Good day, and welcome to the First Quarter 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 statement, I would 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 adjusted basis, future sales orders, backlogs, margins, EBIT, EPS, growth, profits, new opportunities, SoCalGas project schedules, results of recent acquisitions, the schedule, costs, savings and margin improvement resulting from restructuring efforts, and other statements, which are not strictly historical are forward-looking statements within the meaning of the safe harbor provisions of the federal security law. These statements are based on current expectations and assumptions and actual results may differ materially from those projected in the forward-looking statements. Due to risks and uncertainties that exist in the company's operations and business environment including, but not limited to, the risk factors referenced in the company's press release issued today, which is an exhibit to the company's Form 8-K filed today, we undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, during this call, the company may discuss some non-GAAP financial measures in describing the company's operating results. A reconciliation of these measures to their most comparable GAAP measures can be found in the 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 give my perspective on the quarter, I'll turn it over to Gary for a few financial highlights.

Thanks, Vic. Consistent with the theme of our prior year commentary, the clear highlight of Q1 continue to be our ability to win new business as evidenced by the strength of our orders and the growth of our backlog. In fiscal '12, we grew our backlog $64 million over the course of last year and we continued that trend during the first quarter of fiscal '13. Our backlog increased an additional $50 million or 12%, resulting in a December 31 backlog of $457 million. Our backlog grew across all 3 operating segments and was led by our largest customer, SoCalGas, as they awarded Aclara an additional $44 million in Q1, bringing the total order value on the project to $139 million through December 31. Subsequent to quarter end, SoCal ordered additional -- several million of additional product for their rollout. The early stages of the project are on track with our original plan and we're pleased with the initial install quantities that SoCal has deployed. We continue to expect SoCal to generate the revenues we guided to in the last release. For fiscal '13, we guided to an operational EPS range which resulted from the nonrecurring costs associated with the Test business restructure. For Q1, we recorded operational EPS of $0.05 a share, which compared to our GAAP EPS of $0.01. Our operational EPS was generally consistent with our initial quarterly plan. Regarding Q1 from an operational basis, Filtration continues to outperform expectations on both sales and EBIT and we expect our fiscal year sales growth and profit contribution to come in as previously communicated. Test sales and profitability were generally consistent with our operating plan and as a reminder, Test's GAAP results include the approximately $1.5 million of cost related to the shutdown of the Glendale Heights facility and…

Thank you, Gary. We continue to see a lot of positive things happen across the company with the most significant obviously being the much anticipated launch and ramp-up of the SoCal project. We've been working diligently for the last couple of years to make sure we're well positioned to provide SoCal with all the necessary products, software and services to make their AMI project a success. I'm pleased to report the project has begun in earnest and results have been positive. SoCal has made its initial installation quantities and we're delivering products consistent with our plan. Our partnership remains strong and all parties are focused on making this project the state-of-the-art gas, AMI deployment worldwide. SoCal is not the only project that I'm excited about. When we consider the balance this year, as well as our long-term prospects. The continued strength of our new orders and resulting backlog obviously bodes well for the short term, but I'm also excited about the size and quality of new business opportunities that we're currently addressing. There's several AMI opportunities in both water and gas markets that give me confidence in our projected growth over the next several years as a supplement to the SoCal contribution. Our business development teams are fully addressing these opportunities, both domestically and internationally. Operationally, the strength and stability of our Filtration Group continues to exceed expectations. The breadth of our current product offerings, along with our engineering excellence in developing new products, gives me confidence to reaffirm our fiscal '13 growth outlook. As Gary mentioned, the Test restructuring is on track and on budget. And I continue to expect their second half operating margins to be at or near 13% after the consolidation is completed. Doble and Aclara are on track to meet our earlier expectations for '13…

[Operator Instructions] The first question comes from Kevin Masco with BB&T Capital Markets.

First question on Doble, we've talked about this before, but you've got this multiyear goal to double Doble and I know you've hit some singles and maybe some doubles there with opening some international offices, but can you just address that and where you think you stand in that regard and how confident you are that you can do that because that, of course, involves Doble growing faster than it historically has?

Yes. That's not something that's going to happen the next couple of years, but I think it's a good long-term goal for us and what's really going to drive that is a couple of things. Number one, us being able to accelerate -- our ability to penetrate the international market, as well as some of the new products that we're developing to be able to deploy here in the U.S. Let's say the third piece of it is -- we have this fee-for-service business within Doble and I would tell you that today, we probably could grow that about as fast as we want and really kind of the limiting factor there is being able to find the people to man that. So we've talked in the past about factors, some of the utilities are losing engineering talent just to retirement and so they're looking more and more for people to outsource to. And so we are looking very aggressively at adding people to that part of the business to be able to grow that. So there's about 3 different things that we're pushing to try to make that happen.

Okay, Vic, shifting over to orders -- strong orders of course in the quarter. If you look at USG, it looks like nearly half of the orders were SoCal-related. So can you just address the non-SoCal part of the business, how you feel about the income and order cadence and the trajectory of that business?

Yes, we have spent some time over the last couple of weeks looking at that again and what I would say is it looks pretty solid. We've had a good pipeline. SoCal obviously is a big driver, it's not the big driver. We're starting to see the water market pickup and we think we'll have a solid year in order entry in the water market as well. And so kind then of the wild card as we talked about in the press releases, we have a pretty soft first quarter in the co-ops which we expected. And so it's really how we're going to be able to work with the distribution in order to pick that up a little bit in the second half of the year. But I will say that the pipelines feel as good as they have for the last couple of years.

The next question is from Zach Larkin with Stephens.

Vic, I wonder first off, maybe if you could talk about the AMI pipeline? I know on recent calls you've talked a lot about different kind of water and gas opportunities, but I wonder if you could give us an update on your sense for what the size and timing of these awards might be and how we should think about them in terms of kind of the 2013 year? And also, maybe a little color around ESCO's positioning on them?

Sure. I just mentioned that the pipeline, it feels pretty solid now. We've got several water opportunities that look like they're going to happen this year where I think we're very well-positioned. I think, given the fact that we've had as much success as we have with some of the larger water utilities like New York and San Francisco and Toronto, I think that positions us well to have some success. We're not looking for anything that's going to contribute more than $10 million or $12 million to $15 million this year. So it's not like we're looking for something that's going to be $30 million or $40 million that are going to turn into sales this year. So I think we're well-positioned in those and it looks like those are set to happen in the next couple of quarters. But I will tell you, I mean, the biggest concern I have is just the timing of some of these orders. I'm not concerned about the orders happening this year or our ability to be able to win. It's just that they do continue to get delayed somewhat. So my hope is that we'll get some traction after the first of the year.

And then, as SoCal starting to ramp and I think there's been some indications that they might want to kind of increase their ramp speed. What -- are there any issues on capacity or anything on that kind of front from your guys vantage point if they were to accelerate any of their ramp now that we've got some of the initial phases done?

Yes. I'd say probably that's one of the things I worry about the least and we've got really good manufacturing partners and in fact, we just recently been able to expand our production capability with the sub-contractor manufacturer that's doing that. So we significantly increased our ability to deliver products. So I'm not at all concerned about that should SoCal decide that they want to accelerate deployment later in the year.

The next question comes from Sean Hannan with Needham & Company.

Vic, if I could just follow up on some of the comments you made on the water market. Some of the strength that you're seeing there, is there any opportunity that you could see some perhaps upside to the expectations in fiscal '13 as some of the timing of that kind of falls out there? Any color around that would be helpful.

Sure. There's always that possibility. I mean, I would say that the concern I have again is just the timing of some of these orders and -- so if -- what we're doing is we're preparing to make significant deliveries in the second half of the year. So if somebody would come in and want to do something quicker than what we currently anticipate, we are building inventory to be in a position, to be able to meet those deliveries. And also, I think that gives us competitive advantage, so that if a utility is saying we really want to go with you guys, but we want to start right now, we're going to be in a position, we're going to make sure we're in the position to have a product on hand to do that.

Okay. And then in terms of the business over at Doble, the deferral that you had referenced, how do you expect that to come back? Is that addressed fully in the quarter or does that kind of spread out a little bit as we move through the year?

That will be through the year. I mean, as Gary mentioned, I mean, we're not going to have a huge step-up in the second quarter over the first quarter. So we're pretty heavily back-end loaded this year as we typically are. So I think that will be something to be spread out over the year.

Okay. And then lastly, in terms of the ARMS product, can you talk a little bit about the progression of the beta efforts with the utilities today and how you see that picking up for more activity with those customers and how and when that starts to translate to a little bit more momentum? I realize there's a longer-term vision there, but further insight would be helpful.

Sure. What I think we'll be spending this year and working with our beta customers and proven out the product adding additional capability, additional sensors, those types of things that the software builds interface with. So I think before, it's probably going to be next you before we have any significant sales on that product. So we really want to make sure that we have it rung up properly before we launch it on a broader basis. But we don't have any assumption that we've got any big sales on that -- or any sales really this year other than what we already have with our beta customers. But we do think it's a long-term great opportunity for us. I would say it's really meeting the expectations that we have for the product and that of the customer as well.

The next question is from Craig Irwin with Wedbush.

So one of the things we haven't spoken about yet is the international opportunity. So over the past couple of years, there's been different level of excitement about some of the projects that could potentially materialize out there. Can you give us some color on where things stand with your customers at the moment and whether or not you include them in the specific set of high probability customers for customer awards for 2014, 2013?

Yes, I would say that we don't put any international customers except for the ones we already have in the high probabilities, just because it's international business. And we've been talking about it for years as a lot of the other vendors have and these things seem to take a life of their own in some cases. Having said that, we're in a very strong position in central and South America. We continue to have good sales there. It's a little bit of wildcard now when Mexico's going to move forward, CFDs going to move forward with the additional orders. We think we're going through the timing of that. It's a little bit up in the year now. And it's a little frustrating, honestly, because they probably have the best business case out there. I mean, it's a compelling business case. We've got product and field. It's working very well. So I think they will be making additional orders, hopefully in not-too-distant future. The longer-term issues or opportunities we're looking at obviously remain Japan and China as well, and we're active in both of those markets and I think we'll be positioned to get some of those projects as they go forward. But we don't have a lot in 2013 as far as anticipated sales. There's some opportunity I think beyond what we have in there, so I think we have a little upside potential in 2013. But it's not a huge amount of what we're anticipating. We think that's a little longer term project. But again, I'd say central South America and in Asia are probably the best opportunities for us.

Great. Then just changing subjects to your recent acquisition of Metrum Technologies. Could you give us a little bit of color around the approximate size and financial profile of this business? And maybe if you could share some details on potential synergies or customer overlap or customer expansion opportunities that this asset brings?

Sure. Well, I think Metrum is -- it really was a good opportunity for us. And it's going to be a good addition to what we do and just a little background for those of you that aren't familiar with it. Basically they use a cellular connection to communicate with the meters. So as you know, one of the issues that the powerline system has is the amount of bandwidth that's there. Let's say, if you look at some of the investor-owned utilities, and certainly the co-ops that we deal with. Example, bandwidth to do most everything they want to do. Having said that, many of our customers want to have more bandwidth than C&I users. And so what this allows us to do is go back into some of our current customers as well as new customers and provide them with an upgrade, if you will, for their C&I customers, where they'll be able to bring back a tremendous amount of bandwidth. So that's kind of application number one as you look at C&I customers and this is for really, we can go back to our co-op customers now, some of our other customers as well. I mean, PPL already use Metrum so I think that's a good supportive view of why we thought this is a good thing, because one of our major customers, one of our great customers had already been using them. The other thing it does is it helps us in the distribution automation area because again, one of the things about the track system is, it's a great system, but you have to have the system in place to be able to do distribution automation. Metrum can kind of do this on a surgical basis, if you will because you are really able to…

The next question comes from Ben Schuman with Pacific Crest Securities.

Gary, maybe can you just walk through your view of some of the swing factors within the segments in terms of upside or downside this year? And do you see any significant changes to the segment by segment growth projections that you guys gave on the November call?

I'll answer the last part of that first. Because that's the easy one. The answer is we're still on track. We feel pretty good about it. We just had last week some lengthy meetings with all the subsidiary management teams and reconfirm our comfort level there that the guidance that we put out by segment was still applicable and achievable. So that's the easy part of the question. And the next part is when the Filtration profile is always relatively simple, it deviates very little on a quarter-to-quarter basis. So the growth that you're going to see there in the first quarter we're up about $4 million, and we talked about that increasing $15 million to $20 million, so we're well on track with that '13 versus '12. So I would say, just a modest step up from the Q1 levels throughout the year will get us to the finish line that we've indicated is achievable, keeping the margins about where they're at. So we're really lean and mean there, so we're not going to -- you're not going to see 25% margins there based on the cost profile we have. So Filtration gives us very little concern. You can kind of sleep on those numbers. They're so consistent. On the Test side of the business, that's where you get the quarterly volatility based on the size of the projects that we have. So if you start the year at a $36 million level and then it kind of bounces around relative to the size of these chambers that we have. And so coming up to Q2, you can put yourself in the mid-40s there, low to mid-40s. And so you see a step-up from $36 million to $42 million or $43 million and that's really driven by 3 large…

That was extremely helpful. And then quickly, can you just talk about why the expected tax rate is going to 33% from the 35% from last year and on the previous guidance?

It's because of Congress extending the -- when -- after the first of the year, it's part of all the fiscal cliff, whatever you want to call it, when Congress extended the research credit and some bonus or accelerate depreciation that had been delayed. Congress kind of sat on it for about 18 months. And so the way the tax and accounting rules work is, we knew or everybody knows, you should see this across your entire universe of companies, anybody that has meaningful R&D spending. You really couldn't take any in fiscal '12 because it had expired. And so what happens is, it basically sat dormant for everybody in calendar '12. And then when Congress signed all of these stuff on January 3 or 4, whatever that was, as part of the revised tax thing, what happens is, they go back retro to 2011 and basically, you're allowed to do a catch-up. So you get about $1 million cumulative catch-up as a discrete item relative to the calendar '12 R&D spending credits that you get. And so that has about 1%, 1.5% favorable benefit impact to our tax rate. So it's really just a congressional timing of extending what should have been extended. It's kind of a 2-year rolling extension, but sometimes Congress goes to sleep on that for a little bit. But we're back. It's extended for the next two years, so you should see a consistent application of that benefit in '13 and '14 as a result of the current standing.

Okay, great. And then, do you expect the general cadence of the SoCalGas orders going forward to look like what we've seen to date? And with $140 million book, how can we think about revenue timing in the context of these order announcements?

I think the orders -- I mean, we have orders that really would get us through this year and even in some into next year and then we've got piece one piece of it, it delivers over the entire piece. So I don't anticipate significant additional orders from SoCal this year because we already have that backlog built up for the remainder of this year.

The next question is from Richard Eastman with Robert W. Baird.

Gary, how much was the restructuring charge pretax?

$1.5 million.

$1.5 million, okay. So then -- all right, that'll probably get us there because the -- do you happen -- to get to a $0.05 on an adjusted basis, are you applying the 17% tax rate?

No. I'm applying the 35 and the reason it's 17%, Rick, it's the -- as I call it, the law of small numbers. When you only deliver GAAP pretax of $300,000, 35% of that is roughly $100,000. And we had a $50,000 discrete item that normally would fall into the immaterial noise level, but when it's against a $300,000 pretax, it makes the tax rate look artificially -- or it's mathematically 17%, but it makes it look a little bit unique because of the law of small numbers. So that discrete item really has nothing to do with the restructuring. So in the spirit of being reasonable, we just hit the $1.5 million at the statutory 35%. We just thought that's probably the best way for us...

The $1 million reference in the press release is the net impact of the charge?

Yes. Well, the total spending was $1.5 million and what the $1 million that we're referring to, and that is -- that's kind of the related to the facility lease buyout. That's what the $1 million is, and then there's some other things like relocation and severance and things like that, that kind of all bang through there.

Okay. And that's all -- the least -- everything is kind of in the SG&A number on a GAAP basis?

No. It would be in the other income -- the bucket -- other income -- other expense, other income net.

Okay, I'll make sure I'll get that. And then, can I just -- just kind of trying to sift through USG sales, and you had mentioned Doble, you said was flat, so I presume Doble was around $28 million in revs?

Yes.

And at a 20% op margin or EBIT contribution, that's $5.7 million. And so basically, it leaves Aclara at $34.6 million and on that $34.6 million in revs, it lost about $8 million?

Yes. Within rounds term in the 7s. So volume level, it's hard to absorb your fixed overhead when you're setup at $35 million. That's $140 million annualized run rate and that's obviously not what that company is sized for. And so it's really an aberration relative to the sales volume. So if you just kind of think of the fixed cost concept and you hit it with that lower revenue, that's not anywhere near obviously breakeven because the annualized Cleveland -- the run rate at the annualized level on the Cleveland facility is substantially better than that, which is where the SoCal revenue gets recognized through. So it's really a function of $35 million of revenue, which is not what the footprint and the headcount, and the engineering expenditures are built around. So you really can't cover your fixed cost and that volume level. Which, as you ramp through the back of the year and you step it up significantly, you'll see that margin in -- kind of in the Q4 volume levels be back in the low 20s. Because again, we're not growing the fixed cost to get the revenue volumes necessary to meet our objectives, and so the fixed costs are the fixed costs, and then you knock it out of the park when you get the volumes up 2x or 3x times that.

And again, this is really rough math, but the $8 million, loss there, at 50% gross margin suggest that maybe the breakeven level for Aclara is about $50 million a quarter? And is that -- are we going to handily comfortably exceed that in the second quarter?

Yes, I think you might be a little bit high relative to the breakeven level. But if you're running at $50 million at Aclara, you'll be above breakeven. You'll be kind of in the 8% to 10% EBIT contribution. And then when you -- if you moved it up to, just get yourself up into the $70 millions or $80 millions, and you get yourself to the 20% EBIT level. So it's really a volume orientation. So if you just doubled the $35 million, just for math purposes and said we're going to do $70 million in the quarter, the G&A doesn't change. That's about $13 million a quarter. And that's where you see the significant gross margin contribution that covers the $13 million in G&A. So if you just kind of backed into that, you get yourself into the 20%s on EBIT at $70 million-ish in revenue.

Yes, okay. And then just -- the other question I have, when I look at the USG orders in the quarter, and -- I'm just trying to compare them year-over-year. And if I pull out SoCalGas at $44 million, I'm going to assume you had very little in the way of co-op orders, right since you had little sales?

A little over $10 million.

Okay. But if I do the same math and kind of pull out last year in the first quarter, I mean you had $33 million of SoCal gas orders and co-op, you had a monster of $32 million of orders in Q1 of '11. But just kind of doing that math, it looks like the orders adjusting for SoCal gas and adjusting for the co-op business were up like double-digit. Does that feel right?

Yes. Because there's -- believe it or not we still get a decent level of IOU orders that come through, that Florida Power & Light load control system we have is just a gift that keeps giving. We booked over $3 million there. We booked almost $3 million at Pennsylvania Power & Light versus nothing last year and FPL was nothing last year. So those kinds of things incrementally, there's $6 million there compared to zero. The international orders were $1 million or $2 million. And then when you get into -- in my commentary where I talked about the water business there and again, it's not gigantic numbers, but we booked a pretty fair amount of small water customers across the platform. So when you get into that, you do see favorable comps the non big-contract customers.

Okay. And then just -- last kind of related question, SoCal gas did we have some revenue in the quarter? What was that number?

About $9 million.

$9 million? Okay. And all of RF, Aclara RF was how much?

Bear with me a second. About $16 million.

The next question comes from Jim Giannakouros with Oppenheimer & Co. company.

Just to clarify on the SoCal, the $48 million in additional orders adding that $4 million that you had a January, is that all end point deployment is there any service support upfront software or other items that are material contributors to that order number?

That's really hardware. I mean, we entered the majority of the software and services earlier on so this new hardware.

Okay. And sticking within USG, I know that you mentioned Doble is running at about 20%. Is that a blip down given Sandy related deferrals or related to the continued hires of sales engineers you've mentioned in the past or am I just thinking, that I had a 23% number or so for Doble. Is that a longer term type of goal there?

It's not much longer-term. It's volume-oriented as well. Obviously, as we built the model for '13 we obviously didn't anticipate the impact of Sandy therefore a couple of million dollars. But as we migrate these new products from development into the market, we've obviously hired some additional sales folks domestically as well as internationally. So as the sales gets off of 28% and moves itself throughout the year, back up to the levels that we had anticipated, which is in the low to mid-30s%s, then you'll see the EBIT margins in the 23&s and 24%s, that just that little bit of incremental sales. Because they generally run at the nearly 60% gross margin level. So as they lever up from a 28% type level to a 32% or 33%, that incremental margin falls right to the bottom line.

And on the Metrum acquisition, I apologize if you did mention it, but can you outline revenue contribution? What EBIT it runs at and effects on DNA that we should be factoring for -- going forward?

Yes. We really haven't disclosed that yet. I would say it's profitable business and we'll give more information as we get further into later in the year.

The next question comes from John Quealy with Canaccord.

So sorry, the first one is a remedial question. It looks like $3 million in potential charges for Test realignment, is that right in '13?

$3 million to $3.5 million. yes.

And Gary, is that embedded in the $2.30 to $2.50 EPS guidance or is that carved out?

It's added back to it. It's excluding Test restructuring, that's what our guidance is, is absent that.

Correct, okay. And then just in terms of the Doble movement with Sandy and obviously of a hype here in the east coast about the winter storm and all that sort of thing. Do you feel pretty confident that, that businesses is going to come back? I mean based on the type of business, you could see it, as it gets pushed out to quarter or 2. How comfortable are you? Did something else -- any other part of the business come up to make up for maybe a little bit more margin on safety need on Doble right now?

I mean from where we were at today, John, we would respect those customers as pushing those things out and they're saying that things are going to happen this year. So we haven't seen anything that gives us any pause on that pushing it out of the year.

Okay. And then last, a lot of us talked about Elster closing down the mechanical water meter business and you guys have been very, very good at the comp side. Given that there's a good handful of water business coming, the shutdown of that potential partner impact your strategy at all? Does that make other partnerships more valuable? How do you rate it right now, Vic, or is it a nonevent for you ?

I'd say for the most part it's a nonevent. We have some current deployments with Elster. But, I mean those are on go forward and I think that whatever opportunities there were, will get absorbed by the other players, which we have a good relationship with. So as we approach water customers, we sometimes to do it on our own, sometimes do with our partners. So as you know, they weren't a big player. They were a good player, but they weren't a big player. So we don't think it's going to have a big impact on us, one way or the other.

We have no further questions at this time. I'll now turn the call back over to Vic Richey.

Okay. Well, I appreciate everybody's interest and we’ll be in contact next quarter. Thank you.

Thank you. Ladies and gentlemen, this concludes the first quarter 2013 ESCO Technologies Inc. Earnings Conference Call. Thank you for participating. You may now disconnect.