艾默生電氣 (EMR) 2005 Q3 法說會逐字稿

Good day everyone and welcome to the Artesyn Technologies third quarter earnings release conference call.

As a reminder, today's call is being recorded.

For opening remarks and introductions I would like to turn the call over to Pamela Rembaum, director of investor relations.

Please go ahead, ma'am.

Good morning everyone, and thank you for joining us for our third quarter 2005 conference call.

On the call with me this morning are Gary Larsen, Artesyn's chief financial officer, and Joe O'Donnell, Artesyn's president and CEO.

A copy of this morning's press release announcing our third quarter results is currently posted on the Press Release section of our Web site at www.artesyn.com under investor relations.

Additionally, the company filed the earnings release prior to this call on Form 8K with the SEC.

This call is being webcast live over the Internet on our Web site.

A replay will be available immediately following the call on our Web site or by dialing 888-203-1112.

The dialup replay pass code is 1948494 and will be available through November 18.

Before we begin, I would like to remind you that except for historical data, comments on today's call contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements, including projections as to revenues or earnings and other statements relating to expected future performance by Artesyn, involve certain risks and uncertainties which may cause actual results to differ materially from those discussed on this call.

While Artesyn may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to update even if our estimates change.

For a more detailed discussion on such risks and uncertainties, please refer to our filings with the SEC, including our 10K filed on March 16, 2005.

Now I would like to turn the call over to Gary Larsen, Artesyn's CFO, for a discussion about the company's third quarter financial results.

Thank you, Pam, and good morning.

Sales for the third quarter were $102 million compared to $107 million for the same quarter last year.

The power conversion segment recorded third quarter sales of $85.2 million, down $1.5 million or 1.7% from the third quarter 2004, and down $6.9 million or 7.5% from Q2 of 2005.

The server and storage division negatively impacted power segment third quarter sales due to programs going end of life with no program replacement during the quarter.

Additionally, Q3 sales were lower by $2.5 million due to a customer software compatibility issue with a newly introduced rectifier which was not resolved until late in the quarter.

The embedded systems segment had third quarter sales of $16.7 million, a decrease of $3.6 million or 17.6% from Q3 2004, and an increase of $800,000 or 5.1% from Q2 of this year.

Sales were impacted during the third quarter primarily as a result of 3G orders not materializing.

Orders in the third quarter were $106 million, yielding a book to bill of 1.04.

Backlog at the end of the quarter was $81.8 million with approximately 92% or $75.3 million scheduled for shipment in the fourth quarter.

Gross margins of 24.2% for the third quarter were negatively impacted from the slower demand of the embedded systems segment during Q3, and reduced absorption of fixed cost due to lower production levels.

Net income in the third quarter was $4 million and earnings per share was $0.09.

Included in net income for the third quarter 2005 were $350,000 or $0.01 per share of restructuring charges associated with the action announced last quarter to close our manufacturing facility in Hungary and outsource European manufacturing.

Total operating expenses in the quarter were $20.8 million or 28.4% of sales, approximately $1.4 million or 6% less than op ex last year.

The decrease is due to lower accruals for management incentive awards in 2005 and increased expenditures in Q3 2004 to implement Sarbanes-Oxley section 404 by the end of last year.

R&D expense for the quarter was 11.2 million, or 11% of sales.

Net interest expenses in Q3 was $800,000.

To calculate fully diluted EPS for Q3 the if-converted accounting methodology for calculating diluted earnings per share is applicable.

As a reminder, interest expense and debt issuance costs related to Artesyn's convertible note of 850,000 per quarter should be added back to net income and the related share of 11.2 million should be added back to the weighted average share count.

There was overall tax benefit for the quarter of 29.8%.

This included the elimination of $1.6 million of previously established tax contingencies that are no longer required.

Excluding that tax contingency elimination, the effective tax rate was 22% for the quarter.

The effective tax rate for the fourth quarter should range between 20 and 25%.

Now turning to the balance sheet we ended the quarter with $101 million in cash and short-term investments.

Days working capital at the end of the quarter decreased to 52 days from 53 days last quarter.

The decrease in working capital from last quarter is mostly related to a lower accounts receivable balance of $65 million at the end of the quarter.

Days sales outstanding for the quarter were 55 days or three days less than in Q2 on a reduction in past due balances.

Inventories increased by $900,000 from Q2 and inventory turns were 6.2 compared to 6.7 in Q2.

Capital expenditures for the quarter were $2.1 million, depreciation and amortization was $5.6 million in Q3, and finally our factories are operating at approximately 73% capacity in power conversion and at 50% in the embedded systems business.

Thank you, and I will now turn the call over to Joe for a business review.

Thanks, Gary.

I would like to comment on Q3 operating results, technology, and the outlook for the fourth quarter and 2006.

First, third quarter results.

Revenue.

At $102 million, Q3 sales were below expectations.

Server programs going end of life prior to the introduction of replacement products and the delayed 3G rollouts negatively impacted revenue.

While I will discuss design wins later, I would like to focus on servers now.

Over the last 12 months we have enjoyed a number of significant wins with the four market leaders in servers.

These programs in 2006 will more than offset production currently going to end of life.

These projects are currently in design.

Market share.

As planned, more revenue is moving into the higher margin wireless segment.

In the last quarter, wireless increased to 34% of sales.

We expect to end the year with wireless accounting for 35% of revenue growing to 40% in 2006.

In Q3, server and storage remained our largest sector at 39% of sales, telecom was 10%, and distribution 17%.

We will not achieve our objective of 20% of sales for distribution over the next two quarters as distributors exhaust their inventories of non RoHS compliant parts and prepare to only order RoHS compliant product for 2006.

A note on revenues of and our top 10 customers.

Those of you that have followed us over the last year know we have been working to grow our revenue base outside the top 10 customer list.

We are making important progress.

Through nine months, top 10 customers accounted for 69% of sales compared to 72% in 2004.

Another important development among the top 10 is that five are now wireless customers.

Program wins.

In addition to ongoing production, new program wins is how we anticipate future market share.

As a rule of thumb, there's a 12 month lead time between receiving a design win and revenue.

In Q3 we continued what has been an unusually high rate of new program wins.

We had 23 major new awards in the third quarter, with a lifetime value of $184 million.

Over the last 12 months Artesyn has been awarded 99 major new projects with estimated lifetime revenue of $1.1 billion.

This is a record for us.

Without question, we are gaining significant future market share.

Technology.

Prior to discussing the outlook for Q4 in 2006, I believe it would be useful to discuss technology and the pending patent litigation from Power-One.

Artesyn's commitment to investing in new technologies, both hardware and software, continues to remain a core strategy to increase market share with our blue chip customers, expand our emerging customer base and enter new markets and products sectors.

I have described Artesyn's point of load leadership's strategy to you in the past.

As a reminder, Artesyn's strategy is to partner with leading silicon companies and power manufacturers to address advanced point of load technology that enables us to continue to provide the best solutions for our customers.

Last year we created a coalition of leading power and silicon manufacturers to create a new open standard digital protocol for power system control called PMBus.

Earlier this year the new protocol was released and has been endorsed by both of the industry’s major power supply alliances, POLA and DOSA.

There are currently more than a dozen power supply and semiconductor companies that have formally adopted the protocol and continue to collaborate on further development and promotion of this specification.

In September we announced the industry's first PMBus-compliant digitally programmable DC to DC converter.

This is product is a 20 amp, non-isolated point of load converter which features an extensive set of digital configuration, monitoring, and diagnostic facilities, accessible via the PMBus interface.

The converter stores all configuration and set up data in a non volatile memory, and powers up in these preprogrammed default settings, thus eliminating the need for external power controllers.

Last month Power-One filed a patent infringement suit claiming Artesyn had violated certain patents while developing this product.

The company believes this suit to be a baseless attempt to slow the adoption of PMBus protocol through courts instead of through technical merit.

Artesyn is extremely diligent about intellectual property ownership during the product development stage, and believes it is competing aggressively and fairly in the marketplace based upon the merits of our products and technology.

While Power-One has chosen to invest in a proprietary system architecture, I have communicated to you that we believe the future of digital power management is better served with an open architecture such as the PMBus protocol.

As such, we believe in our current defense against this suit and intend to assert them vigorously and to prevail.

Now the outlook.

With Q4 revenues ranging between 109 and 112 million, earnings should fall between $0.07 and $0.09 per share.

This $0.07 to $0.09 includes about $0.02 in restructuring charges and $0.02 in operating inefficiencies associated with Hungary.

We continue to anticipate the Hungarian transition will be completed by year end.

Looking to 2006, we continue to believe that revenue will grow between 15% and 20%.

I would now like to turn the call over to a Q&A.

(Operator Instructions)

And our first question comes from Steve Smigie with Raymond James.

Great.

Thank you.

I was hoping you could talk a little bit about the timing of when the new programs might come on versus the ones that went end of life.

I think you said in the press release maybe Q1.

That's correct, Steve.

Beginning in Q1 -- the end of life is a combination of -- it is not where the product goes from high volume to zero.

It is where the product is ramping down, and ramping down before new products have been introduced.

On some of those projects we have the revenue in both the first program, meaning what is currently in production, and then the new program.

Others, where our growth will come from next year, will be programs where we did not have the revenue in the existing production, but we will in the replacement production.

OK.

But it starts in Q1.

When will we see the last of the Hungary charges and when will that transition be completed?

If we stay on schedule, which I believe we will, those charges will be finished in the fourth quarter.

And that's -- to be clear with everybody, I gave an earnings expectation in those numbers, there is about $0.04 of Hungarian related charges, $0.02 would appear as a restructuring item and $0.02 would be in the gross margin lines -- or within cost of sales, I should say, through inefficiencies.

OK.

Could you talk a little bit about your expectations for embedded systems growth in Q4 and also for ’06?

Right now it is looking extremely optimistic.

The ordering pattern, since we put quarter end numbers out, which is what we're dealing with here, has improved further.

Programs are entering production, so it is actually looking quite optimistic at this point.

Any sense yet what '06 might look like?

My understanding is '06 and into '07 that is supposed to grow significantly.

At least can you sort of indicate that factors that you think will drive future growth?

Yes.

Let me say we have given guidance, it is a broad range, 15% to 20% for next year.

Right now we have not detailed that guidance between various parts of power or the embedded space.

We will do that in the future.

So, certainly, that business will grow at least at the rate of the total company, you should think of it that way.

The growth will come primarily out of wireless for that group.

And the incremental business, meaning what is bigger next year than this year, will be 3G programs.

OK.

Great.

Thank you.

(Operator Instructions)

We will go now to Ken Muth with Robert Baird.

Hi.

A little bit more clarity on the wireless.

We had a little bit of a difficult quarter here with some of the major OEMs of the CDMA side of the Lucent, Nortel and Motorola where they had a little bit weaker than expected growth -- or decline, I should say, a steeper decline sequentially.

The outlook there seems a little bit more muted as the CDMA market may be peeking out, if you will.

Could you give us your position on the last quarter was the same kind of thing in the CDMA market?

What has changed for the better for you guys?

It sounds like things are picking up.

When we look at our market position in wireless, if you look at today's production -- I'm sorry, today's primary technologies, GSM would be one of those -- and then you look at tomorrow's technologies.

So some people characterize that as 2.5G or edge, and then the other people would call it 3G.

So when we look at future technologies, 2.5G and 3G, Artesyn is on 70% of the platforms that are being introduced into the market.

Our position is just remarkably strong for future revenue with the market leaders.

Again, if you add all the companies together in wireless who have any market share that is meaningful, on the OEM side, Artesyn is currently designed into or has started shipping to 70% of those platforms.

Do you see -- on your kind of 3G comments, like last quarter, you were talking about more of the CDMA side, or are you also never talking about the UMTS-HSDPA rollouts?

I am talking about all of these except one.

All of the associated technologies with 3G or 2.5G, the exception is the new technology -- technology is the wrong word -- the new format that the Chinese are promoting, which is primarily directed to the Chinese market.

We are designed onto a number of those platforms, but I'm not including that when I talk about the 70%, because I think it is not yet determined how successful that Chinese effort at a unique approach will be.

OK.

And then just on the power conversion side, the kind of expected pickup there, where do we have to get to to get more of a meaningful impact positively on margin contribution?

What is the kind of hurdle rate there?

The -- I am not sure I can answer that question accurately.

We have -- we see looking forward program wins in power, in servers, I talked about that, and we will see the growth coming back into servers from those wins as we move into next year or out of this year.

That -- the other area of big growth in power, the area of biggest growth will be in wireless.

We've had a number of important wireless wins.

Not just in the embedded space but in the power space as well.

So again, we are projecting -- anticipating 15% to 20% of growth next year and a big part of that, of course, will come out of power.

And a lot of the incremental piece of that, the wireless side.

OK.

And then, as you kind of go to these new platforms, anything on the pricing -- does pricing improve, does it stay the same, does the -- because it is a new design does it allow you to take significant costs out?

Or how do look at these new products from a pricing perspective?

Well, rather than -- I am going to answer it differently than you asked.

OK.

Rather than talk about pricing, let me talk about our cost structure.

We believe that we are able to realize improving margins based on what we are going to market with now.

Although, the pricing we are providing is obviously competitive or we would not be winning these programs with our customers.

So we certainly have to provide the customer at a cost level he needs, so it is our job to improve our margin profile which we believe is in the process of happening with the designs to better cost or newer technology.

OK.

Thank you.

(Operator instructions)

We will go to Louis Miscioscia with Lehman Brothers.

Hi.

This is Hardik Doshi for Lou.

Back in the first quarter you said like (indiscernible) experienced certain delays in the server and wireless areas which were going to ramp in the second half of ’05.

Are those still ramping now, and if they are, would that not be enough to offset some of this weakness you have seen from the end of life programs?

Well, the wireless is ramping, there's no question about that.

It has become a bigger piece of our business, it will continue to do that as a percent of sales, be a larger percentage of what we do.

So clearly it is happening in wireless right now.

In servers, there is a large backlog of new programs.

We, frankly, did not anticipate that some of these projects at our customer level would begin ramping down this quarter.

I think the customers did not anticipate that either.

And that is before the introduction, in some cases, of the new products.

So I think we describe the server situation reasonably accurately, but I would like to be clear that there is a clear uptake on the wireless side of our business.

OK.

Now, these new server programs that are ramping up, I think you mentioned that they want to start in the first quarter of '06, so should we then expect for the first quarter of '06 not to show the normal seasonality that it does?

That it should actually be up sequentially from the fourth quarter?

OK.

The fourth quarter of 2005 versus the first quarter of '06, is that the question?

Yes.

That's the question.

The fourth quarter of '05, we have said in our guidance that we expect to see it grow sequentially.

We expect to see earnings increase appreciably from the third quarter.

So there is growth in the fourth quarter.

The first quarter -- we have not given guidance by quarter in ‘06 at this point.

We will do that next quarter's call.

OK. (indiscernible) get a sense that if the fourth quarter is seasonally weak I would like to know that basically you are forecasting three significant -- sequential growth right through the year to get to 15% or 20% growth --

That is right.

-- in '06.

At the same time I'm trying to get a sense of whether the new program is ramping immediately in the first quarter so that, like, you know, the weak seasonality would will not come through in the first quarter.

Will it go through more linear or is it more second half of '06?

Well, again, I appreciate what you're trying to do in your model building, but we have not provided guidance by quarter.

What we would expect is with the 15% or 20% growth we will see steady growth throughout the year.

Keep in mind, and the reason that we talk about this, the program wins, we worked really hard to understand what their value is going to be, when they will be introduced.

And over the last 12 months we have won over $1 billion of new programs, lifetime revenues.

That will greatly impact our growth for next year and the year after that.

There is no question about it.

So those programs are on the books and they're in design.

And some of them will be introduced in the first quarter.

OK.

And then just regarding restructuring, do you still expect to see any operational inefficiencies in the fourth quarter, or will that all be completed by the fourth quarter?

OK.

If we stay on plan, which we believe we are, we will have all of the inefficiencies behind us in the fourth quarter.

All right.

Great.

Thanks a lot.

You're welcome.

We will now move to Thomas Dinges with JP Morgan.

Hi.

Joe, just a quick look back again -- I am trying to see where the bigger portion of the shortfall was this quarter.

Can you separate between how much of it may be relative to what was expected, sort of 110, maybe $112 million revenue number?

Was the shortfall because of the missed timing on the end of life on servers and how much of it was due to some of the push outs that you saw from wireless?

And then I have a follow-up.

OK.

Roughly, 35% of that shortfall, and people had different models, but if I may use a percentage, would have been in the delay of a rollout in 3G with one of our customers, which certainly I am not at liberty to say which customer that is.

And then the balance would have been wireless -- I am sorry, server demand.

OK.

And then switching gears a little bit, when you guys are completed with the transitions with Hungary and start to see some pick up on some of the wins that you talked about in power conversion, where's that going to take utilization rates if you look out into Q1 and Q2?

Over 80%.

OK.

And is that a level that you guys would have to think about adding internal capacity, or are you going to have enough sort of committed capacity with the outsourcing agreement there that you are not going to worry about getting too close to possibly not having enough flex capacity there?

Yes.

Tom, that is a really good question.

We're spending a lot of time looking at the company, although we have not taken a step beyond Hungary.

Looking at the company using more outside manufacturing, becoming less asset intensive.

And as we go down that road - I'm talking about the evaluation in addition to what we're doing in Hungary, I think we're not going to have to be as concerned about adding capacity in our own facilities as developing continuing relationships with outside manufacturers.

OK, thank you.

We now have Jeff Bencik with Jefferies and Co.

Hi, Joe.

Hello, Jeff.

I just have a couple of questions, I got on the call late so you may have addressed this and I apologize if you have, But did you say that your '06 expectation is now for 15% to 20% growth?

That is correct.

OK.

And now, if I remember correctly, you were talking about roughly $0.10 per share benefit from cost savings in Hungary.

So I guess what I am wondering is why that would not be more.

Maybe it is two different things that we're mixing together here.

What we said was 15% to 20% revenue growth in '06.

We did not give an expectation on earnings growth.

OK.

You are correct, and we still believe is the right number, by the way, that when we announced Hungary that I recommended that people take whatever models they had and add $0.10 to it.

Because that would be the improvement in our profit profile due to the outsourcing in Hungary.

OK.

Very good.

And in terms of the end of life products, I guess I do not understand what changed there, and why you did not know those products were ending -- or why your customers did not know they were ending.

Right.

It's -- end of life is the correct term for the life cycle of a product.

However, again, it does not mean it goes from full volume to nothing.

What it means is that when it is in a downward slope, sometimes that happens faster with our customers -- certain programs that customers anticipate.

We, unfortunately, do not have the insight into the end market.

In other words, when one of our customers is shipping a server.

We have our insight through what our customers tell us, and it would seem to me that you are probably right in what you are implying, that on a couple of programs our customers miss the decreasing demand that they were going to experience before they brought the new products into production.

OK, and for the new products that you are presumably designed in on, is that -- it looks like it is not going to happen in the fourth quarter.

Do you expect that to happen in the first quarter of '06?

Well, I think some of it comes online in the fourth quarter because we are projecting growth in the quarter.

But the majority of these projects, as you know, it's a 12-month gestation period on program wins, and we have for us an exceptionally large volume of program wins, and we have been talking about that over the last 12 months.

So that would say that the timing is toward the end of this quarter and certainly the beginning of the first quarter.

OK.

And just - I mean, I know you have 1.0 or 1.1 billion in orders over the last 12 months, which is huge relative to your annual revenue run rate in revenues.

Right.

So one question is, also, what were your orders in '04 for the whole year?

Let me clarify.

We do not have orders of $1.1 billion.

What we have are customer commitments to new program wins of $1.1 billion, but orders, which you then measure as a part of our calculation and backlog, those are specific releases from customers.

So we would be giving you two different pieces of information here.

OK.

I do not know if you would be impressed with all the things we have available sitting around this table, but it was new program wins over the equivalent 12 month period, I am not sure we have that to give you right here.

For the full year of '04 it was about $750 million.

OK.

And that did actually include a very strong Q4, which was almost $300 million, which is part of the last 12 months that we (multiple speakers), the $1.1 billion.

But in any case, you have very strong customer commitments that at some point should lead to a ramp beyond current consensus numbers when it starts.

So the question is when is that really going to start rolling in?

It starts rolling in in the first quarter, Jeff.

OK.

All right.

That is all I have.

Thank you.

You're welcome.

Now we have Jonathan Huberman with aAd Capital.

Hi.

Thanks for taking the call.

I just wanted to follow up on Tom Dinges' question on capacity utilization.

First, can you just go back and tell us how you define capacity utilization, and then give us a sense for what you expect the wireless side capacity utilization to be?

I think you mentioned 50%.

Do you have any idea what that is going to look like next year, and do you need to spend any cap ex on that side of the business?

The question on utilization I think is an interesting one.

We talk about it in the company as other manufacturing businesses do, because there are lots of ways to measure utilization.

And the important thing is to be consistent so that you get an understanding of where you would have to invest capital going forward.

When we give the numbers, we are using surface mount utilization.

So it does not include test equipment or burn-in equipment or factory floor space.

But surface mount is the largest single capital commitment, typically, that gates our ability to enter production.

So that is our definition as far as reporting, in these calls, utilization.

In 70-odd percent and 50% utilization, the way we presented it was by business unit.

So -- not by market.

So the first one is power, and the second one is the embedded computing space.

The need for capital next year certainly will not exceed this year, and there is a good chance it would be less because – certainly we are anticipating that because of our outsourcing program in Europe.

I hope that answers your questions.

Yes, it did.

I appreciate it.

I guess one last question.

On the 50% that's in the embedded, any thoughts on where that might be first and second quarter of next year?

I think you mentioned 80% for the other side of the business?

It is going to go up appreciably, the utilization, but I do not have the number with me so I would rather not make a guess.

OK.

Thank you very much, Joe.

(Operator Instructions)

We will move now to Brett Buckley with Dolphin Partners.

Hey, Joe.

Hello, Brett.

I guess, in the embedded systems and the wireless customer that you mentioned in the press release, can you just tell me what you think the primary driving factor is with their delay in their 3G deployments?

Internal technical problems.

Internal technical.

Yes.

For them.

I am sorry, I have been on and off this call.

When do you think -- do you have an idea when this delay will end, start --

On one, we have begun the production again.

And the other will be this quarter, although we have not yet.

OK.

So, soon.

All right.

Thanks.

It will be -- They will both be in the numbers before the year is over.

OK.

Thanks.

And it appears there are no further questions.

Ms. Rembaum, I will turn the conference back over for any additional or closing remarks.

Thank you for joining us on today's call.

We invite you to listen to our fourth quarter 2005 teleconference in early February.

That does conclude today's conference call.

Once again, we thank you for your participation.