Earnings Call Transcript - ESE Q4 2020

Operator, Operator

Good day and welcome to ESCO’s Q4 Conference Call. Today’s call is being recorded. With us today are Vic Richey, Chairman and CEO; Gary Muenster, Vice President and CFO. 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, Director of Investor Relations

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 Investors 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, including without limitation, the impact and duration of the current COVID-19 pandemic, the company’s response to these evolving circumstances, future results of the company, investments, acquisitions and the recovery and strength of markets which we serve. 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 which may impact any forward-looking statements and for a reconciliation of any non-GAAP financial measures to their most comparable GAAP measures. Now, I will turn the call over to Vic.

Vic Richey, Chairman and CEO

Thanks, Katie. Before beginning with financial details for the year, I will provide a brief update on how we are working through today’s COVID environment. We have maintained a detailed monitoring of the situation, sensing the change on almost a daily basis. Our goal was to stay ahead of the curve to provide a safe working environment and protect the health of our employees. As I said in the last call, we saw the first indication of COVID’s potential economic impact on our business, and we took decisive action. The actions we have taken over the past 7 or 8 months were down to 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. Our solid operating results in fiscal ‘20 coupled with our strong liquidity position at September 30 demonstrated that the measures we have taken have allowed us to hold our own through this unprecedented time. I am confident these actions, coupled with the remaining items we are working through over the next few months, will benefit us as things begin to return to a more normal state. I am confident that our disciplined approach to operating the business will result in our continued success as we enter 2021. Just recapping fiscal ‘20, after thorough evaluation earlier in the year, we took action across the organization to adjust our cost structure to better fit our near-term sales outlook while still supporting our long-term strategy for profitable growth. While these decisions were not pleasant, they needed to be done because, in the end, we ultimately shrink at our core. We are fortunate to have very experienced leadership teams across the company where we have demonstrated our ability to effectively manage costs to meet changing market demands. The current situation is no different. We are actively addressing the challenges of today while continuing to direct our efforts to emerge from this even stronger. ESCO will continue to benefit from our leading positions in various niche markets, where we deliver a unique 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 by continuing our investment in new products across all three segments. The fundamentals of our portfolio remain strong and our goal remains the same: to create long-term shareholder value. 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 extraordinary commitment to the success of ESCO.

Gary Muenster, Vice President and CFO

Thanks, Vic. I will briefly touch on the financial results laid out in the press release. As Vic noted, when the pandemic hit, our number one financial priority became maintaining our liquidity position because, when challenging times pop up unexpectedly, cash is king, and I am extremely pleased with the record cash flows we generated throughout the year. I am proud of where we stand today, having nearly $730 million of dry powder at our disposal between cash on hand and available credit capacity while carrying a modest leverage ratio of 0.47. Our liquidity outlook partially drove our earlier decision to fund, terminate and annuitize our previously frozen non-strategic pension liability. In the release, we called out three discrete items, which are described in detail and are excluded from the calculation of adjusted EBITDA and adjusted EPS. The discrete items include the results of our technical packaging business, which we sold in Q1, and an impressive valuation that generated gross cash proceeds of $191 million, resulting in an after-tax gain of $2.93 a share. The second item relates to the successful completion of our termination of the pension plan. This action removes all equity market risk and interest rate volatility. It reduces ongoing costs and eliminates future variable cash payments, which resulted in a non-cash charge of $1.55 a share. The third item represents COVID-related cost reduction actions we implemented in our AMD and USG segments to align their operating cost structure with current demand requirements. For the year, these costs resulted in a $0.24 a share charge. I will now briefly touch on a few comparative highlights which are laid out in detail in the release. Adjusted EPS was $0.90 a share in Q4 and $2.76 a share for the year, which exceeded consensus estimates. Given the backdrop of today’s operating environment, I am most pleased to report that we were able to deliver fiscal ‘20 adjusted EBITDA of $137 million, which is only 3% lower than 2019’s adjusted EBITDA of $141 million. We were nearly able to maintain our profitability levels despite the noted sales declines at Doble’s and within our commercial aerospace group, which are our most profitable operating units historically. Sales increased $7 million to $733 million compared to $726 million in 2019. The sales growth was led by our AMD segment, where we increased our navy and space sales by $41 billion, partially offset by lower commercial aerospace sales due to COVID’s impact on air travel. Commercial aerospace sales of PTI, Crissair and Mayday decreased approximately $18 million or 11% compared to the prior year. The test business sales in fiscal ‘20 held up and were flat compared to 2019, despite some timing delays on certain installation projects due to COVID. Strong chamber sales and very solid project execution allowed the test business to deliver an all-time high EBIT margin of 14.6%. USG sales were down consistent with our past commentary as a result of the deferrals of various project deliverables as several utility customers, both domestic and international, realigned their short-term maintenance and spending protocols to focus on uninterrupted power delivery. Maintenance deferrals also reflect various mandates restricting onsite personnel at substations, large transformers, and other customer locations. USG Q4 sales reflected a partial rebound as sales were $53 million compared to a similar number of $54 million in Q4 of 2019. USG’s order bookings were $201 million and reflect an increase of additional cybersecurity-related orders, including Doble’s DUCe solution. We are seeing strong renewals as well as new customer procurements. As mentioned earlier, we took decisive action when we saw the downturn in our outlook. Our SG&A reduction of $3 million in fiscal ‘20 is evidence of that agility. This reduction was achieved despite having growth included for the entire year and despite our continued spending on R&D and new product development. Entered orders were solid in fiscal ‘20 as we booked nearly $800 million of new business and ended the year with a backlog of $517 million, which is up $66 million or 15% from the start of the year. Our DoD business, led by our participation on the Block V contract for additional Virginia Class submarines, drives the strength. I will remind you, as we move forward 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 in fiscal ‘21. On the liquidity side, we generated $109 million of cash from continuing operations or $135 million ignoring the $26 million voluntary pension contribution we made. This resulted in a modest leverage ratio of 0.47, as I mentioned. As we enter fiscal ‘21, the COVID-19 backdrop continues to bring along some uncertainty around the extent and duration of today’s economic circumstances, which makes it difficult to predict how our near-term operations will be affected using our normal forecasting methodologies. As a result of this uncertainty, we will not be providing finite EPS guidance for fiscal ‘21 at this time. From a directional perspective, we can point to several areas where we see positive momentum. As we enter fiscal ‘21, our commercial aerospace and utility end-markets are showing some degree of customer stabilization, as well as notable pockets of recovery. We are seeing signs of recovery in the second half of fiscal ‘21 that point to a solid outlook for the back half of the year. The near-term prospects of a viable COVID-19 vaccine will certainly benefit and accelerate the anticipated recovery in commercial air travel and utility spending as customers begin resuming their normal buying patterns. Given how strong the first half of fiscal ‘20 was pre-COVID, we expect the first half of fiscal ‘21 to be slightly down comparatively. The current outlook for the second half of ‘21 is expected to be favorable in comparison to the second half of fiscal ‘20 given the various elements of recovery that we are seeing and anticipating. So to summarize all of this, we currently expect to show growth in sales, adjusted EBITDA, and adjusted EPS compared to fiscal ‘20, with adjusted EBITDA and adjusted EPS coming in reasonably consistent with fiscal 2019. Obviously, if we complete any additional acquisitions during the year, it is expected that they would contribute to these expectations. So now I will turn it back over to Vic.

Vic Richey, Chairman and CEO

So since fiscal ‘20 is behind us, I think we are obvious that it is going to be challenging in the year as my commentary and release are actually from my perspective. I will offer some qualitative comments about our end markets, and I will emphasize that the situation continues to be very fluid. Let me provide you with a sense of our thinking and planning for ‘21. In September, we completed a thorough review of individual businesses to update our current expectations and the near-term impact of COVID-19 across our various operating vehicles. Starting with our A&D segment, we are receiving signs of recovery in the commercial aerospace. We expect some continued softness over the next 4 to 6 months. We are seeing stabilization in build rates, increasing airline passenger traffic, and flight miles. There are several signs of recovery emerging as quite a few air carriers are bringing some of their idle fleet back in service and the daily TSA passenger boarding numbers are increasing over 1 million per day. The defense portion of our A&D business is and will remain strong for the foreseeable future given our backlog in the platforms in which we participate. We also see the current situation in the aerospace market as an opportunity for ESCO, as we did with the acquisition of ATM in October. We will continue to look at suppliers or competitors who may be experiencing financial or operational stress, where we may be able to provide assistance via partnering or through an acquisition at a reasonable price. Our test business is expected to remain solid given the strength of its served markets, including 5G and related communication technologies, and the increasing need for RF shielding as more electronic and electromagnetic noise is created as a result of emerging technologies. We expect the USG’s customer spending softness to continue for the next few quarters before returning to more normal levels. Once a credible vaccine is in the market, we expect the USG market to come back online quickly as they can relax social distancing guidelines and utility service personnel can return to their normal site visit routines. Utilities have money to spend, and I am certain that spending on test equipment will return in the near future as maintenance spending cannot be delayed indefinitely without creating significant risk to grid safety, efficiency, or regulatory compliance. We have worked hard to communicate with and support our customers remotely. Our client service engineers and their relationships with their utility counterparts are key differentiators for Doble. This will be accomplished through live creative means and positions Doble for success once the previously mentioned restrictions are eased. 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. I am 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 energy offerings, their end-markets are recovering more quickly as investments in renewable energy are increasing in both wind and solar, and we expect that growth to continue. Moving on to M&A, we continue to have several opportunities under consideration. We will continue 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. Our Board is supportive of our M&A strategy and our current balance sheet obviously provides us with plenty of liquidity, which will allow us to add to our portfolio. As described in the subsequent events section of the release in October, we acquired a small, nicely profitable aerospace and defense supplier located in Valencia, California, very close to our Crissair operation. The advanced technology machining and its affiliate, TECC Grinding, which we collectively refer to as ATM, produces precision machined metal parts, which are custom designed and widely used on defense and commercial aircraft as well as on missile and tank programs. Our plan is to consolidate ATM and Crissair’s facility sometime within the next 12 months, which will further improve their contribution margin. So to wrap up, I think we delivered a solid 2020 as we enter ‘21. Our plan is to continue to focus on the fundamentals and look for opportunities to leverage our infrastructure through M&A, create additional operating efficiencies, and ensure we are well positioned for long-term success. I will be glad to answer any questions you have.

Operator, Operator

And our first question comes from Tommy with Stephens. Your line is now open.

Unidentified Analyst, Analyst

Good afternoon and thanks for taking my question.

Vic Richey, Chairman and CEO

You are welcome.

Unidentified Analyst, Analyst

I wanted to start with the directional commentary you gave for next year, particularly in the second half where it sounds like things, at least as you said today, look like they ought to be up versus 2020. What end-markets or businesses or segments could you call out as drivers of that? Let’s call it optimistic outlook, and what are some things you can point to that give sufficient visibility to go ahead and make a call in the back half?

Gary Muenster, Vice President and CFO

Okay. Yes, I will start with that – with the commentary, Tommy, on the numbers, and then Vic can add some qualitative comments. So I will start the test; that was the least impacted in ‘20. Therefore, going into ‘21, we anticipate that will be the least impacted; so that one really isn’t a contributing factor to the growth we see. So, let’s just set that one aside. On the A&D side, we see two things. One, the daily passenger boardings, the stabilization of the build rates. When we are at the back half of ‘20, there was so much uncertainty, Boeing and Airbus were freezing lines, shutting things down, and it was truly a guess to try to ascertain what build rates were and passenger miles were in the tank. And so now there is a lot more visibility because obviously, for them to maintain a supply chain with some level of substance, they need to provide some guidance. So, we have a good level or deep level of guidance on build rates, which helps a portion of it. And then the anticipation of passenger miles, we just formulate an opinion based on the trends that we have seen over the last 6 to 8 weeks and kind of extrapolated as we go forward. That’s consistent with a lot of the things we see in the consulting literature, whether it’s airline monitor and the TL report and things like that. And on the utility side, one more thing on the defense side: the orders we have booked into the Virginia Class, the percentage of completion or its cost across, and as we ramp up in the first half on the Block V, we gain all the momentum in the second half of the year. So the correlation of the back half compared to the front half of ‘21 has a lot more Navy business that’s really easy to predict within that scenario. So on A&D, I’d say the most visible is the submarine business. Next is the stabilization of the build rates. The third factor is a reasonably conservative extrapolation of going forward of TSA boardings. On the utility side, as we looked at Q4, it almost matched a tie; so if you look sequentially from Q3 to Q4 in fiscal ‘20, you see a nice rebound. We aren’t declaring victory on that part, but we think that based on RFPs we have in front of us, based on things that Vic mentioned, those new products will be coming into the market sometime in February and March, which will benefit the back half of the year. The most critical part of the service side is that you can’t defer this maintenance forever, so they are pushing themselves around compliance structure such that they must get something done in the field or risk being out of compliance with their risk factors. The visibility across the utility side is coming from new products, site visits increasing, and the mere fact that they have to spend money; utilities make money by spending money, and we are seeing that through the evidence of RFPs. The other thing that’s important from an EPS side is these cost actions we took, especially in the USG side to restructure the footprint, if you will. We, unfortunately, had to remove some personnel. That will benefit the bottom line faster than the top line because those fixed costs are gone, and the variable costs are better aligned with the revenue. That’s what gives us confidence. Stylistically, we tend to be reasonably conservative, so we are not stretching ourselves outside the realm of reasonableness. So that was a relatively short answer for you.

Unidentified Analyst, Analyst

And all very helpful. Thanks, Gary. Maybe just a follow-up on the utility commentary you offered and really specific to your Doble business where there has been some softness, and it sounds like you have outlook for some continued softness in coming quarters. What kind of anecdotes can you share about how disruptive the pandemic has been for your customer base there? And you kind of already touched on how that can’t go on forever, but it can be helpful to take the anecdote you can offer about the disruption?

Vic Richey, Chairman and CEO

Yes, yes. It’s truly fascinating; if you look at the utilities across the country, I would say, based on people that I have talked to and Doble people talk to, one of our directors who retired recently from the utility industry, I’d say 95% of their employees are still working from home. That makes it difficult because they are not able to work together to put RFPs together. They’re not able to get out in the field. I would say that the conservative nature of utilities—and the utilities are conservative by nature, which is a good thing because you need to generate and deliver electricity—indicates that for all our customers, they are probably the ones that are working from home the most. A lot of our work truly depends on interfacing with those field personnel. There has been very little of that since this started. We've managed to be in some of the nuclear operations because obviously, reliability is even more important there. We have had some limited site visits, but it’s significantly different from what we have done before. Just talking about our full-service engineers interfacing with people; that really has been key. We had already started doing an online Doble university, providing a lot of training and this type of thing to the customer, so we are well-positioned to do that. I think it’s going to help us in the future because I think it’s going to be a while before the utilities really return to normal. I have anecdotal evidence from a few people working at a large utility here, and they aren’t sure they are ever going back to the office. While that isn’t representative of the entirety of the business, it illustrates the impact. This situation has had a significant effect on these customers. As Gary mentioned earlier, we can only defer this testing for so long, whether it’s for reliability or compliance. It has to return to normal eventually. I would say just to add to the first question, assumptions based on the information we have now could easily shift a couple of months in either direction. We need to keep a very close eye on that.

Unidentified Analyst, Analyst

Thank you, Vic. That’s all helpful. I would like to pivot to M&A you made which you referenced several times in the release and in your remarks this afternoon. It sounds like the pipeline is pretty robust. If my questions would be any indications, would you be willing to share on end-markets that you are interested in currently and then just on timing and execution of deals? I could think there are some factors that might accelerate a close just before year-end, potential change in the tax regime with the outcome of the election. On the flipside, if you are looking at trailing or recent earnings power of a potential acquisition candidate, there could probably be some messiness in those numbers and maybe you want to wait a little bit and see kind of where things settle. But anything you could do to help us frame up timing would be helpful as well?

Gary Muenster, Vice President and CFO

Yes, it’s very difficult. I mean, obviously, it’s played out differently than I thought it was going to, honestly. I thought that a lot of people would be hitting the eject button quicker than they are. We have been involved in a couple of opportunities and still are, and we thought people would be more reasonable about getting things done more quickly and pay multiples that we thought were appropriate. Some of this has not happened. Even one of these, as you know, the business will be primarily or probably during times of low demand. That’s just a whole different deal. You have personalities there, and they have their own way of doing things. I think at this point, getting anything done before the end of the year is difficult, given that we are approaching the holidays and unless you’re on the 90-yard line with something, it’s probably not going to close. I do think that people might be more concerned about tax rates, and what we are seeing at least leads me to believe that. I feel good about the opportunities we have out there, we just need to get them closed. As I said initially, it’s playing out a little differently than I thought it would. I anticipated more people wanting to move more quickly in order to clear this behind them.

Unidentified Analyst, Analyst

Thank you both. I will turn it back.

Vic Richey, Chairman and CEO

Thank you.

Operator, Operator

Thank you. Our next question comes from Jon Tanwanteng with CJS Securities. Your line is now open.

Jon Tanwanteng, Analyst

Hey, guys. Thank you for taking my question and really nice quarter. I think you actually had a record quarter in A&D despite the COVID headwinds, which is really impressive. You have talked before about commercial being more stable and now that being more stable than maybe most people would have expected, given where production rates are. Defense is great, I get that. Was there anything else in there that maybe helped the quarter? Maybe share gains of parts you hadn’t made before, which you have spoken about or pull-ins from the next quarter?

Gary Muenster, Vice President and CFO

Well, I would just say that, Jon, on the COVID side, it’s the normal stuff. There is nothing extraordinary, and I’d call it a rounding kind of number because there is not a lot of movement; using Boeing and Airbus as an example, they weren’t in any big hurry to take things. It’s a real challenge to try to pull things in and out of the commercial side. I would say on the Navy side in particular, there is some additional spending coming across in the world, for instance, in particular, there are three or four projects that are in the $200,000, $300,000, $400,000 range apiece that we have been negotiating RFPs on. We thought they were going to be later in the year, and all of a sudden, funding opened up when those came through. The beauty of those is they were non-competitive; therefore, we get a little better margin on. Everything has helped there, but I’ll take forward with your assessment that Q4 out of the A&D group was extraordinary. I mean, relative to our own expectations, we beat the top line, EBIT line, and cash line because when you deal with the Navy, they are paying literally Day 1 when you send the invoice. So we hit on all three cylinders that we brought. I wouldn’t characterize anything as pull-ins, though. We had some overdue things obviously earlier in the year when COVID hit. You can work-from-home if you’re an engineer or a finance professional, but you can’t build navy products in your basement unless you shouldn’t be. We had delays and disruptions due to an absence of staffing, and obviously, for the most part, everybody is back at work on the production floor. So you had some cumulative catch-up that was previously deferred due to lack of people on the floor. That all came together, so I would say that the catch-up on past due things from earlier in the year came to completion in Q4. Those elements also contribute meaningful margin when they come across.

Jon Tanwanteng, Analyst

Got it. And then looking forward, you have talked about passenger miles, or TSA numbers still going up, but are you afraid that might come back down just given the amount of COVID cases here in the U.S. that are just ramping? And also globally, is there another shoe to drop on the customers as we go into the next quarter and into the January quarter as well?

Vic Richey, Chairman and CEO

Yes, that’s a possible question to answer honestly. We would not bake that in; I mean, we are making the assumption that things are going to continue to improve slowly. They are only going up couple of percentage points a week, and so our assumption is that’s going to happen. It’s really hard to tell if that’s going to happen or not. If the cases continue to go up, obviously, things could come back down, but it seems like people are—there are more people trying to travel. Airlines are doing a great job; the airplanes have never been cleaner. I think they have really been strict about people wearing masks. Once people travel once, they are probably more comfortable traveling than they were the first time. We have not baked that in. As I said, I was in a call this morning about it and there is some concern about the holidays, about Thanksgiving and holidays in December, and that more people are probably getting together. So there is always that risk of the numbers popping back up.

Jon Tanwanteng, Analyst

Okay, that makes sense. And it’s nice to see the NRG business continue to pick up. I was wondering how much better are the wind and solar businesses performing relative to where you thought they were going to be as you enter the year?

Vic Richey, Chairman and CEO

Yes, as we enter the year, they are down just because of COVID, but obviously, over the past two quarters, they have performed better than we thought they were going to and then we thought they were going to. We obviously took a dip, but with COVID. We forecast everything, and they have outperformed over the past 6 months compared to their revised forecasts.

Jon Tanwanteng, Analyst

Got it. But not in line with their original forecast?

Vic Richey, Chairman and CEO

No, I mean, I think they are still somewhat below where they were going into the year, but it’s better than we anticipated in the second half.

Jon Tanwanteng, Analyst

Okay, got it. And then just last one for me, Gary you mentioned the restructuring actually does want to get—did you mention how much do you expect to save on a run-rate basis going forward?

Gary Muenster, Vice President and CFO

Yes, I would say in the A&D segment, it was primarily severance, okay? So we have some structural adjustments; we didn’t close the facility or anything like that. In that aspect, it’s an immediate savings, because the volume is going to go forward. We are taking out variable costs. So across the A&D segment, I’d say the savings benefit going forward is somewhere between $1.5 million and $2 million. On the USG side, it was a lot more structural. So, as you guys are building your models, it includes shutting down some product lines. There were about $4 million to $6 million of sales that happened in 2020 that will not go forward because we either divested the business, shut it down, or realigned it, however you would define it. Because of that, you are going to get an inherent uptick because those businesses weren’t very profitable. That’s why we focused on them. I would say the go-forward savings across the USG side is somewhere between $5 million and $6 million. I want to caution that by saying we really focused on costs this year in discretionary costs, like travel and trade shows, and we know they are still going to be mitigated, but at a certain point in time, you are going to see increases in our SG&A compared to the back half of ‘20 because we do have to travel, we do have to continue to facilitate new installations of ETS. So I’d say if you take that all together, it’s somewhere between $7 million and $9 million in savings, and then offset by $3 million or $4 million of additional costs that we deferred in 2020, like travel and other discretionary spending. Net-net, I would put it at $3 million to $5 million in savings.

Jon Tanwanteng, Analyst

Got it. And just to add one more point based on what you mentioned, you anticipate the conference will affect travel. However, I understand your Doble conference is a significant expense and results in a week of lost sales each year. Are you planning to hold it again this year? Will it be entirely virtual? And does that actually lead to any savings?

Vic Richey, Chairman and CEO

It will definitely be virtual. As far as the savings goes, we will have a virtual conference; there will be some costs associated with it. We don’t have our arms all around what that is going to be, but certainly not many hotel and travel costs involved. We are still working with the hotel on the next steps, but that is a big cost item, and we’ll see if that’s going to be put off or extended out for next year. So we are still working through that.

Jon Tanwanteng, Analyst

Okay, fair enough. Thank you.

Vic Richey, Chairman and CEO

You bet.

Operator, Operator

Thank you. And our next question comes from the line of John Franzreb with Sidoti & Company. Your line is now open.

John Franzreb, Analyst

Good afternoon, gentlemen. Thanks for taking my question. I would like to go back to the guidance in the first half of ‘21 relative to the first half of ‘20, but really in relationship to how the September quarter finished. Because it seems to me, if I understand you properly, the test business seems to come back and stabilize; you will be looking at maybe utility relative to the September quarter to kind of bounce around to call it the $50 million threshold, which suggests a sizable step down in A&D. That’s where you posted in September, and it didn’t seem like there is a lot of pull forward from your earlier comments, so can you kind of walk me through how you get such a sizable drop-down in the revenue profile or am I missing something that you are telling us?

Gary Muenster, Vice President and CFO

Let me start with the submarine aspect. Similar to how the Block V orders were recorded in fiscal year 2020, this is based on a percentage of completion revenue model. During the first two quarters, for example, you don't see significant revenue because you're primarily incurring costs without reaching the milestones that would trigger the corresponding revenue. As we move into the middle of the year, progress accelerates. You quickly surpass those early milestones and begin to observe significant growth. From a visual perspective, while manufacturing continues to expand consistently, revenue recognition associated with these milestones is skewed towards the latter half of the year. The contribution from the second half stands out as considerably larger, roughly around $40 million to $44 million. We're not discussing a shift of $50 million in any direction, but the focus on the second half compared to the first half significantly impacts the segment. For VACCO, we have two components: our work involves submarines as well as space programs. We're currently transitioning in our largest project, the Space Launch System, which is a substantial vehicle. We're moving from the development stage into hardware production. Consequently, there’s a timing gap in the first half as we shift from development to production hardware. These factors particularly influence the latter half of the year, which I believe is more predictable since we have it in our backlog and are familiar with the costs and milestone thresholds. Regarding aerospace, we expect a similar pattern for the second half. We don’t anticipate a large increase in Q1; the first half will be relatively stable, with momentum picking up later on. All these elements combined create a significant difference between the second half and the first half compared to fiscal year 2020. On the utility side, the situation is quite similar. When you examine our DUCe, cybersecurity, and transient security solutions, there's a considerable amount of software involved. While the hardware sold may cost several thousand dollars, the software driving those systems is considerably more valuable, with revenue from software not recognized until the system is installed or subscribed by customers. Thus, the software aspect tends to manifest later in the year, while the hardware items are priced around $3,000 to $5,000 each. This also skews the utility side towards the latter half, as software margins are significantly higher than those for hardware.

Vic Richey, Chairman and CEO

John, I think the simplest way to think about it—if you go back and look at our history for the last 3 years—you’ll see we always have a significant drop-off in the first quarter. We’ve been trying to figure this out for the last 15 years, so it’s always been that way. I think the point we are trying to make is that we were off to such a strong start in the first half of last year. When we compare that to the first half of this year, it’s not going to be a good comparison, but we think we will return to more normal levels in the second half.

John Franzreb, Analyst

What about your thoughts on the test segment? Because it seemed like you were suggesting a sustainable revenue profile there. Is that the case, or is there something that would cause a sizable step down in that business also in December and/or March quarter?

Vic Richey, Chairman and CEO

Yes, it’s still, if you go back and look at the segment data, you are going to see the same thing. They still have a ramp from the first quarter to the fourth quarter. I don’t know if it’s because of all the holidays that happen in the first quarter; that probably plays a part in it. The customers are less accessible in the first quarter. I would encourage you to go back and look at that profile, and I think you will find it to be very consistent.

John Franzreb, Analyst

Okay, fair enough. So that’s the color I was looking for, guys. Thank you.

Vic Richey, Chairman and CEO

Thank you.

Operator, Operator

And this does conclude today’s question-and-answer session. I would now like to turn the call back to Vic Richey for any closing remarks.

Vic Richey, Chairman and CEO

Okay. Well, thanks to everybody, and I look forward to talking to you in our next call. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.