Q2 2021 ESCO Technologies Inc Earnings Call

May 4, 2021

[music].

Okay.

Good day and welcome to the ESCO Q2 conference call today's call is being recorded with US today are Vic Richey, Chairman and CEO, Gary Muenster, who is retiring as vice President and CFO and Chris Tucker Senior Vice President and CFO and now 2%.

The forward looking statement I would like to turn the call over to Kate Lowrey Director of Investor Relations. Please go ahead.

Thank you Steve.

Statements made during this call regarding the timing of recovery and growth of our end markets the amounts and timing of 2021 and beyond revenue COVID-19 impacts on recovery expected in the result of COVID-19 vaccine recovery in commercial aerospace adjusted EPS adjusted EBITDA cash shareholder value of the timing of block five deliveries.

Excess of completing additional acquisitions and other statements, 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 on the forward looking statements due to risks and uncertainties that exist in the company's operations in <unk>.

This environment, including but not limited to the risk factors referenced referenced on 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 whether as a result of new information future events or otherwise. In addition during this call of 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 Dot ESCO technologies Satcom on to the link Investor Relations now I'll turn the call over to Vic Thanks Kate.

So on the press release, we do have some management changes here of what you've been working on for some times in the hearing from Chris in a few minutes. In addition to that we've got the shots here with us through the recently replaced Dallas is our general counsel. So before we get into the details of the quarter I'd like to start off by introducing the walk in the Chris Tucker, who joined US a few weeks ago and newest member of our ex.

The management team, Chris will be serving the senior Vice President and Chief Financial Officer, replacing carry on previously announced his retirement Chris.

Chris comes to Us from Emerson, where he served in numerous financial leadership roles with increasing responsibilities over the years. He also led the Investor Relations group for several years I'll turn it over to Chris to give you a little more background on his experience Chris.

Hello, everyone and thanks, Victor the introduction and it's great to join all of you today I just wanted to take a minute and give a brief introduction to myself before we jump into details of the Q2 performance.

This was covered in the press release announcing my hiring of up.

But I'll provide a little more color here on the phone.

I'm, joining ESCO per membership where I spent the last 24 years of my career.

I understand the great company and I had a great experience there I started off on the corporate accounting and finance team back in 1997 and.

And finished the up as the group CFO for one of the few business platforms.

Of course, there were several important stops in between those two bookends.

During my time, there I had the chance to work on a variety of operational issues business development opportunities and overall value creation strategies. I also led the Investor relations effort for few years. During my tenure, there, which was a good bit of training for calls like we're doing right now.

My prior experiences of put me on a strong position as the transition to this new role I'm very excited to be part of <unk> team here at ESCO. Gary has been extremely helpful. As we've worked together over the last few weeks and everyone from the corporate staff to the board of directors has been collaborative and great to work with.

ESCO is really a great company and has a lot of exciting initiatives going on really across all of the businesses I am excited to be here and start building on Gary's legacy of strong financial leadership as we move into the future.

With that I'll turn it back over to Vic and Gary for a more detailed discussion of Q2 and the rest of the year.

Thanks, Chris and welcome on Board, we look forward to working with you.

I'd be remiss, if I Didnt mentioned in today's COVID-19 environment, and how we continue managing around the impact on the aerospace utility businesses I think our results demonstrate we are succeeding.

Since the beginning of the pandemic. Our primary goal has remained the same.

To provide a safe working environment and to protect the health of our employees and today, we're really encouraging our staff to get fully vaccinated for the benefit of the ball.

Our solid operating results in Q2 and for the first six months of the year, coupled with our increasing liquidity demonstrates that the measures we've taken over the past 12 months of significantly mitigated the COVID-19 impact on our earnings and I believe will allow us to continue successfully navigating through this challenge.

Our previous cost reduction actions, along with our enhanced focus on operational efficiency will benefit ESCO going forward as things continue to move toward more normal state and I'm confident of our disciplined approach to operating the business will result in continued success throughout the balance of the year.

While Gary will provide the financial details I'll offer some top level commentary to set the tone.

While our Q2 and year to date.

<unk> sales were significantly lower than prior year due to COVID-19 <unk> impact of the commercial aerospace our portfolio of diversity allowed us to mitigate this headwind as we were able to hold our ESCO consolidated adjusted EBITDA.

Constant at $31 million in Q2 compared to the pre COVID-19 Q2 results from last year. Additionally, we were able to increase our fiscal 'twenty one year to date adjusted EBITDA and adjusted EPS from the prior year despite of 6% decrease in sales the.

This improvement was delivered by solid contributions from our other operating units and as a result of favorable sales mix and meaningful cost reductions across the company from.

From the segment level there are several positives to report.

Within A&D, we're seeing signs of recovery in the commercial aerospace as pasture Borys continued increase and more airlines are adding idle aircraft back into service, our Navy and space businesses remained strong and well funded and our outlook for near term growth opportunities continue to materialize on both of these are.

Areas.

Our test business continues to outperform as we saw sales growth of both Q2 and year to date with increasing margins as our project execution remains solid weeks.

We expect test outlook remain positive driven by the strength of the served markets, including five G.

Our USG business, while reporting a softer Q2 than originally projected reported a solid first half of the year from both the sales and adjusted EBIT perspective, USG delivered an adjusted EBITDA margin of 26% for the first six months of the year up from approximately 22% in the prior year's first half.

This is the result of year end spending captured in our first quarter, along with our lower cash cost base overall of the fundamentals of our portfolio of strong and our goal remains the same to create long haul of long term shareholder value now I'll turn it over to Gary.

Thanks, Vic I'll briefly touch on the financial results laid out on the press release.

As we continue navigating through what we hope is the near end of COVID-19. Our number one financial priority remains of the same increasing and maximizing our liquidity to position us for future M&A growth and increased investment in new products and solutions.

We are of a rock solid balance sheet today, and we are poised to use it to our advantage.

Highlight the significant cash we generated this year is we've set a record for cash flow during the first half it was the highest in our history.

We delivered free cash flow conversion at 134% of net earnings for the first six months.

Our working capital initiatives are producing solid results.

Today, we have approximately $760 million of liquidity at our disposal between cash on hand, and available credit capacity, while carrying of modest leverage ratio of <unk> 23.

We fully realize that while this is the positive metric it is not the ideal capital structure, given the historically low cost of debt and with that said, we are committed to putting our balance sheet to work.

One of our primary objectives in the near term is to add leverage to fund acquisitions with a focus directed at bringing on new businesses that provide an ROIC well in excess of our cost of capital as we believe this return spread is a cornerstone of value creation.

In the release, we called out of couple of discreet items.

Which are described in detail and are excluded from the calculation of adjusted EBITDA and adjusted EPS in both years presented so I will not repeat them here.

I'll now touch on a few comparative highlights noted in the release.

We beat the consensus estimate of 55.

As we reported Q2 adjusted EPS of <unk> 59 of share. This compares to 68 of share in the prior year Q2.

Considering Q2 of this year was influenced by the COVID-19 operating environment I am pleased to report that we delivered adjusted EBITDA of $31 million on the current period, which is equal to the $31 million, we reported last year in Q2 pre COVID-19.

More impressively. This was achieved despite the noted sales decline in Q2, the Vic mentioned earlier.

Our Q2, adjusted EBITDA margin increased to 19% from 17% last year.

Year to date, our adjusted EBITDA increased to over $60 million with an 18% margin up from 17% prior year to date.

Over the past year, we took several cost reduction actions across the company and as a result, we were able to increase our Q2 and year to date gross margins to 38, 1% and 38, 7% respectively.

We reduced our Q2 in the year to date SG&A spending by 3% in both Q2 and year to date periods compared to prior year.

These favorable outcomes were achieved despite including the acquisition of ATM in October which is not yet at full operating capacity during its transition to Chris there and.

And it was done despite our continued spending on R&D and new product development amortization of intangibles and interest expense both decreased while tax expense as a present as a percent of pretax income increase in Q2 and the first half as we had several large tax strategies implemented last.

Year, which benefited the 2020 comparative rates, but were not repeated in the current year.

Q2 orders were solid as we booked $176 million of new business and ended the quarter with a backlog of $522 million with the book to bill of 106%.

The bright spot worth mentioning was the order volumes recorded in our commercial aerospace businesses, which grew their backlog of $7 million during the quarter.

As we move through the balance of the year I'll remind you that our Dod businesses led by our participation on the block five contract for additional Virginia class submarines.

We booked several large orders during fiscal 'twenty, we'll be delivering products against those orders, which are multi year programs, which will mathematically reduce the optics of our book to Bill.

Consistent with our November communications and from a directional perspective, we can point to several areas, where we see positive momentum.

Our commercial aerospace and utility end markets are showing some degree of customer stabilization, which supports our current outlook, suggesting a movement towards continued recovery in the second half of fiscal 'twenty one.

The increase in distribution of the COVID-19 vaccine is anticipated to benefit and accelerate the recovery of commercial air travel and utility spending with customers resuming more normal buying patterns.

While we solidly beat Q2.

Ahead of our original plan at the halfway point, we still expect the second half of 'twenty, one to be slightly favorable in comparison to the second half of fiscal 'twenty given the various elements of recovery that were anticipating.

We expect to show growth in fiscal 'twenty, one adjusted EBITDA adjusted EPS as compared to fiscal 'twenty with an adjusted EBITDA reasonably consistent of that was which was reported in 2019 if.

If we complete any additional acquisitions during the year as expected the fees would contribute to the expectations of just mentioned and now I'll turn it back over to Vic.

Since that touched on quite a few of my thoughts earlier in my commentary I'll offer a few qualitative comments about our end markets and our expectations for the balance of the year, starting with our E&E segment as I mentioned, we're seeing some signs of modest recovery in commercial aerospace. We expect continued softness over the next three months.

We're starting to see stabilization in the OEM build rates and increase in the airline passenger traffic in flight models.

Just as we saw on Q1 of the defense portion of our A&D business is and will remain strong for the foreseeable future given our backlog and platform positions. We also see the current situation of the aerospace market is an opportunity for ESCO as we've been made aware of some situations where the other suppliers of competitors are not fulfill.

The customer requirements and those customers of reached out to us to see if we can step in and satisfy the demands of our test business delivered another really solid quarter for the by beating our internal expectations and delivering on the EBIT margin of 13%.

The test outlook remains solid given the diverse.

<unk> of it's in the served markets.

As I noted on the previous call when USG had a really strong first quarter, we expect the USG sales to be down in Q2 before returning to more normal levels in the second half of the year and that's what we've seen.

But the positive is increased margin contribution U S cheese delivered in Q2 and year to date compared to prior year.

As the COVID-19 vaccine gets more widely distributed throughout the utility service personnel, we expect the USG market to come back on line and more quickly as they can relax some of today's social distancing guidelines and the utility service personnel can return to their normal site visit routines.

We recently visited with their USG management teams and I remain pleased with the enthusiasm surrounding their new products and solutions and we continue to see Nrg's end markets improving as the investments in the new renewable energy are increasing in both wind and solar our solar revenues have been growing far better than anticipated and we expect that.

Turning to continue.

Moving on the M&A, we continue to evaluate several opportunities and we expect to take action on these opportunities to grow our businesses as we have in the past.

Our board is extremely supportive of our M&A strategy on our current balance sheet provides us with plenty of liquidity to allow us to add per existing business.

To wrap up we delivered a solid second half in the first quarter from both the cash flow and earnings standpoint, as we through the second half of our fiscal 'twenty. One our plan is to continue to focus on the fundamentals.

Look for opportunities to lever leverage our existing cost structure through M&A.

Would you create additional operating efficiencies and share we're well positioned for long term success.

So with that I'll be happy to take any questions.

And that this time I would like to remind everyone in order to ask a question. Please press star one on your telephone keypad again to ask a question we stress on one.

On your telephone keypad.

First question coming from the line of common model with Stifel. Your line is open.

Good afternoon, and thanks for taking my questions.

Hey, Tom.

Rick I wanted to start on the A&D. It sounds like you exceeded your internal expectations this quarter on the top and bottom line.

So any context, you could give us there about what what came in better than expected.

Then a related follow on as you look ahead.

It sounds like there may be some structural.

Fit to your margins up for some of the cost out last year the <unk>.

Time.

As the end markets recover presumably there would be some opex you'd look to layer back in.

So what we're kind of incrementals should we be thinking about or what's the approach as you balance those.

Beating considerations. Thank you.

Sure. So when you first question as far as what we saw on the A&D C of couple of things.

The non commercial aerospace part of our business the space the Navy and.

On the small amount of commercial aviation or I'm, sorry of defense aviation, we have all or a little better than what we anticipated in addition to that while.

The commercial aerospace is still a bit behind schedule.

Recovering, but we were able to get a good bit of non recurring engineering from customers for some new product development.

That really helped.

As a result.

It's not something we had initially anticipated getting this quarter.

This is the first half of the year. So obviously those are the major things that we saw to the upside.

As far as your second question is certainly you saw on the leverage I mean, particularly the USG, where our sales were down on our margins were up.

Pretty significantly.

That's really just a matter of the costs that we took at really across the business of the second half of the year. So while we have to do I mean, when the business starts to grow again, obviously going to have to add some folks, but I do think group kind of reset the bar on.

The cost structure, and we're going to be very very.

Diligent about any at any cost back and I think we will be able to.

As a result of that would be able to have better margins than what we've seen in the past some of these businesses.

Thank you Victor that's all helpful.

Just as a follow up.

Wanted to talk about balance sheet on M&A, it sounds like optimizing your capital structure.

And acquisitions of two sides of the same coin. So if we fast forward to on.

Natural comfort zone, or an optimized balance sheet on your mind.

One of the brackets around where you are comfortable with leverage.

If you think about that without putting an exact timeframe around it but just the most likely scenario to get from point a to point the is that probably what larger acquisition should we think about it of longer longer dated on.

On the horizon with multiple deals.

Any context, you could give us there.

Any more context on the pipeline.

How active it is.

Bye, Phil expectations would be helpful as well thank you.

Sure. So obviously.

We can handle a good bit of debt now, we're not going to go out and do it too quickly or too large of acquisitions, I mean, typically where we've been successful as larger acquisition somewhere between.

The 20 million and 100 million of 150 million something like that purchase price.

Expect that's what we'll continue to do there are some opportunities out there. They are bigger I think we would have to pick our hard look at those as well, but we think we've been pretty successful in integrating the smaller and middle sized businesses into into our portfolio.

The pipeline is really strong the maps for us.

We're getting the new book of a couple of days or at least once a week. So theres a lot of activity out there.

I think everybody is aware is a very competitive market right now.

The work hard to try to get into areas.

Before before there's an auction before there's an auction of the lot of strategics as lease but the amount of money out there is pretty amazing right now so I had thought going into the pandemic. The maybe the multiples of becoming down and unfortunately, that's not what's happened and so I think we have to be realistic about.

What we are going to do as we add to the business will probably look on a lot harder at returns now than maybe the multiples that we're paying because that's what I think really makes.

The census in the day of looking for opportunities, where we can really see some synergies in the.

Businesses that we acquire.

And Tony This is Gary let me add something to that because the philosophy is not going to change with the me going away and Chris coming on but the first part of your question on the comfort level. One thing we do for the board as Vic mentioned, they're very supportive and I think I might have mentioned it to you. When we spoke after Q1 as we kind of keep up mathematical profile in front of it on just being dis <unk>.

Under Levered today, we just had board meetings last week, and if we were to spend roughly $250 million and bring along 25 million of EBITDA. The 10 times obvious multiple that would only put us at one five times leverage in the care of that math exercise of step forward. If VIX posts were two five.

We could spend another $230 million, which together says we could spend $450 million and the 10 X multiple only be levered up to $2, five which I think from an ideal capital structure was not something that would be uncomfortable.

That's not I am not implying that's what we have in the pipeline, but just to put some posts around how this math carries forward.

It would be ideal if we could find $450 million of spend and bring along 45 million of of EBITDA, but just really just calibrating. Two five is something that would be extraordinarily comfortable where a company of our size.

Thank you both very helpful and I will turn it back.

And again, ladies and gentlemen, please feel feel free to press star one.

If you have questions next question will be coming from the line of.

On one time of CJS Securities.

Your line is open.

Yes, Hi, it's Pete Lucas for Jon you answered a lot of the questions. Previously just wondering if you could kind of talk about how you look at the potential infrastructure Bill all of it seems like it would be positive for you, but just wondering any specifics in there that you guys are focused on.

Okay.

Yes.

We get that question a lot.

Well defined right now it's hard to say I don't think theres any downside to us that's for sure I do think that some of the things we'll be going into renewable energy some of things of the go on the grid.

Those kind of things that I think should it should be.

Of the potential would be very helpful to us.

But.

The industry of the ill-defined, that's probably the biggest area, where we would see a positive impact I mean, the other thing I think that we look at a lot is what the defense budget is right and when you get a bit of our events business sales A&D and it looks like its holding up pretty well and as we've talked about before.

We really think more about it in the areas, where we participate so looking at the.

The naval side of of particularly submarines.

As majority of our.

Much of our product goes naturally rock solid interest.

The change in at all and then the other thing obviously look at it from a bunch of perspective is the ASUR.

Have a great position on the.

<unk> program.

That appears to be very solid as well. So I think the infrastructure Bill gets a lot of attention as it should I think that will be helpful to us, but as we look at those other two budgets in many ways of just as important to us.

Great and last one for me as far as the test business a competitor of Yours was recently sold to just wondering if that has changed the competitive environment at all or anything special Youre seeing there.

No.

<unk> is we didn't compete with them a lot because they are really very focused on aerospace and defense. We do some of that but I'd say, that's the business, it's a bit different than ours, we do some work with them in fact.

We've done some work within the out of that will continue the.

Work more on the sensor side I think.

Have a good bit more footprint on the chamber side and on the absorber side and Thats the place where we have teams historically and hope to continue doing that going forward.

Very helpful. Thank you.

Yes.

The next question will be coming from the line of John funds around the let's say the <unk>.

Your line open.

Good afternoon guys.

The follow up on the test segment, you talked about returning to more normalized level and we talk about normalized level of pre COVID-19 or normalized level in line of.

But you do in the second half of this.

2020.

The test of load.

Confused I mean are you talking about the test business of the aerospace business.

The test business.

The test business the increased been pretty solid I mean, I think year over year were then.

A couple of million dollars I think we're up a couple of million dollars. Thus far the issue over last year, so that in the promising tire.

On the minor margins higher for sure. So I mean, if you look at the three segments of the test business than the one has been the least impacted by COVID-19 thus far.

And what's driving the margin improvement from cash.

I'd say the big thing is project execution.

We have some in mix I mean, we've been getting more.

E&P filters and more components, but I'd say the biggest in those periods of higher margin than the underlying chamber business, but I'd say, the so to that and it's just project execution.

Just the overall process that they go through the execution on the large projects has improved over the past several years.

Okay.

And then USG you said that the opening up post COVID-19 restrictions will be beneficial to the business are you starting to see any kind of pickup in order activity.

Be it the spring related turnaround reason or any kind of activity of the impacts of debt pieces.

Thesis.

Yes, the activity level, certainly has picked up I think for a couple of reasons Theyre kind.

The entering the test season, if you will and so that's when we typically start buying things.

And then the.

The people getting back to work I mean, the issue is I would say most utility that historically.

Sure.

They've been doing more work from home has been a lot of other than the markets and so as the.

Youre getting back into the office that's really of.

Net activity as well.

Okay.

Hey, John.

The interrupt just to supplement what Vic said, if you look at the Q2.

Order profile in the back of the release, there youll see that the <unk>.

Order book is up about 10% in Q2, so that's a precursor to the conversation that Vic just alluded to which is evidence that the momentum starting there because it's generally a quick turn business in the.

The backlog, it's not on I'm going to get an order on Monday in shipping on Tuesday, So seeing that growth in Q2 is certainly beneficial.

Excellent. Thank you Gary and just one last question you kind of alluded to it I think.

And the response to another question about costs coming back how much staffing do you think you're starting to add this year and in which segments do you think the most staffing will be bring them back.

So I would say the areas, where we'd probably be adding some folks and we're not talking large numbers I said the people have done a good job of managing this but as some of the programs ramp up particularly on the Navy side. There are some specific people we need to add there.

We're always looking to improve our engineering workforce or add to our engineering workforce and so as things return to normal and we were able to afford more of that I'm sure. We add some folks on the technical layers as well.

Okay.

But that.

Could be on large numbers of the thing overall.

So I mean, I think if you look at share numbers, what we'll see is as sales pick up the commercial aerospace side, we're going to have the ads from direct labor people, but obviously debt.

Net finds itself on wouldn't be adding those folks unless we had the work for them to perform in line.

Okay. Thank you very much I appreciate you taking my questions.

Thank you.

And again, if you wish to ask a question. Please press one your telephone keypad.

Okay.

Okay. So I think we're done so I'm going to end the call by saying, thanks to Gary and Allison for their long term support of our value, creating mission here, the ESCO and for their passion and commitment of the company for both kind of mess. We were fortunate to have person day to step in and help lead. The company continued success. So thanks to everybody and I look forward to opportunity on that.

Carl.

And this concludes today's ESCO Q2 conference call. Thank you everyone for your participation you may now disconnect.

Okay.

[music] on.

[music].

Okay.

Good day and walk them through the ESCO Q2 conference calls per day.

This call is being recorded with US today are Vic Richey, Chairman and CEO, Gary Muenster, who is retiring as vice President and CFO and Chris Tucker Senior Vice President and CFO and now two per cent. The forward looking statements I would like to turn the call over to Kate Lowrey.

Director of Investor Relations. Please go ahead.

Thank you Steve.

Once made during this call regarding the timing of recovery and growth of our end markets the amounts and timing of 2021 and beyond revenue COVID-19 impacts on recovery expected as the result of COVID-19 vaccine recovery in commercial aerospace adjusted EPS adjusted EBITDA cash shareholder value of the timing of block five deliveries.

Except the completing additional acquisitions and other statements, 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 on the forward looking statements the risks and uncertainties for the rest of the company's operations and business.

This 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, whether as a result of new information future events or otherwise.

In addition, during the call the company May discuss some non-GAAP financial measures in describing the company's operating results a reconciliation of GAAP measures to the most comparable GAAP measures can be found on the press release issued today and found on the company's website at Www Dot ESCO technologies that com under the link Investor Relations now I'll turn the call over to Vic Thanks Kate.

As you saw on the press release, where you do have some management changes here, which you have been working on for some time. So we are hearing from price in a few minutes. In addition to debt. We've got day shots here, what the issue there.

The recently replaced Allison is our general counsel, so before we get into the details of the quarter I'd like to start off by introducing the walk me, Chris Tucker, who joined US a few weeks yours of the newest member of our executive management team, Chris will be serving the senior Vice President and Chief Financial Officer, replacing Geri and previously announced his retirement Chris.

Chris Thompson from Emerson, where he served in numerous financial leadership roles with increasing responsibilities over the years. He also led the Investor Relations group for several years I'll turn it over to Chris to give you a little more background on his experience Chris.

Hello, everyone and thank you Victor the introduction and it's great to join all of you today I just wanted to take a minute and give a brief introduction to myself before we jump into details of the Q2 performance of <unk>.

Lot of this was covered in the press release announcing my hiring a lot, but I'll provide a little more color here on the phone.

I'm, joining ESCO from Emerson, where I spent the last 24 years of my career.

I understand the great company and I had a great experience there I started off on the corporate accounting and finance team back in 1997.

And finished up at the group CFO for one of the two business platforms.

And then of course, there were several important stops in between those two bookends.

During my time, there I had a chance to work on a variety of operational issues business development opportunities and overall value creation strategies also of the Investor Relations efforts for a few years. During my tenure, there which was a good bit of training for calls like we're doing right now.

So it was really a great company and has a lot of exciting initiatives going on really across all of the businesses I am excited to be here and to start building on Gary's legacy of strong financial leadership as we move into the future.

With that I'll turn it back over to Vic and Gary for a more detailed discussion of Q2 and the rest of the year.

Thanks, Chris and welcome aboard we look forward to working with you.

I'd be remiss, if I Didnt mentioned, today's COVID-19 environment, and how we continue managing around the impact on our aerospace the utility businesses I think our results demonstrate we are succeeding.

Since the beginning of the pandemic. Our primary goal has remained the same.

Provide a safe working environment and to protect the health of our employees and today, we're really encouraging our staff to get fully vaccinated for the benefit of the ball.

Our solid operating results in Q2 and for the first six months of the year, coupled with our increasing liquidity demonstrates that the measures. We've taken over the past 12 months have significantly mitigated the COVID-19 impact on our earnings and I believe will allow us to continue successfully navigating through this challenge.

While Gary will provide the financial details I'll offer some top level commentary to set the tone.

While our Q2 and year to date.

<unk> sales were significantly lower than prior year due to COVID-19 <unk> impact on the commercial aerospace our portfolio of diversity allowed us to mitigate this headwind as we were able to hold our ESCO consolidated adjusted EBITDA.

This improvement was delivered by solid contributions from our other operating units and as a result of favorable sales mix and meaningful cost reductions across the company from.

The segment level there are several positives to report.

Within A&D, we're seeing signs of recovery in commercial aerospace is past. Your board has continued to increase and more airlines are of adding idle aircraft back into service, our Navy and space businesses remained strong and well funded and our outlook for near term growth opportunities continue to materialize in both of these are.

Areas, our test business continues to outperform as we saw sales growth of both Q2 and year to date with increasing margins as our group.

The project execution remains solid weeks.

We expect test outlooks remain positive driven by the strength of the served markets, including five G.

Our USG business, while reported a softer Q2 than originally projected reported a solid first half of the year for both the sales and adjusted EBIT perspective, USG delivered an adjusted EBITDA margin of 26 per cent for the first six months of the year up from approximately 22% in the prior year's first half.

Thanks, Vic I'll briefly touch on the financial results laid out on the press release.

We are of a rock solid balance sheet today, and we are poised to use it to our advantage of.

Highlight the significant cash we generated this year as we set a record for cash flow during the first half it was the highest in our history.

We delivered free cash flow conversion at 134% of net earnings for the first six months.

Our working capital initiatives are producing solid results.

Today, we have approximately $760 million of liquidity at our disposal between cash on hand, and available credit capacity, while carrying of modest leverage ratio of <unk> 23.

We fully realize that while this is a positive metric it is not the ideal capital structure, given the historically low cost of debt and with that said, we are committed to putting our balance sheet to work.

One of our primary objectives in the near term is to add leverage to fund the acquisitions with a focus directed at bringing on new businesses that provide on ROIC C. Well in excess of our cost of capital as we believe this return spread is a cornerstone of value creation.

On the release, we called out of couple of discreet items.

You described in detail and are excluded from the calculation of adjusted EBITDA and adjusted EPS in both years presented so I will not repeat them here on.

I'll touch on a few comparative highlights noted in the release.

We beat the consensus estimate of 55.

As we reported Q2 adjusted EPS of <unk> 59 of share. This compares to the 68 of share in the prior year Q2.

More impressively. This was achieved despite the noted sales decline in Q2, the Vic mentioned earlier.

Our Q2, adjusted EBITDA margin increased to 19% from 17% last year.

Year to date, our adjusted EBITDA increased to over $60 million with an 18% margin up from 17% prior year to date.

Over the past year, we took several cost reduction actions across the company and as a result, we were able to increase our Q2 and year to date gross margins to 38, 1% and 38, 7% respectively.

We reduced our Q2 and year to date SG&A spending by 3% in both Q2 in the year to date periods compared to prior year.

These favorable outcomes were achieved despite including the acquisition of ATM in October which is not yet at full operating capacity during the transition to Chris there.

And it was done despite our continued spending on R&D and new product development amortization of intangibles and interest expense both decreased while tax expense as a present as a percent of pre tax income increased in Q2, and the first half as we had several large tax strategies implemented last.

Year, which benefited the 2020 comparative rates, but were not repeated in the current year.

Q2 orders were solid as we booked $176 million of new business and ended the quarter with the backlog of $522 million with the book to Bill of 106%.

The bright spot worth mentioning was the order volumes recorded in our commercial aerospace businesses, which grew their backlog of $7 million during the quarter.

As we move through the balance of the year I'll remind you that our Dod businesses led by our participation on the block five contract for additional Virginia class submarines.

Consistent with our November communication and from a directional perspective, we can point to several areas, where we see positive momentum.

The increasing distribution of the COVID-19 vaccine is anticipated to benefit and accelerate the recovery of commercial air travel and utility spending with customers resuming more normal buying patterns.

While we solidly beat Q2 <unk>.

We expect to show growth in fiscal 'twenty, one adjusted EBITDA adjusted EPS as compared to fiscal 'twenty with an adjusted EBITDA reasonably consistent because that was which was reported in 2019 if.

If we complete any additional acquisitions during the year. It is expected that these would contribute to the expectations of just mentioned and now I'll turn it back over to Vic.

Since I touched on quite a few of my thoughts earlier in my commentary I'll offer a few qualitative comments about our end markets and our expectations for the balance of the year, starting with our E&E segment as I mentioned, we're seeing some signs of modest recovery in commercial aerospace. We expect continued softness over the next three months.

We're starting to see stabilization in the OEM build rates and increase in the airline passenger traffic in flight miles.

Just as we saw on Q1 of the defense portion of our A&D business is and will remain strong for the foreseeable future given our backlog and platform positions. We also see the curse situation of the aerospace market is an opportunity for ESCO as we've been made aware of some situations where the other suppliers of competitors are not fulfill.

The customer requirements and those customers of reached out to us to see if we can step in and satisfy the demands of our test business delivered another really solid quarter for b by beating our internal expectations and delivering on the EBIT margin of 13%.

Test the outlook remains solid given the <unk>.

<unk> of it's in the served markets.

As I noted on the previous call when the USG had a really strong first quarter, we expect the USG sales to be down in Q2 before returning to more normal levels in the second half of the year and Thats, what we say.

But the positive is increased margin contribution U S cheese delivered in Q2 and year to date compared the prior year.

As the COVID-19 vaccine it gets more widely distributed throughout the utility service personnel, we expect USG market to come back on line more quickly as they can relax some of today's social distancing guidelines and the utility service personnel can return to their normal site visit routines.

Trend to continue.

Moving on the M&A, we continue to evaluate several opportunities and we expect to take action on these opportunities to grow our businesses as we have in the past.

Our board is extremely supportive of our M&A strategy on our current balance sheet provides us with plenty of liquidity to allow us to add to our existing business.

Look for opportunities to lever leverage our existing cost structure through M&A.

You create additional operating efficiencies and share we're well positioned for long term success.

So with that I'll be happy to take any questions.

And at this time I would like to remind everyone in order to ask a question. Please press star one on your telephone keypad again to ask a question with strength are one.

On your telephone keypad.

First question coming from the line of Tommy Moll with Stifel. Your line is open.

Good afternoon, and thanks for taking my questions.

Hey, Tom.

Rick I wanted to start on a N D. It sounds like you exceeded your internal expectations this quarter on the top and bottom line.

So any context, you could give us there about what what came in better than expected.

Then a related follow on as you look ahead.

It sounds like there may be some structural.

Fit to your margins up for some of the cost out last year the same.

Time.

As the end markets recover presumably there would be some opex you'd look to layer back in.

So what what kind of Incrementals should we be thinking about or what's the approach as you balance those competing considerations. Thank you.

Sure. So when you first question as far as what we saw on the A&D C of couple of things that the.

The non commercial aerospace part of our business the space the Navy and the.

The small amount of commercial aviation or I'm, sorry of defense aviation, we have all or a little better than what we anticipated in addition to that while.

The commercial aerospace is still a bit behind schedule is recovering, but we were able to get a good bit of non recurring engineering from customers for some new product development, so that really helped as.

Because it's not simple we had initially anticipated of getting this quarter.

The first half of the year. So I'd say those are the major things that we saw to the upside.

As far as your second question is certainly you saw the leverage I mean, particularly USG, where our sales were down on our margins were up.

Pretty significantly.

And Thats really just a matter of the costs that we took at really across the business of the second half of the year. So while we have to do I mean, when the business starts to grow again, obviously, we're going to have to add some folks, but I do think group kind of reset the bar on the call.

Cost structure, and we're going to be very very.

Diligent about any at any cost back and I think we will be able to.

As a result of the I'd be able to have better margins of what we've seen in the past of some of these businesses.

Thank you Victor that's all helpful.

Just as a follow up on.

I wanted to talk about balance sheet on M&A, it sounds like optimizing your capital structure.

Net acquisitions of two sides of the same coin. So if we fast forward two of our.

Natural comfort zone, or an optimized balance sheet on your mind.

What are the brackets around where you are comfortable with leverage.

If you think about that without putting an exact timeframe around it but just the most likely scenario to get from point a to point B is that probably what larger acquisition should we think about it of longer longer dated on.

On the horizon with multiple deals.

Any context, you could give us there.

Any more context on the pipeline.

How active it is.

Lifestyle expectations would be helpful as well thank you.

Sure sure.

Obviously.

The 20 million and 100 million of 150 million something like that purchase price.

We would expect as well we will continue to do there are some opportunities out there that are bigger than the I think we would have to pick our hard look at those as well, but we think we've been pretty successful in integrating the of smaller and middle sized businesses into the into our portfolio.

Pipeline is really strong the mam spreads since like where we're getting the new book of a couple of days or at least once a week and so theres a lot of activity out there.

I think everybody is aware as the very competitive market right now.

So we will work hard to try to get into the areas.

Before before there's an auction of before there's an auction with a lot of strategics as lease but the the amount of money out there is pretty amazing right now so I had thought going into the pandemic. The maybe the most of us becoming down and unfortunately, that's not what's happened and so I think we have to be realistic about it.

What we're going to do is as we add to the business will probably look on a lot harder at returns now than maybe the multiples that we're paying because that's what I think really it makes most sense. It's in the day on looking for opportunities, where we can really see some synergies and debt.

Businesses that we acquire.

And Tony This is Gary let me add something to that the philosophy is not going to change with me going away and Chris coming on but the.

The first part of your question on the comfort level. One thing we do for the board as Vic mentioned, they are very supportive and I think I might've mentioned the two year. When we spoke after Q1 as we kind of keep up.

Mathematical profile in front of them and just being under Levered. Today, We just had board meetings last week and if we were to spend roughly $250 million and bring along $25 million of EBITDA. The 10 times obvious multiple that would only put us at one five times leverage in the care of that math exercise of the step.

Forward, if VIX posts were two five we could spend another $230 million, which together says we could spend $450 million and the 10 X multiple only be levered up to $2, five which I think from an ideal capital structure was not something that would be uncomfortable.

I'm not implying that's what we have in the pipeline, but just to put some posts around how this math carries forward.

It would be ideal if we could find $450 million of spend and bring along $45 million of of EBITDA, but just really just calibrating. Two five is something that would be extraordinarily comfortable for a company of our size.

Thank you both very helpful on I'll turn it back.

And again, ladies and gentlemen, please feel feel free to press star one if you can.

The question next question will be coming from the line of.

On one side of the CJ add securities your line.

Line is open.

Yes.

Use of that question a lot so ill defined right now it's hard to say I don't think theres any downside to us that's for sure I do think debt and some of the things we'll be going into renewable energy some of the things that we go out of the grid.

Those kind of standard I think shouldn't should be have the potential to be very helpful to us.

But industry the ill-defined, that's probably the biggest area, where we would see a positive impact I mean, the other thing I think that we look at a lot is what the defense budget is right I mean, a good bit of our events business sales A&D and it looks like its holding up pretty well and as we've talked about before I mean, we were.

Really think more about it in the areas, where we participate so you'd look at it.

<unk> side of the particularly submarines, which of the vast majority of our of.

Much of our product goes that's really rock solid in anticipation of the change in at all and then the other thing obviously look at it from a budget perspective is the asset we have of.

Great position on the SLS program.

That appears to be very solid as well. So I think the infrastructure Bill gets a lot of attention as it should they debt will be helpful to us, but as we look at those other two budgets in many ways are just as important to us.

No.

Great and last one for me as far as the test business a competitor of yours was recently sold.

Wondering if that's changed the competitive environment at all or anything special Youre seeing there.

No.

The reality is we didn't compete with them a lot because they are really very focused on aerospace and defense, we do some of that but I'd say that debt.

That's the business, it's a bit different than ours, we do some work with them in fact.

We've done some work within the out of that we will continue the work.

Q2 2021 ESCO Technologies Inc Earnings Call

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