ESCO Technologies Inc (ESE) 2012 Q2 法說會逐字稿

Good day, and welcome to the ESCO Technologies second-quarter 2012 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 Lowery, Director, Investor Relations. Please go ahead.

Thank you. Statements made during this call regarding the timing and amounts of FY2012, FY2013 and beyond expected results, including sales, SG&A, cash flow, EPS and profits, the timing and uncertainty of development in connection with the SoCalGas project, renewal of credit facility, future growth opportunities, 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 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 FY2012 results press release issued today and found in the Company's website at www.escotechnologies.com, under the link Investor Relations. Now, I will turn the call over to Vic.

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

Thanks, Vic. As noted in the release, we reported GAAP EPS of $0.38 a share in Q2, which is the equivalent of $0.41 when adjusted for a normalized tax rate. The Q2 tax rate was significantly higher than previously expected due to a non-recurring non-cash charge resulting from the write down of a purchase accounting-related deferred tax asset. EPS decreased from prior year, which was clearly expected, was driven by lower sales in the USG segment resulting from the wind down of PG&E gas, New York City water and CFE in Mexico, as well as higher SG&A cost being incurred across the Company to support future defined growth.

On the sales front, we are pleased to report that consolidated sales increase by $7 million, or 4%, in spite of the $10 million sales decrease at Aclara. Filtration continues to be exceptionally strong for us as sales increased $9 million, or 23%, in Q2 with every operating unit within the segment showing significant growth. We expect continued strength in filtration for the balance of the year and into the future as the current up cycle in our served markets continues to yield a favorable growth prospect.

Test sales increased $8 million, or 20%, as several large chamber projects were completed in the quarter as expected. While USG sales decreased as expected, we did have a few bright spots in the group as COOP sales increased 35% in Q2 compared to the prior year, and Doble sales were relatively consistent. During the quarter, our gross margin was 39.1%, which was negatively impacted by the changes in the sales mix within Test and USG. USG reported lower sales of high-margin products to PG&E, New York City [quarter], and Test gross margin was exceptionally high in Q2 of the prior year, primarily due to a large satellite test chamber project in Florida, which was completed in 2011.

SG&A increased $4.5 million, compared to the prior year, and I remind you that in 2011, we increased our investment in Smart Grid initiatives at Aclara and Doble. And, as I commented last year at this time, our FY11 spend rate on these initiatives were ramping up in the first half of the year and, therefore, were more back half weighted. As a result, the prior year Q2 SG&A does not reflect the full annual run rate impact of these costs, which are now being compared to the amounts in 2012.

On a sequential basis, our Q2 SG&A is lower than our Q1 costs, and as I noted on the last call, as we move through the balance of 2012, we expect this sequential decrease to continue, and we do not expect such large growth in SG&A when compared to 2011 on a quarterly basis. As a result of the lower Aclara sales and the impact of the higher SG&A investments, our EBIT decreased from prior year. While lower than 2011, Q2 FY12 EBIT was generally on plan. Filtration continues to be the biggest contributor with EBIT margins near 20%, and while our Test business EBIT decreased, this is due to the completion of a large chamber I mentioned in Florida, which carried one of the highest operating margins in the Test business history.

Entered orders, again, were the highlight often the quarter, as we booked $185 million of new business. This resulted in a consolidated book-to-bill of 107%, with USG recording a 1.31 ratio, driven by an exceptionally strong quarter of COOP orders. As a result of the order volume, backlog is increased $62 million, or 18% from the start of the year, which provides us with added confidence in our outlook for the back half of the year. On the cash flow and balance sheet front, we generated over $10 million in cash from operations in the second quarter, and through the end of April, we are on track with our cash flow projections year to date, as well as outlook for the remainder of the year.

As noted on the last call, we reclassified our outstanding debt balances current since our existing credit facility expires in November. We are nearing the completion of our refinancing activities and expect to be wrapped up within the next 30 days. Our bank group is very comfortable with our business outlook as well as strategic plans, and we are very pleased with the way the refinancing process has gone, both from a liquidity and pricing perspective.

As noted in the release, we reiterate our outlook for our FY12 and for 2013, as we continue to expect both sales and EPS to grow, as previously communicated. As a reminder, 2012 growth is expected despite a significant sales decrease at PG&E, New York and CFE, and the 2013 growth is expected to be significant when compared to 2012. I will be happy to address any specific questions during the Q and A, and now, I will turn it back over to Vic.

Thanks, Gary. I think Gary covered most of the operating highlights. So, I will be brief in my commentary about the quarter, and my focus is going to be on the outlook for the future. I'll start by saying, I'm pleased with our second-quarter operating results as we came in generally consistent with our previous expectations, with the exception of unusually high tax rate, which Gary mentioned.

Entered orders continue to be a strong point for us, and I'm very excited about the continuing increase in our backlog. The growth in our backlog is [giving] a lot of confidence in our outlook for the balance of the year. But, actually, I am more excited to report that our pipeline new business prospects as strong. We completed our mid-year strategic planning meetings at all operating units, and I came away excited about our future growth opportunities. Filtration has experienced a strong and sustainable uptick in its end markets, led by the strength of aerospace and space businesses where we are seeing growth from several markets. Our global leadership position in Test, will continue to serve us as a solid foundation for growth across the world, especially in Asia.

And most significantly, Our USG pipeline is most clearly defined in our history. The clarity, visibility and volume of these USG projects are the result of tremendous effort being expended by our business development teams along with the refined focus on vertical markets. I mention our USG client conferences in the release, and I was impressed by the nearly 2,000 customers attending these two events. It's encouraging that our customers view Aclara and Doble as highly regarded and innovative solution partners. These strong relationships and references bode well for the future as we continue to expand our customer account domestically, as well as internationally.

On the international front, our business prospects remain solid, as we continue to make measurable progress in our targeted markets of Central and South America, Asia and Japan, as well. While the international business is generally slower to develop, we believe we are well positioned to capitalize on these opportunities when they hit the market as we've been investing a significant amount of time and resources over the past few years, preparing us to capitalize on these large projects.

Domestically, we continue to see solid growth in our COOP market, and we see good opportunities in gas and water projects based on the current level of activity. All of this bodes well for our future growth. All of these opportunities are additives to our SoCalGas project, which is expected to begin in earnest sometime in the next few months. We are ahead of schedule on several key areas, and we expect to meter at end-point volumes to begin near the end of the calendar year. We are very pleased that the California Public Utility Commission reaffirmed it's earlier approval of SoCal's AMI project following a request for review from the division of Ratepayer Advocates and Utility Reform Network. The PUC's follow-up endorsement of this project is another positive step in the process.

It's great to have this distraction out of the way and will allow everybody to focus their efforts on the success of the project. Our relationship with SoCal continues to be solid, as they view Aclara as a valuable partner on their AMI project. Our outlook for the remainder of '12 remains unchanged, and our projections for significant growth in '13 remain solid. As I noted earlier, my confidence has been validated by recent planning meetings. We are in a fortunate position to be able to project significant growth over the next two to five years across all three business segments, and I continue to be enthusiastic and optimistic about the opportunities ahead of us.

I'm convinced that our three-segment strategy and end-market diversity remains a strength that differentiates us in the market and provides us multiple paths to grow and weather the economic uncertainties today and in the future. On the M&A front, we see several opportunities to supplement our organic growth by acquisition. And, while our primary focus remains in USG, we continue to evaluate options across the Company. We will continue to prudent and disciplined, but with today's favorable credit market, we can afford to remain aggressive. So, in summary, 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 will now be glad to answer any questions.

Thank you.

(Operator Instructions)

Zach Larkin, Stephens Investment Bank.

Hey, good afternoon, everyone. Congrats on the quarter, thanks for taking my question. First off, Vic, you mentioned the strength and size of your [dressable] sales pipeline. Could you maybe give us a little bit more color into what are the most exciting opportunities? And maybe you mentioned also in Filtration, some of the ramp as you are looking to build in to some of the new projects, and what we should expect?

Sure, I will do that. Just so everybody knows, the pollen count in St. Louis is at a 12-year high, so if Gary and I are hacking and coughing, we apologize in advance. And with that, no, it really is across the board. I'd say, certainly, the Filtration business, as you look at the some of platform ramps we are seeing in that business on aerospace side and the space business, the space has really been a bright point for us this year, I would say, because you remember a couple of years ago we had concern with Constellation easing up.

And, so, that's really clarified, and that they are going forward with, not the Constellation, but with some other projects. We have been -- are in a really strong position, here, to be able to win the majority of the projects that we have been working on.

That appears to be a step change, if you will, in what we are seeing in Filtration business. And also, while we are talking about that, I will just mention that Crissair, the acquisition we made two years ago, now, has been a real bright point for us.

The EBIT margin acceleration that we've been able to achieve there is actually ahead of what we thought we were going to be able to do when we made the acquisition. They went from around 12% EBIT margin of business to they are in that 15% this year, and we think it will be a couple of points higher going into next year. That's been a real success.

On the utility side as we look at opportunities, I would say, first always got to give a little shout out to our COOP business because it has remained really solid for us. I think that's been a concern for people. Historically, that business is going really soften up, and not go away but go down a good bit. I would say as a team that Aclara has done a good job of assuring that hasn't happened by reworking their distribution network, working more closely with HD Supply and introducing new products, which have made the difference.

Where we see the real pipeline opportunities, the real bigger opportunities for us, as we talked about in the past, the water market, while it's been slow this year, we are starting to get a lot of clarity towards a end of this year and in to next year, where we see strength, and that really started to pick up. We think the water market will improve going into 2013, certainly.

Then, on the gas, while there's not another SoCal Gas out there, there are some other opportunities, still decent size utilities, that are starting to get pretty serious about that. When I mentioned that we had more clarity in our pipeline, I would just say that the team we have in place now has done a really good job of identifying specific opportunities and building up strong pipeline for us to go after as we go forward. So, that's a long answer to a short question, but the bottom line is we are seeing strength across the totality of the business.

Thanks very much, appreciate the color. Gary, I wondered if you can talk about the bank refi and give us a general sense of the size of the new facility and the type of pricing that you seeing out there as you are getting closer to closing on it?

Yes, I think I mentioned last time that obviously the market is a little different today than it was five years ago where I think we caught the absolute trough in the bank market. Today, at a leverage ratio of about 1.5, we are paying about 48 basis points over LIBOR, so obviously, we are not expecting that.

I will say this. As we've gone through the process and we a lot of spent time with the bank group, as well as expanding and contracting some of the participants there because we want to try to get this as streamlined as possible, the pricing is coming in considerably better than expected. Obviously, if you look at our Company we should be, though we are not rated, probably at a double-b kind of thing.

The pricing we are seeing is ranging from LIBOR plus 100 to LIBOR plus 175, so what that means is if we were to fully lever up in the future via a reasonably substantial acquisition, we would only be paying 2% interest at a leverage ratio of 3.5, and that's extremely attractive. You are not going find a whole lot of companies our size getting that kind of pricing. So, we are very pleased with that. I think that is a validation, as we said in the prepared remarks.

We share -- obviously, we can share a little bit more things with the bank than we can with the investment community, today. But, the banks stand behind our business prospects I think is being validated by the pricing and the liquidity, so the pricing is coming in a lot better than we thought it would be. And from a size perspective, I can't give you the exact number, but I would say it's going to be close to double what we are looking at today.

Today, we have the facility that's expiring is about $330 million, and we're shooting for somewhere in the sixes, so double the capacity, but the way we are structuring it is in a fashion that we are not going to be tying up a lot of the bank's balance sheet.

We are going to have a favorable liquidity quantity as well as a favorable price, and I think that supports the strategy that Vic is sharing on the acquisition side. Part of my job is to make sure I build a foundation for him to be able to select the size acquisitions that we want to do. I think we are going to have a really nice facility in place that's going to allow us to execute our strategy very effectively.

Thanks very much for that. Congrats again on the quarter, gents.

John Quealy, Canaccord Genuity.

Hey, guys can you hear me?

Yes, sure can.

Vic, real quick on the COOP and uni-market, we are all impressed with the strength and resilience. I think last quarter, you talked about the good job that your partner HD Supply is doing in penetrating that market and also helping you guys make a little bit more money with that indirect sales force, can you comment -- are those dynamics still going on? Is it product refresh cycle, what do you think is going on to keep the market strong for you guys?

Yes, it's a couple of things. I think it is just getting a clarification of that distribution network, and work more closely with HD Supply to make sure that we are very well coordinated going to customers. It's a combination of new customers, of building out existing projects.

And then the other thing is more and more of these utilities are going away from electromechanical meters. As they replace those with electronic meters, then that's a good bit of pull through, as well. It's combination of things. The biggest thing is having a good focused distribution network in place and up selling those existing customers.

Then, second question in terms of Doble, can you comment on potential expansion activities there? Give us a flavor for some new product lines and what you are expecting from those new product lines in the next year or two? We hear a lot about distributed automation, transformer monitoring. Obviously, you guys are the best in the world at that. How do you see that cycle playing out and how Doble plays in that?

I think that we're excited about the business, and we have talked about for the past year and a half, we have been making some incremental investments there. Gary and I were just up there a couple of weeks ago, and I will have said that I'm very impressed with the progress that they've made with the new projects. We are introducing seven new projects -- products this year.

As clarification, not brand new products, some of the are significant improvements to what we already had out there, and we talked about this refresh cycle of the product. We've had seven projects, some of them brand new products, and some of them significantly refreshed products that we have. We've also had 50 software releases this year. To improve existing products in those products, as well.

We think that we will start to see the benefit of that next year. That's one reason that we are projecting the growth we are seeing next year. That's not only the SoCal growth, but it's also some uptick at Doble. That will be, primarily, the release of some of those new products but also some further penetration in international market. We've had some recent success there, particularly in South America, where we were able to go head to head with a couple of our competitors and came out winning that pretty significant contract.

I would say that the Doble product or company we are very excited about as well. I will say, I was at the Doble show, and I mentioned in my comments, we had 1,200 people there, and it just continues to amaze me at what a dedicated bunch of customers those are -- very excited about the products, very happy with the investment that we've been making.

I know that it's been something that we've talked a lot about, but I had a lot of customers come over and say -- you absolutely did the right thing, we are glad you're improving the products because we love the company, we love the support we get, but you needed to make some of those improvements. And so, we have done that.

My last question on SoCal and building out some of the network features there with Firetide. How is that tracking to your expectations? Where are we with an overall spend, in terms of getting that network product ready for deployment?

It's going well. In fact, I was talking to the guys about that yesterday. We are starting the initial deployment of that product, even as we speak. It's a matter of getting the product in the field and proving it out. We have a lot of confidence in it because we have a lot of test time on it at some beta sites. That's currently on track, I think is the best way to say it.

Thanks, good luck, guys.

Craig Irwin, Wedbush Securities.

Hi, gentlemen, this is David for Craig. To piggy back on the SoCal network build out and trials, can you give us a more detailed sense of when we can expect? I think you mentioned maybe 10,000 units sometime in October. Is that still happening?

I am struggling a little bit at the 10,000 units. We are starting some initial deployments in the first quarter of next year. Definitely, we will have some product in the field in the first quarter of 2013.

And that's consistent with what SoCal has said, the 10,000.

Okay. Yes. We have no problem with making that. In fact, we were through all the design cycle for the product introduction that we have. Those products will get deployed in the first quarter.

Okay. Thank you. Then, these other AMI projects, do you expect to see some benefits from those maybe in 2012?

I think it will probably be 2013. I think, hopefully, we will be able to close some of that in the fourth quarter or the first quarter, but I think for the real deployments, the start will probably 2013.

Thank you very much. Thanks for answering my questions.

(Operator Instructions)

Paul Coster, JPMorgan.

Yes. Thank you very much. I just wanted to make sure I heard this right. The Test business had a big project concluded in fiscal second quarter. Should we, therefore, expect it to decline sequentially and then maybe grow in to the back end of the year? Meanwhile, the other segments grow sequentially through the year?

That's correct, Paul. The large project that we referred to last year was a satellite test chamber that had a sales value of about $16 million that shipped over the course of about 14 months, with obviously, the dominant piece of it in FY11, and the second quarter last year had a big piece of that.

That margin on that project, because we weren't the general contractor, we just provided the shielding, so we didn't have the pass through content, didn't carry any of the risk of some of the other things. The margin was probably 33% higher than our standard margin of chambers of that size. What you should think about on that is this is the trough quarter, comparably speaking.

The volumes change in the back half of the year. When the volumes go up, the margin will go up with it, and so the mix is a little more favorable in the back half of the year than it was in the first half, especially when compared to the prior year because of the absence of that big satellite chamber. I think you are thinking about it the right way.

The rest of the business we are seeing sequential -- significantly sequential, obviously, because we are still holding to our comment I made last time where from EPS perspective, obviously, we are halfway through the year, it's 30% of the EPS in the first half and 70% in the back, and then the volume is obviously ramped to support that kind of earnings growth.

Got it. On Doble, in the past you have expressed your view that there is a good opportunity for that platform internationally. Where do we stand on an international initiative for that segment?

We are making good progress, in fact this past year, about 20%, 25% of the sales were international. I think I have, probably, not clearly stated how much of the business was already international. Certainly, that's where we see the additional growth going. As I mentioned a little earlier, we've had some recent pretty significant success in South America, we continue to do well in Europe and, actually, in Asia, as well.

In fact, I was over there in January and met with the large customer over there, and they are very excited about the products that we are selling them. There is always been some concern about price, but I will say that we have been successful in selling that product into China, and I think we will continue to be just because there is not really solid competing products.

Particularly with some of the newer products we've introduced, particularly the online monitoring. Today, China has bought more of that product than any other country in the world, including in the US.

Thank you very much.

Carter Shoop, KeyBanc.

Hi, thanks for the time. First question, when you think about 2013 and the guidance that you are reiterating you for that year of your growth. Can you talk about some of the variables that have made you feel a little bit more comfortable or a little bit more cautious about that guidance since you originally initiated it?

Yes, I would say that we are still as confident as we were before, and that's good with the passage of time. Again, the place we are going to get that is -- SoCal is a big piece of it. Doble, we are anticipating some good growth from; the Filtration business is going be higher. There is bits and pieces across the Company, but I would say we did a thorough scrub of that after our planning conferences and still feel confident we are going to have that type of growth in the 2013.

On the margin, you are feeling maybe a little bit more comfortable, a little bit more cautious?

A little more comfortable just because of passage of time, and the opportunities are still there, and so yes, I would say a little more confident than we were six months ago.

Great, thanks. As a follow-up question, I apologize if this was already asked, I got dropped a few times. Did you provide any update on TEPCO? And if you didn't, can you give us update there, explain what you have been doing with the Company year to date, and also, how you feel about how well your positioned for that RFP coming up?

We didn't give an update, yet. Thanks for the question. I think it's important. We really feel good about the position we are in. The fact that we've already been approved for sale in Japan, I think, is a big deal. Because you obviously have to go through that hurdle to be acceptable there.

We just had some people there meeting with our partners, and don't think we talked a lot about the team we are teamed up with there. We are working with GE Fuji and with Sumitomo, so I think we have a good team that we are working with, and the feedback we got after the meetings a couple of weeks ago were very positive.

It is an international opportunity to Japan, but it feels like things are going forward. I think it's just a matter of timing. Also, I would say the broader role that the government is now taking with TEPCO, we also see as a positive because more confidence that the funding is going to be there to move forward with the project.

Great. Thank you.

(Operator Instructions)

Jeremy Hellman, Divine Capital Markets.

Hi, guys. Couple for me, thanks. First off, with CFE, any new news from them regarding any scaling up efforts?

Not in the near term. Our current view is it's probably going to be sometime later this year. The product we have in the field is working very well, I was very happy with it. I think it's just taking a little time to roll out. We anticipate some further activity later in the year.

You get any sense about the scale of that activity, if and when it comes to pass?

I think it would be something consistent with what we have seen in the past, another bite that size. To add on to what we've already delivered.

Okay. Going back to some notes I had from last quarter's call. You made a comment that SG&A expense should trend into the $46 million to $47 million range around the Q4 time frame this year. I just want to double check that's still a good number. And then looking at FY13, is that going to be a good number to bench FY13's cost from?

Jeremy, it still the same. I think said on the last call that Q2 should be consistent with Q1, and it's actually down, not $1 million but close to $1 million. So, what that indicates to me is that we are a little bit ahead of plan in getting some of the contractors completing their projects and also rationalizing some of the other investments. We are off to a good start.

I think the step down that I mentioned a couple of months ago on the call is well on its way, so I think you are in the ballpark on the numbers to think about, for the back half of the year. Then, as we go forward, to get the growth we have, the investment cycle is about 12 years, so if anything does come out new in the SG&A area that upticks that, it's really going to be something in the new product area, but we really don't have anything defined today. I think the numbers that we wrap up '12 with, should be a good starting point for '13 on the SG&A side as you build out your model for next year.

Great, thanks.

That concludes today's questions. Now I would like to turn the call back over to Victor Richey.

Okay. If there is no further questions, we will truncate the call and talk to you next quarter.

That does conclude our presentation for today. Thank you for your participation.