ESE - NYSE

Good day, and thank you for standing by. Welcome to the Q3 2025 ESCO Technologies Earnings Conference Call. With us today are Bryan Sayler, President and CEO; Chris Tucker, Senior VP and CFO; and Kate Lowrey, Vice President of Investor Relations. [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, Kate Lowrey. 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 the forward-looking statements due to risks and uncertainties that exist in the company's operations and business environment, including, but not limited to, the risk factors referenced in the company's press release issued today, which will be included as an exhibit to the company's Form 8-K to be filed. We undertake no duty to update or revise any forward-looking statements, except as may be 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 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 Bryan.

Thanks, Kate, and thanks, everyone, for joining today's call. The past few months have been a transformative period for ESCO. Early in the third quarter, we completed the Maritime acquisition, and after the close of the third quarter, we finalized the VACCO divestiture. The completion of these key transactions marks an important step forward in the execution of our portfolio strategy. With the addition of Maritime's signature and power management solutions, we now have a meaningfully larger presence in the Navy market. Maritime broadens our product offerings and adds significant U.S. and U.K. naval platform content. With the exit of the space market, our Aerospace & Defense segment now has a clearer focus on serving the aircraft and Navy end markets, both of which we believe have durable long-term growth drivers in place. This period of transition has involved an extraordinary level of hard work from our team members related to closing these deals and integrating Maritime into the ESCO portfolio and business system. In addition to supporting these efforts, our team was also busy managing day-to-day operations and delivered another outstanding quarter for ESCO. I want to personally acknowledge and thank our dedicated employees whose hard work is what makes this possible. In addition, I would like to take one more opportunity to welcome our new ESCO Maritime teammates in both the U.S. and the U.K. As we've now had a number of interactions with the Maritime team, it is clear that they are a strong group that is dedicated to a very important mission, which is aligned with ESCO and our core values. We are thrilled to welcome them to the team. I would also like to thank the Maritime staff for their hard work in supporting the ongoing integration, which does require considerable time and focus from across the organization. As I know we are all aware, the macroeconomic picture has been somewhat complicated this year with evolving trade policies and geopolitical uncertainty in the headlines. It's difficult to know exactly how these impacts will play out, but we are monitoring these changing dynamics closely and believe our teams have done a good job of managing the risks and opportunities to this point. While there have been some additional costs, we have been able to mitigate the impacts and deliver exceptional operating results. Going forward, we are in good shape in this regard and are confident in our ability to manage any potential future risks associated with tariffs during the balance of the year. Chris will run you through all of the financial details for the quarter, but before we get to that, I wanted to give you a few comments on each of the segments. Let's start with Aerospace & Defense. We remain very positive regarding the long-term outlook for the aerospace and Navy markets. Production rates across both end markets need to increase to meet underlying customer and market demand. We see fundamental drivers for additional commercial and defense aircraft and expect increasing production rates to drive growth going forward. Overall, our aerospace revenue was up almost 20% in the quarter and is up 15% on a year-to-date basis. On the Navy side, we've been talking for a while about the procurement process for the next 17 Virginia and Columbia Class submarines. It's taken a little bit longer than expected, but it was great to see those orders begin to flow through during Q3 with Globe booking over $80 million in orders during the quarter for Block V.2 and Block VI on the Virginia Class platform, along with orders for initial content on the next 3 Columbia Class boats. By any measure, the A&D segment has had an exceptional quarter, achieving double-digit organic growth, a 560 basis point increase in margin and ending the period with record backlog. Switching businesses now. Let's discuss the utility group, which had a bit of a flattish quarter from a sales and margin perspective but did experience strong orders. If you look at the year-to-date results, the story remains quite positive, and we are confident that the long-term demand drivers remain intact. Numerous factors are contributing to the growing demand for electricity, including data centers, artificial intelligence, electrification of transportation, heat pumps, reshoring activities and more. Expanding the grid will be a long-term and complicated endeavor, and during that process, increased electricity demand, coupled with an aging infrastructure and extreme weather events will make maintaining utility assets more important than ever. Doble will continue to be a critical partner supporting the utilities as they both maintain and expand the grid. Order growth in the quarter was strong, which points to continued sales momentum in the quarters to come. The U.S. renewables market continues to recalibrate right now in the wake of the Big Beautiful Bill. Our team is managing well through some uncertainty, and we remain confident that renewables will continue to have an important role to play in energy markets worldwide and in the U.S. over the long term. Finally, I'll touch on the Test business, which had another strong revenue quarter with 21% growth over the prior year. Year-to-date, the revenue is up by 15%, and it's great to see continuing strength in their test and measurement, industrial shielding and services sales this year. Their margins improved by 350 basis points sequentially but were down a bit year-over-year. The team has taken the right steps to reduce costs over the past several quarters and has done a great job driving the segment EBIT margin back into the mid-teens. Overall, the Test business has stabilized, and we feel good about the trajectory there moving forward. Overall, we are optimistic about our market positions across each of our segments and expect to outperform industry growth. Accordingly, we are again raising our full year guidance, which reflects over 20% adjusted EPS growth compared to the prior year. 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 will start on Page 3, which shows the financial highlights for the quarter. Before jumping into the numbers, I do want to point out that we are looking at everything on a continuing operations basis. Now that VACCO has been sold, it has been classified as a discontinued operation in our financial statements, so the commentary will exclude any P&L impacts for discontinued operations. Now turning to the numbers. You can see that, by all measures, ESCO delivered a great quarter. Orders showed a significant increase in the quarter. We will go through segment details coming up, but a big driver of the reported increase relates to the acquired backlog at Maritime. Excluding that, we still had good orders performance with a 1.3 book-to-bill ratio. We ended Q3 with backlog of nearly $1.2 billion, a new record for ESCO. Sales performance was also strong with growth in the quarter of nearly 27% on a reported basis and 11% on an organic basis, which excludes the impact of the Maritime acquisition. Adjusted EBIT margins increased from 19.3% last year to 21.1% in this year's third quarter. Lastly, adjusted earnings per share increased by 25% to $1.60 per share. I would also point out on the bottom right of the chart that we did have a sizable amount of add-backs for adjusted earnings. This was driven by the Maritime acquisition, where we had significant costs related to closing of the deal as well as inventory step-up charges, stamp duties in the U.K. and an increase in acquisition-related amortization. Next, we will go through the segment highlights, starting with Aerospace & Defense. Orders increased significantly, but you can see that $364 million of this related to the backlog acquired at Maritime. Beyond that, Maritime delivered another $50 million of orders in the 2 months they were owned by ESCO. On an organic basis, orders were also quite strong with Globe receiving large Virginia and Columbia Class orders. Backlog for A&D finished at $832 million. From a sales perspective, growth was up 56% on a reported basis and 14% organically. You can see the Maritime impact was significant, but the core business also performed very well. This translated nicely to margins, which increased over 500 basis points with positive contributions from across this set of businesses. The margin increase was due to favorable impacts from price, mix and leverage on the growth. Moving on to Chart 5, we have the Utility Solutions Group. Orders momentum remained healthy with growth of 5.5% in the quarter. This was driven by Doble, where orders increased nearly 7%, while NRG orders in the quarter were flat. On the sales side, growth was a bit more muted with only 2% growth. This lower growth was also driven by Doble, where timing of shipments resulted in lower revenue growth in the third quarter. We see this as a temporary issue and expect to return to higher growth in the fourth quarter. As you can see on the chart, backlogs are healthy and have increased nearly 15% compared to prior year-end. On the margin story -- on the margin front, the story is similar to sales with the margin drop in the quarter driven by Doble. On a year-to-date basis, the Utility Solutions Group has delivered adjusted EBIT margins that are 130 basis points ahead of last year's first 9 months. So while we have seen some weakness from NRG in the year, the Doble performance has been strong, and we feel good about the full year outlook there. Next, we will cover Test, where the team delivered another strong quarter, starting with orders where we did see a decline of nearly 6% in the quarter. We had some tough comparisons to last year but honestly feel good about where the business is trending. Year-to-date orders are up over 30%, and you can see that backlogs are up nearly 24% compared to year-end. So the momentum here has been strong during 2025. Sales were very good with a 20.7% increase, which drove adjusted EBIT to increase by 15.4%. Margins here were down slightly as we've experienced unfavorable mix and some tariff impacts. Year-to-date margins are up 140 basis points. So 2025 has been a positive step for this business after a couple of tough years in '23 and '24. Moving to Chart #7, we have year-to-date P&L highlights. As you can see, the results have been terrific through the first 9 months of 2025. Bryan mentioned all the portfolio work earlier, which is very important. This chart shows that the core company has continued to deliver, and we are now starting to see the impacts of the Maritime deal come through. Orders have been great. If you take out the Maritime backlog impact, we have growth of 17%. The sales story is also quite positive with A&D up 12% organically and nearly 28% when Maritime is added in. Test sales are up 15%, while the US growth -- USG growth is a bit more modest at 4% due to weakness for NRG so far this year. Earnings are up double digits with adjusted EBIT margins increasing by 200 basis points and all 3 segments posting nice margin improvement over the first 3 quarters of the year. Finally, adjusted earnings per share is up over 24%. So by any measure, the company has performed very well year-to-date in 2025. Next is Chart 8, where we have cash flow highlights. The first 9 months of fiscal 2025 delivered strong operating cash flow results as working capital performance has been favorable compared to the first 9 months of 2024. This is true for continuing operations, and it should be noted that the cash flow for discontinued operations was also quite strong through the first 9 months of fiscal 2025. Capital spending is up for the first 9 months due to various programs in the A&D and utility businesses. Our strong cash generation and the delay in getting the Maritime deal closed means that our leverage position is in good shape as of June 30 at 1.74x. With the VACCO divestiture getting finalized in July, we expect to have the balance sheet in great shape as we close out the year. Last, we will discuss updated guidance for the year, which is covered on Chart 9 and 10. Chart 9 is the words that go with Chart 10, so I'll just talk to Slide 10 here. Fundamentally, the guide represents another increase for us. You will remember that last quarter, we still had VACCO in the guidance, and we had included estimates for Maritime as well. Now we need to remove VACCO as that deal has now closed. That reduces sales projections by approximately $125 million and adjusted EPS comes down by approximately $0.50. For the continuing operations, we are increasing the guide for the year. On the sales side, we are coming up by $20 million at both the low end and the high end of the range. For adjusted earnings per share, we are tightening the range with only 1 quarter to go. So the bottom of the range is coming up by $0.40 and the high end is coming up by $0.25. This adjusted EPS range represents 21% to 24% growth compared to prior year. The additional sales is delivering nicely to the bottom line, and while we are seeing some tariff impact in the numbers, it is at the low end of our ranges that have been guided previously. So obviously, it is shaping up to be another record year at ESCO, and we are excited to share this updated outlook with you today. That concludes the financial portion of the call, and now I'll turn it back over to Bryan.

Thanks, Chris. As you heard, the first 9 months of our year have gone really well, and we're excited about our ability to increase our full year outlook. And we're excited about the portfolio moves that 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 just wrapped up our Board meetings earlier this week, which gave us a chance to visit our Morgan Schaffer operation, which is part of Doble and USG. This business is located in Montreal and was an ESCO acquisition in 2017 that's focused on condition monitoring of transformers. It was a really great session with our Board and an opportunity for us to show them the exciting things going on at ESCO, where we're developing exciting technologies on a regular basis that are being deployed to help customers solve real-world problems. We thank the Board for their ongoing support, and we're excited about the many things going on across the ESCO set of businesses. With that, I think we're done, and we can turn it over for the Q&A.

[Operator Instructions] And our first question comes from the line of Tommy Moll of Stephens.

Bryan, I wanted to start on the A&D orders, in particular for Globe, where you reported some pretty big orders in the quarter. Any update on shipset content? I'm guessing probably nothing changed versus what you've communicated previously. And anything you can tell us just about how that has progressed through the order pipeline? I know you don't want to get in the business of guiding future orders, but just give us some sense of where some of the discussions are for those Virginia and Columbia Class subs.

Yes, I would say no big change from what we have communicated before. On the Globe side, we -- obviously, we have some additional content for Virginia Class and Columbia Class that comes through. On the Maritime side, I don't think we're quite in a position yet to communicate that in detail, and I'll ask for a little bit of patience as we kind of work through our FY '26 planning process. So we'll be in a position to communicate that kind of detail in the future, but I'm not sure we're quite ready for that today.

Sure. On sticking with A&D and here, I'll ask the question on an organic basis, so we can think about ex Maritime, ex the VACCO noise. The margin progression, even peering through both of those changes, looks pretty solid here. And so you called out several of the factors. Specifically, though, on price/cost, I'm just curious for an update there and versus what you would have hoped for some of the incremental margins flowing through, how did the quarter shape up? And how do you feel going forward?

Yes, Tommy, this is Chris. I would say the margins there in the core company were really phenomenal, really good flow-through on kind of the underlying sales growth. I would kind of point out the price first. We're seeing some real good -- mostly on the aircraft component side, we're seeing some very nice price flow-through. Those are efforts that are kind of always ongoing in that business, but sometimes there can be a lag before some of that price flows through just based on working through LTAs and things like that. So we're really seeing some good flow-through there. So that's certainly kind of the top driver. I would say on the material side, we're frankly in pretty good shape. Generally, the material inflation has probably been a little bit better than what we expected coming into the year. So we've got the price good guy, and we've got less of a material headwind. And so that's been a pretty good equation for us so far this year. And then the other things I would point to there, we did see some good mix in the quarter. Mix can kind of move you around a little bit quarter-to-quarter. It was favorable this quarter. So that was another kind of boost. So you won't see that every quarter necessarily, but it came through nicely. And then, again, with a good double-digit kind of underlying growth, we had nice leverage on the sales as well. So I would point to all those things as kind of key drivers for us here in the quarter.

Yes. I think we're getting a little bit of traction from some of the early stages of our ESCO operating system implementation as well, and that's really coming through in the A&D numbers for sure.

A little bit might be an understatement, but we'll settle that later, and I'll turn it back for now.

And our next question comes from the line of Jon Tanwanteng from CJS.

I was wondering if you could talk about the increase in the outlook, maybe what businesses or product lines that's coming from. It looks like a pretty small increase in revenue but quite a big increase in the earnings. I was wondering if you could dig a little deeper into that and just tell us where that's all sourcing.

Sure. So I would say that on the revenue side, we're frankly getting pretty big increases as we move through the year from Test. So that business has kind of outperformed. So we're seeing that come through. I would say on the A&D side, we're also getting a little bit of incremental volume, which is helping obviously. And then those are kind of offsetting the NRG business in utility, where we've seen a little bit of a takedown there as we move through the year just because of some of the kind of uncertainty in the renewables market that you heard Bryan talk about earlier. So those are kind of the -- those are the sales impacts, I would say. You're seeing that flow through at a reasonable rate, let's say, around 30% or so. We've also got -- I mentioned the tariffs would kind of be at the low end of the range we talked about last quarter. So we said $2 million to $4 million last quarter as a tariff impact. We're really going to be more like $2 million, maybe even slightly below $2 million. So a little bit of a pickup there. And then I would also point out that with the VACCO closure, we've got some pretty big proceeds here in July from that, that helped the interest in the fourth quarter. So that's kind of flowing through as well. So all of those things are what are getting you to kind of that lift you see in the press release there.

Got it. That's very helpful. And then just for modeling purposes, how should we think about the impact of VACCO in '26 as you lap the sale?

Well, listen, I mean, I would say that it's -- if you kind of look through what we're going to file in the numbers now, you'll see kind of VACCO kind of comes out and goes to discontinued operations. So you're going to have kind of the company there and the A&D results without VACCO in it. And then it just becomes a picture of kind of how do you think about the growth for '26 and beyond. And I think there, Jon, we've kind of talked a lot about kind of the Navy dynamics being strong, kind of high single digits, similar for aircraft components. And then you're going to have kind of -- the kind of partial year to full year impact for Maritime since we only had 5 months this year. So all those things, we think, contribute to a pretty nice outlook for '26. We're not really in a position to kind of give specific guidance around that. But I think where we sit today, honestly, we feel really good about how we're looking going forward.

Okay. Understood. Last one for me. Just on the naval side, you obviously are showing strong orders. I was wondering if the pace of deliveries is going to stay relatively constant. Or are you're seeing a pickup there, either near term or long term as the Navy tries to increase the throughput of all these things?

Well, I think that we believe that it will increase. I think that it's a little hard to answer the question because in our -- as you model our numbers, you've got to mix both the Globe, all of our existing Navy business along with the Maritime side. I think the other thing that you're going to need to start thinking about more is what's happening over in the U.K. in addition to what's happening in the U.S. So I do think the pace is going to pick up a little bit. We'll be able to provide a better guide on that when we come together in November for the full '26. But listen, we're very upbeat about the Navy progression and what it means for our business.

And we have a follow-up question from Tommy Moll of Stephens.

I had a few more I was hoping we could get through today. On the guidance you provided for earnings per share, Chris, I heard you say that interest is probably a good guide for Q4 just because of the timing of VACCO, a good guide versus what you would have guided to previously. But I'm just putting everything together. It does look like the range you provided is $0.25 to $0.40 increase for the year does assume a better 4Q operationally than what you would have communicated previously. I just want to make sure I'm reading that correctly because there's a lot going on this quarter.

Yes, that's correct. I would say that the fourth quarter has come up from what we communicated last time. Again, I think, obviously, we're 3 months along the road. We had a solid third quarter, as you see. And so the fourth quarter is absolutely higher than what we were -- had baked in last time.

Also wanted to ask on the USG margins. If it's possible to look just at Doble, can you comment on how the margins progressed year-over-year there and if it wasn't what you would hope, maybe what some of the drivers were?

Yes. Listen, I would say that, honestly, the margins in the first and second quarter were probably ahead of where we would have anticipated. So we had really good kind of flow-through and mix in the first 6 months. And so that's why we're trying to kind of not overreact to the third quarter. I would say that, certainly, it was below kind of what we anticipated when the quarter started. But a lot of that was a little bit of sales miss. And I kind of alluded to the timing of some sales here in the third quarter as we closed out the quarter. We just didn't have some things that we anticipated getting out the door and such, so we had a little bit less sales. And so we lost the flow-through from that. I think if we gotten that, we'd be right kind of where we needed to be. So I would not say that we're concerned or disappointed with the Q3 margins. I mean, I guess I'm sure we'd always like a little bit more. But I think how the business has trended for the first 9 months is honestly quite positive. And we feel like the momentum and the factors that Bryan talked about that are kind of driving the market there, we think those are all still in place. But certainly, as we go quarter-to-quarter, we're going to see some ups and downs. And I think as -- so we're a little shaky there on the utility side, but the A&D folks had a great quarter from a margin perspective. And what I would say, Tommy, is in our model, you're going to see some of that, right? So next quarter, we might see the A&D margins not quite so strong, but then the pickup in utility. So we're going to have those kind of puts and takes a little bit quarter-to-quarter. But generally, long-term picture still looks very good.

Yes. And I'd point out that the orders for Doble were very strong in the quarter, and that points to better things in the next quarter or 2 as we move forward.

Last question, and then I'll turn it back for good today. Bryan, in the news recently, there was reference of a treaty between Britain and the Aussies on nuclear subs. I realize that it may take some time before Maritime sees any benefit here. But if there's anything you can do to frame for us on the outside what -- how impactful that could be or just any observations you had would be appreciated.

Yes. Listen, I think every step in that direction is a positive not just for our business but probably for the mutual defense for the English-speaking world. I think you're aware that there's a review going on in the Defense Department right now of the AUKUS program. That's kind of limited to what happens in the 2030s with regard to earlier-generation Virginia Class submarines that are currently slated to be sold. We don't think that there's a lot to that. We think that the decision on whether the U.S. will follow through on those sales, that's a decision that could be made several years from now. But I think that the thing we believe about that is it just increases our conviction that the investments we've made in the Royal Navy and the shipbuilding in the U.K., that those investments are going to pay off. And if anything, our belief is that they may pay off sooner. Now I'd be clear to say that the AUKUS program envisions things that are going to happen in the 8, 10, 12 years from now. So that's a little bit outside of our planning horizon, but it does bolster the commitment that we would see from the shipbuilders in the U.K. to follow through on some of the orders and revenue that we anticipate in the next 3 to 5 years.

I'm showing no further questions at this time. I would now like to turn it back over to Bryan for any closing remarks.

Well, thanks for taking some time to hear from us today. We're excited that we've been able to complete these large portfolio moves. And I think we're even more excited that the underlying performance of the core business has been really, really strong. And so we really look forward to the things that are in our future, and we look forward to talking to you again next quarter.