ESCO Technologies Inc (ESE) 2003 Q2 法說會逐字稿

Goods day and welcome to the ESCO Technologies conference call. Today's call is being recorded. Victor Richey, Chairman and CEO, Chuck Kretschmer and Gary Muenster. And now to present the forward-looking statements I'd like to turn the call to Ms. Pat Moore.

I trust everyone has a copy of the press release. If not it's available in full text on our website or by tailing (314)213-7216.

I will now read the statement. Statements made during this conference call regarding future fiscal '03 revenues, gains, charges, earnings and others statements which are not strictly historical are forward-looking statements within the meaning of the Safe Harbor provisions of the federal securities laws. Investors are cautioned that such statements are only predictions and speak only as of the date of this call. The company's actual results in the future 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 press release filed as an Exhibit to the company's form 8K filed today. ESCO Technologies has no obligation to update the forward-looking statements. In addition management will discuss non-GAAP financial measures. A reconcile relation of these measures can be found in the company's form 8K filed today and contained at the website under Investor Relations financial reports and SEC files. I'd like to turn the call over to Victor Richey.

Thanks, I'd like to welcome everyone to the conference call. We'll start with a brief overview of the second quarter results as well as the first six months. I ask Gary Muenster to do that.

Good morning I'd like to provide a brief overview for the financial results for the quarter including an abbreviated commentary on three previously disclosed items that impacted the reported results.

First, during April, we sold Rantec power systems for $6m plus future consideration. The Rantec financial results are presented as discontinued operations and, therefore, are excluded from the majority of the following discussion. The second item relates to a 7-cent per share charged taken in the second quarter related to the termination of the Watman supply agreement referred to as the MSA. We are currently involved in the settlement discussions with Watman and I believe we will be successful in this matter. Any subsequent settlement will be recorded as a gain in the period realized. The final item relates to the management transition agreement referred to as the MTA between the company and our former Chairman who retired in April. The impact of the MTA was three cents a share during the second quarter and six cents a share year-to-date. The MTA was expensed over Mr. Moore's service period. The impact of the MSA and MFA was 10 cents a share in the second quarter and 13 cents a share year to state.

The operating performance in the second quarter, sales increased $27 million or 32% with approximately 90% of the sales growth being organic. The communications segment accounted for the largest portion of the increase with year-over-year sales increase of $17 million or 85%. This growth is primarily due to increased shipments of automatic meter reading equipment to PPL and continued strength in the overall co-op market. PPL sales in quarterly $15 million for a year-to-date total of $38 million. Test segment sales increased 46% in the second quarter primarily due to the recent acoustic acquisition, sales of addition additional test chambers and Asia operations. Filtration sales increased 4% to $50 million as a result of higher shipments of Filtertek products.

EBIT increased $1.4 million during the quarter as a result of the continued strength of the communications segment. Test segment EBIT also increased in the period on its higher sales volume while the filtration segment was adversely impacted by the MSA and investments in microfiltration and separation. EBIT excluding the MSA and MTA increased to 10.4% of sales during the second quarter as compared to 9.5% of sales in the prior year. The bottom line reflects an 8% in GAAP net earnings to 43 cents compared to 40 cents per share in the prior year. Excluding the impact of MSA and MFA net earnings on a comparable basis increased 34% to 53 cents a share.

Moving to the six-month year-to-date performance, sales increased 33% in the current period with 95% of the sales being organic. As with the second quarter, the communications segment accounted for the largest portion of the increase with year-over-year sales growth of 94%. PPL again accounted for the majority of the growth during this period. Test sales increased 27% and filtration sales increased 8% year-to-date. EBIT increased 28% in the first six months of fiscal '03 compared to the prior year, and the net increase resulted from the profit contributions of the communication segment. Test segment EBIT increased in the period on higher sales volume but partially offset by continuing Asian investment. The filtration segment EBIT was adversely affected by the MSA as well as higher engineering and new product development costs as well as the establishment of a German sales office to support the microfiltration business. EBIT, excluding the MSA and MTA, increased to 10% of sales during '03 compared to 9.4% of sales in the prior year.

Year-to-date GAAP earnings reflect 23% increase to 93 cents per share compared to 77 cents per share in prior year. When excluding impact of MSA and MTA net earnings increased 39% to $1.06 per share when compared to 77 cents a share the prior year.

During the first six months of '03 the company generated approximately $10 million of free cash flow which is defined as net cash from operating activities less CAPEX. Our balance sheet remains strong and our focus on asset management remains a key initiative in improving our operating cash flow for the balance of the year. At March 31st, order backlog remains strong at $268 million with approximately $140 million of that backlog related to the communications segment. The company recorded approximately $102 million of orders during the sect quarter and $204 million year-to-date. The test and filtration segments both recorded favorable book-to-bill ratios in the second quarter and six-month periods. When looking at the communications segmented year-to-date and excluding the impact of PPL sales, they also recorded a positive book-to-bill ratio of approximately 118% which favorably reflects the continued strength of DCSI's underlying core business.

On the accounting front, the financial accounting standards board recently issued new literature which impact our synthetic lease obligation currently accounted for as an operating lease. As a result of this accounting change, we'll be required to capitalize the facilities and the related debt during our fourth quarter of fiscal 2003. This will require us to record a non-cash after-tax charge of approximately 11 cents a share, and it will be reported as a cumulative effective accounting change.

Finally, we are working diligently on the implementation of Sarbanes-Oxley certification. And although the deadline is extended we expect to be in full compliance by September 30th, '03. Now to Vick for commentary.

This is our first conference call. There's a lot going on within the business and a lot of digest. For that reason I'm happy to have the opportunity to address the results and the outlook directly and to give you an opportunity to ask any questions you may have of me or my team.

Overall operating results for the quarter were solid. However, we had a couple of disappointments. Most notably, the failure to resolve the Watman issue and filtration margins, which are somewhat intertwined. I will move to the activity in the third quarter. Subsequent to the second quarter, we completed sale of Rantec. We also favorably resolved a long-standing patent dispute, and we received ESCO board approval to have two restructuring actions.

First, the sale of our Rantec subsidiary. Our Rantec Power Systems was a solid business. It simply did not fit within our core business segments. We therefore made the decision to sell the business. From a financial perspective we received $6 million of cash in the third quarter and will reels a gain of $1.5 to $2 million in the quarter. In addition, we have the opportunity for an additional $6 to $7 million over the next ten years. Second, we settled a patent dispute in the thirty quarter related to a medical device we've manufactured for a number of years. In addition to the $7.3 million of cash we will receive, we will recognize a gain of approximately $2.2 million in the third quarter. The remainder of the gain will be spread over the remaining life of the patent. So not only are we happy to have the cash, we are also pleased of the another distraction behind us.

Third, as I mentioned in the press release, we made a significant decision to shut down the Filtertek manufacturing facility in Puerto Rico. We'll move it towards Mexico and Illinois. We made significant progress at Filtertek over the past several years. However, I felt it necessary to make structural changes to that business to take it to the next level. As outlined in the table, there will be charges in the third quarter and over the next 12 months when the transition will be completed. This action will result in 110,000-foot reduction or approximately 10% of ESCO's overall footprint. I'm confident that the savings highlighted in the press release are real and very achievable.

It's important to understand that we're moving to an existing ESCO facility in Juarez. We consistently have had higher than average productivity and lower than average employee turnover in that facility. We have a well-seasoned transition team leading the effort. While making the decision to close the plant it's difficult because of the impact on the people, it's the right thing poor the business.

Finally, the last item is restructuring of Pan-European test business. As many of you know we made significant number of acquisition in this segment and have been aggressive in plant closures, moves, and restructuring to ensure we have the best possible cost base. With this initiative, we're focused in the Pan-European facilities on what they do best and ensuring that we don't duplicate efforts.

I'd like to now shift to my outlook for the business. Certainly many issues resolved -- or to be resolved coupled with the actions that are taken make it more difficult to provide a definitive EPS outlook balance for the year. For that reason we've widened the GAAP earnings range on the up and down side excluding the impact of the accounting change. I think it's important to understand that from my perspective, nothing in the underlying businesses happened to make us view the aggregate full-year operating results differently. In my view, all of the actions we have taken or will take are positive for the long-term performance of our business.

I've been somewhat vague on our contemplated actions as they relate to microfiltration. This is simply because we have not yet totally flushed out all of our alternatives. But I felt it was important, since we're going through this process, to make you aware of it. We are obviously not getting acceptable results in all parts of our filtration segment. I feel it's necessary to take decisive actions to address this and our move from Puerto Rico is an important first step. I don't want to leave you with the impression that the overall filtration business is bad. That's not the case. Some of our filtration businesses are solid performers. The reality is that in some areas we simply underestimated the time and investment required to fully realize the potential of our technology and product. As such, we are now, among other things, revisiting the propriety of continuing with those.

In our communications segment we have extraordinary financial performance. The question on everybody's mind is when are you going to enter the next investor owned utility. What I can tell you is that where we have ongoing trials, it is performing well. Additionally, we continue discussions with a number of very interested parties. In my opinion, it is not if we enter another investor-owned utility but when. Fortunately the co-op business has remained strong.

Finally, solid improvements in the test business, and after a very challenging year last year, the collapse of the tell telecommunications market have a significant impact on the business, but we have seen a pickup for recently. We have taken a number of actions to focus our energies on the growth markets in the test segments. I will open up for questions for myself and my team. After that I will have a few closing remarks on the business.

The question-and-answer session will be conducted electronically. If you would like to ask a question, press the star key followed by the digit one on your touch-tone telephone. If you are using a speaker speakerphone, turn the mute function off. Please limit yourself to one question and one follow-up question. Press star 1 on your touch-tone telephone to ask for a question. We'll pause for just a moment.

And we'll take our first question from Richard Eastman from Robert W. Baird.

Good morning. A couple things on the filtration business. I'm curious with the ongoing problems with the microfiltration piece. Is that the old AMT? The second part of the question is what kind of sales are impacted there as well as dilution on the EPS line or the EBIT line?

Can you give me a little clearer question? I'm a little confused by what you're trying to understand.

If you were to take some action there -- if I jumped to the conclusion and said are you going to close down that effort, is there a sales impact to you, or is it strictly an EBIT impact?

There's a potential there would be both. I would say that, you know, we're looking at a broad range of things and, so, it's hard for me to give you an definitive answer today. Until we go through that process to understand better what the best at alternative for the salesmen and shareholders, it's hard to give an answer. Chuck?

Rick, some of the alternatives we're considering would reduce our volume. Clearly, they would increase our profitability in the near term because as Vick outlined in his release those undertakings are currently significantly delutive to earnings.

Okay. So as we adjust Puerto Rico and pull those costs out, you know, that's, perhaps, 200 basis points of margin, plus this would be incremental to that. So we potentially would be pushing against 8%, 9%, 10% operating margin and in filtration.

That's correct. We're looking at improving the filtration margins and I think Puerto Rico is an important first step. Anything we do with the remainder of the business, obviously, we're looking to improve those margins as well.

This is Chuck Kretschmer. Rick, for a long time, we indicated that the double-digit EBIT margin was a place we wanted to be with all of our segments. We're well above that in communications. I believe we're on the way there in tests. And, so, these actions are directed at that target that we've had. So I think, as you think about 8%, 9%, 10%, that's consistent with how we're thinking about what's got to be accomplished there.

Let me ask just one more question and I will get back in the queue. When you throw the $1.75 to $2 gap guidance out, there would you try to or attempt to put an operating number out there?

Rick, this is Chuck Kretschmer again. Vick and Gary and I all wanted to do that, but it was suggested by our counsel that we're discouraged from in today's environment providing non-GAAP guidance.

Okay.

And, while we see that others do that, again, I think we're trying to make sure we're observe the right side of the regulatory perspective about earnings guidance these days.

I'd save some cost and cut those legal guys out of it.

We've got one in the room here.

Sorry. All right. Well, we'll come up with that ourselves. Thanks.

And we'll take our next question from Patrick Forkin with Rockhouse Research. On the additional addition.

On additional chamber sales, what end markets are those going to.

The pickup that we've seen is more markets we served historically, the telecommunications market. That was a difficult market last year, but we've seen a pick up. I'm encouraged, as you know, we sell our chambers for use in the new product development process. It is capital equipment and there's no way to hide from that, but the reality is it's not to support manufacturing, it's really to support new product development. So these customers are always going to have to develop new products. And, so, as we see that industry pick up, we're going to be on the front end of that.

Okay. Then on the AMR side of the business, could you sort of characterize from a -- from the perspective of proposals and field tests, where you are today versus a year ago, and your comment with respect to the large IOUs in proposals to the field tests that you have now. Is it 1 or 2 or 4 or 5, and how would you gauge those best the size of a LL PP & L.

The overall activity to address that is probably a little higher than it was a year ago. As far as the size of the investor utility, those really vary. There are some the half the size of the PPL and some half the it is consistent or maybe even a little better than it was a year ago.

Okay. And then you apparently have some field tests going with wrapping in gas and water to the electric side. Can you comment on that at all?

Really, as you know, we have taken the approach of not really talking about field tests. The only exception is we issued a press release and responded to that. We choose to not talk about field tests because there are a number of those that are going on at any given time, and we don't like to give an impression that because we have a field test a contract is going to follow. Sometimes those are done and then the utility never follows through or they do at a much later date. So I think we'll continue that process as we go forward.

Thank you.

The next we'll hear from James Gentile with Sidoti and Company.

I was wondering if you could give me insight into other income line given the range of the charges for the second half. Conservatively, it looks like for the third quarter, with a $400,000 decline be, you know, negative outflow be feasible, or are you expecting something little larger than that.

Gary, would you like to answer that?

Yeah. James, when you look at what's embedded in the second quarter, the Watman charge of $1.5m is the driver there. Then amount sized on the portfolio we purchased last year. So when you look that extraordinary items, I don't think there's anything in there over and above what you have for Watman. So I suggest normalizing it by we moving Watman and give or take 100,000, that's our run rate.

And your tax rate is a little higher than usual for the 37% fore forecasted at the end of fiscal '02. Should we expect that to be around 39% now in the last couple of quarters.

Yeah, for the balance of that year. We had a little bit of unusual item. You know, we're been carrying and a significant net operating loss carry forward. In the last few years we've been utilizing that as our profitability is even and. We had a 13-year-old dispute with our former parent relative to what we have there. So there's going to be an adjustment to our tax provision, which we recognize in the second quarter relative the timing of the NOL. To that's unique to that in the second quarter and will be normalized for the balance of the year.

Great. So beyond the sale of your microfiltration, what else would you consider -- explain to me what options are out there that you're considering.

Yeah, James. This is Vick. You know, let me just kind of back up a little bit and kind of give you my perspective on what the issue is. Over the past four years we've undertaken a number of significant initiatives. We acquired a number of businesses and technologies in that segment. We've added people and infrastructure to support those, and we obviously aren't getting the results that we anticipated. So we've added a lot of costs, and we haven't yet achieved the growth. And, so, there's this whole time and cost issue in investments. And beyond that, I would say there's a potential bit of digestion issue. So individually, these make a lot of sense, but collectively, they're not really, yet, working. So whatever we determine that we're going to do will either be an action that would result in narrowing our focus or reducing our infrastructure costs.

So among the actions that we would consider would include, you know, product line divestitures, maybe discontinuing certain R&D or new product programs, maybe some level consolidation within the operations, maybe outsourcing some of the product we currently do, developing partners with -- on the system side of the business. Or, you know, we could consider a broader divestiture action. So, you know, there's a whole range of things. Some may say, well, why are you talking about this today before you've really explored that? I think the facts are that if you look at the margins we've had over the last several quarters, they've not improved. We have two options, we can continue to march or we can take some decisive action, and we're going to come down on the second half of that.

Great, thanks.

Next, Michael Braig with A.G. Edwards.

Could you sort out the comments on continuing strength in the test sector? Would that include test chambers or test cells, or was the second quarter a capital spending event that's unlikely to be repeated over the balance of the year?

I certainly hope not. I think that what we've seen is a general strengthening of that whole end market of the past three quarters. I mean, the orders have picked up fairly consistently. It's not been just the chambers, the components have improved. The other thing that I think we've done is we've focused on a couple of the growth areas, that being in Asia, and we've really got to get a result out of Asia so far. The medical side of the business has been very good. Also this past quarter we've seen a strong pick up on the government shielding side.

And as a follow-up I believe you indicated the restructure in the U.K. for test would perhaps focus that operation on its strengths. Could you comment on what those strengths are?

Sure. What we've done is, when we -- you know, we built that business through acquisition as well, and what we're currently doing is shielding production in both locations. We had duplicate sales organizations, making shielded doors, a number of products we're doing in both locations. So what we're doing now is we're going to do really all the manufacturing except for some electronic filters we co in we do in our finish operation. We consolidated the sales force, so we have one sales force serving all of western Europe and eastern Europe. So we've put the manufacturing in one location except the very specialized area and we've downsized that dramatically as a result of that.

Okay. Thank you.

All right.

Once again, if you would like to ask a question, please press star 1 at this time. As a reminder, please limit yourself to one question and one follow-up question. We'll move now to David Kurzman with H.C. Wayne Right.

Couple of questions, seems that with the revenue guidance increase for the communications and the test equipment driving the revenue guidance increase for the total company, that one would expect a commensurate increase in the EPS guidance. But instead, what we have is really more of, as you guys said, a widening of the range with lowering the end side of it a bit. The question I have is this largely to due to the -- what you expect to be the expenses incurred for the fixing of the filtration side?

Right. I'd agree with that. As I mentioned earlier, my view of the underlying business is not different than where we started or what we talked about at the end of last quarter. The real difference, you have to go back to that chart that we put in the press release, which hopefully provided some clarity. That was our intent. But the widening of the gap or the range is -- really, have to take all of those I stems into consideration as we widen the gap. But the underlying performance of the business is unchanged from the last press release.

Unless I'm reading this wrong, because I'm looking at the table and I've done the calculations. But unless I'm reading this wrong, really, the top of the range only increased by a penny or two. Isn't that right?

I think -- this is Chuck Kretschmer -- that's how you think of the cumulative effect of the accounting change which is an 11-cent charge in the second half. Again, we don't want to get into a lot of non-GAAP guidance, but to add clarity, that wasn't part of the prior guidance. And perhaps you could start by adding that 11 cents. I also wanted to follow up on your previous question, and while it's true we're seeing -- we've reflected a strengthening in the top line in communication and tests relative to our previous guidance, I think the cautionary note is that we've also, as we've suggested, seen weakening in the microfiltration and separations area, which is the area we intend to take action on. And, so, that's why Vick says the aggregate outlook is essentially unchanged, you're not getting the updraft that you might expect from the good news we see on the communications and test side.

Now, I want to sort of reinforce what Rick mentioned earlier, and that is that, you know, getting the message across is, I think, part of that battle. Let me switch over to the line here that says the disparity of the contribution between the segments continues to be an issue. In that context, you're going to try to meet your longer-term objectives. I guess I'm not clear what steps you're going to be taking to change the disparity of the contribution. Because what I hear you saying is that you're taking a look at your filtration business with a critical eye, but I don't hear how that is, sort of, fixing any disparity.

Well, I mean, the bottom line is we want to improve our filtration margins. Shutting down the Puerto Rican facility, moving to Juarez, we're going to get cost savings. I think what we have in the press release is more than achievable, so that's going to drop straight to the bottom line as we go forward. On the microfiltration side, that's a separate issue. We've not get said what we're going to do because we haven't made that determination. But I think we do is going to be aimed at improving those profit margins. So if we're able to do those things, raise the profit margin to the filtration side, we're going to come much closer to what we experience in our test business. And then all three segments will be performing at an acceptable level.

But you've got a business that grocery much, much more slowly with than the other two when compared to communications. So it's always going to be a game of catch up. So is there a sense of you want to use your existing dry powder to make some acquisitions? Or what else are we talking about here?

As we go forward, we're talking, I think, about two different things. One is how we're going to improve the current business that we have and where we're going to focus in the future. We see, you know, opportunities across the business, but certainly we're going to have a strong focus on our communications business. The margins are higher there. The growth potential -- the growth opportunities appear higher there, as well. So as we go forward with the business, you know, we're going to be open to opportunities across the segments, and certainly we want toll focus on the growth markets as well. Chuck, did you want to add something?

I might add that we didn't mean to imply we're trying to achieve absolute parity in the margins across the segments. As I was speaking to Rick earlier, we had sort of minimum thresholds that we regarded as acceptable, and when those are looked at in the context of the investment, there are reasonable returns for the segments. So the objective for the filtration is to get it at double-digit EBIT margin, and that, too, is the focus of the actions we're taking. I'd say, at this point, it's my view that the actions we are considering would largely be non-cash charges, if there's a charge resulting from them, and they would have, you know, almost a medium improvement on the earnings side, given the dilution that we're experiencing in the microfiltration and separation at this point.

Okay. Thank you.

Steven Colbert with JMP Securities.

What's the top line in the filtration segment in view of what’s double-digit top line growth in first quarter at about four and a half% in this first quarter compared to last quarter.

Yeah, we're reflecting 4.4% second quarter, Steve.

Is it slowing down?

We had a unique pop in the first quarter relative to very strong auto and aerospace contributions. What we're showing second quarter to second quarter, I don't want to call it slowing down, because you're still looking at $50 million, which approximated what we accomplished in the first quarter. And, so, the Filtertek products are the primary driver there, which is the combination of their automotive products remaining strong. And we're seeing the medical aspect of Filtertek continuing strong. We're seeing pullback in the separations in the microfiltration side which is muting the growth. And again, that's reinforcing our necessity to take some action here.

So we're seeing growth in the positive contributors that we've had in the first quarter, primarily auto. Aerospace was reasonably strong as well. And the micro and separations side of the business gave little back period over period.

So, in effect, the breakout of filtration and margins -- I'm sorry -- and markets, the area that was weaker in the second quarter, was the highly-technical type markets, the microfiltration markets tend to serve.

I don't know that I'd call them highly technical. It's a combination in the separation side. It's the E code in the dairy business softened. I don't necessarily agree with high-technical. It's more in the dairy and the paint booth area is the two areas that softened for us.

Okay. Can you help us understand a little bit in terms of the margins or the -- you know, in terms of the second quarter for filtration, if it wasn't for these areas you just talked about as being sort of problem areas in the microfiltration and the separations area, what margins might look like in the quarter?

I don't know that we can comment on that specifically other than to say that microfiltration was mentioned there as delutive to the results. And, so, I think, Steve, you had put out a piece in the past that calibrated that so I guess your conclusion is what you have there. We are not going to comment on what it is but to say it would obviously be north of this because of the dilutive aspect of micro.

With the margins in the second quarter been on par with the first quarter given that the volume was about the same.

Again, I don't think we can comment on the specifics of that.

Thank you.

Greg McKosko (ph) with Lord Abbot.

Would you talk about the orders and book-to-bill? You mentioned that the communications was about 1 point -- almost 1.2. Could you compare that to where it was in the previous quarters and kind of where the backlog stood in the last quarter?

Yeah, in the first quarter, we had 145% book-to-bill, again, because our first quarter, which is obviously the last calendar quarter is where a lot of the co-op businesses step up to the plate. So that's higher than normal. In the communications side, it's 118% in this period. And that doesn't necessarily indicate a slowing down. More it's a typing function of the December 31st December 31st quarter end. So the backlog, obviously, during the quarter decreased by $10 million because we booked $102 million and had sales of $112 million. And, so, at January 1st, the backlog was at around $280 million. Again, PPL is the big one off thing we call out because the [lunchness] of the IOU orders is going to influence the book-to-bill. To provided a reconciliation on the last page of the release to show what the core business looks like in communication absent the one-off investor-owned utility. So when you back off the sales to PPL, you see the backlog strengthened because of the positive book-to-bill ratio across the company in all three segments.

With regard to the guidance range, I'm assuming that would include all of the potential Gaines as well as the charges, too? .

That's correct. When you look at the table and you see the range of the potential costs and/or settlements, you know, one, if you took the low end of every range and took the high end of every range, you can see the breadth of the spread that we allowed to. So on a GAAP basis, you know, we know those are all going to come out within those ranges, but the timing of when the gains will be recognized is somewhat up in the air. So we're confident that the range and the band we put around the thing today is where we'll land on a GAAP perspective.

And you mentioned the establishing of a German sales office for microfiltration. Is that going to continue?

That's completed. We have the people in place for that. We've seen good early results as a result of putting that in. So we've established that office and I think it's an important thing as we go forward.

With regard to Rantec, was that operation profitable in the last year or 12 months?

I was. It was profitable. It was.

For the fiscal year '02, it was approximately 10% EBIT, and that, obviously, has, as we disclosed, the 2.5% management fee embedded in there. So it's a decent business.

And then, of course, it's left out of what the range is.

Correct.

Thank you.

Thank you, and next well hear from Steve McNeil from State Street.

Morning.

Morning.

Was wondering if you could talk a little bit about -- maybe walk us through the decision process on the closure of the port I are Puerto Rico facility versus the closure of other locations. I know you maintain a fair presence in California and Illinois, and just from a cost perspective, thinking that, you know, Puerto Rico is obviously relatively beneficial from that perspective. So maybe you could walk us through on your thinking of why to close on that facility.

Let me give a few comments, then I will let Chuck follow up because he's been heading that effort up. When we bought filter tech they had a facility established in Puerto Rico. And a lot of the advantages in place then have changed or are in the process of changing. In addition to that, our facility itself is not in the best locations, it's in a pretty remote location. The labor rates are not as attractive as they once were. I mean, you can really manufacture in the U.S. at about the same rate you can in Puerto Rico these days. So we're actually going to get a big cost advantage by moving to Juarez. We'll get in a facility that's more appropriately sized for what we're trying to accomplish. And the other thing is, when the facility was established, there were a lot of customers in Puerto Rico, so we were close to the customers. Many of those customers have since moved from the island to other locations. So for a variety of reasons, we made that decision. So, Chuck, do you want to adding anything to that?

I think that gets most of it, the initial reasons for being there, the landscape in that regard has changed considerably. I guess the other thing, as Vick mentioned, it's 110,000 square feet and, essentially, what we're doing by moving to Juarez and consolidating is we're doing that work in 40,000 square feet as it relates to Filtertek. So I think it was the opportunity to separate ourselves from something that was far too large for what we had going on down there.

Were any structural problems, you know, operationally with the plant.

No, I think the plant was running reasonably well. But again, you get to the cost issue relative to the amount of activity that you have in the plant. So when you say structural, I would say, in that regard, that's true. There are also other issues with respect to Puerto Rico, like wind insurance and things you won't see in other locations. So we were experiencing some increase in cost that was specifically related to being on the island.

Okay. And then, related to the restructuring activities in aggregate, it looks as though, you know, you'll get roughly $16 million of cash, let’s call it midpoint of range here, on top of the $30 million you have today. What's your thought as the cash is building on the balance sheet, you know, what the possible uses would be of that cash?

They're all pretty straightforward. We've made a number of acquisitions in the past. We continue to look for that in the right areas. We have the option of buying back stock. So, you know, there's all the traditional uses. We continue feel compelled to do something immediately, but we're obviously weighing our alternatives as we alternatives as we go forward.

Is M & A the logical conclusion here, or are you going to pay down the synthetic lease you're going to bring on.

We haven't determined what we're going to do that. We have to bring it on the balance sheet. We have the option of paying it off or borrowing the money, so the decision has to be made by the fourth quarter, and we'll address that.

I was wondering if you could talk about the working capital drag for the six-month period. Looks like there's been, you know, AR, inventory and accounts payable have all been a drag in that regard and perhaps you can address, you know, the inventory billed and the reasons for that.

The biggest overall issue is the inventory. And it's been the inventory in the communications segment. And very simply, the customer, Pennsylvania power and light, has been installing the product I extremely quickly. And, so, we wanted to ensure that we were in a position to satisfy their requirements. So we got very aggressive, I would say, maybe overly aggressive, some could say, in building inventory to address their requirements. You can look at that in retrospect and say maybe you build too much inventory, but, you know, our view is, a very important customer, we're going to do what we need to do to satisfy their needs. So if we had to spend cash to do that, that was something we were going to do. So we had an aggressive program to get the inventory back to a reasonable level over the year, but that's the simple answer. That's the biggest driver in the working capital change.

Okay. Now, have you built inventory in anticipation of any incremental IOU deals.

No. We always keep inventory both on the substation side and transponder side to be able to respond to customers. Not specifically built anything for investor-owned utility. We have a number of co-ops that come on in the year. In fact, really, the manufacturing side has not been an issue for us. The facilities we have in place, the outsource manufacturers we have in place, I should say, are more than capable to ramp up quickly to address any level of manufacturing that we require.

My sense is that the PPL contact is normalized now. I know we had a big jump in the first quarter because there was a lot more equipment sales. Is it safe to say the install rate is normalized now -- from now through the end of the contract?

Sure. I mean, I would say that we're not going to see a big spike again in that. You know, over time, of course, it's going to start taper off this next year, but we certainly aren't building additional inventory ahead for the PPL project.

Can you just remind us again, specifically, you know, the relationship with ADT and the applications? I think it's more commercial-type applications, but can you refresh us a little bit will?

Sure. It's a video security system, a very advanced video security system, I would say, that we sell almost exclusively through ADT. The end customers are companies like Federal Express, Bank of America, Citibank. The Government has bought a number of those products recently. So the primary customers are commercial in nature with some Government business as well. ADT sells the product for us. And then what they do is they monitor the systems as well, in most cases. In some cases, a large customer will want to monitor their own. We provide the hard ware, they sell it and they monitor the product.

So your relationship with ADT is largely exclusive.

Largely exclusive, I would say.

Okay.

We sell through other outlets, but those sales are less than 5% of the overall sales.

There's no contract or anything with ADT? It's just sort of as they need these units, they order them from you.

That's correct.

Okay. Do you see that business growing any beyond the ADT side.

Well, I don't think it needs to grow beyond the ADT side to be successful because ADT -- if you look at ADT versus the other people in the market, you could add up the next 15 to 20 players in the security market, and ADT would still be larger. So if we're going to be successful with ADT, the product will be successful.

Yeah, because I know GE is in that space now with interlogics, and they seem to have a very similar lineup of products. I'm trying to get a sense there.

Yeah, I'd say the biggest difference is our server-based technology and the fact that we can monitor literally hundreds of sites, provide that information to ADT's control is center where they can monitor these locations around the country.

I wanted to say thanks for having your first call and compliment you on your three-letter acronyms beginning with the letter M.

Thanks.

Please if you have to a question, please press star 1. We'll now hear from Terun Kahana (ph) with Wellington Management.

I've a question on effects and what the impact for the company is as a whole and is there any kind of transaction exposure here?

This is Gary. I will address that. It's nominal. I mean, the majority of our sales are within the continent, so we're not exposed very broadly. If I had to put a band around it on the sales side year-to-date, it's between one $1 to $2 millions and on the profit side between $200,000 and $300,000. Off of a base of $220 million in sales for the six months You're talking inconsequential.

Got it thank you very much appreciate it.

You're welcome.

Next we'll hear from Sanjay Serisa (ph) from First Albany.

Regarding the AMI market, you guys seem to be doing well. From the competitive standpoint, how is the overall competitor landscape in the marketplace as well as you mentioned a little bit about introducing some new products. Can you talk a little more about that? After the introduction of the product, who would you be going after and things of that nature.

As far as the competitive landscape, I don't think that it's really changed significantly over the past couple of years. I mean, the competitors are pretty straightforward. We compete with [Itron], Schlumberger, and a myriad of smaller players. On the co-op side, Hunt and other smaller players. The real players are ourselves, Itron, Schlumberger and Hunt. And like I say, from time to time, there are some other smaller players. We don't talk about new products until we launch them and confident in our capability. We certainly look to continue to develop and expand in the AMR market, certainly on the electric side, and we're always going to leave open the option of moving to the other markets as well.

Okay. That's fair. Would you actually lack to come up with that product in-house, given some of the smaller players in the market have been hurt, would you look to grow that in the business through acquisition as well? And could you comment on the pricing environment where you stand with your technology verse the other technology that's out there?

Sure. To address your first question, we'd look at both. We have a lot of RF capability and power line capability within the company proper and within ESCO as well. So we have the capability to develop those new products but we did also look at the alternative of looking outside. So that's something we could take either approach in. And as far as top pricing, really, this product is not sold on price. There's always pricing pressure, people always want it cheaper. But the way we see it, if people want advanced metering, if they want power line technology, they'll go us with. If they want to do simply automatic meter reading and not have any advanced capability, then they may go with the competitor. So the decision is usually made on the technology and not on the price.

Fair enough. That's great. Thanks a lot, guys.

And next we'll hear from Richard Eastman with Robert W. Baird.

On the AMR side of the business, would it be accurate that PP&L takes quarterly deliveries in the $15 million range? Does it look like that through balance of the year?

I don't have the schedule of that in front of me. It starts to taper off in the fourth quarter and into the next couple of quarters. So you kind of see that natural curve on the installations. And what happens is, with this customer and with most customers, what they do is, up front, they do the densely populated areas so they can get as many of the transponders in the field as possible. As you move from the dense areas to less populated areas, installation goes down.

Did WPS come back in?

We're making sales to WPS today.

Okay. Then just lastly, maybe for Gary, just so I understand, the cash implication of the charges and gains, it appears they're going to net out positively.

Yes.

Charges, obviously cash out for restructuring, some of those things, but do you have any guess with the things you announced today as to what the positive cash implication would be.

Well, obviously, I will address them individually, the patent litigation item, that's real money we'll be getting in the next 30 days. Rantec money is in the bank. We received that at closing. Really, the key point to lay out here is, looking at the Puerto Rico exit cost, the charge relate to that is really just a write-down of the book value to what we've estimated with the independent appraisals we've received. We feel in the next 18 months we can sell the business, so, net-net, it's a large cash positive to us. Again, where you see the $4 to $5 million of cash, we're comfortable we can get $4 million for the property based on the appraisal. So that's the real delta between the charge and the cash. The rest of them match up pretty well.

This will be. You're up around 15 to $20 million positive?

Yes, if you take -- if you just take those three items, absolutely.

Okay. Then you kind of restructuring cash out is going to be a fraction of the charge.

)) Right. The severance and move costs what we've calibrated at $1.5 million and the restructuring from $200,000 to $500,000. So it's tremendously more positive on the cash side.

Okay. Very good.

Thank you, the last question is from Patrick Forkin.

When you were talking about the landscape you mentioned PLC technology and sort of the advanced technology or features. Are you referring to the ability to take hourly reads and how important, if the answer to that is yes, how important is hourly reads to the whole time of use rate structures and sort of, you know, what the rights regulators are saying about accepting AMR into the rate base?

Sure, Pat, that's certainly what I was referring to, not only the hourly reads but other advanced reading we can do. What our system allows utility to do, since it's not a mobile system, they can collect data on a frequent basis. If you're going to introduce time-of-use billing where you charge one rate for 3.00 in the morning versus another for 3.00 in the afternoon, you have to have the granularity in the data you're collecting. With a mobile system you can't do that because you have to dispatch trucks or people out to collect the data. So with our system, that is a real feature that we provide that a drive-by system wouldn't provide. We see, as utilities go forward, that there's more and more interest in being able to do time-of-use building, outage mapping, a whole variety of things that are provided with additional at that data that you're able to derive from our system versus some of the others.

Thank You.

I appreciate everybody's interest and questions this morning. I know we had a lot to cover because of the length of the press release and a lot of things with have ongoing. But as we enter the second half of this fiscal year and, importantly, looking ahead to '04, I'm really excited about the opportunities we have as a company. We have excellent prospects across the company that sustain our momentum and increase shareholder value. We're going to continue to focus on expanding our presence in the AMR market because we're confident of the growth opportunities there. The test segments weathered a difficult economic environment. We maintained the market and focused on the growth markets within that segment. The filtration segment in the aggregate is obviously performing below expectations, but we have some clear insight into the issues and we're taking actions where appropriate and, at the same time, we're going to continue to invest in those businesses which are performing well. And lastly, you know, we are very fortunate to have extraordinarily dedicated and talented employees across the corporation, and I've a great deal of confidence we're going to be able to accomplish our mission, to enhance shareholder value. I look forward to talking again with you next quarter.

That concludes today's conference, thank you for attending.--- 0