Earnings Call Transcript - ESE Q3 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to the Q3 2025 ESCO Technologies Earnings Conference Call. With us today are Bryan Sayler, President and CEO; Chris Tucker, Senior VP and CFO; and Kate Lowrey, Vice President of Investor Relations. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker, Kate Lowrey. Please go ahead.

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 their most comparable GAAP measures can be found in the press release issued today and found on the company's website at www.escotechnologies.com under the link Investor Relations. Now I'll turn the call over to Bryan.

Bryan H. Sayler, President and CEO

Thanks, Kate, and thanks, everyone, for joining today's call. The past few months have been a transformative period for ESCO. Early in the third quarter, we completed the Maritime acquisition, and after the close of the third quarter, we finalized the VACCO divestiture. The completion of these key transactions marks an important step forward in the execution of our portfolio strategy. With the addition of Maritime's signature and power management solutions, we now have a meaningfully larger presence in the Navy market. Maritime broadens our product offerings and adds significant U.S. and U.K. naval platform content. With the exit of the space market, our Aerospace & Defense segment now has a clearer focus on serving the aircraft and Navy end markets, both of which we believe have durable long-term growth drivers in place. This period of transition has involved an extraordinary level of hard work from our team members related to closing these deals and integrating Maritime into the ESCO portfolio and business system. In addition to supporting these efforts, our team was also busy managing day-to-day operations and delivered another outstanding quarter for ESCO. I want to personally acknowledge and thank our dedicated employees whose hard work is what makes this possible. In addition, I would like to take one more opportunity to welcome our new ESCO Maritime teammates in both the U.S. and the U.K. As we've now had a number of interactions with the Maritime team, it is clear that they are a strong group that is dedicated to a very important mission, which is aligned with ESCO and our core values. We are thrilled to welcome them to the team. I would also like to thank the Maritime staff for their hard work in supporting the ongoing integration, which does require considerable time and focus from across the organization. As I know we are all aware, the macroeconomic picture has been somewhat complicated this year with evolving trade policies and geopolitical uncertainty in the headlines. It's difficult to know exactly how these impacts will play out, but we are monitoring these changing dynamics closely and believe our teams have done a good job of managing the risks and opportunities to this point. While there have been some additional costs, we have been able to mitigate the impacts and deliver exceptional operating results. Going forward, we are in good shape in this regard and are confident in our ability to manage any potential future risks associated with tariffs during the balance of the year. Chris will run you through all of the financial details for the quarter, but before we get to that, I wanted to give you a few comments on each of the segments. Let's start with Aerospace & Defense. We remain very positive regarding the long-term outlook for the aerospace and Navy markets. Production rates across both end markets need to increase to meet underlying customer and market demand. We see fundamental drivers for additional commercial and defense aircraft and expect increasing production rates to drive growth going forward. Overall, our aerospace revenue was up almost 20% in the quarter and is up 15% on a year-to-date basis. On the Navy side, we've been talking for a while about the procurement process for the next 17 Virginia and Columbia Class submarines. It's taken a little bit longer than expected, but it was great to see those orders begin to flow through during Q3 with Globe booking over $80 million in orders during the quarter for Block V.2 and Block VI on the Virginia Class platform, along with orders for initial content on the next 3 Columbia Class boats. By any measure, the A&D segment has had an exceptional quarter, achieving double-digit organic growth, a 560 basis point increase in margin and ending the period with record backlog. Switching businesses now. Let's discuss the utility group, which had a bit of a flat quarter from a sales and margin perspective but did experience strong orders. If you look at the year-to-date results, the story remains quite positive, and we are confident that the long-term demand drivers remain intact. Numerous factors are contributing to the growing demand for electricity, including data centers, artificial intelligence, electrification of transportation, heat pumps, reshoring activities, and more. Expanding the grid will be a long-term and complicated endeavor, and during that process, increased electricity demand, coupled with an aging infrastructure and extreme weather events will make maintaining utility assets more important than ever. Doble will continue to be a critical partner supporting the utilities as they both maintain and expand the grid. Order growth in the quarter was strong, which points to continued sales momentum in the quarters to come. The U.S. renewables market continues to recalibrate right now in the wake of the Big Beautiful Bill. Our team is managing well through some uncertainty, and we remain confident that renewables will continue to have an important role to play in energy markets worldwide and in the U.S. over the long term. Finally, I'll touch on the Test business, which had another strong revenue quarter with 21% growth over the prior year. Year-to-date, the revenue is up by 15%, and it's great to see continuing strength in their test and measurement, industrial shielding and services sales this year. Their margins improved by 350 basis points sequentially but were down a bit year-over-year. The team has taken the right steps to reduce costs over the past several quarters and has done a great job driving the segment EBIT margin back into the mid-teens. Overall, the Test business has stabilized, and we feel good about the trajectory there moving forward. Overall, we are optimistic about our market positions across each of our segments and expect to outperform industry growth. Accordingly, we are again raising our full-year guidance, which reflects over 20% adjusted EPS growth compared to the prior year. With that, I'll turn it over to Chris to run you through the financial details of the quarter.

Christopher L. Tucker, Senior VP and CFO

Thanks, Bryan. Everyone can follow along on the chart presentation. We will start on Page 3, which shows the financial highlights for the quarter. Before diving into the numbers, I want to clarify that we are focusing on continuing operations. With VACCO sold, it is categorized as a discontinued operation in our financial statements, so our commentary will not include any profit and loss impacts from discontinued operations. Now moving on to the numbers. By all measures, ESCO had an excellent quarter. Orders experienced a significant increase. We will discuss segment details shortly, but a key factor in this reported increase is the acquired backlog at Maritime. Even excluding that, we still saw strong order performance with a 1.3 book-to-bill ratio. We ended the third quarter with a backlog of nearly $1.2 billion, setting a new record for ESCO. Sales performance was also robust, growing nearly 27% on a reported basis and 11% organically, which excludes the impact of the Maritime acquisition. Adjusted EBIT margins rose from 19.3% last year to 21.1% in this year's third quarter. Additionally, adjusted earnings per share increased by 25% to $1.60. I want to highlight that we had significant add-backs for adjusted earnings, primarily due to the Maritime acquisition, which included closing costs, inventory step-up charges, stamp duties in the U.K., and an increase in acquisition-related amortization. Now, let’s go through the segment highlights, starting with Aerospace & Defense. Orders saw a considerable increase, with $364 million related to the backlog acquired at Maritime. Beyond that, Maritime contributed another $50 million in orders within the two months it was owned by ESCO. On an organic basis, orders were strong with Globe receiving large orders for Virginia and Columbia Class projects. The backlog for Aerospace & Defense finished at $832 million. Sales growth was impressive at 56% on a reported basis and 14% organically. While the Maritime impact was substantial, the core business also performed exceptionally well. This positively influenced margins, which increased by over 500 basis points, bolstered by favorable price, mix, and growth leverage. Moving on to the Utility Solutions Group, orders momentum remained healthy with a 5.5% growth in the quarter, largely driven by Doble, which saw nearly 7% growth, while NRG orders in the quarter were flat. Sales growth was more subdued at 2%, impacted by shipment timing with Doble. We view this as a temporary challenge and expect a return to higher growth in the fourth quarter. Backlogs are healthy, having increased nearly 15% from the prior year. On the margin front, the drop this quarter was similarly related to Doble. Year-to-date, the Utility Solutions Group has achieved adjusted EBIT margins that are 130 basis points above last year's first nine months. Although there's been some weakness from NRG this year, Doble's performance has been strong, and we are optimistic about the full-year outlook. Next, we’ll discuss Test, where the team had another strong quarter. While we did see a nearly 6% decline in orders this quarter due to tough year-over-year comparisons, we are optimistic about the business's trajectory. Year-to-date, orders are up over 30%, and backlogs have increased nearly 24% since year-end. Sales were solid, boasting a 20.7% increase, which drove a 15.4% rise in adjusted EBIT. Margins dipped slightly due to an unfavorable mix and some tariff impacts, though year-to-date margins have risen by 140 basis points. Overall, 2025 has been a positive turn for this business after some challenges in 2023 and 2024. Moving to year-to-date financial highlights, the results have been exceptional through the first nine months of 2025. The core company has continued to deliver, and we’re starting to see the effects of the Maritime deal. Orders have been impressive; excluding the Maritime backlog impact, we have a 17% growth. Sales performance is also robust, with Aerospace & Defense up 12% organically and nearly 28% when including Maritime. Test sales increased by 15%, while Utility Solutions Group growth has been more modest at 4% due to NRG's current weaknesses. Earnings are up by double digits, with adjusted EBIT margins rising by 200 basis points, and all three segments have shown nice margin improvements in the first three quarters of the year. Lastly, adjusted earnings per share are up over 24%. Overall, the company has performed exceptionally well year-to-date in 2025. Now, let’s move on to cash flow highlights. The first nine months of fiscal 2025 showed strong operating cash flow results, thanks to favorable working capital performance compared to the same period in 2024. This applies to continuing operations, and it should be noted that cash flow from discontinued operations was also strong through the first nine months of fiscal 2025. Capital expenditure increased during this period due to various initiatives in the Aerospace & Defense and utility sectors. Our robust cash generation and the delay in finalizing the Maritime deal means our leverage ratio is solid at 1.74x as of June 30. With the VACCO divestiture finalized in July, we expect a strong balance sheet as we close out the year. Finally, regarding our updated guidance, which is detailed in the next charts, we are pleased to announce another increase. In the last quarter, we still included VACCO in our guidance and made estimates for Maritime. Now that VACCO has been removed from the guidance, this reduces sales projections by about $125 million and adjusts EPS downward by approximately $0.50. For continuing operations, we are increasing our guidance for the year. On the sales side, we're adding $20 million to both the low and high ends of the range. For adjusted earnings per share, we’re tightening the range with only one quarter remaining. The bottom of the range is rising by $0.40, and the top is increasing by $0.25. This adjusted EPS range indicates a growth of 21% to 24% compared to the prior year. The additional sales are translating effectively to the bottom line, even while we’re seeing some tariff impacts at the lower end of our previously guided ranges. Essentially, this is shaping up to be another record year for ESCO, and we’re enthusiastic about sharing this updated outlook with you today. That wraps up the financial portion of the call, and now I will turn it back over to Bryan.

Bryan H. Sayler, President and CEO

Thanks, Chris. As you heard, the first 9 months of our year have gone really well, and we're excited about our ability to increase our full year outlook. And we're excited about the portfolio moves that I discussed earlier. ESCO's future remains bright, and we continue to see a path for value creation and enhancement as we move forward. We just wrapped up our Board meetings earlier this week, which gave us a chance to visit our Morgan Schaffer operation, which is part of Doble and USG. This business is located in Montreal and was an ESCO acquisition in 2017 that's focused on condition monitoring of transformers. It was a really great session with our Board and an opportunity for us to show them the exciting things going on at ESCO, where we're developing exciting technologies on a regular basis that are being deployed to help customers solve real-world problems. We thank the Board for their ongoing support, and we're excited about the many things going on across the ESCO set of businesses. With that, I think we're done, and we can turn it over for the Q&A.

Operator, Operator

Operator Instructions

Thomas Allen Moll, Analyst

Bryan, I wanted to start on the A&D orders, in particular for Globe, where you reported some pretty big orders in the quarter. Any update on shipset content? I'm guessing probably nothing changed versus what you've communicated previously. And anything you can tell us just about how that has progressed through the order pipeline? I know you don't want to get in the business of guiding future orders, but just give us some sense of where some of the discussions are for those Virginia and Columbia Class subs.

Bryan H. Sayler, President and CEO

Yes, I would say no big change from what we have communicated before. On the Globe side, we obviously have some additional content for Virginia Class and Columbia Class that comes through. On the Maritime side, I don't think we're quite in a position yet to communicate that in detail, and I'll ask for a little bit of patience as we kind of work through our FY '26 planning process. So we'll be in a position to communicate that kind of detail in the future, but I'm not sure we're quite ready for that today.

Thomas Allen Moll, Analyst

Sure. On sticking with A&D and here, I'll ask the question on an organic basis, so we can think about ex Maritime, ex the VACCO noise. The margin progression, even peering through both of those changes, looks pretty solid here. And so you called out several of the factors. Specifically, though, on price/cost, I'm just curious for an update there and versus what you would have hoped for some of the incremental margins flowing through, how did the quarter shape up? And how do you feel going forward?

Christopher L. Tucker, Senior VP and CFO

Yes, Tommy, this is Chris. I would say the margins in the core company were exceptional, showing strong flow-through from the underlying sales growth. One major contributor is pricing, particularly in the aircraft component segment, where we are seeing positive price flow-through. These efforts are consistently ongoing, though there can sometimes be delays in realizing the full price benefits due to contracts and related factors. Overall, the material situation is also quite favorable. Material inflation has been less than we anticipated at the beginning of the year. So we have strong pricing and reduced material challenges, which has created a positive scenario for us this year. Additionally, we experienced a favorable product mix this quarter, which helped enhance our performance. While this mix may fluctuate from quarter to quarter, it certainly provided a boost this time around. With substantial underlying growth, we also leveraged our sales effectively. These elements have been key drivers for us this quarter.

Bryan H. Sayler, President and CEO

Yes. I think we're getting a little bit of traction from some of the early stages of our ESCO operating system implementation as well, and that's really coming through in the A&D numbers for sure.

Thomas Allen Moll, Analyst

A little bit might be an understatement, but we'll settle that later, and I'll turn it back for now.

Operator, Operator

And our next question comes from the line of Jon Tanwanteng from CJS.

Jonathan E. Tanwanteng, Analyst

I was wondering if you could talk about the increase in the outlook, maybe what businesses or product lines that's coming from. It looks like a pretty small increase in revenue but quite a big increase in the earnings. I was wondering if you could dig a little deeper into that and just tell us where that's all sourcing.

Christopher L. Tucker, Senior VP and CFO

Sure. On the revenue side, we are experiencing significant increases as we progress through the year from Test, which has outperformed expectations. We are also seeing some incremental volume on the A&D side, contributing positively. These factors are helping to offset a decline in the NRG business within the utility sector, which has faced some downturn due to uncertainty in the renewables market, as Bryan mentioned earlier. Overall, these sales impacts are flowing through at a reasonable rate, around 30%. Additionally, regarding tariffs, we previously estimated an impact of $2 million to $4 million, but it looks like it will be closer to $2 million, possibly slightly below that. Moreover, with the closure of VACCO, we received significant proceeds in July that will positively affect interest in the fourth quarter. All these elements are driving the lift mentioned in the press release.

Jonathan E. Tanwanteng, Analyst

Got it. That's very helpful. And then just for modeling purposes, how should we think about the impact of VACCO in '26 as you lap the sale?

Christopher L. Tucker, Senior VP and CFO

I would say that if you look at the numbers we are about to file, you'll see that VACCO is moving to discontinued operations. This means the company and the A&D results will not include VACCO. The focus then shifts to how we anticipate growth for 2026 and beyond. Jon, we've discussed the strong Navy dynamics, which are projected to be in the high single digits, and similar expectations for aircraft components. Additionally, we will see the impact of Maritime as we transition from a partial year to a full year since we only had five months of operations this year. All these factors contribute to a promising outlook for 2026. We're not in a position to provide specific guidance yet, but we feel optimistic about our prospects going forward.

Jonathan E. Tanwanteng, Analyst

Okay. Understood. Last one for me. Just on the naval side, you obviously are showing strong orders. I was wondering if the pace of deliveries is going to stay relatively constant. Or are you're seeing a pickup there, either near term or long term as the Navy tries to increase the throughput of all these things?

Bryan H. Sayler, President and CEO

We believe that it will increase, although it's a bit challenging to answer because you need to consider both our Globe and existing Navy business, as well as the Maritime side. Additionally, it's important to consider developments in the U.K. alongside what's happening in the U.S. I do expect that the pace will pick up somewhat. We will provide more detailed guidance in November for the full '26. Overall, we're very optimistic about the Navy's progress and its implications for our business.

Operator, Operator

And we have a follow-up question from Tommy Moll of Stephens.

Thomas Allen Moll, Analyst

I had a few more I was hoping we could get through today. On the guidance you provided for earnings per share, Chris, I heard you say that interest is probably a good guide for Q4 just because of the timing of VACCO, a good guide versus what you would have guided to previously. But I'm just putting everything together. It does look like the range you provided is $0.25 to $0.40 increase for the year does assume a better 4Q operationally than what you would have communicated previously. I just want to make sure I'm reading that correctly because there's a lot going on this quarter.

Christopher L. Tucker, Senior VP and CFO

Yes, that's right. I would say that the fourth quarter has improved from what we discussed last time. We've had three months since then, and as you can see, we had a strong third quarter. Therefore, the fourth quarter is certainly looking better than what we had anticipated previously.

Thomas Allen Moll, Analyst

Also wanted to ask on the USG margins. If it's possible to look just at Doble, can you comment on how the margins progressed year-over-year there and if it wasn't what you would hope, maybe what some of the drivers were?

Christopher L. Tucker, Senior VP and CFO

Yes. I would say that the margins in the first and second quarters exceeded our expectations. We experienced favorable flow-through and mix during the first six months. That’s why we’re trying not to overreact to the third quarter. It was below our initial expectations at the start of the quarter, primarily due to some sales misses. I mentioned earlier the timing of certain sales in the third quarter as we wrapped up the period. We just didn't manage to push out some things we anticipated, leading to lower sales and subsequently reduced flow-through. If we had achieved those sales, we would have been right where we needed to be. I wouldn’t say we’re concerned or disappointed with the Q3 margins. We always hope for more, but overall, the business trend for the first nine months is quite positive. We believe the momentum and the factors Bryan discussed that are driving the market are still in place. However, we expect some fluctuations from quarter to quarter. While there may be some uncertainty on the utility side, the A&D segment performed strongly in terms of margins. Looking ahead, we might see A&D margins weaken next quarter while utility margins improve. We anticipate these types of shifts quarter to quarter, but the long-term outlook remains very promising.

Bryan H. Sayler, President and CEO

Yes. And I'd point out that the orders for Doble were very strong in the quarter, and that points to better things in the next quarter or 2 as we move forward.

Thomas Allen Moll, Analyst

Last question, and then I'll turn it back for good today. Bryan, in the news recently, there was a reference to a treaty between Britain and Australia on nuclear submarines. I understand it may take some time before Maritime sees any benefits from this. However, any insights you can provide on its potential impact or your observations would be appreciated.

Bryan H. Sayler, President and CEO

Yes. Listen, I think every step in that direction is a positive not just for our business but probably for the mutual defense for the English-speaking world. I think you're aware that there's a review going on in the Defense Department right now of the AUKUS program. That's kind of limited to what happens in the 2030s with regard to earlier-generation Virginia Class submarines that are currently slated to be sold. We don't think that there's a lot to that. We think that the decision on whether the U.S. will follow through on those sales, that's a decision that could be made several years from now. But I think that the thing we believe about that is it just increases our conviction that the investments we've made in the Royal Navy and the shipbuilding in the U.K., that those investments are going to pay off. And if anything, our belief is that they may pay off sooner. Now I'd be clear to say that the AUKUS program envisions things that are going to happen in the 8, 10, 12 years from now. So that's a little bit outside of our planning horizon, but it does bolster the commitment that we would see from the shipbuilders in the U.K. to follow through on some of the orders and revenue that we anticipate in the next 3 to 5 years.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn it back over to Bryan for any closing remarks.

Bryan H. Sayler, President and CEO

Well, thanks for taking some time to hear from us today. We're excited that we've been able to complete these large portfolio moves. And I think we're even more excited that the underlying performance of the core business has been really, really strong. And so we really look forward to the things that are in our future, and we look forward to talking to you again next quarter.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.