Earnings Call Transcript - ESE Q2 2026

Operator, Operator

Good day, and thank you for standing by. Welcome to ESCO Technologies Q2 2026 Earnings Conference Call. Please be advised that today's conference is being recorded. On the call today, we have Bryan Sayler, President and CEO, and Chris Tucker, Senior Vice President and CFO. I'd now like to turn the conference over to your first speaker today, Kate Lowrey, Vice President of Investor Relations. Kate, you now have the floor.

Kate Lowrey, Vice President, 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 and 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 at www.escotechnologies.com under the Investor Relations link. Now I'll turn the call over to Bryan.

Bryan Sayler, President and CEO

Thanks, Kate, and thanks, everyone, for joining today's call. We are pleased to be with you this afternoon to discuss our second quarter results. I'd like to start the call by sincerely thanking all of our employees around the world. Your dedication, collaboration and commitment continue to make the difference, and they were central to delivering another outstanding quarter. In Q2, we continue to see positive momentum across our business platforms as the pace of progress across our end markets continues to build. We had another strong quarter for orders across all three segments, and that sustained demand drove backlog to a record level, clear evidence of healthy end markets and the strength of our competitive position. From an operational perspective, Q2 delivered another strong performance, translating into exceptional results on both the top and bottom line. Revenue strength was broad-based across most of our served markets. We see this quarter as further proof of the power of our strategy and our ability to execute with consistency, delivering sustainable value over time. As we announced in mid-April, we have reached an agreement to acquire Megger Group Limited. This acquisition represents a significant step in our portfolio transition, and I wanted to give you a quick update on what's been transpiring since the announcement. We have begun the regulatory filings process in the required countries. And while the timing of this process can be uncertain, our current expectation is that it should be completed in a time frame that results in closing the deal in the first quarter of fiscal 2027. In addition, I want to let you know that we have already established internal teams with Megger, Doble and ESCO staff working together to better understand key aspects of the integration process. We expect that this early preparation and planning will be beneficial in setting out steps for a smooth and orderly integration of Doble and Megger with a focus on realizing identified synergies once the transaction is complete. Adding Megger to the ESCO portfolio creates a scaled utility solutions platform and strengthens our position as a trusted partner to utilities worldwide. This acquisition marks another meaningful step in enhancing our portfolio, and we remain confident in the long-term outlook for our target markets. With durable demand drivers firmly in place, we are excited about the opportunities ahead. Chris will run you through all of the financial details for the second quarter. But before that, I want to give you a few comments on each segment. We recently completed our annual strategic planning process with our subsidiary businesses. As part of these meetings, we assess each of our end markets and our strategies to deliver above-market growth. My comments will focus on the current order strength that we are seeing as well as some of the longer-term dynamics across our served markets. Starting with Aerospace and Defense. In Q2, we continue to see order strength on U.S. and U.K. Navy programs, both from the maritime business and organically at Globe, where we entered $24 million of Virginia Class orders in the quarter for Block V.2 and Block VI content. In addition, we are seeing broad order strength on commercial aerospace programs. As we have mentioned previously, commercial aerospace orders were a little soft last year as the OEMs worked through some internal issues. So it is nice to see the rebound in order strength here. We continue to see a positive long-term outlook across our A&D end markets, supported by strong demand visibility and multiyear program backlogs. In commercial aerospace, demand continues to outpace production, sustaining historically high OEM backlogs. Annual deliveries are expected to increase from approximately 1,400 aircraft in 2025 to more than 2,000 per year by 2028 and beyond. While we view industry forecasts with appropriate conservatism, we believe that the OEMs are on a recovery path, and we are already seeing order momentum tied to early progress in raising build rates. In defense aero, elevated geopolitical uncertainty is supporting higher budgets and new program starts. The F-47 NGAD program represents a meaningful long-cycle growth opportunity, and we have achieved strong early wins to secure attractive shipset content. In naval markets, both the U.S. and U.K. remain committed to submarine modernization and fleet expansion with increasing build rates and new platform development continuing to be key priorities. Turning to the Utility Solutions Group. We delivered another strong quarter of orders led by services, off-line test equipment and condition monitoring that supported double-digit revenue growth. These results were partially offset by lower renewables demand as developers continue to prioritize project completions ahead of tax credit sunsets later this summer. Looking ahead, we are encouraged by the outlook for utility solutions. Approximately 85% of segment activity is tied to utility capital spending, which we expect to remain elevated as electric utilities invest to meet rising electricity demand. This demand is placing increasing strain on an aging infrastructure, accelerating the need to maintain, expand and modernize the electric grid. Our diagnostic measurement, testing and monitoring solutions help utilities improve reliability and performance across both new and legacy assets. Our condition monitoring equipment and high-voltage test solutions are becoming increasingly important for utilities and OEMs that manufacture transformers and switchgear as they navigate the challenges of maintaining and expanding the grid. Overall, we remain bullish on the longer-term opportunity in the utility end market. Finally, I'll touch on the Test business, which carried its great start to the year into the second quarter. Orders were strong in the quarter, driven by EMC test and measurement in the U.S. and Europe, filter orders for government-funded data centers and multiple industrial shielding projects. Over the longer term, we are seeing broad-based strength across most of test end markets and expect mid-single-digit organic revenue growth over our planning horizon. Demand is being supported by a favorable regulatory and standards environment, rising requirements for electromagnetic compatibility and shielding performance across mission-critical applications. Compliance testing and evolving standards continue to drive increased test frequency and expanded certification requirements. We see sustained demand across EMC and microwave applications, health care, industrial shielding and EMP filters serving utilities and secure data centers. We are optimistic about Test's continued opportunities to drive growth and margin expansion over time. With that, I'll turn it over to Chris, who will run you through the financial details for the quarter.

Christopher Tucker, Senior Vice President 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 second quarter. The bar charts across the top of this page clearly show that the second quarter was another great set of results for ESCO. The key theme with ESCO's financial results right now is that the core company performance on an organic basis is quite strong, and the ESCO Maritime acquisition is adding significantly to that strong base company performance. It's been a powerful combination driving our results since the closing of the Maritime deal in April of 2025. Getting to the numbers, we start with orders, which increased 42%. Organic order growth was double digit for all three business platforms with overall organic order growth of 22%. Maritime added $53 million of orders or 20 points of additional growth. On the sales side, reported growth was 33.5%, which was comprised of 13% organic growth and $48 million of sales from Maritime. On the profitability side, we saw adjusted EBIT margins improve by 370 basis points to 21.7% and adjusted earnings per share increased by 63% to $1.91 per share. Next, we will go through the segment highlights, starting with Aerospace and Defense on Page 4. A great quarter across all metrics, starting with orders, which came in at nearly $184 million compared to $96.5 million in the prior year quarter. Organic orders increased by 35% with strong growth from the commercial aerospace and Navy businesses. As stated previously, Maritime added $53 million of orders in the quarter, which brought reported order growth to just over 90%. Sales in the quarter were $150 million with organic growth of 14%. The strong organic growth was driven by strength from commercial and defense aerospace as well as the Navy business. So really nice performance from all parts of the core Aerospace and Defense platform. On the profitability side, we had good improvement to 28.6% adjusted EBIT margins, an increase of 160 basis points. Adjusted EBIT and adjusted EBITDA dollars increased by 78% and 72%, respectively. Margin increases were due to positive impacts from leveraging sales growth and increased prices. Next, we go to Chart 5 and the Utility Solutions Group. Orders here were up 10% in the second quarter, and that was driven by strong performance at Doble, where orders grew by 20%. We did see weak orders performance at NRG, where the renewables markets continue to be very soft. Sales in the quarter were up a modest 3%. Doble sales growth of 11% was somewhat offset by declines in NRG. Doble continues to see good end market activity across a number of product lines serving the regulated utility customer base. Adjusted EBIT dollars in the quarter were up nearly 11% with volume, price and mix benefits at Doble more than offsetting margin drops at NRG. Next, we have the Test business on Page 6. This business had another terrific quarter with orders up 21% and sales up more than 27%. This business is seeing robust market activity centered around U.S. test and measurement and power filter demand. Adjusted EBIT margins improved nicely, increasing to 15.4%, which represents an increase of 300 basis points from last year's second quarter as the business continues to nicely leverage sales growth. Next is Chart 7, where we have year-to-date highlights. The first six months have been very strong for ESCO as we make progress towards another record year. Order strength has been significant with 30% organic growth year-to-date. All three businesses have delivered double-digit organic growth with aerospace and defense leading the way. Sales have also been strong with 12% year-to-date organic growth, led by Test at 27% and Aerospace and Defense at 14%. Adjusted EBIT margins were up 370 basis points year-to-date as all three businesses have delivered improved margins. Going to Chart 8, we have cash flow highlights for the first six months. Operating cash flow is up significantly at nearly $135 million compared to $46 million in the prior year. A key driver has been increased advanced payments on large Navy contracts. Capital spending is down slightly compared to last year, and there's a $10 million use of cash on the acquisition line related to working capital and tax settlements for the Maritime deal. EBITDA leverage is low at 0.4x, and we are positioned well for the debt requirements that will come with the Megger deal, which is currently expected to close in the first quarter of fiscal 2027. Our last chart is #9, where we have updated 2026 guidance. With another strong quarter, we are increasing full year 2026 guidance. We now expect full year adjusted earnings per share of $8 to $8.25 per share. This represents an increase of 33% to 37% compared to fiscal 2025. This is a substantial increase from our original November guide, and you can see from the bar graphs at the bottom of the page, we expect 2026 to be another record year and a nice continuation of the growth trend ESCO has delivered since fiscal 2021. That completes the financial summary, and now I'll turn it back over to Bryan.

Bryan Sayler, President and CEO

Thanks, Chris. So as you've heard from our commentary, Q2 was another solid quarter, and we're looking at another year of strong revenue and earnings growth. And with record backlog, we continue to feel great about the long-term prospects for ESCO. That concludes our opening remarks, and we'll now turn it over for the Q&A.

Operator, Operator

Our first question comes from the line of Tommy Moll of Stephens.

Thomas (Tommy) Moll, Analyst, Stephens

Bryan, on Test, you talked about mid-single-digit sales growth over the planning horizon. I don't think that's different from what you've said previously, but you gave a lot of detail on some of the drivers for that today. I'm curious, given some of the recovery there, is it fair to say you've got increasing conviction and visibility in that outlook? And then moving to the bottom line there, any change post your planning conference on what the margin aspiration would be for that segment?

Bryan Sayler, President and CEO

Well, thanks, Tommy. Yes, I do think it's a little bit of a change. As you know, we're having a very strong year this year at the business. Historically, we would have said 3% to 5%. We're probably saying more like 4% to 6% now. This year, we're going to be well ahead of that. I would say our outlook for the Test business broadly is improving. And I think what I've said to you before is that we're driving towards 20% EBITDA margins in that business. After what we've seen this year and what we saw in the five-year review that we just went through, we think we're going to get there a little quicker than we might have thought before.

Thomas (Tommy) Moll, Analyst, Stephens

And as a follow-up, I wanted to ask on Megger. At the time of the announcement, you framed the accretion as— I forget the exact word you used, Bryan, but accretive in the first year and significantly accretive in the other years. Two-part question for you today. Are fair bogeys to assume something like low single digits in the first year and potentially even low double digits by the third year? And then second part of the question, how would you frame whatever return parameters you used to underwrite the deal, potentially on the ROIC side or some other framework that you used here?

Bryan Sayler, President and CEO

Yes. Thanks for the question. What we said and still believe is that on an earnings and EPS basis, it's going to be accretive in the first full year, and then it's going to be significantly accretive in the year beyond that. I'm kind of doing the math in my head, but it's approximately double-digit accretive in that second year. I'm sorry, the second question was?

Thomas (Tommy) Moll, Analyst, Stephens

Whatever return-related underwriting you used on the deal?

Bryan Sayler, President and CEO

Yes. Our guiding star there is making sure that our internal rate of return on the deal is going to be better than our weighted average cost of capital. We do see a better-than-double-digit return on an IRR basis, and we have a pretty good spread over our weighted average cost of capital.

Operator, Operator

Our next question comes from the line of Scott Deuschle of Durchell of Deutsche Bank.

Scott Deuschle, Analyst, Deutsche Bank

Bryan, can you characterize the demand that Doble is seeing in its condition monitoring business and also characterize the pricing power you have in condition monitoring?

Bryan Sayler, President and CEO

Yes. Overall condition monitoring continues to accelerate. One characteristic we're seeing is that increasingly public utility commissions around North America are allowing the condition monitoring tools to be built into the rate base. That has served to really accelerate the overall demand. We are seeing strong demand characteristics. It would be at the high end of what we are seeing in terms of our product lines in growth, so it's in the double-digit growth category.

Scott Deuschle, Analyst, Deutsche Bank

Are orders for condition monitoring systems growing faster than the 20% headline number you put up for Doble's orders this quarter?

Bryan Sayler, President and CEO

No, I don't think so. That 20% number is a year-over-year comparison. We're seeing broad-based growth across our entire product line. One of our theses is that the amount of spending was going to be the same whether it went to renewables or to the regulated utility piece. So a bit of what you're seeing is the softness on the renewable side coming through as increased spending on grid sustainment and grid modernization.

Scott Deuschle, Analyst, Deutsche Bank

Do condition monitoring systems help operators reduce their long-term hiring needs for electricians? If so, has that become a key part of the value proposition given the shortage of electricians today?

Bryan Sayler, President and CEO

Yes, condition monitoring allows you to only send a truck roll when you know there's an issue that needs to be responded to, so it does reduce the number of truck rolls. In the grand scheme, I do not believe that's the most important financial reason a utility would adopt this. Condition monitoring provides better real-time data from the grid edge so operators can manage peak load conditions more efficiently and push assets a little harder than they might without that feedback. The bigger value is that it extends the life of existing assets, allowing utilities to defer capital investments and expensive replacements, and thereby allocate investments into needed areas and grid expansion.

Scott Deuschle, Analyst, Deutsche Bank

The declines in energy accelerated this quarter by a meaningful amount in both sales and orders. Is there any hard evidence you can point to that this business is at a bottom? And is a business that can see a 30% sales decline a business you want to be in long term?

Bryan Sayler, President and CEO

The challenge with renewables is they are volatile and responsive to policy changes. The imminent removal of tax credits is changing developer behavior, and that's what we're experiencing now. I'd like to believe this is a bottom, but I don't call bottoms until I start seeing a trajectory in the other direction. It could be a bit deeper, and it could last longer. Long term, renewables are a piece of the overall grid solution. We believe this business can be profitable even at a lower level, and we do think it will return to growth in the second half of 2026 or the beginning of 2027.

Scott Deuschle, Analyst, Deutsche Bank

Is the business profitable at this level of sales?

Bryan Sayler, President and CEO

It is profitable. The challenge is that on a year-over-year comparison it was very profitable a year ago, and it's not as profitable now, but it is still profitable.

Operator, Operator

Our next question comes from the line of Jonathan Tanwanteng.

Jonathan Tanwanteng, Analyst

Nice job on the quarter and the increased outlook. I was wondering if you could first talk about commercial airline demand, particularly in consumables. I know you've seen pretty strong trailing demand. As we look forward, with flights being canceled and entire airlines ceasing operations in some cases, do you see any pressure from that on the consumable part of your business as you look into the future?

Bryan Sayler, President and CEO

It's pretty early to see any impact from something like an airline going out of business. There has been some impact to widebodies coming in and out of the Middle East in terms of overall air traffic, but we have not seen that manifest in a meaningful way in our order patterns. In fact, our orders this quarter were outstanding and implied significant growth on both the aftermarket and the OEM side. We pointed to increases on the OEM side. We're excited about what we're seeing from Boeing and others. We do think they're back on track and we're prepared to support them at higher build rates. I remain appropriately conservative about their forecasts, but our belief in what's happening there is improving and we're optimistic about what that means for our business.

Jonathan Tanwanteng, Analyst

On the revenue guidance, it looks like you didn't change it. What are the moving parts given Test has outperformed expectations? Are you tracking toward the higher end of the range, or are there puts and takes in other segments we should be thinking about?

Christopher Tucker, Senior Vice President and CFO

There are a few puts and takes. Maritime is slightly under $100 million year-to-date, and the full year guide we had given before was $230 million to $245 million, so they're probably going to be at the lower end of that range based on how the first half went. Overall the business is still doing great — profits, cash and orders are good — they're just seeing some delays and slowdowns on some U.S. surface ship programs. We're a little better in Doble than we thought a quarter ago; NRG is offsetting that. We also have some places in aerospace and defense where we're a little better. So these are pluses and minuses and we end up in roughly the same place on the full-year revenue guidance.

Jonathan Tanwanteng, Analyst

Any thoughts on where inflation is going and your ability to push pricing through to your customers? What's built into your forecast today and what could be the risk as we go forward?

Bryan Sayler, President and CEO

We believe we can drive price faster than inflation and we have a demonstrated history of doing so. We keep an eye on commodity and input cost trends. It's a bit early to call anything definitive on oil prices or similar inputs, but we are starting to see some signals that may require us to go back to customers with price changes. You can count on us to be proactive and fairly aggressive on the pricing side when needed.

Operator, Operator

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

Bryan Sayler, President and CEO

Well, listen, thanks, everyone, for taking our call. I think as you saw, we feel really good about our quarter. We feel really good about our year. We're looking forward to talking to you again about another great quarter three months from now. Take care.

Operator, Operator

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