ESE - NYSE

Good day, and welcome to the Q2 2025 ESCO Technologies, Inc. Earnings Conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Kate Lowrey, Vice President of Investor Relations. Please go ahead.

Thank you. Statements made during this call, 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 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, except as being required by applicable laws or regulations. 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 of 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 Bryan.

Thanks, Kate, and thanks, everyone, for joining today's call. The first half of our fiscal 2025 has been highlighted by really good operational performance and positive strategic developments. It's an exciting time for ESCO, with strong underlying business conditions in our key markets, and completion of a major acquisition. So, it's a good time for us to give the investor community an update. Additionally, as you are all aware, the macroeconomic picture has been evolving quite a bit over the past few months, with trade issues coming to the forefront, and geopolitical news items grabbing a lot of headlines. Like everyone, we must watch these activities very closely, and navigate our business through choppy waters. Honestly, it's hard for us to know exactly what will happen next, but our teams have done a nice job of mitigating these risks thus far. We're happy to have this time to speak to you, and we'll update you on the impacts to ESCO as best we can. Before getting into details about the business, I do want to take a moment and say thank you to our employees for their ongoing efforts. You don't achieve results like ESCO has over the last few years without a talented team of employees that are customer-focused and dedicated to solving complex technical and operating challenges. It's hard work. So, a big thank you to the team for the great work so far in 2025. Chris will run you through all of the financial details for the quarter, but before we get to that, I want to give you a few comments on each of the segments. During the past month, we have completed our annual strategic planning process with each of our businesses. As a part of these meetings, we assess our end markets and our strategies to deliver above-market growth. My comments on the businesses will focus a little bit more on these long-term dynamics as compared to current quarter results. Starting with aerospace and defense, we remain very positive regarding the long-term outlooks for these markets. Even with the macro uncertainty that we see, our expectation is for continued growth here. On the aerospace side, we see fundamental demand for additional commercial and defense aircraft, and we expect this to drive growth in our business as we move forward. Order rates have moderated on the commercial aircraft side over the past six months, so as the supply chain adjusts to prior order surges and short-term disruptions, and it prepares for longer-term growth. Long-term, the demand is there and should drive increased build rates. On the Navy side, we also continue to see robust activity in this market. Our business supports prioritized submarine programs, which we expect to be protected and expanded due to national security priorities in both the U.S. and the UK. That assessment supports our long-term growth outlook in line with our previous communications. Before jumping to the next business, I do want to quickly address the SM&P acquisition, which recently closed. We successfully closed the deal on April 25th. It took us longer than we had hoped, but we're thrilled to have the team on board. One key thing to announce today is that we are rebranding the business to do business as ESCO Maritime Solutions. So, as we discuss them in the future, we will likely describe the business as maritime or ESCO maritime. Chris will discuss the impacts on 2025 in a few minutes, but the good news here is that the business has been trending well and is tracking at or above the projections that we made at the time that we announced the deal last July. This is an important strategic portfolio move for us, and we are excited to add a business that enhances our margin and growth profile. Switching businesses now, let's talk about the utility group, which had another solid quarter. Focusing on the long-term here, as you all know, we are experiencing a really good business cycle in the electricity and utility end markets. From our strategic review with this team, it's clear that the market conditions supporting our growth are intact. As we discussed previously, there are several factors which drive increased electricity demand. This increased demand, coupled with aging infrastructure and extreme weather events will make the technologies that Doble provides more important than ever. So, we continue to have a positive long-term outlook for this business. The renewable side of the business is an area that we continue to watch. The sales performance here was better in the second quarter when compared to the first quarter, and we continue to believe that there will be an important role for renewables to play long-term. The renewables market is recalibrating right now, but order activity is better than it was a year ago, and over time, we expect a return to growth. Finally, I'll touch on the test business, which is off to a good start this year. The team here is really doing a great job, and we had a very encouraging conversation with them during the annual strategy update. Obviously, 2023 and 2024 were tough years for this business, but in the first six months of fiscal '25, we saw orders accelerate significantly, leading to very healthy backlogs. One of the strengths of test is the diversity of end markets that it serves, and no doubt we are seeing strong activity in EMC testing, health care, and industrial markets. The macroeconomic uncertainty is something that we have to pay particular attention to here, as this is a global business that has a lot of cross-border trade flows. We are watching the tariff situation closely, and the team is already reacting to mitigate any impacts that we might see. The key thing to leave you with here is that the business has stabilized, and we feel good about our trajectory as we move into the second half of 2025. In summary, we feel strongly that our end market exposure remains favorable, and growth tailwinds should persist as we move forward. With that, I'll turn it over to Chris to run you through the financial details of the quarter.

Thanks, Bryan. Everyone can follow along on the chart presentation. We'll start on page three, where we'll discuss overall financial highlights of the second quarter. Orders were up nearly 22% in the quarter, with increases from all three reporting segments. This resulted in record backlog of $932 million. Sales were up by 6.6% in the quarter, and again, we saw increases from all three segments. Adjusted EBIT margins came in at 18%, with incremental margins on the sales growth coming in at 56%. A very strong result for profitability. This resulted in adjusted earnings per share in the quarter of $1.35, which represents a 24% increase compared to last year's second quarter. Now we go through segment highlights, starting with aerospace and defense. Orders were up 5% in the quarter, as we saw solid growth in Navy orders, as well as a sizable order for PTI's CAD/PAD business. Overall, aerospace and defense continues to operate with high levels of backlog. The sales performance in the quarter was good, with nearly 8% growth. The growth was led by commercial aerospace and Navy. Margins were strong, with adjusted EBIT margins up 400 basis points, and adjusted EBIT dollars up 28%, as we saw favorable impacts from price increases, as well as favorable mix. Next on chart five is the utility solutions group, which posted another strong quarter. Orders momentum remained healthy, with growth of nearly 17%, as both Doble and NRG delivered double-digit order growth. On the sales side, growth was 4%, which was driven by 5% growth at Doble, while sales at NRG were flat compared to prior year's second quarter. You will recall that in Q1, the sales decline for NRG was over 20%. So, we have seen sequential improvement in the trends there. Profitability was very strong for utility, as we leveraged growth at Doble, and also experienced favorable product mix, which helped drive adjusted EBIT margins to 23% in the quarter, an improvement of 290 basis points compared to last year's second quarter. Next, we will cover tests. We have seen continued recovery in this business. Order growth was exceptional, as orders increased 75% compared to last year. Last year was weak, so the comparison was favorable, but there's no question we have seen higher levels of order activity than had been previously anticipated. You can see on the chart, we refer to a few key drivers in the U.S. and China, so the growth there was pretty broad-based, with filters, test and measurement, medical and industrial all contributing. Sales were up 9%, as we saw nice growth from the U.S. and European markets, as well as good performance at MPE. Margins improved modestly to 12.4%. The business did experience benefits from volume price -- volume leverage and price increases. This was somewhat offset by unfavorable mix in the business, which was a result of lower sales in the high-margin wireless business. Moving to chart number seven, we have the year-to-date P&L highlights. As you can see, the results have been terrific through the first six months of 2025. Orders are up over 6%, with a book-to-bill ratio of 1.1. Sales have been even better, with growth of nearly 10% year-to-date. All three segments have delivered sales growth, with A&E and test both delivering double-digit sales growth. Adjusted EBIT performance has shown significant improvement, with all three businesses increasing margins compared to the first six months of last year. All this leads to the adjusted earnings per share growth of 31% over the first six months of the year. Next is chart eight, where we have cash flow highlights. The first six months of fiscal 2025 delivered strong operating cash flow results, as working capital performance has been favorable compared to the first six months of 2024. Capital spending is slightly down for the first six months, so we delivered big improvement in free cash flow and saw our debt-to- EBITDA leverage ratio drop to 0.3 times. As Bryan mentioned during his comments, we closed the ESCO maritime acquisition on April 25th, and the balance sheet was well-positioned for this based on the strong cash flow generation since the deal was announced last July. Last is chart nine, where we'll discuss the updated earnings guidance for 2025. First on sales, we are still projecting 6% to 8% growth before the impact of the ESCO maritime acquisition. For the five months of maritime ownership, we are estimating sales in the range of $90 to $100 million. For adjusted earnings per share, last quarter we guided to a range of $5.55 to $5.75 per share. We are increasing that to a new range of $5.65 to $5.85 per share. We are anticipating unfavorable earnings impacts from tariffs in a range of $2 to $4 million, and those impacts are factored into the new adjusted earnings per share guidance. For the maritime acquisition, we are estimating adjusted earnings per share in a range of $0.20 to $0.30, which is based on the sales assumptions stated above as well as EBITDA margins in the mid-20s and interest expense on new borrowings of approximately $15 million. Adding this to the total, we have updated all-in guidance of $5.85 to $6.15 per share on an adjusted basis. I do want to be clear that guidance excludes any acquisition related to amortization for maritime, and it excludes certain deal and integration costs related to the acquisition. That concludes the financial portion of the call, and now I'll turn it back over to Bryan.

Thanks, Chris. So, as you heard, the first six months of our year have gone really well. We're excited about the ability to increase our full-year outlook, and we're excited about the maritime acquisition, as I discussed earlier. ESCO's future remains bright, and we continue to see a path for value creation and enhancement as we move forward. We certainly see the waters are getting a little bit choppy, and economic growth could be a little bit more challenging, but we feel really good about our mix of businesses and how they will be able to navigate the current environment. With that, I think we're done with the prepared remarks, and we can turn it over to the Q&A.

Thank you. [Operator Instructions]. Our first question will be coming from Jon Tanwanteng of CJS. Your line is open.

Hi. Good afternoon. Thank you for taking my questions, and nice quarter, and congrats on raising the guidance out there. I was wondering if you could touch on the sale of VACCO or the exploration process. Do you have any updates there, and just how should we be thinking about it at this point?

Sure. Well, we've been going through a pretty involved process there to potentially sell the business. We have had a lot of interest, and we have active interest now, but it is taking a little bit longer than we anticipated to come to a conclusion. Right now, we would expect to know how it's going to end by the end of May, and that could include both a sale, and it could also include us making a decision that we're going to retain the business. But, we will provide notice to you if we make a decision to sell the business when we do that. And otherwise, we'll talk about it again on the next call.

Got it. And how has the underlying business performed in the last couple of quarters, just for us to..?

Yes, we've seen a real improvement in the overall business. Chris, you want to talk to that in terms of margin and year over years?

Sure, yes. I would say that we've seen the business stabilize. The performance has been better, you know, better versus last year through the first six months, I would say. But I would also say, the margins are still lower than what we see in the other parts of that business for overall aerospace and defense. But as far as some of the EAC adjustments and other challenges we've talked about in '23 and in '24, we really haven't seen any of those kind of impacts this year and feel like by and large those contracts are have been dealt with and managed, and so we've seen a little bit more of a recovery there so far this year.

Okay, great. Thank you. If you could touch on the tariffs for a moment, is that 2 to 4 million that you called out the net impact after you do pricing and other stuff? Is it a gross number? Just help us think about the puts and takes there and also the underlying assumption as to what level of tariffs does that specifically include? Is that the -- what was announced on April 2nd? Is it some level less than that? Just any color that would be helpful.

Yes, I mean, so first of all, I would say it's kind of a net number. So we're certainly doing things to mitigate. We hope we can stay to the low end of the range of that 2 to 4 million impact or even better, but that encompasses actions we're taking to try to get price, for example, to also make some adjustments in our operations. So all those things are kind of being worked and we would expect kind of the net result the way we gave it to you. As far as percentages, I mean, we're kind of using what's been kind of issued so far and again, we kind of went back and forth on how to handle this, but we felt it was appropriate to go ahead and bake something in and share that and then obviously, if there's big changes, we'll kind of update the guide for that going forward. But where we are right now, we see -- we're more of a net exporter, I would say, than an importer. So, maybe the broader risk becomes kind of demand related if we see significant retaliatory actions or things like that. So, we'll kind of have to keep an eye on all those things and keep you updated, but that's kind of how we did the math for this turn of the crank.

Understood. Thank you. I'll jump back in the queue.

Thanks, Jon.

Our next question will be coming from Josh Sullivan of the Benchmark Company. Your line is open, Josh.

Hi, good afternoon.

Hi, Josh.

Hi, Josh.

On the Maritime Solutions cash generation, I think you referenced it in the prepared remarks there. Is that strong cash profile just a short-term dynamic or how long will that, you know, kind of strong free cash from the asset continue?

Well, I think what we were talking about there was more kind of the earnings impact and adjusted earnings per share in sales. So, on the cash flow, honestly, we would expect some benefit there in the year. We're still kind of working through some of those details with them as we onboard them, but the numbers we were talking to were more adjusted earnings per share.

Got it. And then just given the closing of the Maritime Solutions asset and your increasing exposure to just shipbuilding and particularly submarines, what are your thoughts on the '25, '26 budget as they're proposed? And then, the recent executive order on shipbuilding?

Well, first of all, Josh, I love the fact that you're already calling it ESCO Maritime Solutions. Appreciate that and we're going to make that go viral. But yes, listen, we feel really good about -- with a long time getting through this deal. You worry a lot about what you're going to find when you open up your presence. And what we found is that they are on or ahead of plan for all of the programs. And this is a -- these are businesses that have lots of good visibility to the programs that they're on and the milestones and that sort of thing. And so, we had a really good idea of where they should be. And what we found was they're probably there or a little bit better than that. And so, as we look into 2026, we feel really good about where that settles. Good progress, with their customer base in addition to the U.S. Navy, which we are very familiar with. They have a lot of Royal Navy exposure. And everything over there seems to be on track moving ahead, no pun intended, full steam ahead. And we feel really good about it.

Got it. And then maybe just one on the RF order flow, is it indicative of any new cycles within those markets or is it your exposure just too broad or too early to make that assumption?

You know, there's nothing like the 5G story or the AI story to talk about there. As I said on the prepared remarks, they have broad exposure to a wide range of markets. And I think that, we are seeing some recovery in China. We're seeing some good recovery in the electromagnetic compatibility market. Don't forget that every device in the world that has electricity in it is subject to those standards. And every country in the world has an EMC standard that they follow. And in order to produce product and sell it anywhere in the world, you got to test to those standards. And so I think there's some evidence that kind of maybe the repositioning of manufacturing might be a part of it, but we definitely seen a pickup there. The healthcare, there's a lot of, we're seeing a lot of investments, particularly in what we call magnet swaps. So these would be upgrades at hospitals, you know, swapping out a, you know, 5, 10-year-old magnet for a new one. Those are actually, believe it or not, those are actually larger projects for us. Because you have both the deconstruct and decommissioning and the construction piece. And they tend to be higher margin for us. So we're excited about that. And listen, the industrial markets, electromagnetic pulse testing, we took some really large orders for EMP filters, both at data centers and at utility control centers. And that's a trend that we think is going to continue as we move forward. So yes, I think that no one story there, but a good broad-based positive trend.

Great. I'll leave it at that. Thanks for the time.

Thanks, Josh.

Thank you.

And our next question will come from Tommy Moll of Stephens. Tommy, your line is open.

Good afternoon, and thanks for taking my questions.

Hi, Tommy.

Hi, Tommy.

I want to start on ESCO maritime solutions. It's always dangerous. It's always dangerous when analysts take partial year P&L impacts and try to project into future years when we don't have a whole lot of historical to go from. And so, if a fair baseline assumption might be to just look at the profit contribution you're offering us for this fiscal year. Think about the annualized version of that and then slap some form of a double-digit growth rate on that base as we think about 2026. Is there any more intelligent way that you can help frame what we all ought to be thinking about for 2026? Understand you've controlled the asset for not that long. But any guidance you could provide would be helpful?

Yes, I think your construct there, Tommy, is reasonable. You're right. I mean, we were able to get with them right after closing on the 25th, get some kind of detail to kind of pull together what we saw for the balance of our fiscal year. We haven't been able to get under the hood for very long, as you say. And so I think that the good news is, as Bryan said, I mean, we see them as on track. The backlogs are really healthy. So they're kind of trending at or above the kind of plans we were thinking of whenever we announced this last July. And I think, yes, if you kind of do a monthly run rate for this year and you put growth on top of that in kind of the low, double-digit range, we would expect that's kind of the way it's trending. Obviously, you know, we're working with them. We've got to get the plans re-calendarized and all these kind of things. They've been kind of a calendar year company until now. So we've got more work to do. So we'll give more precision, hopefully, and more clarity on that as time goes forward. But I think, what you're talking about is really a pretty reasonable way to look at it as you think about '26.

Thank you, Chris. Follow up on the incremental margins, in particular for A&D and USG this quarter. I think for USG, what we might be seeing there on the significant margin expansion, strong incrementals might just be a mixed dynamic given you've got solid double growth and flat NRG. So maybe you could confirm or give a little more detail there. A&D is really where I'm focused and would be curious for any insight you can give on the solid incremental dynamic there. Thank you.

Sure. Yes, I would say that on the utility side, you're right. I mean, the Doble is driving the growth. That's where the bigger margins are. So that helps, although, I give the NRG team credit. They've done a great job of kind of reacting to this weak market and really not hurting us from a margin perspective. But with the growth in Doble, you see a favorable impact there. But then I would also say inside of Doble, we've seen a little bit of mix so far this year to a little bit more of some of the legacy, let's say, offline testing type product lines. Those are going to be kind of our highest margin product lines inside of Doble. So the condition monitoring is still doing good. That's a good margin business for us, but it's not really driving the growth the way it had kind of last year. And so that's a favorable mix impact inside of that business. So it really drives the incrementals to a nice level. So that's kind of the key thing there. Then I would say on the aerospace and defense side, a couple of key dynamics I would point to. We do have a little bit of favorable mix there, just some kind of customer mix and program mix. We also are seeing some really nice price impacts on some of the commercial aerospace lines of business. Again, some of these things, we've been working price for a while, but we've been sitting on a lot of past new backlog. It takes time to work through that. So it takes some of that price a little bit longer to flow through. So we're starting to see some of that really helping us and coming through nicely. And then we've also had some pretty good Navy business and Navy margins are good for us. And I would say then if someone asked about VACCO earlier, we are seeing a little more growth there this year from Navy versus space. That also kind of helps the mix. So all those things I think really, you know, kind of add up and have moved that in a meaningful upward direction this year.

Thank you, Chris. I'll turn it back.

Thank you.

Our next question will be a follow-up from Jon Tanwanteng. Your line is open.

Thanks for the follow-up. I was wondering if you could provide just a little bit more color on just the commercial aircraft orders. I think you mentioned they moderate a little bit from maybe what was a hotter period just a couple quarters ago. Do you see that ending at some point and normalizing to end demand or is there something else going on there? Just any color that would be helpful?

Well, listen, Boeing's a part of that story. They had a strike in the first quarter and they've kind of moderated some of their build rates. I do think that the industry had gotten to a point where they started to kind of manage their inventory a little bit more tightly so that we've seen a little bit of a slowdown, not a huge slowdown from that overall piece. Fortunately, we have a lot of backlog and we've been able to continue to grow. We are pretty confident that Boeing is going to be able to pull themselves through this. I think they're doing all the right things. And so we're already starting to see signs that things are moving in the right direction.

Okay, great. And then compared to last quarter where I think maybe Doge was a little bit more of a bogeyman compared to now. How do you see the state affairs, I guess, Department of Defense programs and the status of them and if you think any cancellations or delays or reductions in any of those programs that you're exposed to might be affected or impacted?

Yes, I would probably point you to a document that I think is out on the internet that has, I think, 17 priorities of the Defense Department. And I would say the programs that we're on are all in the top four or five of those priorities and there's plenty of spending that they can go and cut without, but they basically said submarines are really high on the list. Some of our other Navy programs are pretty high on the list. Overall, industrial base shipbuilding infrastructure pretty high on their list. So we feel really good about where we are there. And I will say that the order flow from the Navy side is pretty good right now. And we've got a good line of sight to that. We already have a good backlog and we've got a lot of pretty significant pending work.

Great. Thank you.

And our next question will be coming from the line of Tommy Moll, Stephens. Your line is open.

Thanks for the follow up here. Just wanted to ask for a little more detail on the pro forma capital structure. So I'm seeing $15 million is the interest expense that you've burdened the fiscal guidance with. I guess a two part question here. How many days of the current quarter are included in that just so we can get to a close annual run rate again as we think about next year? And are you able to comment on the pro forma leverage profile thinking on like an all in full year basis, whatever timeframe you want to use? And then how you anticipate that might tick down as you start to repay the debt? Thank you.

You bet. So first on the pro forma debt profile, what I would say is we expect this. When we announced last July, we kind of communicated that we were expecting around a three times leverage. Now that we've closed quite a bit later than we expected and we've had really good cash generation in the interim, we're just over a 2-2 at closing, right out of 2-2, sorry, at closing. So the ratio is really quite good at closing just based on kind of where we came in. And as we look at cash, towards the end of the year and the pay down we can do from now until then, we would expect that number to drop below two for sure. Let's say, more towards the mid ones, let's say 1-6 or so in that ballpark. We don't necessarily give strict guidance there, but the point is we expect to be able to frankly continue to grow EBITDA and pay down debt such that the ratio is going to look better than it does today. So that's kind of how we're looking at capital structure right now. And then as far as number of days, I guess what I would tell you, Tommy, is we really did run that out from the 25th. So we funded the deal on the 25th, sent the money out the door, you know, that day. And we're borrowing right now on a term loan A that we're paying close to six and a half on. And we're borrowing on our revolver that we're paying right around six on. So those are kind of the numbers we're at. And we expect, because of our pay down that I just talked about, that we can lower those rates yet this fiscal year as we move to the different categories of our rate structure in our debt facilities. Such that we can get those numbers, you know, slightly below six on the revolver and slightly above six on the term loan A. So that's kind of how we've got it dialed in right now.

Great. Thank you, Chris. That's all I needed. I'll turn it back.

Thank Tommy.

Thank you. I'm showing no further questions. I would now like to turn the call back to management for closing remarks.

Well, listen, thanks, everyone, for taking a few minutes to spend with us. As I said in the opening remarks, this is an exciting time at ESCO, and we will talk to you again in a quarter. Take care.