Earnings Call Transcript - ESE Q1 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the First Quarter 2023 ESCO Technologies Earnings Conference Call. Please be advised that today's conference call is being recorded. On the call today, we have Bryan Sayler, President and CEO; Chris Tucker, Senior Vice President and CFO. And now I would like to hand the conference over to our first speaker today, Kate Lowrey, Vice President of Investor Relations. Kate, you now have the floor.

Kate Lowrey, Vice President of Investor Relations

Thank you. Statements made during this call, 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, except as may be required by applicable laws or regulations. 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.

Bryan Sayler, President and CEO

Thanks, Kate. Thanks, everyone, for joining today's call. It's really great to be on the call for the first time as CEO here at ESCO. Our year is off to a great start, and I'm excited to talk about the financial results. But before that, I'd like to say a few words on the transition to my new role. Overall, the process has gone very smoothly. I've been able to relocate here to St. Louis with my family, and we love it here. We've really hit the ground running as the new calendar year got started. And I've had a chance to go out and visit every subsidiary at least once, and a few a couple more than once. So it's been a pretty busy start to the year, but an exciting one for me personally, and I'm really energized to be in the new role. Vic and ESCO's Board of Directors continue to be very supportive of me and the role. And we just finished up a set of board meetings last week, where we were able to take the directors out to visit the factories at a few of our subsidiary sites. The business has a lot of really cool things going on, and we have some really neat capabilities. It was fun to allow the board of directors to get a close-up look at that. So I want to thank the board, and I want to thank Vic for their ongoing support of me and of ESCO. Their dedication continues to be crucial to our overall success. So with that, let me pivot to the quarterly results. We had a really great start to fiscal 2023 with all three of our business segments posting nice increases in both sales and earnings. Across the company, we continue to see favorable dynamics in the markets that we serve. We have really strong businesses that are serving very healthy end markets. So our outlook really remains positive. So having said that, we still see some challenges. All of us have seen headlines indicating improvements in supply chain conditions. And while we've seen some relief on the raw material side, availability of skilled labor continues to be a significant challenge. Due to the technical nature of ESCO's product portfolio, the labor shortage continues to be a drag on our overall growth, particularly at our Aerospace & Defense and Utility Solutions Group. Our operating leadership in each of those businesses is managing through the challenges effectively as they have been for the past year or so. But it's important to understand that we continue to face a pretty difficult environment. The good news is that the underlying demand for our products and services continues to be very strong. Our first quarter ending backlog of $718 million represents an increase of more than 12% compared to the prior year first quarter. So Chris will get into some of the financial details in a few minutes, but I did want to offer some top-level commentary about each of the business segments. Let's start with Aerospace & Defense, where we had another great quarter. Sales increased by 18% and adjusted EBIT dollars were up by over 25%. It's been exciting to engage with these businesses since taking my new role. And there's a lot of exciting things that are happening across the platform. The commercial aerospace business continues to see a robust demand environment, while our Navy and space business are really working on some important programs. These businesses are newer to me, but we're really fortunate to have strong management teams with deep knowledge about those industries, and they're really showing me the ropes as I get used to the new role. Also, as you probably saw in the press release, we closed on an acquisition for this group on February 1. CMT Materials will now be part of our globe business, which is based in the Boston area. We're excited to welcome CMT and their employees to the ESCO family. They bring with them exciting technologies and capabilities which will strengthen our naval offerings and provide ESCO exposure to some anticipated growth in the unmanned submersible vehicle market as it matures. Next is the Utility Group, where we had a strong quarter. Revenue growth was nearly 12%, and adjusted EBIT margins expanded from 21.8% to 22.7%. The core utility business continues to be solid as our customer base invests in their infrastructure, and we continue to see backlogs grow. On the renewable side, the growth continues to exceed expectations. As most of you know, 2021 and '22 were both 20% plus years of growth for NRG, but the growth story remains intact as we look forward. NRG has certainly benefited from a strong market, but I'm particularly pleased by the results from new product developments and utility-scale solar. I mentioned before, the component supply issues have improved a bit compared to the prior year, but shortages do impact our operations, and this has been pretty noticeable overall on the utility side. Our teams are aggressively addressing the issue. We are making some progress, but we expect that to take another quarter or so to resolve. Lastly, let's touch on the Test business, where we had a nice quarter of sales growth and EBIT margin expansion. Q1 sales were up by 19%, and EBIT was up over 35%. So a really good quarter for the Test business. As you saw in the press release, orders did decline in the Test segment compared to the first quarter of the prior year. Overall, we think the outlook here is still positive. And you should remember that we had outlined lower growth expectations for Test, and we gave our initial guidance back in November. For Q1 in particular, we had some exceptionally high orders in the prior year related to power filters as well as test and measurement products in the U.S. and China. That activity did not repeat during Q1 of this year, and so our orders came in as expected. So to summarize across the overall business, it really is a great start for ESCO this year. We're on a good path as we look forward to achieve the guidance that we gave you back in November. All three businesses delivered nicely, and our backlog position really positions us well for the balance of 2023. So now I'll turn it over to Chris to give you some more financial highlights on the first quarter.

Chris Tucker, Senior Vice President and CFO

Thanks, Bryan. Everyone can follow along on the chart presentation. We'll start on Page 3, where we have the overall financial highlights. As Bryan mentioned, we had a great quarter, and this chart illustrates that very well. Sales were up over 16%. Adjusted EBIT was up over 31%, and adjusted EPS was up over 30%. Another strong growth quarter for ESCO. Orders growth in the quarter was 2%. We will get into those details in a moment, but we did see good growth in two of our three business segments on the orders line. Overall, the order trends have remained robust, and our December '22 backlog of $718 million is a record and demonstrates the strength of the overall business. Next on Chart 4, we'll get into the segment results, starting with Aerospace & Defense. Solid performance continues here with sales up 18% and adjusted EBIT up 25%, and margins expanded by nearly a full point to 15.3%. The ongoing commercial aerospace recovery led to sales growth, as we saw increases of 30% from this market. Beyond that, we still saw good growth from other parts of the business with Defense & Aerospace, Navy, and Space, all up more than 10%. Orders were also good with growth of 8%, driven by Navy and commercial A&D strength. The next business is on Chart 5, Utility Solutions Group, where we also had a very strong start to the year. Sales growth was 12%, with high levels of activity from the electric utility customer base and explosive growth from the renewables business. Adjusted EBIT margins were up 0.9 points as we did see favorable leverage on the sales increase. Orders were very strong in the quarter with growth of 21%. The core utility space delivered order growth of 18% and saw strength on a global basis. The renewables business continued to deliver exceptional growth at 35%. Backlogs at $137 million are elevated in part due to supply chain challenges mentioned by Bryan previously. The final segment we'll talk about is Test, on the next chart. Another strong quarter for this group, with sales up 19% and EBIT up 36%. Really nice margin expansion here as we saw solid leverage on the volume increases. Orders did drop by 24% during the quarter. You see on the chart that we had more than $20 million of large bookings last year for power filters and project activity that did not repeat in this year's first quarter. Overall, the book-to-bill in Q1 of fiscal '23 was still at 1.0, and the orders were in line with projections at the beginning of the quarter. So we still feel good about the '23 outlook for the Test business. The next chart, Chart 7, is our first quarter cash flow highlights. Operating cash flow declined by almost $11 million during the first quarter. Working capital was unfavorable in the quarter with inventory and accounts payable driving an unfavorable impact compared to last year's first quarter. Capital spending was down just over $9 million in the quarter compared to last year, and acquisition spending dropped by nearly $16 million as there were no deals closed in Q1 this year, and last year had the NEco acquisition in the A&D Group. On share repurchases, we completed just over $4 million in this quarter compared to $10 million in the prior year quarter. Chart 8 is our guidance. The full-year outlook does remain intact. We did take out the lower end of the range. You'll recall that the prior guidance was $3.45 to $3.60 per share on an adjusted basis. We have tightened that up to $3.50 to $3.60 per share in the current outlook. For the second quarter, we expect a range of $0.68 to $0.74 per share on an adjusted basis. The outlook for the second quarter reflects a somewhat lower forecast in the Test business as they manage ongoing disruptions in China due to COVID policies. We view this as a timing issue. And as mentioned above, we see the Test forecast for the full year is still intact. That concludes the financial update, and now I'll turn it back over to Bryan.

Bryan Sayler, President and CEO

Thanks, Chris. I touched on a lot of my thoughts earlier, but I do have a couple more comments before we move to Q&A. You saw the numbers from Chris. So obviously, a great start to the year for ESCO with strong financial performance. This is really a great company. We're operating in healthy end markets and serving some really great customers. So, I want to take a moment to just thank all of our employees across the company. As I mentioned before, I've had a chance to visit all of our subsidiary locations since taking over, and everybody's really been welcoming. I really appreciate that. But more importantly, everybody has been really busy, and they're working really hard. We're growing, and we're managing a number of challenges that could put a lot of strain on people, and I'm really grateful for their dedication and for their efforts. So with that, we can start the Q&A.

Operator, Operator

Our first question comes from Tommy Moll of Stephens.

Tommy Moll, Analyst

So I wanted to start on the revenue outlook. Just comparing the guidance that you gave last quarter and then the quarter you just reported. If I just go through the segments, for A&D, I think it was 10% to 13% year-on-year, USG 5% to 7%, Test 3% to 5%. Those were kind of the ranges you gave us last quarter. And each of the three segments you blew away above the high end of the range in the first fiscal quarter. So is there some cause for a big deceleration in growth as you go through this year? Or are those ranges potentially biased higher after what you just reported in the first quarter?

Chris Tucker, Senior Vice President and CFO

Yes, Tommy, this is Chris. I would say that we're likely leaning towards the higher end of the ranges. I wouldn't say we would revise the ranges. You are absolutely right. We initially anticipated that growth would be more concentrated at the beginning of the year due to our backlog position. Q1 certainly performed better than we planned, but it aligns with our overall strategy that we will still see growth for the remainder of the year, though that growth will slow compared to the first quarter levels.

Tommy Moll, Analyst

And is that moderation more just timing of backlog or comps? Or is there something underlying that you anticipate to decelerate as you go through the year?

Chris Tucker, Senior Vice President and CFO

Yes. I would say really more just comps. If you look at last year, again, our growth was a little lower in the first half, and then we had really strong double-digit growth on an organic and reported basis last year in the third and fourth quarter. So you just come into tougher comps. We still have, as you know, high levels of backlog and a good outlook. But it's hard to get those big double-digit growth when you got comps like that coming in this year.

Tommy Moll, Analyst

Yes. Understood. I wanted to pivot to commercial aero, where you reported, I think it led the segment. And I'm just curious what inning it feels like we're in, in this recovery, strong several good quarters together in a row here, you're going to start lapping over those. Does it still feel like early innings? Or any context you could provide would be helpful.

Chris Tucker, Senior Vice President and CFO

Yes. I would say honestly, Tommy, it's a little hard to say what we would say is that we feel like the recovery still has legs. As far as what inning we're in, if you look out a couple of years at kind of industry projections, they still have pretty robust double-digit growth expectations just kind of in the build rates. If you look at kind of single-aisle dual-aisle type forecast. The industry is still struggling to ramp up throughout '22 and now in '23; the build rates aren't quite where the OEMs want them. And so all that tells us that we should still see some pretty good runway in front of us. And again, it's hard for me to say what inning. I don't know if we're in the middle of the game yet. I'd say we're maybe not to the middle of the game yet, but we do feel pretty good that the outlook is still pretty robust there.

Bryan Sayler, President and CEO

Yes. I think the innings thing is throwing us off. I think we feel pretty good about the overall growth, Tommy. Each of the major OEMs are ramping up. I think there's some question as to how quickly and how effectively they're going to be able to ramp up because commercial aerospace, there's still a fair amount of supply chain disruption across the board. And so they're struggling to get back to where they want to be, but there's certainly underlying strength in the overall segment.

Operator, Operator

I'm showing no further questions at this time. I'd like to turn the call back over to management for any closing remarks.

Bryan Sayler, President and CEO

Well, listen, everybody, thanks a lot for participating in the call today. We're pretty excited about the direction we're heading in. We've had a good quarter, and we think we're going to have a good year. So we'll talk to you next time.

Operator, Operator

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.