ESCO Technologies Inc (ESE) 2004 Q2 法說會逐字稿

Good day, and welcome to the ESCO second-quarter conference call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO; Chuck Kretschmer, President and COO; and Gary Muenster, Vice President and CFO.

And now, to present the forward-looking statement and for introductions, I would like turn the call over to Ms. Pat Moore, Director of Investor Relations.

Thank you, everyone. Good morning. Before I read the statement, if you do not have the press release, it is available on our Website at escotechnologies.com or by dialing 314-213-7216.

Statements made during this call regarding the results and timing of divestitures and real estate sales, the associated costs and resulting savings to be achieved, future revenues, EBIT and EPS, gains, charges and earnings, contributions from new programs and products, the level of co-op and IOU activity 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.

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 Company's press release as an exhibit to the (technical difficulty) 8-K, both filed today. The Company disclaims any intent or obligation to update these forward-looking statements.

In addition, during this call, management may discuss some non-GAAP financial measures in describing the Company's operating results. A reconciliation of these measures to their most comparable GAAP measures can be found in the Company's Form 8-K and accompanying press release on our Website at escotechnologies.com, under the links investor relations, financial reports and SEC filings.

I will now turn the call over to Vic.

Thanks, Pat. Good morning and welcome to our second-quarter conference call. I will have Gary Muenster, our CFO, review the results for the quarter, after which I will have a few comments, and we can answer any questions you have. Gary?

Good morning. As noted in the release, we're nearing the completion of our repositioning activities that we began last year. We have presented the second-quarter results in a manner consistent with the detail presented in our previous communications. As with the first quarter, the only item called out separately is the final costs related to the exit and relocation of Filtertek's Puerto Rican operation. The closure was completed in mid-March, on time and essentially on budget. Rather than recap the press release financials, which we can address during the Q&A, I will provide a few brief highlights. Overall, our results were better than our previous expectations. For the second quarter, we reported earnings per share from continuing operations of 57 cents and 60 cents per share on an operational basis. Our discontinued operations resulted in a loss of 17 cents per share in the quarter. Year to date, earnings per share from continuing operations was $1.06 and $1.14 on an operational basis.

The two MicroSep businesses, which were sold on April 2nd, were the operating units that drove the 17 cent per share loss reported from discontinued operations during the second quarter. Interest income in the second quarter was approximately $300,000 higher than expected, as a result of the final payment of a note receivable related to the Riverhead property which was sold in 1999. The $2.1 million in cash was received in February. The operational tax rate in the current quarter was 37.5 percent versus 39.9 percent in the prior-year second quarter. The current quarter tax rate was favorably impacted by the contributions of our foreign operations and lower state taxes.

Our balance sheet remains very strong, with a solid cash position and minimal debt. The $41 million of cash reported does not include the $18 million proceeds received on the MicroSep sale. From continuing operations, we generated $8.6 million of free cash flow during the second quarter and 19.5 million year to date. Including the discontinued operations, we generated approximately 7 million of cash during the current quarter and 15 (ph) million year to date.

As you noted in the release, we have raised our operational guidance for the year by 5 cents on the upper end and 10 cents on the lower end, based on the strength of our first-half results and the additional visibility provided by the mix of our backlog at March 31 and our order activity through today. We now estimate our operational EPS to be in the range of 2.50 to 2.60 per share, up from the $2.40 to 2.55 per share previously communicated.

Finally, on the governance front, we continue to work diligently on the implementation of the 404 certification requirements of Sarbanes-Oxley. We have completed the formal documentation of our controls for all locations, both domestic and international, and have begun our compliance testing of these controls. We feel that we are in excellent shape to be in full compliance well before the required deadline.

I will be happy to address any specific financial questions during the Q&A, and now I will turn it back over to Vic.

Thanks, Gary. As Gary mentioned, and as was described in the press release, we did have a solid second quarter. I am particularly encouraged that we had strong contributions from across the Company. We still anticipate improvement in the second half versus the first half. This improvement will be a result of several factors, including the benefit of the Puerto Rican shutdown and the move to Juarez, and the elimination of the associated dual-facility costs. We'll have increased delivery of the SecurVision product and additional volume in our filtration segment.

As it relates to the AMR business, the activity remains good, both for the co-ops and the investor-owned utilities. We are pleased to announce a win we had at Bangor Hydro last month. Bangor is an investor-owned utility located in Maine. As far as other near-term opportunities, I remain confident that we are well positioned for success as projects move forward. But many of the customers do not want premature discussions of their plans, and we certainly will continue to respect their wishes.

A real bright spot for us thus far this year has been our cash generational position. Our plans for the use of this cash are pretty straightforward. We will continue to expand our investment to enhance our AMR offering, while (ph) fully funding our new product programs in filtration and tests. We will also continue to pursue good-fit acquisitions that include entry in the gas and water AMR and medical devices companies. We are also considering additional stock buybacks under our current authorization.

In summary, we had a solid second quarter. We've made significant progress in our repositioning actions. In the first half, we're now squarely focused on accelerating the profitable growth of our business. We have robust new product development programs in place across the Company, and plan to augment these with appropriate acquisitions. I would now be glad to answer any questions you may have.

(OPERATOR INSTRUCTIONS). Richard Eastman, Robert W. Baird.

Just a question on the test business, Vic. The backlog's declined a bit quarter to quarter. And I'm curious; could you just maybe outline that business, where it stands, whether there are some large chambers, either shipments or orders that affected the quarter, and maybe how the profit margin looks in the existing backlog?

Yes. That business, as we have talked about before, does have that component where we have large shipments of large chambers at one point or the other during the year. So I'm not concerned about the fact that we did have a little bit of a decline this quarter. We have other large projects that we are currently bidding that could easily replace those.

As far as what's in the backlog, we have a solid backlog, still, in that business. What you have to understand is that we do have some of these larger chambers that are delivered. There can be a significant amount of pass-through content in those, which does caring carry a lower profit margin.

So, if some of the large stuff is shipped, or if there were any shipments in the quarter, is the backlog a bit more parts oriented? Can we hold this margin on slightly less volume, if we need to?

I would say yes.

And then just -- I guess I get a follow-up here. The PP&L contract -- we know it's going to be completed here in Q3. We still face maybe $10 million variances in sales in Q3/Q4, because of the runoff there. Some of that we backfilled with Bangor. Is it possible, with growth on the co-op side and the Bangor business, that we could see flat communications comparisons in the second half, or are we still likely to be down a bit?

I think we will see that being flat. We have been very successful in further penetrating the co-op market, and certainly the Bangor investor-owned utility is going to help, as well.

Patrick Forkin, Rockhouse.

First of all, congratulations on the substantially improved EBIT margins and filtration tests of 10 and 11 percent. It's been a while coming, and I applaud you guys for the work that you've gotten done in making those significant improvements.

Vic, your comment on potential acquisition in the gas and water segment, the AMR market -- two questions. I am assuming you're talking about something that has a wireless platform. And do you think that can be accomplished between now and the end of the year?

Well, certainly we will have to use a different technology than we currently use. Ours is a powerline-based system, and obviously we don't have powerline contact to all the gas and water meters. Where we do have the proximity of the electric meter, we have a solution for that today. We are precluded from addressing gas-only and water-only utilities. So that will require different technology, certainly. So that hopefully answers the first question.

As far as your second question, that's certainly our hope. There are opportunities out there that we are evaluating, all the opportunities available to us. We are going to make the right acquisition at the right time. Sooner rather than later is our preference, but we are more concerned about making the right acquisition, rather than doing it quickly.

(OPERATOR INSTRUCTIONS). Steve Sanders, Stephens, Inc.

Just a follow-up question on the filtration side. I think you had guided that orders and shipments could be a little soft in Q2, ramping up in the second half of the year. I wonder if you could just comment on the quarter in particular, and then just refresh us on the second half of the year. I know you have got some new products. Commercial aviation does not seem to be particularly strong, but stable. So just a little more detail on the filtration side?

Well, as I said in my opening statement, that is true; we do see that accelerating in the second half. This quarter was what we had anticipated, essentially what we anticipated; margins were a bit better. But as far as the second-half sales perspective, it does look like it's going to increase over the first half.

And then, Gary, on the discontinued operations, what should we expect in the next couple of quarters? I guess the sales actually closed the first day of this quarter, and you still have the Italian operation?

Right.

Can you provide a little guidance there?

Yes. Generally, as we have communicated in the past, the Italian operation, which is the remaining MicroSep business, has been profitable. And so we don't anticipate a discontinued operations event like you see in the second quarter there. So I would say marginally profitable for the balance of the year. Obviously, there will be a few close-out items relative to April 2nd, but they are not material. I would calibrate it at a penny or two, plus or minus. So operationally, BEA is profitable.

And a final question, on the Bangor contract. Can you just give us a little more detail on implementation there? I think it was expected to pretty much start immediately and be a 12-month kind of install. I just wanted to get some more details there.

That's correct. That contract has been signed, obviously, and we will start deployment in the next 90 days or so, and that will be done within that 12-month period.

It's 110,000 meters, so that's something that is really driven by their ability to install them rather than our ability to deliver the product.

James Gentile, Sidoti & Co.

About the filtration margins, could you kind of look out beyond the next couple of quarters, and indicate whether or not there is an incremental upside to your operating margin in that segment? Can we potentially see 13 to 14 percent in that segment, maybe next year or long-term?

Well, James, as we talked about before, next year our plan is to get full benefit from the move from Puerto Rico. So just with the cost savings there, we are projecting that at about $2 million a year. And certainly, you know us well enough now to know that we are not going to sit still on where we are at; we are going to continue to push the margins. So we should be able to continue to push those up in the future, as well, beyond just that savings.

Which product lines in the second half do you expect particularly strong? Filtration?

Generally, James, it's the defense-aerospace products; they are continuing to be very robust for us, and also some of the medical filtration devices that we manufacture out of Filtertek are picking up. And just generally, with having Puerto Rico close, where we can focus more on the manufacturing out of one location, I think a lot of the effort is going to be refocused into the sales efforts there, once we have all that distraction behind us. So it's really across the board. The automotive business has been stable, but defense-aerospace and medical are going to be the primary drivers there.

Next year, are you expecting a more difficult comparison in defense?

Well, we really have not commented on next year. But I think, relative to -- you hate to hang this on the war effort and the war dividends that are coming out of that, but as long as the activity over there in the Middle East continues, I think we're going to continue to see reasonable strength in that.

Taryn Conner (ph), Wellington Management.

Just a question on the inventories. We saw a decline sequentially, Q1 to Q2. And I guess, if you go back and look at the last couple of years, your inventories usually go up. And I am wondering if that is related to the sale of the businesses, or if there is anything going on there.

No; the sale of the businesses were all deconsolidated down into the line item called assets from discontinued operations. So those are totally excluded from the numbers that you see. But relative to 12-31, the decline that you see there is about $1 million. The majority of that comes from -- in the test business, the large chambers that Vic alluded to, where we delivered a substantial amount of product over in Europe. And obviously, the inventory associated with that has been sold. So you're seeing a net $1 million decrease, and it is resulting from the test business, the large sale of the chambers, and it is being offset by the ramp-up of inventory to support the growth in the second half. So the net decrease is really manifested by the test chambers.

Just one follow-up for Vic, and this is related to the AMR business. You have had a few contract wins here, Maine Power and things. And I am just wondering, from your standpoint, what do you think is holding some of the other big utilities back from investing in this technology? It seems like it does work, and you have had a successful implementation with PP&L, and now you have got some follow-through with some of the other smaller utilities. So I am just wondering, from your perspective, what do you think is kind of the sticking point here?

I don't think that there's any single thing. You have to look at each of these utilities individually, because although there are some macro trends that will drive people, it really does come down to a business case decision at each and every one of these utilities. So I don't think I can make a comment that says there is one thing or the other that is holding those up. But I am encouraged that we're starting to have some activity in the investor-owned utilities side. But really, you have to go and look at each of these projects on an individual basis and try to work the individual business case for those businesses.

But at the end of the day, that's what it's all about. They need to be able to convince themselves that yes, the technology does work. And I don't think there's any doubt about that now; it's really, more importantly, how am I going to get the full benefit? How am I going to rationalize and justify the investment that we are making? And people are certainly actively looking at that, and we are actually trying to help them with that process.

(OPERATOR INSTRUCTIONS). Richard Eastman, Robert W. Baird.

Gary, does the tax rate stay down here? Is it going to depend a little bit on where your profits come from?

Yes; it really rides off of that, Rick. Again, I can't overemphasize the chamber business contributions in Europe. Obviously, as we ship more product over there through our Euroshield business, we have a lower effective tax rate on the European content. Filtertek Ireland contributed there, as well. So we are not going to see it bouncing around like 2 or 3 points per quarter, but really the contributions and where this product is manufactured and ultimately sold has a big thing to do with that, because test business products that are sold out of the United States, especially in the MRI side, if they're manufactured in Chicago you have the Illinois state tax rate. And that the kind of thing that will bring it back up. So really, the volatility in the tax rate is a function of where it is manufactured.

And could you also remind us the net cash per share that you realized on the sale of basically the two MicroSep assets?

We realized $18 million off of a base of 13 million shares, so it's about $1.10 to $1.20 per share.

That's net cash in now? Okay. And lastly, Vic, you guys have put some resources into the Asian test market, set up business there, selling marketing there. Is some of this growth in dollars coming out of Asia? We talked a little bit about Europe and the bigger chambers, but how does Asia look, at this point, on the test side?

It's increased. We are starting to get some traction there. It's a bit of a slow go, but that was a way we had planned it. We were already doing some sales into Asia through our U.S. operations. And think by planning to operate (ph) we have a manufacturing operation in China, and we have a sales and engineering office in Japan. And we are starting to get some traction out of those. Obviously, we made that investment for the future, and it's starting to pay some dividends now.

And this does conclude today's question-and-answer session. And now, I would like to turn the call back over to Mr. Vic Richey.

All right. Well, we will close out and appreciate everybody's interest. Thank you very much.

Once again, this does conclude today's conference. We thank you for your participation. You may now disconnect.