ESCO Technologies Inc.

Good day and welcome to the SKLQ3 conference call. Today's call is being recorded. With us today are Vic Ricci, Chairman and CEO, Chris Tucker, Vice President and CFO. And now, to present the forward-looking statement, I would like to turn the call over to Kate Lowry, Director of Investor Relations. Please go ahead.

Thank you. Statements made during this call regarding timing of recovery and growth of our end markets the amounts and timing of 2021 and beyond revenues, impacts of COVID and COVID variants, and recovery expected as a result of COVID vaccines, recovery in commercial aerospace, adjusted EPS, adjusted EBITDA, cash, shareholder value, the timing of Block 5 deliveries, success in completing additional acquisitions, success in integrating acquired businesses, the results of cost reduction efforts, the correction of production and inventory issues, and other statements which are not strictly historical, are forward-looking statements within the meeting on 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 8K 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 thanks, everyone, for joining today's call. Before we jump into the details of the quarter, I'd just like to thank our employees across the company for their ongoing efforts to run the business. With the ongoing challenges from COVID, we continue to see great efforts and contributions from everyone across the company. And for that, I'm very appreciative. Since the beginning of the pandemic, our primary goal has remained the same, provide a safe working environment and protect the health of our employees. And today, we continue to encourage our staff to get fully vaccinated for the benefit of everyone. There were a few challenges in the third quarter, but overall the company continues to perform well. Cash generation year-to-date has been excellent. We have teams focused on the working capital initiatives around the company, and there's still room for improvements as we move forward. This could be a long-term value creation tool for ESCO. Our previous cost reduction actions, along with our enhanced focus on operational efficiency, will benefit ESCO going forward as our end markets continue moving toward a more normalized level of activity. and I'm confident that our disciplined approach to operating the business will result in continued success as we move into fiscal 2022. While Chris will provide the financial details, I'll offer some top-level commentary to set the tone. While our year-to-date A&D sales continue to be lower than prior year due to COVID's impact on commercial aerospace, our portfolio adversity allowed us to mitigate this headwind as our year-to-date consolidated adjusted EBITDA margins are only down slightly compared to prior year-to-date margins. This performance was driven by solid contribution from our other operating units as a result of a favorable sales mix and meaningful cost reductions across the company. From a segment level, there are several positives to report. Within A&D, we're seeing signs of recovery in the commercial aerospace as passenger boardings continue to increase and more airlines are adding idle aircraft back into service. Sales of our commercial aerospace customers were still down in the third quarter as the recovery in this sector has been a bit slower than we anticipated. U.S. domestic travel has picked up, but it's still slightly below 2019 levels. Those of you who have been to an airport lately are probably surprised, but this is what the TSA statistics show. It's important to understand that business travel remains soft, and air travel in Europe and overall international travel are still well below 2019 levels. The good news is that we're starting to see order activity increase in the third quarter, and our overall A&D segment orders increased by more than 40% compared to last year's third quarter. Additionally, our Navy and space businesses remain strong and well-funded. And our outlook for near-term growth opportunities continue to materialize in both of these areas. Our test business continues to be steady. We have a good order input on a global basis, and we're actively managing material inflation and transportation issues as they arise. We expect test outlook to remain positive, driven by the strength of its certain markets, including 5G, medical, and automotive. Our USG business continues to outperform from a profitability perspective, with year-to-date adjusted EBIT margins of 19.4% compared to 15.1% last year. The renewables business at NRG has performed well in 2021, while the orders from Doble's utility customers have been a bit soft. We did see sales growth from Doble of approximately 8% of the quarter, but we have not yet seen demand return to pre-pandemic levels. We feel great about the long-term outlook for the USG business and are very excited about the announcements today regarding closing two acquisitions. Our agreement to acquire Alta Nova had been announced back in May, and we were able to get the deal closed on July 29th. This business brings exciting new product offerings to our USG business and also significantly increases our global footprint. Additionally, we announced today the purchase of Phoenix Technologies. This is also an exciting business that further enhances the product offering of our USG group and provides greater access to the commercial industrial markets. We've had initial meetings with the teams for both of these businesses and very encouraged by the quality of the people and their enthusiasm to join ESCO. We're confident these will be strong additions to ESCO and USG's portfolio that will drive future sales and earning growth. So overall, the fundamentals of our portfolio remain strong. The second half sales outlook is a bit behind initial projections, but orders have started to increase, and we feel good about the growth outlook for 2022 and beyond. Now I'll turn it over to Chris. Thanks, Vic. I'll start by briefly touching on a few comparative highlights. Sales in the third quarter grew by 5%, with A&D up 1.8%, USG up 12%, and tests growing 4.6%. This has been the first quarter in 2021 where we saw sales growth from all three segments. Adjusted EBIT margins were 12.7% in the quarter compared to 14.2% in the prior year quarter. The margin decline was driven primarily by the operational inefficiencies and inventory write-offs at Westland. We had some commentary in the press release regarding Westland, and we wanted to mention that here as well. In the quarter, we did become aware of some issues at Westland. They have experienced several challenges related to new product development programs, which led to increased production costs and product quality issues. No bad product was sent or billed to customers, but we did have charges recorded in the quarter of $2.1 million and year-to-date charges of $4.4 million. The first and second quarter charges represent corrections to our previously reported financials And going forward, our 2021 year-to-date numbers will be updated to reflect these amounts. We have started work immediately to get the production issues fixed and to address cost issues within the business. There are strong synergies between Westland and our Globe subsidiary, and we have already begun the work to bring these businesses together under one leadership structure. We have a strong outlook for this business and are committed to driving significant improvements as we move forward. Adjusted EPS came in at 67 cents per share in the quarter, below prior year's 76 cents per share. Adjusted pre-tax dollars were down 2.5% compared to prior year Q3, and we had an exceptionally low tax rate in prior year Q3, which further reduced EPS. Segment highlights in the quarter are as follows. A&D did see a return to sales growth in the quarter. The Navy business grew by over 20%. which more than offset declines in the commercial aerospace sales of approximately 10%. While the commercial aerospace sales were down, we did see the rate of decline improve, and we are seeing signs that the business is beginning to rebound. Margins for A&D were down, driven by the issues at Westland. USG saw growth of 12% in the quarter. The renewables business was very strong. The utility business did grow in Q3, but has not returned to pre-pandemic levels. Adjusted EBIT margins were 18.3% in Q3 compared to 14.8% in the prior year Q3. This strong improvement was driven by leverage on the sales growth and benefits from prior cost reduction activities. The test business grew 4.6% in the quarter. Continued steady performance from this group. Margins were down in the quarter due to mix and timing issues. Due to date, operating cash flow is up over 40%. We continue to see great results from our focus on driving balance sheet improvements. The teams across the company continue to work multiple strategies for operating capital improvement, and the results are very good. Some programs driving this performance include negotiating performance-based payments in our A&D and test segments. This has had a significant impact as it oftentimes results in new orders being cash positive throughout the life of the contract. Other efforts include adjusting safety stock levels and extending payment terms. Year-to-date, our adjusted EBITDA was nearly $91 million with a 17.8% margin compared to 18% in the 2020 year-to-date. Over the past year, we took several cost reduction actions across the company that have allowed us to hold margins during this down sales environment. Examples here include closure and consolidation of facilities, the move of manufacturing content to our Mexico facility, and ongoing make-buy programs. Amortization of intangibles and interest expense decreased while tax expense as a percent of pre-tax income increased in Q3 and year-to-date, as we had several tax strategies implemented last year which benefited the 2020 comparative rates. Orders were a good story in Q3, as entered orders were strong. We booked $203.8 million of new business in the quarter ended, with a backlog of $539 million and a book-to-bill of 112%. This represents 29% growth compared to prior year Q3. Strength in orders came from all three segments, with A&E orders increasing 44%, USG increasing 10%, and test increasing 28%. As we continue navigating through what we hope is the near end of COVID, our number one focus remains the same, increasing and maximizing our liquidity to position us for future M&A growth and increased investment in new products and solutions. We have a strong balance sheet today and are excited about the recent acquisitions that Vic mentioned earlier. We still have ample capacity for further acquisitions, and we obviously continue to invest in the core business to enhance our organic growth profile. Our significant cash generation this year is a testament to this focus on liquidity. We have delivered free cash flow conversion at 118% of net earnings for the first nine months. As mentioned above, we have clear momentum in our working capital initiatives. Did want to talk for a minute about the Q4 guidance. In the release, we did provide Q4 guidance. This is the first quarter that has included guidance since COVID began. The guidance for Q4 is a range of 73 cents to 78 cents per share. The sales levels in Q4 are a key issue as we think about the guidance, and this range is predicated on a sales level in the range of 190 to 200 million. In the last three months, we have reduced the Q4 sales outlook for the commercial aerospace businesses and also for the utility businesses. The commercial aerospace backlogs are beginning to build, but we see those more as drivers for 2022 as opposed to Q4. For the utility space, we are seeing some growth compared to prior year, but not to the levels we had previously anticipated. The long-term outlook for both of these markets continues to be positive, and we feel good about our positioning as we look towards 2022. We also want to be clear that this outlook excludes any impact from the acquisitions that were announced today. We will have sales and earnings impacts from those transactions, but they are not yet quantified and are therefore not included in the guidance that is provided. With that, I'll turn it back over to Vic. Thanks, Chris. Since I touched on quite a few of my thoughts earlier in my commentary, I'll just offer a few more comments before we move into Q&A. As Chris mentioned, we are a little softer than planned here in the back half of the year. for the commercial aerospace and Doble's utility market. This doesn't change our long-term commitment to these markets. We feel great about our in-market exposure, and our diverse portfolio allows us to manage through periods like this. Outside these markets, we see a lot of growth opportunities in A&D for the military aerospace, Navy, and space end markets. Investments in the renewable energy market continue to drive very strong performance for our NRG business, And test business sees a lot of opportunities for the telecom, automotive, and medical markets. We just finished up a board meeting in Boston last week. And during those meetings, we took the time to visit the Doble and Globe operations. We had a great set of meetings and really exciting interactions with the teams at the operating units. At Doble, we did a full update of the USG segment. The team has made great progress updating the product line across the business, from renewable-focused products at NRG to the new F8 launch at Doble. It's great to see the innovation happen inside that business. As our customers start spending again, we'll be ready to support them. This also provided a chance to update our board on Phoenix and Alta Nova acquisitions so they could firsthand see the excitement around these transactions. After visiting the Doble headquarters, we took the board to visit the Globe facility. This was another great visit. The team at Globe has done an exceptional job. They're driving tremendous growth with the Navy Surface Hall treatment product line. The team has worked very hard to master a difficult manufacturing process. They're really rolling, and it's fun to see a winning team in action. We had a full couple of days in Boston accomplishing all of this, but it was time well spent. I'd like to thank our board for their ongoing support and guidance. So with that, I think we're ready for some Q&A.