ESCO Technologies : Q1 2021 Transcript

REFINITIV STREETEVENTS

EDITED TRANSCRIPT

ESE.N - Q1 2021 ESCO Technologies Inc Earnings Call

EVENT DATE/TIME: FEBRUARY 08, 2021 / 10:00PM GMT

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CORPORATE PARTICIPANTS

Gary E. Muenster ESCO Technologies Inc. - Executive VP, CFO & Director Kate Lowrey ESCO Technologies Inc. - Director of IR

Victor L. Richey ESCO Technologies Inc. - Chairman, President & CEO

CONFERENCE CALL PARTICIPANTS

John Edward Franzreb Sidoti & Company, LLC - Senior Equity Analyst Jonathan E. Tanwanteng CJS Securities, Inc. - MD

Thomas Allen Moll Stephens Inc., Research Division - MD & Analyst

PRESENTATION

Operator

Good day, and welcome to the Q1 2021 ESCO Earnings Conference Call. Today and [number 39'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 statement, I would like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead.

Kate Lowrey - ESCO Technologies Inc. - Director of IR

Thank you. Statements made during this call regarding the amounts and timing of 2021 and beyond revenues, COVID impacts and recovery expected as a result of COVID vaccines, EPS, adjusted EPS, EBITDA, adjusted EBITDA, new products, margins, cash, shareholder value, the timing of Block V orders, success in completing additional acquisitions 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 the most comparable GAAP measures can be found in the press release issued today and found on the company's website atwww.escotechnologies.comunder the link Investor Relations.

Now I'll turn the call over to Vic.

Victor L. Richey - ESCO Technologies Inc. - Chairman, President & CEO

Thanks, Kate. Before we get into the financials, I'll provide a brief update on today's COVID environment. We continue monitoring the situation on a regular basis, and our primary goals remain the same. Stay ahead of the curve, provide a safe working environment and protect the health of our employees. The decisive actions we've taken and the operating protocols we've implemented since the start of the pandemic were done with a clear focus, which was to protect our strong financial condition, to deliver products and services in support of our customers, all while keeping our employees safe and healthy.

Our solid operating results in Q1, coupled with our strong liquidity position, demonstrates that the measures we've taken will allow us to successfully navigate through this challenge. Our actions will benefit ESCO going forward as things continue to move toward a more normal state. And I'm

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confident that our disciplined approach to operating the business will result in our continued success throughout the balance of fiscal '21. While Gary will provide the financial details, I'll offer a top-level comment by noting that while our Q1 A&D sales were lower than prior year due to COVID's impact on commercial aerospace, our portfolio diversity allowed us to overcome this headwind as we substantially increased our adjusted EPS from prior year due to the strong performance from our other operating units.

Our Navy business remains strong and well funded, our Test business continues to outperform with increased margins, and our USG business saw some meaningful calendar year-end spending across the utility customer base. Coupled with the cost reduction actions we recently implemented, USG delivered an adjusted EBITDA margin of nearly 25%, up from approximately 19% in the prior year's Q1. We're fortunate to have strong and experienced leadership teams across the company who continues to demonstrate their ability to effectively manage costs to meet market -- meet changing market demands. Our teams are actively addressing the challenges of today while continuing to focus on being even stronger tomorrow.

ESCO will continue to benefit from our leadership positions in several niche markets where we deliver a set of unique and highly technical products and solutions, specifically designed to meet customer needs. This makes it difficult for our solutions to be replaced by alternative sources. The fundamentals of our portfolio remain strong, and our goal remains the same, to create long-term shareholder value.

Now I'll turn it over to Gary.

Gary E. Muenster - ESCO Technologies Inc. - Executive VP, CFO & Director

Thanks, Vic. I'll briefly touch on the financial results as laid out in the press release. Navigating today's COVID world, our number one financial priority remains the same, maintaining our substantial liquidity. As I said from the start of the pandemic, when challenging times pop up unexpectedly, cash is king. I'm extremely pleased with the significant cash flow we generated in Q1, as normally our first quarter is the weakest quarter of the year when it comes to cash generation. Following up on the strong cash flow performance of the past year, we kicked off fiscal '21 with a record amount of cash flow, resulting in a free cash flow conversion ratio of 127% of net earnings.

Clearly, our working capital initiatives are taking hold across the company and while impressive today, we have set larger goals for the future. Today, we have approximately $740 million of liquidity at our disposal between cash on hand and available credit capacity, while carrying a modest leverage ratio of 0.38. In the release, we called out a couple of discrete items, which are described in detail and are excluded from the calculation of adjusted EBITDA and adjusted EPS in both Q1 periods. I'll briefly touch on a few comparative highlights.

We reported adjusted EPS of $0.55 a share, which increased $0.12 or 28% from the $0.43 we reported in prior year Q1. The $0.55 also exceeded the consensus estimate of $0.45. Given the backdrop of today's COVID operating environment, I'm pleased to report that we delivered Q1 adjusted EBITDA of over $29 million, which is approximately 4.5% higher than Q1 of last year despite the noted sales decline in A&D that Vic mentioned related to softness within commercial aerospace, which historically, is one of our most profitable operating units.

Total sales in Q1 decreased $9 million compared to Q1 of last year, but Navy and Space sales were up $4 million in A&D, which helped to mitigate the decline in commercial aerospace, and Test and USG sales were up a combined $2 million. Despite the noted increase in USG's Q1 sales resulting from the release of some pent-up demand, Doble continues to expect some near-term deferrals of project deliverables and maintenance work as many utility customers, both domestic and international, are continuing their COVID protocols, reflecting the various mandates restricting on-site personnel at customer locations. Consistent with our earlier communications, we believe the back half of '21 will be stronger than the first half and as vaccine rollouts continue to accelerate, this should allow Doble's customers to return to a more normal operating environment.

We took several cost reduction actions recently and as a result, we increased our Q1 gross margin by 150 basis points to 39.4% and reduced our SG&A spending by nearly 3%. These favorable outcomes were achieved despite adding the recent ATM acquisition in October, which is not fully operating at capacity during its transition to Crissair and despite our continued spending on R&D and new product development to benefit our future. Amortization of intangibles, interest expense and tax expense as a percent of pretax income also decreased in Q1 as we look at all costs and spending similarly.

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Entered orders were solid as we booked $158 million of new business and ended the quarter with a backlog of $512 million with a book-to-bill of 97%. As we move forward throughout '21, I'll remind you that our DoD business, led by our participation on the Block V contract for additional Virginia class submarines, where we booked several large orders during fiscal '20, we'll be delivering products against these large multiyear programs, which will mathematically reduce the optics of our book-to-bill going forward. As we work through the year, COVID will continue to bring along some uncertainty, which makes it difficult to predict how our near-term operations will be affected using our normal forecasting methodologies. And as a result of this uncertainty, we will continue our current protocol of not providing finite EPS guidance for the balance of the year.

Consistent with our November communications, from a directional perspective, we can point to several areas where we see positive momentum. Our commercial aerospace and our Utility end markets are showing some degree of customer stabilization, which supports our current outlook suggesting movement towards a recovery in the second half of '21. The increasing distribution of the COVID vaccine is anticipated to benefit and accelerate the recovery of commercial air travel and utility spending with customers resuming more normal buying patterns. While we solidly beat Q1, we still expect the first half of '21 to be slightly down compared to the first half of '20, and the outlook for the second half of '21 is expected to be a favorable comparison to the second half of fiscal '20, given the various elements of recovery that we are anticipating. We expect to show growth in fiscal '21 adjusted EBITDA and adjusted EPS compared to fiscal '20 with adjusted EBITDA and adjusted EPS reasonably consistent with that reported in 2019. If we complete any additional acquisitions during the year, it is expected they would contribute to these expectations.

And with that, I'll turn it back over to Vic.

Victor L. Richey - ESCO Technologies Inc. - Chairman, President & CEO

Thanks, Gary. I won't spend much time recapping the first quarter. My commentary in the release captures my perspective. But I will offer some qualitative comments about our end markets and our expectations for the balance of the year. Starting with our A&D segment. While we're seeing some signs of modest recovery in commercial aerospace, we expect continued softness over the next 3 to 6 months. We are seeing some stabilization in OEM build rates and increasing airline passenger traffic and flight miles, evidenced by the fact that quite a few air carriers are bringing more of their idle fleet back into service and daily TSA passenger boarding numbers are moving in the right direction. Just as we saw in Q1, the defense portion of our A&D business is and will continue to remain strong for the foreseeable future given our backlog and platform positions. We also see the current situation in aerospace market as an opportunity for ESCO, and we continue to look at suppliers or competitors, where they may be --we may be able to provide assistance via partnering or through an acquisition.

Our Test business delivered a really solid Q1 by significantly beating our internal expectations and delivering an EBITDA margin of nearly 13% versus 11% last Q1. Test outlook remained solid, given the diversity of its served markets. While USG had a really strong first quarter, coupled with a favorable sales mix driving a solid EBIT margin, we expect USG's sales outlook to be -- we do expect it to be soft for Q2 before returning to more normal levels in the second half of the year.

As the COVID vaccine gets more widely distributed throughout the utility service personnel, we expect the USG market to come back online more quickly as they can relax some of today's social distancing guidelines, Utility service personnel can return to their normal site visit routines. We continue to communicate with and support our Utility customers remotely, and our client service engineers are doing a really good job capitalizing on their relationships with their Utility counterparts to provide real-time solutions. This has been accomplished through a lot of creative means and positions Doble for success when the current site restrictions are eased. I'm pleased with the enthusiasm surrounding USG's pipeline of new products and solutions, and we continue to see NRG's end markets improving as new investments in renewable energy are increasing in both wind and solar. Our new solar product introductions have been growing far better than anticipated, and we expect that trend to continue.

Moving on to M&A. We continue to evaluate several opportunities, and we'll continue taking a prudent and deliberate approach. We expect to take action on these opportunities to grow our business as we have in the past. Our Board is supportive of our M&A strategy and our current balance sheet provides us with plenty of liquidity to allow us to add to our existing portfolio. Regarding our recent acquisition of ATM, I'm pleased to report the integration into our Crissair facility in Valencia, California is on track and should be completed within the next 2 to 3 months, which will further improve ATM's contribution margin.

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