May 9, 2012
Operator
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 Lowrey, Director, Investor Relations.
Please go ahead.
Kate Lowrey
Thank you. Statements made during this call regarding the timing and amounts of fiscal 2012, 2013 and beyond expected results including sales, SG&A, cash flow, EPS and profit, the timing and uncertainty of developments in connection with the SoCalGas project, renewal of our 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.
Kate Lowrey
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 2012 results press release issued today and found on the company's website at www.escotechnologies.com under the link Investor Relations.
Kate Lowrey
Now I'll turn the call over to Vic.
Victor Richey
Thanks, Kate. Before I give my perspective of the quarter, I'll turn it over to Gary for a few financial highlights.
Gary Muenster
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 to a nonrecurring, noncash charge resulting from the write-down of a purchase accounting related deferred tax asset. The EPS decrease 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 costs being incurred across the company to support future defined growth.
On the sales front, we're pleased to report that consolidated sales increased 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.
Gary Muenster
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.
Gary Muenster
USG reported lower sales of high margin products to PG&E, New York City Water, 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 fiscal '11 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.
Gary Muenster
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 the 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, our Q2 fiscal '12 EBIT was generally on plan.
Filtration continues to be the bright or the biggest contributor, with EBIT margins near 20%. And while our Test business EBIT decreased, this is due to the completion of the 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 of 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.
Gary Muenster
As a result of the order volume, backlog has 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 our outlook for the remainder of the year.
Gary Muenster
As noted on the last call, we reclassified our outstanding debt balance as 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 our strategic plans. And we are very pleased with the way the refinancing process has gone both from a liquidity and pricing perspective.
Gary Muenster
As noted in the release, we reiterate our outlook for our fiscal '12 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.
Gary Muenster
I'll be happy to address any specific questions during the Q&A. And now, I'll turn it back over to Vic.
Victor Richey
Thanks, Gary. I think Gary covered most of the operating highlights.
So I'll be brief in my commentary about the quarter and my focus will 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 the unusual -- unusually high tax rate, which Gary mentioned.
And our 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 gives me a lot of confidence in our outlook for the balance of the year.
But actually, I'm more excited to report that our pipeline and new business prospects are strong. We recently completed our mid-year strategic planning meetings at all of our operating units, and I came here excited about our future growth opportunities.
Filtration has experienced a strong and sustainable uptick in its end markets, led by the strength of our aerospace and Space businesses, where we're seeing growth coming 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 the most clearly defined in our history. The clarity, visibility and volume of these USG projects are the result of the tremendous effort being expended by our business development teams, along with the refined focus on our vertical markets.
Victor Richey
I mentioned our USG client conferences in the release, and I was expect impressed by the nearly 2,000 customers attending these 2 events. It's encouraging that our customers view Aclara and Doble as highly regarded in 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're 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 to prepare 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.
Victor Richey
All the opportunities, all of these opportunities are additives to our SoCalGas project, which is expected to begin in earnest sometime in the next few months. We're ahead of schedule in several key areas, and we expect to meet our endpoint volumes to begin near the end of the calendar year.
We are very pleased that the California Public Utility Commission reaffirmed its earlier approval of SoCal's AMI project, following a request for review from the Division of Ratepayer Advocates and The 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.
Victor Richey
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 2 to 5 years across all 3 business segments. And I continue to be enthusiastic and optimistic about the opportunities ahead of us.
I'm convinced that our 3 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 via acquisition.
And while our primary focus remains in USG, we continue to evaluate options across the company. We'll continue to be 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'll now be glad to answer your questions.
Operator
[Operator Instructions] Our first question comes from Zach Larkin from Stephens Investment Bank.
Zach Larkin
First off, Vic, I wondered -- you mentioned the strength and size of your addressable sales pipeline. Can 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're looking to build into some of these new projects and what we should expect?
Victor Richey
Sure, I'll do that. Just for -- so everybody knows, the pollen count in St.
Louis is at a 12-year high. So if Gary and I are hacking and coughing some, we apologize in advance, so -- and with that, no, it really is across the board.
So certainly, the Filtration business, as you look at some of the platform ramps we're seeing in that business on the aerospace side, and on the Space business. The Space has really been a bright point for us this year, I would say.
Because if you remember, a couple of years ago, we had some concern with Constellation easing up, and so that's really kind of clarified and that they are going forward with not with Constellation with some other projects. And so we've been on a really strong position there to be able to win the majority of the projects that they're working on.
So that appears to kind of be a kind of a step change, if you will, in what we're seeing in the Filtration business. And also, while we're talking about that, I'll just mention that Crissair, the acquisition we made, I guess, 2 years ago now, has been a real bright point for us.
I mean, 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. So they went from around a 12% EBIT margin business to -- they're in that 15% this year, and we think it will be a couple of points higher going into next year.
So it'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, if you will, to our COOP business because it has remained really solid for us.
I think that's been a concern for people. Historically, that, that business was going to really kind of soften up and not go away, but go down.
And I would say the team at Aclara has done a good job of ensuring that hasn't happened by reworking their distribution network, working more closely with HD Supply and introducing some new products, which have made the difference. So that -- where we see the real pipeline opportunities and the real bigger opportunities for us, as we talked about in the past, the water market, while it's been slow this year, we're starting with a lot of clarity toward the end of this year and going into next year, where we see some strength, and that really started to pick up.
So we think the water market will improve going into 2013 certainly. And then onto Gas, while there's not another SoCalGas out there, there are some other opportunities, still decent-sized utilities that are starting to get pretty serious about that.
So when I mentioned that we had more clarity in our pipeline, I will just say that the team we have in place now has done a really good job of identifying specific opportunities and building a strong pipeline for us to go after as we go forward. So it's kind of a long answer to a short question, but the bottom line is we're seeing real strength across the totality of the business.
Zach Larkin
And then, Gary, I wondered if you could maybe 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're seeing out there as you're getting closer to closing on it?
Gary Muenster
Yes, I think I mentioned last time that obviously, the market's a little different today than it was 5 years ago, or I think we caught the absolute trough in the bank market today at a leverage ratio of about 1.5. We're paying about 48 basis points over LIBOR, so obviously, we're not expecting that.
But I will say this, as we've gone through the process and we spent a lot of 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 we expected. Obviously, if you look at our company, we should be -- even though we're not rated probably a BB kind of thing.
The pricing we're seeing is ranging from LIBOR plus 100 to LIBOR plus 175. And so what that means is if we were to fully lever up in the future via a reasonably substantial acquisition, we don't want to be paying 2% interest at a leverage ratio of 3.5.
And that's extremely attractive. You're not going to find a whole lot of companies our size getting that kind of pricing.
So we're very pleased with that. And I think that is a validation, as we said in the prepared remarks, when we share -- obviously, we can share a little bit more things with the bank that we can't with the investment community today.
But the bank standing behind our business prospects, I think, is being validated by the pricing and the liquidity. So the pricing is very 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'd say it's going to be close to double what we're looking at today.
So today, we have -- the facility that's expiring is about $330 million, and we're shooting for somewhere in the 6s so, kind of double the capacity, but the way we're structuring it is in a fashion that we're not going to be tying up a lot of the bank's balance sheet. So we're going to have a very favorable liquidity quantity, as well as a favorable price.
And I think that kind of supports the strategy that Vic is sharing on the acquisitions side. Part of my job is to make sure I build the foundation for him to be able to select the size acquisitions that we want to do.
And so I think we're going to have a really nice facility in place that's going to allow us to execute our strategy very effectively.
Operator
And we'll now go to John Quealy from Canaccord Genuity.
John Quealy
Yes, so Vic, real quick on the COOP and Uni [ph] market. We're all impressed with the strength and resilience.
I think last quarter, you talked about the good job that I think 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 that market so strong for you guys?
Victor Richey
Yes, just a couple of things. I think the business is getting the clarification of that distribution network, and it worked more closely with HD Supply to make sure that we're very well coordinated going to [indiscernible].
So 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 to replace those with electronic meters, then that's a good bit of pull through as well.
So it's a combination of things, but I would say the biggest thing is having a good focus, the distribution network in place, and upselling to those existing customers.
John Quealy
And 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're expecting from those new product lines in the next year or 2?
We hear a lot about distributed automation, transformer monitoring. Obviously, you guys are the best in the world with that.
How do you see that cycle playing out and how Doble plays in that?
Victor Richey
Yes, I think that we're excited about the business and as we've talked about for the past 1.5 years, we've been making some incremental investments there. Gary and I were just up there a couple of weeks ago.
[indiscernible] been very impressed with the progress that they've made with the new projects. We're introducing 7 new projects -- products this year.
And a clarification, that brand new products, some of them are significant and proof as to what we already had out there. And we talked about this refresh cycles of the products.
So -- excuse me. And so we've had several 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 and those products as well. So we think it will start to see the benefit of that next year.
And that's one reason that we're projecting the growth that we're seeing next year. That's not only the SoCal growth, but it's also some uptick at Doble.
And that will be primarily the release of some of those new products, but also some further penetration in the international market. And we've had some recent success there, particularly in South America, where we're able to go head-to-head with a couple of our competitors and came out winning that pretty significant contract.
So I would say that the Doble product or company, we're very excited about as well. And I will say, I was at the Doble show and as I mentioned in my comments, we had 1,200 people there.
It just continues to amaze me at what a dedicated bunch of customers those are. I'm very excited about the products, very happy with the investments that we've been making.
I know that it's been tough and 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're glad your improving your products because we love the company, we love the support we get, but you needed to make some of those improvements. And so we've done that.
John Quealy
And my last question on SoCal and building out some of the network features there with Firetide. How is that tracking to your expectations, where we would fit overall spend in terms of getting that network product ready for deployment?
Victor Richey
It's gone well. In fact, I was talking to the guys about that yesterday.
And we're starting the initial deployment of that product even as we speak. So it's a matter of getting the product in the field and improving it out.
But we have a lot of confidence and actually, we've got a lot of test time, if you will, on it at some beta sites. So that's currently on track that I think is the best way to say it.
Operator
We'll now go to Craig Irwin from Wedbush Securities.
David Giesecke
This is David for Craig. I was wondering if you could -- to piggyback on the SoCal network buildout and the trials, can you give us maybe more detailed sense of when we can expect -- I think you mentioned maybe 10,000 units sometime in October.
Is that still happening?
Victor Richey
I'm struggling a little bit with the 10,000 units. We are starting some initial deployments in the first quarter of next year.
But yes, we definitely will have some product in the field in the first quarter of 2010.
Gary Muenster
And that's consistent with SoCal...
Victor Richey
[indiscernible] they're okay, yes. Yes, we have no problem with making that.
In fact, we went through all the design cycle, if you will, for the product introduction that we have. And so those products will get deployed in the first quarter.
David Giesecke
Okay. And then these other AMI projects, do you expect to see some benefits from those maybe in 2012?
Victor Richey
I think it'll probably be 2013. I think hopefully, we'll be able to close some of that in the fourth quarter or the first quarter.
But I think for the real deployments to start, it'd be probably 2013.
Operator
[Operator Instructions] We'll now go to Paul Coster from JPMorgan.
Paul Coster
I just want to make sure that I heard this right. The Test business had a big project conclude in fiscal second quarter.
Should we therefore expect it to decline sequentially and then maybe grow into the back-end of the year? Meanwhile, the other segments grow sequentially through the year?
Gary Muenster
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 fiscal '11.
And the second quarter last year had a big piece of that. And that margin on that project because we weren't the general contractor, we just provided the shielding, so we didn't have any of the pass-through content, didn't carry into the risk of some of the other things.
And that margin was probably 33% higher than our standard margin of Chambers of that size. So what you should think about on that is this is kind of the trough quarter comparably speaking.
The volumes change in the back half of the year. And 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. So I think you're thinking about it the right way.
Paul Coster
Very good...
Gary Muenster
And then the rest of the business, I didn't answer that part. The rest of the business, we are seeing sequential, significantly sequential.
Obviously, because we're still holding to our comment I made last time, where, from an EPS perspective, obviously, we're half way through the year. It's about 30% of EPS in the first half and 70% in the back.
And then the volume's obviously ramped to support that kind of earnings growth.
Paul Coster
Got it. And then on Doble, in the past, you've expressed your view that there's a good opportunity for that platform internationally.
Where do we stand on an international sort of initiative for that segment?
Victor Richey
We're making good progress there. In fact, this past year, about 20% to 25% of the sales were international.
So I think I've probably not clearly stated how much of the business was already international. But 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, 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're very excited about the products that we're selling them.
There's always been some concern about price, but I will say that we have been successful in selling that product. into China, I think, we'll continue to be just because there's not really solid competing products, particularly with some of the newer products that we've introduced with particularly the online monitoring.
To date, China's bought more of that product than any other country in the world including the U.S.
Operator
And we'll now go to Carter Shoop from KeyBanc.
Carter Shoop
First question, when you think about 2013 and the guidance that you're reiterating rating now for that year-over-year 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?
Victor Richey
Yes, I would say that we're still as confident as we were before and that's good with the passage of time. But again, the place where we're going to get that is, SoCal is a big piece of it.
Doble, we're anticipating some good growth from the Filtration business is going to be higher. So there's 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 that we're going to have that type of growth in 2013.
Carter Shoop
Okay. So on the margin, you're feeling maybe a little bit more comfortable or a little more cautious?
Victor Richey
Well, a little more comfortable just because with passage of time and the opportunities are still there. And so yes, I would say a little more confident than we were 6 months ago.
Carter Shoop
Great. And then as a follow-up question, I apologize if this was already asked, I got dropped a few times.
But did you provide an update on TEPCO? And if you didn't, can you give us an update there, explain what you've been doing with the company year-to-date?
And then also how you feel about how well your positioned for the RFP coming up?
Victor Richey
Yes, we didn't give an update yet. Thanks for the question, I think it's important.
We really feel good about the position we're in. Again, the fact that we've already been approved for selling in Japan, I think, is a big deal because yes, obviously, I had to go through that hurdle to be acceptable there.
We just had some people there meeting with our partners, and I don't think we talked a lot about the team we're teamed up with there, but we're working with GE Fuji and with Sumitomo. So I think we have a good team that we're working with, and the feedback we got after the meetings a couple of weeks ago were very positive.
It is an international opportunity there, Japan. But it feels like if like things are going to move forward, I think it's just a matter of timing.
Also, I'd say, the broader role that the government's now taking with TEPCO we also see as a positive because more confidence to fund is going to be there to move forward the project.
Operator
[Operator Instructions] We'll now go to Jeremy Hellman from Divine Capital Markets.
Jeremy Hellman
A couple for me. First off, with CFE, any new news from them regarding any kind of scaling up efforts?
Victor Richey
Not in the near term. Our current view is just it's probably going to be sometime later this year.
But the products we have in the field's working very well. They're very happy with it, and it -- again, I think it's just taking a little time to roll out, but we anticipate some further activity later in the year.
Jeremy Hellman
Do you get any sense about kind of the scale of that activity if and when it comes to pass?
Victor Richey
I think it'll be something consistent with what we've seen in the past, kind of another about that size to add on to what we've already delivered.
Jeremy Hellman
Okay. And then just going back to some notes I had from last quarter's call, you had made a comment that SG&A expense should trend into the $46 million to $47 million range around the Q4 timeframe this year.
I just wanted to double check that's still a good number. And then looking at fiscal '13, is that going to be a good number to bench fiscal '13's cost from?
Gary Muenster
Yes, Jeremy, it's still the same. In fact, I think I 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're a little bit ahead of plan in getting some of the contractors, completing their projects and also rationalizing some of the other investments. So we're off to a good start.
So I think the step down that I mentioned a couple of months ago in the call is well on its way. So I think you're in the ballpark on the numbers to think about, as you mentioned, for the back half of the year.
And then as we go forward, to get the growth we have, the investment cycle is about 12 years. So if anything does come up, come up 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, so 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.
Operator
That concludes today's questions. And now, I would like to turn the call back over to Mr.
Vic Richey.
Victor Richey
Okay. Well, if there's no further questions, we'll truncate the call and talk to you next quarter.
Operator
That does conclude our presentation for today. Thank you for your participation.
Gary Muenster
Thanks.