Earnings Call Transcript - ESE Q4 2024

Operator, Operator

Good day and thank you for standing by. Welcome to the Fourth Quarter 2024 ESCO Technologies Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today’s conference 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 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 to describe the company’s operating results. The reconciliation of these measures to the most comparable GAAP measures can be found in the press release issued today on the company’s website at www.escotechnologies.com under the link Investor Relations.

Bryan Sayler, President and CEO

Thanks, Kate, and thanks, everyone, for joining today’s call. We are happy to give you an update as we close out another great year at ESCO. We are pleased with our fourth quarter and fiscal 2024 results. We hit a significant milestone this year with orders and sales both eclipsing $1 billion. This is a great achievement, but we feel like there’s still a lot of momentum in our business and in the markets we serve. So while we feel great about 2024, we feel even better about the future. Chris will run you through all of the financial details for the quarter and the year, but before we get to that, I want to give you a few comments on each of the segments. Starting with Aerospace & Defense, we continue to have a strong outlook here. As you saw in the release, we finished the quarter with a record backlog of just over $600 million. The backlog growth in 2024 was substantial on continuing strength from commercial and military aerospace, as well as continued strength of Navy orders at VACCO and Globe. Notably, we did make progress during the year on reducing past due backlogs. That’s been a big focus for our teams, and it’s nice to see this start to move in the right direction. Probably in anticipation of some questions we might get later, I’d like to address the Boeing strike. We did not see any impact in our fourth quarter, and now that the strike is resolved, we do not anticipate any financial impacts to 2025. There could be some movement between quarters as the business ramps up and things are rescheduled, but with the overall backlog strength that we have, we anticipate that the outlook for 2025 can remain intact. Next is our Utility Solutions Group, where we had another good quarter and also another year of nice topline growth and margin improvement. The sales growth here picked up a bit when compared to the third quarter, and we were happy to see the margin expansion that the team delivered. Taking a second to parse out the different markets here, we see ongoing market strength on the regulated utility side of our business. The customer base here continues to increase capital spending forecasts in order to meet demand for increased electricity, and they also have to be sharply focused on running their current assets as efficiently as possible. These are both good trends for our global business. On the renewable side, the team delivered really nice orders and sales growth in the fourth quarter. We are still positive on our outlook here as we feel renewables will continue to have a role to play as overall demand for electric power increases. Finally, I’ll touch on our Test business. We are really happy with how the year turned out. We saw nice sequential improvement from the business as we moved through the year. Certainly, the growth here is less than our other two businesses, but the team responded quickly when the business softened up at the beginning of the year. We saw profitability recover, and we also saw sales increase sequentially as each quarter progressed. The good news is that we’ve seen strong activity from our medical and industrial shielding customer segments of the business, and when the key wireless markets begin to recover, the team will be ready to capitalize on that activity. With that, I’ll turn it over to Chris to run you through the financial details for the quarter.

Chris Tucker, Senior Vice President and CFO

Thanks, Bryan. Everyone can follow along on the chart presentation. We will start on Page 3 where we have the overall financial highlights of the fourth quarter. Starting with orders where you can see we had a decline of 15% in the fourth quarter. We will go through the segment details in a moment, but the decline was driven by the Aerospace & Defense Group, which had a tough comp with high Navy orders in last year’s fourth quarter, and it should be noted that we ended the year with record backlog of $879 million. Sales in the quarter were up 9.5%, which was comprised of 8.5% organic growth and one point of growth from the MPE acquisition. Adjusted EBIT margins were up 130 basis points to 17.4%, with margin increases from all three segments. Adjusted EPS was $1.46 per share, an increase of 17%. Guidance was for $1.38 per share to $1.48 per share, which excluded potential profit erosion from the VACCO Space Business of $0.15 per share to $0.21 per share. The actual erosion was at the high end of the range, or unfavorable $0.21 per share, so it was great to close the quarter at $1.46 per share on an adjusted basis, inclusive of the issues in our space business. Next is Chart 4, which covers the Aerospace & Defense business. As mentioned previously, we had tough comparison here in last year’s fourth quarter orders, so we show a sizable drop, but you can see at the bottom right of the chart for the year, we ended up with a backlog of just over $600 million, an increase of 24%, so certainly we still have good momentum inside of the business. Sales in the quarter were up 16%, tremendous growth from Navy, commercial, and defense aerospace. Adjusted EBIT was also quite good, improving 160 basis points to 19.4% of sales. Really good performance across the group that was able to more than offset the project profitability issues mentioned previously in the VACCO Space Business. Moving on to Chart 5, we have the Utility Solutions Group. A really solid quarter here with orders up 2%, sales up 6%, and adjusted EBIT up 70 basis points to 26.4% of sales. Total sales growth was 6% as we saw continued growth from service offerings and condition monitoring products. Additionally, the renewables business had a strong quarter with sales growth of 9%. The sales growth overall helped drive the margin improvement, so it was a good close to another strong year for the Utility Solutions Group. Next is Chart 6 and the Test business. Overall, it was a really nice quarter for Test. Orders were down 8.5%, but backlog ended at $159 million, which is a slight increase compared to September of 2023. Importantly, we saw sales growth and adjusted EBIT improvement in the quarter. Sales were up 4% with organic sales down slightly and the MPE acquisition adding approximately 5 points of growth. Margins increased by 80 basis points to 18.3%, a really nice result as the team’s quick action earlier this year on cost reductions has helped mitigate the impact of lower volumes. We have been watching for sequential improvement from this business throughout 2024, and the fourth quarter continued that trend nicely. Moving on to Chart 7, which summarizes the full year financial highlights. It was another record year for ESCO and this chart illustrates that very nicely. All the bar charts across the top of the page here show really nice trends with orders up 10%, sales up over 7%, adjusted EBIT up 14%, and adjusted earnings per share up 13%. The order growth was led by the Navy and the aircraft component businesses, and ending backlog was up over $100 million or 14% compared to prior year end. For sales, growth was led by Aerospace & Defense with a 14% increase. The Utility Solutions Group was also quite strong with an increase of 8% coming after two strong years in 2022 and 2023 for that group. Notably, sales exceeded $1 billion for the first time in ESCO’s history, an important milestone that we are excited to build on. Profitability metrics were strong with good margin improvements from A&D and Utility, which were somewhat offset by a drop for the Test business. Next is Chart 8 with cash flow highlights. We finished the year very well in operating cash flow, and the full year came in at over $127 million. This was a substantial increase from last year as earnings growth and working capital performance drove the increase. Capital spending finished the year at just over $36 million, with the increase primarily from the A&D businesses who are investing to support their strong growth outlooks. Acquisition spend increased this year with the MPE transaction being a bit larger than the CMT deal that was closed in 2023, and share repurchases moderated somewhat compared to 2023 and were $8 million in 2024. The final chart will be our guidance chart for 2025. You can see from the charts at the bottom that we’ve had a nice trend in sales and earnings over the last couple of years, and we expect that to continue this year with sales growth in a range of 6% to 8% and adjusted earnings per share growth in the range of 12% to 17%. By segment, you can see we expect high single-digit sales growth for the A&D and USG segments next year. For Test, the growth is a bit more subdued at 3% to 5%, as we expect growth for medical and industrial customers to be somewhat offset by continued softness in the wireless market. We are driving for double-digit growth in both EBIT and EBITDA for 2025, and that gets us to the full year adjusted EPS range of $4.70 per share to $4.90 per share. Also, for the first quarter, we expect adjusted earnings per share in the range of $0.68 to $0.75. Lastly, I want to be clear that this guidance is based on how the company is currently configured. That means no impact from the SM&P acquisition and no impact from the strategic review of the space business at VACCO. We are hopeful that the SM&P acquisition can close in our fiscal second quarter, but since the timing is uncertain, we will wait and provide an updated outlook after closing.

Bryan Sayler, President and CEO

Thanks, Chris. So, as you can see, we had another good quarter and are looking at another year of double-digit earnings growth. With record backlogs, we continue to feel great about the long-term prospects for ESCO. Before moving to Q&A, I wanted to give a quick update on the Signature Management & Power acquisition that we announced back in July. Chris touched on this a minute ago, but I wanted to let everybody know that we have completed the required regulatory filings in both the United States and the United Kingdom, and as was mentioned in the press release, conditions for closing in the U.S. have been met. We’re still waiting on securing the U.K. approvals and are optimistic that this process will be successful in the near-term. Timing is always hard to predict on these things, but we’re hopeful of getting the deal done in our second fiscal quarter, and we’ll keep you all updated as we get news on that front. As I said last quarter on this call, Signature Management & Power is a very exciting deal for ESCO as we bring on a talented group of employees and expand our capabilities to serve the growing Navy market in the U.S. and in the U.K. That concludes the opening remarks, and we can open up the lines for the question-and-answer period.

Operator, Operator

Thank you. Our first question comes from the line of Tommy Moll of Stephens, Inc. Your question, please, Tommy.

Tommy Moll, Analyst

Good afternoon, and thank you for taking my questions.

Bryan Sayler, President and CEO

Hey, Tommy.

Tommy Moll, Analyst

Bryan, I wanted to start on the A&D outlook you provided for the 7% to 9% growth in the coming fiscal year. You mentioned on Boeing that there shouldn’t be any big impact for the full year, but I also suspect that you may have some conservatism embedded in there, just given the state of play. So, if there’s anything you can do to unpack your commercial aero assumptions, that would be helpful? Thank you.

Bryan Sayler, President and CEO

Well, yes, I would say that we’ve always been prudent to forecast at a build rate that’s a little bit less than the published build rates that Boeing puts out. And, frankly, that’s because historically, they have been underperforming that a little bit. I think there is impact or there could be some impact on the Boeing-specific contracts this year, but we feel confident that we’ll be able to offset that with work from other customers. Two of our businesses did work down their past-due backlog, so we’re running a little bit closer to their requirements at this point. Listen, we’re rooting for the guys at Boeing. We think they’re going to get this squared away with the strike behind us. I think that the path is clear to see good growth this year, and we would expect to see significant growth in the years to follow.

Tommy Moll, Analyst

Thanks, Bryan. And Chris, I wanted to circle back to your comments about what the fiscal 2025 guidance excludes, which is helpful context, specifically on the SM&P. It’s excluded for now, but presuming you close in fiscal second quarter, at some point, you’ll need to adjust. And I just want to make sure we’re prepared with whatever information you can provide. Originally, when the deal was announced, you indicated it would be accretive in the first year, excluding the one-timers and excluding the M&A amortization. So, I guess, it’s a two-part question there. Do you anticipate that when you do update guidance, you’ll do it accordingly, excluding both of those items? That’s point one. And then point two, Chris, you’ll have only a partial year impact from the asset once you fold it in. And so, if there’s anything noteworthy in terms of the seasonality there that we should be prepared for, that might be worth mentioning as well? Thank you.

Chris Tucker, Senior Vice President and CFO

Yes, Tommy, when we provide the updated guidance that includes the acquisition, we will outline the different components so you can see the acquisition amortization and other significant effects on our outlook. Regarding seasonality, there is nothing noteworthy to mention at this time. If there are any important updates or unusual dynamics as we prepare guidance, we will certainly inform you then, but currently, there’s nothing to highlight.

Tommy Moll, Analyst

I resisted asking if you’d like to adjust any of your underwriting assumptions post-elections, but we’ll just sit tight and see how it goes. I’ll step back. Thank you.

Bryan Sayler, President and CEO

Ask and answer.

Operator, Operator

Thank you. Our next question comes from the line of John Franzreb of Sidoti and Company. Your question, please, John.

John Franzreb, Analyst

Good afternoon, everyone, and thanks for taking the questions.

Bryan Sayler, President and CEO

Hi, John.

John Franzreb, Analyst

I’d like to pivot over to the Test business and your assumptions of 3% to 5% growth, is there any expectation there of better results in China embedded in their outlook?

Bryan Sayler, President and CEO

We have not included significant improvement in China. Currently, the situation remains quite uncertain there. Therefore, we have not anticipated a major turnaround or anything similar in that region. We expect it to remain steady for now. Over the long term, there may be a chance for improvement, but we have not factored that into our forecast at this time.

John Franzreb, Analyst

And I’ll throw an administration change question out there in Utility and NRG. What’s the thought process of maybe a less friendly administration towards renewable energies? How do you kind of think about that on a go forward basis?

Bryan Sayler, President and CEO

Sure. Sure. Well, so, listen, we start by thinking about the underlying market demand, which is steadily increasing. And so regardless of policy, the market is requiring more electrification, more build out of generation, more build out of transmission. So we think that’s really reflected on the regulated utility side of our business. What we’re seeing as we watch what our customers are doing from a capital investment perspective, they’re steadily increasing those investments. And as we watch that, I think you’re seeing a more balanced approach from them with a good mix of new gas assets, new solar assets, and in some cases some wind assets. But on the renewable side, I think there is a little bit of a threat that the incentives that are in place with the IRA could be diminished. But we do think that renewables will have a role to play. In the meantime, the most imperative thing for our customer base is really to get the most out of the assets that they already have. And that really plays very, very well to our Utility Solutions Group story. And we anticipate continued growth in all of those markets, regardless of what the policy changes might be.

John Franzreb, Analyst

I tend to agree. And just a question on the adjustments. On what line items are they coming out of, the debt refinancing and the restructuring? Are they all coming out of SG&A or is there a mix there in SG&A and cost of goods sold?

Chris Tucker, Senior Vice President and CFO

Yeah. There’s a mix. And actually, the debt financing hit the interest expense line. So, we had to pay for our kind of revolver backstop and for kind of a bridge loan to show our committed financing when we announced the acquisition. So, those items were worth about $3 million and hit the interest line. And then on the restructuring side, that’s going to hit OIOD. So, that comes in at the EBIT line. So, those were the two main places where you saw the adjustments come in this quarter.

John Franzreb, Analyst

Great. Thanks for that. I appreciate it. I’ll get back to you.

Chris Tucker, Senior Vice President and CFO

All right.

Bryan Sayler, President and CEO

Thanks, John.

Operator, Operator

Thank you. Our next question comes from the line of Jon Tanwanteng of CJS. Your question, please, Jon.

Jon Tanwanteng, Analyst

Hi. Good afternoon. Thank you for taking the questions and really nice performance even with the space headwind that you had.

Bryan Sayler, President and CEO

Thank you.

Jon Tanwanteng, Analyst

If I could, I was going to ask to dig a little bit more into that. Do you think you’ve completely run through all the issues there and that Q1 should be a clean quarter, or is there more to work through, number one? And number two, what are the prospects for the business? Just where are you in the strategic review?

Bryan Sayler, President and CEO

Sure. Sure. Well, listen, we’ve been making really steady progress on these troubled development, fixed price development contracts we’ve been working through. A few of those are behind us now. We’ve still got a couple that we’re working on. But the good news is that we’re actually delivering product now, and so we have a solid basis for really being able to estimate the cost on a go-forward basis. And so, we’ve adjusted all the estimates accordingly. So, we’re no longer anticipating what it’s going to take to develop the thing. We’re now working on what’s the cost to produce a product. And it’s a little bit higher than we had originally estimated, and that’s why the estimates had to be adjusted. So, I would never tell you that there’s zero risk, but we do believe that the risk has been largely mitigated. As to your second question, we did take a really deep look at the business throughout the most recent quarter with a view towards what would it take to split the business up into two. And frankly, we came to the conclusion that we can’t do that economically or efficiently. And so, now really the question is, what are our options going forward? And we’re considering whether we would sell the entire VACCO business. We don’t have an answer to that question today, but we believe that by the time we get back together with you in February, we should have an answer to that question and be able to communicate what our plans will be going forward.

Jon Tanwanteng, Analyst

Thank you for your question. Regarding the administration changes, I believe there may be some long-term risks for VACCO Space related to the support of NASA and private contractors. However, our backlog is strong for the next few years. In the longer term, there may be some risks associated with the SLS program.

Josh Sullivan, Analyst

Hey. Good evening.

Bryan Sayler, President and CEO

Hi, Josh.

Josh Sullivan, Analyst

Just as far as the outlook for 2025, what are you assuming on the aftermarket growth side? There’s a growing conversation around momentum transitioning from aftermarket to OEM. I’m just curious about what you’re baking into 2025 there?

Bryan Sayler, President and CEO

Sure. As you know, the Navy segment of our business does not have a significant aftermarket. We are mainly focusing on commercial and military aerospace. The area with the most exposure is our PTI business, where we produce aftermarket filters for items such as Blackhawk helicopters. Additionally, our Mayday business manufactures bushings that are utilized in the rebuild and maintenance of landing gear systems. We are making a substantial effort to expand these segments, and we expect to see some success. For instance, the 787 aircraft are reaching the point where they require a comprehensive overhaul of their landing gear systems, and we are targeting that opportunity. Each time this occurs, it represents a considerable chip set content for us. We have already secured a few contracts in this area and believe it will be a significant growth driver for the Mayday business.

Josh Sullivan, Analyst

Got it. And then maybe jumping over to the naval side of the outlook, there seems to be an issue with some of the larger shipbuilders just getting the labor they need negotiating with the Pentagon for higher wages to attract the talent that they need. But from a supplier perspective, it seems like the suppliers that have longer lead times are weathering the issues a little bit easier than others. Just curious maybe if you’re seeing any impact to that right now or whether you kind of fall into that group with some longer lead times and it’s not as big of an issue?

Bryan Sayler, President and CEO

We are not experiencing any impact at this time. We are being advised to move as quickly as possible. However, we have not been building at the targeted pace, so you can expect an increase in our build rates, which will be reflected in future revenues. We are seeing some opportunities, particularly on the Navy side, that could be significant. There is always demand for Navy spares and related products. Nevertheless, we don't believe there is any reason to expect a slowdown in our business due to the current discussions happening with the larger shipbuilders.

Josh Sullivan, Analyst

Got it. And then just one last one just on the SM&P acquisition. I mean, what is the big or large tentpole to get over to close the deal at this point? Anything we should be watching out for?

Bryan Sayler, President and CEO

You may know that in the United Kingdom, a new law called the National Security Infrastructure Act was implemented in 2021 or 2022. This law requires a comprehensive and detailed strategic review of any acquisition that could have national security implications, which is relevant for a submarine builder like us. Typically, they will take at least 30 business days after receiving our inputs for this review. We have been in communication with them, and currently, they are reviewing our responses. We expect to hear from them in about 30 days. They have the right to extend the review period if they choose to, but we don’t foresee any issues. Everything is progressing at what seems to us to be a normal bureaucratic pace.

Josh Sullivan, Analyst

Great. Thank you for the time.

Operator, Operator

Thank you. I would now like to turn the conference back to Bryan Sayler for closing remarks. Sir?

Bryan Sayler, President and CEO

Well, listen, everyone. Thanks for the update. We’re really excited about the prospects for our business. I want to extend our thanks to our entire worldwide team of employees who have worked really hard to make these results and are going to continue to work hard to build our business into the future. Thanks a lot for the time today.

Operator, Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.