ESCO Technologies Inc (ESE) 2006 Q4 法說會逐字稿

Good day, and welcome to the ESCO fourth-quarter year-end conference call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO, and Gary Muenster, Senior Vice President and CFO.

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

Thank you. Statements made during this call regarding fiscal 2007 and 2008 results, future activities in connection with the Company's PG&E contract and the Company's TNG software and other statements which are not strictly historical are forward-looking statements within the meaning of the Safe Harbor provisions of the federal securities laws. These statements, based on current expectations and assumptions, and actual results 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 Company's Form 8-K, also filed today. We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

In addition, during this call, 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 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 will now turn the call over to Vic.

Thanks, Pat. We have a lot to cover this afternoon, so I'm going to turn it over to Gary and let him provide some insight into the fourth-quarter and 2006 results, as well as the assumptions we have for 2007. Then I'll talk more about 2007 and the future.

Thanks, Vic. As noted in the release, our fourth-quarter EPS was $0.40 a share, and was favorably impacted by certain tax benefits recognized in the current quarter. This resulted in total-year EPS of $1.19. Additionally, the current-year fourth-quarter results included $2.4 million of intangible asset amortization and stock option expenses not reflected in the 2005 fourth quarter.

Operationally, our aggregate fourth-quarter results were in line with our internal expectations on both a sales and EBIT basis. Filtration sales were on target, but EBIT margins were slightly lower than expected, due to cost increases on two new development programs and certain raw material costs. Test sales and EBIT margins were higher than expected as a result of better execution on larger projects and a higher level of component sales. Communications sales and EBIT margins were below our previous expectations, primarily due to timing issues, as some DCSI deliveries slipped out of September and Nexus experienced revenue recognition timing delays on a few software installations. Hexagram performed well above expectations, and made a significant EBIT contribution during the quarter.

Our balance sheet remains exceptionally strong, as we ended the year with $37 million in cash and no debt outstanding. We generated $2 million of cash in the fourth quarter, which was consistent with our previous communications and was driven by the timing of several large receipts and vendor invoice timing related to the June 30th quarter end. During 2006, we spent $92 million on acquisitions, $37 million on capital equipment and software upgrades, and our operating units generated approximately $61 million of cash during the year.

Entered orders were consistent with our plan, and backlog at September 30th remains strong at $253 million, which reflects an increase of $20 million from the start of the year. A particular bright spot with the orders was the receipt of two new AMI contracts at DCSI, which Vic will talk about in his commentary.

Moving on to our 2007 guidance, we expect 2007 consolidated revenues to increase over 20% and EPS to increase over 30% and be in the range of $1.50 to $1.65 a share. Although all operating units will be reflecting sales and profit increases in 2007, the majority of this increase is driven by the expected revenues from the PG&E contract. As a reminder, the electric portion of this contract is subject to revenue recognition deferrals contingent upon the delivery of TNG Version 3.0, currently expected to be implemented during the fourth quarter.

Additionally, 2007 includes $9.1 million of amortization related to purchase accounting intangibles in TNG software, as well as $2.8 million in stock option expenses. Regarding PG&E, although we cannot currently recognize revenue on this contract, we continue to incur additional indirect costs, such as engineering and R&D associated with this contract, as well as other IOUs in the pipeline that are reflected in the P&L in 2006, as well as the projections for 2007.

As I have noted in previous calls, EBIT within the Communications segment will continue to be impacted by our ongoing investment in SG&A. The majority of this spending is the result of our outlook for the AMI business, and is being spent on engineering, new product development and program management to enhance our ongoing pursuit of the AMI market opportunity.

As we enter fiscal 2007, we expect to further this level of investment as we continue to introduce new products, features and software enhancements to our overall AMI product offering. In 2007, we expect to generate approximately $50 million of cash, and spend approximately $10 million continuing our investment in the additional upgraded versions of TNG and nearly $15 million on capital projects. I also want to point out that during 2007, we will begin making US federal tax payments, as our long-standing NOL will be fully-utilized.

In closing, we continue to maintain our strong system of internal controls and rigorous management oversight. I am proud to say that we remain in full compliance with the provisions of Sarbanes-Oxley, and I will be happy to address any specific financial questions during the Q&A.

Thanks, Gary. I think we have covered the fourth-quarter results in significant detail in our press release, along with Gary's commentary. During fiscal 2006, we have continued to strengthen our communications business, completed strategic acquisitions of Nexus and Hexagram, as well as making further investments in our TNG software. I would characterize those actions as significant accomplishments toward our primary objective of strengthening our positions in the AMI markets. I would also like to recognize the contributions of our Filtration and Test businesses as they continue to provide reliable revenues, profitability and cash flow.

Turning to fiscal 2007, while we expect a significant increase in both sales and earnings, the focus is heavily weighted toward the second half of the year, due to the deployment schedule of PG&E and revenue recognition associated with that project. As Gary mentioned earlier, a good deal of our PG&E electric revenues will be deferred until certain milestones are achieved, relating to the upgrades to our TNG software. I want to assure you that we're making solid progress on this very important project.

I would like to take a few moments now to talk about our outlook for the Filtration and Test segments, and we will then address our Communications business in more detail.

In Filtration, we expect continued solid financial performance, although our growth outlook remains somewhat modest. Our Filtration segment provides a reliable base for our business and is a significant cash generator. Although we have pockets of growth in aerospace and medical applications, the aggregate growth prospects are somewhat muted by our automotive and industrial content. As such, we will remain highly selective in our investment decisions, and will be heavily focused on improving the returns from our existing operations.

In the Test segment, we see above-average growth prospects as the introduction of new electronic products and new testing standards continues at an unprecedented pace. My confidence in our ability to capture a majority of these opportunities is based on our leadership position, expanding international presence and superior technology.

Turning to Communications, we continue to experience a solid mix of AMI system sales, primarily driven by our co-op and municipal market customers, combined with several small-scale IOU deployments and additional opportunities at existing customers. Most recently, we signed agreements to provide a limited number of endpoints and a more meaningful amount of substation equipment to Duke Energy Corporation's territory in Kentucky and EDESUR's commercial and industrial customer base in the Dominican Republic. We're very excited to have been chosen by these customers for these installations, and certainly hope for continued expansion.

With respect to our largest current IOU customer, PG&E, our deployment schedule calls for small-scale deliveries through April of 2007, at which point volume should ramp up to a near full-scale deployment run rate by year end. In total, given the current schedule, we expect to deliver between 700,000 and 750,000 electric and gas modules during fiscal 2007. This is significantly fewer than we had anticipated earlier this summer.

There are additional future opportunities in the communications market for large-scale deployments, and I would like to discuss my view as to our technology's ability to address these opportunities. Several of these potential projects require that vendors demonstrate an ability to achieve an open architecture that would enable other communication devices to access or become integrated within the AMI system.

In order to have a true open architecture, a system must offer multiple opportunities for utility customers' choice of technology. First, the customer must have the option to deploy any meter, whether electromechanical or solid-state, or whether new or retrofit. Secondly, the customer must have the ability to use a variety of backhaul communications such as WiMAX, Fibre or cellular. Third, the customer must be confident that the system will function with its selection of meter data management software. ESCO's AMI systems do, in fact, offer open access at each of these levels while providing a reliable, secure and robust backbone for the system architecture.

Additionally, it's true that utility customers today are very interested in the openness of the system beyond the meter. ESCO systems continue addressing this with new product offerings. For example, we have introduced an in-home display that provides a wealth of information to retail customers. We're developing a real-time energy output device and are continuing to work with a variety of thermostat manufacturers. Our goal is to offer a choice of ZigBee-enabled products by the end of 2007.

Other new product developments introduced to the marketplace in fiscal 2006 include DCSI's universal metering transponder, of which we have shipped nearly 0.25 million units this past year. This transponder features the ability to remotely upgrade firmware to the metering endpoints, allowing the system to be reconfigured for functionality, as future customer demands dictate.

Now, while it's true that our systems are designed to work exceptionally well with a variety of vendors' software offerings, ESCO does offer its own best-in-class complementary software products. I'm very excited to report that just last week, when the new meter data management software systems went operational, PPL Electric Utilities became the first utility in the nation to manage hourly electric usage from its entire customer base, consisting of nearly 1.4 million meters.

The meter data management system, developed and installed by Nexus Energy Software, establishes PPL as the first utility to process, store, analyze and distribute hourly meter data generated by DCSI's advanced metering network to enable a variety of enhanced business processes. The PPL implementation is the largest MDM system to date in North America in terms of data volume, and the most comprehensive in terms of applications that leverage the data.

I'm also encouraged by how well our fixed network power line and RF-based architectures work together to provide data to utilities that have a combination of electric, gas and water metering endpoints. The combined deployment of DCSI's TWACS system and Hexagram's RF system at Wisconsin Public Service is an excellent example as to how our two systems work together to fulfill our customers' needs, and we expect the same success at PG&E.

Hexagram's system as a stand-alone solution is also seeing a significant amount of opportunity in the marketplace, particularly with respect to gas and water utility projects. As our volume has increased and unit costs have declined, the overall cost of Hexagram's system is swiftly approaching that of a drive-by. I believe that as potential utility customers consider the significant benefits that a fixed network system offers over a drive-by or walk-by, we will see significant momentum in this business.

To summarize my view of our Communications business, we hold a prominent position in a large and growing market. In my view, our systems strike the right balance of being open while, at the same time, providing a reliable and secure communications. Most importantly, we have proven that our advanced metering products perform at scale -- and I would like to emphasize proven performance at scale while, at the same time, point out that we remain very focused on innovation and committed to extending our lead on performance and achieving business benefits for utility customers. To do this, we will continue to invest in new products that will further strengthen our existing systems, and we have a very impressive and talented group of employees who will allow us to reach our goals.

With that, I would be glad to answer any questions.

(OPERATOR INSTRUCTIONS). James Gentile, BB&T Capital Markets.

Very, very nice in-depth press release. I'm wondering if you can give us, A, some insight into the Nexus software business, forecasting close to call it 8% of forecasted FY 2007 Communications revenue, at kind of a disproportionately low operating margin. Could you go over the dynamics of that business, with regard to an inflection point that could be reached, with regard to volumes, to show some better profitability in that area?

Sure. Our view is that it's probably going to be another year before we get the volumes up to a sufficient level to where we're going to see the types of EBIT margins that you expect in a business like that. Really, what we are facing today is there's a lot of SG&A embedded into that business, and that does require a higher level of sales than what we are currently experiencing. Given the strength of the backlog that we have been able to build over this year and what we anticipate in 2007, we feel pretty confident that we will get there within the next year.

With regards to the cooperative and municipal business into 2007, of the $230 million plus in revenue, how much could we expect from that segment of the Communications business?

I think that's somewhere around a $70 million to $80 million range.

That's sizably lower than prior forecasts that you have articulated, Vic. Could you comment on the competitive movements that are occurring in that area?

I'm not sure that it's significantly lower. We have ranged somewhere in the $80 million, $90 million range over the past couple years. Certainly, we are seeing a couple of things. We do have two competitors out there.

But then the other point, I think, that's important to remember is the co-op market in particular is probably in the high 50's as far as penetration level. Obviously, the first 30% or 40% or 50% is much easier to get than the rest. What we are doing to augment that, though, is certainly going more aggressively after the municipal market, because the penetration level there is closer to 30%.

Are the days gone where we see high 20's to 30% operating margins in that segment of the business?

I think what we're seeing with the business is the amortization that we have on TNG and some other things are certainly muting the margins. By I would say the underlying margins have not changed significantly.

Fair enough. Then one last question with regard to your Hexagram guidance for 2007, $60 million to $63 million. Could you give us insight into the percentage of that driven, obviously, by PG&E, the gas portion of that and also other gas projects and water projects, in those three buckets?

The PG&E piece of it is approximately $25 million. The rest of -- the remaining business, I would say the majority of that is water.

Duke Energy -- saw the beginning stages there. That's been, obviously, a contract on the come. Is this is the start of a much more fruitful marriage, or --?

Certainly, our hope is that we have a larger deployment there. But I would say that what we have under contract today is what we talked about. In discussion with them, they wanted us to kind of limit our discussion to that.

How big is that network?

Well, in Kentucky, in the Kentucky area, it's about 200,000 endpoints.

Steve Sanders, Stephens, Inc.

A couple of questions on PG&E. The 700,000 to 750,000 -- is that relatively evenly split between the gas and the electric?

It's a bit heavier on the electric side than it is the gas.

How confident are you in that number at this point? Talk a little bit about some of the things that could move that higher or lower over the course of the next quarter or two.

I think, over the next quarter or two, what they're talking about, as I said in my comments, it's going to be a pretty slow ramp-up until the April timeframe. I'm as confident as -- that's the current schedule that we have. I think, as we move through the year, there's opportunity for it to move up or to move down.

I would just say, today, that's the best information we have. What we'll have to do is commit to update everybody as we get more information.

In terms of some of the hurdles to get the project fully ramping, are most of those at this point within PG&E, IT, prepping for the project? Are they a combination of what's going on at PG&E and ESCO? Just any additional color there might be helpful.

I think it's really a matter of this is a very large project. There is a lot of internal -- the PG&E development that's taking place. Obviously, we are doing things, Hexagram is doing things, WACS are doing things, IBM is doing things. So this is a very complex project. While I wish that we were going to have a larger level of deliveries in 2007 than what we're currently projecting, I want to make sure the project gets started right so that, as this ramp-up starts, when it does start, that the project is very successful, rather than just starting it early and potentially having hiccups.

So I do think it's a combination of things. The bottom line is it's just a very large project with a lot of parties involved.

A broad question on the margins in the Communications segment. It looks like the midpoint is about 19% operating margin. I think there are about 2 points there for incremental TNG amortization, maybe a little bit of a drag from Nexus, higher spending. Can you connect some of the dots there, and just sort of help us understand the factors beyond what I have mentioned that are impacting that?

I think you hit most of them, and I'll take a few additional things. Then maybe Gary can add on if I miss some things here.

Certainly, it is amortization. It is a higher level of spending. We're not able or we're not capitalizing all the costs associated with TNG, so there are expenses associated with that. Also, there are expenses associated with PG&E outside of the TNG, which we're expensing and not, obviously, recognizing revenue on today.

The other piece in there is contract. They had a very solid year a couple years ago; they are essentially at a breakeven in 2007. So that's also muting the margins a bit. I think I have hit all the major things, combined with what you had already mentioned.

On the VACCO side, we saw low 30's kind of margins in 2004, high 20's in 2005. I thought 2006 was a little depressed by the spares and the T-700. We're not getting a bounce here on what sounds like mix. Is there any other color on VACCO?

Probably the biggest driver is the mix is changing. We are getting back a little bit of the defense project, but it's mainly the T-700, which has a lower gross margin than the defense spares grouping in total does.

Why that is, if you recall, during 2006 we had a production break as the customer didn't take any deliveries. Well, at the start of that, when you basically have to re-up the line, obviously there's start-up costs, plus the casting vendor that we use that provides the titanium base for this thing basically had to shut -- not shut down, but break its production line as well. So he incurs start-up costs that he passes through to us.

So in the first half of the T-700 ramp-up, we're pulling gross margins through there probably in the neighborhood of 15% to 20%, as opposed to a normal run rate on that project, which would be 25% to 30%. You're getting the sales pop, but you're not getting the full contribution margin that you would expect because of that production break.

Maybe Vic, if you could just comment -- we have seen what looked to be some pretty nice awards in Ontario. Just bring us up to date on where you guys stand there.

Gary, did I understand, including the cash taxes, that free cash flow will be pretty minimal in 2007?

I'll take the free cash flow one. I think the free cash flow is still going to be in the neighborhood of $25 million, so I don't know if that's minimal, but --

I missed it, thanks.

Then as far as Ontario, we're still involved there. We haven't seen a lot of things pop out just yet. They still seem to be reviewing a lot of things, but we do remain active in that area. But we have not received any awards.

Richard Eastman, Robert Baird.

I just wanted to follow up for a second on the PG&E gas and electric shipments. Are the gas shipments also starting later? I guess I wasn't quite clear on that. Or the gas shipments started and will run through the -- just continuous?

They will pretty much run in parallel. What I said was there's not as many gas endpoints as there are electric endpoints. So what happens is they'll go into one territory and they'll populate the entire territory, so they don't have to go back and revisit.

So they are going to be on similar ramp-ups, if you will, in that we're going to have low-level delivery for gas and electric through the April timeframe, generally. Then they will both accelerate more in the second half of the year. But they are not going to go to the field and put in gas and then go back and put in electric. They will go in and put in substations, put in the collectors, and populate both the gas and electric at the same time.

So the slowest deployment schedule will kind of dictate the run rates here, for the most part?

I'm sorry?

The slowest deployment schedule, whether it's gas or electric, will kind of dictate the run rate for either product?

Well, yes. But I think you just need to think of it as they are going to go into a territory, and whatever is there, whether it be gas -- whatever that mix is in that territory, that's what is going to be deployed in that timeframe. So what I was trying to say was, by the end of the year, we ought to be pretty close to a full run rate. But that's going to vary from month to month, quarter to quarter, just dependent on which territory they are populating.

When you look into 2007, I think two things clearly step out. When you do recognize the deferred revenue portion of the electric PG&E contract, I am presuming that that will be -- on the deployment schedule you're currently using will be more like a $40 million revenue number. Is that fair?

I think on the electric side, it will be closer to $25 million.

So when you do in the fourth quarter, reckon it will be $25 million of revenue. Then I'm still a little bit confused. The margins still seem fairly low. Does the margin improve out into 2008 with volumes?

Yes. It's two things. One is obviously, with the subcontract manufacturing relationship, we have pricing or costing, if you will, that's contingent upon the volume. So as the volume ramps up, we pay a lower unit cost for the modules that our subcontract manufacturers are producing. So we do get a pop in 2008 strictly off of the volume on the pricing arrangement that we have made with the subcontractors.

Second, we're continuing in 2007 to invest. There are some things that we're going to be delivering later in the contract to PG&E, and we're developing that engineering content today that we're not going to have revenue for. So if you look at DCSI on the situation not counting amortization, 2007 to 2006, their G&A is up about $3 million. That is primarily engineering and new product development costs for some of these things that we're working on -- as Vic was saying, the behind-the-meter stuff and some other things that we're not in a position to talk about today, that are still in the development stage that are going to be delivered kind of in 2008-2009.

So we're taking the full complement of costs in R&D there, and that revenue is going to start coming through in 2008 as well. So we have those two factors working against you on the margin.

Are they, in effect, paying for that engineering content? Is it built into the module price, and you're just front-ending the expense?

Yes. The technology that we're committed to deliver gets delivered near the end of the contract, and we're developing the stuff today. So yes, they are paying for it, but they are paying for it when they get the modules that are delivered in a future period.

The acceptance trigger, I guess, now has moved from the third quarter to the fourth quarter. I'm curious, is that a delay in delivering acceptable software, or is that a unit-volume-driven acceptance trigger or what?

No, we always talked about the second half of the year, and it's really a matter of when we're going to have the software complete and accepted. So there is not any unit volume trigger at all. It really is our ability to deliver the software, the version that they have acquired.

What version of the software are you deploying at Duke?

That will be a [TNS] deployment.

David Smith, Citigroup.

This is James, actually, his associate. Can you guys give any incremental color around the FP&L contract, any updates on that?

Not anything other than what we have already talked about in the press release we put out. We continue to support the system we have there, and have folks on-site and continue communications with FP&L. But there's not been any significant development since we last talked.

What about the Democrats taking over both the House and the Senate? Any legislative opportunities possibly on the horizon?

Well, it's a little early to tell. We'll have to see what they come out with. But certainly, we will be pushing our agenda, if you will, as far as trying to get more tax credits associated with these types of deployments. I don't know if this is going to be a friendlier Congress or not, but certainly we're going to take another run at that.

John Quealy, Canaccord Adams.

First, some housekeeping. Nexus and Hexagram revs in the quarter were, I think, $11 million. Can you give us the breakout between the two businesses?

Hexagram was about $7.7 million, and about $3.3 million for Nexus.

We saw a fairly lumpy Nexus order flow in the quarter, and we touched on some of the drivers. But can you comment -- and this is probably both a software and a hardware type question. Certainly, there seems to be a lot of RFP activity out there. But in the next quarter or two, it seems like the industry has got a bit of an air patch or a soft patch, in terms of actual orders getting funded. Can you talk a little bit about, first, Nexus and their relative positioning; and then secondly, broader on the AMR, AMI market?

We continue to have good results with Nexus. As I mentioned, they had a really strong year from an order perspective. There's still a lot of good opportunities. I don't know if those opportunities are going to be as affected by whatever you want to call it, a soft patch or however you characterized it.

But generally, I don't disagree. I think there is a lot of activity, both domestically and international, a lot of RFP activity. But it doesn't appear that there are a lot of people making decisions right at this time, although, obviously, we're happy about the two awards that we got. Although they are not huge awards, I think they are indicative of the fact that the market is continuing to move forward and, in this case, make a decision to select our product.

Moving to PG&E, in terms of the milestone, sort of Q4 revenue recognition on the software side that was discussed earlier, the $25 million amount, if I understand you correctly -- number one, I thought that number was significantly higher in previous periods, in terms of the anticipated one-time hit. That's number one.

Then, number two, in terms of the milestones, how many quantifiable milestones do you have over the next 12 months -- or, I guess, nine months, at this stage -- to hit that? Will you be able to tell, in one to two months, if you're on track for Q4, or is it heavily back-end weighted, and if it's final acceptance? That's really it.

I'm sorry. I forgot the first half of your question.

Just in terms of --

Okay, I remember it.

-- the dollar amount.

What had happened was we had anticipated a lot more units being delivered in the first half of the year than what has happened, as I answered Steve's question earlier about why that's kind of delayed, and just kind of the complexities of the project and so forth. So we thought we were going to be in October where we're going to be in April now. So that has really shifted a large number of units out of this year into the out years. So that's just kind of when the program starts and the slope of the ramp-up.

The second piece of your question, as far as the TNG, we currently have Version 1.6, a version of that deployed in the field. We will have another that is going to be delivered yet in the fourth quarter. Then we have 2.0 and 3.0. So we will have more data points, plus as time passes, we will have a better insight into where we think that's actually going to land. Obviously, if that changes, we will be talking with everyone.

On TXU, I guess if you go through the math and their public filings, it looks like there's a fairly healthy amount of meters that need to be installed in the calendar Q4 period. First, can you comment on relative ramp in business at TXU in Q1 and Q2? Then I've got a quick follow-on.

We do have a good bit of delivery and deployment that's going to take place in the first half of the year down there. So I think you're right on there. They are happy with what we are doing with our part of the system. We have continued to deliver to them, and they have continued to make orders.

In fact, I was down there a couple weeks ago and met with them. They seemed very pleased with our system, so we feel good about what we're doing there.

More qualitative -- and I'm not sure I understood you entirely when you were talking about open architecture and having ZigBee functionality. Was this more on the sort of Hexagram side of things, or can you just recap for us what you're going at there, with the open architecture and the ZigBee comments?

Yes, well, that specific part of my commentary -- really, we will have products at both DCSI and, longer-term, at Hexagram as well, where they want to have products inside the home. So we need to be able to communicate from our meters, our modules, to those types of product.

So we have an in-home display today that works through the power lines. We're working to have one that we used an RF component, also this real-time energy output and what that is -- and that's very important to the folks at PG&E. They want the consumer to be able to go over, and in a real-time basis, see how much energy they are using. If they make some changes inside the home with appliances, lights, those types of things, what type of impact it has.

So what we're doing is continuing to work, and this is not something that we're just starting to work on. We have been working on it for some time. We started to work, really, behind the meter, because there is some level of interest in that from a number of utilities.

On the definition of open architecture, is that what you're talking about inside the home? It's sort of open? Or you're going from the wireline back to the substation, or where are you going with that, with the open?

Well, again, I think it does come in three pieces. You need to be open to any meter, which we interface with most all the meters out there today.

In fact, I sat down the other day and went through our development schedule for next year. We got an additional 12 modules that we're developing this next year. So that's an important piece of it, because you need to really be able to go and interface with any meter.

If you go in someplace like PG&E, for instance, where they are retrofitting meters, there's probably 100 meter types that we're retrofitting with. Unless you have that ability to interface with all those meters, you're going to have a difficult time being successful.

In addition, we have got this ability to use any variety of transmission mediums between our substations and also between Hexagram's collector units to send a signal back to the utility. So if they already have WiMAX or WiFi or some of the cable, whatever they want to utilize, we're able to do that.

Then the other piece of it is really back at the head end. You need to be able to interface with a lot of meter data management systems, a lot of the software packages within the utilities, and we have the ability to do that as well.

Chris Kotowicz, A.G. Edwards.

I wanted to ask about PG&E. You talk in the press release about annual purchase order releases, which is pretty normal for a big project. I think you've talked about that in the past. Have you guys actually gotten a release for the work that you expect to do in 2007 already, or is that something that's on the horizon still?

We've just got some very small orders for things that we're currently delivering, so we have not gotten a large purchase order for the full year.

So the bulk of the 700,000 plus sounds like it's, hopefully, what? By the end of the year, or --?

I would assume, because we do have to have some leadtime to be able to ramp up our vendors.

So as far as the stuff that you have shipped that has been billable, has that been -- well, maybe the electric stuff is not billable. But has that been split pretty evenly, then, between the gas and the electric side?

Yes. To date, it has.

Can you talk about where the deployment is going to start?

Well, they have got the Vacaville substation, and I believe the next area is in the Bakersfield area.

On the FP&L team, I know you guys had invested and been preparing for a big project, I guess ostensibly FP&L. Where are those folks, I guess, being allocated right now?

Well, some of them are supporting that system, but we have brought some of them back to St. Louis and, I believe, one or two folks out to California.

On M&A, obviously a good year. I don't think anybody could argue that especially Hexagram looks like a home run. Are there any other things, as far as outlook goes, that you feel like you need to do? I know you're doing a lot of product development. Do you see some opportunities, either through deals in the US or maybe pursuing international markets out there, that you could talk about, at least at a high level?

Well, you asked if there's anything we need to do. I don't think there's anything that we have to do. We have a good set of products to offer. Certainly, our desire is to continue to grow this segment. We are missing an investment on organic growth, but we also are looking very hard at acquisitions as well. In fact, I'm spending a good bit of my time evaluating that and talking with folks.

So we do see opportunities, both domestically and potentially international, if that would be through some type of partnership or an acquisition. Those are all things that we're evaluating. Pretty early in the process to get much more specific than that, though.

Patrick Forkin, Tejas Securities.

With respect to Duke Energy Kentucky and your 2007 guidance, is the $1.5 million -- is that all that you have in 2007 for Duke Energy Kentucky?

Well, that's all we're under contract for. I really don't want to get into very specifics on what's in the contract or what's in our forecast and what's not, but that is what we're under contract for.

They make it pretty clear in their regulatory filings that they have made their selection of technology, which is obviously DCSI. But it looks like it's gas and electric. Will you guys be participating in both gas and electric on that?

Yes, we will be using our short-hop RF system that we have developed.

So there are 230,000 end points. They are expecting regulatory approval before the end of the year. Is that the timeframe you guys would look to get a contract signed on the balance?

As I mentioned earlier, we have been in talks with these folks. Really, all they asked us to talk about was what we currently have under contract.

With respect to the Dominican Republic, if you could go through -- it looks like you are limiting your discussion to some front-end equipment there. What does the total opportunity look like there, and what does the timing look like?

Well, again, what we're under contract for today is just all of their C&I meters. But we are doing a full deployment of our substation equipment. So certainly, our hope is that once we get this deployment in place -- and this is all going to be done in the first half of the year -- that they would look favorably at maybe expanding that to the residential side. Don't have any commitment from them at this point for that, but certainly, we would have that hope. But today, we're just under contract for the C&I and substations.

(OPERATOR INSTRUCTIONS). Jason Simon.

In the press release, you had suggested that you are going to see, I think, 1.2 million units more in production volume in 2008. Gary, I was wondering if you are suggesting that you're going to see some pricing benefits, obviously, from the subcontractor and there's going to be, what, $3 million-some-odd stripped out of SG&A. What kind of margin assumption should we anticipate?

I don't want to go into the specifics, but I think you will see upward movement there at a reasonably meaningful level.

Oh, that was nice and specific, thank you.

Second of all, the TXU program -- I am guessing that you would have deployed about 400,000 units to date. I'm guessing [DP&L] was supposed to be something like 2 million units. That would leave, what, 600,000 to be deployed for AMI technology? Is that a fair way of thinking about it at this point?

Yes, I think that's a fair way to think about it.

Obviously, the suggestion has been that -- or not the suggestion, but DP&L has been somewhat of a disaster. I'm just wondering what your conversations have been with these guys over the past couple quarters, with respect to potential deployments further into 2008 and 2009.

As far as our system, they are planning to continue deployment up to that million meters today, is the discussion we're having with them. They have not gotten any more specific about the timing of that. As you know, they have been taking a more measured approach on this rather than coming in and saying, okay, here's our deployment schedule. We're going to go commit to this million meters, or whatever the number is today. So they have been doing this on an annual basis. I'm not sure that I've seen anything that's going to change that in the near term.

Just one last question, on Sempra, if there's any kind of update as to what is happening down there, as far as activity discussions?

Where is this? I'm sorry.

Southern Cal.

We continue to be in discussion with them, but I have not seen any big movement recently.

That does conclude our question-and-answer session for today. I will turn this call back over to Mr. Vic Richey for any additional or closing remarks.

I just have a couple of remarks in closing. First, I would like to thank our employees across the Company for their contributions throughout this past year. We have a lot of exciting opportunities in front of us at ESCO, and that would not be the case without the ongoing effort and support of our employees. While we expect significant growth in sales and earnings in 2007, we expect even more significant contribution in 2008 from the investments we have made to extend our position in the AMI market.

I would like to thank everybody for their participation on the call, and look forward to talking with you next quarter.

That does conclude today's conference. Thank you for attending.