ESCO Technologies Inc (ESE) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the ESCO second quarter 2005 conference call. [OPERATOR INSTRUCTIONS] 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, I would like to turn the conference over to Ms. Pat Moore, Director of Investor Relations. Please go ahead.

Good morning, everyone. If you do not have a copy of the press release that we released this morning, you can dial the number 314-213-7216.

Statements made during this call regarding the level of revenue contributions from each segment, future investments, potential acquisition, growth in the AMR market, and potential customer contracts, fiscal 2005 revenues, EBIT, EBIT margins, EPS, fiscal 2005 corporate operating expenses, the success of cost-reduction efforts and effective tax rates, the longer-term revenues and earnings of the Company, the Company's financial control systems, compliance with the Sarbanes-Oxley Act, 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 had such statements are only predictions and speak only as of the day 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 issued today, which is an exhibit to the Form 8-K filed today. The Company disclaims any intent or obligation to update the forward-looking statements.

In addition, during this call the Company may discuss some non-GAAP financial measures in describing the Company's operating results. A reconciliation of these measures, to their most comparable GAAP measures, can be found in the above mentioned Form 8-K, and accompanying press release on the Company's website, escotechnologies.com, under the links Investor Relations, Financial Reports and SEC filings.

I'll turn the call over now to Vic.

Good morning and welcome to our quarterly earnings conference call. As was detailed in our press release, we had a solid second quarter and have improved our earnings outlook for the year. I will now turn it over to Gary Muenster, our CFO, to provide some additional insight into our financial performance, and I will follow-up with specific commentary on our opportunities.

Thanks, Vic. Good morning. As noted in the release, our second quarter and year-to-date results were at the top end of our previous earnings guidance of $1.50 to $1.60 a share for the six months ended March 31. Total sales increased 4% in the current quarter and 6% year-to-date. Communications sales increased in the second quarter over prior year, due to another strong quarter for deliveries of SecurVision products and a 9% increase in the deliveries of AMR products. Our second-half outlook for SecurVision revenues is approximately $5 million lower than the first-half actuals, due to the catch-up of past-due deliveries within the first half related to the previously mentioned software upgrade.

Tech sales were relatively flat during the second quarter and filtration sales decreased slightly , due to a downturn in the automotive sector. Commercial and military after-market sales within the aerospace group remained strong during the second quarter. SG&A increased approximately $2 million in the second quarter compared to prior year, almost entirely within the AMR business, as a result of our deliberate investment in marketing, new product development and program management , spent in conjunction with our expectations to further penetrate the investor-owned utility market. In total, the SG&A outlook for the second half of the year is expected to be consistent with the run-rate experienced during the second quarter.

GAAP earnings per share increased substantially in the current period, as the prior year results included -- I'm sorry, $0.40 a share which included the $0.03 charge related to the Puerto Rico plant shut-down and the $0.17 charge in discontinued operations related to the MicroSep businesses, prior to their divestiture. EPS of $0.80 increased 33% during the second quarter, as compared to the prior year's operational EPS of $0.60. While all segments increased their EBIT dollars year-over-year, the most significant contributions to the EPS growth were the continued strength of the communications segment, a cost reimbursement realized at Filtertek, and continued strength of the aerospace markets.

In our outlook section, we raised our total year EPS guidance, based on the additional visibility we have at this time. In the process, we also lowered the effective tax rate expected for the year, due to a more favorable profit contribution from our foreign operation. Our March balance sheet remains very strong with the net cash position of approximately $74 million. We generated over $12 million of free cash-flow in the second quarter and 25 million year-to-date. These amounts include the $1.5 million received relating to a license agreement signed in the second quarter. The year-to-date cash balance also reflects the $25 million spent during the first quarter to repurchase 335,000 shares of our stock. We expect to continue our strong cash-flow generation for the balance of the year.

Entered orders in the second quarter were 114 million, which resulted in a back-log of 253 million at March 31. In the filtration segment, we recognized approximately $16 million of the $18.5 million multi-year order related to the Virginia Class Submarine, mentioned in the first quarter earnings release. The balance will be recorded upon completion of the final negotiations. Within the communications segment, orders from co-op customers remain solid year-to-date and we are somewhat impacted by timing within the six-month period. If you recall from my comments during the first quarter call, co-op orders were higher than expected due to the timing of the orders received in December versus our expectations of the receipt in January.

As you are aware, the FASB recently extended its new guidance related to the expensing of stock options. This rule will now be effective beginning with our fiscal '06 first quarter. On the governance front, we continue to work diligently on the implementation of the 404 certification requirements of Sarbanes-Oxley. We feel that we are in excellent shape to be in full compliance by our September 30, 2005 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. Again, we are pleased that we had solid results across all segments of our business, despite some challenging end markets. While our filtration earnings are up year-over-year, further progress was hindered by the impact of petroleum prices on our raw materials and a quick reaction of customers away from larger domestic vehicles. In communications, the activity level for advanced metering products remains very high.

A quick update on the three IOU pilots we discussed during our last call. We anticipate the expansion of one project in the next couple of months. The second pilot should advance to the next phase in the next six to 12 months. And the third remains in the early stages. Additionally, we have proposals in at a number of other IOU customers, where we feel we are well positioned.

We also continue to make good progress in our co-op market, with approximately 28 million of orders in the second quarter and greater than 50 million year- to-date. One example is an Indiana buying group of ten cooperatives, which worked through a selection and due-diligence process together and selected our (inaudible) solution for their 100,000 customers. We also added three new states to our back-log this quarter and are doing business with nearly all states that have electric cooperatives. Additionally, we are starting to make in-roads in the municipal market and, in fact, we received orders from ten muni's thus far this year. So, while we are encouraged by the significant IOU opportunities, it is also important that we continue to support our co-op and municipal customers who provide annual sales of approximately $100 million.

As I mentioned in the press release, we have not been successful to date, in adding to our communications segment or acquisitions. However, we remain active and are confident that we will ultimately achieve our goals in this arena.

Moving to the test segment, we continue to make good progress across the board. The Asian market remains strong, particularly for wireless customers. Additionally, our component shipments have been higher than anticipated, which enhances the overall margins. We continue to diligently work our cost and are pursuing drop-in component acquisitions.

In summary, this is a very exciting time for ESCO. We have a good position in the advanced metering business to serve the IOU's. Our number one priority is to protect and expand that position by fully supporting the business with the necessary financial and human resources. Our co-op business base, combined with our other two segments, provides a reliable, profitable foundation on which we can build. I will now be happy to answer any questions you may have.

Thank you. [OPERATOR INSTRUCTIONS] Our first question this morning will come from Steve Sanders with Stephens Incorporated.

Good morning.

Hi, Steve.

Question first on the AMR side of the business. We are obviously seeing a lot of data points that would suggest the RFP activity is pretty robust. Would you characterize that sort of across the spectrum of small to large orders? Do you think these data points are based primarily on, you know, a few big orders that are brewing out there or do you see the activity pick up as being very broad base?

I would describe it more as broad base. Certainly, there are a couple of large orders or opportunities out there that most people are familiar with, but it's not just those. I mean, we -- As I mentioned, you know, beyond the things that we have from the pilot perspective and some of the other measurements people are aware of, there are a large number of other RFP's that we have been responding to over the past six months. I would say it has been a flurry of activity around here for the past 60 days or so.

When you look at your specific business there and the value proposition, can you talk a little bit about what you have been able to do in terms of taking cost out of the system and improving functionality that would, I guess, supposedly improve the value proposition for the customers.

Two different points there. One is the functionality. We have been talking for the past -- well, probably the past year, we do continue to invest in that. We have enhanced the functionality we have. We talked about pre-paid acquisition that we made last year. We have introduced a disconnect, remote disconnect switch more recently. We've added some other software enhancements that are important to the utility things, like the outage map. We have enhanced that, as well.

So there's a lot of functionality, I think, that does improve our position, particularly given the fact that we have a fully two-way system. I think that's important to a lot of utilities. On a call side, we talked a couple of quarters ago about the fact that we were able to take some cost out of the products and we continue to work that. I think we will be able to make some further progress there, which is important I believe, as we look at the competitive basis of some of these larger opportunities.

And a follow -up on that. I suspect you are not going to give us any percentages. I would love to have them if you would. But when you look sort of look at the system for a larger installation today versus, maybe, a couple of years ago, can you tell us anything about the cost side? You know, have you taken 10% out, 15%, 20% and/or could you tell us anything about your opportunities there going forward?

I would say to date, certainly we have taken out greater than 10% of the cost. I think that we have the opportunity to probably do that again, as we go forward.

Okay. And then a question on the filtration side. First, on the numbers. I think that the auto piece, and I may be wrong here, is 10 to 12% of the overall Company, 20 to 25% of that segment. I'm also guessing that it's a relatively tough margin business, not bad business but tough. Could you just check my assumptions there and then, comment on whether the weakness you see on the auto side is, you know, from where you sit, a significant problem for the overall Company or something that you can work through here without a meaningful bottom-line impact?

The first thing I would say that I believe all your assumptions are correct, that you made early-on. As far as the long-term impact of the business, I don't think that's going to have a huge impact on the business. While our sales on a domestic basis and in Europe are down on the automotive side, we have been able to replace some of that in Brazil, where we have been able to do more, actually, product than we have participating in before. So we have actually taken some market share from other folks. That's going to help offset some of that. But, it is not going to have a huge impact on our business. We feel it is important that we are, you know, upfront with everybody that there is some softness there and we have had some impact.

Okay, thank you very much.

Moving on, we'll hear from James Gentile with Sidoti & Company.

Good morning. Just following up on the AMR comments that Steve made, there was one sizable utility contract announced with no particular vendor specified. But apparently, you know, a North Carolina utility is going with an RF kind of drive-by system which, I guess in many of our opinions, was almost a legacy-type of technology. I guess I would like for to you reiterate where the competitive advantages are in terms of where you are seeing the bidding of some of these other larger pilots that you are participating in and if, in fact, we could see some price pressure over the next couple of years in order for you guys to get your fair share of the business?

Sure. Yes, we obviously were disappointed that that utility went in that direction. I would call it an anomaly. Everything else that we see, from other utilities, the ones that people are aware of and maybe that aren't, really are pointing towards advanced functionality.

Just to give a little background again on that, to do things like time of use billing, critical peak pricing, excuse me, outage mapping, on-demand reads, anything that it really -- where you have to be able to communicate with the meter on a very frequent basis, that's a real value proposition that a system like ours brings versus a straight drive-by system. Now, there are live drive-by systems out there, and they do a good job for what they are designed to do. I do think that, obviously, we think the future is with a fixed network and certainly the vast majority of customers, at least the new ones coming on-board, are heading in that direction, as well.

As far as the pricing pressure, certainly, the larger utilities, because of the volumes that they have, do expect improved pricing and that's one reason we continue to diligently work on the cost side, so that we are able to remain competitive in that arena.

Great, thanks.

Now our next question will come from Patrick Forkin with Rockhouse Securities.

Good morning.

Good morning.

Last night, there was some correspondence out of the one of the commissioners in California responding to an application that was made by one of the utilities for AMI deployment, and it seemed like a common theme in her question was, are you sure you are going to be able to meet the functionality mandates that were laid out by the state in 2004? And, if you proceed with AMI deployment, will it cause any conflict or future stranded assets if that same utility decides to do something with BPL broadband over power line?

Vic, can you kind of address what you think the functionality of your system is with respect to those California mandates, and then, you know, some of the recent questions surrounding compatibility with BPL?

Sure. Certainly, the thing that we -- obviously are very close to what is going on out there and what the requirements are and we feel that our product does satisfy those needs. Obviously, we have been working with the utilities there to understand the requirements and, you know, we feel confident that we are going to be able to do what they are asking for.

As far as the BPL question, what I would say is that we can operate harmoniously. There is nothing that precludes a utility from coming in after the fact, and if they want to do that on a spot basis to do that, because of the fact that our signal closes at the same level as the electric signal itself, there is really -- it is kind of, can't be seen by the system, if you will. So if they come in and put another system on top of it, there shouldn't be a problem with compatibility.

And with respect to your engineering efforts over the last couple of years, is -- you know, it seems like BPL might have some interconnect with your core competencies. Is that anything that you guys are looking at?

Certainly, we stay close to that. There have been some thought about using a back-haul mechanism. There has also been some thought that maybe you could use that as a complementary technology, rather than -- you know, BPL maybe being a system-wide application, which would require, really, a change to the -- I would say, to the utilities approach to business, as well as making a pretty large investment, which may or may not be used by all the consumers.

So, what we would see is continue to use a system like ours for the advanced metering portion of it, and then -- and in some circumstances where it could be used as a complementary technology in localized areas. That's still something that could work with our system.

And then with respect to the three funded pilots that you talked about last quarter, I know you guys, for a good reason, did not name those utilities. But, it's my understanding that you are under consideration at PG&E. Could you confirm whether or not that was one of the funded pilots or not? It's my understanding they didn't use sort of the pilot approach?

Yes, they did not use the pilot approach out there.

So if you were successful at all with PG&E, that would be in addition to those three funded pilots?

That's correct.

Okay. Very good. And last question. The new order number for filtration, I think roughly 60 million, was fairly strong. Could you comment on that?

The real strength there was the one order that Gary mentioned for the Sea World where we had a three-year -- I'm sorry.

For the Virginia Class.

For the Virginia Class, I apologize. I get my submarines confused here. For the Virginia Class. That was a three-year contract. That was, I think, $16 million that we booked. So, that was kind of the over-and-above piece of it.

In addition, we did book the order for the T-700, which is a system for the T-700 and other engines, but that's a five-year contract so we only booked a couple of million dollar, $2 million of that within a quarter. But, longer term, over the next five years, that should be approximately a $20 million contract.

And last question, Vic. I think you had mentioned there had been a lot of activities in the last 30 or 60 days. Would you kind of contrast where you are at today versus where you were at when we spoke last quarter, as far as the overall AMR activity?

I think that it's consistent with where we were a quarter ago. It's just that now a lot of those RFP's came in, and we respond to those and we continue to respond to those. So, I would say it has been consistent over the past, you know, couple of quarters.

Okay and then from a legislative standpoint, we are starting to see some positive signs of legislation that could both -- more at the state level than the federal level, I guess -- that could, I guess, be a positive for -- make it easier for large utilities to deploy AMI systems. Any comments along those lines?

No, I would agree. We have been a little disappointed that the federal bill has not retained. Well, number one, they have not been able to pass anything just yet, but it has not retained some of the benefits that we thought might be there that would maybe accelerate this. There has not been anything that has really been a setback, either.

I mean, they do suggest studying adoption of advanced metering. But we have seen some of the states, particularly Texas, that it looks like they are going to move forward with some more meaningful support of rate recovery. And, obviously, if the utilities can get some assurance of rate recovery up front, then it is probably going to enhance their ability to move forward.

Right. Okay, thank you very much.

[OPERATOR INSTRUCTIONS] We'll now hear from Steve McNeal with Jennison.

Good morning.

Good morning.

I actually had a question regarding the license fee. You guys are recognized within the filtration business. By no means am I an expert on licensing-fee revenue, but my thought was that would be a much higher margin stream of revenue. Can you help us understand why -- it looks like there was -- one over -- I guess a $1.3 million dollar cost stream associated with that revenue.

Now, Steve, how that works is -- what we did is we licensed some patented technologies that we have and we are allowing them to use that over the patented period. And, so, what you have to do from an accounting perspective, you are only allowed to recognize the revenue on the past -- the paid up portion. So, from the time they started using the product up through today, you are allowed to take revenue over that period. And then the balance that you see there, the differential between the 1.5 million and the 200,000 basically gets accreted into income over the balance of the license period, which goes through approximately 2011. So, you are only -- we did get the cash of 1.5 million , the paid-up portion is 200,000, and the balance of that income will hit ratably per quarter over the next, whenever that is, six or seven years. That's how the accounting drives that license.

I see. I wasn't aware of the duration. So, 200,000 for the next seven and a half quarters, something like that?

Yes, in ballpark terms. It's reasonably a straight-line accretion period. So, there -- to address your other point, there is no cost associated with that.

Okay, fair enough. Just on the buy-back in the balance sheet, I think you guys have traditionally articulated your strategy vis-a-vis buy-backs on a quarterly basis. What are the expectations in the current quarter for the current quarter?

Yes, we do not anticipate making any buy-backs in the next quarter. We evaluate at every quarter. But what we -- today, I would say that we really want to try to keep our cash available for any acquisitions that we can make. I know we have not made much progress there, but we will continue to work that. We think that's the best utilization of the cash after we fund our organic growth.

Steve, let me clarify something just -- as you responded to that license question. That 200,000 you were talking about is over the next few years, not quarters. It's not 200,000 a quarter.

Okay. Fair enough.

Because the 200,000 income that we recognize was the cumulative catch-up of all the past usage that they had.

Do you know what the go-forward rate is going to be then.

You can just about take the balance of that over, like, a straight-line basis, over the future periods.

Okay. Through 2011.

7.5 years, I believe it is.

All right, fair enough. And then, Vic, back on this -- I think in your commentary regarding the co-op business, you had talked about, I think -- you had thrown out a number of $100 million?

Right.

What did that refer to?

Well, over the past year or so, and as we look at the business going forward, between the co-ops and the muni's, I think that's kind of the base that we should see from those businesses.

Okay. But that's not a commentary on what the revenue is going to be this year?

No, no.

In that business? Okay. Okay, very good, thank you.

All right.

We will now hear from Greg Macosko with Lord Abbett.

Yes, thank you. Could you talk a little bit about any development or technology you are working on with regard to the natural gas area and how you may ti -- the opportunity there to tie that into your existing network?

We had mentioned a couple of things in the past. I will just reiterate those. First of all, we had developed a product that we sold to one customer for a short-haul RF system where we were able to speak with the gas meter, transfer that information to our electric meter. Then more recently, I believe, two quarters ago, we announced that we were working with Badger to further that product, both on a water and on a gas side. Again, what we have is only where there's -- today, is only where there is an on-network capability, and we have to have the electric meter present to be able to read the gas meter. That's what we are doing today.

And is that -- is that capability part of the California discussions?

I don't think it's appropriate for me to talk about specific contracts, but that's the approach that we are taking with -- an approach to the gas market today.

Okay, thank you.

We'll now take a follow-up from Steve Sanders.

I want to follow-up on the acquisition side. You know, you made a comment in the press release that, you know, potential sellers are feeling sort of proud about their businesses, obviously based on the RFP activity and some of the things that are going on. I just wanted to see if you could update us on your thoughts versus partnering, building, buying. I know you just made a comment a minute ago about what you are doing with Badger. Just an update on what you are thinking there?

Sure. There are certain capabilities that, you know, obviously we are working on in-house as it relates to our core product, electric product. I think it's important for everybody to remember, that's where we have our strength and we are going to ensure that we are doing everything that we can do to ensure that we have the best product available for the electric utility. We are doing a lot of things internally to make sure that that happens and to support those customers, both investor in the utilities and the co-op's and the muni's.

But, beyond that, we are going to bring -- get the different technology in, whether it be for stand-alone gas and water or, you know, to get more vertically integrated in this market . That really would really require an acquisition. We think that would be the best approach, probably the lowest risk approach and that is the type of approach that we would take.

I think you made a comment that you are seeing some opportunities on the test side. I didn't hear you say anything about filtration. Are you seeing acquisition opportunities there?

There are some things out there. I would say that, today, we really want to stay primarily focused on our communications segment. That's the best near-term upside opportunity to really make some progress for ESCO. So we are going to focus on that. And second would be the test. I think that you know us, and we to try to do what we can do and do it right, rather than try to do all things at once. We're going to keep our focus near term on the communication side.

Okay. And then a final question. I know you gave some detail, Gary, on the second half for the contract products. What about a little more intermediate-term to the long-term outlook. How do you feel about that business? It's my understanding it's a good margin business and sort of thinking over the long-term, it's got good potential. What are your thoughts?

Yes, I wish I could give you a clearer answer today. But I am struggling to do that, just because we are coming o -- we have been focused on getting through these last six months with this customer , and now continuing to satisfying their requirements, that we are now kind of getting back into the game on additional customers. We know we have a good solid product. It is a good margin business. We have the strongest partner with ADT, but we have been so focused that -- that team has been so focused on satisfying the near-term requirements, that now we are in the process of stepping back and saying, where do we go next with it.

Okay, thank you.

We will now hear from Jason Simon with JMP Security.

Good morning, guys. Did you say what SecurVision was for the quarter?

Yes, we did. We said 3.5 million.

3.5 million. And anything from PPL this quarter?

For PPL, I'm sorry?

No. Second question was anything from PPL, as well?

Yes. There was about 0.5 million. I believe it was 400,000 was the exact number.

Alright. And it seems to me like something closes in the next few months. Is that something that you would expect to see revenue from in the June quarter or would that be closer to September?

If we get anything in the second half, I would think it would be fairly moderate. I mean, it's really more of an '06 and '07 type.

And, VIc, how would that be announced? I mean, would it be a pilot project at first or would it be a contract that will be announced in total, that we get kind of -- you know, estimate or guesstimate some revenue numbers off?

It really depends on which opportunity would be. Different utilities are taking different approaches. I mean, there are some that are ready to commit for full-scale deployment. There are some that are talking about, you know, doing a more staged approach. I can assure you that, as soon as we find out something, I will communicate it with as much clarity and insight as we have.

Certainly.

To address your specific question, the most near-term opportunities that Vic's referred to are either expansion of existing pilots or they would be going out forward without a pilot.

And just on the test side, I think you mentioned in your press release expansion in Asia.. Could you maybe update us on that, give us some clarification. And you mentioned of the ability to cut costs. I was wondering how are you are going about doing that?

Sure. Asia has been very good for us. We, about two years ago, put a manufacturing facility in mainland China. And, really, the important thing there was to have people on the ground to be able to access the customers. And a lot of the development work has started moving in to China for some of the wireless companies. And so, when they do that, they need to have the test chambers and we really do have an excellent product there to service that.

So the chamber market has been improving in China, as well as in Japan, and what that does, in addition to just the chambers themselves that we manufacture and deliver, it also increases the amount of component pull-through that we are able to sell from the states into those system, as well. So, while some of the other markets, end markets for the (inaudible) business have softened a little bit, Asia has really accelerated. I think our move of a couple of years ago has put us in an excellent position to be able to harvest some of those opportunities.

As far as the cost, that is something that we to a lot of, but we do have a focused effort. There are some other places to try to reduce our material cost and we are starting to see some benefit from that.

Alright, very well. Thanks very much.

You bet.

And that will conclude today's question and answer session At this time, I would like to turn the conference call back over to Mr. Richey.

Okay. Well, I appreciate everybody's continued interest in ESCO and we'll talk to you in the future.

That will conclude today's conference. We do thank you for joining us.