ESCO Technologies Inc (ESE) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the ESCO third-quarter conference call. Today's call is being recorded.

With us today are Mr. Vic Richey, Chairman and CEO and Mr. Gary Muenster, Vice President and CFO. And now to present the forward-looking statement and for instructions I would like to turn the call over to Ms. Pat Moore, Director Investor Relations. Please go ahead.

Good afternoon, everyone. Statements made during this call regarding fiscal 2007 and subsequent year's results, future developments, and the timing of revenues in connection with the Company's PG&E contracts, the Company's TNG software, Hexagram's RF fixed network electric product, stock repurchases 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 are 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 the Company's Form 8-K 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 Form 8-K and accompanying press release on the Company's website, ESCOtechnologies.com under the links, investor relations, financial reports, and SEC filings. I will now turn the call over to Vic.

Thanks, Pat. I'm going to first turn it over to Gary to let him review the third-quarter results and the outlook for the fourth quarter.

Thanks, Vic. As noted in the release, we reported GAAP earnings of $0.33 a share during our third quarter, which included a $0.06 charge from an old Test segment dispute on a contract completed in 2005. Absent this charge and from an operational perspective, we earned $0.39 a share in the quarter.

I also want to remind everyone that included in our operating results is an additional quarterly charge of approximately $0.06 a share or $0.18 year to date for the amortization of intangible assets.

As I mentioned on the May earnings call, we were expecting a strong third quarter with projected EPS of $0.33 to $0.35 a share, which I believe we delivered on and in fact exceeded our commitments. Our operational EPS of $0.39 for the third quarter came in even better than we anticipated, as all three operating segments generated higher profit contributions than our May forecast. The filtration segment in particular had another very strong quarter as both PTI and VACCO delivered EBIT margins greater than 20% and we expect this outstanding performance to continue for the balance of the year. Compared to the second quarter, communications showed the most improvement during the third quarter as sales increased nearly 10% and EBIT increased over 40% sequentially. These increases were driven by DCSI's 17% increase in sales with a 25% increase in their EBIT contribution, which reflects the continued strength of the co-op market and the stable IOU business. The Test segment remained strong during the current quarter and delivered a solid 12.4% EBIT margin, excluding the arbitration charge.

Our balance sheet remains exceptionally strong as we ended the quarter with nearly $22 million in cash. Year to date, we have used $15 million of cash, which was consistent with our plan and was driven by the ongoing investments in capital equipment, TNG software upgrades and the inventory build to support the significant increase in expected sales for the fourth quarter of the fiscal year.

During late June, we began repurchasing our shares in the open market and have repurchased approximately $10 million worth of our stock through the middle of July and we still have an open authorization to repurchase an additional 935,000 shares. Entered orders continue to be a bright spot in the third quarter, where we booked $146 million in new business, bringing our total backlog to $316 million at June 30th. This reflects an increase of over $63 million or 25% from the start of the fiscal year. Of particular interest was a receipt of $30 million of AMI orders received from PG&E at DCSI and Hexagram in the third quarter, bringing the year-to-date total PG&E orders to over $48 million. Additionally, VACCO booked an order for over $7 million for the next allotment of T700 valves for the Blackhawk helicopter.

Moving onto our guidance for the remainder of the year, although we have had a few moving parts operationally throughout the year, we continue to expect 2007 EPS to be within the range that we established at the beginning of the year. As a result of the $0.06 non-recurring charge in Q3, we narrowed the range of our expected GAAP EPS to between 1.50 and $1.55 a share. Excluding this charge, our operational EPS outlook remains unchanged from the previous call.

To hit the full-year estimates, we are expecting a very strong fourth quarter and I will now discuss a brief overview of the fourth-quarter expectations as compared to the third-quarter actual results.

Filtration will once again have a very solid quarter as sales are expected to increase to around $55 million and EBIT margins should be slightly above 16%, which will be at an all-time high. Test sales are expected to increase over 25% from Q3 with EBIT margins also up significantly as they are expected to exceed 14%. Communications sales in Q4 are expected to be over $92 million, which obviously includes DCSI's expected revenue catchup from the PG&E contract.

Hexagram sales, driven by the gas product deliveries at PG&E, should increase nearly $14 million and Comtrak is expected to deliver over $6 million of product in the fourth quarter. Assuming these sales levels are achieved, the Communications segment EBIT margin for Q4 is expected to exceed 25%. As a continuing reminder, the electric portion of the PG&E contract is subject to revenue recognition deferrals, contingent upon the delivery of version 3.0 currently expected in September.

Regarding PG&E deliverables, we continue to build and collect cash on a regular basis related to this contract.

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. As reflected in the press release, we had a solid quarter with good performance across the Company.

Looking at the operations by segment, in filtration we saw a consolidated EBIT, back about 14%, with strong results from both PTI and VACCO. The order input positioned us well for a strong quarter in filtration. In test, the adverse legal settlement was certainly a disappointment, but operationally, we are very happy with their performance. We continue to see strength in all end markets for our Test segment from wireless testing to medical and government shielding. The market in Asia also remains active and we're in the process of moving additional work to our Chinese location to take advantage of the beneficial cost structure.

In communications, our sales were up from the second quarter and up significantly on a comparative basis from 2006. We are positioned for a big fourth quarter, which does include $20 million of sales, which is expected to be recognized on DCSI's contract with PG&E. This revenue recognition will be triggered by successful delivery of Mesh Network gateway software version 3.0, which is currently scheduled for September.

Let me take a minute to status our progress. We are several weeks late to our internal delivery date of 2.0 due to some issues found in testing, which we chose to fix before we delivered the software to the customer. Fortunately, we were able to continue development of the 3.0 version of the system in parallel and still have a plan to meet the delivery schedule for September. Greater than 90% of the 3.0 code has already been written and much of it is to be tested concurrently with 2.0. The issues we found have been minor and require a modest rewrite of code. However, any change does require a significant retest process. The bottom line is the schedule is tight and the final delivery date will be driven by the number of issues we find in test.

Having said all that, we are extremely happy with the performance of the software and very confident when it's delivered, it will have a proven capability to provide the extensive functionality that we committed to deliver to PG&E for greater than six million electric endpoints. This does include our already proven capability to remotely download firmware to the substations and to the endpoint which essentially future proofs our system. Also it should be noted that this delivery date has no impact on the PG&E customer as their plan is to use 1.6.3 until the first or second quarter of 2008.

We did receive the RP from PG&E in July and responses are due in mid-August. Unfortunately, due to our confidentiality agreement with PG&E, we are unable to discuss the RFP or the RFP process in any detail. We have begun the deployment of Hexagram's electric pilot of PG&E and the early results have been very positive. We continue the development of our home area network products, in addition to our previously employed in-home display and real-time energy output device. We will be demonstrating these products at AMRA in early October.

We continue to see a high level of activity in both the electric and water markets. We have a number of bids outstanding and are aware of several products slated to kick off their process in the next three to six months.

Bid activity and our closure rate remains high in the co-op market, which has always been a strong suit of ours. We have made a number of changes in addition to our sales and marketing group at DCSI to enhance our market coverage, particularly with the IOU customers. We have brought in five very seasoned salespeople to ensure we provide good coverage of the market and effectively get our message out. Additionally, we have hired a very experienced vice president of international sales, who is already developing some meaningful opportunities for the Company.

Nexus was awarded their second full meter data management system in the third quarter but ADCO, who is a longtime DCSI customer. Their meter data management deployment of PPL remains on track and the orders remain strong across their product lines.

So we've obviously got a lot going on here at ESCO and we are on track for a strong fourth quarter. We have a number of new products under development and are well positioned to grow our business in 2008 and beyond. So now I'd be happy to answer any questions.

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

Vic, just to follow up on the PG&E RFP process. I know you can't talk about a lot in the way of detail, but can you shed any more light on the time line and the process here?

As I understand it, the responses are due mid-August. They're looking at doing some pilots, demonstrations, whatever the case may be toward the end of the fiscal year into the fall of '08, and they have not given any indication on when there might be a decision made beyond that.

Okay.

As I mentioned earlier, we already have our unit under pilot with the Hexagram product. That process has already started.

Okay. And then where do you stand on shipments for the 700,000 modules and how does that schedule look over the course of the next couple of quarters?

Everything we have under contract should be deployed or should be delivered in the fourth quarter of '07. So I would say at least the vast majority of what we have under order will be delivered this quarter.

Okay. And then in terms of their installation, do you have an update there?

I think their plan is still to have somewhere around a quarter of a million to $300,000 employed by the end of -- by the end of this calendar year and then they would have all of our product deployed probably by the end of our second quarter, so the March timeframe of '08.

Okay. And then on the TNG side, you mentioned the issue that you had and the fact that the schedule was tight. Should we characterize the current state of delivering that by September as you've lost your cushion or you still have some slack in the schedule? How should we think about that?

There's a little slack, but there's not as much as we'd hope to have at this point in time. But we do have a plan to do that. The issue is, it's not like there's one big issue that's caused it. As you go through this whole testing process, you find some mistakes in a code. You have to go in and fix those. And as I mentioned, there haven't been significant issues with the code at all or with the software. It's really the fact that to ensure we are delivering a product that is going to work like the customer wants it to work it has to go through very, very thorough testing. And so you find an issue, you fix it. You go back to the retest and if you find another issue, it's almost a restart. So unfortunately we don't have as good of an insight into that as we would like. It really is going to be driven by the number of issues that we find.

Okay. And then two quick questions and I'll just do them both at the same time and get it out of the way. First, Vic, can you just talk a little bit about the technology roadmap and sort of where you stand for the hybrid solution? And then Gary, I know it's too early to talk much about '08, but with the uncertainty around PG&E supply chain, some increased spending we've seen, can you just talk a little bit about the levers going into 2008 in the communications business and how we should think about your ability to control margins there?

So as far as the technology roadmap, we, as I've talked about the last couple of calls, we're getting a lot of advancement that we have with TNG that's going to really aid in the capabilities that we have with that product. At the same time, we have DCSI and Hexagram working more closely together so that we can go into a customer and deliver a hybrid solution and obviously that's something that we're pushing forward with at PG&E.

The same time as we've brought in some of these senior sales folks into the DCSI organization, they're very familiar with the electric end market, very familiar with a number of technologies because most of these folks were hired from competing companies, they have a clearer understanding of the RF technology as well as the powerline technology. So we're certainly going to use their expertise to aid in that development as well as selling that capability and the solution if you will to the customer.

Okay. Thank you.

Steve, are you still there?

Yes.

Okay, on the supply chain side, obviously with PG&E's announcement well in advance of the deployment, we obviously had time to react to that with both Jabil and Solectron. And so what we have done, we have two dedicated teams, one at Hexagram and one at DCSI that manage these relationships. And while disappointing, at least we had enough leadtime to scale these guys back from an infrastructure perspective as they're building this stuff out. And so we're not putting our supply chain in jeopardy by any stretch so we don't have anything to worry about there. And obviously, keep in mind we deliver to 240 other customers. So that supply chain is still going to be very robust; it's just not going to have the big pile on top of PG&E.

And so what the negative is from an acceleration of margin improvement as we've mentioned in the past, there's a stair step cost profile that the more units you put through those two individual companies, you get a better pricing structure as you achieve certain milestones of hundreds of thousands of modules. And so what it really means from a margin perspective is the first tranche of decrease isn't the big level of decrement that you take. And so what we had baked in, in 2008 versus what 2008 may look like based on expected deliveries is not going to be meaningfully different, ok? So it's disappointing that we're not going to accelerate the cost reductions as we had planned, but we're only talking 1 or 2% differences at the front end of this thing. The real cost savings are realized once you cross over a threshold much more significant than we would have realized halfway through 2008. So it's not something that should cause you to be tremendously concerned that you are going to see a 5% margin change. It's nothing like that at all. It probably would get lost in the rounding, but based on what we think '08 deliveries could be.

Okay. Thank you very much.

Patrick Forkin, Tejas Securities.

Vic, in the press release, it mentioned the activity, some of the activity with respect to Duke Energy and TXU. I was wondering if you could update us a little more specifically on those two projects.

We're still deploying at both of those locations. I would say that the deployments we have there are working very well. At TXU, I think we've got about 400,000 units deployed and like I say, it's performing exceptionally well. At Duke, we're still doing that initial piece of northern Kentucky. Our hope is to get that completed this summer and get an expansion right on the heels of that based on the performance that we're going to have.

Pat, just to put some numbers around that, on the Duke project, for the nine-month period, we're at approximately $4 million in sales on that first phase of that and on the FPL project, it's about $4.5 million, which is the load control devices that we've been delivering. And then one of the nice surprises is the project we announced a couple of quarters ago down in the Dominican Republic with EDESur. That's a little over $3 million in deliveries year-to-date. So the IOU business is relatively stable, granted smaller than we would like it to be, but each one of those is gaining traction.

Okay. And then with respect to Hexagram's electric product, I believe that you guys have a fairly significant deployment of that someplace in Indiana. You mentioned that you have some of that out in the field already at PG&E. Could you tell us how many units you have out at PG&E and if the results at the Indiana deployment support a much larger scale being able to roll out at PG&E going forward?

Yes, at PG&E specifically, we're going to deliver about 2000 end points for this trial. We have about 1000 end points deployed today and collecting data and collecting it very well. The thing in Indiana I believe we have to date about 30,000 deployed and we are eventually going to have I believe 63,000 deployed there. The scalability issue, I don't think it's going to be an issue. Obviously we have to get through that phase just like everyone else, but because of the way the system is set up, we don't think there's going to be an issue of going to a much larger deployment than what we currently have.

Okay, very good. Thank you.

Chris Kotowicz, A.G. Edwards.

Good afternoon, guys. Maybe just to flush out the TXU question a little bit more, you talked about deployments. How are we looking on I guess order progress? Is any of the additional 600,000 units that were kind of out there, was that in any of the backlog discussion or order growth this quarter?

No. We've not gotten an order from -- an additional order from TXU as of yet.

Okay. Kind of prospects for something in the September quarter?

I'm not sure it would be September quarter or not but we feel very confident we will be getting some additional orders from TXU.

Okay. And then could you break down the orders for PG&E between DCSI and Hexagram? Is it weighted toward Hexagram or the other way?

The DCSI side of that 48 was about $23 million for DCSI and the balance is at Hexagram.

Okay.

25, so it's pretty close to 50-50.

Okay, and then in the quarter, how much of your order total overall was co-op?

On the orders? We did about $18.2 million of co-op orders in Q3.

Okay. Any comments on the impact -- PG&E is looking at changing the remote connect/ disconnect functionality to I guess add that directly to the meter if I understand them correctly?

Right.

What would that do to your contract, assuming that it all goes forward, that you manage to pull off the kind of keep the project in hand. Is that a negative for your contract overall?

Well, there have been some disconnect collars assumed -- not a large number of disconnect collars, but there have been some. But we have already -- we're already obviously in interface with a lot of electronic meters. Some of the folks now are developing I don't think anybody has deployed these yet, but they have under development and will deploy the disconnect switch under the glass.

Now, they need to work with companies like ours to be able to activate that disconnect switch. Those are all activated by an AMR system or an AMI system of some type. So we are actively working with the folks that PG&E and other people are interested in working with to be able to activate those connect and disconnect switches.

Okay. So there's maybe a small hardware headwind in terms of the value of the contract, but it's not really a big deal?

Right, right.

Okay. As far as the transponders that you're going to ship in that 30 million in orders for the quarter and 48 for the year, I know that we're looking at by the end of calendar year '07, I think they've said 240,000 endpoints deployed. What if they slow the schedule down and worst-case, I guess, they decide to do something different? Do they just eat the cost of those transponders that you guys have already basically shipped or do they return some of those?

No, I don't think there's any return clause in the contract at all, so they're taking ownership of these, yes.

Okay. And then my last question is your accounts receivable actually grew faster than your sales quarter to quarter -- not year-over-year, but quarter to quarter. Was that related to PG&E and other IOUs or was there something else going on there?

Yes, Chris, because we are billing these guys, but it goes up in the deferred revenue. So there was about $16 million of deferred revenue in the quarter across the Company, and so you don't see that in the revenue line, but you're going to see it in the receivable line and that's what kind of turns that a little bit upside-down for you.

Okay. Thanks, guys.

[Mark Segal], Canaccord Adams.

Hi, it's John Quealy. Real quick, I'm sorry I'm jumping on late here. You folks are planning on submitting a bid for the PG&E updated RFP in a couple of weeks. Is that correct?

Correct.

And Vic, still no change on the gas side? If anything, are they giving you any more indications that the gas side is safe and it's going to stay with the Hexagram product as they sort of relook at this whole process?

Really haven't gotten any. We are not talking specifically about the future, to be honest, other than what we're doing as project. Because of where we are at with the RFP, we can't have specific discussions about that. So we are kind of where we are on that until future or further notice I would say.

Okay, that's fine. And then on the Nexus side, what are you folks seeing in terms of activity, whether it's meter data management or energy management for the Nexus product? In terms of RFP's, we've all talked about the hardware RFP's for quite some time, but how is Nexus positioned here as we do a lot of data integration if you will for some of these hardware systems?

It's been good. I would say particularly for the customer facing piece of this. That's the place where they have really unique capabilities and so since they've become part of ESCO, we really -- their order profile has increased significantly. I'm not trying to take credit for that, obviously. I'm just saying that I think the traction in the industry has been positive and their backlog has grown almost every quarter since they've been part of us. They have also won a couple of meter data management systems, which I've talked about a little earlier in the call. So that has been a new area for them and so they are having some successes there. But the core products that they've always had remain very strong.

And can you comment on the level of R&D or engineering spend at Nexus? Obviously there's a lot of competitors out there spending a lot of money in this space. Can you comment on year-on-year if levels are up for Nexus or how do you see the investment needed there in the near-term?

I would say that year-over-year, the investment is probably up 20, 25%, so we have been, particularly with this meter data management system, have made some investment there. Unfortunately, a lot of the development takes place is supportive of a customer that will come in and say we need additional functionality and so we are able to pass some of that onto the customer as they buy the additional products.

Okay, great. Thanks, Vic.

Stuart Bush, RBC Capital Markets.

Can you detail what other AMI RFPs other than PG&E you guys are currently bidding on or looking to bid?

No, we've always taken a stand we don't talk specifically about those. There are a number of them that, where we have RFPs outstanding. Some of them I think are fairly common knowledge, but we've always kind of tried not to identify those. But there's probably a half a dozen where there are bids outstanding. I'm talking about investor-owned utilities of one size or the other. And a number of other people that are starting to talk about doing this in the latter half of this year or the first part of next year. And in addition to that, on the water side or on the co-op side or the electric side, we are probably getting a dozen or more a quarter that we're bidding actively.

Okay. Well for the existing set of AMI, the first wave utilities out there in California, Texas, and other places, can you help characterize what the dynamics are that they're looking at? Is the priority the feature sets, the scalability, price, service? I know there's a lot of factors, but if you could help prioritize what you are seeing as the main factors as the different utilities look to choose a vendor?

Well, the ones that you identified I would say are a little different than what we see in some other places around the country. The folks, particularly in California, at SDG&E and SCE in particular are very, very focused on the home area network and demand response. And so that has been an area that they've been the most interested in. If you look in some of the other utilities in the Midwest and even some on the East Coast, there has been more focused on advanced metering and not as much focus on the home area network. And we've certainly seen that outside of the U.S. where they're looking more for some of the basic functionality. But certainly I think the whole industry is interested in the home area network and that's one reason we've been working on that for the last 18 months or so.

Some of the issues I think that are inherent in that is which of the protocols are ultimately going to be successful in controlling some of these in-home devices, whether it's going to be ZigBee or Z-Wave or some of the others. So what we're trying to do as we develop our products is to have an in-home product that are supportive of any of those protocols, because I think there is going to be some shakeout period before final determination on what the ultimate protocol is going to be or if utilities are going to settle on different protocols.

Okay. Very helpful. And then sort of switching gears, can you talk about the dynamics driving the increased EBIT margins in the filtration side of the business and how sustainable that might be?

Yes. Let me talk, comment, quickly in then maybe Gary may want to jump in as well. I would say that the aerospace business both at PTI and VACCO has driven that performance improvement and quite honestly, a lot of it has just been done the old-fashioned way. The guys have raised prices where they could. We've taken costs out. If you look at PTI specifically, their SG&A is level with what it was a couple of years ago and their sales have increased significantly. So we have benefited from the fact that the commercial aerospace market has picked up. VACCO has been successful in rewinning some of their military programs and so I would say all of those things, being able to get the volume up, but also being able to control the costs and just deliver better margins. It does appear that it's going to be sustainable in the near-term. My crystal ball is not any clearer than anyone else's, but certainly the backlog that we've been able to achieve going into '08 and beyond looks very strong. The position that we've been able to achieve on a lot of the programs -- and you have to understand that these aerospace programs are usually long-term programs -- has been significant.

Point of interest I would say with VACCO is they have a lot of products on the space shuttle and as that is being phased out, the new system is coming on, is the crew exploration vehicle. And there's been eight projects that have been awarded that we chose to participate on or were prepared to participate on and we've won seven of those eight projects. So I think these guys have done a really good job of taking advantage of the business that's there, winning more than their fair share of the business and then execute on it very effectively.

I'll just add a couple points to what Vic added. PTI in particular on the aerospace side, we've been very successful, as Vic said, on the cost management side, but also on the pricing side we've had two dynamics work in our favor. Obviously the airlines are finally trying to figure out (multiple speakers) money and a few of them are actually making money and so when that is the case, we have held our prices somewhat constant, which would be maybe a couple of years worth. And as these companies are coming out of some of their challenging financial situations, they recognize that and so we're getting pretty aggressive on pricing since we have held the line and that's manifesting itself straight to the bottom line.

Another dynamic in the commercial aerospace side is Boeing purchased one of the largest aerospace distributors in the marketplace maybe a year or 15 months ago. And through the process of doing that, it's allowed us to better link our OEM supply chain to the aftermarket supply chain and get more comparable pricing. And we've done a lot better on the OEM side in the past and so what we've basically been able to do is move some pricing that was a little bit lower in distribution up to the OEM kind of pricing structure and that's benefited us in the commercial aerospace side as well.

And the last thing I'll add is if you look at our CapEx budget in filtration in particular over the past two or three years, if we're spending 8 to $10 million a year, about 75% of that is geared towards filtration and what it's really doing is putting in advanced automation and things that we call process improvement opportunities, where you go in in some of these pleading liens where you are dealing with pretty high-cost membrane and the less scrap and rework you have, you save 2 or 3%. And so we're seeing the benefit coming out of our CapEx plan in the efficiency side following straight to the bottom line as well. So as Vic said, we're kind of hitting on all cylinders right there and it feels pretty good for the foreseeable future.

So would you characterize it then, given this pricing environment, given the strength in the aerospace side of the business, that your guidance or your outlook has improved versus a quarter or two ago?

Yes, I think it's just realizing -- we had expectations that these prices would stick and not get a whole lot of pushback. As Vic said, you have a little bit of a crystal ball when you put these new machines in place so you're going to realize the efficiencies on the scrap and rework as quickly as we thought. And so what we're really doing is, again, with the very, very solid management teams we have out of the operating units, they have accelerated a lot of these things and they are in place now, probably quicker than we anticipated.

And so what we see here in this third quarter and going to the fourth we think is sustainable because these things are real. It's not just a little oneoff thing that kind of blips it up here and then three months from now we have to try to figure out how to save a few more bucks. It's something that I think the disciplines are in place and the processes have been proven and I think we can execute to those plans here for the foreseeable future.

Excellent. Thank you.

Matt McGeary, Centennial Asset Management.

Regarding the TNG or the 2.5 and the 3.0, did I hear that -- I sort of was on and off the call. Did you -- 2.5 is a little bit behind schedule; is that what you said?

Yes, it's actually 2.0, but yes, 2.0 --

I mean 2.0. Right.

I don't want to confuse somebody else. I want to get confused myself. 2.0 was a couple weeks late from our internal schedule. No, we didn't have a set schedule with the customer, but it's our internal schedule.

That was -- you expect to be done sometime in July; is that right?

Right. And so what's happened is as we've gone through the testing phase, we found some issues that we wanted to get finalized or finally corrected before we delivered that.

So is it safe to -- not being a code writer myself, is it safe to assume that given the fact that you were able to do -- continue the 3.0 development in parallel, that the issues you faced in 2.0 were not really structural in nature, not anything that's going to give you problems down the road as you try to hit that September 3.0?

The issues that we have addressed, I mean this whole process is a continual process of writing the code and going in and identifying where there are errors. That is just the nature of it. But they have all been fairly minor. You have to go in and you have to do -- rewrite the code or a piece of it. It's not like you start over, but you have to rewrite a piece of it, but then where really the time crunch comes in is just then you have to go through it and ensure that it's done properly, you have to go through a very extensive testing process to make sure that when it gets out in the field it's going to perform appropriately. But those have not been significant issues that have been identified, first of all.

And second of all, as I mentioned, you may not have been on the call at the time, but we're really happy with the overall performance of the product. So where I would say a year ago people were asking hey is this thing going to work or not, as we sit here today, we have a great deal of confidence that when it is delivered it's going to work really well for the customers. So I think we've gotten past that hump, and as we've talked about in the past, the big issue is getting 6.3 to work properly, which it is and now a lot of additional functionality we have with 2.0 and 3.0 are getting finished and put into the product.

(multiple speakers) in the September deadline you said for 3.0, is that also an internal thing or is that a contractual issue with PG&E?

Well, we have to do that to recognize our revenue. So it's not contractual with PG&E specifically that date. We do have to deliver that to them, but that was the date that we put in to recognize the revenue.

Okay, great. Thanks.

(OPERATOR INSTRUCTIONS). [Hasan Doza], Luminous Management.

A quick question on the PG&E electric piece. If we assume for a second that PG&E selects another vendor for the electric piece, can you talk about offsets that you can achieve in your business, like G&A reductions?

Well, certainly, we are already looking at those kinds of things because we have been ramping up the business to participate in a full deployment of PG&E. Obviously if they make a change or if they decrease it significantly, then we're not going to have the on-site support at PG&E, which we envision we will actually have some, then it won't be nearly at the level that we had before.

Kind of the same thing, if you just kind of look across the Company, with that contract that size going through, there's as much support or more support in St. Louis required to support that as there is in the field. So obviously we would be able to take that cost and hopefully redirect it to another investor-owned utility, but we can't obviously keep the same structure in place or put the same structure in place that we had intended to do with the full deployment of PG&E.

Said another way, Hasan, it -- obviously a lot of the people have modeled this out by taking a full cut out at PG&E at the electric side. So whatever number people have selected to remove and they backed out the incremental margin that that sales would yield, that's probably not the best way to look at it because we wouldn't just have an absence of that level. So I think what Vic was saying is you take -- assuming it is zero, which is obviously the worst case, you take out the incremental margin, you can pretty well add back a level of G&A, whatever that is, if it's 10% or 30% of the margin that we would sacrifice on the volume, I think is how we are looking at the cost savings that we would not be expending by -- if it really manifests itself to zero, there is internal costs and there's PG&E specific costs that would go away comparable '08 to '07. So I think it's not as bad as some people have modeled it out.

That's helpful. Gary, in presentations back in June and also in March, you guys have stated as part of your financial goals to achieve $3 of EPS in '09. Do you guys still feel that you can achieve that goal?

We're certainly still focused on that goal. I think there's a lot of opportunity in the market both for organic growth and growth through acquisition and that's still what we are squarely focused on doing. And I think there's ample opportunity to do that.

And what are the plans for buyback?

Well we have bought back some stock and what I would say is we still haven't opened authorization, as Gary talked about, and we will be active as appropriate.

Thanks, guys.

Chris Kotowicz, A.G. Edwards.

Didn't want to hog the call, you know. I guess my follow-up questions are sort of around the technology. You are working on integrating Hexagram into DCSI as far as a combined or integrated hybrid platform. Are you seeing any specific technical challenges there that are going to make that difficult? They both basically have their own communication protocols, right?

Yes, the way it will be done is much like PG&E is doing it, much like WPS has done it, you have some piece of interface software and basically you're bringing information back, bringing data back and you're taking it to a common database and you're displaying it to the customer. So my view is as we go talk to a customer, they don't really care how we get the data back. If we get it back using RF, or we get it back using PLC, we'll make the decision on the best way to do that. And what they will be interested in is how the information gets displayed to them, the ease of maintenance, that type of thing.

So that should not be an issue. Certainly, as I mentioned before, we are already co-deployed in a couple of places, so it has proven effective in the field.

Okay. And does that at all play into -- that sounds like a separate track from looking at like open architecture, which seems to be something of a push that I think they've talked about, having maybe more open architecture further out into the field as opposed to I think you guys go more open at the substation, typically, right?

Well, we are open from the substation back; we're open at the central location. We are open at the meter -- well, open at the meter; we're flexible at the meter in that we can utilize anyone's meter. I think what we're doing and I think really kind of everybody is doing the same thing is you still have a proprietary way to talk to the meter, whether it be from the substation or whether it be from some type of a data collection unit.

Okay. So that's not something that you guys are necessarily working on is opening that up at this point? It's more of making sure that you've got an overall system that will work, whether it's wireless for the electrical or PLC for the electrical?

I'm not sure I understand the question, Chris.

I guess when we talk to people, we continue to hear interest in opening things up and I hear [scata] thrown out a lot and it sounds like you've got -- and most people have historically, right, a proprietary system like you said, out to the substation basically. And I get the impression that PG&E and others are wanting more openness further out toward the meter. And it sounds like that's not something that's maybe on the plate right now for you guys to work on.

Well, if you are talking -- we are open, again, we use a lot of different ways to backhaul the information. We have a couple of different ways to talk to the meter itself. And what we don't have, and I'm not sure anyone else does either, some people have talked about well, we can use WiMAX to the meter. We can use Wi-Fi to the meter. We can use any number of communication devices to the meter. But then at the end of the day, something has to control all of that. And so, and you have to adapt your meter for that. But if you have the capability to talk all those different ways to the meter, then you have to have those types of devices in the meter. I mean you still have to have the capability to communicate with the meter. And if you use WiMAX, then you have to have a WiMAX module in the meter.

So there's still going to be some proprietary way, if you will, to talk to the meter, to everyone of the meters now. So if you are going to have a half a dozen different ways to do it, then you're going to have to support all of those. And I'm just not sure that that realistically makes a lot of sense.

Okay. And then maybe switching gears then, another thing we hear a lot about is distribution automation. I think we've talked a little bit about that in the past. Is that something that as you integrate Hexagram and DCSI, is that one of the incremental components of functionality that you are looking at adding or is that going to be something that will be handled by others?

Well, there's some product that we already have under development internally at both locations to do some distribution automation. At the same time, we're talking to some third-party vendors that would bring that as well. That's an area certainly that most utilities have a great deal of interest in. We have some capabilities just because once you have that infrastructure in place, whether it be PLC or whether it be RF, then that's something you should take advantage of and you can piggyback on. So we have developed some product there and we are working with some other people to deploy product.

Okay. That sounds good. Thanks, guys.

Rob Mason, R. W. Baird.

Yes, Vic, last quarter you spoke of I believe two water pieces of business, one under contract in Kansas City and one that was still in negotiation phase. It looks like you've recognized some sales from Kansas City, but is that project now tracking as you had planned?

Yes, now that it's got rolling, it is tracking as we planned. It was just later getting started.

Okay. And could you bring us up to date on the one that I guess was still in negotiation, maybe where that stands now?

Yes, we still have not closed another significant project. We have some ongoing discussions with some customers. So still not anything to report.

Okay. Thank you.

That concludes today's questions. Now I'd like to turn the call back over to Mr. Vic Richey.

Okay. Well I appreciate everybody's attention today and we will be talking throughout the quarter. Thank you.

That concludes today's conference call. Thank you, everyone, for attending.