Good day, and welcome to the ESCO Technologies Third Quarter 2020 Earnings 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 statement, I would now like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead.

Thank you. We issued a press release earlier today that will be referenced during the prepared remarks on this call. You can find a copy of our press release and our safe harbor statement regarding forward-looking statements made during this call in the Investor Center of ESCO's website at www.escotechnologies.com. During this call, the company may make forward-looking statements, which are inherently subject to risks and uncertainties, particularly given the unknown impact of the current COVID-19 pandemic and the company's response to these evolving circumstances. Actual results may differ materially from those projected in the forward-looking statements, and the company does not assume any duty to update forward-looking statements. Please refer to the company's press release for risk factors that may impact any forward-looking statements and for the reconciliation of any non-GAAP financial measures to their most comparable GAAP measures. Now I'll turn the call over to Vic.

Thanks, Kate. Before I hand it over to Gary to discuss the third quarter results, I'll provide a brief update on how we're managing the company in this COVID environment. The situation seems to change on a daily basis, so a lot has changed since we last spoke. I think it's important to share some of the details of how we're managing the business in real-time, and how we're positioning ourselves for the future. When the pandemic hit and we saw the first indication of potential economic impact on our business, we did what we do best, and we took decisive action. From the start and through today, we continue to take actions that have a clear and precise focus, which is to protect our strong financial condition, deliver products and services, and support our customers, all while keeping our employees safe and healthy. The measures we've taken so far have allowed us to hold our own over the past few months, as demonstrated by our third quarter results and our strong financial position. We continue to review additional actions across the organization that will adjust our cost structure to fit our near-term sales outlook and support our long-term strategy for profitable growth by strengthening our core. We've demonstrated our operational efficiency and improved our ability to effectively manage costs to meet changing market demands in the past, and the current situation is no different. We're actively addressing today's business pressures and directing our efforts to come out of this even stronger. We are controlling what's within our control and focusing on the near-term situation without losing our vision for the future. Our actions will have a near-term benefit while maintaining our flexibility to ramp up quickly when demand returns to more normal levels. ESCO will continue to benefit from leading positions in various niche markets, delivering a set of unique and highly technical products and solutions specifically designed to meet our customers' needs. This makes it difficult for our solutions to be replaced by alternative sources. We continue to focus on our future, as demonstrated by continued investment in new products across all three segments, which will continue to create new opportunities and drive organic growth. Our deep and experienced management team is providing the leadership to manage through this period of uncertainty. Our disciplined approach to operating the business will result in our continued success. Our employees are our most important asset, and I want to say thank you to our manufacturing employees, leadership teams, and staff around the world for their hard work and dedication, as you have all demonstrated an extraordinary commitment to the success of ESCO. I'll now turn it over to Gary.

Thanks, Vic. I'll comment briefly on Q3 and the year-to-date operating results, which are laid out in the press release. As Vic noted in his comments, our liquidity position is of the utmost importance to us during this challenging time. I'm extremely pleased with where we stand today, having nearly $700 million of dry powder at our disposal between cash on hand and available credit capacity, while carrying a modest leverage ratio of 0.95. I'll touch on a few comparative highlights from the release. Given the backdrop of today's operating environment, I am most pleased to report that we were able to deliver Q3 adjusted EBITDA of $35 million, consistent with the prior year despite the noted sales decline at Doble and within commercial aerospace, which are our most profitable operating units historically. Our Q3 sales decreased only 3% in the current quarter compared to Q3 of last year, and our nine-month year-to-date sales increased 2% year-over-year despite the COVID-19 impact. A&D sales increased $1 million in the quarter and $28 million year-to-date, driven by the addition of Globe's submarine component sales, coupled with additional Navy and space sales at VACCO and Westland, which were offset by softness in commercial aerospace. Year-to-date aerospace sales at PTI, Crissair, and Mayday decreased approximately $4 million or 3% compared to the prior year. Test sales increased 9% in Q3 and 2% for the nine months. Sales were impacted year-to-date by a three-week shutdown of our Chinese manufacturing facility earlier this year, coupled with some delays at certain installation sites where access was restricted. Chamber project sales continue to be strong, and installation site availability has mostly returned to normal. USG sales were down due to continued deferrals of various project deliverables as several large utility customers, domestic and international, have realigned their short-term maintenance and spending protocols to focus on uninterrupted power delivery. Maintenance deferrals also reflect various mandates, restricting on-site personnel at substations, large transformers, and other customer locations. USG's recent order bookings reflect an increase of additional cybersecurity-related orders, including Doble's DUCe solution, where we have seen strong renewals as well as new customer procurements. As we noted earlier, we take decisive actions when we see downturns in our outlook, and our Q3 SG&A reduction of $4 million or 10% is evidence of that agility. Our year-to-date SG&A is flat compared to the prior year, and that was achieved despite having Globe included in the current year and despite our continued spending on R&D and new product development. Entered orders remained solid in Q3 and are strong year-to-date, where we booked $624 million and ended June with a backlog of $551 million, up 22% from the start of the year. Our DoD business, led by our participation on the Block V contract for additional Virginia Class submarines, drives this strength. I'll remind you that as the year progresses and as we move into fiscal '21, we will be delivering products on these large multiyear programs, which will mathematically reduce the optics of our A&D book-to-bill going forward. On the liquidity side, year-to-date, we generated $54 million of cash from continuing operations, or $64 million, ignoring the $10 million pension contribution we made in Q3, which, as I said, resulted in a modest leverage ratio of 0.95 and nearly $700 million of available liquidity. Q3 and year-to-date adjusted EBITDA improved from the prior year, with Q3 reflecting a 20.3% margin despite the lower contributions from our highest margin operating units. Finally, Q3 adjusted EPS was $0.76 a share, up from $0.75 a share delivered in Q3 of 2019. For the remainder of fiscal '20, the COVID-19 backdrop continues to bring along considerable uncertainty around the extent and duration of today's economic circumstances, which makes it difficult to predict how our Q4 operations will be affected using normal forecasting methodologies. As a result of this uncertainty, we will not be providing Q4 guidance at this time. To supplement Vic's comments on our cost savings actions, we are clearly focused on the right things, and we are working diligently on maintaining and optimizing our cash flow and our liquidity. Our plan is to prudently manage spending in the short-term and focus on those costs that do not have a negative outcome that would impact our ability to meet increasing demand or growth in the future. And now I'll turn it back over to Vic.

Thanks, Gary. I'll offer some qualitative comments about our end markets, but I will emphasize that the situation continues to be very fluid as to the duration of the current end market softness. In an effort to give you a sense of our thinking and planning, in July, we completed a thorough review of our individual businesses to update our expectations for the near-term impact of COVID-19 across and within our various operating units. These results were shared with you in the earnings release commentary, so I will only touch on a few highlights for emphasis. Starting with our A&D segment, we expect to see continued softness in the commercial aerospace deliveries over the balance of the year, resulting from reduced build rates and lower airline passenger miles. Recently, we started seeing some signs of recovery emerging as several air carriers are bringing more of their idle fleet back into service and daily TSA passenger boarding numbers are increasing. The defense portion of our A&D business is and will remain strong for the foreseeable future, given our backlog and our platform positions. Our aerospace supply chain partners continue to be strong, and in some cases, we are seeing some weakness. We're working on bringing some of these products and services back in-house, such as machining and other capabilities that we can replicate. We also see the current weakness in the aerospace market as an opportunity for ESCO. We continue to look at suppliers or competitors experiencing financial or operational stress during this crisis, where we might be able to provide assistance via partnering or through an acquisition at a reasonable price. Our test business is expected to be strong over the balance of the year, given a solid backlog and strength of the served markets, including 5G and related communications technologies and RF Shielding in general. We expect USG's customer spending softness to continue for the next few months, as they come out of their summer testing protocols and return to their more normal buying patterns. Once some of the social distancing guidelines get sorted out and utility service personnel can return to their normal site visit routines, we expect our service business to return to normal. Utilities have money to spend, and I'm certain that spending will return in the near future, as maintenance spending cannot be delayed indefinitely without creating significant risk to safety, efficiency, or regulatory compliance. COVID-19 does not change the fundamentals of the global utility industry, as society needs reliable, safe, and secure power. The critical need to maintain, repair, and improve the utility's aging infrastructure is not reduced by this pandemic crisis. On a positive note, I'm really pleased with USG's pipeline of new products and solutions, especially related to cybersecurity and related asset hardening solutions. We have several new solutions that have been introduced recently, and based on consumer feedback, these products have been enthusiastically received. With regards to NRG and our renewable offerings, I'm pleased to see NRG end markets recovering more quickly, as investment in renewable energy has increased in both wind and solar better than we anticipated, and we expect that growth to continue. Moving on to M&A, we have several actionable deals under evaluation in our pipeline. We're taking a prudent and deliberate approach, and we expect to take action on certain opportunities to grow our business, as we have in the past. It does appear that the current environment has brought valuations back to a more reasonable range. Our Board is supportive of our M&A strategy, and our current balance sheet provides plenty of liquidity to allow us to add to our existing portfolio. In summary, we delivered a solid first nine months of the year. For the balance of the year, our plan is to continue to focus on the fundamentals and to look for opportunities to leverage our infrastructure through M&A to create additional operating efficiencies and ensure we are well positioned for success in 2021. We will weather the storm, and we will prosper. We'll be glad to take any questions.

Our first question comes from John Franzreb with Sidoti & Company.

Congratulations on a good quarter.

Thanks, John.

I guess I want to start with the order trends and what you're seeing across all three segments in July versus June. It sounds like things are getting better, but I just wanted you to kind of talk us through what you're seeing there.

Yes. I would say that really across the board, we're starting to see a little pickup. I mean, it was a pretty good dip for a couple of months, but we have seen a pickup really across the board. I've talked to the guys in the utility segment today, and they had a solid month this past month. It appears the fourth quarter was a trough, and now we're starting to pull out of that.

So are your expectations that the service side rebounds in the first quarter of 2021 along the lines of a normal turnaround season or maybe a better than normal turnaround season based on some of the deferred spending?

Yes. It's a little hard to predict. I mean you would think that there's going to be some pent-up demand, but I think there's certainly work to be done. So our hope is to return to earlier levels with potential for some upside. But this is such a volatile market, so it's hard to pin that down. Absolutely, this is what's going to happen, but certainly, we're close to our customers and talking to service companies who also provide services utilizing our equipment to the utilities. They are all ready to go, and I believe as soon as this picks up a bit, we should see a solid pickup.

Got it. Got it. And in regards to test and 5G, could you provide any insight on how the timing of that rollout is going to be from your perspective? I've been hearing that things are being deferred, a lot of telcos are kind of working on their own backbone versus the 5G rollout. What are you hearing?

So I think the 5G rollout is going to go forward. And the most important thing for you to understand from our company's perspective is that the timing of the actual rollout to consumers is probably more in question than it was a year ago. But what I would say is all the testing—if you remember, for our business, we're doing the testing of new development or the components of the handsets and towers. So our testing really takes place in the early phase of this, and I think that's continuing. We've seen very strong opportunities there and the orders have been robust for both some standard products and some upgrades for systems we had out there, as well as new products. So I don't disagree that the actual rollout may be delayed, but we are not seeing any impact on our business as a result of that just because of where we follow on a continuum of the development cycle.

Okay. And I guess one last question, and then I'll get back into the queue. Regarding the SG&A, you already highlighted that it was down $4 million or 10%. Could you just remind us what the cost actions you are taking? And how much is variable, and how much is fixed of those actions?

Yes. I'd say, John, when this first hit a few months ago, we were pretty good cost managers. We stood on all discretionary spending, such as travel that was outside of our control. We do a lot of traveling around this company with Doble going out to sites, and if that becomes zero, there's an immediate cost saving there. So travel is a big part of it. We deferred some compensation adjustments that might have been coming through in midyear. Our goal is to control costs that didn't have a cost associated with them. It wasn't like we shut a facility, and that cost us $2 million and would save us $2 million. These were all costs that were trimmed without associated costs. As we go forward, you'll see some of that pick up as some of these things reopen; we'll have a correlated revenue stream when Doble sites open up and when ETS is able to travel. Again, you'll see the G&A move up, but you'll also see the sales and gross margin to serve that move along with it. We're really pleased with how we were able to do that without taking draconian steps and cutting people's pay and doing other things around that. So this level that you see in Q3, I think it will be pretty comparable in Q4 as we move forward. As we get into fiscal '21, we'll size the SG&A according to whatever we see the forecasted revenue looking out, so we can maintain that same percentage of sales as we go forward.

Yes. I think the thing that I would add, though, is that SG&A is one piece of this. But we have been—as sales have gone down in some locations, we have the right size of the operations. Those typically fall into the non-SG&A bucket, those are direct costs. Those are going to go away and will not come back until such time that sales pick up. So SG&A is a big piece of it, but a lot of what we've done is really more associated with direct costs.

And our next question comes from the line of John Tanwanteng with CJS Securities.

Very nice quarter. My first question is on the commercial aerospace business. I know you mentioned you're seeing some signs of pickup. I was wondering if you could go into a little bit more detail on that, delineate between the OEM side and the aftermarket side. Do you think you're past the trough in that business? Or maybe there's another dip to come depending on production rates or inventory levels in the channel?

Well, I mean, John, there are two big variables, as you know, and they are both pretty unpredictable. I mean, we have build rates from the OEMs now, so we're building to. If those hold, then I think we have a clear understanding of what that looks like. Now there's a second burst of COVID, or we have another spike, and they have to change their build rates again, that will obviously have some impact on us. We're not seeing that today, and we're kind of planning for what we've been informed of. The other piece is just a pickup in travel. What we saw last month— I haven't looked at it for a week or so, but given that there was about 25% of pre-COVID numbers for people flying, we do see that starting to pick up, too. Obviously, that drives our spares business, our service business, and our OEM business. Again, I think the big variable there is whether we have another spike or not. I was just on a call with a guy, and he said he was on a flight to Montana, and it was totally full. He said it was free coming out a little bit. But I think it's been a mixed bag. So as you know, flights are flying fuller today, but there are still not nearly as many of them. I think that's the big issue. But it seems, unless things turn south again in a big way, we feel like we've hit the trough.

And John, just to add something to that. We've talked in the past about tracking weekly sales reports. We've done that for a long time, but we've paid a lot more attention to it here over the last three or four months. If you look at the profile of the last five weeks, they are nominally moving in the right direction, as Vic said in his comments, with aircraft coming back in service and TSA passenger numbers coming through. So I would say stabilization is probably the best we're looking at right now. If it does go down, we're talking about one or two percent, not 10% or 15%, because this feels pretty comfortable based on the last five weeks of deliveries.

Got it. That's very helpful. And getting over to the Doble business. We had record heat waves in the south, blackouts across the East Coast. Any read-through to the utilities and their maintenance maybe lacking because they skipped it this season? How does that flow through to your business when the summer heat dies down and they're free to do service again; what kind of bounce back could we see?

Yes. Again, we're not assuming an upside to this. Our current view is that this next quarter is probably going to be consistent with what we've seen, maybe up some in the fourth quarter. Next year, we're projecting that we should get back better than we're doing this year, but I think there's still going to be a bit of a ramp. It really depends on when they get out there and start hitting the sites. Some of these sites are just not being visited right now, and that will dictate a lot. For us, the only sites that we've been authorized to go to are the nuclear sites. Much remains to be determined, but certainly, this is an issue with a finite life. The question is how long is that finite life, but they cannot continue to ignore this type of testing.

Okay. Fair enough. And then just last for me. What's driving the strength at NRG? I know you mentioned wind energy is coming back. A bit of solar product is being successful now. Just a little more color on the strength you're seeing, where it's coming from, and how sustainable that is.

Some of it, I would say, is focused. The people we have there are a little more focused on the solar side now, and we have some products, but I didn't think we were taking advantage of those as much as maybe we should have. So I'd say the solar side of it has been dramatically better this year than we anticipated. Part of that is just improved focus and investment. If you look at it in general, the interest rates being as low as they are, I think it's up a ton because people were worried about the tax credits before. There was a concern that when those went away, that business would go away. The reality is that the low-interest rates coupled with renewable energy being so close to traditional energy generation means those investments make a lot more sense now than even six to eight months ago. Hence, people are jumping in, plus there's the obvious demand for renewable energy. The other economics make it more favorable than it had previously.

That makes sense. If I could ask one more, you declined to provide guidance for the fourth quarter. Just wondering where your biggest sources of uncertainty are in your revenue earnings projections at this point, halfway through August?

Yes. I would say it's really commercial aerospace and whether there is going to be any further adjustment, and it's really the recovery of the utility business. I think we have great insight on the rest of it. We have made assumptions on those two pieces, but we just don't have enough clarity to really say this is exactly what we think we're going to do because those two markets are still a little fragile.

And we do have a follow-up question from the line of John Franzreb with Sidoti & Company.

Just on the M&A pipeline. It sounded like you were interested in picking off some companies that are in duress in the aerospace and defense side of the market. Could you talk a little bit about your appetite for maybe a number of companies you may be looking at on that side of the business and maybe the size of those businesses that you're targeting?

Yes. I would say we are not going after distressed companies because that's not really what we do. A lot of people do that, but we always say we want to buy solid, good companies. I'd think of it more like this: The companies that we're currently looking at are strong companies that, for whatever reason, people decide they don't want to weather the storm any longer, and thus they look for an exit. I'm not saying that we aren't paying close attention to other vendors and companies that might have issues, but we are really not looking for troubled companies. As for size and number, we're going to take a very cautious approach to make sure. We've always been very aggressive on our due diligence to understand what we're getting. That's even more the case now, particularly as we look at forecasting because we're having a little trouble forecasting our business right now. Just like we discussed earlier, forecasting someone else's business is even more difficult. I would say the advantage in the aerospace business is that it’s very platform-driven. If you understand exactly what part number somebody is producing, what aircraft they're going on, what the build rate is, and what the repair cycle is, there are numerous variables that allow you to gain very good insight into what's going on with those businesses. The other thing I would point out is that we're focusing more on defense aerospace and commercial aerospace because they are doing exceptionally well. If we can find a business that is leaning further that way, it would be a preference for us right now for the foreseeable future because there is much more stability in the next couple of years.

Got it. And one last question. It sounded like there might have been some supply chain issues in the quarter. Was that the case? It sounded like you put some production in-house while bringing some production in-house. Can you quantify maybe what impact that had in the quarter on the P&L? Any additional color would be helpful.

Yes. We really have not had significant supply chain issues. What we are trying to say is we've been paying close attention to that to make sure we haven't. What we've done is look at everything we subcontract to an outside vendor and ask if this is something we can do in-house. The reality is, I want to keep as many of our employees employed as possible. And also, it gives you more control over what's going on. I've said to everybody that if we need to buy additional capital equipment to bring work inside, we should do that. I believe that is a good investment in our business because one thing we cannot predict about COVID is how long it will remain, but at some point, it's going to get under control, and normalcy will return. I want to ensure we are well positioned to take advantage of that. The more we can do in-house where it makes sense, the more I want to do that, both for cost savings and employee retention.

One thing I'll add to that is that when you go out in your market with a big strategy like that, it also makes your supply chain aware that you're willing to do that. In some cases, there have been immediate cost reductions because those suppliers didn't want to lose our business. We have a break-point algorithm where that threshold is concerned. Thus, in some cases, we are looking at bringing things in-house, and we actually got better pricing from an existing vendor, leading us to a lower cost structure moving forward. To Vic's point, we're pulling several levers on that side, which I think has been really effective.

This concludes today's question-and-answer session. I would now like to turn the call back to Vic Richey for closing remarks.

Okay. Thanks to everybody, and I look forward to talking to you on our next call.

Thank you.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect. Everyone, have a great day.