ESCO Technologies Inc (ESE) 2010 Q4 法說會逐字稿

Good day, everyone and welcome to the ESCO fourth 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, I would 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 amounts of fiscal 2011 and beyond expected results. The success and timing of the Company's pursuit of AMI opportunities including the SoCalGas project, new product developments, future growth prospects, the success of our Ascendant RF network development, 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 Security law.

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 presentation press release issued today which is addition to the Company's Form 8-K filed today. We undertake no duty to update or revise any forward-looking statements, whether it's a result of new information, future events or otherwise.

In addition, during this call the Company may discuss some non-GAAP financial measures in describing the Company's operating results. A reconciliation of these measures to their most comparable GAAP measures can be found in the fourth quarter and 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 will turn the call back over to Vic.

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

Thanks, Vic. As noted in the release, we reported EPS of $0.89 in Q4, reflecting a 9% increase over the prior year. The fourth quarter EPS increase was achieved despite a challenging comparison of the effective tax rates. Q4 2009's tax rate was 8.5% compared to roughly 35% in the fiscal 2010 fourth quarter. A better way to gauge our strong Q4 earnings performance is to compare pre tax earnings, which increased 54% year over year, with all three operating segments significantly increasing their profit contributions. Our Q4 sales increased nearly 23% to a record $208 million, again with all operating segments making a meaningful contribution to the sales growth.

A favorable product mix across the Company, along with effective cost reduction initiatives enabled us to achieve this 54% incremental profit leverage on the sales increase. Filtration sales increased over $10 million or 36% with every operating unit showing growth and included Crissair, which added approximately $4 million. Filtration delivered a nearly 21% EBIT margin in the quarter led by VACCO and PTI's exceptional performance. Test sales increased over $5 million in the quarter as several large chamber projects were completed, and with this level of quarterly sales, tests delivered an EBIT margin over 13%. USG delivered the largest Q4 gains in both sales and profits. Sales increased nearly $23 million or 23% with a corresponding increase in EBIT dollars of $9.1 million resulting in USG's EBIT margin of 25.7% in the fourth quarter.

Also during the quarter Aclara delivered over $18 million in additional sales and Doble added over $4 million compared to the prior year's Q4. Aclara clearly was the big profit contributor as well, as our AMI product mix continues to deliver solid incremental margins. During the quarter we shipped nearly $24 million on the PG&E gas project, which is comparable to the sales level of Q4 during 2009. Cumulative through September, we have delivered nearly 4.4 million gas units on the PG&E contract worth $244 million. This project continues to be the largest fully functional fixed network AMI deployment in the country, and continues to be instrumental in serving as a favorable reference customer for other AMI opportunities.

We continue to be enthused about the significant amount of orders received across all three operating segments as well. We booked $162 million in orders in the fourth quarter, on the heels of our record nine-month order book. This brings our fiscal '10 total orders to a record $669 million or 110% of sales. Also during the quarter we booked additional orders from PG&E on the gas project. On the cash flow and balance sheet front, we are pleased with the $51 million of cash generated by operating activities during Q4. As well as our solid capital structure and available liquidity.

Our net debt outstanding was approximately $125 million at September 30th, with a comfortable leverage ratio of 1.68 and continued favorable pricing on our outstanding debt. Regarding our outlook for fiscal 2011, we expect both sales and EPS to grow between 10% and 15% during 2011 and this growth is expected despite a significant sales decrease at PG&E as the contract is nearing completion and considering the $10 million in incremental investments in USG. These incremental costs, compared to fiscal 2010, are related to new smart grid applications, a global market expansion initiative and, and pre deployment costs expected to be incurred on the SoCalGas AMI project.

In total, these incremental investments are worth approximately $0.23 a share during 2011. We have identified market opportunities where we see these new products and solutions addressing very specific and critical needs for our utility customers. Our proven track record in providing next generation utility solutions are expected to provide us with meaningful growth opportunities for years to come. I will be happy to address any specific financial questions during the Q&A, and now I will turn it back over to Vic.

Thanks, Gary. I'm very pleased with our operating results for the fourth quarter and the fiscal year in total, as it again came in above our expectations. These strong results reinforced my confidence that we are making the right investments, and we are [continuing] to expand our market share in our target end markets. Achieving this level of sales and earnings growth along with our strong cash flow in the fourth quarter is very satisfying.

As you know in July we announced our selection for the contract negotiations on the SoCalGas AMI project. As I mentioned before, due to the confidentially agreement we signed with this customer and the fact we are actively engaged in negotiating a definitive agreement, I am not able to discuss any specific details on this topic. I can tell you the contract negotiations are on going as I meet regularly with the SoCalGas and separate senior management teams. Contract negotiations are progressing as expected, and our working relationship is very positive and I will have to leave it at that. I remain very excited about where we stand today in the AMI and smart grid markets as well as what I see ahead of us in the way of new business opportunities.

When I look back at our recent AMI successes domestically as well as internationally, I can't help but be pleased with the successes of our wide ranging technology offerings and how they will continue to benefit us in the future. Fiscal 2010 was one of the best years in our history of winning new business as we added over 50 new customers across the Aclera platforms. This success continues to validate we have one of the best, most proven AMI solutions available for gas, water, and electric applications, and it is apparent our customers feel the same way.

To update you on Aclera, as I mentioned on the last call, I remain very impressed with our management team and our growing market position. We are focused on the near term release of several innovative new products and are confident that our new product road map will support Aclara's future growth. We have recently completed a realignment of the Aclera organization, which will more effectively take advantage of the talent across the entire organization. Additionally it will result in more consistent interaction with our current and future customers.

We continue to make good progress on our Ascendant RF network development and I remain confident this system differentiator will lead to new opportunities and further enhance our market strength against all three utility end markets. While much of the current focus is rightfully on our growing AMI and smart grid business, it is also important to note the other businesses within ESCO continue to significantly contribute to our operating performance and growth. Each of our business segments plays a key role within ESCO to ensure our successful performance and to support our growth.

To continue this success, all three segments require ongoing investment that we are fully committed to provide the support in the future. Doble, ETS-Lindgren, and our filtration businesses all enjoy leadership positions in our respective end markets which contribute significantly to the strong performance we realized in fiscal 2010 and positions us to continue this performance in the future. So in summary, we remain in a very solid operating position across the Company with ample opportunities for growth. And we will continue to prudently invest [in this business] to ensure our long-term success.

So with that I would be glad to answer any questions you might have.

Thank you. (Operator Instructions). We'll go first to Craig Irwin with Wedbush Securities.

Thank you, gentlemen. Congratulations on the solid quarter.

Thanks, Craig.

So over the course of the last three, four months, I have talked to in particular two of your largest installations, and both of these customers have told me that a certain very large utility from South America has been to visit them and seriously considering moving forward. This is one of the two that already has done pilots. It is a very well-known name. I was wondering if you could update us on the status of the pilots and the overall traction with the customer and how we could potentially see this implementation going forward.

Just a point of clarification, assuming I understand the customer you are talking about, and we have a couple of deployments underway in South America, they aren't large deployments. One [of them] is a $20 million deployment and the other is a $5 million deployment. So these are well beyond what I would call the power stage. We do have a number of pilots underway in South America as well, and they have been there for some period. But these two deployments are also underway and they are going well. We've started deployment, products in the field; it is working well. Our expectation is that for one or both of those we should see a re-up of that contract within the next quarter I would say. And when I say a re-up of the contracts, as you remember we've talked before that both with Cali and with CFE in Mexico they can essentially add to the contract, they could double the contract value they currently have without going back for a rebid or any type of additional approval. We would anticipate either one or both of those customers most likely are doing that in the next quarter.

Beyond that, it depends on how that goes. They will have to go get additional funding, but it is always in my view if we can get the technology in the field, get it proven that it works well which we are very confident that's happening today and it will in the future, then the business case is certainly there. What they are trying to do with both of those utilities, in a lot of ways, is to reduce the losses that they are currently experiencing. Our system very effectively does that. I will say some other systems have gone down and tried to operate in some of these environments, and haven't done as well. So my view is once we are able to prove that and we're [walled] down to really doing that, that they will expand these deployments.

As I have said previously on some of these calls, I think it is going to play out in a different way then what we see in the US, where most cases a US utility will go in and they will commit to do a full system deployment. I don't think that will be the case with some of these international clients. More likely they will go and complete a city at a time or a couple of cities at a time. So I don't see them committing for a full scale deployment, but I do think we will see significant deployments with both of these customers over the next several years.

Great, thank you. And then my next question was really, after the very successful installation of PG&E and the big win at SoCalGas, can you update us on the overall momentum in the gas market? Are you seeing any large potential bids out there that you think could materialize in 2011? Or is this something that is going to sort of move in a similar way to early days of electric AMI, back about a decade ago where things incrementally picked up momentum over time?

Certainly, the way this one is different than what we saw on the electric side is some of the larger utilities are committing up front, the larger gas utilities. If you remember, and I think a lot of people have forgotten the fact that really the people that led the charge on the electric side were really the cooperatives. And so we had a large number of cooperatives utilizing our two-way power line system well before the investor-owned utilities started getting actively engaged in this. I would say the majority of the large deployments you saw, not all, but the majority of the large deployments you saw on the electric side were drive bys. Really with electric, you saw more of the momentum start with co-ops and a pick up with investor and utilities.

What we are seeing on gas is we have always had some smaller deployments particularly with the municipals, but now with a couple of these large ones taking place, certainly it should give the gas utilities a lot of confidence that these large deployments can be done and done very effectively. While we don't see anything the size of SoCalGas or PG&E out there, because they just aren't out there, those are the two largest utilities of that type. At least on a stand alone gas basis, but we do think there will be some other decent-sized gas utilities will be making a decision over the next couple of years.

And then last question, if I may, Doble has obviously been a very successful acquisition for you. Can you update us on the geographic diversification of Doble, what is going on with the market share there and whether or not this is really helping out with the other core products in the utility solutions group? The Aclara product is really helping pull those through into the broad base of utilities out there.

Yes, as you know our real strength with Doble today is domestic. We have about 95% market share domestically. And fortunately we have been able to maintain that. It has been through a lot of hard work by the folks there and continuing to invest in [our] products, which we have talked about doing this past year and this coming year. I think that investment of products is really paying dividends and ensuring that we maintain our very strong position in the US. Internationally, that is where we see the significant opportunity for growth. We are currently in six different locations, and our plan is open two new locations this year. It is a little bit of investment that Gary mentioned in his portion of the introduction that these international expansions while they are absolutely the right thing to do are not inexpensive, but given our success here, and given our success in some of the international markets we have already penetrated, we are looking at opening a new office in South America and one in the Middle East yet this year.

We do see good opportunities to continue to grow that business and it has been a very successful acquisition for us. I mean, they performed as we had anticipated; in some cases even a little better. I have had the opportunity to spend some time with their customers and I will tell you they have a very strong loyal customer base that I think we are able to maintain because we provide a really good service to them. As far as the last part of your question on pull through, we haven't seen a lot of that yet, to be very honest. We sell into different parts of the utilities. Having said that, we are starting to get more cooperation at the operating level between our Aclara organization and the Doble organization. I think we will see some of that in the future. It has been more trying to get both of those businesses well established in their own right.

Thanks, congratulations again on the impressive quarter.

Thank you.

We'll take our next question from Kevin Maczka with BB&T Capital Markets.

Thank you. Vic, I guess my first question strong orders for the year, record orders, but of course the USG segment is down from that huge quarter you had in Q2 and even from the levels of Q3. I'm just wondering how we should think about the order cadence going forward? When should that turn around a bit? Does it really take SoCalGas orders to start to be booked to make that happen?

Yeah, the reason the second quarter was so large is we had a large order from one of our largest distributors on the power line side. We anticipate that we will continue to get solid orders from those folks. We don't have insight in any really significant orders this year beyond what we are going to see from SoCal, what we are going to see on some of the international things, but I think we are going to have a very solid year as we talked about earlier. We are seeing a solid year in 2011 from a sales perspective. I would say while we have seen some variability in the orders, I'd say it's above where we thought it was going to be and gives us a lot of comfort going into this next year.

The place where we have some risk, and I talked about this in the last couple calls is with our municipal business. I would say we see that across -- everybody is going to see that because of the municipal funding is generated through taxes, and that has been a little soft over the past 12 months. Our view is that is going to pick up this year, because some people have pushed off things like they did to co op orders last year or the year before last and that has picked back up. We think the same thing will be happening with the municipal market this year.

And can you give a little more color on the break down of the sales in USG for the year? How much was Doble; how much was the co-op business and some of the other big buckets there?

Kevin, Doble was right about $91 million in sales. And the co-ops were roughly 95 to 100 in there. Then I mentioned what the PG&E gas was in the quarter and for the year at PG&E it was about 50, 50 of sales. I think you can work around that. The PLS side. The international side was 10 in the quarter and about 25 for the year.

Okay, and then Gary within filtration, can you just give an update on the VACCO side, anything new with the Constellation happening there?

We had a really good year on Constellation because with all the chaos that was going on. The funding was already in place. NASA was in this use it or lose it situation, so they accelerated a lot of programs there. When you look at VACCO for the year they were up nearly 10% and I'd say Constellation was a big driver of that. Obviously, that is not going to repeat itself, because there is still a little bit of churn and chaos going on in Congress as to what the funding levels are going to be and how they are going to allocate that. I would say the success this year was on Constellation. They increased or accelerated the schedule which allows you to keep some of those cost plus things working in your favor, especially if they are going to pay for acceleration fees and things like that. For the year, even though VACCO had some incremental investments on some other things, they still did 20% EBIT on nearly $50 million in sales.

And as far as you know right now, is that your expectation, some of those accelerations will continue to happen as we move into fiscal 2011, or do those start to taper off here?

I think in 2011, the view that we have today is we are going to have another strong year with the space project -- projects, I should say. Constellation does not look like it looked going into last year. A lot of the individual pieces are going forward. We are seeing a lot of work on the launch vehicles and some other pieces of the Constellation or ex-Constellation projects, if you will. Because the funding at NASA really hasn't been reduced. It has just -- it has not been as focused as what we'd anticipated going into last year.

Thank you.

We will take our next question from Walter Nasdeo with Ardour Capital.

Thank you. Good afternoon, guys. If you could, I'm just trying to get a little bit of a handle on SG&A going forward. I read where the guidance is going up a little bit. But do you have any feel for how this is going to shake out over quarters now that things are starting to normalize throughout the global economy? Are you expecting to get things smoothed out a little bit or are we still looking at some pretty bumpy quarters going out?

I will give you the profile of the quarters in general. The nice part of what 2011 looks like it is not going to have the steepness that 2010 did. Obviously, as we look back at 2010 we started Q1 with $0.02 and finished up with $0.89 or almost $0.90 there. So it is not going to look like that. It is still going to be back end loaded, but I would say in the first half of the year, where we did about 14% of our earnings, in the first half of 2011 we are going to do about 25% of our earnings. While it is still 25-75 it is flattening itself out, which is always a good thing. It gives us a lot more predictability in what is causing the first quarter and the second quarter to be better than the first and second of last, is the fact our backlog is so high and we have the visibility as to what is there. There is a lot of quick turn things that we will be shipping in Q1 and Q2. I think you were asking about the G&A.

The G&A is obviously going to be up by at least the $10 million that we just mentioned for the incremental investments. Plus you will see incremental G&A in filtration. Obviously the Crissair acquisition we had for two months in 2010, and we are going to obviously have them for 12 months in 2011. There is just a calendar delta there. And then as Vic said in his prepared remarks, we are continuing to invest in the aerospace business. We have the Airbus contract for the A350. And there are some development costs there and at VACCO with the space program we had some incremental things going on there for the launch vehicles and some other things there. I would think G&A is going to be up pretty significantly, again driven by the USG delta. We are comfortable we are still going to get this growth in spite of the G&A investment.

Great. And then just shifting a little bit on the international, are you seeing a lot of interest in the AMI products and just that whole concept internationally or is that something that is still a little ways off?

I would say there is a great deal of interest in it. I would say maybe the biggest difference is that while they want a good deal of functionality, they most likely are not going to require quite as much functionality. Some of the domestic investor-owned utilities to get in some of the in home display things and some of the control functionality inside the home is probably not going to be as relevant to some of those customers as what we see here. But certainly they aren't interested in only having an AMR system. So they are looking for two-way AMR system.

Great, great. I appreciate your answers. Thank you.

You bet.

We will go next to Stuart Bush with RBC Capital Markets.

Hi, good evening, guys. Can you talk a little about the dynamics of the test business? It looks like the book to bill was below 1 for the last couple quarters. Are you still expecting that to have EBIT margin growth next year, and where should we see that? How much should we see that grow? More towards 2007 levels or maybe you can just give us the understanding of what's going on there.

Yeah, just kind of in general terms, That's kind of whatever GDP used to be called. It is a 3% to 5% growth kind of business there. While the orders are lumpy, keep in mind we had a big order in Q2 for the big chamber down in Florida that we have that is roughly $13 million to $15 million so a lot of that is going to ship in fiscal 2011. Relative to the most recent two quarters we are not that concerned, because a lot of it is already in backlog. What we are seeing here and especially the first month in, we saw the component bookings being strong, so we are off to a good start on the orders for this year, and the first quarter orders in general based on the prospects we are bidding on right now, certainly going to be strong. So that business while it does have large contract components to it, the position today on the backlog really isn't that disturbing to us.

I'm not really concerned about it at all. In fact, I would say what we have seen is the second half of the year and then going into this year, orders have started to pick up. And really around the world. We have had some pretty decent orders very recently and one in South America, one in China and one in the Middle East. This is a very global market. While it does have, as Gary mentioned, some lumpiness, I'd say if you look at it in totality year over year, we see some solid performance. We think the EBIT margins should improve a bit next year over this year certainly.

Okay. There has been a lot of discussion around the opportunity in the gas smart grid market in Europe given some of the EU mandates over there. Are you doing any of your R&D efforts to position yourself for that market? Or what is your thinking about your strategy for that wave of projects expected to come over the next five year or so.

I would say we haven't spent a lot of time there as I've talked about on some of the past calls. We did a pretty thorough analysis of where we want to take our international business. Really we decided to focus on South and Central America and Asia, only because of the competitive environment that is already in Europe and the number of different countries you have to go into and a lot of different regulatory environments, those type of things. Having said that, we have started spending some time more recently talking with some partners we may be able to work with there. That would make more sense rather than us going in and trying to Greenfield it on our own. I am not exactly sure how that is going to play out, but that is something we are going to evaluate because Europe has picked up the pace more recently in that area.

Great. And last question is were you involved at all in CenterPoint's gas project? Did you participate in an RFP process there? Or was that pretty entrenched by some of the existing players that won that?

Yeah, that was pretty entrenched already. That didn't really go out for a wide distribution.

Thanks a lot, guys.

You bet.

(Operator Instructions). We will go next to Carter Shoop with Deutsche Bank.

Good afternoon, guys and congratulations on a good quarter.

Thanks, Carter.

First question here, can you talk a little bit about growth by sub segment? We danced around this a little bit on the call, but can you break down where you see the most growth, least growth through fiscal year 2011 by segment -- by the main three segments?

Do you want to take that or do you want me to? I would say, Carter, it is not surprising it is going to come from the utility solutions group. When we look at filtration, we will see most of the growth obviously is going to come from Crissair being in there for 12 versus two months obviously. Mathematically that is going to be $20 million plus worth of growth and then within our TekPack business, we have talked in the past about that $50 million Thermoscan business with the ear thermometer caps, that sort of thing. We just started that in August and so incrementally from 2010 to 2011 that should be worth about $7 million or $8 million of incremental sales. When you add that to the Crissair calendar and the Thermoscan ear device, you are talking $28 million, $29 million in incremental growth there. That is going to be pretty substantial off of the base we had of roughly $120 [million] this year. Within test, the big driver there is, as I said, the large chamber down in Florida. And we will probably get $8 million to $10 million of that incremental contract in fiscal 2011

And the balance of the business is relatively consistent. So you are going to see growth, nominal growth across the globe there, but the big contract with the Florida customer is going to be the big driver. Then when you get into utility solutions, on the Doble side, some of the new products that are refreshed products that we are coming out with, I think we will see decent growth there. As Vic said, we are going to have some international expansion, some sales offices opening up that will also create a fair amount of growth. Looking at kind of the Doble side, it is a high single digit kind of growth prospect there. And Aclara has -- the international thing is driving a big chunk of that. Hopefully that helps a little bit on the top line. Then when you look at the margin that comes along with that, obviously both in filtration and test, we expect to see the margins move favorably a couple points there. The investments aren't as great in filtration and test in fiscal 2010. Within test we originated a systems business where we can incorporate several of our products into a system sale, so obviously we staffed up and came up with some R&D projects there that the sales are coming through in 2011. You will see margin expansion there.

We're expecting it to be north of 10, versus the 8.8. In filtration, at 16.2 in fiscal 2010, we should see that moving up decently with the sales growth. Really the delta and our goal is to manage the investments we are making across the utility solution. So looking at the $10 million we are investing in utility solutions, if you took the sales growth, and I'm talking about Aclara and Doble, and kept it in that 25% to 30% incremental and then back up to $10 million, you should be able to model it out pretty reasonable. So you are going to see a net delta negative in utility solutions because the $10 million hangs out there for the year, and then as we go forward we are certainly not anticipating that type of incremental investment going forward. So in the corporate cost we are not staffing up for this growth, so the corporate cost should be generally flat. So you pull that all together and I mentioned the 37% tax rate. You should be able to get yourself into a 10% to 15% EPS growth in spite of that $10 million which is roughly 13% or 14%. We feel pretty good about it. We have a very good visibility. We have a lot of it in backlog, and, as Vic said, really the only risk profile we pay a little bit more attention to is on the municipal side at Aclara RF.

That's very helpful. Thank you. Two follow-ups to that answer, one on the municipal side. What kind of a rebound are you looking for there in absolute dollars in 2011? Are we looking for $5 million to $10 million increase over fiscal year 2010 levels?

Probably a little more than that. I [would anticipate] it is probably -- is north of $10 million.

And then I know 2012 is a long way away, but is there any reason to think that USG margins will not rebound aggressively in 2012?

I would think they should. Certainly, we will have a lot of this investment behind us. Hopefully, we will have SoCal starting to deploy, and so we should be able to get our margins back up to more historic levels.

And lastly, SoCalGas in fiscal year 2011, how much do you expect that to contribute roughly?

I would say it is going to be less than $10 million. It is really going to be a slow start, and it is going to continue to slide a bit which we're not concerned about because very close to the customer [it is] going to happen and they just want to do it right. We are all for that.

Great, thank you very much.

You bet.

Ladies and gentlemen, that concludes today's questions. And now I would like to turn the call back over to Mr. Vic Richey.

Okay, I don't have anything to add. I just appreciate everyone's interest. Thank you.

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

Thank you.