ESCO Technologies Inc (ESE) 2005 Q4 法說會逐字稿

Good day and welcome to the ESCO fourth-quarter and year-end 2005 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 statements and for introduction I would like to turn the call over to Ms. Pat Moore, Director Investor Relations. Please go ahead, ma'am.

Good morning, everyone. You should have a copy of the press release, but if you do not you can access it at our website, ESCOTechnologies.com, or by calling 314-213-7216.

Statements made during this call regarding the level and timing of revenue contributions from each segment; future investments; potential acquisitions; future contract awards; the timing, ultimate value and quantity of products, software and services to be ordered and accepted under our contract with PG&E; growth in the AMR market and of our DCSI, IOU co-op and municipal programs and opportunities; future VACCO T-700 orders; the impact of the federal energy bill; stock option expensing; fiscal 2006 revenues, EBIT, EBIT margins, sales and EPS; fiscal 2007 revenue, EBIT margin and EPS; fiscal 2006 corporate operating expenses; the success and timing of product and software development efforts; effective tax rate; the longer-term success 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 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 reflected 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 these 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 at ESCOTechnologies.com under the links Investor Relations, financial reports and SEC filings. I'll now turn the call back to Vic.

Thanks, Pat. We've obviously got a lot to cover this morning, so what we'll do is I'm going to first turn it over to Gary, let him provide a little insight into the fourth-quarter and '05 results and then talk about the assumptions we have for '06. And then I'll talk more about '06 and the future. Gary?

Good morning. As noted in the release, our fourth-quarter EPS of $0.39 was at the top end of our previously communicated range and was driven by an improved EBIT contribution and a slightly lower tax rate. My commentary will focus on the fourth-quarter results versus our previous expectations that we communicated in the August earnings release.

On the revenue front, we expected sales to be up slightly in Q4 over Q3 and we were able to realize an increase of approximately $1 million. Filtration sales came in at the high end of our range driven by better-than-expected commercial aerospace deliveries at PTI. Test revenues came in at the low end of our range as we had a few large chambers which were completed in October versus our plan to be complete in September.

Communication sales of 37.3 million came in slightly above the high end of our range as DCSI delivered about $2 million more than previously projected offset by slightly lower SecurVision deliveries. We expected consolidated EBIT to be up slightly in the fourth quarter as compared to the third quarter. And the actual consolidated EBIT also came in $1 million higher driven by the additional communications revenues.

Filtration EBIT came in slightly lower than our previous range as Filtertek experienced higher raw material costs primarily on their petroleum-based resins. PTI and VACCO came in essentially on plan. The test business EBIT of 3.5 million beat our expectations as a result of the favorable changes in sales mix leaning more towards the higher margin component business. The communications EBIT was near the high end of our expected range and was volume driven.

Also impacting EBIT within the communications segment is the fact that we continue to invest in SG&A at DCSI. The majority of this spending is the result of our outlook for the AMR business and is being spent on marketing, new product development and program management to enhance our pursuit of additional IOU opportunities. As we move through fiscal '06 we expect to further expand our investments in this area as we continue to introduce new products, features and software enhancements to our overall AMR solution.

Our balance sheet remains exceptionally strong as we ended the year with $104 million in cash and no debt. Fourth-quarter cash flow of 19 million was slightly better than we expected due to a large cash receipt from an AMR customer in Q4 which was delayed from Q3 along with the progress payment received earlier than expected at VACCO. This level of cash on hand along with our untapped credit facility should be sufficient to allow us to continue to invest in our internal growth initiatives and to support our currently identified acquisition opportunities.

Regarding fiscal '06, our EPS expectations are in the range of $1.15 to $1.30 per share which is obviously lower than our '05 actuals. We have several moving parts which are significantly impacting our expectations and the negative comparisons are primarily driven by the following items. On the PG&E front, although we expect to be delivering product and providing services to PG&E in '06, financial accounting standards do not allow us to recognize any revenue on this contract until we deliver and the customer accepts the final version of the software necessary to fully operate the system at the level the customer is requiring.

From a cash standpoint it is much simpler as we are entitled to collect cash on normal terms subsequent to the delivery of hardware, incremental releases of TNG (ph) software and program support services. I will address this in more detail in the Q&A. Additionally we had very strong performance from Comtrak in '05 as they completed the catch up of previously delayed shipments from the prior year. This level of deliveries is not expected to be repeated in '06 which reflects a decrease of approximately $3.5 million in EBIT.

At VACCO sales of defense spares are expected to be lower in '06 and the T-700 program deliveries have been pushed to '07 due to the timing of demand and current inventory levels at the customer. This causes EBIT to be approximately $4 million lower at VACCO.

Next, as we are in the process of significantly upgrading our TWACS software, we will begin amortizing the capitalized portion of this development in '06 which will impact EBIT by approximately $2.2 million. And lastly, although we cannot recognize revenue on the PG&E contract, we will be incurring additional indirect costs such as engineering and R&D associated with this contract and other IOUs in the pipeline that will hit the P&L in '06.

We are required to begin expensing stock options in the first quarter of '06 and we expect the annual EPS impact to be $0.10 to $0.12 a share which is reflected in our guidance. On the governance front, we are nearly complete with the implementation of our 404 certification. As a result of the tremendous effort expended by our dedicated associates throughout the organization, the project to date has gone very well and we feel that we are in excellent shape to be in full compliance when we file our 10-K and annual report next month. I'll be happy to address any specific financial questions during the Q&A and now I'll turn it back over to Vic.

Thanks, Gary. I think the fourth-quarter results were well covered in the release. And as Gary commented, sales and earnings were generally in line with our expectations. And at 19 million our cash flow exceeded expectations. My comments will focus on what we see going forward.

At the highest level, while I'm disappointed with our '06 outlook, I'm extremely enthused about the foundation we have to deliver a very strong '07. While I would have preferred we made more level progress toward our stated long-term objectives, the timing of our opportunities have not unfolded that way. Most importantly, though, as we look beyond '06 we have programs in hand and near-term opportunities that should provide another period of sustained earnings growth at levels well above what we accomplished in '05.

I also want to add that while my view of our longer-term outlook does not require acquisitions, we are actively involved with two opportunities which should further strengthen our position in the utility communications market. I'll briefly cover filtration and tests and then provide a more in-depth view of our communications business.

In filtration we're making adjustments necessary to respond to the current market conditions. The most challenging macro issues are resin prices and softness in the automotive business at Filtertek. In response we've made adjustments to our workforce, we're continuing to move work to our lower-cost facilities and we're working with our customers on both pricing and product cost changes.

At VACCO our biggest challenge with respect to '06 is the volume decline, the single biggest issue being the T-700 program. Our current understanding of the requirements suggests that we will have a production break mid-year '06 before deliveries will resume in '07. At PTI we've taken a number of steps over the past 18 months to reduce our cost and sharpen our focus. The actions we've taken together with in market improvements should allow for continued improvement in our commercial aerospace business. In the aggregate we're facing a down year in filtration in '06. But the actions we have taken and the current market perspective should provide for improved contribution in '07.

Our outlook for the test businesses is for continued improvement in '06 and beyond. We have a market position in an environment which supports that view. Additionally, we're focused on reducing our product cost and I intend to press harder for more leverage at the overhead cost as we grow our sales. Our performance in (indiscernible) attests our continued expansion in Asia, growth in our components and service work and improved execution on our government programs where we experienced some cost problems in '05.

In communications we continue to believe that if we can maintain a strong foundation in the COOP and municipal markets and layer on top of that multiple IOU programs we can deliver substantial increases in performance and shareholder value. When we talk about the COOP market as our foundation we're generally speaking of the COOPS, municipals and the follow on business that grows with our installed base. So how do we see this segment today? The COOP market has continued to build out, the municipal market's option is accelerating and our installed base is growing.

Despite the fact that we had six soft months in COOP orders, I'm confident that we've re-established our position in this space through software and (indiscernible) mapping enhancement we have recently released and branded AMIgo.

In the municipal space we're gaining traction. To date we have approximately 14 municipals under contract, up from seven in '04. We have two initiatives which support continued progress in this segment of the market. First, the work we're doing with Badger to communicate water reads back to our electric module, and secondly the affiliation we've recently established with Hometown Connections which is a membership sponsored group that identifies technologies which can be deployed by municipal utilities.

Approximately 1400 of the 2100 municipal utilities are members of American Public Power Association and therefore affiliated with Hometown Connections. Annuity from our growing installed base taken together with our new products and the affiliations suggest to me that we can continue to sustain a solid foundation on which we can add our IOU business.

In the investor owned utility space our primary reason for confidence is are previously announced selection of PG&E and the further development of the TXU program. Beyond what is in hand, we're also seeing a continued building of interest in advanced metering at other major IOUs both in the form of additional pilots and active requests for proposals. Additionally, I believe the energy bill will act to further extend the interest in advanced metering. The opportunities are strong, but I believe the business will be available to only those who have a demonstrated capability to handle the challenges of advanced metering.

We have been preparing for this over the past couple years through our investment in new products, next generation software and the human resources necessary to support multiple IOUs as well as our important customers in the COOP space. While we're not completely there yet, I believe we're well ahead of the competition.

In summary, I think we can accomplish what we set out to achieve in communications, that is to maintain a strong foundation in the COOP space and be the solution of choice for advanced metering in the electric utility market. As a result we should also get the financial results that we're all seeking although a year later than we would have liked.

In closing, as I look at ESCO today I believe we have a balanced -- financial strength, opportunity and people to deliver extraordinary long-term results. With that I'd be glad to answer any questions.

(OPERATOR INSTRUCTIONS). Patrick Forkin, Tejas Securities.

I was wondering if I could get some clarification on the 2006 guidance with respect to TXU. Do you have anything in that guidance for anything beyond the current 365,000 end points?

No, just what we have in backlog is all we currently have in our forecast.

Okay. And what do you think the prospects are for further expansion of that system?

Certainly our hope is that they will expand that. It's been our experience in the past that once a utility makes this type of decision they typically will move forward with a broader deployment. As you know, particularly with our system, once you put the substations in place you really have to have a more full build out. So certainly our hope and our expectation would be that they have a broader deployment. And as you know, they have about 3 million end points.

And then the pricing on that additional 100,000 looks like it comes out to $91 per end point; that looks quite a bit higher than -- I think the original 265,000 was like at 70 and PG&E is at 60. It is that 91 and 70 an apples-to-apples comparison?

I think there's a lot of commercial transponders in this particular order which are at a higher price level. Or a higher price point.

Also there's some additional support services included in there as well. As they build this thing out it requires a little bit more back room type things as well.

Okay. And then sticking with 2006 guidance, you mentioned in the release initiation of a full scale deployment on another significant IOU. Do you have anything in 2006 guidance for that project?

It's a fairly insignificant amount, there is some there but it is fairly insignificant.

So has your confidence level on that particular engagement picked up since the last call?

It has.

Okay. And do you expect some kind of announcement on that during fiscal 2006?

That would be our belief, yes.

Okay. Last question and I'll get back in the queue. With respect to acquisitions it looks like you're lying something out for meter data management and something for the gas and water markets. You guys have been working on this for a while. With respect to the entry into gas and water, is there are one target that you're focused on and could you give us an idea as to where you're at in the process and whether you've got anything in 2006 guidance for the acquisition?

We don't want to get in exactly where we're at in the process, but I would say we're very actively engaged with someone. As far as the second half of the question, we do not have anything in 2006 as it relates to an acquisition.

Are you fairly confident you're going to be able to get something done here?

I've said I was confident before so I hesitate a bit but, yes, it feels pretty good. We're working very hard and I think we should be able to get something done.

Okay, thank you. I'll get back in the queue.

Steve Sanders, Stephens Inc.

I wanted to follow up on the AMR M&A side. I think your historical focus has been on acquiring an established vendor and I think a small player has been pretty far down the list. But you've had some big wins, your brand is obviously better; the market's got a lot of momentum. Is it becoming more important to get something done soon rather than get the ideal transaction done?

Our view is still the same. We would like to get a more established player. I don't think that we're -- the folks that we're talking to are more established players. I think we could pull off more of a technology acquisition as you're talking about, but it's still not our first priority and I don't think that's where we'll end up.

Okay. And Gary, I did want you to provide some additional detail on the free cash flow outlook for '06. But I guess a related question would be, Vic, I know you're saving your money for acquisitions and to fund your growth, but the stock is down pretty significantly and it sounds like the strong cash flow is expected to continue; your outlook is very bullish for '07 and beyond. Does a buyback look more attractive here?

I think we really want to take another three months to see where the acquisition is going to shake out before we make that kind of decision. Just because I think that's the time frame that we need to be looking at. But certainly if we're not able to make acquisitions in that time frame then we have to look seriously at that.

Gary, can you provide some detail on your free cash flow outlook for '06?

Yes, I think generally the way we're looking at it, Steve, is it should be consistent with this year with one exception. As I noted in the release that we're going to be spending an additional $15 to $20 million to further enhance our software that we're going out with here. And so from an operational perspective it should be the same, slightly the same with this year in the upper 40s and then if you back out about 25 million for this additional investment in the TNG software which obviously is going to pay for it self over the near-term here with these additional opportunities.

So net net, if you think of it in terms of 20 to 25 with this 15 to 20 million investment on top of that. So it still feels very, very strong and from a tax perspective we don't really anticipate being a federal tax payer until '07, so that certainly encourages the outlook as well.

And then a final question, I know you've laid out a pretty detailed timeline for PG&E both in terms of installations beginning in revenue recognition; there are also obviously some hoops that you still need to get through. Vic, what's your level of confidence that this is going to get done during '07 and not slip?

The things I would point to that give me a good level of confidence are, first of all, they have signed contracts with all the prime vendors. I think that was a big step forward. And then probably the biggest thing is the predeployment funding level that was received by the customer. There have been some discussion on whether that was going to be -- not being whether it was going to be 7 million, whether it was going to be 49 million and they did receive the $49 million in funding. And it was a unanimous vote by the PUCs to give them that funding. So that's the thing that gives me the most confidence that they're going to go forward. They've got a big investment already in what they've done both personnel wise and now financially tied up in this.

Okay, thank you.

Richard Eastman, Robert Baird.

Just a couple questions. One is, Vic, could you just talk a little bit about the competition on the COOP side? In the past it seems like the competition has got some people's attention based more on payment terms, not on the technology. Your response is more technology oriented. And I'm curious just how you see that playing out, are we able to regain our footing there and some marketshare there with software?

Exactly. We've done a couple things as we've noted in the press release. First, I think we have been a little more -- we've been able to work our cost pretty effectively which puts us in a more competitive position financially. But in addition, as I just mentioned, we have introduced some new software which should also set us apart from the competition.

And then the third point I would make is that there's so much focus over the past couple of quarters on PG&E and some of the large investor-owned utilities that I would estimate maybe we didn't pay as much attention to that customer -- that set of customers as probably we had historically. But as I also mention, we have seen a decent rebound in the fourth quarter, we had a good focus -- or in the first quarter of this year we had a focused initiative there and have gotten some pretty significant orders in already this first quarter.

And then some of the trailing business in the fourth quarter and the third quarter, was it a situation where that business was not awarded and additional evaluation was going into the process or was it awarded away from you?

I would say it was more the previous one. There weren't a lot of jobs that were lost. I mean there's always some smaller jobs that do go to competition that it was more a delay than it was us actually losing jobs to other folks.

Okay. And then the second question, maybe for Gary, could you just -- I'm a little bit -- I'm wrestling a little bit with this software expense -- capitalized expense in '06, this $2 million number. Why are those development costs expensed ahead of the revenue recognition on PG&E?

The way the rules work on that is that we've been developing the software using a third party outside contractor, so we've been capitalizing those incrementally for the last two years. And what the rules say is when the product is readily available for sale is the trigger to begin the amortization on that cost. And so ballpark terms January of '06 is when the software in its early configuration, which is version 1.5, is salable to the mass customer base and so we have to begin the amortization on that, further complicate it with the rules on revenue recognition because what PG&E is actually contracting for is an incrementally higher version of that and so the final sale to PG&E would be something like a 3.0 of that.

So as we incrementally deliver from a 1.5 to a 3.0 we will be taking the amortization but we have to defer the revenue until the 3.0 type software gets delivered. So you get a mismatch there and it really is an accounting driven thing which this is really a big focus of the SEC and the FASB.

So the 2.2 million number that you referenced there is really an early package that's now available to the masses?

Correct.

And that gets expensed on a straight-line basis?

Yes, we'll begin amortization on 1.5, like I said, in roughly January and it's a five- to seven-year amortization depending on which version is in play.

Okay. Do you have any early COOP orders that will include that software?

No, we'll continue to sell the TNS software for the most part to the cooperatives. A lot of advanced functionality and scalability that we're bringing on board are really more suited for the larger investor-owned utility. So we will continue to sell and support TNS. It's an important product for us, there's a lot of customers who use it. So we will maintain an engineering staff to support that product as well and maybe over the longer-term we'll start to migrate some of that to the other folks. But that won't initially be the case.

Okay. And then just the last question. On this additional investor-owned utility which is moving and you obviously sound reasonably confident on, will that also be a percentage of completion project?

It most likely will be depending on when the order would be received.

Okay, thank you.

(OPERATOR INSTRUCTIONS). James Gentile, Sidoti & Co.

So we're investing $20 to $25 million in the development of the TNG 3.0? Is that correct?

That's correct.

Okay. And how much was expended I guess over the past two years in the development of the version 1.5?

Roughly about $15 million.

Is this TNG 3.0 required for -- is this essentially mandated by the guys at PG&E?

We had started a couple of years ago in the development of the product and our view at that time was we were going to have a product that will be usable by any large investor-owned utility. But again, the things we're trying to do are more scalability because we're going from essentially 1.3 million meters to 5 million meters in this case. We want to have more automation. We went to have better average (ph) mapping, a large variety of things. So we had really started this before we got fully engaged with PG&E.

The requirements that the PUC in California levied on PG&E are not as extensive as what they will receive with 3.0, but that's what the customer wants, some of that more advanced functionality. So as we look at it it will be supportive of what the customer wants, it's also something that's going to be very supportive of what any large investor-owned utility that's going to do advanced metering will require.

And the TXU 365,000 end points, are they going to move toward a 3.0 type of software package?

We're currently using the TNS software with TXU and they may make a different decision at a later date, but that's currently what we have deployed there.

Great. And from time to time you mention the Puerto Rico electric power authority contract kind of pops in and out with 5 to 2 million in revenue. Could you give us some insight into the percentage of deployment there, how much is left?

We currently have about $12.5 million of product yet to be delivered. That will be delivered in the second half of '06 and in '07 is the current schedule. It does pop in and out because they've not been as consistent as some of the other customers about taking delivery. And that's one reason we mentioned in the press release that the first half is going to be significantly lower than the second half is because we originally thought they were going to be taking some of that in the first half. The inventory levels that they currently have on hand don't require them to take anything in the first half.

And is the remaining $12.5 million worth of end points or modules or whatever for Puerto Rico, that will finalize?

It should be -- the final delivery should be made in '07.

And how long was that contract?

It's been about seven years.

Seven or eight years when it's all said and done.

And how much was it in total?

Slightly over 100. I think the final tally is going to be about 108.

They'll have about 1 million meters deployed down there when they're complete.

Great. And then with regard to the cooperative utility market, as you look at some -- you suggested, which surprised me, I guess potentially the lack of sales effort as you guys were working on some of the larger opportunities out there. Have you added some headcount? What does the market look like in terms of penetration? It seems that the percentage of COOPs would be higher using an AMR technology than an investor-owned utility in terms of total deployments out there.

So how much of that market is left? And you focused -- and the second part of the question is you're focused on the base business that we're expecting from COOP sustainably through call it fiscal 2010. What level are we at right now? What could we expect from a growth perspective moving forward? And how big could the total COOP opportunity be on an annual basis when you figure a peak deployment type of situation?

I think the way to look at this, as I mentioned, is the COOPs, the munis, and kind of the follow-on business, if you will, that we get from deployed systems and that -- we should be able to maintain that as a base business in the 80 million or so range is what we're shooting for and then later the investor-owned utilities on top of that. The COOPs are probably approaching 50% penetration. That's the reason that that's slowed down some. But then the things that we're doing to offset that somewhat because once you get past a certain point of penetration then it's just not as easy to get that last half done, although as I mentioned earlier we're making good progress.

But we are getting a stronger foothold with the municipal markets with the products that we have, some associations we have, and then working through our distribution network to do that. Historically we've not had a strong product offering for the municipals because they do -- quite a few of them do require an ability to read water as well. So this relationship that we developed with Badger last year is starting to take hold.

So as we look at it the municipals are probably more in the 20% range of penetration, maybe 25%. And so there's still a lot of headroom there. In addition to that, as we get more and more of our product deployed it's going to have a recurring 3 to 4% product expanse and with those deployed customers. So the three of those things together give some confidence that we should be able to maintain that base level of business that we then can layer the investor-owned utilities on top of.

Great. And if I remember correctly, in prior presentations COOPs, the total market could have been quantified in North America as 8 billion, is that true?

The 8 billion number is for all end points. So that was the COOPs, the municipals and the investor-owned utility.

How big is the municipal market compared to the COOP market?

They're roughly the same size. They're both roughly $18 to $20 million -- end points I mean, excuse me.

A million end points. Great, thank you very much.

John Quealy, Adams Harkness.

On the communication side, specifically in AMR, Vic, could you comment a little bit about how you see the IOU market shaping up through '06 into '07? You had some language on the energy bill, clearly this is going to cause some utilities to rethink or pay a bit more attention to AMR. Can you just give us a little qualification of what you think things are going to look like of your competitive positioning in IOU outside of the contracts that we're getting close to signing here?

If you look outside of those, I think you look at a couple of pieces and that's kind of what the real activity in the market is. And it's been consistent I would say over the past six months, the past year that the activity level has been strong. So we're still getting a lot of queries, a lot of RFPs, so a lot of real activity. And then the second piece of that is really what's going to happen with the energy bill.

We're not exactly sure, although I would say that anything that requires utilities to go and take an honest evaluation of what's out there and the potential to improve customer service and reduce cost, it's only going to be good for the market. It's a little bit early to really quantify that. I would think over the next six months or so we'll get a better insight into how serious a lot of the customers are going to take this. And I would have to say that any conversation we have about this now is only going to help to activate the market further.

And can you comment on the remaining folks in -- the remaining large utilities in California? What you're seeing out of them, where you think ESCO is positioned for the potential ramp up as that business develops over the next couple years?

I have to say that the biggest advantage we have today is that we do have a large deployed system in Pennsylvania. We've been selected by PG&E. And so I think we're going to get a very, very hard look from folks and I think a lot of the things that we're doing, particularly in product development both on the hardware and software side are only going to put us in a stronger position. So I don't know that I can talk specifically about where each of those are, but I really like our position as much now as I have in the past and even more because of some of the things that we've more recently done.

And just a final quick follow-up. Gary, perhaps on the margin side for Pacific Gas in the '07 time period, can you just give us what you folks are comfortable talking about for margin assumptions there? And does the 2.5 or give or take 2.2 million in amortization change that at all?

No, because really the amortization is being spread on a straight line basis in it doesn't necessarily tie directly to that customer because we're planning on rolling out TNG to this next customer that we feel confident about as well as others in the pipeline. So it's really not a direct correlation to that. So if you strip that aside for a moment, I would say the PG&E margin is consistent with the margin that we're currently experiencing in the market. So we did not sacrifice price on this to win it. And so from an aggregate contribution margin I think it's consistent.

And my last two questions. On the SG&A in that business communications in the quarter, it looks like there was a $1.3 million increase year-on-year. Is that the type of run rate that we can expect of an operating expense spend moving through '06 to build that business up?

Yes, I think that's accurate. Again, if you carve out the amortization which is going to be layered on top of that because that's kind of a specific identified item. But from a real expenditure perspective, I think we're getting near the point where I think we're comfortable on what we're spending it on. I think our product roadmap is very clearly defined. We're not chasing a blank sheet of paper around. These are very targeted expenditures that I think once we get to market with our product portfolio I think you'll see that level off.

And my last one, moving to filtration margins. You folks laid out some pretty detailed guidance of where you think that will go. In terms of confidence or conviction in those expectations, it seems like VACCO visibility is shaping up a little bit. Can you comment on now the visibility of the other businesses is right now?

Yes, I think we have a lot of confidence in the level that we have laid out for '06. I mean, we do a very -- as I think you know -- do a very thorough planning or evaluation of the whole financial plan. So we understand at a great level of detail exactly where we are at in each of these businesses. Barring further macroeconomic issues like we had in on the resin this past year, we have a lot of confidence in what we have in the forecast.

John, I'll add one thing to that. PTI in particular on the aerospace side, I think when you look at the aggregate orders for the year relative to the run rate we've had in the past, we feel very confident relative to what is in backlog to be shipped in '06 that PTI in particular is near the highest level it has been. From a shippable backlog perspective, it is the highest level it has been at least in the last five years, so we feel very good about that.

Great, thank you.

Steve McNeil, Jennison.

Good morning. I just wanted to circle back to some of this M&A dialogue. In a way, I feel like we're waiting for Gateaux. This has been on the table for probably the past 12 months actively discussed. And how do you guys think about capital allocation and the fact that you have a large buyback program in place? You have over 100 million in cash on the balance sheet, you have credit lines available that I think could help accomplish your M&A goal. So why not a more active buyback program in the face of what we're looking at here? And I think, Vic, you talked about three months wait and see, but do we see a more active buyback if within three months from now we have not accomplished our M&A goals?

Yes, I think the short answer is yes. We have to look at redeploying those funds more actively if we aren't able to get some things done. I do understand it's been a long wait. Gary reminded me this morning, we went back and were reading some of the old things and we were talking about being on the cusp a year ago. And I can assure you it has not been for lack of effort in getting some things done. But I do feel better about it today than I have in a while and we're just going to continue to push forward over the next three months or so and if it does happen that we can't get that done then we'll have to look at different ways to redeploy that cash.

Given your inability to predict the finality or completion of a deal, why not just deploy the idle asset on the balance sheet to an active buyback program and when the M&A deal comes you use that to finance the deal?

I understand where you're coming from, but I would say that being inside the business and understanding where we're at with some things that I think three months is not an inordinate amount of time to wait.

Okay. And then secondly, on the filtration breakout, thank you very much for breaking out the three different businesses, it's very helpful. Was there any other driver -- or I guess the driver of that breakout was really just to help us get some granularity behind the three businesses.

Yes, I think a big part of it, Steve, is probably starting a year or so ago in the narrative we started discussing the individual entities and I think people were kind of getting a little confused on the strength of VACCO versus PTI versus Filtertek. And I think just to provide the clarity and to allow you to see the general trends, and when you see the annual report here in a month you'll see it over the last three years and it will give you a lot more visibility into tracking the margin contributors, who's moving up, who's moving down, that sort of thing. So I think it's helpful.

Okay. In terms of parity with raw materials -- I mean, is it fair to characterize Filtertek as having the most acute raw material situation given the resin buy there?

No doubt about that. You get beyond that and we don't see a lot of variability. There's some with copper and steel, but certainly those are the guys that have the biggest exposure.

Where does Filtertek stand on raw material pricing as it relates to the cost? Are they at parity on raw materials, are they below parity?

I'm not sure what you mean by parity.

Have you exercise price increases?

Okay. We've been able to do that with some customers but not with all customers. As you know, a lot of that business is with the automotive customer and they're not very good about taking cost increases. So what we've done is continue to work with the resin suppliers to try to get longer-term agreements in place. And where we can is to pass on some of those costs.

Okay, fair enough. Thank you.

Amin Denali (ph), John Hancock Advisors.

A lot of my questions have been asked, I just wasn't clear on your answer to your competition in the COOP business when I still thought of it as your core business. I wasn't sure whether you said that you were losing market share or there were some minor contracts that some other people had won instead of you.

As I talked about on the last conference call, we've seen a little renewed competition from Canon, Hunt has always been a competitor in that area. So really a third player, if you will, has centered the competition that caused some turmoil -- not turmoil, but it caused the market to readjust a bit. And so what we've been able to do obviously over the past quarter though is address that pretty aggressively with some software deployments and it's able to take some cost down which put us in a more competitive position. So we had a bit of a slowdown for three to six months, but I believe we're back on track now.

So if things get to the point where you're defending your market share do you foresee or do you expect to have to sacrifice margin because of that or do you foresee things coming to that?

As long as -- we shouldn't have to sacrifice margin only because we've been pretty active in getting cost out. And as we get some of these larger investor-owned utilities on board as well, that gives us some more leverage. So where the competitors, particularly on the COOPs side have a finite market and they're pursuing the cooperatives rather than this larger market they're not going to be able to get the economies of scale that we're going to get. So while we might be able to be more aggressive with pricing, it doesn't necessarily mean we're going to erode our margins.

Okay. All right, thank you very much.

Sean Daily (ph), Daily Holdings.

Good morning. Thanks for the detailed analysis. In reference to the previous caller's question regarding the stock purchase and your response that you'll take a few months to see some of these M&A transactions. You got a stock that you've wiped out basically a year's worth of return in two hours today. You've got over $4 a share in cash, no debt. If you believe your '07 forecast, repurchasing shares would be, I would assume, quite accretive. And why isn't it your best investment and why don't you be more aggressive with it?

I understand what you're saying and that's something we'll continue to evaluate. It will be a good investment, but we don't want to use that cash if we're on the verge of doing something on the acquisition side. For that matter we could use our credit facility to repurchase stock as well.

But I mean, do you realize the stock is down 21.75% in the last five days?

I'm very aware of that.

And do think people should just wait for another -- so you're saying you're just going to wait for another three months and why not buy stock down here before -- while you've got this opportunity?

I understand what you're saying. I mean, we continue to evaluate those things.

And at what point does the Board evaluate if shareholders would be better served by reviewing strategic alternatives and perhaps selling the whole Company?

We review all the strategic alternatives on a very frequent basis with our Board.

Okay, thanks very much.

Tim Hassara, Kennedy Capital.

Of course I have a follow-up to the M&A question. What led you to set this expectation 12 months ago about M&A? Were you close on a deal and you've continued to reiterate that over the last four quarters here and will there be some point in times, say six months or nine months where we're still talking about it and will you announce that you're no longer pursuing that? Or will you always have that expectation out there for us?

I think what drove us to it is we decided quite some time ago that we thought it was the right thing for the business. I think it's important to remember it's not a requirement for the business, okay? If all we have is the best electric solution we've still got a very nice business. What we're trying to accomplish is to essentially double the market share -- or market size of our served market that we could go after. So that's the reason we'd like to do that.

We've been close on several occasions to getting something done and, yes, probably a year ago was the first time we felt like we had a good opportunity to make something happen. If we get to the point where we've expended every option or we've explored every option out there and something is not going to happen, yes, we'll come and tell folks about it because I think we do a pretty solid job of letting people know what's going on in the business.

Just keep in mind, when you did it a year ago you set an expectation to shareholders, so we should be looking for an acquisition. And it's an expectation that obviously you have not met. So you need to be careful when you set an expectation like that. I know you're very careful on your earnings guidance, but it seems to me that you have not been careful on this particular expectation you set for people. And what gives us the assurance now that after four quarters in a row here of say an expectation you're going to get something done?

I understand where you're coming from. The facts are we've always -- when I've made the statement that we were close -- we were pursuing that, that was the case. And unfortunately nobody is more disappointed than I am that we haven't been able to get anything done. I still believe we have a good opportunity, we're pursuing that aggressively and we'll keep folks informed if that changes.

Okay. I guess we'll wait three months then. Thanks.

Greg Macosko, Lord Abbett.

I wanted to ask about the communications business. I know you've talked a bit about the investment in software and also some SG&A investments that were added in the quarter and perhaps less than expected. In the course of the last three to six months have you learned anything with regard to the profit structure of the communications side of the business that should affect it going forward? You've had more negotiations with PG&E and others, can we expect the same kind of SG&A and development costs as we have been expecting?

As Gary mentioned a few moments ago, we see pretty quickly that the SG&A percentages should be leveling off as we have made some investments already in the past which continue to support not only our existing set of customers but future customers. As far as anything that we found from a profitability standpoint, I would say that it's been pretty consistent and that as some of the larger utilities have required different pricing structures we've been able to address that with different cost structures because we've been able to get some decent leverage with our subcontract manufacturers.

But I think that would imply that the software that you've invested in, it sounds as if that is being amortized a bit faster than you had originally thought so that in the later half of contracts as they rollout could we expect that sort of engineering and software amortization cost might be, as an example, lower than originally expected or is there going to be ongoing support necessary there?

Greg, you're exactly right. As we're amortizing this on a straight line basis in you start layering these IOUs on, and let's just use those seven as the launch year on at least the next one and you can start thinking ahead in '08 and '09, you're going to see a significant expansion because the cost profile is going to continue to drop as the volume goes up. The expenditures on the incremental R&D and that sort of thing are obviously going to level off to decrease once we get the product portfolio pulled together that we need. And the amortization is going to come to an end a few years out and you're going to see significant margin expansion in the long-term off of the leverage that we're going to get on the upside and in the absence of the cost side, so you're exactly right.

And incremental contracts would not necessarily require significant changes in the software that's available other than normal updates?

Absolutely. Because the 3.0 example that I gave earlier, that is, and I think Vic even commented, that's -- PG&E and specific terms, that's even more than the PUC is requiring and it's going to be a software platform that I think the rest of the IOU marketplace will find extremely attractive to satisfy their needs for the additional levels of communication we're going to need, size is not going to be an issue and especially when they layer on the time of use of the critical peak pricing scenarios they're looking at. When they see the speed and the easier use of this software I think it's going to be in a very attractive opportunity for them to further move towards AMR and further move towards us.

The other thing we might add is as we get this higher level of software deployed we'll be able to command a higher recurring revenue as we support that software going forward.

Okay. And then if we could quickly move onto the filtration area. The sales level was about 172 million for the fiscal year. Is that now at a lower level than we've seen in past years and have we restructured that in such a way that the cost structure is stable?

I think from a revenue perspective it's going to continue to grow. We've always mentioned that business as a GDP or a GDP plus type business. But we continue to have structured cost initiatives across the Company and we feel that in the near-term here we're going to get the realization of that cost. Once we get the resin cost issue resolved I think we're going to see margin expansion in the long-term on that as well.

If you remember, we, a couple years ago, did shut down a large plant in Puerto Rico and moved that to Mexico. So we have been active in trying to move to lower-cost locations to try to lever the sales that we were getting in that business.

But excluding resin costs, are you comfortable that the operating margin structure of the business today is significantly lower at similar revenue levels than it was three years ago?

That the operating costs are lower, yes. The thing that's been a little frustrating is that we did, in fact, get all the savings that we had anticipated in moving it from Puerto Rico to Mexico. There's no doubt about that. Unfortunately what happened was all of that savings essentially was eaten up in the increase in resin prices.

Thank you very much.

Patrick Forkin, Tejas Securities.

In the press release you mentioned other pilots in process and then, Gary, in your comments you mentioned other IOUs in the pipeline in 2006. Can you give us some kind of feeling as to the number and the nature of those projects? I mean, are there pilots in addition to the one unnamed pilot that you -- or IOU that you have a high confidence level on?

We have started up or been awarded a couple smaller pilots with customers and we have at least one very large RFP that's in play and then a couple smaller ones that are in early stages. So again, I don't want to get into a lot of specifics because we don't talk the specifics as we go forward, but there's a good bit of activity under way right now.

Okay. And then back to the acquisition. Obviously if the intent is to gain entry into the gas and water markets you're obviously looking at an RF type platform. And my first question is would it be -- I'm assuming it would be a fixed network, but would there be a mobile component to that? And couldn't that RF technology actually help to round out your product offering on the electric side?

Yes, as we've talked about on these acquisitions before, certainly whatever we do we're interested in fixed network because we think that's where the future is not only with electric but with gas and water. It's not as important for gas and water because they don't need the same level of functionality, but I do think there are a lot of benefits to having that so that would be our interest. It also would give us some opportunity to augment what we currently have and also on a shortfall RF side. We do have a relationship with Badger, but customers want different things and we'll be able to increase the number of product offerings that we would have. So I think there's a lot of places this would play, make a lot of sense and be good for the long-term business.

Okay. And then for what it's worth I'll throw in my 2 cents in support of a more active and immediate buyback program. Thank you.

You bet.

That concludes today's questions and now I would like to turn the call back over to Mr. Vic Richey.

I appreciate everybody's attention today and we'll be communicating with you in the future. Thank you very much.

That concludes today's conference. Thank you for attending.