奇異 (GE) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the ZENON second-quarter earnings results conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Wednesday, August 10, 2005.

I would now like to turn the conference over to Mr. Andrew Benedek. Please go ahead, sir.

Good morning, ladies and gentlemen. Sorry for the late start; we had a technical slipup on the conference call side. We also had a technical slipup in our quarter. We are very disappointed with what we have to report to you today. We had warned you prior to this quarter that this year, the first half of the year is not going to be like last year. It's going to be more typical of previous years, when we generally don't make much money in the first quarter, make more money in the second and accelerate and finishes on a high note. We are in fact there, but we still expect it to be much better this quarter. And we unfortunately did not get our 1000 production, the new 1000 production, to the level that we were estimating. Unfortunately, this only became clear as the quarter went on. And we have taken steps now to improve on that, and Rafael will discuss that with you.

On the positive side, we had an all-time record in bookings in the quarter. We see growth right across the globe in many of our new regions, but also in North America. So overall, what we have been telling you is still holding; it's a slipup in production that we are fixing, and the Company will have a very good second half of the year.

With this, I would like to pass it on to John Barker, our Chief Financial Officer.

Thank you, Andrew. As Andrew says, it was a disappointing quarter for us. Revenues were up 7% over last year at $62.6 million. There was a trend we saw, higher revenues in North America this quarter and a drop-off in Europe and Hungary. Europe and Hungary in 2004 was a very high quarter for us, so there was some upside from 2004. And the downside that was the drops we saw in Europe and Hungary were offset by increases in Asia, and that was mainly China. So blending it all together, we had a 7% increase, and it could have been higher, had we got the v3 production out.

Gross profit was at 36% compared to 39% for the year, still within our range. And there was some downward pressure, again, on the gross margin because of the v3 issue.

On our selling and general and administrative expenses, we're at 29% of revenue in the quarter; it's still above our targets. We do see our -- with the strong last half of the year, we still are predicting that this will come in in the below 25% range. Legal fees in the quarter were $1.7 million. And the other thing, when you compare it to last year, we had new sales offices and acquisition overheads built into this year, and that accounted for about $1.8 million of our SG&A increase.

I'd also like to comment on our legal fees, that Enviroquip has been settled. But with the settlement, there was no award for either party for -- and any costs. But the lawsuit is terminated, and there will be no more legal fees being spent on that lawsuit.

Operating income -- the major impact was about a $3.2 million drop in our income based on the v3 lack of production. And taxes are basically still holding at our 20% range, which we see continuing.

As far as cash flow, when you look at both our marketable securities and cash in total, we had a utilization overall of about $9 million. We saw some slight improvement in working capital over last quarter, where we had increased dramatically. We are still seeing some increase in our unbilled revenues. I think that reflects our -- that does reflect some extended buildings in our municipal accounts. That increase was about $10 million in unbilled revenues in the quarter. Hopefully, we see some of that coming out in the fourth quarter of this year, as the payments become due.

Generally, the 9 million that was used in cash was used for the purchase of capital assets, and that was pertaining to mainly our Oakville plant and some rental CapEx, some pilot units throughout the Company.

Thank you, Andrew.

Rafael, would you go over operating issues?

I'm going to focus most of my talk on the v3 problems, as that was our major issue for this quarter. In summary, I think we have to admit that we underestimated the complexity of this particular manufacturing expansion. It involved installing new production equipment with new manufacturing processes, a higher level of automation as well as a tripling of our capacity. What also caused us significant problems with this is that, in order to get this new equipment and line installed, we had to shut down our old line. And I think we had a very aggressive schedule that we were not able to meet, in terms of how long the period would last where we had no production coming from the old line while the new line was not yet ready. And that lack of production and a longer window than expected was the main source of our problem in the second quarter.

I'm pleased to report, though, that the ramp-up is now going well. We are making good, high-quality products. All of the equipment is working, it has now been validated, and we are in the process of now just ramping up to get to our full production targets. As a result, we expect that most of our production shortfall for the year will be made up in the second half of the year, so that will have a positive impact on our earnings for that part of the year.

In addition, no customers will be impacted as a result of this issue, that all of our orders will be fulfilled. And, because we have some very large orders with production spread out over 12 months, no delivery deadlines will be impacted, as well. In our compressed schedule, we will be able to meet all of our delivery obligations.

Finally, I would just like to finish with the fact that our product is working very well in the field. I think the v3 ZeeWeed 1000 membrane is clearly the top-performing membrane in the world. And now, with our manufacturing production ramp-up, this is going to become one of our largest product sellers in ZENON.

Thank you very much, Rafael. We are standing by for your questions.

(OPERATOR INSTRUCTIONS). Bert Powell, BMO Nesbitt Burns.

Andrew, what was -- coming up with the $3.2 million in operating profit that was as a result of the production issues, what was the revenue you used to come up with that?

John?

It was just approximately $6 million, and there was some strong margins on the mix that we had predicted for that quarter.

So this would have been just straight membranes, though, with that kind of margin?

It was a mix.

And when you missed delivering stuff, although you stated that you are planning to -- nobody is going to be affected -- clearly, some people will be affected. Is there anything that you guys anticipate, in terms of penalties for missed deliveries, those kinds of things?

We generally are the last part of a plant to be installed, and to make our modules, we often will start fairly early and run our plants at a fixed capacity level in order to make sure that we have a window prior to when we need to ship, because our production is constant but our orders are very choppy because -- and on one particular order, we have got one which is taking up a good portion of a year's production, so -- with the delivery deadline, which is well into 2006 and could even slip later. So therefore, we are able to manufacture the product now that we have the ramp-up proceeding in a way which is not going to significantly inconvenience our customers.

So the production line now is running version 3 only, correct?

Yes.

If we look at the backlog for the quarter, how much of that backlog is attached to the 1000 product, the new version?

We don't have that number available. We have basically two products, those of you who are not that familiar with us. One is the 500, and the other is the 1000. All the comments here is the 1000. The 500 continues full pace.

We don't normally release the exact proportions of those two products. As it is, with competitors sitting on the line as we are talking, we're the only company in the world that is a pure play in this field. And so we already released much more information than anyone would even dream of, among our competitors. And we, of course, do our very best to keep you informed, and we do release what we think is appropriate. We are proud of the openness with which we treat our shareholders.

John Chu, Research Capital.

Can you give us a sense of when did this actually happen, and how long was this delay or the lines shut down for?

We had a ramp-up period, so we weren't expecting by any means to be full production. In fact, we won't have that even this quarter. But we had a significant level of production in June, and we basically had the pieces in play. But the complexity of the issues which just kept dragging to get to that level of production -- anything you want to add to that?

Just to clarify that we had a significant amount of production planned for June and for late May. And that was well short of what we had planned. That was the main period with also extending -- when you delay that ramp-up, then of course it's going to be delayed out longer.

So you saw some of the production delays starting late May, early June, I guess -- late in the quarter, that is, when you started seeing these problems?

John, you should know that this never happened to us before.

Right. And that was going to be another question. So I don't think this has ever happened before, so it seems to be more of an anomaly than anything --

Let me address that. Everyone -- we built -- we put a major (indiscernible) in Hungary. Everyone expected us to be late, not to have product sales in the beginning and have a major hit on our numbers. In fact, the reverse happened. That plant went in well ahead of schedule, below budget, and the production was high-quality immediately.

In this particular case, we have gone up the ladder to both a more sophisticated manufacturing, as Rafael outlined, but also our quarterly tolerances (ph) and so on have been increased because we really want to continue to be the first, by far, in the world. So we just underestimated the complexity.

And, as I mentioned, the final factor was that in most of our capacity expansions, it's an incremental expansion, so it's adding another line to existing lines. This was a different one; there were certain parts of the production process that we had to replace completely. So that's fairly rare that we have a situation where we have to do a shutdown to do a capacity expansion. So all of these factors together are what contributed to the problem.

So going forward, are there any other transitions taking place for a newer series that would require that kind of same process?

No, John. The issue is that we had been delayed. We are just now getting to where we were supposed to be in June, and we feel that we have got this problem more or less licked.

Now, just following up on Bert's question, so there were no fees or penalties or lost customers as a result of this?

No.

And just in the press release, you mentioned on the 3.2 million, in terms of operating profit -- you indicated that most of this loss will be made up over the next three quarters. Are you not going to be able to recoup all of that loss, or am I just misreading the wording of that?

Well, in the quarter you don't recoup that quarter, for sure.

No, but over the next three quarters or going forward, do you expect to recoup all of the --

We will recoup all of the revenue, because we will be fulfilling all of the orders. However, in terms of our cost base, it's obviously having the plant not producing. And continuing to have people in the plant means that we have unallocated loss which we are not going to be able to recover. So that's going to be a hit, but most of the profit and all of the revenue will be recovered.

And then, just finally -- well, actually, two questions. Just on the oil sands and the oil fields, have you had a lot of orders from that area? Or is that just something you just started to get some business from recently?

We have been working in this field for a long time. We work around the globe, actually.

But this is probably one of the bigger contracts that you have --?

As you know, a tallsands (ph) plant is a very big job for everybody. It's big money, and the water part is a very important part of those plants. But you don't have tallsands plant every day.

And just finally, one last question. Just on the backlog --

-- probably because Canada needs that oil revenue. Maybe we will become the blue-eyed sheiks.

Finally, just on the backlog, can you give us a sense of whether municipal orders are representing a larger proportion of that backlog with the new orders that you have coming in?

No. I think we are maintaining --

The status quo?

-- pretty much what we had. In fact, if anything, the industrial side, given the big order that we talked about, increasing a little faster than municipal. But the good news here -- I want to repeat that -- is that the membrane adoption is happening worldwide. The market is increasing significantly, and we are by far the market leader, and we will continue that.

And actually one last question. Just pricing pressures -- are you seeing that right now, or is that not that bad?

It's normal. In fact, some of it is good. The lower the price, the wider the market, and we have been always faced pricing pressures throughout our history. And that's the reason we constantly invest in R&D and develop new products, so we could maintain the margin as we have over the years.

So the pricing pressure does have a cycle. The market grows significantly, more people are willing to subsidize their sales. But in the end, the largest volume manufacturer with the best marketing presence has major advantages that will ride it through the long term.

Sara Elford, Canaccord Capital.

Some of my questions have been answered, but I have a few more. With respect to some of the changes that you mentioned with respect to the production side of things, you talked a little bit about the installation of new production equipment and then also increased automation. And I guess what I believe to be the case -- and I just want to clarify it -- is this new equipment or some of this new stuff coming from the acquisitions that you made in Germany earlier this year? Is that some of the changes that you are making there in terms of the production side of things?

No. This equipment was really designed last year. There's a fairly long leadtime here, so it's going to be future improvements that we're going to get from the German acquisition. And just to clarify what was mentioned before, when we do most of our improvements, it does not involve decommissioning a manufacturing line and then installing a new one. Most of the improvements can be made by upgrading certain parts of the manufacturing line.

Okay, so I understand. This one is obviously the Canadian facility and relates to the 1000. I'm just curious; are there similar plans or similar changes anticipated for Hungary in the 500 line?

Hungary has expanded several times since we first built the plant several years ago. Those expansions have gone well, and they involve replicating pieces of equipment in lines to just produce more. So they have not involved decommissioning any equipment. But in the majority of our expansions, they go well, they're performed on time and on budget, and we don't necessarily make a big deal out of them.

I guess the other thing that I just wanted to try to understand, when you talk about the v3, is that a product that is specifically specified in any given project or contract, or is that something that it's entirely up to you as to which 1000 membrane you deliver? I'm just curious as to whether or not customers have been anticipating the v3, or whether or not that is something that is more or less irrelevant to them but more relevant to you.

It's exactly like the Pentium 4 versus Pentium 5. It's the same size, it looks the same and they are interchangeable, but it has more capacity.

And then, could you help me -- I don't know whether you're going to be willing to answer this question, Andrew. But I'm curious of the cost reduction magnitude of the v3 relative to what you have had out there. I understand --

We generally don't introduce -- it's not worth introducing a new product unless the savings is over 20%. This is significantly over that.

And as in past years, that additional cost reduction will be used to open up the market? That's fair enough to say, that it's already something that, as far as savings would go, would be used for market expansion?

It's used to maintain our margins, but the net result is that it's more cost-effective for the client, and we continue to be the leader and expand our markets and maintain our margins. At this stage of the game, with this added growth globally and people willing to invest, I think that needs to continue to be our policy.

And then, I have one final question, and this is really just a clarification, because I always find the segmented data a little bit confusing. And I know it's probably tough to put together, but the one thing that confused me during the quarter was in the context of some of the production delays that we have all discussed, I'm just trying to understand how for the quarter we have external -- when I look at external revenue, technology membranes in corporate specifically, it's a high number, and it's higher than what we have seen in the past. And I would have thought -- I'm sure you can help me understand why it would be the case, but I would have thought that that would be a number we see hit during the quarter. So maybe help me understand why that -- what drives that number, and why it would be high during the quarter, when the production delays were experienced.

That relates to membrane-only sales. And we still were producing our 500's.

So the difference, really, was obviously all 1000, and what we see there is just a very strong quarter for 500's. Is that right?

Yes.

And then, just finally, and in the same breath, I'm curious, Andrew -- I know you were heading up, until recently, the European operations. Is there anything in particular there, other than the fact that it's still an emerging market, that is causing the year-over-year revenue decline, and then also the losses on an EBIT basis over the first couple of quarters? Is there any color you can provide on that?

It's a very important issue, so you are right to ask it. We have been investing significantly in opening up new markets, and they are paying off. But the problem is there is a two-year lag time between investing and pay it off. We are seeing that, so you see the backlog increase. That's continuing. Many of our new offices are doing great in bookings, but you see 0 revenue for them for at least another year. We see enormous opportunities in these markets. We have invested significantly some of them. Because we see them, we are bidding on major jobs, we are getting the orders. Sometimes we are not even getting the orders yet, like in Australia, but we see tremendous water shortage problems that will ultimately result in big orders, and we have to staff it properly. So we are carrying the costs.

As far as the European revenue side, John mentioned already that it was unusually strong first half of the year last year. It's not bad, but the backlog is up right across Europe. Now, we also are carrying a couple of acquisitions, and we are carrying the SG&A associated with these acquisitions. These are also not yet contributing to the level we will see them contribute.

So that is included in Europe and the Middle East, that segmented data, then?

Yes, it is included. We are starting to do well in all of the regions in Europe. I'm very proud to say that.

Lawrence Casse, M Partners.

Just to go back to the manufacturing issues, as a general point, you have talked over the last year about reducing your manufacturing costs in half by 2007. Is that still on track?

We have talked about reducing our total costs for water treated, which will include a major reduction on the order you're talking about for manufacturing. That is, with installation of the v3 line, that takes a major step forward in achieving that objective. And so, by 2007, we're going to be on track to be where we need to be. This is not going to delay that in any way.

So if I had to take a percentage of reduced manufacturing costs over the next year or two -- in other words, how much you're reducing your manufacturing costs by introducing these new lines -- could you give me an estimate? Would it be 20%, 25%?

I don't think would want to go into more detail.

Now, I noticed you mentioned quite a number of industrial orders in the mix of backlog. Do you see the mix changing between industrial and municipal?

These mixes change from quarter to quarter. You need to look on it on a longer term. I do believe that industrial will increase over time, because we're slightly higher in municipal than in industrial, as the market goes. But it's not quarter by quarter; you can't read that trend from quarter to quarter. You have to maybe look at annual trends, perhaps is a better way.

And on the industrial orders, what is the timing cycle compared to the municipal? Obviously, it's going to be shorter, but can you give me an estimate of the lengths it takes to deliver a typical industrial order?

It depends on the size of the order. If it's a tallsands plant, it's closer to the municipal cycle, which is one to two years. If it's an industrial, medium-size order or smaller, then it could be as little as six months.

And finally, just in terms of China, have you received any orders for municipal drinking water or wastewater in China yet, or do you anticipate receiving some in the next six months?

Pretty much most of our projects are industrial. We have a municipal job from Beijing for recycling water for the Olympics. We expect more of those kinds of jobs.

Anoop Prihar, JMP Securities.

Just with respect to the Burlington plant, when that capacity expansion is complete and ramped, what will be the order of magnitude increase in production capacity?

I had mentioned a tripling of capacity.

Tripling? Okay, great. Just with respect to the lawsuits, as well, the Enviroquip, you indicated, was no longer going to be an issue from an expense perspective going forward. But if I'm not mistaken, at the end of the first quarter, we were talking about potentially recouping some of those costs. I wonder, can you tell me where we are on that front?

The agreement we have done is that we settled that we are not proceeding on a meaningless lawsuit. We still have an opportunity to recoup those costs. We are debating whether to do that or not. John is assuming that, at least from that lawsuit, as it is, we are not spending more money. The only question is whether we're going to spend more money to get some of our costs back.

For those of you who have not followed that particular lawsuit, it was a lawsuit which we believe was inappropriate. We were defending ourselves on charges that had no validity, in our view. And in those cases, you can sue for a malicious lawsuit. And we are debating -- we were debating and have continued to debate whether or not we should take the risk of getting some of our costs back. But they were significant.

So to recoup your costs, then, that's just not a negotiation process; you actually have to go to court to get that?

That is correct.

And with respect to the costs you incurred on the U.S. Filter suit in the second quarter, I was somewhat surprised by the magnitude of those costs. Is this going to be the case that you believe, for the second half of the year, as well, that will continue to incur costs at that level?

Remember, in the second quarter, we had the first major hearing in the case. And that's where -- the preparation and the actual execution of that hearing is where most of the costs went into, and as we reported, we were very successful in that hearing. We are planning on having another hearing in the fourth quarter. So that's also going to be fairly costly.

And just with respect to Homespring, the potential change of control at Maytag -- what impact, if any, would that have on your relationship with them?

There has been no significant change, but as you can imagine, a company that is in those kind of circumstances is not as active in pursuing the sale of new products as it could otherwise be. So it has been slower than we expected.

(OPERATOR INSTRUCTIONS).

It sounds like we have answered your questions.

Pardon me, sir; we have one further question. It's a follow-up from Bert Powell.

Just quickly, I want to make sure I understood this. There was 1.8 million in integration costs that were booked into G&A that won't be there next quarter that were there this quarter? Did I get that right?

No. That's the cost compared to last year that we're incurring for our new acquisitions and the opening up of new sales offices.

If there are no further questions, thank you for tuning in. We appreciate your listening to our story, and we look forward to having a better discussion three months from now. The universe, in our view, is still unfolding as it should. Thank you very much.

Thank you. Ladies and gentlemen, this concludes the ZENON second-quarter earnings results conference call. Thank you for participating in today's conference. At this time, you may now disconnect.