ESCO Technologies Inc (ESE) 2010 Q2 法說會逐字稿

Good day and welcome to the ESCO second quarter 2010 conference call. Today's call is being recorded.

With us today are Vic Richey, Chairman and CEO; and Gary Muenster, Vice President and CFO. And now to present the forward-looking statement and for introductions, I would like to turn the call over to Kate Lowery, Director of Investor Relations. Please go ahead.

Thank you. Statements made during this call regarding the timing and amounts of fiscal 2010 and beyond expected results, the success and timing of the Company's pursuit of AMI opportunities including the SoCal gas project, new product developments, future growth prospects, the future of NASA's Constellation program, success in international markets and other statements which are not strictly historical are forward-looking statements within the meaning of the Safe Harbor provision 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 10-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 may be found in the second quarter fiscal 2010 results press release issued today and found on the Company's website at www.ESCOTechnologies.com under the link, Investor Relations. Now I'll turn the call over to Vic.

Thanks, Kate. Before I give my perspective of the quarter, I will turn it over to Gary for a few financial highlights.

Thanks, Vic. As noted in the release, EPS for the second quarter was $0.22 per share which came in above are our internal expectations. While this is down $0.18 from the prior year, the decrease is primarily the result of lower sales at Aclara RF on the PG&E gas project as it continues winding down its successful deployment.

As a reference point, PG&E gas sales decreased from $23.9 million in the prior year second quarter to $7.2 million in the current quarter. Cumulative through March, we have delivered over 3.6 million gas AMI units on this contract worth over $205 million. This represents the largest fixed network AMI deployment in the country.

We were obviously enthused about the significant amount of orders received across all three operating segments which resulted in a consolidated book to bill ratio of 1.7x. We recorded a record $219 million in orders in the second quarter and $357 million year to date, resulting in an all time high backlog of $414 million.

Calling on a few specific items, we received $19 million in follow-on on PG&E gas orders during the second quarter. And subsequent to quarter end, we booked an additional $12.8 million, bringing the total committed AMI units to over $4.3 million which represents a quantity in excess of the expected number of units in the original contract.

Regarding the New York City water AMI project, we booked an additional $22 million of orders during the quarter; and subsequent to quarter end, we received an additional $8 million of orders from this customer. The second quarter also included the entire $13 million on the San Francisco water AMI project.

We're also very pleased to see the Aclara PLS orders come in at $55 million with co-ops being $37 million of that total. The Test segment recorded a strong $52 million in orders and Filtration reported a solid order book as well. These orders and the corresponding backlog give us additional confidence in meeting our second-half projections on both sales and EPS.

On the cash flow and balance sheet front, we continue to be pleased with our cash generating opportunities for the balance of the fiscal year as well as our capital structure and available liquidity. Our use of cash in the second quarter was driven by the timing of working capital requirements needed to meet the second-half sales and profit expectations. Our net debt outstanding was approximately $143 million at March 31 with a comfortable leverage ratio of 2.3 and continued favorable pricing of 1.5% on our outstanding debt.

Regarding the balance of the year, our current outlook for fiscal '10 remains consistent with the expectations we laid out previously. Considering the year to date EPS of $0.24, the year is obviously second-half weighted on sales and EPS as it has been in the past; and consistent with prior years, the fourth-quarter sales and EPS are expected to be higher than the third quarter.

I will be happy to address any specific financial questions during the Q&A. And now I'll turn it back over to Vic.

Thanks, Gary. First of all, I want to say that I'm also pleased with the second quarter results. They were above our original expectations.

Most importantly, the strong (inaudible) orders in Q2 following the strength of our first quarter orders has given me more confidence in our outlook for the balance of the year. These orders are also indicative of our strong product offering across all three business segments.

To give you an update on one of our large AMI prospects, as everyone is aware, the SoCal gas project received PUC approval since we last spoke and has continued to move forward. The current schedule calls for the announcement of vendor selection sometime in May-June timeframe and begin the project shortly thereafter.

We continue to believe we remain in the mix on this project and that our position remains solid. SoCal has stated publicly and repeatedly that they have not made a final vendor selection. And this view is also supported by ongoing communications and detailed technical due diligence meetings with our teams.

As we have said before, from a financial perspective, we do not have any meaningful revenue expectations on this project in 2010. For 2011 if selected, we would anticipate the project to ramp during the second half of the year.

As a result, the current project's timing does not give us any financial risk this year; and for 2011, the projected contribution would be half-year based. I think it's best that this be my only commentary on this project until the vendor selection has been formally communicated.

As most of you know, I am currently serving as the lead executive in charge of Aclara as a result of the recent departure of Aclara's group president. This change has led to renewed enthusiasm with the management team at Aclara and I'm confident it will result in more expedient release of several innovative new products.

Our new product roadmap will support Aclar's growth and will provide state-of-the-art solutions to the electric, gas and water markets worldwide. I'm very excited about our recently introduced Acendant RF Network and its high bandwidth capabilities. This is a network that we have have co-developed with Firetide and based on a recent beta test, I'm confident this will lead to new opportunities across all three utility end markets.

Moving onto the segment summaries, in Utility Solutions, there's several items that I view as significant and positive. Clearly number one is the order book in the quarter which came in at nearly 200% on the book to bill side, with all business units showing significant strength.

Second, we continue to move forward with several large AMI customers in Central and South America. Third, our fixed-network water product continues to experience meaningful success as evidenced by our wins in San Francisco, Toronto, and Florida along with our ongoing success in New York City.

And finally, at Doble, our new product development and upcoming product introductions have me excited about their future, both short-term and long-term. Regarding Test, I'm very pleased to see the order volume increasing as significantly as it has both in the quarter and year to date.

My recent visit with the management team has given me added confidence in our ability to successfully execute on our existing projects and also has provided me with additional optimism about the future prospects in this business. Turning to Filtration, on the last call, we talked about the uncertainty surrounding our opportunity on the Constellation space program at Vacco.

Earlier this year, the administration's fiscal 2011 budget contained some significant cuts at NASA. Since that time, I'm pleased to see that NASA and Constellation in particular has been given another look. While it is too early to tell how this ultimately will turn out, today's view is that the Constellation program will survive in some modified fashion and obviously we are thrilled to see this turning in the right direction.

While nothing is final at this time, the latest communications indicate some level of survival for certain aspects of Constellation. Either way, there would be no significant impacts on fiscal 2010 as the overall business at Vacco remains very strong with more upside than downside.

So in summary, we remain in a solid operating position across the Company. We have ample opportunities for growth and we continue to prudently invest in the business to ensure our long-term success. With that, I would be glad to answer any questions.

(Operator Instructions) John Quealy, CanaccordAdams.

A couple on the numbers, if we could. Vic, on the backlog that we are looking at, whether it's Utilities or Test or Filtration, can you give us some sort of a benchmark about when that backlog will be worked off into the P&L in the coming quarters? Is it half by year end? Is it a quarter? Can you give us some yardstick?

It's over half, John. On the Filtration side, obviously it's a quick turn business. There's a couple long-term items in there like the Virginia class submarine which goes out a multitude of years. But when you take that away, it generally turns relatively quickly.

On the Test side it's probably about 60% of that to 65% of that will turn before the end of the year. And then Utility Solutions, it's probably 70 to 75% of that will turn.

Doble is a very quick turn. RF with the new products that we have -- I'm sorry, the new contracts that we have with New York City and PG&E gas, the majority of that will ship this year. So I would say if you blend all those percentages together, you'll probably come somewhere in the 60 to 65%.

Okay and, Gary, in terms of PG&E; I think you mentioned about $32 million of business all in post quarter. How much more is left as an opportunity? Are we done there? And what's the total amount of PG&E in the budget for fiscal 2010?

You know for this year, it was approximately 40. And what we have delivered so far, we have delivered about 14. So we were a little bit surprised because in my commentary, I mentioned that the original contract we singed back in '05 or '06 was roughly 4.1 million units for about $225 million and we're already past that.

And where that comes from is what they call growth meters. When they put the contract together four or five years ago, they had a fixed number of endpoints and obviously in spite of the housing, they have built new houses and strip malls and stuff like that.

So we have built out -- or the backlog right now builds out beyond the original $4.1 million. So we would hope that going forward, kind of like we're doing with Pennsylvania Power and Light, that contract has been long completed and we do 3 to $5 million a year with PPL.

So PG&E is kind of the same thing. We are over and above the original $225 million and I would expect that for at least the next couple of years on the growth meter side to continue some level of run rate.

These orders get us through I believe January, December/January timeframe. I think there will be -- the current view is there's a couple hundred thousand more meters beyond that. And then as Gary said, it kind of falls into this replacement growth meter type thing which with PPL being about one third a size of PG&E, I think we would anticipate something in excess of what we are receiving from those guys going forward.

And, Vic, lastly for you; in terms of running the Aclara business day-to-day, can you talk about succession plans, what you're thinking about timing for hiring a replacement, and then also your characterization of the product roadmap? You talked about the new Firetide co-developed product, but can he give us an indication of what else is on the docket for new products or smart grid in the next couple of quarters or years?

Sure, in answer to your first question, I'm going to take my time as far as bringing somebody else in. The commitment I made to the employees was that we wouldn't really do anything for at least six months for a couple of reasons. I'm going to kind of let things settle down there and let people get back to work and do the things they need to be doing.

And second of all, I want to make sure that when we do make another change that we have the overall organization that we want in place. And I think until I spend some more time over there on a day-to-day basis, I'm not prepared to make that decision.

So in a lot of ways, this is good. It's given me an opportunity to get more involved over there. And honestly, I've been very happy with what I've seen. These are really good management teams across Aclara. They're working very well together. We're going to get some of the synergies, some more synergies out of that than we've got in the past.

As far as the roadmap, we kind of look at it as -- in a couple of different pieces. Certainly we had to continue to improve what we have. The major thing we have as far as significant improvement is going an RF electric product.

We have introduced a product with solid functionality and we sold that to about 18 municipals. But we continue to work for a product that we can sell both internationally to the broader IOU market. So as the standards get solidified that the people are looking for going forward, we're working to finalize that product. That's something that will probably be available later this year.

So that's the biggest thing on kind of the core products. Then the other things we're looking at are more demand response products. We have a significantly enhanced demand response product that we can sell in conjunction with our current product lines or even on a stand-alone basis.

The Acendant Network is the other thing that we're working for. This is what we originally called the M-360. Of course we wanted to give it a catchy name, so that is the Acendant Network.

As I mentioned in my opening remarks, we have had that beta test for some time. It's working exceptionally well and we've got a good bit of interest with that.

So the initial usage for that will be for backhaul of AMI data, but certainly we think it has much broader uses as far as being able to do distribution automation and some of the other smart grid applications, continue to enhance and take costs out of our current products whether it be the gas, water or electric products.

So I would say that the roadmap is in good shape. we've got a lot on our plate obviously. I guess the other thing I didn't mention are some of the international products and we are finishing some of those up to meet the demands we are seeing in Central and South America. So a lot of good opportunities, a lot of good progress on the roadmap and I feel very confident that we get some of these things completed, then we will be well positioned for quite a long time.

Jeremy Hellman, Divine Capital.

I just wanted to look at the orders in the utility group if I could. And congratulations on a nice quarter-over-quarter bump there. I was wondering, did you see your win rate changing at all or was there just a more robust bidding environment? Can you give us a little perspective on that?

I would say some of it was timing as much as anything else if you look at a lot of the large bids. I'm talking outside of the co-op business, but some of the things that we're able to get with some of the larger utilities since they happened to land in the timeframe within the last two quarters.

Certainly the continued strength of PG&E in New York City has been I believe because of the performance of the product in there. I think they're finding it a lot easier particularly in New York City to put that product in than maybe they'd anticipated.

So the ease of the installation process and initializing the product has gone very well. So that's kind of driven their desire to get more product more quickly.

On the co-op side, that's continued to be a strong business. Fortunate that we've got good orders in the first half of the year.

I mean typically this level of orders kind of stretches out through the year. So we have seen a good solid demand from new customers and from distribution. So I would say that (inaudible) remains fairly robust and beyond that, I'd say the market remains very solid as far as the opportunities that are out there.

And then secondly, just speaking about Central and South America, your contracts down there have some doubling provisions. Any sense that those are going to be kicked in?

We really don't have any indication yet. Really, they [are going to want] those products installed and those are going to be installed in the second half of this year and the first quarter of next year. So we don't have any indication either way.

But as I said on the last call, I think it's just a matter of getting the product out there and showing people that it works and I don't see any reason why they wouldn't double those contracts.

Richard Eastman, Robert W. Baird.

I guess I'll stick with the Utility Solutions Group here for a minute. Vic, how did -- did you actually book any New York City water revenue in the quarter? What was that number?

Just one second here Gary (multiple speakers)

(multiple speakers) the revenue in the second quarter was $5.7 million and it was $5 million in the first quarter.

And then the thought is that builds here with the orders and with the shipping schedule in the back half?

Yes.

Okay and then, Vic, how did Doble do in the quarter? We talked a little bit about new products and the timing of introductions, but what was their revenue and how did that look year over year? Have they kind of regained some traction?

Yes, they picked up year over year in that quarter and the margins remain good and solid. We talk about investment, we certainly are making that. But even with that, they're well over 20% EBIT margin.

So compared to last year, Rick, they were generally flat which is okay because that business had had some difficult times on the hardware side of the business. But as Vic said, it came in a little over 23% on the EBIT side during the quarter. So that's pretty impressive considering the magnitude of the investment we're making.

Okay and from a revenue perspective, they probably did around $21 million or something?

Yes, somewhere in that area.

Okay and then just given the EBIT in USG, in the Utility Solutions Group, given the EBIT, would you attribute that -- I'm kind of looking at the incremental margin sequentially but a nice high number, margins came back some for us. Would you attribute that overall to what maybe the mix within the Utility Solutions Group?

Yes, that was a big part of it. We had a decent amount of shipments to Puerto Rico, down to PREPA, which that's a long-lived contract. It certainly has good margins associated with it. Doble's margin like I said, over 23%.

But just the fact that at the PLS business, getting that volume back on track, it was roughly $31 million compared to the first quarter, it was $15 million. So we double the revenue there sequentially and the fixed costs are down. The SG&A is down and that sort of thing.

So you get a big bang on the margin there. So that was a big part of it. So I would say volume at PLS and mix including the PREPA contract were both significant contributors to that side.

And then the other piece that doesn't get a whole lot of attention, the software business which we made some investments in the past and we have got a new leadership team in place over there and they are doing a great job and they came in at about 12, 12.5% EBIT margin which is I think the highest quarter. I would have to go back and look three or four years, but I think that is the highest quarter percentage that we have had. So they did a great job as well.

Is that business -- I guess I still think of it as the Nexus business but is that running at a revenue run rate closer to $25 million or $20 million or (multiple speakers)

It's in the 20s but they did about 4.8 to $5 million in the quarter on the revenue side and they did about that same number. It's kind of leveled off quarter to quarter because we have a good mix between the hosting side now. We used to have licensed revenue which kind of had some volatility up and down depending on how many customers you book.

But now that we have a good solid contribution of hosting, that becomes kind of a straight line revenue item which obviously makes it easier to predict the forecast, but it also provides stability quarter to quarter again as we cover the fixed costs. So I think of it as this year probably in the 20 to 22 range.

Just one last thought. On the working capital front, is there a piece of the business that is absorbing that? Is that the Test business or how comfortable are you that that gets worked off by the end of the year?

I would say the test is probably second, the Aclara RF is first. This PG&E -- we knew the orders were coming, but the revenue in the first half of the year was a little bit muted compared to how we originally saw that thing running out. And so the revenue there was about 7.5 in the first quarter and 7.2 in the second quarter.

So let's call it 15, so you're going to do 25 to 27 in the second half of the year. And so a lot of that -- we kind of [level load] the folks that manufacture that product for us. So there's a little higher level of inventory at March 31 than one would expect and the reason is because you're not exactly doubling the revenue in the second half, but you have a big chunk of that.

It's the same with New York as we mentioned earlier. It's back half loaded as well. So getting that product manufactured instead of start and stopping the thing along the way, it's a lot more cost effective to just level load the factory down there at [Jabul] and Flextronics and internally and just run a flat inventory production line, knowing that those things are going to be shipped in the second half of the year. So it really is timing.

Do you think -- can you give us any range for free cash flow for the year? And I think free cash flow -- I would just add the dividends, dividends about $8.5 million?

It's only going to be 6 this year because we really didn't start it until January. So we're really -- in the fiscal year, you're only going to have three payments. So I would think if that more as 6, 8 going forward, but 6 for this year. I think you'd be comfortable thinking that in the 50s kind of range.

Including the dividend or excluding?

We think of free cash flow as looking at the cash flow statement as cash flow from operations less the capital expenditures. So if you call it 55 and then back the dividend off of that, you'll get to 50. So somewhere between 50 and 56, you'd be okay.

Carter Shoop, Deutsche Bank.

Congratulations on a strong bookings quarter. A question for you on the kind of pipeline right now. If you think about the gas AMI business excluding SoCalGas, can you talk a little bit about what you're seeing in your pipeline right now in regards to bid activity?

On the gas side, I wouldn't say there's a tremendous amount outside of what we see with the municipals. So there's not another big gas project setting behind that one currently. There's some early discussions on some things, but I would say the majority of what we're seeing domestically is -- or with the municipals, starting to get some interest on the gas side in South America though.

In regards to PG&E in the second half ramp versus the first half, Gary, what is your confidence around that 25 to $27 million number? How does it usually play out in regards to when you get the orders and how long does it take before you're actually shipping them out the door?

Well historically, if you go last year when they were in their peak run rate, it was about 30 to 35 day turn when we got the order and we booked. If you remember, there was relatively consistent order book and as we came into this year, as we were coming to the end of the project, they actually -- you think you get this at the beginning, but you are probably three quarters of the way through the project until we got a firm delivery schedule by month.

So at the start of this year, we got that delivery schedule by month and it kind of slipped to the right, but they've made a commitment to us that they are holding the year and then the order book being this accelerated -- meaning compressed, not accelerated, I'm sorry -- I think gives us the confidence that it's there because I would say of the second quarter order that we booked, I think we had modeled in about 75% of that number.

And then the April order that we booked at roughly $12 million or so, we thought that was going to be about 7 or 8. And so through April month end, we saw a lot of compression there which to me reinforces the confidence that the forty-something million is going to actually happen.

And then when you compound that with the fact that they are over the original unit estimate, gives me further confidence that they're now looking at other folks. They're going to wind this thing out with us and they're going to step it up to get it done on the schedule they originally determined for us back in October. So a little awkward between quarters, but I would say confident for the year in total which relates itself to the back half load.

That's helpful, thanks. When you look at gross margins, they were down sequentially on about a 15% increase in sales and I think you guys are forecasting gross margins would pick up sequentially heading into the quarter. Can you talk a little bit about the drivers there? Was that more of a mix issue or was there some restructuring charges you weren't anticipating?

No, it wasn't that. It wasn't any restructuring. It was more of the mix. There's some things we are doing on the -- what we call sustaining engineering which is a little higher than we thought and part of it is -- not hanging this on Vic, but when he went over there, he has a lot more accelerated thinking on things and his pace of play is a little quicker.

So some of the things that were probably going to be spent a little more ratably throughout the year are a little more accelerated which is a good thing. The cost is happening but the end product is going to come out a lot quicker. So I would say it's some timing things and some investments we're making. But I would not think of it as restructuring as much as really kind of a timing thing in the R&D and sustaining engineering side.

Based on that, you'd still feel pretty comfortable with getting gross margins into that low 40% range in the second half of the year?

Absolutely.

Last question on OpEx management. Likewise that was actually a little bit lower than expected, if you look at total OpEx spend. Anything in particular going on there?

No, I think a little bit of that was timing as well. At Doble, we're staffing up some people to support a lot of these new products. Boston is not the easiest place to higher high-end talented people at a reasonable price.

So some of that I think is kind of moving to the back half of the year. We had a little bit more of an aggressive hiring plan. And then I also think with the timing of the ramp-up going from $0.02 and $0.22 and working like that, I think we really did a good job of standing on some of the discretionary spending just to make sure that we maintained a reasonable level of cost matching up to -- as the revenue ramped. So we look at all the costs and we don't flip nickels over obviously. But I think we did a really good job in all the discretionary spending in the first half of the year.

(Operator Instructions) Walter Nasdeo, Ardour Capital.

This is Shawn Lockman for Walter. Just wondering if you guys could give us -- you had a nice quarter in terms of just growth for tests and then also the backlog is moving ahead as well. Can you just walk us through what you're experiencing in that segment?

Yes, that segment has been a little stronger than I thought it was good to be. We've had some good success both on domestic and international. We talked about the large project that we won in the (inaudible) second quarter for about $13 million, a couple big large shielded chambers which helped with the order side.

And then internationally, we won a couple of nice jobs in China, two nice jobs in India and then one nice job with Sony in Japan. So this business is -- the business has held up well; doing a little more on the systems side.

We see that as an opportunity for us to grow the business as we go forward. So rather than selling just the chamber and some of the other hardware that goes with it, we have won tree systems jobs fairly recently. We think that's going to be a good growth opportunity going forward.

You talked a little bit about that there -- as we can see, there's a little bit of optimism about Constellation. Can you walk us through how you guys are looking at Vacco right now and just other opportunities that are out there for the company?

Yes, Vacco, we were just out there a couple of weeks ago and the thing I told several people I was encouraged about was even with Constellation getting kind of squishy as it has, these guys have done a good job of going out and finding other opportunities. So there are a lot of opportunities with NASA and with some of the large vendors to NASA.

Because while they're still talking about cutting funding for Constellation, they are talking about a very large uptick on R&D budget for NASA. There aren't that many people that do what we do. And so whether it be the Constellation program, whether it be the replacement of the Constellation by going through some of these commercial vendors or whether it be some of the other R&D projects, I think [back] those are going to have a very solid role in that.

So we see the business continuing to remain solid. It's really a very profitable business and good growth opportunities. The disappointment with Constellation, if it does go away, it's something where in the out years, we thought there was going to be an additional 5 to $10 million in sales and that may still happen. It may not but if it doesn't, we still think there's opportunities to grow the business at least as fast as kind of GDP is growing because of the position they have in the market.

Okay, great. Thanks a lot, gentlemen.

Stuart Bush, RBC Capital Markets.

Outside of the muni and co-op markets, can you talk a little bit about how the pipeline looks for the Aclara electric side with any of the IOUs or the DOE stimulus funded smart grid projects that are likely to come towards the end of this year?

Yes, as we talked before, I mentioned a little earlier, our current position is with PLS products, we're deploying a couple of investor-owned utilities now. I'd say the majority of the people are on the IOU side, at least the larger ones are looking more toward an RF-based product and that's why I'm looking forward to getting that product rolled out probably in the fourth quarter of this year. I think that then will give us an opportunity to go after some of those projects. But as we said here today as we talked before is the one area of weakness we have.

Okay, can you give us a little more color on what that RF mesh product is going to offer to the market, especially compared to some of the competition? What are some of the key differentiators in that offering?

I would say the biggest thing is ours is not an RF mesh product. It's a point-to-point product. So as we go out and start talking to customers about this, the big thing that we will talk about is the fact that the communications link between the meter and the data collector is the same communications link that we currently use on a gas [quarter] side. I think there's no doubt that's a very well proven, reliable system that's given a high level of reads.

with the 4 million plus endpoints who have it. PG&E and a number of other large deployments, both on on the gas and water side, that communication link is consistent. I think that's a very solid piece of it.

So what we're working on today is getting that information, the tables and all the data out of the electric meter that you have to pull out which is different than doing the gas and water side. But that's exactly what we do with the PLS products.

So one thing that we've been working pretty hard here recently is getting a lot of the metrology folks, engineering folks from the power line side to work with the RF side to ensure that we take that intellectual property that we have already developed and that knowledge base we've already developed and migrate that to the RF side.

So (inaudible) then should have the best of both worlds in that we've got the metering people that had the experience and have a proven product working with the communications people that have that communications data link that's well established. So we'll be able to go to market and say we've got a product that meets the specifications you're asking for, has the functionality, meets the standards that's [this is] coming out with and has a very proven communications technology.

The other piece of it then is this Acendant Network which I mentioned earlier that we can set right on top of our data collection unit. So rather than a utility being required to go to one of the cellular backhaul folks to backhaul that information, they can have their own radio system to take back that data that's collected by the (inaudible)

Okay, great. So to follow up on the gas side, you've had some good order flow with the PG&E there and you talked about them upsizing that a bit. But I saw that PG&E filed with the PUC their intent to pilot test other gas AMI solutions from Silver Spring. Can you talk a little bit about why they -- you give us some color on what might be the intent there?

I'm not sure of the timing of that, Stuart. Our understanding and some of the communications we saw come out of PG&E said they had decided not to do that.

I think they're going to focus their efforts with, it's at least our understanding, they're going to focus their efforts with Silver Spring on the electric side and continue to employ our gas products. So if it's something other than that, I'm not sure how many they would deploy because as Gary mentioned earlier, they've already exceeded the original contract on the gas side and got no indication from them at all that they plan to do anything different.

And then just lastly to follow up about Gary's statements about the gross margins in the back half of the year, last quarter you mentioned we should expect in 42 to 42.5% range. Is that still a reasonable assumption?

I think so. Yes, it feels pretty good. If you look at the second half, we're not changing the overall spending. So my comment about accelerating some of the things in the second quarter or from the back half of the year into the second quarter I think gives me a lot more confidence that that's the right way to think of the second half of the year because it is more timing related.

We're not incrementally spending more. We're really just -- we kind of time spent it a little bit differently than our original plan. I still feel really good about it.

And when you get the kind of volumes obviously necessary to hit the numbers we're talking about or that we talked about at the beginning of the year, we obviously have to have a significant sales volume in the second half. Just by having that volume, it's going to also improve the gross margin compared to the first half just because again, we are covering the fixed costs at our manufacturing places a lot more efficiently.

Ben Schuman, Pacific Crest Securities.

Vic, were the strong muni co-op orders indicative of any snapback following more clarity around the stimulus, even for utilities that weren't receiving stimulus funds? Or is this kind of more a sustainable level of bookings?

I think there is a little bit of that certainly. I do think the orders are consistent for the year with what we had said going into the year. And I think we should see -- it's a little early to be predicting this, but we don't see any reason they won't kind of continue in the next year. But I would say the strong timing of these was somewhat as a result of that just because some people, once they realized they weren't going to get that, they already had kind of the plans on the shelf that they came out with and said, okay, it's time to go forward.

And then I think is another way to add to that, what Vic said, is there's also -- we split the co-ops into two different groups. We have the direct sales group and then we have the distribution group and the distributor orders were very strong and I think part of that was just like a lot of folks did, they ran their inventories down a little bit and so we had what we call restocking orders. I think probably for the last six, nine, 12 -- I don't what their inventory looked like, I know there was a little bit of a restocking catch-up if you will.

So I think on top of the stimulus related money, I think getting [HD supply] and some of the other folks we use on the distribution channel, getting their inventory back up to what I would call kind of a more of a safety level I think was part of that as well.

That's very helpful. Gary, in terms of the EBIT margins in Test and Filtration, any pricing pressure there or is the margin decline kind of relative to last year just a function of revenue being down a little bit?

Yes, I think it's more with the revenue and I think last year in Test, we had a little bit higher level of component sales and those component sales bring in 50 to 90% margins on some of these antennas that we sell. And so having less component sales, it's not a huge decrease, but when you start pulling out the midpoint of that at 70 or 80%, it's noticeable. So it was a mix issue relative to the sales.

Okay, in terms of South America, can you guys give an update on what you're seeing in Brazil specifically and maybe the timing of some of those decisions with the major utilities down there?

Yes, I would say that -- I've been spending a good bit of time on that specifically and meeting with some of our partners. I would say that what we'll probably see for the next 12 months is more looking at pilots and the legislation is currently going through -- is going to authorize more of a large smart meter funding. It's just working its way through.

So I would say that the timing for a significant order in Brazil specifically is probably at least a year off. I think we'll see continued pilot activity there though.

South America in general, we have seen some good activity as we mentioned earlier and some of the awards we've had in Mexico and Colombia both; additional opportunities both with those utilities specifically and some other utilities in Colombia and some of the smaller South American countries as well. Also have a lot of interest on the water side. So we have a couple of pilots underway in South America on the water side and seeing quite a bit of interest there.

So interest in gas and water in South America?

Just a little bit of interest in gas, certainly more on the water side just because they experience the same thing we do here except in a bigger way with the loss of post-processed water; gas, not so much. We have had a couple of inquiries there, but more on the water side.

Sean Hannan, Needham & Co.

Just to follow up actually on the topic of South America. Is there a way if you can provide perhaps a little bit of color given all the activity you have had in booking some business; Colombia and Mexico. What are we looking at when you look at your backlog today and particularly the orders? What is representative of that region? How much is reflected there for South America?

Well I would say right now, looking at what we have at CFE which was the contract that we booked the first portion of which was over a little over $20 million, we've only delivered a couple hundred thousand against that contract. So that's in backlog.

And then on the -- in Cali down in Colombia, we booked up the first $5 million. We've probably delivered -- it's hundreds of thousands but it's not $1 million and so we have four there in backlog and then we've got some other small pieces here and there across.

So I think somewhere in the 25, $27 million of the backlog relates to those projects. And we do have some piloting activity and some stuff like that that comes through. But we don't really -- it's not in consequence because that sounds terrible. But, it's small numbers.

Yes, I guess the other piece of that is really how to you classify PREPA? Because we do have some PREPA product in backlog and anticipate some continued orders there as well.

That's terrific. Switching over to Doble side. In terms of the new products, is there anything that you are getting as critical feedback around some of these new products or hurdles that you're trying to get over? And then actually I have some follow-up questions around Doble after that.

Okay, when we talk about new products, we're not reinventing the types of products that we're doing. What we're doing is making some significant improvements on the functionality on the products we currently have.

I'd say the other thing we're doing is kind of leading the way on the online products. With online products, what I mean there is typically the way that these products work today is you have a piece of hardware you take to a transformer, you take the transformer out of commission, you do the testing on the transformer, gets results, you run that in our database, do the analysis, that type of thing.

Obviously if there's some high-value assets that you want to monitor and you can monitor those continuously, use an online monitor. So we've had products like that both domestically and internationally for quite some years.

We're working to enhance those as well. One of the issues you have now is you can buy one of these products and one of our other products for -- depending on the product you buy, between $30,000 and $50,000 and you can go and test a large number of transformers. If you have an online product, maybe you only have to pay $5,000 to $8,000 to $10,000 for that but you're only monitoring one asset.

So we're working to really bring the cost of that down and improve the capability of that type of product as well. So again, I wouldn't say that we are reinventing the product at any stretch of the imagination. We're doing significant enhancements to the product to provide more functionality.

The other thing that we are doing is with the company we bought in Germany that does a different type of testing rather than the power factor testing that we do in the US through partial discharge testing and there's some real interest in doing that in the US. There's some hurdles that we have to work through, technical -- I won't say technical challenges because they're -- once you get we're not reinventing anything, we have to make some modifications to allow those products to be able to interface with US-based products.

So we're working through some of those so that we're can bring a partial discharge product here and actually vice versa, take more of the current Doble product into Europe and other parts of the world. And that's a real important piece of what we're trying to do.

As we've talked about before, we have significant market share here in the US, above 90% market share. And so we see the significant growth for Doble outside the US and our current plan is to open a couple of new offices this year in some international locations and then next year probably another two to three as well.

Okay, that's helpful. And then lastly, in the past, you have differentiated a little bit in terms of what you are seeing on the leasing side versus the hardware sales side. Wanted to see if we could get an update on some color there?

Yes, that really remains consistent. I mean the business is about 50-50. I would say the difference this year is we're seeing more strength on the hardware side.

So last year, the service side remained rock solid and I would say that the forecasts we went into the year with we exceeded by a little bit but the hardware sales were soft. This year it's back to kind of that 50-50 range, at least what we're seeing now. That's a result of some strength domestically as well as we've got some pretty good orders outside the US this year as well.

Richard Eastman, Robert W. Baird.

I just want to go back for one second on the Filtration business. Did that thermal scan order -- how much of that shipped or did that ship in the second quarter?

We started shipping in the third quarter.

At the end of the third quarter, so we should get some nominal sales activity in June. It actually is scheduled to ship around the second week of June and then ramps up. Fourth quarter will be the big run.

And that whole $11 million goes to the balance of this year then?

No, we should get about 6 of it, 5 to 6 of it this year. It's a quick run on products. So once we get it running -- and it's on schedule. Vic and I were just up there a week or so ago. It's a pretty impressive manufacturing cell.

It's pretty neat, Rick. I mean the one machine or the one center that we have producing that product, they are going to make 800 million pieces of product a year.

Holy cow. Okay. And then also, Vic, how did PTI do on the aerospace business, PTI's aerospace piece? Any inventory restocking or is that business just pretty much stable?

I would say it was pretty stable. It was within a couple hundred thousand of the last quarter. And one thing I wanted to point out, I only answered earlier on Ben Schuman's question, I only answered half of it. So this is a good point to introduce the other half.

Part of the margin detriment that we see in alteration is we're coming up to a critical point in that Airbus A320 contract that we won a couple of years ago -- or last year I guess it was. And critical design review is fast approaching and so there's an inordinate amount of engineering and R&D on that product to get our element and our system to the critical design review stage.

And that's hundreds of thousands of dollars. For this year, it's going to be over $1 million. So you're seeing some margin compression there.

Sequentially from first quarter to second, we're up about $600,000 in sales and we're relatively consistent with the last second quarter. And then you kind of have to extract this, what I want to call a one-time investment to get the prototype if you will to the critical design review stage with Airbus.

And we are in the final stages of that. But obviously that's a cost item that doesn't have any revenues associated with it at this point. So I'd say it was very strong and if you carve out the A350 investment, it would have been pretty close to back to where the margin was in the first quarter.

I don't think there is -- the one piece of your question I want to make sure we answer correctly is the -- there wasn't any significant order from one of the -- one of our customers as far as restocking. So there wasn't anything where we really bled this down over the past three quarters, so now we're going to restock. So there wasn't any of that in the orders.

So then I would think, does this Filtration piece in the second half deliver much stronger results primarily from Vacco shipments then or again, we will pick up the $6 million from Thermoscan, so that's pretty significant in the fourth quarter? But does Vacco have a fourth quarter weighted ship scheduled this year or not?

Yes, it's -- that's the timing on that Virginia class submarine. We deliver one or two valves per year [up to electric boat] and it always hits in the June-July time frame. That's why we don't want to give specific guidance on Q3 or Q4. There's enough things that straddle June 30 that it would be a little awkward to give you a number there. But that valve is in the neighborhood of $4 million or $5 million, then you have the Thermoscan and then you get the ramp-up that we always get in the second half of the year at PTI. So that's why we are confident in how we're projecting that business.

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

Okay, well thank you, everybody, for your interest and we look forward to talking to you next quarter.

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