Good day and welcome to the ESCO Technologies First Quarter 2022 Earnings Conference Call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO; Chris Tucker, Vice President and CFO. And now to present the forward-looking statement, I would like to turn the call over to Kate Lowrey, Vice President of Investor Relations.

Please go ahead..

Thank you.

Statements made during this call regarding the timing of recovery and growth of our end markets, the amounts and timing of 2022 and beyond revenues, impacts of COVID and COVID variants and recovery expected as a result of COVID vaccines, recovery in commercial aerospace and utility markets, impacts of supply chain issues and cost inflation, availability of labor, adjusted EPS, adjusted EBITDA, cash, shareholder value, the timing of Block V deliveries, success in completing additional acquisitions, success in integrating acquisitions, the results across production efforts 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.

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 will turn the call over to Vic..

Thanks, Kate. And thanks to everybody for joining today's call. At the risk of being redundant, I'd like to start the call off again, by thanking our employees across company, for their ongoing efforts to manage the business. There continue to be a lot of challenges to overcome on a regular basis.

We continued to see supply chain challenges with delivering cost inflation, and the Omicron variant of COVID impact in our businesses. Despite of that, our teams continue to demonstrate tremendous resilience. Our employees are working very hard and doing all they can to support our customers and drive the business forward.

And for that, I am very appreciative. The business has continued to gain momentum as we start fiscal '22. Two of our three business segments delivered organic sales growth in the first quarter. We expect all three segments will deliver organic growth in the remaining three quarters.

We have a lot of confidence in that outlook due to our continued strong order output. If you recall the fourth quarter fiscal '21 had ordered growth of more than 30%. Over the first quarter of '22, we achieved order growth of more than 40% compared to prior Q1.

Our backlog is a record level, and that bodes well for the balance of the fiscal '22 and beyond. Chris will get into some of the financial details in a few minutes. I'll start off with some top level commentary on each of our business segments. Starting with the A&D, we see the recovery continuing for this business.

We continue to monitor the commercial aerospace markets closely. There'd likely be some more disruptions with travel as the pandemic situation continues, we're undoubtedly seeing higher levels of business activity from our commercial aerospace customers. 2020 and 2021 were really tough years in this market, so we're glad to see the growth returning.

For A&D overall, we saw entered orders grow by 38%. Admittedly, we're coming off a low base. It is great to see the backlog rebounding like this. You saw in the press release mention of challenges regarding supply chain performance and labor availability. Those challenges are definitely being [indiscernible 00:04:08] by the A&D Group.

In particular, are California-based businesses, are VACCO, PTI, and Crissair, have seen challenges as we work to ramp to higher levels of business activity. We did miss some sales in the quarter because of these challenges.

But the teams are highly focused on increasing capacity, to meet our customer demand, and we're confident that these are just timing issues within the year. The last thing I wanted to mention regarding A&D was our acquisition of NICO, which we were able to close in the first quarter, and we're excited about what NICO brings to our portfolio.

This business will fold into our PTI subsidiary, bringing a solid management team with great product technologies. We're very happy to have them on board. So, A&D our test business also had a great orders performance in the first quarter. Orders are nearly $68 million for the first quarter, compared to $43 million in the prior year's first quarter.

So the growth is significant and broad-based, with double-digit increases in all global markets. Sales growth was a little higher in Q1, which we expected, and we're planning to see strong sales performance over the coming quarters for Test. We continue to face some challenges with profit margins during the first quarter for Test.

The margins were slightly down compared to what we had in our internal plans. And as you saw in the press release, we're also down versus prior year. This has been a key focus for us. No doubt the inflation challenges are cued for Test. So we have programs around cost management and price realization to help drive the margins as we move forward.

This segment is our largest user of freight services. And as we all know, there are higher cost increases in this area, which is also impacting our margins. Margin expansion needs to come as we grow this business. That's a key part of our value story here, and we're focused on achieving that result. For USG the story of Q1 was a bit mixed.

We had the expected sales contributions from the recent acquisitions, so it was nice to see that coming through. Integration of the acquired businesses is going well and is on track. We also saw another strong quarter for NRG, so things continue to go very well in renewable space. We did experience some challenges at Doble.

Approximately $3 million of the sales shortfall was related to supply chain challenges with our contract manufacturer. We also had tough comps in the last year's Q1 with customers release some funding for calendar year-end purchases. We didn't see a repeat of that this first quarter. But the comparisons ease for Doble over the coming quarters.

And we expect the growth to kick back in during Q2 and Q3. We continue to feel strongly that utility markets have very favorable growth characteristics over the long term. And we also feel this portfolio of companies that we put together, will be very well-positioned to take advantage of this growth.

Overall, the quarter came in right on top of the internal projections we had when the quarter started. The high order activity supported our higher level of sales, but we couldn't get that out the door, given supply chain and labor challenges. At the end of the day, we're on track for the '22 expectations that we laid out in November.

The plan is back-end loaded, but that's consistent with our original projections and support of our backlog. Bottom line, we feel good about where we are after the first quarter. Now I'll turn it over to Chris..

Thanks, Vic. I will start with an overview of the consolidated financial performance in the quarter. Sales in the first quarter were up 9% compared to last year, excluding the impact of acquisitions. Sales were down 1% with growth from the aerospace and defense and Test businesses being offset by a decline in the utility solutions group.

The acquisitions added $15 million to sales in the first quarter. Adjusted EBIT margins were 9.3% in the quarter compared to 11.1% in the prior year quarter. The margin decline was driven by decreases in the Test and USG businesses. Interest expense in the quarter was $733,000 compared to $541,000 in the prior year due to higher borrowing levels.

Taxes were 22.3% in Q1, compared to 22.5% in the prior year. All these items delivered adjusted EPS of $0.46 per share, below prior year's $0.52 per share, but consistent with our internal forecast. Operating cash flow in the quarter was $1.9 million compared to $24.8 million last year.

The decrease was mainly due to milestone payments received last year, which did not repeat this year, and also past of accrued expenses that exceeded prior year amounts. Inventory increases were unfavorable to cash in the quarter, but this was more than offset by good performance on accounts receivable and accounts payable.

Capital expenditures were $14.1 million in the quarter compared, to $6 million in the prior-year quarter. This increase was driven by the purchase of the NRG headquarters building in Q1 we were presented with a unique opportunity to purchase the building at a favorable price relative to annual rents and drive a cost reduction for this business.

Turning to segment performance highlights in the quarter are as follows, A&D saw a return to growth in the quarter with reported sales of 5.4%, excluding the impact of the Nico (ph) acquisition, these businesses delivered 4.1% sales growth. In Q1, we saw return.

The return of growth in the commercial aerospace markets with an increase of 11% driven by our PTI subsidiary. Military aerospace was very strong with 36% growth. Crissair and Mayday were key drivers of this growth. The Navy business grew 4% while sales to industrial customers, which are a smaller part of the overall segment, were down 43%.

As Vic mentioned previously, we did see very strong order growth by the A&D Group in Q1. Orders were up 38% with good activity across the military and commercial aerospace markets, as well as Navy business. PTI, Crissair, Mayday, and Westland, all posted significant order gains, and were the drivers of the 38% increase for the business.

USG saw reported sales growth of 16.4% in the quarter. Excluding the impact of the Altanova and Phenix acquisitions, revenues were down 10.2%. This decline was driven by Doble, which saw sales come in approximately $7 million below prior year.

About $3 million of this was driven by the supply chain challenges Vic mentioned earlier, with the balance related to soft end markets. The renewables business at NRG had another strong quarter and delivered 21% growth. Adjusted USG EBIT margins in the quarter were 21.8% compared to 24.5% in the prior-year Q1.

The reductions were driven by deleverage on the sales decline at Doble and dilution from acquisitions. Orders for USG in Q1 came in at $66.2 million, which was a 36% increase. Backlog finished at $94.4 million compared to $44.9 million in the prior-year quarter. Approximately $34 million of this increase was driven by the acquisitions.

For the Test business, we saw sales growth of 4.2% in the quarter. The growth was led by strength in China, which has continued to see very high levels of activity for test and measurement projects. We did see margin pressure in this business during the quarter as adjusted EBIT margins went from 12.9% in the prior year to 9.2% in the current quarter.

The business is experiencing inflation driven by materials, labor, and freight as they manage increasing demand. We're very focused on driving cost containment, productivity, and price increases to offset these impacts, as we move forward. On the orders front, we saw continued strength in the pace of business for Test.

Orders were $67.9 million in the quarter, which is an increase of over 50% compared to last year. The topline outlook for this business is strong with order strength being experienced in all world areas. That represents the summary for Q1 financial performance.

As Vic mentioned, it looked like we could get a little better, do a little better than our internal projections as the orders were so strong during the quarter. But with persistent supply chain and labor challenges, we ended up a bit constrained on the top line.

But we are still on track to deliver the year as laid out during our November earnings announcement and call. If we turn to the guidance, in the release we reiterated the earnings per share guidance for fiscal '22, calling for adjusted EPS in the range of $3.10 to $3.20, or growth of 20% to 24% this year.

These earnings per share range assumes 2022 sales in the range of $815 to $835 million, or growth of 14% to 17%. We're not breaking out guidance by quarter for '22, but we do expect only modest EPS growth in the second quarter, and very strong growth in Q3 and Q4.

We are watching closely, as the Omicron variant was disruptive across the economy in January, creating more employee absences and supplier disruptions as well. It appears that things are stabilizing, and as you can see, we certainly have the backlog in place to drive to the guidance range. So now I will turn it back over to Vic. Thanks, Chris.

Since that touched on quite a few of my thoughts earlier in my commentary, I'll just offer a few more comments before we move into Q&A. We feel good about to start of 2022 and are excited about the forecast we have out there. Lots of growth coming as we move into second quarter and beyond.

Backlog supports the outlook and we feel that ESCO is good place right now. The cycle of our different businesses are starting to kick in and that bodes well, not just for '22, but the future years as well. All our subsidiary management teams will be in St. Louis next week.

And I can assure you will be focused on all the activities that must take place to get '22 delivered. I see the businesses, again, in April for access and more focused on long-term growth and profitability. It's always a fun time of the year. We will have two in-depth touch points coming up.

This allows us to drive proper alignment with the operating leadership and moves us toward our ultimate goal of profitable growth efficient use of capital, and higher returns. So then I think we're ready for Q&A..

[Operator Instructions] Please stand by while we compile a Q&A roster. Our first question comes from the line of Tommy Moll from Stephens. Your line is open..

Good afternoon and thanks for taking my questions..

Hi, Tommy..

I wanted to start on Doble today. If I heard you correctly, Chris, I think you said for the quarter the change was down seven, which was $3 million from supply chain issues that your contract manufacturer and then another four on the tough compares from the budget flush at the end of last calendar year.

Did I hear those numbers right? And can you give any more context around them?.

Yeah, you got it right. I would say last year in Q1, the growth wasn't explosive in the segment. I think, it was around 3%, but we were still newer into the pandemic at that point. And honestly, we expected the numbers to be a fair bit lower last year. We did see that flush of year-end stuff you mentioned that gave us that growth a year ago.

So that's the reference to that, and the softer end markets this year where we didn't see a similar activity. But you've got it right on the seven and the three..

And in terms of any context you can share on the issue there with the contract manufacturer.

Does it feel like some, all of that, has been resolved as you go into Q2? Or that might be a nagging headwind for some time?.

I would say more it's going to resolve itself over the next six months. I'd like to say it's all behind us, but - and it's almost all chip issues. The boxes are built, they're ready to go but we do have some chip shortage at those places. But I do want to make sure everybody understands we're not sitting on our hands just waiting for things to happen.

We redesigned about 90 boards at Doble last year to make sure we can keep up with things. And we get all the way there.

But had we not gone through that process over the past 12 months, I think the impact of the supply chain would would've been more significant and that's probably something that we're going to continue to do, I'd say through the first half of this year as these things flush themselves out..

Thank you, Vic. And just moving to the higher level here again, around USG and maybe Doble, specifically. In the release, you pointed that some of the themes that are probably become a little better known at this point just in terms of the overall electric utility market impacted by some of the reduced consumption, potentially pandemic-related.

The same time in your outlook, I think it's pretty safe to assume you're implying growth for Doble on a full-year basis. So if you could just help us reconcile those two data points or provide any context, that'd be appreciated. Thank you..

Yeah. I think, if you go back to last year a little bit, Tommy, again, it's a little bit -- I hate to talk about the comps too much, but we had quite a soft second quarter there. And then, even in the third and the fourth, we didn't see the business recover the way we were expecting from those pre -pandemic levels.

So we expect growth really as we go into the second quarter, just based on how weak it was a year ago. And then again, we feel like the second half of the year, the overall activity levels, should continue to stabilize. And I would tell you in the fourth, we have pretty conservative numbers.

And so overall it's just a little bit of easier comps as we move through the year and continuing to get into, let's say, hopefully a more normalized environment in those markets..

I'll just add, I think, it's not -- I'd like to say those are all really hard things that we've been pointing to. We'll really get our comfort if we're going to see that kind of growth over the remainder of the year, is really talking with the customers.

And so we have a lot of people that are constantly interfacing with the customers, and so we can gauge where their summit is, what kind of buying activity they see. The other thing, I think, it's going to be really important for us is, in the past year, everything that we did with customers virtual.

And so we've not at our client conference last year, we didn't have the lively transport form of adverse [Indiscernible] and we're doing that this year. And so while, I think, attendance will be certainly less than it's been historically, get many people in the same room, get them excited, having them see our new products.

I think it's important to remember we did introduce a number of new products over the second half of last year. And I think those will get traction in the remainder of this year.

I do think that although the overall utilities base isn't picking up as quickly as we'd hoped, I think for us, with the areas that we're in, we're going to see some growth this year. Appreciate it, Vic. Appreciate it, Chris. I'll turn it back..

Thanks, Tommy. Our next question will come from the line of John Franzreb from Sidoti. You may begin..

Good afternoon, guys. And thanks for taking our questions.

Given the recent increases we're seeing in the curio and labor costs, where are you having the most success amongst your businesses in raising prices to offset those costs? And by what magnitude can you do it by?.

Yeah. I'd say, that probably the two biggest places are in our test business, although it takes a little time to pick that up, to be able to realize that because we increased the price already have contracts, and it's such a quick turn business that you don't necessarily get it on one contract, but may get in on a next. We had some success there.

And on the aerospace side as well. I think, we've seen a good bit of opportunity. And then, pieces of our utility business. But I would say that's led less broad-based..

And when you look at the portfolio in a broad sense, which business is there most concern that there's still excess inventory in the channel that you have to work through before you reach maybe a revenue equilibrium?.

I don't really view that there's a lot of inventory, finished inventory that the customer has there to work through the most part. I think the fact that our orders levels have been so high over the past two quarters is kind of evidence of that.

I mean, there's probably somewhere people are just like we are trying to get ahead of the thing and buying more product, buying more raw material. I'm sure there's some of that with our customers. I think the vast majority are just to pick up the business. I don't think there's a lot of inventory after that has to be worked through.

We have to remember particularly on some of the commercial aerospace, they stopped buying for a while. I mean, looking 77, they just not buying in. And so now as that ramps up, they wanted yesterday. So that's the other challenge you always have when you have these kind of quick up, upticks..

Okay. And just one more.

In light of the recent acquisitions, are there any cost savings benefits that you might be able to realize in the coming year that you want to call out and let us know about?.

So we're looking at - I would say on the utility side, I don't think it's as much cost savings as it is leveraging the technology and the sales force that we have, the rep network and those type of things. So I think what we're going to see there is more - through delivery, get more orders as a result of having those together.

Because again, as we've talked about some of the last calls, it truly is a matter of having a stronger presence in Europe and Asia. And, I think, it's going to help, not only the businesses that are already serving that market, but we think there'll be some pull-through of Doble products in those markets.

And vice versa, with some of the products that are being sold currently in Europe. We'll be able to bring some of those back in the U.S. I think, that's really the play on that side. With NICO, which is a relatively small acquisition, we are going to move them out of their current facility into PTI facility.

It will be able to take some significant costs. Again, [Indiscernible] a small business, out of that business..

Okay. Great. Thanks. I'll get back into queue..

[Operator Instructions]. Our next question will come from the line of Jon Tanwanteng from CJS Securities. You may begin..

Hi. Thanks for taking my questions. Actually, I just wanted to follow up on that previous question just about to [Indiscernible] you're expanding in Europe.

How is that going kind of have you seen that pull-through of your products yet, or is it still going to take some time to realize those kinds of revenue synergies?.

[Indiscernible] can dig a little bit. With a little bit of time, we've assumed some pick up across the business this year, but it really kicks in next year because the big thing we've done so far is to rationalize the organization and the sales force.

And again, making sure we have the best reps in each of the areas, making sure people are focused on the right things, getting them trained on each other's products and so that's a bit of a process, if you will. The next step will be looking at the products, making sure we're selling the best products of each company in each location.

So I think you'll see the big pickup with that combination late this year and going into next year..

Understood. Thanks. And then just moving onto the Test business. What's driving the strength in the activity that you're seeing there that's a pretty big orders number? Is that sustainable, number one.

And then number two, I guess, when do you get back to your historical margins there with? What's the inflation the weighted and the offset that you are trying to ramp up?.

Sure. So I'd say the biggest adding we've talked about on the last call are these filters that we're making for the A&P filters that we're making for data centers. And we do those for some commercial customers but the largest driver right now is the U.S. government. And so they're putting a live data centers and it's not like they're share data center.

So each has different agencies, they've got their own data centers. That's been a big, big driver for us this year. And everything they are telling us, and I think they have good insight into the next couple of years, is that that piece of the business is pretty sustainable going forward.

The interesting thing which is different than what we've seen in past years, we typically would have a very large project flowing through, right? We'd have a large automotive project, and a large defense project, that was flowing through, coming out of backlog, going through the sales channel. And right now we don't have those.

Yet, we're able to grow the business. And some of those opportunities are still out there. But it's very encouraging to me that we're able to grow the business, at the same time, not pull those big projects. Second half your question, as I mentioned earlier, I think, it's going to take a little time.

We're now pricing some of those costs increases into the bids. And so, I would think, you're going to see pretty steady margin growth throughout the year for two reasons.

One, I think we have a higher level of volume, so we're going to be leveraging our overhead, and then the other one is some of these price increases should be hitting next quarter, and then I think even more so in the subsequent two quarters..

Okay. Great. And then lastly, just a higher level question.

What's giving you the confidence to reiterate your guidance for the year? I think I get the demand side; that seems pretty evident, but what's your thinking about when and how the supply chain issues resolve? Or is it more of a pricing pass-through that you're aiming for as opposed to being a relief from the inflation and labor and supply chain issues?.

It's both of those. I would say, the other thing is, we're putting in additional capacity to be able to ramp up the business.

And so for instance, in our Test business because it is an outsized growth that we're seeing, so each additional facility will have that up and running in the second half of the year, where we can move in some of the lower-end products into different location to make sure that we have all these filters in one place where we can perform on those rather than another shift.

In our facility in Mexico, to be able to manage some of the growth. So it's a combination of more capacity pricing should be better particularly, in the second half of the year. And the supply chain, I think we're understanding it better.

And so I think as you understand it better, you make some of the changes you have to make available to work through that process..

Great. Thank you..

Thanks, Jon..

Thank you. And I'm not seeing any further questions in the queue at this moment. I'd like to turn the call back over to the speakers for any closing remarks..

Okay. Well, thank you everybody for your interest. We will end the call now and look forward to talking to you in our next call..

And this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day..