ESCO Technologies Inc (ESE) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ESCO third 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. Now to present the forward-looking statement and for introductions, I'd like to turn the call over to Kate Lowrey, Director, Investor Relations. Please go ahead.

Thank you. Statements made during this call regarding the timing and amount 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 success of our RF electric product, success in international markets 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 the 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 third quarter fiscal 2010 results press release issued today and found on the company's website at www.escotechnologies.com under the link, Investor Relations.

Okay. This is Vic. Before I give my perspective of the quarter, I'll turn it over to Gary for a few financial highlights.

Thanks, Vic. We reported EPS of $0.55 for the quarter, which reflects a 28% increase over the prior year third quarter EPS of $0.43. Similar to the second quarter, the $0.55 came in above our internal expectations. The increase in EPS was realized despite a negative comparison on the effective tax rates where we had 37% tax this quarter and 23% in the prior year. At the pre-tax line, we are up over 60% in the comparable third quarters.

While USG sales were relatively flat in total, I remind you that PG&E's gas project continues to wind down, and sales to PG&E decreased nearly $10 million in the current quarter compared to last year. In spite of this significant headwind, we were still able to increase total sales 6.4% this quarter. And if you exclude PG&E sales from both periods, third quarter adjusted net sales increased 16% in fiscal '10.

Cumulative through June, we've delivered over $3.9 million gas AMI units on the PG&E contract worth over $220 million. This project represents the largest fixed network AMI deployment in the country, and we believe continues to be instrumental in serving as a favorable reference customer for other AMI opportunities.

While all three operating segments contributed to our growth, the Utility Solutions group was the clear profit winner with EBIT increasing 55% over the prior year. USG reported a 22% EBIT margin in the current quarter, which compares favorably to the 14% EBIT margin in 2009's third quarter.

Within USG, the largest profit contributions came from Aclara Power Line Systems and Doble, as both reported EBIT margins over 25%. The power line AMI business continues to benefit from the strong co-op in international sales, and Doble continues to perform at an exceptional level.

The Filtration segment's EBIT margin was nearly 20% in the third quarter, with PTI and Vacco, both reporting very strong operating margins on increased sales. Total filtration sales increased over 12% in the third quarter versus prior year.

The Test Business grew the top line nearly 19%, driven by a significant increase in large chamber deliveries, but the margin percentage decreased as a result of the sales mix which includes pass-through content and construction-related margins on these large chambers.

We continue to be enthused about the significant amount of orders received across all three operating segments. We booked $150 million in orders in the third quarter on the heels of our record-setting second quarter order book. This brings our year-to-date orders to a record $507 million or 127% of sales.

Also during the quarter, we continued to book significant orders from both PG&E and New York City.

On the cash flow and balance sheet front, we continue to be pleased with our cash generating opportunities for the balance of the year, as well as our capital structure and available liquidity.

Out net debt outstanding was approximately $139 million at June 30th, with a comfortable leverage ratio of 2.1, and continued favorable pricing on our outstanding debt.

Regarding the balance of the year, our current outlook for the remaining few months of fiscal '10 remains consistent with the expectations that we've previously laid out.

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

Thanks, Gary. I'm very pleased with our operating results for the third quarter. They again came in above our expectations and reinforce my confidence in the balance of the year.

Achieving this level of growth in the third quarter, despite a much lower level of PG&E gas sales was very satisfying. As you know, we recently made an announcement on a SoCal Gas AMI project. Due to a confidentiality agreement we have with this customer, and, in fact, we're actively engaged in negotiating [definitive] agreements, I'm not able to discuss any more than we disclosed in our July 21st release.

As I mentioned in the release, I'm thrilled with the selection and our contract negotiations with SoCal Gas, and I'll have to leave it at that.

I'm very excited about where we stand today in our AMI market, and also for what I see ahead of us in the way of market opportunities. When I look back at our recent AMI successes, including New York City, Boston, Washington DC, Kansas City, and San Francisco in the domestic market, as well as CFE and you have Cali on the international side, I can -- can't help but be pleased with the success of our [wide range in] AMI technology offerings.

There are now over 100 customers using Aclara's RF system and well over 400 customers using our Aclara power line technology.

We've added 32 new PLS customers in the first nine months of the year, which is up nearly 25% from our recent full-year win rate. This, I believe validates that we have one of the best, most proven AMI solutions available for gas, water, and electric applications.

I'm most pleased that our customers feel the same way, especially when they serve as valuable references during the evaluation process with potential new customers.

To update you on Aclara, I remain very impressed with our management team and our growing market position. Our engineering teams remain clearly focused on the release of several innovative new products. I believe -- I strongly believe our new product roadmap will support Aclara's growth for many years to come and will provide state-of-the-art solutions to address the needs of all three end markets worldwide.

I continue to be excited about our Ascendant RF network and its high bandwidth capabilities. This is a network that we co-developed with Firetide, and I remain confident the system differentiator will lead to new opportunities that further enhance our market strength to cross all three utility end markets.

I'm also pleased with the progress we're making with the enhancements to our RF electric AMI product, and believe we're on track to roll this out in the near term. Since the communications network is the same as we use on our gas and water products, I'm confident that once released we will gain market traction with the electric IOUs. This RF electric product will be compatible with our Ascendant network and provides a more integrated solution to this highly competitive market.

In summary, we remain in a solid operating position across the company with amble opportunities for growth, and we continue prudently invested in the business to ensure our long-term success.

We'll be glad to answer any questions.

(Operator Instructions) First up, from Stephens, Incorporated, Steve Sanders.

Good quarter.

Thanks.

Thanks, Steve.

Vic, maybe to start, just to follow up on your RF electric product, can you talk a little bit about where you are? You mentioned that you're getting close to rolling it out. What exactly does that mean? Are you quoting it in a significant way? Are you planning on piloting it with a few customers for a while? Just some additional color there would be helpful.

Sure. The current plan is we're going to be piloting it with a couple customers in the very near term. There's still some work to be done. We think we'll be in a position to roll it out in full force probably by the end of the calendar year at the latest. We want to make sure that we've got it completely finished before we do that. But we will be rolling products out for the pilot phase within the next 30 days.

Again, the majority of the work that's being done is with the metrology side of it. We're going to use the same communications network that we use with water and gas. So it's a pretty near-term deal.

And I want to remind everybody we do have an electric product out there with about 18 municipals. It's just [fairly] limited in its functionality. So the work that's been taking place over the past year is to enhance that level of functionality and make it competitive with what the IOUs require.

Okay. And then a follow-up on that on the network side, the Ascendant network. You obviously have some big projects coming up. So your level of confidence and the ability of that network to deliver, the testing you've done so far. And then is that something that we should think about that you're going to roll out internationally as well?

Yes, just as far as our confidence in it. I mean, I was just out at Firetide a couple weeks ago, and [met with the gas person] again. And we have engineers with those fellows on a regular basis. And, yes, I feel very confident, primarily because if you look at the utilization that they're getting from the core product, which is, if you remember, is really for transmitting video and so they're transmitting live video primarily for security purposes today. So the amount of bandwidth required and the data that's being sent is significantly higher than what's going to be required for our applications.

And as far as just the kind of size of deployments, they have one deployment where they have 1,000 units deployed doing this type of -- this type of transmitting of video. So I think our ability to be able to do that, utilizing the -- or setting on top of the utility or the AMI system is very doable. The things that we've been doing in our pilot is to make sure we're going to be able to get the range that we need, because what we'll do is put one of these radios on top of each of our DCUs. And that's gone very well.

So the pilot that we have underway has shown very good results. So I don't anticipate any issues with ramping that up to a larger level, given what we've experienced in our pilot and given what Firetide's experienced with some of their larger deployments in much more -- in much harsher environments, I would say, than what we're going to experience.

As far as the international --

And then two final ones, maybe to --

I'm sorry?

No. Go ahead. And then two final ones maybe for you, Gary. Can you just talk about the free cash flow outlook to wrap up the year? And then in the incremental margin across the overall company and in a few segments was pretty impressive. Can you drill down a little bit on that as well?

Yes. Addressing the margin side. Obviously, when you see this kind of volumes, when we step up from Q2 to Q3, and you see that incremental volume that comes on covering the fixed cost, obviously, is real simple, dollar-for-dollar the gross margin basically falls to the bottom line. So, obviously, to hit our internal goals and what we've generally guided you towards for the year, we have to have another increase in sales in Q4.

So as that Q4 sales growth comes on top of the Q3 sales growth, you should be able to decipher that the margins are going to be pretty substantial on that level of sales growth required. So getting the gross margin to where it is now, I think we'll see a little bit of expansion at the gross margin line, which will put you into the low 40s. And I think that'll translate down to a pretty substantial EBIT across all three segments, relative to what we have today reported.

Okay. And then the free cash flow?

Well, if you look at our balance sheet, you'll see pretty substantial growth in receivables. A lot of that's tied to some of these international customers as well as the timing of the sales in the relative quarters. We expect that receivable balance to come down substantially, so when you look at the free cash flow, I think you're going to see it multiple times where it is for the third quarter.

Okay. Thank you very much.

Bye.

Moving on next to Sean Hannan at Needham and Company.

Yes. Good evening.

Hey, Sean. How you doing?

Good. So I know this is going to be perhaps a little bit early. But, Vic, you had actually commented around the international opportunities, and, Gary, I think you've spoken around this as well. And when we look out to next year, is there, perhaps, a way, if you can help us to just think about a general rank order of where you see the contributions coming from when you consider all of these different geographies, whether it be Mexico, Colombia, Brazil, TEPCO, et cetera.

Yes. As you look at 2011, our best opportunities for additional orders and sales are in Mexico and in Colombia. It's probably going to be a little bit of time before Brazil gets going with the large-scale deployments, and we continue to pilot some projects there. We have a lot of international customers. But their legislation's working its way through and you're talking about another 12 to 18 months before they get full approval to move forward with larger projects.

So I would say that between CFE and Colombia where we have ongoing projects and the opportunity to expand those significantly, those are our best near-term opportunities.

TEPCO, I think, again, as we've talked about before, is still more in a research phase. That's a huge opportunity, but I see that's a ways off. We are starting a trial with a Chinese customer later this summer, as we've talked about before. So there's opportunity there. I'm not sure how significant that is for 2011.

So again, I think we see good opportunity for growth next year over what we're doing in 2010. I think the primary focus will be in those two countries.

Okay. That's helpful. And then next question kind of multi-part. Is there a way if you can update us a little bit around the progress and feedback that you're getting through your Ascendant RF network? And, separately, the SoCal Gas win and other RFP efforts, if there's a way if you can elaborate on the value that utilities are seeing in you having that Firetide offering, the extent this has been or could be a difference maker and how that momentum with Firetide may pick up.

Well, as far as the performance, we have -- we don't have a large -- we don't have a deployment yet. What we've been doing is doing the testing with a large customer. That testing's gone very well. So we think longer term we'll be fine as far as performance of the system. But, just to be clear, we don't have a big deployment as of yet. But we do have a number of opportunities for those.

As far as how people are looking at it, I mean, we've talked to potential new customers where we'll be deploying a system, you know, an AMI system. And this can be done on any of the three, water, gas, and electric. So there's real interest there. And there's interest, actually, in doing it on a standalone basis, setting on top of some other systems as well.

And then lastly, but certainly not leastly, this is an opportunity for us to go back to existing customers and retrofit that, because, again, the basic functionality of this system, and it's just the most basic piece of it because we can do a lot more with it. It was really just to provide the utility with the opportunity and capability to do the backhaul from our data collections or from our substations.

So I see this as a great up-sale opportunity to go back to customers where we have good relations and good experience and goodwill, and retrofit their system. So I would say we're still pretty early on with this, but longer term I think it has great opportunity for us.

Thanks terrific. Thanks very much. And congratulations again on the SoCal Gas.

Thanks, Sean.

Moving on now to Jeremy Hellman at Divine Capital Markets.

Hi. Good afternoon, everybody.

Hi, Jeremy.

Just wanted to talk a little bit about the business that you might have that's exposed to PUC, pending PUC approvals, just kind of framed off against what's going on with Baltimore Gas and Electric. Do you have any quantification around bid activity that you have out there that could be exposed to potential negative PUC decisions?

Yes. Since we aren't big in, today, aren't big in the electric investment utilities, we really don't see any exposure there.

Probably the area where I have a little more concern is just with the municipals, particularly on the water side and some of the smaller electric municipals. There has been a softness there. Fortunately, some of our other projects have more than covered that. But, municipals get their moneys from tax revenue, and that's down now. So that's a place where we've seen softness.

The fortunate thing about that is those typically aren't very large. They're important to us. They're good customers. And it's really the latter of the way that the Aclara RF system kind of grew up with selling to those guys. But as we've been able to migrate into some of these larger deployments, that's helped to cover that.

But as far as the PUCs themselves, we really don't see a lot of exposure there.

Okay. That's good. One more for me. Just on test, can you give a little color on what industry verticals you guys had the best success with the large chambers? Is it still telecom oriented or did you see it expand into some other articles?

Yes. Well, I'd say that that's probably the biggest one, the wire -- wireless industry is probably the biggest. But we also did have success with the automotive side. And then some of the government agencies, particularly in Asia, some of the large government agencies such as their FCC type of organizations, we've had some success as well, particularly in China and India.

Okay. Great. Thanks.

You bet.

Now we'll go to Craig Irwin at Wedbush.

Excuse me. Gentlemen, congratulations on a solid quarter.

Thanks, Craig.

I know you can't talk about SoCal Gas. But, first, congratulations on that significant award. I was hoping you might be able to talk a little bit more about further opportunities in gas RF in North American, maybe frame this out as far as the longer term opportunity for your products.

Yes. I think, obviously, we're in a very good position, having one with PG&E and now working with SoCal Gas. The issue is there aren't a lot of really large ones left. There's a couple of pretty significant ones, which, again, as I think those happen, we'll be well positioned. Well, you see with the gas side, there's a lot more with the smaller gas utilities.

I think where there are some and there are some with a half a million, million end points, where we will be, I would think, more difficult [un-seed] given the success that we've had with some of the larger ones.

But again, as we've talked about before, really electric is probably the place where the value is the highest, water second, and then gas is third. So, fortunately, we participate in all three of those, as well as the international market.

Excellent. And on the international side, I was hoping you might be able to give us a little bit more color on the contribution from CFE and Cali in the quarter and whether or not the trials going on at these utilities will contribute to fourth quarter revenue as well.

Yes. As far as the size of those, it's pretty insignificant for the third quarter. And we're talking, between those two projects, probably 3, $3 to $4 million or something like that. So a lot of that's going to be flowing on -- flowing into 2011.

Okay. Excellent. And do you have color on each of these major utilities when their decision timeline could be for potentially going forward with a wider scale implementation across their entire customer base or maybe a larger traunch?

Well, we have the opportunity in the way the two contracts, both of those contracts are written. They have the opportunity to order that much again. So, in one case was CFE, 20 million, the other case with -- in Cali, $5 million. They can order those without going back for additional approval. And so that decision I think will be made as we complete deployment of this first phase and kind of prove the technology out, which is -- I think will happen over the next quarter, I would say. So they'll be in a position to make an additional decision.

I think a larger scale deployment decision will probably be pushed out into sometime in the middle or late next year.

And again, as I've talked about on calls before, I think it'll be a little bit different than what we see in the US, where, in the US, a large utility make a decision say, we're going to go with a full deployment. I think with a lot of these international customers they'll be done over time where they may automate a city or a couple of cities at a time rather than making a full deployment decision.

Great. And then if I can change subjects to the Filtration Segment. Obviously some pretty nice sequential growth and really revenue above year-ago levels. I was wondering how much the Virginia class sub contributed to the revenue in the quarter and how we should look at expectations over the course of the next few quarters.

Yes. Incrementally it wasn't that different because this, what we shipped in this third quarter was the last part of the multi-year buy from several years ago. So incrementally, compared to last year, it was probably in the hundreds of thousands of dollars, low hundreds of thousands.

And so the announcement we put out, whatever it was, a few weeks ago, that really is more incremental going forward, because there's some additional [boats] and then there's some additional content that we're doing on that. So looking at what Virginia class was in total in this quarter was about 3.5 to 4 million, but it's pretty comparable to Q3 of the prior year. So it's a big contributor always in the third quarter, but incrementally wasn't that much. Going forward, the additional content and the additional number of boats I think will show incrementally positive tractions, '11, '12, '13, and beyond.

Great. Thank you. Congratulations on a strong quarter.

Thank you.

Next up, JP Morgan's Paul Coster.

Yes. Hi. It's Mark Strouse, I'm on for Paul. I'll just throw in our congrats on the quarter, too. Most of our questions have been answered. But are you guys participating in any of the large European pilots that are starting to rollout back half of this year in 2011? And then if not, do you think any of these new product introductions will allow you to be well positioned when those move to full deployment?

Yes, we have -- we aren't currently. I think that we have that potential. But as we've talked about before, we made a conscious decision to concentrate on South America and Asia first, just because the competitive environment and technology we bring to bear. So we haven't participated in those from the AMI side. Doble certainly has a strong presence there.

But as some of these things start deploying over -- these are others I think that will be deployed over a long period of time. I think we may have an opportunity to participate at some point in the future, but near-term that's not something that we're doing.

Yes. Okay. That's all for us. Thank you.

Okay.

And we'll move on now to Walter Nasdeo at Ardour Capital.

Thank you. Good afternoon, guys. Vic, I was listening to your comments. And, again, most of my questions have already been answered also. But one of the things that I was hoping to get a little bit of color or clarity on is, on the electric side of the business, what is the general market outlook that you're seeing here in the United States? I mean, we've been seeing some issues on the metering, on the AMI side, some questions being raised, and on the government subsidies and how that's playing into your customers and their ordering processes.

Well, let me talk about it in two pieces where we participate and one we're participating a lot more today, and the other where we will in the future. On the co-op side, that's been strong. Obviously, with the number of new customers that we've introduced this year, kind of running well ahead of what we've had in the past. We see that as a positive sign, both on new deployments, and we do think there's some of that. And it's really hard to get your arms around who -- how much of that has been driven by the stimulus and how much of it has been driven by the fact that people didn't get stimulus funds, but they understand that now, but they have a strong business case.

So the co-op side seems to be very strong. As I think I mentioned on the last call, one thing we're looking at doing is going back to a lot of those customers and upgrading their system, selling them new products, whether it be disconnect or DRUs or other types of products [through] Ascendant network.

As far as the investor and utility side, again, that's something we'll be in a position to participate in late this year, early next year. I will say that it does feel like the activity level hasn't been as strong as it has been in the past. As I've talked about on previous calls, I think a lot of that is people looking to see how some of these other deployments go. So once you see some of these larger deployments successfully get large numbers of products out there, then I think that will spur people to re-engage with some of their deployments or some of their RFP activities.

What's the typical sales cycle on something like that?

With investment utilities, I mean, it's anywhere from a year to forever, basically. I mean, a year, I think is pretty aggressive from the time somebody starts. The thing that maybe is different today than it was, though, that may accelerate that some is that people are more educated, I would say, than they were three or four years ago about what the options are, what they're looking to do, what functionality they're looking for. And I think they have a lot more confidence that some of these technologies are really ready for broad, large-scale deployment.

Okay. And then also, I noticed receivables are up a little bit. Is there anything going on there? And what were the day sales outstanding?

Yes, the day sales outstanding are a little high right now. And as I mentioned earlier, we're at about $120 or $121 million in receivables there. And a lot of that was the timing. When you see the sales in the quarter, they were pretty heavily weighted to June. So when you look at the three months within the quarter, the third quarter carried most of it, and that's why the receivables were hanging there. We expect the majority of the June things to convert to cash here in the fourth quarter.

So there's really nothing unique. We do have a little more international content now, and so that expands the DSO. The international folks kind of think 90 and 120 days is standard terms. And so we work on pricing issues with them to be able to get some of the cost of that capital in there. So as the international content has increased, the DSO is increased a little bit. But stepping back away from it, it doesn't give us a lot of concern other than we realize there's a big number there that needs to convert to cash, and we're confident it will by -- back down to normal levels by September 30th.

Great. Okay. All right. That's all for me. Thank you.

You bet. Thanks.

Moving on now to Bill Harrison from Robert W. Baird.

Hey, Vic, Gary.

Hey, Bill.

Just want to ask on this Utility Solutions margin, 22%. Just based on what's in backlog, is there anything that could shift it positively or negatively, kind of looking out over the next, call it six to nine months?

I'd say we are continuing to invest in the business. At Doble in particular, we are updating some of the products. I think as we talked on the last call, we're trying to get it towards -- a little ore towards the online monitoring of our devices and things like that. So that little bit of investment in the future will obviously bring them down. We don't expect them to be at 25% and 26% EBIT forever, because there will be some investment and some competitive pressures. But it's certainly going to be in the low to mid-20s, which is very impressive.

So that's really the only thing that's going to influence Doble's margins. And then on the PLS side, again, we -- when the mix moves into this more heavily in the distribution network on the co-op side, we got some favorable pricing. The stimulus money has allowed the customers to spend a little more aggressively than they have in the past. So we were able to squeeze out a little more price on that. And I think we're executing on the supply chain very well.

So as we get a little bit more improvement, the RF side of the business, obviously with PG&E going away, as our potential new customer starts ramping up, we would expect to see higher volumes longer term on that which will pull margins back up to where they used to be when PG&E was running at full tilt. And so when you see that sales decline there, the gas margins are above electric. So as we get more gas content through over the next couple years, you should see margins longer term improve on the RF side.

So you pull all those three together, and I think, keeping this longer term margin in the low to mid-20s is certainly our goal.

Okay. All right. Fair enough. And you [view] that over the next six months to kind of -- just looking over the next couple quarters, you think it stays in the, call it high teens to low 20 rate --

I think it is just --

-- kind of support that?

Yes, the volume really drives -- I think in Q4 we'll be comfortable with that because the volumes, obviously, are going to be pretty substantial. But going into Q1, we always have that kind of awkward phenomenon or fourth quarter -- or fourth calendar quarter, our first fiscal quarter, always tends to be the lowest quarter of the month. So the volumes kind of ramp up in Q4. It should be sustainable, if not increasing any Q1. The volumes will drop and it'll pull down the margin. But then my guess is that 2011 will look similar to 2010, where it's a stair step, one, two, three, four. So looking at it in the aggregate, we expect expansion. But Q1 probably will not be in the 20s, just based on our historical first quarter volumes.

Okay. All right. That's fair. And then I guess moving on to the test segment. Are we expecting kind of a sequentially -- sequential increase during the fourth quarter just based on what's in backlog?

Yes. If you remember in, I think it was the last release, we talked about this large shielding project down in Florida. It was about $15 or $16 million. A reasonable chunk of that project gets installed in our fourth quarter. So that milestone revenue will come through. And so that alone will be $3 or $4 million incrementally to what we showed in Q3 here. So we expect the test volumes to kind of be in the 10% to 15% higher than what we're showing here on the $35 million. So it'll be close to 40. And if we get a couple of these other projects completed by then -- it's a little awkward to predict that business because some influencing factors can move it a couple weeks around the quarter. But we're very confident that we're going to have meaningful growth in the revenue line in Q4 for test, relative to Q3 actuals.

Okay. Very good. Thank you.

You bet.

Now from RBC Capital Markets, Stuart Bush.

Yes. Hi, guys. I was -- just wanted to be clear, you're guiding to the low 40s margins for next quarter, which is -- that's your historical high levels. That's mainly being driven from operating leverage? And going forward, you would expect it to dip in the first half of next year and then come back to those levels and potentially gas ramps up? Am I reading that correctly?

Yes, I think that's the right way to think about it. Again, as the volumes kind of are variable throughout the quarters, as we look at it on an annual basis, our goal is sequentially in '11, to have a higher gross margin in the aggregate than what we're showing here in '10. But the quarterly volatility is really driven off of the volume.

So again, just like we had this year, the second half of next year, my guess would be we don't have it fully wrapped up yet, obviously, or rolled out yet. But my guess would be it'll be above average in the second half and below average in the first half, because the volume mix will be the same as we've done for the last three or four years.

So I think targeting an annual rate in the low 40s, at the gross margin line with that volatility being kind of bouncing around based on volumes, is a fair way to think about it.

Okay. Great. And I know PG&E ordered -- has ordered -- has ordered beyond its contract. Do you have visibility and when, how much more there is that they will need to finish that out completely? And will you have some element of ongoing replacement business there?

Yes. We just have insight through what they've ordered so far. Our experience is that we'll get somewhere between 3% and 4% of the total contract on an annual basis. So I think we'll continue to see some level, and maybe say less than $10 million a year from PG&E, just because you have growth meters and replacement meters and things like that over time.

We don't have -- honestly, that's more of our experience with the electric. We don't have the same level experience with the large gas deployments. So we're making the assumption it's going to be the same. It certainly is going to -- it's going to roll off and have a much lower level, but we think an ongoing level, probably for the next 15 or 20 years.

And just to, Stuart, give you a reference on that, Pennsylvania Power and Light's been long completed, I think that was probably '06, so we're four or five years beyond that, and we still do on that electric project between $2 and $3.5 million a year at PPL for what they call replacement meters, and, you know, that's new homes and strip malls being built as well as some swap outs of some meters. So, and that kind of ties into the 2, 2'ish percent that's kind of the annuity stream that comes off the backend of that. But PPL's our best reference because that's the one we have the largest one out there and the most history with.

Okay. Great. And congrats on the SoCal Gas win. Can you remind us who you have partnered with in the past for your [comm] to connect to the meters?

As far as the installation company, you mean, or?

With the -- yes, that's right.

You say the comm with the meters? I mean, these are all communications network.

Yes. No. I know. But when you partner for the underlying meters.

Oh, I'm sorry. For the meters, yes. We really interfaced with everybody. So that's really their decision. One difference with the gas and what you see with some of the electric meters is, a lot of these will be retrofitted. The vast majority of this deployment will result in us going to the field and retrofitting existing meters because you can do that in the field. There will be some number and -- of new meters, but it's not a total replacement like you see with electric.

Yes. I guess what I'm getting at is, in the past you've integrated your technology with a wide variety of vendors meters, correct?

Right. No, we've really done it with everybody's meters, that's correct.

Okay. Thanks so much.

And we'll continue -- we have the capability. Obviously we looked across what PG -- or I'm sorry, what SoCal has and what they're looking to do. And so we integrate with everybody that makes a water meter. So that for us, that's somewhat immaterial.

Great. Thanks a lot, guys.

Okay.

And moving on, we'll take a question from Carter Shoop at Deutsche Bank.

Good afternoon.

Hi, Carter.

Hi, Carter.

So handful of quick questions here. Could you tell us what the shipments were for New York City Water and also for PG&E in the quarter?

You want dollars or units or --

Dollars if they're --

Okay. On the PG&E it was $14.9 million, so $15 million you can call that, which was 306,000 units. And then on New York City, it was $24.5 million, and 465,000 units.

Okay. And then going forward, would be expect (inaudible) to slow from the current levels? And then New York City Water, that sounds like that's up pretty dramatically --

Carter, let me correct --

-- quarter-over-quarter.

-- myself there, because -- let me correct myself there. Sorry about this. On New York City it was $7.7 million. I was reading something off of PG&E off a different page. So it's $7.7 million. I apologize. And 105,000 units.

Okay. That sounds better.

Yes. Sorry about that.

And then when we think about the growth in PG&E electric -- I'm sorry -- gas going forward, is that -- should we start to accept that winding down as early as this quarter? Or do we have another quarter to -- at this type of level?

I think the projection for the fourth quarter's a little bit less than this. So the $14, $15 million of sales probably will come somewhere in the $12'ish, $12, $13 million.

And then it drops off.

And then it drops off pretty significantly, as you will, into '11. It should be somewhere in the neighborhood of $10 or $12 million for the year next year, unless they continue to expand beyond the number of units they're talking about now. So the big drop off will be in Q1.

That's helpful. Thanks. When we think about the impact from the stimulus, have you had a chance to look at the orders in the USG group that were impacted by stimulus funds, be it water or smart grid related this quarter?

We really didn't look at it that closely as far as the quarter. We need to go back and take a look at that. But I would say that it's not been overly significant. We have had a higher level of orders from what we experienced last year. But again, it's kind of hard to get your arms around exactly which utilities are using the funds and which are just moving forward as a result of having good business case.

Okay. In regards to orders this quarter, could you comment on how they've trended through the first month of the quarter?

Still feels pretty good. I mean, July, I don't have the actuals down to the penny. But we're on track for another decent quarter here in Q4. So we'll finish with a very strong backlog at September 30th. Obviously we're not going to duplicate Q2 at the $220 million. But certainly it looks as strong as Q3 if not nominally stronger.

One more question, if I may. When we think about the international opportunity, how long do you envision it taking until we can get that kind of Latin American region representing $50 million a year in sales for the USG group. Is that more kind of fiscal year '13 versus fiscal year 12? Or could that actually happen as early as fiscal year '12?

It may -- it could happen as early as '12. I mean, it's very hard to say. I mean, it's not going to happen next year and it's whether -- how quickly some of the large utilities really get going. I mean, if Brazil was a little farther along, I'd feel more comfortable in saying '12. But it's really going to be driven by CFE, I would say today, or if something happens in a larger way in Asia. But certainly by 2013, I think we're going to be in a position to have a significant contribution from the international group. I've got them all in town tomorrow, so maybe I'll little -- know a little more tomorrow afternoon.

Very good. All right. Thanks, and congratulations.

Okay. Thanks.

Moving on now to John Quealy at Canaccord Genuity.

Hey, Vic. First off, congratulations on the SoCal. Couple things. One, and I may have missed this. Did you give a Doble breakout or a range for this quarter or for the year?

I mentioned that for this quarter they did north of 25% EBIT, and the sales associated with that was about $22 million.

Okay. Okay. And then, Vic, on the Aclara business line, are you still leading it day-to-day? What's your outlook there in terms of, obviously you've had good success leading it in the last sort of six months or so. What are you planning on doing there day-to-day?

Yes, I'm still spending a good bit of my time over there. I think it's been time very well spent. I understand the business. Not that I didn't understand it. But better, I mean well before. But if you're over there on a day-to-day basis, you really get your arms around more the level of detail than you typically would. And as I mentioned before, I mean, I've been very impressed with what I've seen.

We're moving toward looking hard into our organization how best to take advantage of all the capability we have there. But if I had to guess, I'll probably be there for another three or four months, I would say, before we have a transition. And that's okay. I mean, I think, again, I think it's the right thing to do. And it's -- that's obviously a very -- the most important part of our business today as far as growth opportunity. So I've been pleasantly surprised with what I've found over there, I'll just put it that way.

And my last question, on R&D, can you give us -- and I apologize if it's out already. But can you break out R&D in terms of operating expenses? And can you talk about relatively where those funds are going? PLS? Firetide? Wireless? Gas? Electric? Can you just give us some context in where the R&D dollars are going this quarter and moving forward?

I'd say just to kind of frame it up for the year, because we made some pretty substantial investments across the company, I think if you look back over the last three years, we kind of do in that 7.5% to 8% of sales, on a consolidated basis. And I think this year it's going to be a little bit higher. And I'll just touch on a few of the pieces financially, and then Vic can talk on strategically what we're doing there.

Obviously, at PTI on the aerospace side of the business, we're making some R&D investments in the new product that we're going to be launching on the Airbus program that we announced a year or so ago on the A350. At Vacco obviously we had spent some money on Constellation in the past, prior to its confusion, whether it's canceled, not canceled, in, out, whatever. Obviously, we've been reimbursed for a majority of that. So we're not going to see that going forward.

But we are still investing in some of the new products that -- and projects that NASA's contemplating as they go across.

Within the Test Business, we are developing a systems business, and that's requiring about $1 million or $2 million of investment there, to basically become more of an integrated supplier as opposed to just doing hardware pieces and some of that. So I think we're going to participate in a meaningful level going forward on some of the high-value-added stuff. So that's taking a $1 million or $2 million.

I'd say Doble is where the majority of the dollars are going right now, getting us positioned globally, as Vic said. We're expanding our footprint across the world with opening new sales offices and support offices, as well as updating our hardware, which is getting a little bit long in the tooth, still very functional but just -- you know, we hadn't invested, our prior owner hadn't invested much in the last five years, and just updating the stuff. So I'd peg that in the kind of $5 or $6 million range alone on just upgrading the new product development cycle over there.

Then on RF, the Ascendant network, and a few other things we're doing getting the Aclara RF electric product out, probably in the aggregate's another $5 million or $6 million, based on what we're doing there. And PLS is more -- I'd say it's a little more muted this year. Last year was the big investment in the pole mount solution, getting the box up on the pole to mitigate theft. And I'd say the investment now is more for the future, and so it's not as big today as it was last year.

So that's a lot of data points. But I think if you kind of walk across, you can see that we're doing very well on the EPS line in spite of increasing our R&D in the aggregate, probably to 8% to 8.5% of sales this year. Does that help?

That's very helpful. Thanks, Gary.

Okay.

You have one more question. Ben Schuman, Pacific Crest Securities.

Hi, guys. Good afternoon.

Hey, Ben.

Hi, Ben.

Gary, you talked a little bit about the test segment in the fourth quarter, some of the drivers kind of quarter-over-quarter there. Can you address the other segments? I know the revenue growth is pretty much inline with the seasonal pattern. But any major lumpy drivers there in the other segments?

No. I think PTI's going to have a nice fourth quarter just from some re-stocking at the -- on the distribution channel in the aftermarket. And the other thing is, which we really haven't talked about a whole lot, not that it's a gigantic number, but sequentially it'll be a decent contributor in our [tech-pack] business. We announced that Thermoscan ear thermometer cover that we won eight or nine months ago, we just started the lineup here in July. So we'll get August and September sales through that, which will be a pretty decent incremental add.

Test, I mentioned. And then across the Utility Solutions group, there's several pretty decent size projects that we'll be moving out on here. Individually they're insignificant, if you will. They're not $5 million per contract. But you add these all up, you're going to see a very nice increase across Utility Solutions. So it's not one -- sorry. It's not one specific item at USG. It's just a multitude of co-ops and some international contents coming through. And, as Vic said, we do have a little bit of risk on the RF side, but I think we've calibrated that into our outlook.

Yes. Probably the biggest driver in the USG side is our biggest distributor's HD Supply. They have made significant orders through the year. And a lot of that product will be delivered in the fourth quarter. So that's what really kind of gives us incremental growth in that segment is satisfying that distributor.

Okay. Great. And then just one more on the improvements to the Doble product. Can you talk a little bit more about that? Is that going to expand the addressable market? Or does that address some competitive concerns there? What are kind of the drivers of improving the products?

Yes, it's a little bit of both. Honestly, the products, we need to, obviously in a product -- in a company like this, you really (inaudible) your product development. And so we're looking to add additional functionality to our existing products to update those, just because, as Gary mentioned, they haven't been updated for a while. So it's just kind of moving forward with the technology.

The other piece of it is, though, as Gary mentioned, getting more of these products online. Because today if you go and you use the product, they work very well, but you have to router from one transformer to another transformer, so you're going to have to take it out of service. And ideally what you like to do is continuous monitoring, particularly in some of the higher-value items that you're testing.

So today, that's a pretty expensive proposition because you're dedicating an asset to monitor another asset. While it's cheaper than the basic product that we make, it's only monitoring a single asset. So we've been driving that development so we can get cost out so we can provide a product to the customer that will allow them to do continuous monitoring. Because, obviously, you can put that out there, track it on an ongoing basis, that's better than just kind of doing a scheduled maintenance where you're going to check it on a regular basis. I mean, you'll catch it, but it's not as effective as having it online. So that's another place where we've been doing a good bit of investment.

And then also, with the business that we bought in Germany a couple years ago, we're making some modification to that product so it can be sold inside the US as well as -- as well as outside the US.

So I would say, if I had to kind of calibrate it, I'd say 50% or 60% of it is just basic upgrading the functionality of the products, and the other 40% or so market expansion.

Great. Thanks. And I'll throw in my congratulations on SoCal Gas as well.

Thanks.

That concludes today's question-and-answer session. I'd now like to turn the call back over to Vic Richey.

Okay. Well, that completes it. I don't have any further comments, so we'll talk to you next quarter.

That concludes today's call. Again, thank you all for attending.