Kate Lowrey - Director of IR Vic Richey - Chairman, President and CEO Gary Muenster - EVP and CFO.

Jon Tanwanteng - CJS Securities Chip Moore - Canaccord Sean Hannan - Needham & Company Shaun Nicholson - SBH Ben Hearnsberger - Stephens.

Good day, and welcome to the ESCO Third Quarter 2015 Conference Call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO; Gary Muenster, Vice President and CFO. And now, to present the forward-looking statements, I would like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead..

Thank you.

Statements made during this call regarding the 2015 and beyond EPS, EBIT, tax rate future growth, profitability and revenue, margin, sales, acquisitions, capital allocation strategy, corporate costs, and other statements which are not strictly historical are forward-looking statements within the meaning 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 8-K 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 a press release issued today and found on the company's website at www.escotechnologies.com, under the link Investor Relations. Now I'd like to turn the call over to Vic..

Thanks, Kate, and good afternoon. Before I give my perspective on the quarter, I’ll turn it over Gary for few financial highlights..

Thanks, Vic. As noted in the release our third quarter earnings came in at the high end of our internal expectations despite incurring $2 million or $0.05 a share of non-operating charges in the test business, In May we expected Q3 EPS to be in the range of $0.38 to $0.42 and I'm pleased to report that we delivered $0.41 a share.

Our Q3 2015 GAAP EPS was $0.45 a share, which included a $0.04 gain in discontinued operations resulting from the favorable arbitration settlement related to Aclara closing working capital.

The strength of our Q3 earnings was driven by the continued up cycle in commercial aerospace markets and PTI and Crissair, a 24% EBIT margin quarter at Doble, exceptional performance at TEQ and we delivered a record EBIT margin of nearly 18% and lower than planned corporate spending.

While Q3 performance in test was disappointing due to continued softness in the shielding markets and throughout Europe, coupled with someone time charges incurred in the quarter we addressed this situation with significant cost reduction actions and we have realigned the organization to better manage test global infrastructure.

Consistent with our goal of positioning ESCO for sustainable long-term earnings growth, additional cost reduction actions are begin implemented throughout test that are expected to result in a much more favorable operating margin. We remain firmly committed to our well defined financial goals. During Q3 the impact of FX was not material.

As a remainder for comparative purposes the 2014 results exclude the charges related to Crissair facility consolidation completed last year. I’ll call out a few highlights from the release to allow you to better understand the underlying results.

Q3 sales increased $4 million from prior year primarily due to an 11% increase in sales at Doble coupled with a 5% increase in filtration sales. These increases were muted by test sales decrease of $2 million in the quarter.

A significant accomplishment within filtration is highlighted by the continued strength of PTI and Crissair’s commercial aerospace sales, which increased over 15% or $4 million in Q3, which more than offset the $2 million decrease noted in VACCO resulting from lower SLS program sales in 2015.

PTIs Q3 EBIT margin was 21% and Crissair delivered over 24% EBIT, driven by the significant operating efficiencies continuing to be realized from last year’s facility consolidation.

As commented on throughout the year, Doble’s EBIT continues to come in better than planned driven by higher than expected international sales and additional software and service business. Doble’s Q3 EBIT margin of 24% was significantly higher than the 21% reported in prior year Q3.

Test sales in EBIT were below plan and prior year as noted in my earlier comments and this is being addressed aggressively. For Q3, excluding the $2 million of special charges test would have delivered approximately 9% EBIT.

Corporate cost were lower than last year due to a decrease in spending on professional fees and ongoing cost management discipline.

The Q3 effective tax rate increased over prior year due to the amount of discreet tax benefits recognized in the respective quarterly periods as well as changes in the mix of international versus domestic pretax earnings. On the balance sheet, we continue to maintain a modest level of net debt, which was $28 million outstanding as of June 30.

We remain committed to our capital allocation strategy which includes share repurchases and dividends. As such we returned over $16 million to shareholders during the year-to-date period.

We expect to continue to opportunistically repurchase shares in the open market during the balance of 2015 as we continue to be supported by this strong balance sheet. A significant highlight of the year continues to be the strength of our entered orders and our backlog.

We booked a $121 million in orders in Q3 which reflects the impact of the acceleration of orders into the first half of this year and this brings our year-to-date orders to $415 million, which reflects a $32 million or 10% increase in our ending backlog, which currently stands at $334 million as of June 30.

The order strength and current backlog support our sales outlook over the balance of the year. Regarding our remaining guidance we narrowed our full year EPS to be in the range of $1.70 to a $1.75 to impact -- as a result of the impact the softness in Test.

When comparing Q4 to last year we’re expecting a meaningful increase in both sales and EBIT at filtration and at Doble along with continued lower spending at corporate which drives the favorable EPS comparisons in Q4.

Lastly, we expect a more normalized tax rate of approximately 34% in Q4 and I’ll happy to address a specific financial questions when we get to the Q&A. And I will turn it back over to Vic..

Thanks Gary. As outlined in the press release and Gary’s comments, our performance for the quarter and the first nine months are on track as coming in a form slightly different than originally anticipated. Our Fluid Flow and utility solutions businesses are performing well ahead of expectations, which is offsetting the softness we’re seeing in Test.

As we talked about on many occasions, this is one of the benefits of maintaining a multi-segment business. As Gary mentioned, the aerospace business is performing well. Aerospace spares business has been stronger than expected and the downturn in the SLS program at VACCO is not as severe as we anticipated going into the year.

Our commercial aerospace business is well ahead of plan led by new orders for the A350, which have been stronger and are earlier than anticipated and this into the strength of our orders, the execution of the business has been solid which has resulted in improved operating margins.

The outlook for this business remained strong for the balance of the year and is expected to continue into fiscal year '16. Our packaging business TEQ is performing well. As Gary mentioned, the EBIT margin at third quarter was approximately 18% and we anticipate some additional improvement in the fourth quarter.

This is a solid business with above average margins, which is a result of our nice niche in the medical markets. Doble continues to perform at high level and what I’m most excited about is the success they're having with their new offerings to augment what is already a market leading set of products, services and solutions.

They were awarded their first significant order for the Doble fine product which is a newly developed online solutions package. They also won their first full scale deployment of Doble ARMS. The pipeline for this solution is robust and we have discussions underway with over 50 utilities.

Given the nature of this product, the sales cycle can be long, but since we’ve been working on a number of these accounts for quite some time, it’s good to see tangible results. Additionally, during quarter three, we won our first significant contract for the Doble Universal Controller. This is a field force automation product.

One of the nice things about both the Doble Universal Controller and Doble front is that they were new products developed using existing building blocks, therefore minimizing development time and expense. Our M7 product which is the most capable test set in the market has been commercially launched and is gaining good customer acceptance.

Bottom line Doble is looking good and the divestments we made are paying dividends. On a test front as we talked about over the last couple of quarters, the current market remains soft. The primarily areas of concern are the shielding business both medical and industrial and Europe in general.

To address this we have taken several cost reduction actions and we will continue to evaluate the business to ensure we're properly organized and structured to deliver an acceptable return. On the bright side, Test overall backlog continues to grow which bodes well for the future. Regarding acquisitions we're seeing a pickup in these activities.

I’m sure you've all recently seen some of the major acquisitions that have taken place in aerospace market. Obviously the last few multiples being paid are raising seller expectations. Our approach is to continue to look in for small to medium sized niche players which we can acquire for reasonable multiple thereby providing acceptable return.

There continues to be some opportunities out there and we’re working hard to supplement the growth of our Fluid Flow business. Additionally we would like to add to our utility business and are currently evaluating several interesting opportunities.

In summary very strong quarter and we’re on track for solid year and we’re well positioned for growth in all three segments. Our focus is to improve our operational performance and execute on our growth opportunities both organically and through acquisitions. I would be glad now to answer your questions you have..

[Operator Instructions] Our first question comes from Jon Tanwanteng of CJS Securities. Your question please.

Hi guys. Thanks for taking my questions..

Hey Jon..

How are you doing? Can you provide some more detail on the headwinds in Test and maybe is it more of a demand issue or is there a component of scheduling cost?.

Yes I would say it’s really the -- one thing you would notice I think is that while we're talking about some softness particularly in the shielding business, the backlog continues to grow. So what we’re seeing is particularly in the medical shielding business that I think a lot of that is related to questions around reimbursement in the U.S.

and those types of issues. We've seen some of that business get softer, but what we've seen in the offset that is some of the longer term system business has gotten stronger particularly in Asia and some here in the U.S.

and so what we're really going through I think is a repositioning of the business and that there are cost associated with the shielding business that we need to valuate to make sure that we have the organization set up properly and that we manufacture the right things in the right places.

So it's really the shifting of the business I would say, but the shielding business has gone down pretty dramatically within the year and it's kind of hard to catch up with those things while we're kind of repositioned for some of these longer term systems whereas we've been experiencing..

Okay. Great.

And what kind of cost do you expect to incur in restructuring and I guess maybe what's the timeline to margins that are in the mid teens again on an EBIT basis?.

We haven't completed the valuation to understand exactly what additional actions we take. I think we'll have those clearly in focus by yearend if there are any of those.

I would think that the margin should improve fairly dramatically even with -- well, dramatically too far on that, but I do think we'll see significant improvement next year and I think we'll see full benefit of the actions that we're taking now in the second half of next year..

Okay. Great.

And then just given that the headwinds in the test business and the relative scarcity of M&A that's reasonably priced, how do you feel about the -- by your ability to hit the long term revenue and earnings target you set out in this three year plan?.

Yes, I still feel good about it. I do think there are acquisitions out there. As I mentioned, we're seeing more things today than we probably saw six months ago. I know people's expectations for the things would probably happen by now, but what the multiples are being paid, obviously we are trying to be very disciplined about this.

But again I think have been -- or have been encouraged by the level of things that we've seen more recently. We're the more aggressive and looking for opportunities for thinking more about opener amateur within our core businesses to ensure that we're capturing as much as possibly can.

I think there has got to be some end to these multiples at some point, but -- so I do still feel positive about our ability to make those longer term forecast and a lot of that due to remember we're seeing some natural pick up in our filtration business or flow business as some of these products go from development to production.

I am very encouraged as I mentioned in my prepared comments about what we're seeing at Doble because that's where we're seeing some significant growth.

If you remember when we put those out, Doble was the piece of business going to grow the most over the next three years and certainly the wins that we've had over the past quarter with some of these new products I think bodes very well for our ability to be able to experience that kind of growth in Doble..

Great. Thank you very much..

Thank you. Our next question comes from Chip Moore of Canaccord..

Yes, thanks. Hey guys, great to see the momentum with some of those newer solutions at Doble.

Maybe you can give us a little more color on how that sales cycle has progressed and now that you have some reference customers how you think that plays out?.

Well what we're seeing particularly on the two products I talked about, the Doble Universal Controller and Doble Prime, there has been a pretty rapid build of pipeline. So those are things you can convert very quickly. So I think we'll see an acceleration in those businesses certainly over the next six to 12 months. So that looks very good.

The ARMS product we've been working that a long time. As I mentioned we have lot of people that we're talking to about that.

I think getting this first award with a significant utility is going to bode well because you know there is also kind of mentality with some of these things and we've gotten in front of a lot of senior executives at a number of these utilities.

We sort of take -- really selling here is something that is going to go in as part of their IT system and so that decision is made really at the highest levels of the organization. So a large number of the customers we're talking to we've already gone through that executive briefing stage.

So the next stage is product award or responding to an RFP, if there are going to be competitors there. So feel good about our ability to make some of those things happen this next year.

So, this has been a great quarter gaining in momentum and I think that we'll see a lot of uptake on all three of those products as well as our typical products over the next year. And the other win that I had mentioned was M7 and that was a big development that we undertook about 18 months ago.

Really took the functionality of five different boxes, combined it into a one very capable box and it for sure is the most capable tester on the market.

The real benefit it has is not only putting all that functionality in one box but you’re able to really, significantly reduce the test on to do these types of -- to do these test because what you’re able to do is rather than, hook it up certain leads than having to take those down and do different tests with the different piece of equipment and we’re talking about a significant over 50% reduction in time to perform the test.

And so that, obviously time is money with these things as well as safety because if you have to hook up different leads, fill lines, you have to go up and down the pool or up or down with a high lift, those increase potential safety issues and so we’re able to overcome a lot of that with this new box..

Hey Chip, this is Gary just put a little numbers around Vic's commentary there which you think obviously is spot on, but what we’re seeing the momentum come through in the numbers sequentially after Q3, here where we did roughly $31 million in sales with the unexceptional EBIT percentage in Q4 we're looking at almost 15% sequential growth from that $31 million putting ourselves up $35 million to $35.5 million.

So obviously when you have that type of incremental step up, its driven by -- that’s where you see the validation of all Vic’s commentary and the momentum we’re gaining there and with that volume obviously there is an EBIT increment pull through as well. We’re going to realize this in the short term..

And how do you think about margin runway, as you build out that software and services component a bit more is just later on top of that..

Yeah, obviously the software and services do carry a higher margin. We’re already performing pretty well in that business, but certainly while the dollars are not as large as what we see in the league pool or with our hardware the margins are certainly better..

Okay, and you didn't really on international too fold double-digit talked on international too much Doble, I mean you can give up some update there?.

Yeah, we feel good about that particularly Middle East. We’re completing a contract. We had Saudi anticipate getting a reload on that contract and not too distant future.

That’s opened a lot of doors in the Middle East and as well as just doing the service business we have done there we'll probably do a couple million dollars of additional hardware sales as a result of being there on the ground with those customers.

So what’s nice about that his business is that sometimes lead with hardware, sometimes lead with software and, brining in from the other direction.

We also had some good wins in South Africa over the past six months they’ve always been a good customer, but we had a pretty significant hardware sales there with the new customer over the past quarter as well.

So I would say the international business is always a little trickier than the domestic business were we get such a big market share, but I would say our plans to expand internationally or on track..

Perfect, and just lastly you talked about record quarter Tech maybe getting better next quarter, is that Helen of Troy cover driven or what are the dynamics there? Thanks guys..

That’s certainly a big piece of it that’s a biggest project that we have and if you remember in the first half of the year we had a shutdown of about four months while they changed the design and while the customer changed the design.

So part of what we’re seeing was such a strong second half is a catch up on their project, but I would put all on that. In fact we’ve had good orders with that business this year as well.

We were about $7 million ahead of what we anticipated going into the year and a lot of that has been driven by the fact that we’ve been looking for working with customers getting longer term contracts where historically we get a kind of month to month on some of these jobs and that we're pushing for longer term annual in some cases even two-year contracts and obviously that allow get some efficiencies and material buzz and as well as what we’re doing in factory to increase productivity..

Great. Thanks..

[Operator Instructions] Our next question comes from Sean Hannan of Needham & Company..

Yes hi folks, thanks for taking my question, can you hear me?.

Yes. We can..

Okay.

Can you expand a little bit more on the orders within the quarter/ So and overall book-to-bill was down quarter-over-quarter but I do certainly sense some opportunity you have hit on a few things there, maybe that you’re positive on and I have a follow-up specific to some of the orders year-to-date within test that seems to be something you’re fairly optimistic about and so if there is a way to perhaps expand on that as well, thanks..

Okay. So let me give you a overview and I think Gary can jump in on some of the specifics, but as you know we’ve been running well ahead of orders for the first six months and a lot of that was some things that have been pulled from the third quarter.

So I’m not surprised that we had a little softer quarter from an order's perspective but if you look at it for the first nine months, I think we’re still about 8% to 10% above our -- 10% over on a book-to-bill.

So generally we still very positive about it with our business is actually little fluctuation from quarter-to-quarter but maybe need to kind of focus on the year-to-date that seems very positive..

And Sean just to throw some numbers around that, just when I talked about acceleration into the first half I will just give you a couple of examples, PTI for instance on the commercial aerospace side in Q2 did a little over $20 million in orders and in Q3 it about 13 and the reason that was about $6 million or $7 million on just the A350 alone that was pulled into Q2 because of the acceleration on those deliveries that they’re seeing.

So when you pull that forward obviously we’re not going to sustain $5 million, $6 million, $7 million on the specific customers we go forward.

So what I had asked you to do is look at the quarterly profile within the groups there and so probably the most substantial in Q1 was the big win in the Test business for that Nissan Chamber in China, but on the filtration side that’s where we’ve seen most of the -- I would say earlier than expected which is really good thing obviously to get it in hand.

VACCO also had a very substantial first half of the year, where they booked almost $48 million in orders and obviously that’s not their normal run rate.

That would put them close to $100 million a year and so what you're there is again some pull forwards on some things in the Virginia Class which is an exciting time there and also as Vic alluded to in his commentary the SLS program which is kind of in a slowdown mode for this year, what we thought was going to be down $10 million or $11 million we garnered $5 million of that back in unexpected orders in the first half.

So the first half momentum obviously isn’t going to carry into Q3 because of those extraordinary individual items that I just called on. So when you pull that all together for the year-to-date, I think we’re in really good shape relative to the nine month order book again understanding the acceleration into the first half..

Okay.

And then when you look at year-to-date bookings within Test, I think within the press release commentary there is certainly is optimism that's coming from that, how much and maybe if you can comment on Test as well as some of the other pieces of business, how much of what you had booked this year have you now recognized backup door in terms of revenues and how much of this is giving us preview perhaps of at this point looking into fiscal '16 and what may carry into that period, thanks..

I think I will give you the numbers overview first and then I will let Vic put the qualitative aspect on it, so the way we look at it is if you set aside the Nissan Contract is kind of a one-off that was $11 million order and if you back that out of the equation just so you can kind of normalize what the regular recurring business is, we’re still expected to be up somewhere in the neighborhood of 5% or 6% at the end of this year.

If we were talking at September 30 right now you would still see a positive book-to-bill, There $5 million or $6 million which is a good way to start, it is a good way to start the year.

So what we’re seeing as Vic said moving away from small and medium sized shielding products more into the solution oriented projects, which tend to be a little bit larger, a little more complicated or complex and so with the complexity comes better pricing and better opportunities to make a little more money.

So we feel pretty good where we stand today absent the little bit of a slowdown we’re seeing there and some of the charges we took. We think we’re really good position as we enter '16 based on the order book they we're staring at today..

Okay, and I didn't know if Vic was going to provide some commentary as well..

Yeah, I would say that from an orders perspective across the company obviously that’s not the big issue and we’ve been very well there, even in the test side we've had some issues as Gary alluded to as where we've had some mix changes which that we’re addressing through the cost side but orders fortunately for industrial business and I think is pretty positive that we’re able to grow our backlog year-over-year.

And the fact that we’re doing that across all three businesses I think really does bode well for us going into ’16 and certainly what we’re seeing whether it be the new product introductions at Doble that are getting traction and the international business there and then what we’re seeing as far business projects going from development to production on aerospace side all those things give us confidence and fact to John’s earlier question whether we thought out longer term goals are still achievable and I think this does give us the confidence as we go into ’16..

Okay. Thanks folks..

Thank you. Our next question comes from Shaun Nicholson of SBH..

Yes, hi I was hoping Gary can you walk us through that $2 million charge that’s included in that $0.41, is that correct and what things would look like given that one time charge?.

Yes, I think kind of tying into the whole repositioning as Vic said realignment of the -- what we did has changed the reporting structure from a geographical bases to a more functional bases and in Vic comments where he talked about making sure we’re producing the right products in the right geographies for the right customers.

So we’re not shipping stuff all over the place and also kind of help mitigate some FX things like that. What we did is kind of realign some of the inventory and some other things as well and so with that we took the one-time charge of $0.05.

So mathematically absent that we would have done $0.46, which would have been well above the high end of our expectations that we communicated both at the start of the year and now and that would be driven by the Doble outperformance and the Filtration outperformance.

So what we take away as a positive is despite the headwinds that both the shielding market as well as the special charges we took that we still came in at the top end of our range. So you could think about this as $0.46 and you wouldn’t be irrational with that thinking..

Okay. All right. Thank you..

Thanks Shaun..

Thank you. Our next question comes from Ben Hearnsberger of Stephens. Your question sir..

Hey thanks for taking my question.

Gary on the 4Q guide, are there any charges embedded in that 4Q number you gave us?.

We’re contemplating that and I guess kind of to John’s question earlier, we're not looking at $5 million and $10 million worth of restructuring. We streamline the big things there couple of years when we closed the Glendale Height. So what I would put this is similar ranges what we did in Q3 relative to this.

So I would call it more trimming around the edges and so if you calibrate it, it’s somewhere below $5 million or below, you would be okay and we’re certainly hoping it’s at the lower end but it is baked into our numbers.

So if you looked at the rational in lowering our guidance by $0.05 and if you were to assume that $0.05 in Q3 and if you said it was $2 million in Q4, you would be at $0.10, it would be kind of back to where we started.

So it’s not a big number and it will have a payback that’s pretty immediate which again validates back to Vic's strategy of getting back to the mid-teens there I think the actions that we’re undertaking certainly bode well for how we get there..

So if we see a relatively immediate payback on some of those charges, the idea would be you’re back to that -- are you getting to that low double-digit in '16 in terms of EBIT margins in the segment?.

Yes we should be..

Got it. And then another question around Test I know earlier in the year you had some timing and execution issues within the segment and it sounds you’ve got some mix issues this quarter.

Can you give us -- I’m trying to get a sense for whether project timing execution played out any in 3Q are those issues were pretty much past and this was all driven by mix?.

Yes, I don’t think there were any significant timing issues in the third quarter. And we did have some in the first half. There’s always a little bit of shifting from to the left to the right whatever but there wasn’t a significant piece of what the issue was at third quarter..

Got it. And then just maybe to clarify your earlier comment you mentioned that you should get back to low double-digit margins in Test next year.

Is that going to be on a maybe into your quarterly basis or are we talking about on a full year basis?.

I would say on a full year basis we should be there..

Got it and then one last one you mentioned that A350 is maybe running a little bit ahead of schedule.

Can you give us a sense or some color around how the other large projects are ramping or the platforms are ramping?.

Yeah they’re ramping on schedule. We've not see any acceleration of any of the other ones. The important thing those are all relatively smaller compared to the A350. So the A350 is the biggest one of those both from a ship set value as well as the number of airplanes will be shifting in the year.

But the rest of them remain on schedule and not ahead we're fortunate enough we're not behind schedule either..

Got it. Okay gentlemen, thank you very much..

Thank you..

I show no further questions on the queue at this time sir. You may continue..

Okay. So to wrap up on this point in the short-term performance at Test I remain confident that we’re on track to get the segments EBIT back to the low teens and going into '16 we’ll be well positioned to capitalize on our market leading positions. Very pleased with Doble and filtration’s performance.

I’m confident with our three year financial goals are on track. I’m optimistic about our growth prospects, both short-term and longer term.

Our priorities remain simple and straight forward, execute and deliver on our commitments in a core business, maintain our focus on new product development, supporting organic growth and supplement our existing plan with accretive acquisitions around our core business. Thank you everyone I look forward to talking to you on the next call..

Thank you. Ladies and gentlemen for attending today’s conference. this concludes the program. You may now disconnect. Good day..