ESCO Technologies Inc (ESE) 2009 Q2 法說會逐字稿

Good day and welcome to the ESCO second quarter conference call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO; and Gary Muenster, Executive Vice President and CFO. And now to present the forward-looking statement and for introductions I'd now like to turn the call over to Ms. Pat Moore, Director of Investor Relations.

Good afternoon, everyone. Statements made during this call regarding the timing and amounts of fiscal 2009 expected results, sales, cash flow, EPS, future growth prospects, anticipated deliveries to our AMI customers, the success of AMI pilots, success in international markets, the receipt of additional space project awards, impact of the stimulus package 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 fiscal 2009 second-quarter results press release issued today and found on the Company's website at escotechnologies.com under the link investor relations.

I'll now turn the call over to Vic.

Before Gary gets into the specifics on the financials, I'd like to provide a few comments on the quarter and the year and also discuss our perspective surrounding our adjusted earnings guidance.

I'm very pleased with our second-quarter results as we came in at the top end of our previously expected EPS range in a very challenging economy, as all of our operating units delivered solid performance. I strongly believe that our diversified end markets, driven by our three-segment approach, continue to pay strong dividends for us in the current business cycle. Certainly, we are not immune from challenges during these difficult times, but I feel our multi-segment approach gives us the resiliency to weather the storm.

In addition to our sales and EPS growth in the second quarter, I'm also very pleased to see our Q2 entered orders come in with a book to bill of greater than 1.

All of our major AMI projects remain on track, and we are executing the plan on the big three programs. The PG&E gas project is now over 3 million units on order, worth $175 million. New York City Water is at $21 million in firm orders, representing nearly one-third of the project. And Idaho Power orders grew over $6 million, representing nearly 25% of that project. Our co-op [and immunity] orders remain on track, consistent with our original plan, and our distribution partners continue to provide us with the level of confidence that we will be able to deliver to our plan.

Regarding our backlog, I want to remind you that our backlog only reflects the amount of purchase orders received and does not include the full contract value expected of each project. As an additional data point, we are starting to see some positive signs with our utility customers. We base this on the impressive turnout we had at both the Doble client conference and the Aclara users group conference, which were held over the past 45 days. Utility customer attendance was exceptional at both conferences and was consistent with historic levels, which I believe is indicative of interest and the commitment we have from our customers through this trying time.

On the international front, we continue to make meaningful progress with our pilot activity and proof of concept work in both Latin America and Asia. While this process continues at a slow pace, we are making steady progress in getting these projects moved from testing to deployment. In fact, we had our first win in South America, where a small utility in Colombia has selected our Aclara PLS solution for systemwide deployment. While this deployment is not large in quantity, as it is less than 25,000 endpoints, it is very meaningful as a reference customer for other ongoing projects in that region.

In addition to our electric AMI opportunities, we are now seeing several new and significant opportunities for our RF fixed network water AMI solutions in Latin America. Lastly, on the international front, even though our LDIC acquisition has not performed according to plan, given the very soft European economy, we are seeing a significant level of interest in the LDIC products here in the US as we are cross-selling the LDIC products through the Doble sales and distribution channels.

Now I'll turn to full-year outlook. While we continue to have meaningful [pocks] of opportunity throughout the Company and I'm cautiously optimistic about the balance of the year, I think it's prudent to adjust our '09 outlook, given the uncertainties of the macro environment. As you know, we have a very rigorous and detailed planning process with our operating units that regularly provide us with numerous touch points throughout the year. Through this process we are able to maintain a high degree of visibility and confidence surrounding our near-term outlook. But because we are operating in a rather unique business cycle, I believe a more conservative posture is warranted as we address our outlook. I would characterize this adjustment as a reflection of our conservative planning approach.

Our EPS adjustments reflect softer than anticipated commercial aerospace deliveries and lower sales of Doble's hardware products. The Doble recurring service business remains rock-solid, but the hardware side of the business has been slowed by the capital constraints at the utilities. Since the Doble hardware is very critical to the overall maintenance and reliable performance of the electric grid, I'm confident that these slower hardware orders and sales are temporary in nature.

In total, our overall business remains very solid and our current operating plan is well understood and appears achievable.

Regarding the stimulus package, there's a lot of activity going on. It's moving very fast and seems to be changing constantly. We are actively engaged in monitoring this process with dedicated internal people and resources as well as participating with the various industry groups in advancing our agenda, and we are working with other AMI companies on these opportunities as well.

We feel this is going to be a positive catalyst for our industry over the long term, but until it's more clearly defined the timing of any near-term benefit is a bit unclear.

As I wrap up my commentary, I'm going to point out that while we have confidence in our ability to achieve our financial goals, we are not standing idle. We continue to be aggressive in looking at all of our operating cost, and we continue to work our ongoing contingency plans. We have a very seasoned management team in place across the Company who continue to make the hard decisions every day to ensure that we continue to return value to our shareholders.

We are very fortunate to have these dedicated individuals in each of our operating units.

Lastly, I'd like to touch on an administrative matter. Several of our key managers have five and 10-year stock options which are expiring throughout 2009. A significant number of shares have already been exercised with cash, and more shares will be exercised over the next nine months. It is our corporate policy to allow limited stock sales periodically by our key executives, basically to cover the cash required to exercise the options and to cover the personal income taxes related to those shares. As a result, you will see some modest selling activity over the next few weeks to cover these options. But the net result is that the executive officers will, in all cases, own more net shares as a result of these transactions and will continue to significantly exceed their mandated ownership requirements.

Now I'll turn it over to Gary for some brief financial comments.

As noted in the release, EPS from continuing operations was $0.40 a share in Q2, which represents a 60% increase over the prior-year second quarter EPS of $0.25. In addition, the $0.40 in Q2 represents an 8% increase in EPS sequentially over Q1 of '09. Also sequentially during Q2 we increased sales approximately $7 million from Q1, and we were able to increase EBIT greater than $7 million in the same period, validating our cost control efforts along with a more favorable sales mix. The $0.40 came in at the top end of our previous EPS guidance and was driven by additional sales of Aclara RF AMI products and higher sales at VACCO.

Additionally, we were able to realize manufacturing cost efficiencies and other cost containment strategies put in place throughout Test and Filtration. During the quarter we also sold the assets of Comtrak and received nearly $3.5 million in cash and recognized a modest accounting loss in discontinued operations.

On the cash side, while our cash flow was slightly negative in the quarter, it came in significantly better than expectations. The cash usage in Q2 was driven by our inventory build at Aclara to meet increased Q3 and Q4 sales demand as well as to build safety stock to meet delivery schedules during the RF facility move later this year. Cash was also impacted by slower than anticipated collections from one large international customer. While the payments have been slower than expected, this AR is not at risk, as this is not a financially challenged customer.

While our Q2 performance was better than expected, I still want to point out that Q2, as with Q1, was impacted by our decision to continue spending additional R&D dollars at VACCO and Aclara RF on new product development and existing product enhancements to support future growth. The VACCO R&D spending continues to be made to ensure that we are in the best position possible to continue to win the additional space projects that are currently up for bid.

Regarding the balance sheet, I am very pleased with our capital structure and our available liquidity, as our net debt outstanding at March 31 was approximately $180 million. This debt level on top of our trailing EBITDA results in a very comfortable 1.99 times leverage ratio. By getting below the 2.0 ratio, we further lowered our cost of borrowings, as our spread over LIBOR decreased at this level to 57 basis points.

Regarding our current outlook for the balance of '09, as Vic mentioned, we adjusted our outlook for '09 to provide a more conservative view of our Q3 and Q4 expectations. We now expect 2009 operational EPS to be within the range of $2.37 to $2.47 a share. This equates to GAAP earnings, which includes intangible asset amortization and the Aclara RF facility exit move costs, which are expected to be around $0.05 a share, to be between $1.90 and $2 a share.

As I mentioned during the last call, it is not our preference to provide quarterly guidance, since we regularly have several moving parts within our customer base as well as other long-term contract deliveries that can move a month or two around at quarter end. But with that said, I will tell you that our fourth quarter will be higher than our third quarter.

I'd also like to point out that even with our more conservative outlook, we continue to expect favorable sales and EPS comparisons for the total year of '09 versus the total year of '08. Assuming EPS comes in at the midpoint of our guidance, this would reflect an 8.5% EPS growth in a very challenging economy.

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. That does wrap up our prepared comments, and now we'll open the call to any questions you may have.

Steve Sanders, Stephens Inc.

First, just a question on stimulus. It looks like the initial draft is skewed towards smaller projects. It seems like that would be a pretty significant benefit to you guys in 2010, if in fact that's how it turned out. Is that a fair way to look at it?

Yes. I would say, Steve, that the way it's currently written -- it's currently written, the key -- those do cap out at a fairly low level, less than $20 million. So we would see more of that money going to the co-ops and municipals and those types of utilities. And, obviously, I think we are best positioned in that market of all of the competing technologies.

And what are you hearing from an insider's perspective on the comment period? Clearly, there are some large projects that would like to go after bigger chunks of the funding. What's your best guess at this point on how that plays out and what we ultimately end up with?

I still think that what's currently in place will probably hold together for a number of reasons. I think that they really do want to spread the wealth, if you will, to a larger number of utilities. And as I've said previously, I think just from a PR perspective, it probably looks better if the government is providing a number of these things to the smaller cooperatives and municipals versus to large investor-owned utilities because, if they do that, they are only going to have a much more limited number that they can actually award.

And then in kind of a related area, security has become a pretty high-profile issue. Clearly, it's been a high-profile issue for the vendors and the utilities for many years. How comfortable are you guys with your current RF and PLS products as it relates to the current focus on security?

As you can imagine, this is something that we've been working through over the years. And most every one of these projects will have some level of security requirements -- testing, verification. Certainly, we went through that. Probably the most rigorous place was with PG&E, with both of our technologies. And we were able to perform well there.

So I think that we are in a pretty solid position there. There is a lot of activity underway with some of the standards committees, where they're looking at cyber security because that has become more and more important. And there may be some changes to come out of that, but I don't think there's anything inherent in our technology that's going to give us any issues, as that does get more clarified. But until it gets clarified, we won't know the final answer. But I would say today we're pretty comfortable with our ability to meet those requirements.

On the PG&E gas project, you've received orders for I think it's 3 million units, $175 million or so against 3.7 million potential and an incremental $50 million. Where do we stand in terms of shipments? I guess what I'm trying to figure out is, it feels like at the current shipment rate that the project winds down sometime during 2010, assuming that they don't make a significant shift back toward electric installations and away from gas installations. So I just want to get a sense of how you're looking at that project over the course of the next year and a half or so and how we should be thinking about that.

I'll address the quantity issue, and I'll let Vic take care of how we are looking at the thing. So cumulative to date in the number of units, we've sold and shipped 2.4 million units worth about $140 million against that 3 million and $175 million that you mentioned. So you can do the math on that and what their yet-to-install rate is on that.

The way the rollout looks for the balance of the year, it should be relatively consistent with the volumes that you'll see in Q2. But I will point out also that there is some additional growth meters as we look at the fall-off in 2010. I don't think it's going to be as severe as everyone thinks because, keep in mind that contract was signed in 2005 and there's been additional building activity going on out there. So if they are going to go forward with the complete installation, then the ultimate number at the completion of that project will be greater or is expected to be greater than the numbers you have. So the fall-off that you will see in 2010 is probably somewhere in the neighborhood of $20 million to $25 million off of the run rate in '09 and not as steep as a lot of people might think because of the creation of growth meters as that service territory has expanded over the last 4.5 years. It's a much larger service territory than it was when that contract was originally signed.

And we are not making any assumptions on the electric meters, so we're really focused on the gas meter today. And I think Gary did a good job of capitalizing on when that rolls out.

I think you talked last quarter about some push-outs on the Doble hardware side, and I think it was something you mentioned along with commercial aerospace weakness as it relates to your guidance over the balance of the year. Can you just bring us up to date on Doble? From the context of -- does it look like this issue is compounding, or does it just look like you are going to be unable to catch up maybe what you lost over the first half of the year?

I don't think it's really compounding. We're really seeing -- I think there is a lot of pent-up demand. I spent some time at the client conference in the first part of April and talked to a number of customers, talked to our internal sales guys, and I don't think there is any doubt that the orders are going to start loosening up because demand is there. They need the product, they want the product. In some cases they have the open purchase orders to -- or they have the ability to order product, but they're just not drawing against those purchase orders as of yet.

So I don't think this is a systemic issue as much as it is a timing issue. At the end of the day it is capital equipment, and it's anywhere from a $40,000 to $60,000 piece of equipment. If that's something, if they can buy eight of them rather than 12 of them, that's kind of the decisions that utilities have been making.

The other reason that I think it is a timing issue, as I mentioned in my introductory comments -- the recurring part of the business is just as solid as it ever has been. And so I think the utilities are still quite enamored with the products, with the service they're getting from Doble. It's just that they are taking a bit of a pause, and pause is probably even too strong of a term because people are still buying things, they just aren't buying in the same quantity that they did before.

I think the other thing that it's very important that we all remember is that even with us talking about the Doble sales being down, they are not down versus what they been in the past, they're down versus what our expectations were. And so I think we have built a good bit of growth into this year. And the other thing that's important to remember is their EBIT contribution is still very significant.

That's just a tough business right now. The Boeing strike hurt us in the first quarter, and we're seeing the travel -- the flight miles are just not where they had projected to be. The number of parked planes is a lot higher than it has been in the past. And so, again, that has come down from what our expectations were going to be. But again, I think it's important to remember a couple of things. PTI, the business that has that, is coming off their strongest year ever last year. And the other thing is, that management team has done such a good job of managing cost that even though their sales are down pretty dramatically this year -- well, dramatic is probably an overstatement again. They are down significantly this year, but they are still delivering EBIT in the upper teens, and so they have done a really good job of managing the business.

Kevin Maczka, BB&T Capital Markets.

Vic, a little more color, if I could, on the guidance. It sounds like you're talking about PTI and Doble hardware, kind of where the weakness is, at least relative to your prior plan. I'm just wondering if you can quantify at all the significant decline at PPI versus the growth at VACCO.

And also, is there anything in that guide down related to the rest of the utilities other than Doble, or specifically the muni business, or even the Test segment?

I don't want to get into a lot of specifics about versus what we had thought and where we're at. But you are right; the two areas where we are seeing the biggest downturn is with the Doble hardware and with PTI. The VACCO business is higher than what we anticipated, so that has offset it some.

The Test business is a little softer in the second half than we thought it was going to be, but it's not a significant number. So again, I'd say the area where we made the decision to take the guidance down was a result of Doble and PTI.

How about in absolute terms, Vic, not necessarily relative to your expectation, but just in absolute terms in the quarter? Can you tell us how much VACCO was up, how much PTI was down?

I'd say for the second quarter, VACCO was up over 2 million, and PTI was down about 2.5 million. So that's where you see, compared to second quarter last, I think we are down 700,000. So they almost offset each other dollar for dollar. And to Vic's earlier point, the impressive side of PTI, while their sales were down $2.5 million, the EBIT contribution was only down nominally. And to Vic's point, in the upper teens, they basically were ringing right at 20% EBIT in the second quarter in spite of the lower sales.

Now, with the VACCO sales being up over $2 million, their margin contribution was down slightly. And that's in reference to the point that I wanted to make sure everyone was aware of, that we're investing pretty substantially in that crew exploration vehicle, to the tune over the course of the year somewhere in the neighborhood of $1.5 million to $2 million in additional spending on that project.

So I don't want to say we're purposefully muting the EBIT contribution, but the point we are trying to make is there's a substantial revenue opportunity coming out of those programs based on the bid and proposal activity we are signing off on, and this money we are spending on the R&D in spite of the challenging economy we are not constraining them on their spendings because I think the opportunities over the next three to 10 years on this program are going to be substantial.

So when you put that all together, you do see a little bit of compression in the Filtration EBIT margins. To the point on the Test side, the sales as you saw in the charts are up nominally, but the EBIT contribution is up five times the sales increase. Again, that's where these guys at the units have really taken a very hard look at the cost initiatives. We are really tightening down the screws on our manufacturing efficiencies. And to see that type of margin contribution coming out of the test business, I think, is exceptional.

I guess the one thing I'll add, because you did ask the question and I didn't address it, was what we were seeing in the rest of -- in the Aclara business. And I would say it's down only nominally from where we thought it was going to be.

That's how it's trending or it was trending in Q2, Vic, or that's how you see the rest of the year playing out?

That's how we see it through the rest of the year.

And that's compared to our original plan.

Okay. So you haven't seen any significant change in customer behavior? This is not a function of significant cancellations or push-outs or anything like that?

No. Again, I think you have to look at our business in pieces a bit and that the co-op business has remained fairly strong. Now, we do have book and ship that we have to do the remainder of the year, so if there's additional risk, that's where it would be, but -- and being very close with our distributors and with our customers, that appears to be on track. Beyond that, then you're really looking at the major deployments that we have that I kind of outlined. That would be in New York City, PG&E Gas and Idaho Power. So those three are remaining on track. So if you look at that and then you drop in some of the smaller municipals that we're also winning and delivering on, I would say overall the business is pretty much on track.

Sure, there's -- I mean, we've not seen anybody cancel a project on us to date. So from that perspective, they've been behaving well.

Carter Shoop, Deutsche Bank.

First, on the stimulus, can you discuss in detail what you are doing to make sure that your utility customers capture a large portion of the stimulus funding here?

Yes, we're doing a couple of things. The biggest thing is staying close to what is going on. There has been a lot more published more recently. We had some specific sessions at our Aclara customer conference, talking specifically about what we knew, the activity that was underway. We also have on Aclara's website, the internal one they have for the customers, they update that on a regular basis to inform the customers of what's going on. We've also been working with them to help think through the grant writing process because that is a process that's going to take place with a lot of this.

So what we're trying to do is just stay as close as we can to them, do as much of that for them as we can to make it easy because it's not something they typically have had to do.

Could you elaborate a little bit on helping these munis and co-ops walk through the grant-making process? Are you dedicating personnel to that? Do you expect to (multiple speakers) --

We've got, as far as tracking this, we have two full-time legislative affairs folks that are tracking on a real-time basis. The fellow that runs our marketing communications group is responsible for updating the website, keeping that information up to date in front of the customers, and he's also looking for or working with an outside grant writer to help in that process.

So I think that's essentially it, as far as -- and then we are educating our sales force as well to make sure that as they are talking to folks they can help them through the process as well.

Okay, that's helpful. And (inaudible) space contracts that are currently out to bid, can you discuss the opportunity here over the next couple of years? Is this something that can be a $20 million, $30 million, $50 million opportunity by 2011?

You are talking about through the stimulus bill?

No, on VACCO.

Oh, I'm sorry.

I'll address that, Carter from the numbers side and I'll let Vic put the overview on what's going on with the program.

These are long-lived programs. Obviously, they are still trying to figure out what to do with the Shuttle -- should they fly it, should they retire it -- and that sort of thing. So what they're doing is they are accelerating a lot of the development work on the CEV because it's pretty obvious that the Shuttle is, in its aged condition, is a bit challenging to fly.

So what they're doing is they're compressing a lot of what the plans was going to be over the next three to five years. So I would say in the last five months we've signed off on over $125 million in projects. Now, with that said, those are extended lived programs. So to your point, is it going to be $20 million in a given year? Probably not. At the front end of that, you do the development work, that you get paid for. Then you do the prototyping work, and then you do all the production work. So it really is a ramp that I think you'll start seeing revenues of any significance in 2011 migrating up. Maybe somewhere out five, six years out, it could be at those levels. But the profitability is strong because there are not a whole lot of vendors that can provide these products. There's really only two or three. And we've been winning an inordinate share of those because of our legacy products on the Shuttle. So it's a very large contracting opportunity for VACCO in the aggregate, but I think spreading it over the number of years would be a better way for you to look at it. But it's very large.

Okay, that's helpful, thanks. In regards to linearity and particularly for orders, can you discuss where you were three months ago and talk about how orders progressed throughout the quarter? I'm trying to understand if orders are maybe slightly behind where you thought they were each month of the quarter or if the softness is more of a recent phenomenon.

I would say throughout the quarter the orders came in generally on plan and maybe even a little bit higher when you look at the Filtration side of it, because there were some additional orders that we had assumed in the second half of the year that came in earlier. So I'd say, within Utility Solutions, we were on track, especially on the co-op side of the business. And as we alluded to in the commentary, we stay very close to our distribution channels, and so we have a pretty high level of visibility on the customers that are in the order pipeline. So when we make commitments for the second half of the year, as Vic said, we still have to book some orders and ship it. But the majority of that stuff for the co-ops is simplistic product that's already in inventory. So if we did get an order later than expected, we can still ship it within the period.

So I'd say the order book held together. It wasn't a last-minute push in the last two weeks to get 75%, it was nothing like that. And it's shaping up the same for Q3. We feel confident based on the Utility Solutions Group on where we are going with PG&E and Idaho and New York, and our distribution channels seem to be, on the order book, holding together relative to the original plan. So that feels pretty solid.

Test always has its volatility because these chambers can be so large that a customer may tell you you're getting the order in March, and it slips two weeks, and it becomes April, for a couple million dollars. But generally, the things that we had expected to happen are happening. Some things are moving to the right, but nothing of great concern. And in Filtration I think we came in a little better than our plan on the order book.

So I think, in total, the way it wrapped up with the $157 million or so in orders, I'd say we were pleased and it probably came in $2 million to $5 million better than we had expected the last time we spoke.

Okay, that's helpful; last question here. In regards to the international opportunity, I was hoping that you guys could give us a little bit of an update on how your pilots are progressing in Latin America and also discuss some of the prospects for a large volume win either in Latin America or Japan.

Yes, we continue, as I mentioned in the intro, we continue to make good progress there. It's never as quick as you want, but I would say the performance that we are seeing with the pilots that we currently have in place are good. We were encouraged with the small win that we won in Colombia; that was our first win there. Even though it's a small deployment, it's a full deployment.

And as I mentioned, the water thing is the other thing that's pretty exciting. We do have a -- I'm not going to get into any details about it -- a couple of water pilots in Latin America as well that we've recently put in place. And so we're excited about that as well. That's fairly new news, I would say, in that we didn't see that opportunity, and so we started spending a lot more time down there.

So I would say that we're still very bullish on South America. And really, timing is the issue. As far as a large deployment, that really is the question. We met with the international team last week and talked about that, and it's just a very hard thing to characterize. I would certainly hope that we're going to have something more substantial in 2010 than we're seeing this year. I don't think, and I think I've mentioned this before, I don't think it's going to be a case where utility is going to say, okay, we are going to buy 5 million end points, and off we go. They are going to say, we are going to deploy in this city for a couple hundred thousand end points and another city for 500,000 end points.

So I think it's still, even though they start going to deployment, it's going to be much more incremental than what we see with some of the domestic customers.

Could you possibly give us an update on how many pilots you currently have going and how many points that entails, if you have that information with you?

Yes. We currently have about seven pilots going in Latin America, and I would say the total number of end points is under 100,000.

John Quealy, Canaccord Adams.

First, when we look at USG EBIT margins moving forward, do deployment schedules at PG&E or it looks like New York Water is ramping bookings quarter on quarter. How should we think about EBIT margins moving forward for that business? You got all the way up to almost 22% last year in the Q4 period. How does it look this year?

I think it should trend about the same, John. I think obviously, when you look at where we need to be at the end of the year versus where we are now, we obviously have to increase our sales volume. And once we do that, you start to see the incremental margins follow the sales because, obviously, we're not going to be ramping up G&A ratably. So what you're going to start seeing in Q3 and Q4 is basically the gross margins essentially falling through to EBIT.

So two things are working in our favor, the volume increase; and second is on the New York City Water project. All water projects in general tend to carry inherently higher gross margins than the gas and certainly the electric do. So as we get higher volumes of water projects, whether it's New York or Kansas City or Corpus Christi, wherever, the gross margins there are in the neighborhood of 8% to 10% higher. Still, it's not the largest percentage of the total Aclara volume. But as that mix changes, it will favorably pull through the EBIT margin.

So as you look at Q3 and Q4 percentage-wise, it should be reasonably consistent to even slightly higher than we had last year, because last year we did not have the same volume of water. So it's trending positive.

That's good. And then also, just on Doble, if we can just go back and revisit it, I'm thinking about last quarter, where it sounded like we had a couple bigger customers push out year-end spending. Is that basically what you are seeing again, these customers not coming back? I thought at that time that you guys had a pretty conservative handle on when those bigger customers would come back. And quite frankly, I think you had sort of writing them off for the year, quite frankly.

So what's happening in Doble just to cause you to lower guidance just a bit?

I would say that what we're seeing now is more -- well, it's a couple of things. They aren't big, big customers like we had in the first quarter. This is just a lot of the smaller customers aren't buying at the same level we thought. So if you've got two big customers that change their buying behavior versus 10 smaller customers that do that, you kind of come out in the same place.

So we just -- where we thought at the end of the first quarter that some of the smaller customers would continue to buy as they had in the past, that hasn't happened. So we've seen more softness there than what we had anticipated. The other thing is, we are being hurt somewhat from a pricing perspective on our international business because as the dollar strengthened against some of the other currencies, we've got more price pressure than we have in the past.

And then the third thing I would say and I mentioned in my opening remarks is the LDIC acquisition -- we had anticipated better performance from that than what we've gotten. Really, the economy in Europe -- our timing wasn't the best. It's as simple as that. We bought the business, and that economy has gotten exceptionally soft and their sales have been impacted as a result. I still think it was the right thing to do. It's a good acquisition, good technology. I think we'll be able to sell a lot of that internationally and a lot of it now domestically. We had a special session on their products at the client conference in April, and it was exceptionally well attended and a lot of people were very excited about what they saw.

So I still think it was a good acquisition. But just quite frankly, it's not meeting what we had anticipated them to do the first year.

Under the USG Group, for power line, I think you said co-op was strong but it remains one of your risks as you are looking to the back half of '09 being proactively conservative, if I can use that term. For that business as you look out for the remaining six months, do you think that's a grower this year, Vic, or how do you characterize DCSI this year?

The way we have that is flat year-over-year from the co-op perspective.

And then the last thing, just a little bit more sort of qualitative macro thought, if you will. We're seeing a lot of discussion on the federal level about licensed versus unlicensed in Smart Grid, not just in the metering but in other places. Obviously, you've got great history on the license side. Can you talk about how you think that argument moves forward, and then how USG is positioned, however it comes across and comes down from the Feds?

Yes. We've gotten much more involved on the standard committees than we have in the past. In fact, we have a number of internal resources as well as some outside resources that are involved in that. We want to make sure that everybody has a full understanding of what that really means as they go to these standards. And I think we're going to be well-positioned as it goes through the process.

I don't think that people are going to say, here's a one-size-fits-all. I think there are opportunities for a number of different technologies to be successful. And so, while the standards committees, I think, have a job to do, and I think they're going to do that, I think there are a number of different places on the grid where the standards are going to be different because they really have different applications. And so I think what we've done is just to make sure that we've got people in place to make sure we do a good job of educating all the consumers and shareholders in this activity.

Rob Mason, R.W. Baird.

I wanted to see if you could just go through a similar margin discussion that you did on USG group, but do so for the Filtration segment, just given that you have some mix possibly moving around, and also your development costs. I'm not sure if those will fluctuate as we go through the second half of the year, but just some margin perspective for the second half.

Are you talking about second quarter specifically first and foremost?

Looking forward. But if you could frame it against the second quarter, that would, I guess, be helpful.

How about I address it for the year, and then I think -- make it a lot more efficient, and then you can back into how the second half looks for the total. I think, on this Filtration side in the aggregate, the EBIT margin probably will be down in the neighborhood of 1%. Last year, we did 18.2, so somewhere in the neighborhood of 17.2, I think, is a fair way to think about that. So looking at where we were in the second quarter, we were at 16%. So you can see how the volume and the mix is going to impact the second half of the year. And as we've talked in the past, when you look at the second half of the year, we have a large recurring delivery at VACCO on this Virginia class submarine valve that we sell. It's a very significant product, several million dollars worth of product that always ships in the second half of the year and it has nice margins associated with it.

And so the second half of the year obviously coming off of where we started and where we are in Q2 is driven by the mix as well as the volume. So putting that somewhere in the neighborhood of low 17's, I think, is the right way to think about it.

On the Test side, last year we did about 9.5% EBIT, and I think we are going to be in the neighborhood of 11% to maybe a point over that, 11.1%, 11.2%. So I think what you are seeing there is favorable mix as well. But also you're seeing a very effective cost containment program being managed through the test business globally.

As Vic said on the Doble business in Europe, Test is impacted on some of the international content as well. Asia is very strong, Europe is very soft, domestic is fighting to a tie. So the nice part of Asia being the strongest -- it has really good margins right now, and so that mix works in our favor. And the exceptional cost management disciplines that the Test guys are working through that is paying dividends for us. So you're going to see expansion there.

And then on Utility Solutions, I think we kind of walked through the pieces. We should see that higher in the aggregate in '09 versus '08 as the Aclara RF business, which is the big, big grower this year, works in our favor. And it carries a higher margin than power line because power line has the drag from the TNG amortization, and the water content at Aclara RF works in our favor.

So those are really the catalysts that give us confidence that we are going to see this 6% to 10% growth in earnings driven by that mix in the second half. I think we do have visibility, and I think we've dialed in the right amount of risk.

Okay, thanks Gary, that's helpful. And Vic, it sounds like Test was more or less on track; just your commentary around orders. It was also absent from any adjustments that you may have made to your guidance or sounds like it was. So the idea, though, that orders are trending lower or have in the first half, year-over-year, we're still thinking that Test has a good chance to be flat, possibly up this year, despite it is a tough comparison. Is that still the thinking, and then maybe the lower orders, maybe portend a lower 2010 or at least a slower start to 2010?

Let me point one thing out just on the numbers side before Vic gives you his global thinking on it. Keep in mind that the NATRIP project, the big automotive chamber in India, or series of chambers we are doing in India -- that order was booked last year, and it was $17 million. And half of the deliveries occur in the second half of this year. So that's already in backlog. We can call that $8 million or $9 million in the second half of the year, so that gives us confidence in the back half of the year because it's already there, it's on track and we are already starting the front end work on that thing. And so we don't need to book a whole lot of things to get the second half performance because that, while you do see the order trend in the first half of the year a little bit down, a big chunk of the second half performance is already in backlog.

Vic, I don't know if you want to add to that.

I think that's certainly the biggest driver. We still do -- with that business, as you know, we do a lot of book and ship within the year. So I can't say it's not without risk, but we have been through the details of that. And fortunately, a lot of the things that, particularly in Asia, are government-sponsored projects, and as I think we all know, all the governments right now are spending money to try to keep the economies moving forward.

Do you have any updates that you can give us on Toronto in terms of timing there or expectations of when we might start to see that project begin?

I think it's probably -- I don't think we have anything baked in this fiscal year. So -- that contract process has been a bit slower than what we thought, so we don't have anything in this year. So that will be incremental going into 2010.

Stuart Bush, RBC Capital Markets.

First, on the OpEx side, you mentioned that you would keep R&D on for VACCO. Do you expect any additional rationalizations on the expense side? Or what is it going to take besides just product mix and flow through to get the greater uplift on the bottom line in the back half of the year?

I think it's mostly driven by volume, Stuart. The ramp-up in the second half of the year, there's some military applications that we have on some of the aircraft product lines at VACCO that are working as well. And that Virginia class submarine valve that I referred to earlier is a -- it depends on when we actually complete it. But to give you a relative perspective, looking at VACCO in particular, this second quarter they did about $10 million or $10.5 million in sales. And in Q4 it's roughly $13 million. And so -- obviously, that's roughly 30%. So when you start to see that kind of incremental volume coming through with their gross margins north of 40%, that's where you get a little bit of the uplift.

And also at PTI, on the commercial aerospace, some of their -- while we are in a very soft period, and compared to last year we are down 10% or a little bit more than that, we are seeing a little bit of order strength in the second half of the year and we are seeing some deliveries in Q3 and Q4 that give us confidence that the volume pull-through covering the fixed costs will also work in our favor.

And while we don't talk much about the packaging business, the residual packaging business left over from Filtertek, that has -- year-over-year, while you hate to think of it as seasonality, the third and fourth quarters there are relatively strong as well. To put a number on that, they did about $3.5 million in sales in Q2, and they are about $5.5 million in Q4. And clearly understand where that's coming from; those contracts are in backlog. The performance of that again is driven by volume. And when you see sales volume coming through at 5.5% there, we do rationalize G&A, and that will be a 20% EBIT business at that kind of sales volume. And so it kind of gets lost because it really doesn't make sense being in there. But we don't have a better place for it at the moment because of its small size.

But we've spent a lot of time with the operating units looking at their monthly forecasts, looking at their backlog, looking at the products that need to book and ship and that ones they have in backlog, and we feel good about where we are in Filtration going into the second half of the year.

So for the whole business, we should expect, if not additional cost-cutting measures to be implemented for the year?

I would say that what we always try to do is run a pretty lean business. So typically -- I don't remember the last time we went in and just said, okay, here's a huge cut we're going to take. Every business we have is a different business. I think the operating managers with review from us take the actions proactively. So is there going to be continual cost-cutting throughout the year? I'm sure there will be, and we are looking, and people always think of people as part of that or as the only piece of that. And while, unfortunately, that is a key part of it, there's also a lot of other costs that we look at. And our guys are getting down to the nickels, looking at material cost, looking at scrap efficiencies, looking at every place, whether it be travel or any of the other expenses.

And so we will continue to have very tight cost management activities throughout the business. But I think the things that need to be done and we haven't focused and are doing those as necessary.

In addition, when we kind of saw this thing softening up the end of last year, we did say to all the operating guys, you need to put some contingency plans in place so that if your business falls off 10% you know what to do, if it falls off 15% you know what to do. And so a lot of those contingency plans have been executed, and we have additional contingency plans if the year doesn't unfold the way we clearly think that it will now.

So we don't have any huge reductions or cost-containment plans planned, but we're going to do what's prudent for the business.

Can you guys give us an update on SoCal Edison with their AMI gas opportunity and anything that we should expect to see developments out of there?

Yes. Really, nothing that you can't see on the public filings. I think the plan is currently for them to get closer to a vendor selection sometime early summer. And then I think it goes for final approval in the fall. So obviously, we don't have any more insight than what's public information.

Sure, but is it likely they would be able to make a vendor selection before it gets final approval?

I would be surprised if they didn't. The reason for that would be what they're going to have to do is with all of these large projects, you have people that come out and say, well, we want to make sure that the technology is going to work, we want to make sure you get the business case, we want to make sure that the consumer is going to be serviced well.

And so as part of that process, I think that unless you can say to those people, well, here's a vendor that we had, here's the experience they have, here's where they have proven technology, here's where the payback has been received -- then I think it's going to be very difficult for them to have those kind of discussions. I can't say 100% that's the way it's going to be, but that's typically what has happened in the past. Even if you look at some of the other large deployments, those decisions have been made and then the vendor themselves have to support and be enjoined in with those discussions that the utility has, whether it be the public utility commission or whether it be some of the consumer advocacy groups.

And if you can just lay out for us what projects for the AMI electric biz outside of PG&E you are currently working on and what proportion that makes up for your 2009 Utility Solutions segment?

Yes. If you look at 2009, we're not pursuing -- we don't have anything in the forecast that we don't already have in backlog, other than the cooperatives. So there are no large electric bids that we are counting on winning and delivering this year to make our forecast. It's solely focused on the cooperatives.

And so that would be upside if anything did come in, in the tail end of the year?

That would be correct.

(Operator instructions) Richard Baxter, Ardour Capital.

First question is on Doble. What is the breakdown between like service and products?

It's almost exactly 50-50.

And then I guess for US and international?

It's probably 70% domestic -- 75% domestic, and the rest would be international.

Okay. And then I guess another question on the stimulus for the -- and, I guess, the visibility into the sales cycle for the munis and co-ops. Do you see them looking at the stimulus bill as accelerating an existing project, or just looking to accelerate or like pull forward something they haven't started yet?

I think it would be a mixture. Most of the people that would be making decisions in the next 12 months are already actively looking at projects, I would say. But I think it does give us another arrow in the quiver, if you will, as we go talk to people and say, hey, here's an opportunity. We are going to be able to get some of this. And by the way, that money does run out at the end of 2010. At least, that's the current plan.

So if people want to access that money, then that may require them to move a little faster than what they had anticipated in the past. And I think it's also important to remember that one area where we are we are really going to aggressively go after things is, we have a very large deployed base, particularly with the co-ops and the munis. And there are additional products that we have to offer them that we feel they should be able to acquire under some of these stimulus grants rather, than all of them just being brand-new deployments. It's always easier to sell (multiple speakers) --

Can you elaborate on that (multiple speakers) --?

-- going to find a new one.

Can you elaborate on what some of the new products and services (multiple speakers) --?

Some of the things like the capacitors, bank switching units that we have. And probably the biggest one is the manned response unit that we have, also some of the software products. Most of our Aclara Software products have been historically sold investor-owned utilities, and maybe an opportunity there with the cooperatives as well.

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

Okay, well I appreciate the interest, continued interest and good questions today. We'll talk to you next quarter.

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