ESCO Technologies Inc (ESE) 2011 Q2 法說會逐字稿

Good day, and welcome to the ESCO second quarter 2011 conference. 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 statements, I would like to turn the call over to Kate Lowrey, Director of Investor Relations.

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, spending on Smart Grid initiatives, future growth prospects, success in domestic and 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 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 second quarter and fiscal 2011 results press release issued today and found on the Company's website at www.escotechnologies.com under the link Investor Relations.

Okay, before I give my perspective of the quarter and the year, I'll turn it over to Gary for a few financial highlights.

Thanks, Vic.

As noted in the release, we reported EPS of $0.49 in Q2, which reflects 123% increase over the $0.22 reported in the prior year. The EPS increase was driven by significantly higher sales across all three operating segments.

Consolidated sales increased $38 million or 29%, with filtration increasing 54%, test up 33% and USG 18% higher. Filtration sales increased $14 million with every operating unit showing meaningful growth and Crissair adding $7 million in the quarter. Test sales increased nearly $11 million, as several large projects were completed in the quarter ahead of their original delivery schedule. USG's $13 million sales increase reflects $7 million of additional sales at Aclara, resulting from higher domestic COOP and water AMI sales, and nearly $6 million of additional sales at Doble.

In the second quarter, EBIT increased over $12 million with the corresponding margin increasing to nearly 13% of sales with, again, all three segments contributing significantly. Test and filtration were the strongest performers, where EBIT dollars more than doubled. These increases are the result of a favorable product mix and solid operating execution, which drove solid--or strong incremental margins. USG delivered a 19% EBIT margin on Aclara's favorable sales mix.

During the quarter, we shipped $5.9 million to PG&E, compared to $7.2 million in Q2 of fiscal 2010. Cumulative through March, we've delivered $4.6 million gas AMI units on the PG&E contract worth $256 million. This project is the largest fully functional fixed network AMI deployment in the country and is instrumental in serving as a favorable reference customer for other AMI opportunities.

We continued our positive entered order trend, as we booked $167 million of new orders in the second quarter, and in addition, we booked $5.6 million of PG&E gas orders in the quarter.

On the cash flow and balance sheet front, we were very pleased with the $17 million of cash generated by operating activities during the second quarter, as well as our solid capital structure and available liquidity. Our net debt outstanding was approximately $108 million at March 31st with a comfortable leverage ratio of 1.28.

Looking at the balance of fiscal '11, I want to point out that similar to the first quarter, our second quarter sales and EPS included certain products and services delivered to customers earlier in the fiscal year than our previous expectations. The timing of these sales and related profits resulted in a pull forward of a portion of our EPS, which had been previously expected in the second half of fiscal '11. In addition, the timing of our previously discussed Smart Grid initiatives is more second-half weighted than previously expected.

As a result of these timing-related items, our third quarter EPS is expected to be lower than our second quarter, but our fourth quarter is expected to be higher than our third quarter. While our quarterly EPS profile came out slightly different than previously expected, our total year outlook remains consistent.

Therefore, we are reiterating our full-year outlook for 2011, as we continue to expect both sales and EPS to grow between 10% and 15% in 2011. As a reminder, this growth is expected despite a significant sales decrease at PG&E and considering the $10 million of incremental investments in USG. As noted earlier, these incremental costs are related to new Smart Grid applications, global market expansion initiatives 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 in 2011.

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 second quarter and year-to-date operating results across the Company. These strong results continue to reinforce my confidence that we're making the right investments, which allows us to continue to expand in our market share in several areas. Our year-to-date sales and EPS growth along with the progress we're making on new products and market expansion opportunities continue to be very satisfying.

I'll briefly touch on the SoCalGas project. As I mentioned previously, due to the confidentiality agreement we've signed with this customer, I'm limited in what I can share other than to pass along that we're very pleased with the current status of the negotiations on a definitive agreement. I'm not able to discuss any specific details on this topic, other than to tell you I'm impressed with the level of cooperation between Aclara and the SoCalGas and Sempra senior management teams. Contract negotiations have gone well, and our working relationship is very positive. And I'll leave it at that.

As noted in my commentary in the release, I'm more excited than ever about our significant growth prospects over the next three to five years across all three business segments. My enthusiasm is supported by strategic plans I've recently reviewed across the Company. As part of our regular planning cycle, Gary and I just completed our mid-year planning meetings. And after spending considerable time with our operating management teams across the Company and reviewing their growth plans, I'm more optimistic today about the size and number of opportunities in front of us, both domestic and international.

I remain excited about our market leadership positions in nearly all of our end markets, as well as what I see ahead of us in the way of new business opportunities. Within the Smart Grid area in particular, I remain enthused with the success of our wide-ranging technology offerings and our new product roadmap.

Obviously, one of the biggest drivers of our near-term growth surrounds the ramp up, volumes and timing of the SoCalGas project. This project is expected to serve as a major catalyst for our significant growth trajectory over the next 4 to 5 years.

To update you a bit on Aclara, I'm extremely pleased with the early impact that I've observed with the addition of Brad Kitterman as the President of Aclara. Brad hit the ground running and is making a significant contribution toward fully integrating Aclara into a single customer-facing organization. He is instrumental in leading our transition from being a hardware, software and service provider into being a full-service solutions provider. The early read is very positive, as our customers and our employees have really embraced Brad's hands-on leadership, industry knowledge and customer-focused management style.

In addition, I'm excited about our recent hiring of Nancy Rich as Aclara's senior sales executive. Nancy brings a wealth of industry experience and a significant contact list from her years in the utility industry. She's expected to make a significant contribution to the growth of our AMI solutions offering.

I continue to be pleased with our performance across all three operating segments, as all of our businesses continue to contribute to our success. Doble, test and our filtration businesses all enjoy leadership positions in their respective end markets, which contributed significantly to the strong year-to-date performance. And these businesses position us to continue to this performance in the future. Our operating experience and our solid execution on major projects continues to be a significant contributor to our sales and profit growth.

So, in summary, I'm very happy with the management teams we have in place across the organization, both the long-standing leadership and the new additions, which continue to bring in fresh ideas. We remain in a solid operating position across the Company, with ample opportunities for growth, and we will continue prudently investing in the business to ensure our long-term success.

I'll now be glad to answer any questions you might have.

Thank you. (Operator Instructions) Steve Sanders, Stephens Inc.

Maybe first on the 3Q versus 2Q sales and profitability trends. It looks pretty clearly test surprised on the upside this quarter and that you're going to be spending more on the OpEx line. But, I just wanted to see if you could drill down a little bit further on that.

Yes, I'd say all three segments, Steve, came in a little better than expectations. Test clearly is the big winner on that side, and it's pretty close to $10 million for the 6-month period. It's about $10 million -- if you remember in the first quarter, I mentioned 3 or 4 ahead, so we thought they'd kind of neutralize that in Q2. Well, they exceeded the forecast significantly in Q2 as well.

So, for the year to date, they're about $10 million on revenue ahead of plan. Filtration's kind of in the $1 million or $2 million ahead of plan, and the USG Group is generally on plan. So, when you pull that much revenue forward, the fixed costs don't change. And that's why the margin was so substantial.

So, we're going to have a little bit of a soft spot in Q3, just timing related. As you know, these chambers, it's hard to predict exactly when they're going to be completed because there's a lot of outside influences. So, some of that pulls forward.

And then, the timing on the Smart Grid initiatives that we've calibrated at about $10 million, it's going to be more of a 30%/70% first half/second half. So, the combination of getting some of the new people hired on the international side, as well as some of the new product development engineers -- they're now onboard, but they weren't onboard as early in the quarter as we had anticipated. So, that shifts some of the cost from the first half to the second half relating to the timing of some of those new hires.

Okay, thanks for that.

And then, it looks like Doble had a particularly strong quarter. I wanted to see if you could provide a little bit more color there. Where is that growth coming from? Is it coming at the kind of margins that they've delivered historically?

Yes, they just -- I would say across the board. I mean, as you know, the business is the two pieces, the recurring business, which has remained solid even through the downturn.

But, what we've seen more recently is increased sales on the hardware side, as well as the service side. And so, that's an area where we don't do a lot. We'll do a couple million bucks a year on the service side. It's a very profitable piece of the business. And we've seen a pick up in that as well.

Also, a couple of decent size projects outside of the United States, particularly one in China, which has started to roll through. So, I would say overall that business has just picked back up. The margins have been pretty solid. As Gary's mentioned several times, we are making an investment there. So, they're not where they were historically at the bottom line, but I would say that the margins that we're getting on the projects themselves are very, very solid.

Okay.

And then, two more quick ones. Gary, the Crissair purchase accounting, that's flushed out now, so those are -- those margins are clean going forward?

Yes, it was maybe $100,000 that came through, so starting in Q3 it's clean.

Okay.

And then, Vic, can you provide any more specifics around your planning conference commentary? I know it sounds like you're excited about the opportunities across the board, but anything in particular you could highlight?

I would just say for the first time in a long time all three businesses are looking really solid. And so, historically, in this multi-segment type of business, we'll have a couple of them that'll have very solid outlooks, and maybe one that's a little softer. And I would say that really the four major businesses, filtration, test, Doble, and Aclara all have good outlooks going forward. So, that's probably the biggest thing without getting into too much detail on specific opportunities, just because those are things that still have to be won.

But, I would just say that the two things that really give me a great deal of comfort is that there are good opportunities across all the businesses. And I would say we probably have -- I've talked some about the management teams earlier, and I think that's a real key because not only do we have folks that we've had for a long time, but I think some of the new folks that we have, particularly in the USG side, both at Doble and Aclara, are a real significant pick up.

Also, I would say that Doble -- as we've talked the last couple of calls, we're making an investment there because I think we need to not only to improve the products that we currently have, but I think they're doing some very interesting things that are going to add additional products and services that are just going -- that has the opportunity to significantly grow that business.

Paul Coster, J.P. Morgan.

It's Mark Strouse on behalf of Paul. Just following up on Steve's question with the 3- to 5-year outlook here -- and maybe not a specific contract or anything like that, but is there anything specific, like geographic region or product line, that you can point to, like a new government mandate or anything?

I wouldn't say that as much as -- number one, as I mentioned in the opening remarks, we get some pick up just as a result of -- once we get SoCal locked down and going forward, so that's going to give us a significant piece of it.

Also, we have specific product initiatives underway that I think are going to pay dividends fairly quickly. And then, on the international side, we see expansion opportunities, particularly at Doble, somewhat at Aclara as well. We've had some success there, and I think we'll continue to build on that in the out years. The timing's always a bit of a concern, but I think it's certainly there and it's just a matter of timing.

So, I would say, again -- so it's product -- some products that we're going to be introducing, some international expansion, and particularly at Doble, Aclara and in test as well. The test business, while it's always been a very international business, I'd say we're seeing even more of that. And if you look at the year-over-year comparisons between 2010 and 2011, we're well over the 50% mark in 2011. Some of that's driven -- as we all know this is pretty much a project-related business, but we've got several pretty sizable contracts underway outside of the US that are going to drive some of that growth going forward.

Okay.

And then, did you see any even initial signs of a -- any kind of a rebound in the muni market for Aclara?

That's -- no. I mean, a short answer, I'm just going to say we've not seen a lot there yet. We're taking some different approaches at that business. I think there's still good business there, and I think we'll get a good piece of it. But, that has been very soft.

Okay.

And then, just the last question for us, on the gas side with RFPs, can you just talk qualitatively at least as far as what the pipeline looks like, domestic or international, compared to this time last year?

Yes, it's about the same. As you know, these things come in big chunks. And I think we're aware of the things that are out there over the next 12 to 24 months. And given our market position with some very significant wins in that area, I think we'll be well positioned to take advantage of those.

Okay, thanks a lot. Congrats on the quarter.

Thanks.

Thank you.

Ben Schuman, Pacific Crest Securities.

Vic, can you give us your latest expectation for SoCalGas deployment timing? Is that going to be a calendar 2012 or more or 2013 event in terms of the high volume deployment phase really kicking in?

Yes, the higher volume is going to be 2013. I mean, we'll -- assuming things lay out the way they appear to. And again, I'm not going to go into a lot of detail, but 2013 is when it really -- that really will kick in, in a big way. It'll be very little this year, some next year, but then the big ramp up is in 2013.

Okay.

And we saw a pretty sizable pilot in Brazil awarded to Elster with an RF solution. If RF is the direction that those guys decide to go in, will you be prepared with a solution given some of the R&D initiatives or are you still pretty confident that the TWACS solution is pretty applicable down there?

I think there will be deployment of both. I mean, we've had discussions with some of the utilities about RF, and I think when the time's right that we'll be in a position to participate in some of those, so we'll just go forward with that. I think that's going to be a little bit longer term.

But, certainly, I think there's going to be a role for the PLS solution, the TWACS solution, both in Brazil and a lot of other areas in South America. And that -- those -- that's a product that we're deploying today. As you know, we've got about $40 million worth of product that's going into CFE in Mexico even as we speak.

Okay.

And can you provide any color as to when some of these new Doble products and initiatives would kick in and be accretive to the strength really that you're already seeing in that business?

I think some of the things that we're looking at are probably going to be second half of 2012.

Sean Hannan, Needham & Company.

Yes, I was looking to see if you could provide a little bit of color or further color, Vic, around some of the expansion opportunities that you have within Doble? I understand that there's certainly been, obviously you guys have talked about this for a while, some investment within the product there within the Group reenergizing that as well and that there's been a lot of hiring.

So, I'm just looking to see if we can get a little bit more detail around what degree this is more of a sales effort in the near term versus the medium term, and then to what degree we're going to actually see more of a line expansion?

Yes, I'd say there's really about three things that are going on there. First, just getting our products with additional functionality, which we've talked about before -- so that's number one. And I think that will help us maintain our current position in the domestic market.

It will also help us in the international markets as we continue to expand those. And that's the second area, I would say. We have a number of locations around the world. We're in the process of opening a couple of more this year to take advantage of that. And when I say location, I think it's important to understand that it's more than just a salesperson out there. What we're doing is -- because of the way this business works and because every country, at least region, approaches things differently, we need to have engineers in place, we need to have to service people in place, we need to have people that really can interface directly with those local utilities. And so, we're in the process of opening a couple of additional offices there outside of the US to try to take advantage of some of the offerings that we have.

And then, the third thing is truly line expansion. And not to go into a lot of detail on that just for competitive resources, but we've certainly seen more of a move toward having more of the products being online type of products, so that rather than having to take a transformer out of service to do the testing that we do or for the utility to do that type of testing, to be able to have some online monitoring of devices that we currently look at. And that's part of the expanse we've seen going forward is really to monitor additional pieces of equipment that a utility has. And so, it really goes into the reliability of the grid and the safety of the grid.

And so, we're going to take advantage of the fact that we're already there with a lot of those utilities and take advantage of the position we have with those utilities to further expand the offer that we have because if you look at our business, we like to think of it as a lot more than just a hardware business. It really is a knowledge business, if you will. And so, it's really taking all those test results and doing something with them. And so, I think rather than collecting data, what we do is we take some readings, and we turn it into knowledge that the utilities can use.

I continue to be impressed by the relationship that we have with a lot of our customers. We had our users group -- users conference in Boston, I guess, back in the early part of April, and there were, like, 1,100, 1,200 customers there. And would say that we talked to them about some of the initiatives that we have underway. And I would just say in short, they were really buying what we were selling.

So, Doble has such a close relationship with their customers and such a trust from their customers that as they roll out new products, they're well positioned to be able to sell those to those customers.

Great, thank you.

Then, in terms of the -- when we look at Central and South America, obviously you've had a little bit of some momentum there in terms of water and some large momentum on the TWACS side. You've also talked to a degree around some interest on the gas side. And I was looking to see if we can get a little bit more of an update there.

There's a couple of specific opportunities there, but I don't think there's anything to the point where I'd feel comfortable in talking about it. But, I do think that that's going to be something over time that there's a true opportunity there. But, those aren't really near, near-term opportunities.

Jeremy Hellman, Divine Capital Markets.

I wanted to go back to the pull forward you saw in the quarter, and also the product mix, which worked favorably on margins. As we think about both Q3 and really the second half of the year, is that margin effect you saw in terms of product mix something that we'll see reversion of or is that more of an enduring effect that we can expect to see continue?

No, I think the mix, obviously, was extremely favorable in the first half of the year, so -- in a couple chambers in particular within test, the incremental margins were well into the 30s, which is a little unique for that business. So, in the second half, we're going to be more normalized. So, I would think -- with -- as I've indicated, the Q3 EPS being below Q2, there's -- obviously the margin's going to move back a little bit with that as the mix changes back to what I'd call more normalized.

And second is, of the spread of that $10 million of incremental investments, as I mentioned earlier, it's a 30%/70% spread. And I think of the 70% in the second half, you can split that somewhat evenly. So, you're going to have a reasonably sizable delta in the operating cost. As Vic said, with all these things we're doing on the Doble initiatives in particular, coming out of that conference and the excitement that we shared -- or we felt was being shared with us by the customers, we're stepping up some of the efforts there. And so, the cost is going to come through pretty significantly in Q3 there.

So, what you could expect is in Q3 test to have a lower margin than it had in Q2, and you would expect Doble to have a lower margin than it had in Q2 because of the investments. So, the pull forward really is going to impact test, the incremental investment is really going to impact Doble, and filtration, I think, will show a favorable incremental step up as their revenue continues to increase.

So, when you work that all in, you're going to end up with EBIT margins that'll be slightly above what we did in the first quarter, and I think we did 10.5 or something EBIT in the first quarter, and it should be in that range as you look at Q3. And then, Q4 should resemble Q2 a little bit more.

So, as you map that out, you take the dip from the timing, and then you get back on track in Q4, and then the year holds together. So, hopefully that helped.

Yes. No, that's great. I appreciate that.

And then, one last one for me. Just touching on Japan a little bit, you guys have been doing some work with TEPCO in terms of working on pilot projects. I wanted to see with all that's going on over there -- obviously, tremendous disruptions. Is your work with them currently being put to the side and -- as they pursue, obviously, higher priorities? And also, as you look out long term, is there any bigger backend opportunity as they rebuild over there?

Yes, I'd say it is probably a little too early to tell. I mean, it was a horrible thing that happened, obviously, and so -- but we have been in contact with them through the folks at Aclara. And what I was -- what they're telling us is -- hey, we're taking a little pause here because we do have higher priorities, but we're committed to move forward at the right time.

And so, I think the timing of that's still a little bit up in the air, but certainly -- and it really is a shame from our perspective because there was so much momentum with that right before this happened. But, I think that once things settle down that they'll pick that back up. And I think that longer term we still have a very good opportunity there, both at Aclara, and then I'd have to say also, secondarily, Doble is making some good inroads there as well. And so, I think that as they do rebuild some of these things that there would be good opportunities for us to participate in that.

John Quealy, Canaccord Genuity.

Hi. Good afternoon, guys. It's [Mark Siegel] for John.

I was just wondering if you could put a little more color around some of the margin drivers in utility solutions for the quarter.

Yes, I would say the mix obviously worked a little favorably for us. As we've said, as you look across the -- take Aclara in particular, the water margins tend to be the highest margins we have, followed by gas and COOP were about a tie. And so, when you get the mix -- we did a fair amount with New York City Water, we did almost $10 million of sales in Q2, and when you're pulling that product through, you're pulling sizable incremental margins through. And then, to the surprise -- on the -- as I said on the PG&E gas, we did almost $6 million. So, you pull those two through, and it gives you a favorable mix.

The second thing is the COOPs were very strong, and where there -- and it wasn't a shortfall relative to plan. It's just it was the dip on the backend of the first tranche of CFE prior to the start of the second tranche. We only did about $2 million on CFE in the second quarter, and that's obviously a lower margin contributor because there's a lot of pass-through content in that pull-mount solution where -- compared to Q1 where we did almost $15 million at CFE. And so, when you switch the mix around and put in a little more water and a little more gas and less international in the short term, you get a favorable mix there at Aclara.

And then, as Vic said, on the Doble side, we did almost 25% EBIT at Doble. As Vic said, as the service mix works favorably, that's a little higher margin than the products. And then, we also had some end-of-lease situations where when certain customers are at the end of the product, they can either buy the product or just let the lease expire and start a new lease. So, we had a couple customers buy the equipment at the end of the lease, which is obviously at zero value at the end of the lease. So, you get a little margin pick up there as well.

So, I'd say mix at Aclara with water and gas and lower international, and then a higher contribution on services and a couple lease buyouts at the end all worked in our favor.

Okay, that's helpful.

And then, in the past, we've talked about pilot activity in Brazil and in China. Just wondering another quarter out on those initiatives how you feel about the progression there?

Yes, I would say the most positive thing is the product works in the field. So, going into China, that was a little bit nervous because you don't know exactly what the grid's like. And so, until you actually get the product in the field over there, and you can see if it works or not. And fortunately it went in and it worked very well.

So, I can't say there's a huge amount of update there, but the things I talk about with our folks internally is we've got to get product in the field, show that it works, and then I think the rest will happen.

Brazil, I think, is going to take a little time. As we've talked before, they really do have an initiative underway, and it's going to take some federal push, some government push, and I think that's scheduled to happen more next year than this year. So, we've got some product in the field that continues to work well, but I think it's going to be a little time before that moves forward in a big way.

And in China, again, I think it's a matter of just having some product there and seeing it work. And we'll see where that goes a little longer term.

Okay.

And then, just lastly on Doble, the international expansion there still primarily focused on the Middle East and Brazil or are there other geographies you feel offer as rich an opportunity? And then, also, have you talked internally or could you quantify for us what your expectations might be for early revenues internationally?

Well, I'll just make sure that -- let me answer in the order that you gave them to me. Brazil and the Middle East are the places that we're focused on this year. Going forward, we think there's a big opportunity for us in India. We've had people in India for quite some time, but more on an ad hoc basis. And so, we're going to put a more full time cadre of people there because we think that's a really good opportunity.

As far as these turning into bigger opportunities, I think it's important to remember we already do -- 20% or so of Doble's business is international. So, we're not new to the international business. It's just that we're looking for ways to grow it faster.

With each of these offices, it does take a little time, obviously, but we have businesses -- we have business -- I'm sorry, we have business in the areas where we're opening. So, we already have business in Brazil and South America. We have business in the Middle East. It's just that we think by putting a little more emphasis on that, putting a few more folks in there, we'll be able to grow it more over time. But, those things don't happen overnight, but I think that in the next 12 to 18 months, they should be much larger contributors.

Okay, thanks for all that color.

Craig Irwin, Wedbush Securities.

So, just to continue along the line of the new sales offices for USG, what sort of investment are we talking about here per new office? I mean, is this something in the low hundreds of thousands of dollars or is this potentially a greater investment over the next several quarters?

Yes, I mean, what we're talking about is -- and certainly it's covered in what we're talking -- the incremental investment we're talking about. But, we're just talking about people. So, it's really driven by what the costs of the folks on the ground there are. So, obviously, if you're adding engineering folks in India or China versus Europe, that's a lower-cost approach. So, we're talking about hundreds of thousands of dollars, not more significant than that.

And the other thing to remember is, in some ways, you get a little bit of an offset because what happens today is it seems like we're continually flying people from the US to some of these areas. And so, by getting trained expertise on the ground, that's going to allow those folks not to have to travel so much and have that cost and have them diverted from the things that they're trying to do domestically.

So, there will be some costs associated with it, but it's not a significant level of cost.

Great.

And then, just to follow up there, obviously you've got some significant experience in all these markets, and your decision to put a permanent office down in Brazil is something that is going to be a roadmap for how you undertake these actions. Can you maybe discuss the time to productivity for these offices as far as pushing new products in the different geographies or is that not really the right way to think about it?

No, I think it varies a little bit just based on the region and the expertise of the folks that we have there. But, we're not talking about years; we're talking about probably 6 months or so to get somebody trained up and have an office up and running.

And again, as you said, it's not like we're new to the markets. It's just that we're trying to enhance the service level that we can provide to the customers because with that type of product, it's very difficult to say -- okay, we're just going to do it like we do it in the US, and so you need to do it like they do it in Brazil or do it like they do in China. And the only way to do that successfully is to do that with the local people.

But, obviously, it does take some time to get them trained. But, we're not hiring people that -- we're not just hiring engineers out of college. We're hiring people out of the utilities. We're hiring people from the competition. We're hiring people that work for one of the vendors. So, people are coming in with a basic level of knowledge, and it's a matter of us getting them up to speed on our products and services, so that they can be successful.

The other thing that I would mention that particularly -- well, with the office in Brazil, this is one of the first times where we have a joint ESCO office, if you will. So, in that office, we have Doble people, we have Aclara people, and we have test people as well. And so, we're going to try to do more of that as we go around the world. It's not -- it doesn't always work because in a lot of places, we already have people on the ground. And so, we're not going to move them to a different part of India, for instance, but certainly having some expertise in some of these international locations helps the new divisions as they go in to set up an office and get through some of the legal issues that you always have in moving it to a new country.

But, we are looking for additional opportunities for two or three of our subsidiaries to share off a space, if you will, and share expertise.

Great, thank you.

And then, I wanted to ask about your strategic planning process. You mention in the release you've recently completed your multiyear strategic planning process. And I was hoping you might be able to share with us some of the priorities for investment, particularly both on the R&D dollar side and maybe manufacturing expertise or something else and how you weight that investment and how that might differ from where you're investing your capital today.

Yes, well, this is a process we've been going through -- I mean, this is my 25th year at ESCO this month, actually, so I've been around for a while. And it's probably the 20th time that I've gone and done these planning sessions, if you will, because we do this -- this is a part of what we did when we were part of Emerson, so it's a very, I'd say, strict planning process that we go through with each of the subsidiaries to do exactly what you're talking about because you know, obviously, a lot of Gary and my responsibility is capital allocation. So, we're looking at each of the subsidiaries and what opportunities they have and what market expansions they're looking at, product expansions, and then we look at how we're going to invest the dollars.

But, I would say the majority of what we see our investment on today is new product development and market expansion. From a manufacturing perspective, I think we're in pretty good shape. We do make, obviously, capital investments in equipment, but we're pretty well facilitized. I would say that that's something we've kept up with on an ongoing basis, as well as we make sure that we're manufacturing the right things. And by that, I mean instances where we're going to use subcontract manufacturers or those types of things. We've done that as well.

So, I'd say the majority of our capital investments really have been on growing the business rather than improving the manufacturing because I think we already do a pretty good job of that, not that we're not always adding another CNC machine here or thermoforming or whatever the case might be. But, those aren't significant investment versus the product development side.

Let me just add one thing to it. As we look at it, when the -- as we call it, the wish list gets presented, a lot of the folks at the operating units have a lot more substantial plans than maybe we allow them to because we do have a fixed amount of capital that we prefer to allocate.

So, what we do is we challenge the subs to basically give us an individual P&L on some of the new initiatives they're thinking of because would we let someone invest next year on something that might have a 5-year return? The answer is probably no, so we challenge the operating folks to give us a standalone P&L to show how quickly this can come back.

As Vic just said on the Doble expansion, opening these new offices, it's about a 6-month window to get the people on the ground, get them trained and start pulling revenue in. So, that's certainly palatable when you look at the hundreds of thousands.

So, I'd say the process is very rigorous. It has a financial metric threshold that we look at. And we also look for customer input. We continue to stress the fact that we're fast becoming a solution provider. The best way to be a solution provider when we meet with the subs is to see what the customer wants and then go get it for them, as opposed to if we build it, they will come kind of concept. So, the fact that we have a lot of customer interaction, the fact our subsidiary folks are in the trenches with our customers, we know what they want.

So, when our folks present to Vic and I what the strategic initiatives are, the product expansions or market expansions, it's usually done with a financial overview and specific metrics we ask for, but also a customer input, so that we can see what the customer reaction with this stuff would be. As Vic said, at the Doble conference it was significantly overwhelming how enthused the customers were with some of the new products that we rolled out in beta there.

And so, that's how we step back and look at it because we don't do everything that the subs want us to because of a fixed capital structure. But, I think that the process is very structured. As Vic said, we came from Emerson, he's got 25 years of leading this, and the folks know how to present it.

So, I think it's a very good process, and Vic's enthusiasm's warranted, and it's shared by me. Coming out of this and seeing what we have in front of us, it's pretty exciting.

Great.

So, my next question was about the COOP business. I think 3 months ago, you were probably facing a little bit of uncertainty about the magnitude and overall frequency of follow-on orders out of the COOPs and out of your distribution channel there. Can you comment a little bit about order trends there and how you see that tracking and whether or not you think that that's sustainable over the next -- well, in the short term?

Well, we continue to have really solid COOP orders. I think it's been a little stronger -- actually, it has been stronger in the first half of the year than what we'd anticipated. Hopefully, that'll sustain itself through the remainder of the year.

A little longer term, this is a market that is getting more and more saturated, so it's something we pay a lot of attention to. But, one of the things that we spend a lot of time talking about at the Aclara conference -- or, I'm sorry, the -- yes, at the Aclara planning conference was really about opportunities to sell more products to those customers. I mean, I would say that if you -- I talked a lot about Doble's loyalty -- Doble's customers' loyalty to them. Obviously, if you look at the COOPs that we have, the loyalty that they have to Aclara is really very, very high because you put the product in and it works. And at the end of the day, that's what people really want.

So, we're looking for opportunities in that, and I think we have some really good opportunities to continue to sell additional products and services to those folks. So, while at some point that's going to start tailing off a little bit in the -- I'm talking about in the out years, but at the same time I think we're going to have more products and services selling. So, that should be a very sustainable business going forward.

Great. Congratulations on the solid quarter.

Thanks.

Richard Eastman, Robert W. Baird.

Vic, could -- or Gary, could you just provide a little bit more color as to the core growth rate in filtration? It's probably 10 points better than I thought it might be. And is that Thermoscan or aerospace accelerating? Where did that come from?

Yes, I think it's coming across the board, Rick. We -- PTI, the legacy business with PTI is coming on strong, and Crissair certainly supplements that. And then we -- I think we're starting to see some leverage there as well. We obviously sell to the same customers, so being able to go back to those customers with a joint product offering now and a single product book, if you will, I think has been beneficial because Crissair's significantly ahead of plan, 5% or 6%. And we were expecting them -- relative to our acquisition plan, a success was if we just hit the numbers. So, being ahead of plan at Crissair certainly is a positive, but PTI is executing very well.

And I'd say where the real surprise is coming from within filtration is at VACCO. With all the uncertainty around Constellation and NASA's budget, it's hard to predict where we're going to go. But, what we're thrilled with is seeing how the investments by NASA, whether they're going to do this or do that, we are a core supplier to them. And regardless of where they go with the ultimate heavy-lift vehicle or wherever they're going to go with the Constellation replacement or that sort of thing, we're benefiting from that.

And so, we're probably $2 million ahead of plan at VACCO for the 6-month period relative to what I would call unexpected orders in the space business, which are favorably -- certainly, when they come in, they're very favorably priced.

So, I would say we've historically thought of filtration in the aggregate as a GDP-ish kind of business with whatever GDP used to be. And now, I think it's a little better than that. I think -- thinking of filtration in the aggregate 5% to 6% or even 7% longer-term view I think is going to be sustainable based on favorable pricing we're getting, seeing consistency within the Crissair PTI portfolio.

And then, as you mentioned, on the Thermoscan thing at the -- at TekPack, we're going to be up $8 million or $9 million this year on that product alone. So, there -- that was a roughly a $50 million contract we're wrapping up the first year on, so we're going to maintain a core business there. Plus, I think through that relationship with the ultimate customer, I think we have some opportunities to expand into some other lines with those folks as well, over time.

So, I think keeping a longer-term filtration view at 5%, 6% or 7%, which is significantly better than it has been the last 3 years, I think, is the right way to think about that.

And that entire business, is it 80% domestic?

The entire filtration business or -- I'd say it's higher than that.

Yes, it's probably closer to 90% domestic.

Yes, okay. All right.

And then, also I guess I was a little bit surprised -- with the test sales as strong as they were, it -- I looked at this quickly, but it looked like the book-to-bill was about 1, so you were able to replace in backlog most of this accelerated shipment.

Yes, and it -- that's what -- if you remember, the first quarter we set a record. We did almost $50 million in orders in the first quarter. So, we're at roughly 90 for the sixth month, and so we feel pretty good about it.

A lot of these -- some of the new chambers we've got are a little longer lead time. We might be able to get them in, in the fourth quarter, but some of the construction projects, on the international side in particular, probably won't ship until the first quarter. But, we're very pleased -- we just came out of their planning session about a week ago, and we're very pleased with the momentum they're gaining on the international front.

As Vic said, we've got that sales office up and running in Brazil. In the first quarter, we booked that $7 million or so satellite order down in Argentina. And those are the kind of chambers and sizes of chambers you're going to see on the international market as you get these sales offices open.

So, being able to keep that book-to-bill at 1 or north of 1 relative to the size of these contracts that run off is extremely satisfying to us.

Yes.

And they're coming in -- I know these are a little larger projects, so one would assume, as you pointed out earlier, maybe a mid-20s incremental. But, that's the type of margin you're getting these billed at --?

-- Yes --.

-- Or bid at?

Yes.

Approximately? Okay.

And then, just maybe the last question on USG, what were the COOP muni sales in the quarter?

At the PLS side of the business -- let me back into it -- international was about 3 and the IOU business was about 5, so that means we did about 25 in COOPs.

And then, on the --.

-- And then, the other project in Toronto, how did weather treat you or did you get anything shipped there in the quarter?

Yes, we did about $1 million worth, which was consistent with plan. I think we were looking at $600,000 or $700,000. We did about something like $950,000. So, I think the weather didn't bother us in the -- we're on schedule with what we're supposed to be doing there.

And that ramps, then, in the second half of your fiscal year?

Well, not a whole lot. I mean, this is a pretty slow-rolling project, to be honest. I mean, for the size it is, they're taking a different approach than New York and San Francisco have. It's going to be -- I think it's a 3-year -- 3- or 4-year project, so it rolls out pretty slowly.

Okay.

Was there any -- how does the -- I think it was CFE Mexico there was potentially a follow up piece of business there of some size. Is there any progress there or like a phase --?

-- Well, we got the follow on at CFE. So, the original contract was 20, and we got a follow on for another 20 -- first quarter?

Yes.

First quarter --.

-- Yes, but wasn't there some thought or discussion about literally a phase 3 that was big?

No. We really hadn't talked specifically about a phase 3 on that project yet.

Okay.

And then, how much of that -- let's see, 40 -- you billed about 20 -- you shipped about 20 against the 40 at CFE or a little bit more. How much is left on the 40, the combined?

Yes, we've done about 25. Some of it was last year, and then this year. So, cumulative against the 40, we've shipped about 24 to 25.

(Operator Instructions) Walter Nasdeo, Ardour Capital.

This is Travis Steed on for Walter.

Most of our questions have already been answered at this point. However, we'd like to get a little more color on the international business; specifically, where are you seeing the most international growth opportunities for AMI?

Well, for AMI, as we've talked about before, I mean, our primary focus is in Central and South America and, to a lesser extent, in Asia. And that's where we're seeing the -- good growth there. So, I would say that continue to deploy at CFE. Hopefully, there'll be something after this initial phase, which we think there will be. Central America, we have a couple of things that have been longer term in Brazil. And then, the last piece of that is just what happens in Japan longer term, and in China, hopefully, in more of a mid-term type thing.

But, we've really stayed away from Europe to date just because all of the other folks that are over there and limited resources. So, our primary focus is in those two areas.

Matthew Crews, Noble Financial.

Just a last question here on test. You'd said that you'd pulled forward maybe $10 million of -- ahead of plan. Do you expect that'll roll off in Q4 based on plan or do you see that as potential upside for the rest of the year based on what you've booked and what's in your backlog today?

I think there's opportunity, but there's -- these things have a schedule. We adhere to the schedule. Historically, it seems like they always get pushed out. And so, this is the first year in quite some time where we've had some pull in of some of these. So, I would say, as we said here today, we're not anticipating that, but there's always that kind of opportunity.

And also, you have to remember that in addition to the chamber sales, a lot of the product, it can move through pretty quickly -- or some of the components that we make where they order things or some of the over-the-counter absorber sales that we have, and those are a little tougher to predict. We have some of those assumed, but there's always an opportunity for some of those to happen a little quicker than what we anticipate.

So, if you were looking at a ramp between Q3 and Q4 would you expect that to trend down or -- I mean, I'm just trying to get a basic profile here.

Yes, I'd think Q4 in tests will be higher than Q3.

And again, it's -- keep in mind the $10 million pull forward was for the 6 months. It was about $3 million in the first and $7 million in the second, and so we're going to be flattish in Q3 because that's where the stuff got pulled through from. And so, Q4, we're still on track.

And as Vic said, there are some variables relative to site preparedness and things like that that are outside of our control. But, we feel pretty good about what the balance of the year looks like. And while the quarterly profile is a little different, it was pulled forward as opposed to pushed out as the historical trend has been, so I think Q4 will be flattish in test -- Q3, I'm sorry, and then Q4 will be up.

Okay.

And just to clarify on the spending on the 30%/70% that you had about $1.5 million of incremental spend on investments in USG?

Yes, I'd say closer to $1 million, maybe a $1.2 million. Probably not as high as $1.5 million.

Craig Irwin, Wedbush Securities.

I'm trying to understand your guidance, your EPS guidance for the year. So, 10% to 15% growth suggests $1.85 to $1.93 if we grow that on top of last year. Take out the two quarters that have already been reported, we're looking at something like $0.95 to $1.04 for the two quarters together in the second half of the year. And that compares to $0.89 in the fourth quarter of last year. Generally, conditions seem to be improving. It would suggest that there's potential upside to your guidance here. I was hoping you might be able to give us a little bit of insight into what it would take for you to raise your guidance or where the potential uncertainty is that has you maintaining your guidance right now.

Yes, I'd say the biggest thing -- and we -- somebody asked me the question earlier about the municipal market, is we've entered -- as we entered the year, our expectations were we were going to do better there than what we're doing. And so, fortunately, some of the other businesses are picking up some.

But, other than the large water projects, we've not seen the level of smaller water projects that we've historically seen and, quite honestly, that we've projected for this year. So, if those start to kick in, in the next 3 months -- and that's what it would have to be in the next 3 months for us to be able to deliver some of those -- that would be the only thing that I think would give us some confidence to say something different.

I assure you, if we had that in focus today and we thought it was going to happen, we'd be talking to you guys about it. But, there's just been a pretty fundamental change in what we started out the year expecting and what we're seeing now. So, the good news is we've seen strength in some areas that we did anticipate, which is offsetting some of the softness we've seen, particularly in the municipal water market.

Great.

So, then, looking at the contribution of PG&E -- obviously, we all have to compare year over year where this is going to land us. Is it reasonable to expect generally flattish revenue out of PG&E over the next couple of quarters or are we likely to see something of a hockey stick, like we saw last year?

I think it should continue to run off the hockey stick if it's facing down, is probably the right way to think about it because we are coming near the end of that. And as I said, we did about $6 million in sales, and then we also got about $6 million in orders. So, I think keeping this $6 million-ish view for Q3 and Q4 is the right way to think about it, which would put us at about $24 million or $25 million for the year compared to about $53 million last year.

So, we don't see -- based on the buying trends that they've done for the last three quarters now, we keep saying we're getting near the end of the project, and they keep buying $5 million or $6 million. But, we don't see -- we don't have expectations for a $10 million or $12 million order quarter forthcoming, just based on the quantities that they have. We know where the deployment is yet to go, and it's not really big numbers.

So, we think there will be a life on that project for a number of years beyond, but it's not going to be something that would be thought of as a hockey stick.

Great. Congratulations on the solid execution again.

Thank you.

Thank you.

And this does conclude today's questions. I would now like to turn the call back over to Mr. Vic Richey.

Okay.

Well, I appreciate everybody's interest, and I'm sure we'll be talking more. And I'll talk to you again at the end of the next quarter. Thank you.

Thank you.

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