Kate Lowrey – Director, Investor Relations Vic Richey – Chairman & Chief Executive Officer Gary Muenster – Vice President & Chief Financial Officer.

Jon Tanwanteng – CJS Securities Jim Giannakouros – Oppenheimer Ben Hearnsberger – Stephens Shawn Hannan – Needham and Company Sean Nicholson – SBH.

Welcome to ESCO Third Quarter 2016 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 2016 and beyond EPS, EPS - As Adjusted, EBIT, tax rate, future growth, profitability and revenue, operating margin, cash flow, orders, successive new products, sales, acquisitions, implementation of the Company's capital allocation strategy, the costs, benefits and timing of restructuring and cost reduction activities, the results of recent acquisitions, corporate costs and other statements 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 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.

As a reconciliation of these measures to the 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'll turn the call over to Vic..

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

Thanks, Vic. at the start of the year we identified certain restructuring actions being implemented throughout 2016 related to our lower margins, international operations primarily in the test business. We described and quantified these actions as well as the annual cost savings anticipated once the process was completed.

The restructuring costs were excluded from original FY'16 guidance provided in November and we communicated that we will be presenting our quarterly and annual financial results for '16 on an EPS as adjusted basis and GAAP basis.

Our restructuring actions have substantially complete as June 30, and I am pleased to report that we remained on schedule and budget and few remaining items are expected to be completed in Q4. With the restruction [ph] essentially complete we are now in position to begin realizing identify cost savings, and operating benefits that we anticipated.

I believe our Q3 results in the test business appear to be reflecting those benefits.

Turning to few specifics noted in today's release, I am pleased to report that our Q3 results came in above our adjusted earnings guidance, as communicated during the May release which means we have now delivered several quarters in a row where results have met or exceeded our internal expectations, both from an earnings and cash flow perspective.

Additionally I'd like to point out that the first month of -- performance consistent with our acquisition model, and the growth opportunities that we identified as part of the acquisition continued to materialize.

During Q3 we reported EPS EBIT adjusted $0.49 a share which was 20% higher than the $0.41 of EPS from continuing operations that we recorded in Q3 of 2015. The $0.49 also is $0.04 above the top end of our previous EPS as adjusted guidance range of $0.40 to $0.45 a share.

Our nine-month year-to-date EPS as adjusted was $1.36, which is also above our original year-to-date expectations we established last November.

Compared to our May guidance, the increased earnings came from every operating unit with the exception of Doble, whose sales continue to be impacted by the timing and volume of utility customer hardware sales.

Filtration, technical packaging, and tests Q3 earnings all exceeded our previous expectations, and our Q3 and year-to-date cash flow continues running several million dollars ahead of plan. The $398 million of orders year-to-date reflect the continued strength of our commercial aerospace business and, in particular, the A350 program.

This is coupled with the order strength we generated in technical packaging as well. While the test business orders were below expectations, we are encouraged by the level of bid and proposal activity we are currently addressing.

Given the size and volume of these opportunities, we are confident that the current order softness is project timing related due to the lengthy sales cycles on larger projects. Here are a few additional highlights from the release to allow you to better understand the underlying results.

Q3 consolidated sales increased 4%, or $6 million, compared to Q3 of the prior year. The increase was driven by technical packaging, where sales doubled from prior year, reflecting the strong performance from tech, and the contributions from Fremont and Plastique.

Filtration sales increased 10%, with strong performance both in our aerospace businesses and at VACCO. As I noted earlier, Doble sales decreased as a result of the hardware softness, and this was partially mitigated by higher software and service revenues. And test sales decreased due to the timing of revenue recognition on several large projects.

Corporate costs were higher than last year, primarily due to the timing and volume of spending on professional fees and the additional amortization of intangibles from our recent acquisitions. On the balance sheet, we continue to maintain a very favorable debt level, with $46 million of net debt outstanding as of June 30.

We remain firmly committed to our capital allocation strategy, which includes share repurchases and dividends. During the first nine months of the year, we spent $4.3 million to repurchase 120,000 shares, and we spent $6.2 million on cash dividends, which brings the total shareholder-related cash outlay to $10.5 million as of June 30.

Being this close to fiscal year end, we also confirmed our full year EPS as adjusted guidance of $1.95 to $2.02 a share. As you recall, we raised our full year guidance back in May. This annual guidance results in a Q4 outlook for EPS as adjusted to be in the expected range of $0.59 to $0.66 a share.

Finally, commenting on our longer term view, we continue to see meaningful sales, EBIT and EPS growth across the business segments consistent with our previous expectations in earlier communications. Also, I'll be happy to address any specific financial questions when we get to the Q&A and with that, I'll turn it back over to Vic..

improve our operational performance and execute our growth opportunities, both organically and through acquisitions. So now I'll be glad to answer any questions you have..

Ladies and gentlemen, if you have a question at this time, please press the star and the 1 key on your touch-tone telephone. [Operator Instructions] Our first question comes from the line of Jon Tanwanteng of CJS Securities. Your line is open..

Can you just talk about the impact of the push-out that Doble led on the press release that the timing fell into July as opposed to June.

What was the magnitude of that?.

It was about a couple million dollars..

Okay.

On a revenue basis?.

Correct..

Correct, okay.

And can you just go over what happens that your customers -- when we see headlines about airlines talking about delaying orders on commercial jets which you guys have a large dollar content on, say like the A350, do other airlines simply move up to take their place? How does that play out in planning and how do you think about the next year?.

Yes, we're also are on larger aircraft. So even if there are movements within this, it won't have a major impact on our business because of the large number of airframes that we're on. But the A350 specifically, we don't see any impact on our business..

Okay, great.

And then just finally, an update on the M&M environment; what evaluations are you seeing? Any update on how far you're willing to lever up to go after some stuff and just a general temperature of target opportunities?.

Let me answer the leverage question first, before I forget and get into more general things. We always talk about our willingness to go to 3, 3½ pounds levered. We don't see that changing for the foreseeable future.

The overall market, the aerospace multiples remain high, there's a couple of guys out there that really pay up for these things and we think, though, that some of those businesses are getting so big that the areas where we look, the businesses -- you know, $20 million to $100 million in sales, those are probably too small for some of the larger businesses.

It simply doesn't move their needle. That being said, the valuations there are still pretty strong, but they're within striking distance for us. There's a good bit of activity, not just in aerospace business, but we're seeing some things in our other businesses as well.

So the activity, it feels like there's more going on than there was maybe six months ago. The issue always is timing, though, and if people -- if they're going to make a decision quickly and their ability to get through the process.

So I'm encouraged that some things will be happening over the next three to 12 months, but it's really hard to control the timing of those and the facts are, we're really going to stay disciplined because anything being accretive, we really need to make sure that we're able to get a good return on those as well..

Last one.

Just given these valuations that are out there, does it make more sense to be repurchasing more stock, especially if you can't get one done by the end of the year?.

Well, we'll continue to look at that. We've always talked about doing that opportunistically and that certainly is one of the utilizations of cash that we continue to look at. But our preference right now is to make some acquisitions and we think we'll be able to get some things done there.

Certainly, the acquisitions that we've made in the technical packaging business this year, we got done at very reasonable multiples and ended up really paying the dividends we thought they were. So they're out there, I think we just have to keep fighting the fight to make some of these things happen..

Great, thank you very much..

Thank you. Our next question comes from the line of Jim Giannakouros of Oppenheimer. Your line is open..

Hey guys, congrats on the good quarter. On the quarter and the guidance that you had set for the second half, and the implications for the ramp that you had foreseen for the second half -- I guess I'm trying to understand, you guys maintained guidance you beat by about $0.04 from the high end.

Where are you? Incrementally cautious in your fiscal 4Q or is it just, there's plenty of wiggle room just in the range that you've provided? I'm trying to understand where I should be thinking about if it's temporary or permanent pressures, whether it be in tests or -- because I'm not hearing anything that I should be concerned about in Doble or filtration..

Sure. So I think the easiest answer is -- the timing with our business sometimes is hard to predict. And so while we had three strong quarters and above expectations somewhat, some of the things that we anticipated being delivered in the fourth quarter actually got done in the third quarter.

That's why you didn't see us go out and say okay, we're going to raise our guidance as a result of that because some of the things simply just got pulled into the third quarter. As far as the ramp in the fourth quarter, I feel it is still a decent ramp, third quarter to fourth quarter.

We're very confident of that, obviously, or we'd put something else out, but Gary and I were just calling out for the majority of the operating units last week and talked to the rest as well, and spent a lot of time talking about the fourth quarter because, with that kind of ramp, we wanted to have confidence that we're able to execute that.

I'll say that the businesses say that it's a matter of getting it out the doors. So we feel good about our ability to make that ramp in the fourth quarter. As you know, as anybody that's followed us over the years, knows that our fourth quarter is always our strongest quarter. And so, this time's no different.

And in fact, if you look within some of the businesses, the fourth quarter ramp is not as high as it was last year.

So we feel good about that but -- I wouldn't have any concern about the test business -- either you mention that we've got some good opportunities, as I've mentioned, our prepared comments with some larger projects as we move into next year. So I'd say overall, things are looking very solid..

Got it. Okay. And then, to understand the -- I guess the dynamics of that pop in 4Q, one has been historically has been the deliveries that you have in Doble.

To better understand where you guys are currently in your mix that's impacting your margin progression there; equipment versus software services, how should I be thinking about that and is that shifting for 2017 and 2018?.

Q3 which we just reported and how we look at Q4. John asked what was the sales mood between and I think we indicated it was a couple million dollars, and so you're going to see a sequential Q3 to Q4 at Doble of that at least $2 million and then you get the normal fourth quarter stuff.

So we fully rationalized that step up so moving that thing up $2 million to $3 million to $4 million, Q3 to Q4 -- the nice part of that, it brings along a lot of margin through that as well, so that addresses that.

On the test side, as Vic indicated, looking at what we're doing Q3 to Q4, it's very consistent with what we did last year, when fourth quarter carried probably 33% of the volume.

The one thing I think we did to be prudent is to make sure that we didn't outsize ourselves on expectations in Q4 so if you get through the math, you'll see that we're presenting Q4, in tests, slightly lower than Q4 last year, and that certainly appears rational based on the last three or four years of our Q4 performance.

So I'll comment on that one because you're going to see a clean quarter in test and while you'll see kind of adjusted 13% EBITs there, it's going to be north of 14% in Q4 just because that volume carries a lot of overhead absorption through it. So we feel pretty good on that.

On the filtration side, we always indicate that the Virginia Class Sub, the largest manifold that we sell, that product ships in Q4.

And so, of our big step-up in filtration revenue, if we peg that in round terms of $10 million, $8 million or $9 million comes from VACCO, primarily between the Navy business and the space, and that as well pulls additional margin through.

So that's a bunch of narrative around the sequential aspect of how we see Q4 playing through, being prudent -- I don't like the word conservative because it indicates something else, but I think we're being very prudent because this is all real time live for us.

So that hopefully gets you comfortable on Q4, and then I'll defer the conversation on 2017 and 2018 until we get through September. But everything that we've indicated in our prepared remarks where we say the growth opportunities are tangible and presentable, I think it's reasonable to take that as we have comfort..

Fair enough. Thank you..

Thank you. Our next question is from Ben Hearnsberger of Stephens. Your line is open..

Hey, thanks for taking my question. I have a question on test margins. Historically, if we look back, it looks like they peak in the 11% to 12% range.

Is that an appropriate level to think about, longer term for the test business?.

I think after we've taken these actions, we're looking more 13% plus margin in the test business.

I mean, this is -- between taking costs out with the two international operations, some of the initiatives we have under way to reduce cost at our domestic locations and some of the things we're doing at our plant in Austin, I think we have a very clear path of sustainable 13% or 14% margin in that business..

And assuming the top line shows up in that business next year, we can achieve 13% to 14% as early as next year, or that's going to come at a higher revenue run rate?.

I think if we're able to get some growth this next year, we should be able to hit those types of parts in 2017..

Okay. And maybe another question on 2017.

I know it's early, but we've got a ramping commercial aero pipeline, the packaging business looks very promising, is it fair to think about growth in 2017 -- or is it fair to think about seeing more top line growth in 2017 relative to what we saw in 2016?.

I'd have to go back and see how much growth we got here, but we certainly will see growth over what we had this year, just based on the things that we have -- the fact that we'll have Plastique for a full year, so I would say that will see some growth going into 2017, I really don't talk about how much yet because we spent all our time recently talking about the fourth quarter and so we have provided back together in late August early September talk about 2017, talked about that were given up on early sense vapid that power will kind of farm up what analysis would be for 2017 talk about that, on our next call..

Okay..

The thing I will say that I mean I feel really good about some of the actions we take to get our cost in line and what you would - it is Obviously everybody sales are strong as it they anticipated this quarter even the facts are really done a good job, the companies that a good job of controlling costs making sure that's in line.

The great thing about that is going to next year the growth that we get we should be able to leverage pretty significantly, so that's one of the things very encouraging to me, the hard work that they did they done this year will get additional benefits for next year. .

Okay. That's helpful, and one last question for Gary. Free cash flow conversion was really strong in 3Q.

What everything about it longer term what's an appropriate free cash flow conversion rate, I guess how you think about it over time?.

Yes well we have to address it across each of the businesses -- I think that within the filtration business it is very quick.

And now you know we don't have big capital appetite infiltration all the stuff we need is done so that the conversion rate there is in the high eighties to low nineties relative to achieve its contribution again because we carried the tax burden that and corporate.

So I put them in the high eight plus bucket on not on how they quick turn that plus the customer we have the air buses and Boeing's believe it or not pay on an efficient basis for the convergence really quick.

It is kind of anomaly because on some projects you get advance payment, then another one your retention on the back to be able to get things certified so you might get 20% of the cash up front and you might run eight months with no cash in and you get 60% completion and then the other 20% upon sign off the contract, that's a real hard one the predicted because it is really a function of what projects you have running through the pipeline.

Now let's go to that class -- the plastic that are the packaging business that's kind of somewhere between because here we have these long runs of programs things like gas we get paid quickly on.

And some of the medical ones we're running that program for 90 days and you really don't feel the customer so the 90 first day in and then you collect little after that. So I put the filtration in the 90% bucket, and I put test in the 40% or 50% bucket on a conversion.

Again, it is time phased and then press the --packaging group I put probably in a 75% conversion because there is catlike -- capital appetite there you know relative to the efficiency of the machines, as well higher capital appetite in the other places.

And I think doubles, conversion rate can range from 50% to 90% because even though were critical customer to them each of these don't always pay as quickly as well so you think they would, again we have some leverage over them which you choose not to use it and so. You bring all that stuff -- particularly international.

And then when you bring that all together I would say if you were just picking out one number and said 75% would be the conversion across the platform that would be out the right way to think about it, and so well but again a lot of data you really need to understand the four components of that before you say well 75% not very good. .

Okay that that's really helpful and I actually have one more question.

On that DUCe product of the universal controller, you guys cited in the press release of the potentially meaningful contributor can you frame that up at a little and give a sense for how big of a product that could be?.

What's really are ruggedized computers that have very specific application. So that the specific product itself is not that expensive but typically they'll buy enough of these to outgo a large number of their 12 engineers.

This is something I think kind of -- forecast that $7 million or $8 million a year after we get it up and running which we should be up and running the next year.

We get a really good rate option on that that and so we get a good future and the biggest reason well it is a great product first of all but a lot of regulatory pressure for utilities in a certain area which you satisfy so and then that kicks in, in April so I think a lot people are going to be charged supply half of next year of equipment. .

Okay, that's helpful. Thank you, gentlemen. .

Thank you our next question is from Shawn Hannan of Needham and Company. Your line is open..

Thank you for taking my question both. Going back to a comment you made they make sure that we acknowledge that you folks certainly aren't immune many slowdown on -- on the industrial power within the industrial market.

If possible if you can give us a perspective from your vantage point where within your business is you see the most risky you're monitoring how we should think about that. Thanks..

Okay, so again I'll do gearing [ph] each of the businesses also what's the full business and I don't think it is really big issue there at all, so I think we are both comfortable with that, the packaging business probably the same way I mean it was very good long term contracts there, good backlog, good insight, what with Doble solid business we have seen some pressure on the hardware side just resolve the budget they are just little tighter than they have been historically for a lot of reasons.

What we tried to do to address that are couple things and we've been working at the last couple of years; one is development of products as we talked about so this may be a very temporary thing is something new products you can earn 7,000 which we produced last year we're way ahead on sales, on that product versus what we thought we were going to be going at this point in the year, so it's not like all hardware's sales or so.

So anyway you price and hardware set, really strained at our offerings on the software side that's been a partially through internal development, partially through acquisition in this -- acquisition we did a couple years, it's been a real success is fully integrated both within our hardware and some other people's hardware, so that's been great thing for us, there's well the arms project, and the other thing is a service side and the service side that there's something else you'll see with utility business is they don't have hardware budget, they may have service budget, and while they may not be able to buy the equipment they still need to test out and they reach out and work with us on that.

So while our hardware part will be solved, the other pieces have never been stronger. So net-net, I think we'll be fine and the other thing that I mentioned on my prepared remarks is really a reduced focus on international business that's something we'll work on as well.

And then the tests business, the test business is the toughest to predict, having said that if you look at the orders that we had this year we would really not handing any paper works.

And so the biggest orders you had $3 million to $4 million, as we said earlier today we're figuring a number of larger projects going to next year so you can anticipate that will continue to get the type of orders that we've gotten this year in additions on these larger projects may come then.

But those are the most susceptible obviously to some of the budget constraints that are out there, so short answer is a little bit concerned though a little bit concerns to test. But we can we understand those who think other opportunities all set, what we are seeing the other two business I think are pretty solid. .

Okay, that's very helpful. And in my next question can you folks update us in terms of where you are with some of the business you have global related to the Middle East there are some hardware stages that -- of multiple stages haven't been completed.

Can talk a little bit about where we are the ability to expand that in some of the opportunism you might be able to us capture within that market or any other perspective, thanks..

Sure.

So they're -- way background we're coming up to the end of year two of the Saudi contract, which is the largest contract we had there, they are essentially happy we have two people there today working on the extension of the third year of that contract, we completed the job at Merfiq [ph] which is another Saudi utility, and part of what we had is responsible for that area over there and he starts two months to go and he had probably eight meetings with eight different utilities a lot of interest in what we're doing, I think is we get through this process with Saudi and people see the results are able to get that will continue to get good.

That's a big opportunity for us and obviously Saudi very well respected and in the region as far as what we say and totally sad and then traffic here with that as well everything we're doing today it is primarily services, we have sold them maybe $2 million of hardware as well they been going onto the next phase more, more equipment will be sold to support their ongoing operations is what you're really trying to do is kind of get a baseline and then bring a lot of that in house and for them to be able to do that they may be able to have equipment that were using, to complete our piece of the process.

.

Okay, great. Thanks so much for the feedback..

Thank you. And the next question is from Sean Nicholson from SBH. Your line is open..

Hi guys, just one quick question and I guess talked about earlier in the call that the M&A pipeline.

Just curious from you guys focus on attention on the deals down there really different stages come and go, any indication of where you're at, anymore processes, more mature further along in kind of probability of getting something done by the end of your fiscal year.

Or we still in that you know in terms of just the pipeline is this pretty much notice waiting for timing something to shake loose. Thanks..

Yes that will be a little bit of what we say but we look -- we're pretty far along on one opportunity and there's probably three others that were no -- are coming to market that we are very interested in over the next four to five months. .

In these ranges $20 million to $100 million roughly size..

Correct. .

Thank you. .

Thank you. And that concludes our Q&A session for today. I will now hand the call back over to management for any further remarks..

Well, I do want to make one clarification; I guess we talked about DUCe, socially organized computer, obviously it's that from hardware perspective but what really drives is our software that we put on that, so it's not like we're just resell somebody else's computer, we really put a lot of intelligence into that product.

So with that I'd just thank everybody for their participation. I look forward to talking to you in the next call..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, you may all disconnect. Everyone have a great day..