenty of liquidity to allow us to add to our existing portfolio. In summary, we delivered a strong first half of the year, And for the balance of the year, our plan is to hunker down while the dust settles, work hard to control our cause while maintaining our critical workforce, develop contingency plans for multiple scenarios, and look for opportunities to leverage our infrastructure. We will survive and prosper. And I'll be glad to answer any questions you have.

Excuse me, presenters, are you ready to take in questions?

Yes.

Thank you. And at this time, I would like to remind everyone, in order to ask a question, simply press star followed by the number one on your telephone's keypad. Again, simply press star one on your telephone's keypad. First question comes from the line of Robert McCarthy with Citizens. Your line is now open.

Good afternoon, everyone. How are you today?

Hey, Rob. Hey, Rob.

So maybe the first thing is to talk about in the quarter the strong cash conversion you cited. Could you talk about some of the dynamics of that and how we should be thinking about that going forward?

Yeah, I think, Rob, as we've talked in the past, you know, it's a clear focus of ours to get that percentage up, you know, from where it's been historically. So some of the initiatives are taking hold, and it really is kind of our across-the-board focus on, You know, doing the things that are the easy things to do, which is making sure you're paying your vendors and that sort of thing on the appropriate kind of time scale. And also working the receivable side and collecting some things. We're also doing some things with an inventory where, you know, we're not accepting inventory early and things like that. So those are kind of the basic things. But I'd say the other side of it comes from on some of the contracting things we're doing, you know, across the ZOD world. When we win these contracts, part of our negotiating strategy is ask for larger down payments up front to try to keep our investment in those programs to a minimum. And so we're successful with that. I'm sure you've seen some of the headlines out there where the DOD is increasing their progress payment flexibility in some cases. So we're starting to see some flow in coming in from that. And so, you know, it's kind of across the board. But we're really pleased with it. I don't think it's sustainable. I don't think it is. I know it's not sustainable at 127% because on the quarterly volatility, you're going to have, you know, swings and roundabouts. But I think you're going to see for the year, you know, depending on how the back half of the year plays out relative to the order book and things like that, you're going to see pretty decent cash conversion in the back half of the year as well. Again, not at the 127%. So what you're starting to see is some traction. on the things that we've been working on. As I said six months ago, you know, this is, you know, we're trying to turn around a battleship here with some of our customers and that sort of thing, and we're seeing some progress. So hopefully that's helpful.

No, it is. And maybe we can talk a little bit about your commercial aerospace exposure as a whole and just amplify your comments around it in terms of, you know, sizing the business and the exposure and then just giving us some level of comfort or dynamics because, I mean, you know, we can start citing third parties. You get some pretty scary numbers pretty quickly because you're tied, obviously, ultimately to airline travel and movement. So just help us how you're thinking about that, not only in terms of near-term dynamics, but also just, you know, how long do you think that, you know, we could be in, you know, this kind of – choppy environment and what is the implication for you all? Because clearly you didn't see it in the quarter, which we understand, but it's important.

Sure. So, Rob, overall, you know, it's about 20% of our overall business. So that gives me a lot of comfort in that 80% of our business is not associated with that. Commercial aerospace is still going to be a good business longer term. And if you look at what happened after 9-11, you look at what happened in After 2008, you know, there certainly was a downturn, but, you know, these things don't go to zero. You know, people are still going to fly. People are still going to travel. So these are things that these businesses are going to be fine over time. And if you look at it in pieces, you know, about 18% of our overall business is 16% to 18% is to OEMs. And then the rest of it is the aftermarket, and that's what's really driven by the flight miles. I mean, obviously the OEMs will be impacted to some level as well, but I don't think as near term as dramatically as the aftermarket will. As far as recovery, I mean, I think we just have to kind of look at history and make some assumptions on that. You know, it looks like, and everything I hear and people I talk to, they're thinking it's going to be $3. to maybe five years to get back to 19 levels. So this is not something that's going to turn around, you know, in the next 18 months. But again, I don't think it's going to go down as far as some people may think. I mean, it's not like 95% – you know, the flight traps down 95%, we go down 95%. That's just not the way it works. So what we're doing is looking for opportunities, as I mentioned in my statements, to do some insourcing – to try to fill some of that void. So it will definitely have an impact in the near term, but I think longer term those are still good solid businesses.

And then finally for me for now, USG, could you just comment on some of the behavior you talked about with this kind of push out of some of the deployments in terms of the switching of resources to unearthable power for the utilities and then I do think there was a comment in the press release about Doble and kind of some of the struggles there, or either in the quarter expected. Could you just amplify kind of your comments around that?

Sure. So with utilities, you know, utilities are pretty conservative, and so the most important thing for them to do right now is to keep power flowing, right? And so typically what we would see in the spring is where you start taking a lot of substations offline, They would do the testing. They would utilize our equipment, our services. That would kind of, you know, remind them they need to buy new equipment. And so what they've done is kind of jump past that piece of it and act like it's more summertime. And so they really have not been taking substations out of service to do some of the work. Now, you know, one thing that's happened when they do that, then they take more oil samples. And so our oil labs have been running overtime. but not enough to make up the difference in what we were doing from a product and service standpoint. This is something that's not sustainable. I mean, everything we're hearing, and obviously we're staying very close to the customers. We can't visit them right now, but we're spending a lot of time on the phone with them. And everything they're saying is, hey, this is going to come back. We're thankful to start to see some good movement in the fourth quarter and certainly going into the next year. So unlike the airlines where It's a little more unclear. The utilities are going to have to do this type of maintenance and testing, and so we think it's going to be a much shorter duration dip with the utility business than what we might see in the airline business.

Thanks for your time.

Next question will be coming from the line of Shantan Wenfeng with CJS Securities. Your line is now open.

Thank you, guys, for taking my questions. And nice quarter. And also, Gary, to echo your comments, you know, nice job on the sales packaging, the refi, and even the action on the pension that you mentioned in your press release, just all of that very timely stuff ahead of what we're seeing. My first question, I guess, you mentioned utilities business servicing not being an option right now. How big was that business on a quarterly run rate? And is that actually going to zero at this point? Or is there still some minimum level services going on?

Well, the service business itself, I mean, it's not a huge piece of our business. I know that number right in front of me. But it's not gone to zero. I mean, there's some very critical areas like nuclear that still have to be serviced. But, you know, we're talking, you're saying it's like $25 to $30 million and certainly not going to zero. And as you can see, even with their performance in the last quarter, they were down but not to that kind of level. So... I think people always have to be careful when we talk about businesses dipping. I mean, they almost never go to zero unless you're in a retail business or something like that. But with our businesses, you know, they're impacted, and so it's really relative. So that business, I mean, I would say they're chomping at the bit to get people back out to facilities, but they've been really restrictive about letting people in their property, just like everybody else. I mean, we're not letting visitors come in at our facilities either. So that service business is certainly taking a dip. It'll come back. I think it'll be back in the fourth quarter. In fact, we're hearing from some of the testing companies that, you know, provide some of the services to the third parties, provide utilities that, you know, there's a lot of thin-up demand for them as well.

Got it. So if you're running at $25 to $30 million maybe a year, how much is the run rate in the month of April, for example?

Yeah, you know, again, as Vic mentioned, the seasonality of when they're allowing people out, it's not rateable, you know, one-twelfth across the platform. So, you know, it tends to be at this time of year, if they were in the normal cycle, it would be a couple of, you know, $4 million, $3 to $4 million a month. And then, like Vic said, when they go into summer mode, it's a little different profile because that's what we're living in today is they've accelerated that. So if you think of it as kind of in this, you know, $2.5 to $3 million a month right now, That's kind of where we're seeing the softness at that kind of level today.

Got it. Okay, that's really helpful. Thank you. And then maybe just the same question.

John, if I could add one thing, too. I mean, we had a call this morning, and one of the things we talked about was kind of the RFP level that we're seeing, and that's really increased over the past two weeks. So I think that's indicative of, You know, those aren't orders, but those are RFPs, so people know that the need's there and they're trying to get us to be ready for a shotgun start, if you will, when things start opening back up. Right, because they can't put it off forever.

That makes sense. Okay, and then just a, you know, similar question on the aerospace side. What kind of run rates have you been seeing maybe split between the OEM sales side and the filtration side and, you know, through the end of March and into April and maybe to the beginning of May? Was there a buffer of inventory at the carriers, or how should we think of the run rates you're seeing today in those businesses?

Yeah, one thing we do, John, is you've been around us a while. We pay a lot of attention to details as part of our planning process. So one of the things that we keep an eye on is what we call the weekly shipping report. So when we lay out our plans, you know, there's some obviously volatility. It might ship on a Friday versus the following Monday. But generally, the weekly shipping plans are pretty tight. And so, you know, obviously we're monitoring that a lot more closely now. And so what it's looking like on a weekly basis is kind of in the, you know, $200,000 to $500,000 shortfall. You know, and again, that's coming off of numbers that are in the multiples of millions. So you know, we had a great first half. We were ahead of plan, as I said, by two or three million. And now we're probably behind plan, you know, sitting here today for, you know, four weeks or five weeks into the Q3. We're about two and a half million behind where we thought we would be. You know, so as Vic said, it's not going to go to zero. And the beauty of our stuff is we get orders, you know, for finite products. You know, we're not selling widgets and things that they buy off the shelf. And so as of you know, we sit here today, the customers are taking the products that they had requested a little bit lighter. There's been some push-outs, but the push-outs are, you know, weeks a month, not years. And so I would say, you know, for the first five weeks of this period, we're about two and a half or so short of what our plan would be. And we're not seeing a dramatic acceleration. So if we look at each of those weeks and, you know, we go all the way back to the start of the year, We're not seeing, you know, millions and millions of dollars of shortfalls on a weekly basis. So, you know, we're in a beautiful spot because, you know, we're seven months into the year. And so for the next four or five months, you know, if that trend continues, yeah, it's going to be headwind, but it's not, as Vic said, it's not going to go to zero and they're just going to suspend all deliveries. And, again, it's validated by the cash flow that we've gotten. So not only are we delivering product, we're getting paid for it. So I think all that's kind of helped. if that makes sense to you.

Yeah, it does. And just to be clear, is that just the aftermarket or is that the entire aerospace business in terms of the shortfall?

On the weekly shipping, the level that I look at is really dollars. And customers, I'm not getting the split between OEM and aftermarket. But to Vic's comments earlier relative to the relationship, when you look at our contribution, of OEM and aftermarket, it's about an 80-20 split, 80 to the OEM side. And so within a dollar of sales. And so that helps us because they are still building planes. They're just not going to build as many of them. And so the product and the contracts we have are still being executed at 80 or 90% of the deliverables that are in the plan. That's not going to continue, obviously. We think build rates are going to slow down. We just don't know to where.

And, again, I think it's important to remember that the only place we're seeing that type of impact is on the commercial aerospace. And so our defense sales are still strong. Our Navy sales are still strong. And our space sales have been strong. So it's, you know, we've got to focus on one area, and obviously that's where we spend a lot of time to look for ways to bolster that business.

Understood. Just one last one, if I may. The Virginia order, you received the Block 5 boats. When do those liquidate? What's the schedule and timing for those, you know, flowing through to the P&L out of backlog?

Yeah, I would say the, you know, it's multi-year. So relative to Block 5, there will not be a whole lot of sales this year because obviously they're still producing. They're at the front end of Block 4 on the calendar build. And so, you know, we'll have some long-lead materials. purchases this year, which, you know, are part of the contract, so we'll get some revenue. So if you think of it as, you know, we booked about $105 to $110 million of Block 5, and we'll probably deliver somewhere in the neighborhood of $3 to $5 million of that over the back half of the year, and the rest of it will carry over. And so when you look at that backlog number of 565, 68 to 70% of that backlog will ship over the next 12 months. And so obviously that equates to about $385 million. So on the Virginia class, the reason that it's 68% are historical has been around 80 or 82 is because the Virginia class at Globe in particular, it goes out about three years. Getting back to the whole stability, when we purchased Globe, as we mentioned back then, one of the most attractive features of being in the Navy business is the long-term visibility and the long-term duration of these contracts. And this is this is where we're sitting today with it. So it's really, really good setup.

Great. Thank you very much guys. Good luck.

And again, if you would like to ask a question, please press. Next question comes from the line of John. Your line is now open. Good afternoon guys.

Thanks for taking my questions. Let's start the test segment. Um, I'm getting, you know, different feedback as far as spending in that marketplace, in part because R&D is a discretionary spend.

Hey, John, we can't hear you. I mean, you're really making up bad.

Okay, I'll try again. In the test segment, I'm getting some people that are telling me that it's a discretionary spend and they're not getting – great orders, others that are large jobs actually continuing to go through. You seem to be saying that your business is doing well. Can you kind of talk to us why that's the case?

Okay. I still couldn't quite understand, but I think I know what you said. So let me try to ask the question. You asked to tell me if I got it right or not. I think what you were saying was some people are telling you that orders are really soft right now in the test segment. Other people are saying... They're pretty strong. And kind of what are we saying? Is that what you said?

That's a good summation, yes. Okay, okay.

Maybe I need to get a translator, but for Scott. So we're really, you know, our test results really is pretty solid. We've seen good orders, and, you know, And, you know, in our test business, it really comes down to if you look at our business, you know, there's a lot of different areas. So we have the medical. We've got the components. We've got the absorber. We've got, you know, we've got our auditory booths. And so there's a lot of it that's pretty, you know, straightforward and it's very dependable and, you know, it's really not discretionary. And so then as soon as you you've got probably 80-plus percent of the business that, you know, is pretty rock solid in any given year. So then what you have is another piece that is, you know, over and above that. It really depends on if that's discretionary purchase or not. And so many of our customers, you know, these are long-term projects that they have to have done. They've already got the buildings built for, so we just put the test chambers in that. And so we've really not seen that level of variability as of yet. In fact, as we sat here today, I think we're in really great shape for this year. You know, we've got a lot of backlog for next year. We've got good opportunities going into next year. So I think just the diversity of the end markets that we have in our test business is what has really given us a lot of stability in that area. Now, having said all that, I mean, at the end of the day, Some of it is capital equipment, and that is a place where people will look to cut. But, you know, if they're not using our equipment, then they're probably going to have to put it outside third party to do this testing, and most of the customers will have the capability and flexibility to be able to do it themselves.

Okay, fair enough. And in the commercial aerospace business, how much excess inventory do you think is in the channel for your products?

Try that again, John, if you would.

How much excess inventory and commercial aerospace do you have to burn through in the channel?

Are you talking on our end or relative to fleets that are parked or things like that?

Relative to how much you've delivered that has been built yet.

Okay. Yeah. One more thing about that is there is such a thing as if we're going to deliver a product, it's usually going to go on an airplane within 90 days. So it's not, you know, we're not delivering, excuse me, just in time. So we don't ship things on Monday to Boeing or Airbus and it gets put on a plane on Tuesday. So, you know, what we've shipped so far, you know, it has been utilized. So what we hear from, you know, either the distributors that we go through or the direct sales content is that, they probably have somewhere between 30 and 45 days of inventory sitting there for planes that haven't been built. And that's where, like I said earlier, we're starting to see this $2.5 million slowdown here in the last five weeks really is a function of them slowing down their expectations for delivery timings until they sort out their build rates. So hopefully that helps. We're not going to see this thing, this isn't going to be a cliff. that we drop off of. It's going to be more of a little sliding board kind of thing that goes down over time as opposed to just stop all deliveries for the next 90 days. That's not what we're seeing relative to backlog we have and expectations. We said in the prepared remarks, you know, we're talking to our customers every few days, and we have not received a formal notice to cease and desist deliveries from anybody.

Nope, that's perfect what I was looking for. On utility service side of the business, is that seasonal, spring and fall, kind of like a turnaround season or not?

Yeah, there was a point I was trying to make earlier on is a lot of times, you know, they will do testing in the spring, but this spring they're not doing that because they want to keep the power on, so they don't take anything offline. So typically we would see a little bit more this time of the year. So there certainly is some seasonality to that business. I think that's going to change some this year because they have some delays underway now, which I think they'll try to pick up either in the fourth quarter of this year or the first quarter of next year.

Perfect. And I guess two last quick questions, if I might. Is there any change in your capital spending plans for the year based on COVID? And can you just talk a little bit about the tax rate in the quarter and what we should think about going forward?

Okay, I'll talk about capital expenditure, and then Gary can talk about the tax rate. Certainly, we are taking a hard look at that. You know, we've asked people to go back and re-justify everything, and then we're meeting with each of the CFOs and subsidiary presidents of each of the companies to go through their capital plan, so they're going to have to re-justify that. And they're, you know, these really seasoned management teams, so they were already doing that, but we'll be going through the details with them, but Certainly, I mean, for instance, we were looking to add on to one of our plants. Starting at the second half of this year, we put that on hold. You know, there's been some equipment buys that we put on hold. So that is an easy kind of, I want to say painless, but a fairly painless thing that you need to do. And so we're doing everything we can to conserve cash.

And on the tax side, John, look, if you look at last year, it's kind of the same profile. The second quarter last year had an unusually low rate because of some strategic things that our tax group works on, that they basically come to fruition in the second quarter, and we've had the same thing this year. So if you look at it on an annual basis, you know, it'll be in the kind of 24% range, similar to where our expectations were at the start of the year. And again, you know, to get to 24 for the year with this, you know, 10% to 12% rate in Q2, again, consistent with last year. We're going to probably have 25% or 26% rates in Q3 or Q4 to get to that, you know, blended rate over the average. So the numbers look the same, and it has the same key, and it has the benefits of some strategies.

Okay, guys, I'll get back to you and stop bothering you with this phone.

And again, if you'd like to ask a question, please press star 1 on your telephone's keypad. Next question will be coming from the line of Robert McCarthy with Stephens. Your line is now open.

Yeah, just a few follow-ups, if I may. I guess first, I mean, just looking at your overall exposure, and I understand and respect, obviously, given the dynamic situation at COVID, it's very hard to forecast these things. However, we do not have that luxury. So I guess the first question I would have is, you know, obviously a lot of your businesses are fairly cyclically resistant. You know, that's been talked kind of ad infinitum, ad nauseum. And you can talk about, obviously, the Navy business is, space defense to a certain extent, and then obviously aerospace has more of a cyclical patina, and the utilities is fairly defensible. But maybe you talk about testing. I mean, testing really tied to kind of CapEx among the corporations that are using them. How cyclical could we expect there? Could we see some pretty dramatic cuts there? Just any kind of color that you can provide so we can kind of ring fence where we would see a little more volatility in kind of the end market, in your view?

Yeah, I would say that today, and, you know, we spend a lot of time looking at this, and I would say today that business is very solid. I really think it gets to the end market for serving, and some of the primary end markets there, again, are medical, both on auditory testing and MRI shielding, you know, industrial shielding, and then you get into the 5G piece of it. So I'd say that those are very dependable. Also, and I think people who cite, there's a good bit of, say, recurring kind of business there and that we have all types of instruments that we provide, and those are going to be sold in a pretty rateable approach every year. And so people are buying antennas, they're buying turntables, they're buying amplifiers, they're buying those types of things. So really where I think you would see the volatility would be in the large projects. And fortunately, we don't need a lot of large projects today to make the numbers that we have out there for this year and what we're looking for for next year. I think those provide more protection and upside than anything else. So you're right, it absolutely is capital equipment, but it's a different type. And it's not like somebody's buying a machine from us. they're buying a testing chamber. And again, for companies that are required to do this type of testing, and again, anything that there's electronic content or electronic products have to do this type of testing, they only have two options. One is to do it in-house. The other is to send it outside to a test house. And most people want to have control over that. And so that's the reason we sell a lot of the chambers to the end customers. Again, if you look at what some of the electronic manufacturers are doing, they're moving forward. I mean, they're developing products to sell in the holiday season at the end of the year, and they're certainly moving forward with that because if they don't do that now, they're not going to be in a position to meet the demand they have later in the year.

And, Rob, I'll add a number around what Vic's comments. It's going to support kind of how we think about that. One of the other metrics we track is what's called shippable new orders or SNOW, which says, okay, here's the backlog position you have today at March 31st. You know how that backlog runs out and the construction gets done. To meet your second half sales commitment, what do you have to book and ship in the same period? And so that's a metric we track that I would say this year, you know, despite COVID being what it is, we only have to book about $18 to $19 million and ship it this year relative to the commitments, you know, relative to your model and our model and that sort of thing. And so what that means in English is, you know, we basically have 83% of the stuff we need to meet our commitments this year already in our hands. And so to take that to Vic's point of we sell antennas and things like that that are, you know, the more routine kind of deliveries, When you break that down into, you know, let's call it three to three and a half million dollars a month, that's kind of what our normal run rate is, you know, for antennas and some of the off-the-shelf products and services and things like that. And back to the installation delays, you know, again, on these calls that we have every other day with all the group leaders, the customers, as countries open up, you know, we have a couple projects in Europe, Italy in particular, that have been shut down for two months. And, you know, it's one of those things you can't be on site. Then also when the site opens up, they say, where the hell are you? You guys are late. Let's get on it. And so what's great is, you know, we're going to see acceleration there. And, again, that's already in backlog. So having a book-to-bill ratio that we have today and a shippable new order that's at only, you know, 17% or something like that, you know, $20 million-ish, is really comforting knowing that that's what we have to do to meet our test business commitments.

Okay, and then just I guess as a follow-up then, go ahead. Yeah, I guess as a follow-up then, you know, in terms of the M&A opportunity set, I mean, clearly you have, you know, with the favorable outcome of the divestiture and the strength of the balance sheet and the cash you receive, you're in a very good position for capital deployment. Maybe just level set what your expectations are for kind of a bounded size or outer bound for doing deals. I understand that, you know, niche and bolt-ons are kind of the coinage of the realm, and you're not going to do, you know, a crazy big deal, particularly in this environment, I would think. But talk a little bit about the bid-ask out there. Obviously, presumably the consensus would suggest that, you know, this is a very difficult time for M&A, just given buyer and seller expectations and an overall inward focus on operations as opposed to, you know, deals transacting. But I have heard episodically, like, for instance, coming out of middle market private equity or other places where, you know, folks have assets that they want to deploy and return capital, and they might have other businesses that might be tougher workouts or problem children, that there might be, you know, some of these properties unlocking because people know they can get, you know, a sum certain and then focus on that part of the portfolio that might be more troublesome and then get some capital return to their limited. So I didn't know if any phenomenon like that was going on that would lead you to believe that perhaps this could be, you know, counterintuitively a decent M&A environment.

You know, I think if you think about it the right way, I mean, we think there are going to be really great opportunities coming out of this. I mean, I think some people are going to be in a position where they need to sell their books and some people are going to be in a position where they just, They don't want to have the risk of going through this again. So we've told all of our management teams that they need to identify where they think the best opportunities are. They need to be having those conversations with people now. They need to be close to them so that when we start coming out of this and people decide they want to do something, Maybe they call us first and we have a discussion and we move forward. If you have those relationships, that's just a lot easier to do. I think the multiple that can have to come down as a result of this, I'd certainly say that we've always been very diligent in our due diligence, but I think that the toughest thing on the other side of this and something we will have to spend a lot of time on is just verifying forecasts because that's what it's really about. You know, every industry is going to be a little bit different, but I think we are experts in areas where we participate. Some things you can't really understand. I mean, build rates on a commercial aircraft are going to be murky for a while. I think we'll have a lot better sense in 60 days and 90 days and every month after that, but that's the area where we have to make sure that we don't buy into somebody's forecast. It's just, you know, based on bad assumptions. So we'll spend a lot of time doing that as a result. But one comment you made, absolutely right, we're not going to go make a big acquisition. This is the wrong time to do that. I think we'll be looking for acquisitions of the size that we've done over the past couple of years because we can do that without putting ourselves in a position from a liquidity perspective that we don't want to be in. One reason we're really happy, what we're at is we do have a good strong balance sheet. We want to maintain that. But I think you also can't sit on your hands when there are good opportunities out there. So we're just going to have to be very diligent about identifying those, delving them hard, and then move forward when it makes sense.

Thank you for your time.

Okay, are there any other questions?

Yes, I'll line up John Tonwinson with CJS Securities. Your line is now open.

John?

I think you might have clicked off.

Hi, can you hear me now? I'm sorry about that. Yeah, we can hear you now. Okay. I guess the first one for my follow-up, I was wondering, can you quantify the kind of cost reductions that you're looking at, maybe in the aerospace business? I don't know if you mentioned the actual amount and kind of what you're saving year over year there.

We've not quantified that entirely yet. I mean, we're still – there's some things we just, you know, put a stop to, like travel and some compensation things. You know, we have not had to have forced cost reductions yet, and, you know, our hope is that we can – you know, find ways to work around that. But, you know, obviously we're going to have to make decisions we have to make. But I don't think we've got a firm number on what the cost reductions are to date.

Okay. Got it. And then second, this may be a little bit out there, but I know you guys are involved in the cabin air filtration space, and I'm wondering if there may be some increased demand for that or new products. You know, just as it relates to hygiene and filtering air for virus particles and that kind of stuff when these planes go back into business.

You know, that's really – we've been asking the same question internally. And the real issue is that I don't think the filtration of the air on the airplanes is really as much an issue as kind of the stew you set in the four or five people around you. So already – You talk about these COVID-19 masks, N95 masks, so that means they stop 95% of the particles with a certain size, and already the HEPA filters that are on airplanes are well above 99%. So that's not where the issue is. It's really going to be on proximity of people. I think they may switch them out more frequently. We have developed some things with some antibacterial on the material itself. But I don't think that's, you know, that was one of the first things we asked because we thought, well, maybe there's a great opportunity for us here. But the real issue is the person sitting on each side of you.

John, if you notice some of the press communications or even I saw it on a TV commercial last night that the airlines are touting that. They're saying, you know, they're increasing their HEPA filtration elements and they're doing this and that and it's Really just, you know, the marketing there is to put comfort into the traveler's mindset to be able to get them back on the plane. But the airlines are thinking the same way, and if they want to be overly cautious and replace those more than they need to, we're all for it.

Got it. Okay. Thank you for that. And then just last, I know you're not quite as in a rush to close M&A, but I know before you were going into this with, I think, two acquisitions that were within line of sight of closing and maybe ten more. Can you just update on those? specific opportunities and if closing may be any time in the near future?

Well, one of those we decided to put a close down on, you know, to stop it because of the market it was in and really not being able to get a clear forecast on it. There's another one that we're still working, but we're working it, you know, a little slower to make sure we don't miss anything because I don't think this is a time to take a big risk. And so we're going to make sure that You know, no acquisition is risk-free, but I'd say in this environment you want to have a lower risk tolerance than you typically might.

Great. Thank you very much, guys. Sure.

And again, if you would like to ask a question, see the press bar followed by the number one on your telephone's keypad. We don't have any further questions. Please continue.

Okay. Well, I appreciate everybody's interest today, and hopefully we'll have a last eventful next 90 days before we talk again. So thank you very much. Thanks.

And this concludes today's conference call. Thank you, everyone, for your participation. You may now disconnect.