ESCO Technologies Inc (ESE) 2013 Q2 法說會逐字稿

Good day and welcome to the Q2 2013 ESCO Technologies Incorporated earnings conference call. Today's call is being recorded. With us today are Vic Richey, Chairman and CEO; Gary Muenster, Vice President and CFO; and now, to present the forward-looking statements, I'd like to turn the call over to Kate Lowrey, Director of Investor Relations. Please go ahead.

Thank you. Statements made during this call regarding the timing, amounts, and sources of fiscal 2013 and beyond expected results, both on a GAAP and an as adjusted basis; future sales; orders; backlog; margins; EBIT; EPS; growth; profits; new opportunities; the SoCalGas project schedule; developments in the COOP and water markets; results of recent acquisitions; the schedule, costs, savings, and margin improvements resulting from previously-announced restructuring and cost reduction initiatives; 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 material 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 will be included as an exhibit to the Company's Form 8-K to be 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 of the 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 press release issued today, and found on the Company's website at www.escotechnologies.com under the link Investor Relations. Now I'll turn the call over to Vic.

Thanks, Kate. Before I turn it over to Gary to review the financials, let me make a few comments. As I discussed during our April call, we're seeing some softness at Aclara, primarily in the electric COOP and water end markets. Faced with this reality, we have taken action to reduce the infrastructure we have in place to better position us from a cost perspective going into 2014. Going to the full outsourced model at Aclara will not only allow us to reduce the cost of the product, but also reduce the overhead associated with in-house manufacturing. In a project-related business like Aclara, we see this as a superior business model.

On the last call we talked a good bit about the COOP market. It is important to remember that we remain the market share leader in this space, and it remains a good market. Historically, we have had revenues between $80 million and $100 million, and we will be in that range again this year, albeit in the lower portion of the range. We are suffering a bit due to the comparison with last year, when the COOP sales were at an all-time high of $125 million. We recently had our Client Conference at Aclara with over 550 customers in attendance, and I was impressed to see they remain engaged and loyal to our proven technology.

I'm sure that you've seen the news at TEPCO and their selection of Toshiba for the deployment of a smart-grid solution to their entire service territory. As I told many of you over the past 12 months or so, I saw any participation by us coming in the out years of the deployment. It became obvious that TEPCO's plan was to deploy product in the more densely-populated areas first, and move to the more rural territories later. We felt that given our long history at TEPCO and the very positive results during testing and evaluation, that our technology would be deployed in these rural areas. The selection of Toshiba definitely puts this in question. We have been in contact with the members of our team and plan to remain actively engaged in Japan with TEPCO as the deployment unfolds, and with the other seven Japanese utilities which currently have planned deployments in the future. Regarding our outlook, we had not assumed any sales to TEPCO in 2013 or 2014.

We remain on track at SoCalGas, as we are filling product pipeline and deployment is underway. Our relationship remains solid, and the orders keep on coming in. We're very pleased with the progress on this very large, important project. Outside of Aclara, our business is very solid. We introduced several new or updated products and solutions at Doble's Client Conference last month in Boston, and received very positive feedback from our customers. Overall, this was a great conference to showcase Doble, with over 1,300 clients in attendance.

The Filtration segment is performing ahead of expectations, and out-year performance appears solid. The Test business is performing as expected, and the restructure is on track and essentially complete. In conclusion, while we have muted our expectations for the balance of the year, we continue to have robust, profitable business. Where we have issues, we have taken action to mitigate the impact and position us for future success. I'll now turn it over to Gary to review the numbers, and then we'll be happy to answer any questions you have.

Thanks, Vic. Consistent with the theme of our previous quarterly call, the clear highlight of Q2 and the first six months continues to be our ability to win new business, as evidenced by the strength of our orders and the growth of our backlog. At the half-way point of fiscal '13, we grew our backlog $58 million or 14% from the start of the year, resulting in a March 31 backlog of $465 million. During Q2, we had a 1.05 book-to-bill, and for the first six months, our backlog grew across all three operating segments as we reported a 1.19 book-to-bill. The backlog growth includes our largest customer, SoCalGas, as they awarded Aclara an additional $12 million in Q2, bringing the total order value on the project to $151 million through March 31. We continue to expect SoCal to generate the revenues we guided to in the last release.

For fiscal '13, our guidance is based on operational EPS, which results from the non-recurring costs associated with the Test business restructure and the other profit improvement actions noted in our April announcement. For Q2, we reported operational EPS of $0.28 a share, which compared to our GAAP EPS of $0.06. Our operational EPS in Q2 was below our initial quarterly plan, primarily driven by the end market softness Vic noted at Aclara. To recap the non-recurring adjustments, USG's EBIT reflects the $5 million inventory write-off which hits cost of sales; Test EBIT reflects $1.4 million of restructuring charges in the quarter and $2.9 million for the six months, primarily included in Other Expenses Net; and the $1.8 million Doble Lemke deferred tax write-off is included in tax expense in the consolidated P&L.

Regarding Q2 from an operational basis, Filtration continues to outperform expectations on both sales and profit, and we expect our fiscal year sales and profit contribution to come in as previously communicated. Test sales and profitability were generally consistent with our operating plan, and includes the cost related to the shut down of the Glendale Heights facility and the incremental costs relating to manufacturing inefficiencies resulting from this disruption. Test profit expectations for the balance of fiscal '13 are on track and, as Vic noted, our restructuring is nearly complete. Doble continues to perform well, and Q2 sales were generally consistent with the prior year, but came in slightly lower than planned. As discussed during the last call, we noted several customers had delayed their purchases of hardware and services due to the East Coast storm, and that the return to normal buying patterns would move these revenues to the second half of the fiscal year. Q2 is below plan at Aclara, for the reasons Vic noted in his comments. SoCal accounted for $12 million in revenue at Aclara, COOP sales were $15 million, and PG&E was nearly $5 million of revenue in the quarter.

On the cash flow and balance sheet front, we ended the quarter with a strong balance sheet, as our net debt was $142 million and our leverage ratio was 2.25 with continued favorable pricing. We continue to show -- I'm sorry, we continue to maintain a strong backlog position, and a solid plan for SoCal deliveries for the balance of the year. The recent COOP and water market developments will have a negative impact on the second half of the year. Aclara's water and COOP businesses are expected to be lower than originally planned, due to delayed customer decisions in the water market and lower distributor demand impacting the COOP market, as distributors have reduced their inventory levels. Management continues to believe the issues impacting the water and COOP market are timing-related, and the overall market remains strong. Based on the lower revenue projections of these higher margin products, Management expects 2013 EPS as adjusted now in the range of $1.60 to $1.80 a share. I'll be happy to address any specific financial questions during the Q&A, and now I'll turn it back over to Vic.

Okay. Those are our prepared comments. Be glad to answer any questions you have now.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Craig Irwin, Wedbush.

First question is can you give us update on the half-dozen major projects that you're targeting -- you'd said before, three in gas, three in water, and could you clarify for us this is calendar 2013 not fiscal 2013. And maybe any updates do you have on commission activity related to these project, financing activity, or any other important gaiting factors?

Yes, obviously not going to give a lot of specifics. I will say that the market, particular the water market, remains very active. Pipeline, as I mentioned before, is very strong, probably the strongest it's been. And it is just a matter of getting people to pull the trigger on some of these things.

The only specific I will get into there is, at one of the larger water projects there is ongoing discussions between a couple of the parties involved there that have slowed it down and that's -- and, well, I talked about that on the last call -- but that is only one where there's any significant regulatory impediment in place. And I'm not sure I'd even call that regulatory impediment as much as just couple of the parties trying to decide the timing and that they're going to go forward with. But other than that the other ones are moving forward, albeit very slowly.

And can you maybe frame out for us what the size range is for each of these projects? Are we talking 200,000 units up to 1 million plus units, or does the average size tend to be a little bit smaller than that?

Well of the things that we're actively pursuing now, you have got it calibrated about right. Some are 200,000 end points and at least one has over a 1 million end points.

Great. Congratulations on the strong plan for the rest of the year.

John Quealy, Canaccord.

It is Chip Moore for John. For Doble, I was just wondering if you could talk a little bit more about what you're seeing here in the northeast, six or months or so past Sandy? How do things look past versus past couple of years. Are rental rates returning to normal, et cetera?

Yes, and rental rates really never did change. And so one of the great things -- one of the many great things about Doble is 50% of their business is in -- I won't say in the bag -- is in the bag well, is already signed up as we enter the year. So the rental business remains very strong. So that really what we're talking about is the purchases of the equipment.

And, as Gary mentioned, the first six months they were a little softer because of some of those things. We're seeing that start to pick up now. I got a lot of activity both in North America and really starting to see some traction internationally. So that business is -- looks very solid going forward.

Great, that's helpful. And then one more just as you get past restructuring on the growth side what are you thinking M&A and organic?

Yes, we're currently looking at a number of things. They never seem to happen quite as quickly as we want but there are some opportunities out there that have presented themselves. And it seems like M&A market is picking up a bit, versus, say, certainly 12 months ago.

Thanks.

Sean Hannan, Needham & Company.

So just a question for you in terms of the guidance. I realize you're not specifically providing that around the top line. But if I were to assume that you get some of these efficiencies that help within the margin and bottom line, at the midpoint you're really looking for a flattish year.

Do we have a real potential this year where revenues could be down year-over-year? Or could you help provide a little perspective around that?

Yes, the revenue obviously drives the bottom line. As we look at revenue, we're still going to have an increase over the prior year but I just want to remind everyone on the mix change. When we talk about COOPs and water being a little softer this year, in order, the COOPs are the largest profit contributor. They're in the low to mid-50%s and an incremental margin in water isn't too far behind.

So we're swapping that off for SoCalGas which, when we sign that up obviously on the quantities and volumes they have, they're not pulling that kind of incremental margin through because that was expected to be more of an overlay project that we build off of. So you're swapping off revenue from a let's just call it a blended 48% incremental margin for something that's closer to 38%.

So you are going to see revenue growth. But to your point, Sean, you're probably going to see flattish EPS because that mix change doesn't pull as much profitability through post-restructuring. And that's why when Vic was talking about the operational things we're doing to improve the efficiency there, that's where we're trying to mitigate some of that impact should COOPs and water maintain a lower volume going forward.

If you think about it, that's exactly -- Gary's point is exactly why we have taken some of the actions that we have. It's very simply that, we've got to get the cost out of the product. We had more flexibility by having the manufacturing in place, but that came at a pretty big cost. So by reducing the cost it's going to help offset some of this mix change that we have.

That's helpful. And Gary, that's a great reminder as a perspective to keep in mind. So thanks for that.

Now, in terms of the water softness you're seeing, do you sense today that this issue is really quite pervasive within the industry in North America as a broader issue? Or is there a factor where it's just the way that the ball bounced on the projects that you're specifically working on that have pushed a little bit more?

No and that's a good point. The reality is, you guys see the same releases that I do, and I would say the overall market has been soft. And so it has not been a matter of us losing a bunch of jobs and that's the reason it's moved away from us. It just a matter of people not making the decisions in the timeframe that we had anticipated.

That's great. And then last question for the moment if I can. Could we get a breakdown on the trends that you're seeing within that Filtration group, the strength that you're seeing in the different businesses right now. I would assume that there is some pretty decent consistency with what we've seen in the last few quarters but an update would be helpful? Thanks.

Yes, all three of those businesses -- and just as a ware reminder, we have three businesses involved in the Fluid Flow Filtration group and all three we have seen good growth in this year both from a sales and profitability standpoint. But certainly the leader of the pack is VACCO, primarily driven by the space program and by spares from the Navy. So that's where we've seen, let's say, out-sized growth much more than we had anticipated I would say a year or 18 months ago.

And it really, as I mentioned, either in the release or in my comments, we had very good visibility in that Filtration business. And it looks like it is going to continue, some good solid growth over the next couple of years.

Okay. Thanks very much.

Ben Schuman, Pacific Crest Securities.

Just a quick one on TEPCO. Were you guys involved in that bid with any other consortiums besides the Toshiba consortium or Toshiba itself that you thought could have led to some of that rural business?

We were not with Toshiba Group, we were with GE and Sumitomo.

Okay, great. And then we've heard about readiness being a source of maybe some cuts on the defense side with this sequestration and everything. Are you pretty comfortable with the Navy spares business and everything else on the Filtration side as we hear chatter about federal budgets?

Yes, we're in pretty good shape. In fact, we were just out there gearing up last month and spent some time and obviously that was a question we ask a lot about. Our view and I would say supported by most people, if you're on some of the newer projects that have an opportunity to get cut, there's a bigger opportunity of getting cut. Most of what we do with -- on the Navy side and then the air frames that we're on don't seem nearly as susceptible. So we don't think that that is going to have an impact on us at least in the foreseeable future.

Okay, great. And then on the COOP side, that is just market weakness, there is no competitive impact or competitive change there?

There is -- I would say there is certainly -- we talked before, there is more competition there. We are continuing to win our share of more than half of the business out there -- well more than half of the businesses out there. What's happened with some of the competition is, people come out and say we can do that too. And people take time to try to try it out.

We've had several instances where utilities have tried out a competing technology, figured out it did not work in their service territory as anticipated or as promoted. And then they come back and go with us. But then that's slowed things down as a result of that. So as you look at the Investor owned utility electric market in the US has slowed down as a result of some of the larger projects being completed.

So now those folks that were in that market are now trying to compete in the COOP market. So that has slowed some things down. I will say that for the most part, those technologies don't work the way ours do.

Dealing with a power line in a rural territory is really hard to beat, because if you've got electricity in your house, we can read your meter. And trying to set up an RF approach there -- I won't say it's not doable, because it's doable. Quite often, it becomes too expensive because of the infrastructure you have to put in place to read that.

Okay, great. And then, Gary, could you just repeat the SoCal revenue and the Doble revenue? I missed that earlier?

The Doble revenue in the quarter was about $25 million and SoCal revenue as part of Aclara was around $12 million.

Thanks.

Richard Eastman, Robert Baird.

Yes, Gary, what do you expect Aclara's revenue to come in at for 2013 at this point?

Yes, I'd say somewhere between $215 million and $225 million.

Okay. And then obviously Doble on top of that and then Metrum is in the numbers at this point?

Yes, that is embedded in Aclara -- and just as a ballpark range that's approximately $5 million in the second half of the year.

Okay. And that's in the $215 million?

Correct.

Okay. And then just a question on -- Vic, do you, given where Aclara's business has come in, and I know we just went through the -- this cost restructuring announcement. But it still strikes me that the cost structure at Aclara is too high and it's not necessarily -- well, it's partially the manufacturing, like you said, there is a cost to the flexibility of the manufacturing side. But are our costs in line when it comes to more of the back office, the bidding, the support, those costs? Because our hit rate on some of these projects hasn't proven to be as high as I would think that you had supported?

Right. So. Well--

How do you view the cost structure there?

And that is something that we continue to look at. We have taken some actions, nothing obviously to the extent that we did on the manufacturing side, but what we have been trying to do is make sure that Aclara operates as one business.

And as we've told Metrum at -- that is an good example -- we integrated Metrum in day one, so that they got it in all of our systems rather than having a redundant set of processes out there. So we're continuing to consolidate as much as we can between the Cleveland facility and the St. Louis facility and the facility we have in Boston. So we're doing some of that. But obviously, as the business developments or doesn't develop, and we have to continue to look at that. And if you look at the number of employees that are out there, one thing that a lot of people forget, is we have 450, 500 customers at Aclara, and you have to support them.

And one reason that we have been successful and will continue to be successful, particularly in the COOPs and with our other water and gas customers, is that they get really good customer support. And we have to do that. Because if we don't do that, then we're going to really struggle gaining new business because obviously utilities talk to each other.

So as you look at the overall force count there, it is probably -- there's a lot there you wouldn't typically understand being there just because of the customer support both on-site. And then what we have in-house to answer questions and troubleshoot things. So we'll continue to look at that because, obviously if the business doesn't pick back up, the cost structure is too big.

And when you look at the water business at Aclara, is there any risk here that the water business is increasingly moving through distribution versus direct sale? Because we seem to sit on expectations for wins and projects whereas if you look at what is going on in the water industry, in the March quarter and probably in the December quarter as well, we're seeing distribution sales in the water industry up, and up generally double-digit.

So I'm trying to understand -- you guys are more project-related direct sale. But is there a risk that the market is moving through distribution for local support, or whatever, because you're -- again, I'm just -- could you just respond to that maybe?

Sure, no, it is a good point. It's a very good question, and it's something that our VP of Sales has spent a lot of time this past year working on is to get a distribution network. And as we've talked about on previous calls, part of the fight we've had is so many of the distributors are tied up with the meter manufacturers. And so they're not going to go sell the Aclara product and give up their meter line because they make a lot of money on it.

So it has taken longer than we'd hoped to get a good distribution network in place but we feel more confident now that we have got a good distribution network in place. We will continue to work to improve it but that has been a longer process than what we'd anticipated.

But certainly -- and the place where that really impacts you is in the smaller utilities. Our direct sales force does a good job of interfaces with the larger cities and some of the larger municipalities but where we've struggled is with a lot of smaller utilities. And so by getting a distribution network in place we're starting to see some benefit of that but it is just taking longer than we anticipated.

Okay. And just one last question. I just wanted to jump back for a second to the COOP market. Is your agreement on the PLC -- with the PLC product -- is your agreement with HD Supply an exclusive agreement? Or can they can sell somebody else's PLC technology?

They are -- I'm trying to remember exactly how that side of it was written -- I thought you were going to ask about if we were exclusive with them, and what we do is we set it up by different territories. But I would say for the most part they sell just our product.

Okay, okay. Thank you.

Jim Giannakouros, Oppenheimer.

On Test, can you put some finer points on the trends you're seeing and at the outlook there? What projects are driving sales in the second half of this year? And what -- longer-term, what end markets are potentially greater contributors to growth going forward?

Sure. And that's a -- we've spoken so much on the test market on the restructuring getting the cost structure in place and that is important and it's the right thing to do. But what is lost there is our backlog is up 10% or so since the first of the year. So we are seeing some good trends in those end markets.

And one of the good things about that business is that the end markets are so varied both from the markets you go to and as far -- add as well as the geographic locations. So it's hard to say here specifically the things that are driving it because it is such a broad base of customers. But some of the trends we're seeing certainly as more companies drive the development of new products into different areas, different countries, that necessitates the development -- the installation of additional chambers or upgrading chambers that they have.

We've also, as we have talked about more recently, developed a few new end markets, particularly the E&P market for data centers, for utilities, for those types of things. As well as some new standards that are driving the development -- particularly in the wireless market -- the development of new standards and driving additional sales through that business, as well.

So I would say overall the end markets there are stronger than we saw a year ago. And again Gary and I were down there last month and spent a good time with these guys and this seems to be a multi-year trend that we're seeing for that market. So we'll be well-positioned now that we have got a better cost structure in place to get the margins up in that business.

Okay. That is helpful. And can you remind us if we should be thinking about 13% as a run rate go forward or are there opportunities to expand that in your fiscal 2014 and beyond?

Going forward, we should see an expansion above that. It's not going to be a 20% EBIT business but we certainly think there is opportunity because of the way we're structured now to get above 13%.

Okay, thanks, guys.

Kevin Maczka, BB&T Capital Markets.

Most of my questions have been asked but, Vic, I just wanted to clarify on this TEPCO situation and the decision to go to Toshiba. So they're planning to do the more densely populated areas first, which you didn't really plan to play in that market anyway. So is there still some potential that longer-term, down the road, you can be a player in that more rural area, or is that just not a potential customer any more?

I would say that the reality is today that Toshiba has not called to say, how about helping us out in these rural areas. They just haven't. Having said that, I'm not sure what solution they plan to use in some of those areas. So that is the reason, as I mentioned in my prepared comments, that we are going to stay involved with TEPCO, with our teammates, so that if that opportunity arises, we're well-positioned to take advantage of it.

And again, as we've mentioned for past couple of years, unfortunately we are qualified to sell our product in Japan. So it would be an easy thing to do if they got to an area and said, okay, we probably don't have the right solution for this, who does? Okay, here is Aclara, they are already qualified so maybe we should use them.

So I'm not holding out the high percentage of that happening. We're certainly going to stay involved with them so that if they reach that point that we will be well-positioned to help them out.

Right. And you have been piloting and doing other things to get qualified there for a couple years now. So those activities are still all continuing, it sounds like is what you're saying?

Well, we've completed -- essentially we've completed the test and we have been qualified. So it's not going to -- there is not really an investment for us to continue to be involved there are other than support the teams that we have in place there.

Okay. Okay. Thank you.

Sean Hannan, Needham & Company.

Yes, thanks for the follow-up. Gary, just clarify something. The SoCal revenue that you have mentioned, I thought you said $12 million and, yet, the orders were also $12 million? So we had the same number?

Correct.

Okay. Just wanted to ensure that.

For the quarter.

Right. Right. Okay. And then.

Yes, but the quarters-to-date are like $150 million, right?

Yes, we've done -- In the year we've done $56 million in orders for the six months, and about $21 million of revenue. And then so the $151 million represents last year and this year cumulative order are $151 million.

Right, right, great. Okay. And then in terms of you had mentioned in the release the traction that you're making within E&P, just wanted to see if you could maybe elaborate on that a little bit for us in terms of specific traction? How you're viewing that market and size today and how you expect that could grow for you there? Thanks.

Yes, it's a little bit hard to really put sides around, other than we've won a couple projects -- and they're good sized project, they're $4 million, $5 million, $6 million projects. So -- and the need is there. In fact, I mentioned the Doble conference earlier and we had the chairman of FERC was the speaker there.

And on the second slide, as they were talking about areas of concern for utilities as far as security, E&P was listed front and center. So it is a real issue. And so we're working hard to make sure that we identify the right markets to go after.

But our view, at least today is this could be a significant market. If you have only have to win -- if you win four or five of those a year, it can easily turn into $25 million annual market. And that's just talking domestic and we're well-positioned because of our footprint to take that internationally because they have the same concerns there as we do here.

Okay. That's great. Thanks so much for the additional questions.

(Operator Instructions)

Richard Eastman, Robert Baird.

Gary, what was the underlying tax rate that you used to get to the adjusted $0.28?

Well, for the adjusted items, the two items that are not tax related, I just used 35%, just a normalized rate for those two items. So the Test adjusted item, which is about $1.4 million in the inventory write-off tax, I tax effected at 35%. Obviously the $1.8 million of the DTA goes straight through tax so that is 100% because it is a tax item.

And I just want to remind you as you go back through what the rate would have been if we wouldn't have had this, if you remember from the last call after January 1, when Congress extended the -- several tax benefits primarily for research, credit, and things like that, the core rate would have been in the upper 20%s -- 27% or 28%, had not had all this other noise. Because when you got that congressional extension put through, you had a cumulative catch-up for pass on any credit. And that is probably where you're wrestling with the math.

Okay. So it would be more like 27%, 28% number, okay, to get to the adjusted $0.28?

Yes, just use 35% for the two adjusted items and then as it crosses apart you'll see the EPS impact of those individual items.

And then do we bounce to 33%, 32%, 33%, then, for the second half, tax rate?

Probably not that low. I would say 34% to 35%. So you're close.

Okay. And just another question. What was the exact amount of the Test restructuring taken in the quarter?

$1.423 million.

Okay. All right. Thank you, again.

We have no further questions at this time.

Okay. Well, that concludes our conference and we'll talk to you next quarter.

Thank you.

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating and you may now disconnect.