漢威聯合 (HON) 2003 Q3 法說會逐字稿

Good morning.

Thank you for joining UNOVA's third-quarter 2003 earnings review conference call. (OPERATOR INSTRUCTIONS) This conference is being recorded at the request of UNOVA.

If you have any objections, you may disconnect at this time.

I would now like to introduce your host for today's call, Mr. David Brooks, Director of Corporate Public Relations and Investor Relations.

Sir, you may begin.

Thank you, Missy.

Good morning everyone.

Welcome to the call.

Your hosts today are Larry Brady, CEO, and Michael Keane, CFO.

Before we begin today, I wish to remind investors that statements made in the course of this conference call that express the Company's or management's intentions, beliefs, expectations or predictions of the future are forward-looking statements.

It is important to note that the Company's actual results could differ materially from those projected in such forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially is contained from time to time in the Company's press released and in its SEC filings, including but not limited to, the Company's annual report on Form 10-K for the year ended December 31st, 2002 filed in March of this year, and the Company's report filed on Form 10-Q for the quarter ended June 30th, filed in August.

Copies of these filings may be obtained by contacting the the Company or the SEC.

And now it is my pleasure to introduce Larry Brady, CEO of UNOVA.

Thank you, David, and good morning everyone.

We're pleased that you could join us this morning for the report on our third-quarter performance.

A summary of our performance reads much like our reports in prior quarters, that is achieving the third quarter expectations we set in our prior conference call for our industrial automation business, and exceeding the outlook we provided for our Intermec business.

We also continue to break new ground in net debt reduction to the point that we have had to change our vocabulary.

We have increased cash to a level that exceeds our outstanding debt.

Just as a reminder, our net debt three years ago was nearly $500 million.

Mike Keane will update you on the progress and trends later in this presentation.

There also some new themes in our third quarter report.

These include more aggressive spending at Intermec on targeted growth programs in R&D and enterprise selling; the rapid stimulation of customer interest in RFID, following announcements by both Wal-Mart and the Department of Defense; and divestiture of one of our industrial automation divisions that was market disadvantaged and experienced chronic losses.

The selling price approximated the book value of assets sold.

For the quarter, and adjusting for the sale of Lamb Body & Assembly, UNOVA's continuing operations earned a $16 million segment operating profit on sales of $278 million.

After corporate expense, special charges and interest, the Corporation earned $6.1 million pretax from continuing operations.

As has fortunately become commonplace in our quarterly calls, we again had favorable intellectual property settlements in the third quarter of this year and last, eliminating the pretax effect of the IP settlements and special charges, pretax income for the Corporation from continuing operations was up $6.3 million on a sales decline of $15 million.

At this point it is probably most beneficial to move to segment comparisons for a more detailed look.

We'll start with the Industrial Automation Segment.

Our IAS segment in the third quarter, as projected, showed a slight improvement in the rate of loss from continuing operating versus the second quarter of this year, improving about $1.8 million on a $1.4 million sales decline, versus the prior year quarter losses increased $2.3 million on a $20 million revenue decline.

It is not so much the comparisons to prior periods, however, as the progress on our turnaround plan that will measure future success.

We commenced a consolidation plan a year ago in our Industrial Automation Segment with the purpose of achieving breakeven level spending by the end of 2003.

The turnaround plan was complex, involving division mergers, plant and IT consolidation and relocations, substantial manufacturing outsourcing, and a large personnel reduction.

The more difficult and risky parts of the plan are largely complete.

The Hebrawn (ph) Kentucky plant has achieved a successful startup, building all-new aerospace orders, and all spare parts there.

The last few projects at the old Oakley campus of Cincinnati are being completed.

The Mega (ph), our newly introduced large horizontal machine has been moved to our Windsor, Canada plant.

IT consolidation was completed last quarter, and headcount reductions of more than 800 personnel are running ahead of plan.

As we suggested last quarter, however, these changes are not achieving the desired breakeven level due to an erosion of gross margin over the past year.

To date we have reduced costs by more than $40 million annually.

This effect has been partially offset by gross margin declines.

In the upcoming quarter, we anticipate only a small improvement.

Cost reductions within the period, but not fully reflected, will total about $2 million.

Thus, we will fall short of our breakeven objective.

There are two paths to resolve the remainder, further headcount reductions and improved margins.

The special charges that you see for the third quarter reflect some of our intentions.

Final budgets our being prepared to remedy or the remainder.

These actions to be taken over the next 90 days should allow achievement of breakeven.

Interestingly, several other factors could contribute.

Firstly, the number of large international projects is increasing.

Several of these involve large volume diesel engine programs where optimal process knowledge is our sweet spot.

Secondly, those aerospace programs involving our composite equipment are nearing threshold for equipment orders.

This has the potential to add a higher margin increment to sales growth.

Let me comment on three additional items before leaving this segment.

We completed the sales of our Body and Assembly Division in September.

The business was seriously market disadvantaged versus its competitors having a world market share of well under 3 percent, and losing money in each of the past three years.

As such, the unit required either significant investment by UNOVA, or consolidation with another entity.

The buyer provided that improved scale.

The transaction price was approximately equal to the divested assets.

Corporate cash flow has benefited from the divestiture and from reductions in the working capital of the remaining IAS business as well.

Excluding the divestiture, working capital reductions have totaled in nearly $90 million in the last 12 months.

Also, some commentary is in order about backlog adjustments as a result of the divestiture.

The Body and Assembly business represented about $10 million per quarter in bookings and sales.

And backlog at the time of the divestiture was also about $10 million.

As a result, our bookings in the quarter of $106 million represented the result after the adjustment.

Without adjustment, bookings would have been at the top end of our bookings run rate.

We have told you that for the last, literally, almost two years our bookings level has been running at 115 million, plus or minus 10 to adjust that for continuing operations, you would subtract $10 million because we also took out the backlog, and an unadjusted level would have been 126 million, or the top end of the range.

Next I would like to return to the subject of our new product from Cincinnati the Mega manufactured at our Lamb plant in Windsor.

As we have consolidated business units, we have improved across division understanding and cooperation.

One result is the large number of hanes (ph) quoted for Lamb Flexible Machining Systems.

The new machine has resulted in a meaningful improvement in cost and functionality for our Lamb Transfer Line, an important feature given the surge in offshore opportunities.

Finally, we continue to show promise in our Asian alliance strategy.

In September we signed an agreement with Shenyang Machine Tool Company, the largest machine tool company in China.

The new alliance expands our ability to access China's rapidly growing manufacturing industry.

The agreement also provides a competitive advantage for growing incremental business in markets outside of China by utilizing the expertise, resources and experience of both businesses.

We will collaborate with Shenyang by leveraging our system integration, assembly, and installation expertise with Shenyang sales and service capabilities and lower manufacturing costs.

As I indicated earlier, IAS is taking a highly directed strategy in China, bidding on projects where we have a specific competitive advantage, programs which require machining systems to produce high volumes of diesel and gasoline engines.

Turning now to Intermec, we should first discuss the guidance we provided last quarter.

We projected an increase in sales in a range from 0 to 5 percent over the prior year quarter, and that incremental profits would return to our targeted range of 30 to 40 cents over our quarterly breakeven sales level of $145 million.

The projected sales range was therefore between 162 and 170 million.

Our actual results were up about 4 percent in the upper end of our projected range.

At the upper end of our projected profit range, actual sales would have produced a segment profit of $8.9 million.

Our actual profits were nearly $13 million.

Let me just explain the model to make sure everyone understands.

If you take actual sales and subtract 145, which in this instance would give you a number between 20 and 25 million, and then multiplied it by 40 percent, that is the sales over breakeven that would experience an incremental margin of 40 percent, or fundamentally, the ability to get all of our gross margin to the bottom line.

Were you to do that calculation this quarter, you would have achieved a number of 8.9 million.

Because we did 13, obviously we exceeded that.

And the recently we exceeded it is because our margins improved in the quarter.

It is clear from the estimates that followed our production last quarter that some of you had begun applying a favorable forecast error to our projections.

While I would discourage this approach, it is equally clear that in this instance you were more right than we were.

It is also important to put our sales level in perspective.

From the first to the fourth quarter of last year, sales increased 25 percent.

In the third and fourth quarter of last year, our product sales increased 13 percent and 16 percent, respectively over the prior year quarter.

Our core Systems and Solutions business increased 24 percent and 21 percent over the same respective periods.

These increases were well above market growth.

As we explained at the time, the third and fourth quarter benefited significantly from a large enterprise account that was not repeated this year.

Thus in the third, and again in the upcoming fourth quarter of this year, we have to grow our base business by over 5 percent just to maintain the prior year's sales level.

Now we'll examine the product and service revenue comparisons in more detail.

Growth over prior year came from the same sources of strength that we have seen all year.

Versus the third quarter of 2002, our core Systems and Solutions business increased 6 percent; service increased 9 percent; and Printer Media decreased 5 percent.

Sequentially, Systems and Solutions were up 1.5 percent, while Printer Media and Service declined by 9 percent and 5 percent, respectively.

Importantly, gross margin improvement was more favorable than sales improvement in every product category on both a prior year and sequential basis, continuing established year-to-date trend.

Geographically, Europe remained our region of strength.

Versus the prior year quarter, Europe increased 42 percent;

North America declined 4 percent; and the rest of the world decreased 27 percent.

Sequentially, North America was up 1 percent, and international markets were down 8 percent, reflecting traditional seasonality.

The currency impact versus the prior year quarter was about $5 million.

And sequentially it was less than $1 million.

Looking at sources of profit, continued improvement in gross margin is more than offsetting the impact of higher spending to support strategic investment.

Product and service gross margins have improved by more than 3 points versus last year, accounting for the more than 3 point improvement in segment profit margins.

Expenses were up by a little over $2 million versus the prior year quarter.

In fact, no single event has dominated the quarter more than the discussion about RFID and Wal-Mart's historic announcements in June.

Just after the end of the quarter, the U.S.

Department of Defense announced its own plans that will require an RFID tagged on shipments in the DOD supply chain starting next summer.

Next week in Bentonville, Wal-Mart will hold a technology demonstration where Intermec and several other suppliers will showcase RFID technology to an audience of Wal-Mart's top 100 suppliers.

In December the DOD will hold a similar showcase.

These are two very large customers who represent the ability to drive behavior in their supply chain.

Their requirements will likely accelerate both market development and the adoption of standards so critical to broad-based market acceptance.

To hasten this process, Intermec has been an active participant in global and national RFID standards activities.

Further, we have a long, established record of licensing and cross licensing our intellectual property to support the development of standards.

In fact, Intermec's IP has formed the basis of important global RFID technical standards, such as ISO 18000 and ANSI NH10 (ph).

Also Intermec had been a member of the Auto ID Center for several years, and believes the center has performed a valuable service in promoting RFID technology awareness and potential benefits.

We support the goals of the Auto ID Center's new parent organization, the UCCEAN (ph) and its subsidiary, EPC Global, in their work to create an electronic product code, or EPC standard.

We're actively working with a consortium of Auto ID Center members as part of the hardware advisory group to create a technical standard that will accomplish the needs of Wal-Mart and the DOD, while preserving a bridge to global ISO compliance.

Beyond standards, we're helping customers identify and solve downstream issues surrounding RFID implementation.

Our new partnership with Georgia-Pacific Corporation is designed to help companies understand how to meet retailers' RFID requirements with respect to packaging.

Intermec and GP will work to support all levels of case and (indiscernible) tracking at distribution centers and in the stores via a variety of systems.

Apart from RFID, we are launching another development within our traditional AIDC market business to tap into the small and medium business market.

According to Gartner Group, small and medium businesses, or SMB's have the highest percent increase in IT spending -- will have the highest increase in IT spending in the next five years.

Several companies are already addressing this opportunity from the application software side, including Microsoft UNIX, Now Vision (ph), Great Plains, and Saul (ph), SAP's Business One, and J.D.

Edwards' One World.

All are tailored to meet the needs of SMB companies.

An investment in ADC software for SMB warehouse and distribution center applications provides a meaningful boost in ROI.

Microsoft's research has shown that ADC systems can accelerate the payback for its Great Plains ERP software from three years to one year.

Intermec's comprehensive product line positions the Company as a supplier of choice to provide fully integrated solutions.

Our easy (ph) ADC trademark will be launched later this quarter and be commercially available in the first quarter of next year.

Warehousing and distribution markets will be addressed first with Great Plains and SAP Business One, both of which will be available early in the fourth quarter.

Earlier this year we communicated the strong shift in our business toward wireless capabilities in our 700 product line.

In fact the number of Intermec handheld terminals ordered with some wireless capability continues to increase.

These are all terminals, global or industrial, with either bluetooth, LAN or WAN capabilities.

As wireless infrastructure becomes more accessible, both in terms of proximity and cost, customers increasingly see the benefits of a wireless enterprise.

Advances include real-time signature capture, or wireless dispatch for logistics operations, improved inventory accounting, and a fast-paced warehouse, or the elimination of bulky printer cables for the DST driver.

These visible benefits stimulate customers to consider system upgrades, expansions, and whole new automation programs.

Finally, in view of the unusually strong third and fourth quarter comparisons that we discussed earlier, our outlook for the fourth quarter will be flat more or less with the prior year, and up 4 to 8 percent sequentially.

Profit versus the prior year period should be at the upper end of our 30 to 40 cent incremental profit over breakeven sales.

If you do the math, that equates because of the unusually large enterprise sale last year, that equates to about an 8 percent compounded growth in each of the third and fourth quarters versus over the two year period.

If Intermec accomplishes this projection, the full year 2003 result will have been an approximate 7 percent increase in sales, with a profit improvement multiple of 2.5 times the prior year segment results.

I will now turn the discussion over to Mike Keane.

Thank you, Larry.

And good morning everyone.

First, I would like to make some comments regarding our restructuring activities.

Our special charge of the just under $1 million in the third quarter was in line with our expectations, and they reflect the ongoing cost reduction efforts.

Our expectation is for these charges to be slightly higher in the fourth quarter as market conditions cause us to increase our cost reduction activities within our IAS segment.

The nature of these charges will primarily be severance costs, which will lead to immediate benefits in 2004.

The loss from discontinued operations of 5.5 million in quarter 3, and 9.3 million year-to-date, represent operations and the sale of our Body and Assembly Division, including a loss on sale of 3.1 million in the third quarter.

We received cash approximating the net book value of the assets transferred.

And the loss on the sale is primarily due to the certain severance of lease obligations not assumed by the buyer.

Our balance sheet continued to strengthen in the third quarter.

As Larry previously indicated, UNOVA continued to generate positive cash flow in the third quarter.

As a result, our cash balances are 226 million, and now exceed our debt balance of 208 million by approximately 18 million.

That represents a positive change in net cash flow of approximately 23 million for the quarter and 64 million year-to-date.

The positive results for the quarter were principally attributable to profitable operations at Intermec, continued reduction of networking assets within our industrial automation operations, and the sale of our Body and Assembly Division.

Further sales of idle real estate and equipment, including our Cincinnati campus, will contribute to the future clash flows of the Company.

These assets have a current net book value of 30 million, and have been classified as assets held for sale within our balance sheet as of September 30th.

Our goal is to monetize these identified assets within the next 12 months, if not sooner.

As we have previously stated, we have no bank debt outstanding and we have no expectation of bank borrowings in the foreseeable future.

The balance sheet is strong and provides us a proper foundation to invest in UNOVA's future growth.

Our depreciation and amortization was 6.2 million for the third quarter, compared to 7 million in the previous quarter, and is reflective of our ongoing emphasis to monetize excess or inefficient assets.

This run rate should continue to trend lower in the fourth quarter.

Total capital expenditures of 14 million year-to-date are on plan, and in line with our expectations to invest approximately 20 million in 2003.

We have previously stated that we expected capital expenditures to be somewhat lower in 2004, however, we identified several growth opportunities within our Intermec business that may require a modest increase in our overall capital expenditures in 2004, offset somewhat by lower expenditures within our IAS segment.

As a result, our overall capital expenditures in 2004 may approximate our levels in 2003.

We are currently in the middle of our 2004 budgeting process, and we will be able to better communicate a range of investments during our year-end call.

Thank you, Mike.

And now, Missy, could you open up the phone lines for people's questions?

(OPERATOR INSTRUCTIONS) Walt Liptak of McDonald Investments.

First question I have got is on the IAS part of the business.

You had mentioned that there were a couple of things that look like they are going to be in the pipeline shortly, some diesel truck projects, some aerospace, as well as China.

I wonder if you size those opportunities for us?

They would all be in the category of elephant hunting, Walt.

The business, the Lamb business in particular has long been characterized as a business where we have this sort of flow of smaller projects and refurb projects, but then every once in a while we get this 20 to $50 million program.

There are several such programs currently in the Asia-Pacific markets.

Because of the fact that we have not historically participated in those markets, that we're working with alliance partners, the predictability is much different.

The only thing we can tell you is that the combination of our greater exposure to that market at this point, and some of the benefits that we're seeing from our lower-cost position as a result of the Mega Machine, give us some optimism.

But it is a tough call, like all really large programs.

But they're all north of 20 million, or the several that we are talking about are north of 20 million.

In August, you may or may not have seen this, but in August the AMTBA (ph) reported higher machine tool orders sequentially.

Yes, sequentially after this disaster.

Have you been seeing a pickup in standard machine tools?

No, we have not.

What we have seen, as we reported with the bookings level of higher end of the range, but that is not anything to write home to Mom about.

I think what we have been seeing are some more of these international automotive projects that we have not historically seen.

And that is where the opportunities seem to be.

On the operating margin at Intermec during the quarter, was there some R&D spending that was pushed out, because the margin was obviously a little bit higher than we expected?

I know part of it was due to the gross margin, but is the R&D spending on track?

And then if you could quantify it for us, R&D spending for RFID work versus Model 700 and other mobile computing?

I'm not comfortable with your last question.

But the answer to your first question is, we have not been able to, and we have cataloged that in each of the last two reports.

We haven't been able to spend R&D at the level -- we're continuing to accelerate in R&D.

We're spending more money than we have as indicated in the comments.

We will continue that trend.

We will continue to accelerate.

RFID and data capture in general will be, from an R&D standpoint, the major recipient of that, but also the whole idea of the comeback that we're hypothesizing in the industry suggests that greater spending for several large enterprise accounts.

And in conjunction, the market development support in these accounts for RFID requires a greater spending level.

So we will continue (multiple speakers)

One more question and I will let someone else go.

Just to clarify, in the IAS segment, it sounds like breakeven is going to push out from the fourth quarter of this year into maybe the first quarter of next year.

Is that what I'm hearing?

I wouldn't say that.

What I would say is it probably will not occur in the first quarter.

And that is just the dynamics of the first quarter.

It is when we recognize margins, when we typically have a weak baseline quarter.

Right now we think it will occur second or third quarter of next year.

And we believe that if you look at the progress we will make we will wind up exiting the year with a small profit.

Mark Roberts of Wachovia Capital Markets.

Did I understand you to say that the meeting with Wal-Mart where you will be for exhibiting your solutions will be next week?

Yes, November 3 through 5.

November 3 through 5.

And of the -- your best guess -- you may know it specifically, you may not, of the top hundred suppliers of Wal-Mart, what percentage of those are existing Intermec customers?

No, I don't know the answer to that.

Do you have a guess?

We haven't identified that -- Wal-Mart hasn't identified the top 100, and the issue is that we're playing with a larger category than that.

But the expectation would be if we are upper 90th percentile of the Fortune 500, there is a large probability that we cover most, if not all of those accounts, but I can't give you that specific percentage.

(OPERATOR INSTRUCTIONS) Tom Carpenter of Hilliard Lyons.

Can you give us an update on the thermal printer market share, and also your handheld market share?

Maybe give us some idea of the trends for this year and what you think is going to happen next year?

No, because the data that we get, the data that we tend to use for market share, unless you just compare flat, here's our sales versus their sales, the industry doesn't have a good source of data, except data that comes out three months in arrears.

And so I can't give you a good answer to that question.

Our assumption has been that in the handheld market we're seeing an increase in market share.

But because none of us play in precise overlaps of vertical markets, and because we're all to some extent niche marketers, it is not a very satisfactory kind of a commentary.

In the printer business there are also lots of different comparisons when you look at total sales and the disclosures don't tend to be by vertical market, or even by printer type.

And so again, the comparisons get to be difficult.

Although the in that arena our assumption is that are market share is slightly declining, and it is declining because our approach to printer market is not so much a horizontal approach of we sell printers as, we pull printers along as part of a total solution in the handheld markets.

Great.

You touched briefly on the call about some of the standards.

Can you give us a little bit more color on the EPC, which I think is going to becoming out soon in the next month or next six weeks?

And also some of the differences on the EPC and ECC, talk about having some type of bridge between the two standards?

Sure thing, Tom.

Firstly, just for everybody's benefit on nomenclature, the old Auto ID Center and the MIT Group are folding the Auto ID Center into the efforts of UCC, which is allied with EAN, and created a subsidiary organization called, EPC Global, which will continue to rely on the old Auto ID Center as its research arm to continue to provide input.

That transition is actually scheduled for November 1, and it will be the intention of the hardware action group, and to a lesser extent the software action group of the Auto ID Center, to provide recommendations to UCC/EAN and to the EPC Global about future standards.

In our mind, there have been some historic standards work which I referenced, both the ISO and the ANSI standards in the past.

Always in standard's effort we work to try to get some kind of uniform activity so that we don't wind up with standards competing with standards, which is in an unfortunate potential outgrowth.

We, Intermec, have been a participant in the auto ID center, but as the center moved more and more towards standards, we developed a consortium of six or seven companies that represented all of the capabilities in the delivery of the system.

And that consortium has provided input to the Center for its work in establishing that standard and establishing that hand off.

And in our mind the activity is progressing well, and we're supportive of the activity.

And we anticipate that the conclusions which we believe UCC and EAN will reach shortly following the turnover, and following the recommendation from the hardware action group, are conclusions that we will be able to sport support and embrace.

Do you believe there might be two different standards, one initially for retail, then one for other industries?

That is a real hard call, but clearly we hope not.

Clearly we hope that the standards will all be compatible.

Now, let me just make sure that I answered your question correctly, because when I say -- when you say for retail, you might mean, will there be standards for line item tagging that are different than standards for pallet and container tracking.

And the answer to that question really depends on the technology we're talking about, whether we're talking about read only, or write once read many, or read write a number of times.

And in the infamous class 0, class 1, class 2 standards, we believe that over time those will become compatible.

There is some opportunity for line item tracking technology to be an outlier over a bridge (indiscernible).

Right.

That was more what I was getting at initially, there would be a different -- it seems like class 1 has a lot of traction right now, could there be a EPC class 1 initially for retail, just to get something out there, and down the road over the next -- they have to do something over the next year, year and a half to make meet the department of DOD deadline, again then maybe it evolves to something --.

At least my personal view, and it is my personal view that the issue around class 1 will, in fact, be resolved so that you got compatible standards within the timeframe of implementation of DOD and Wal-Mart.

Great, thank you.

I think they will both drive that as well.

Walt Liptak of the McDonald Investments.

Just to get an idea of what Intermec sales look like during the quarter, could you talk about just the monthly trends, and if you saw a pickup following the September Frontline show?

Sure.

That is an interesting milestone, Walt.

I am not sure that that was the driver, but it is true that we came into the quarter in what I would call midrange bookings level.

As we hit the end of July and early August, the bookings rate cratered.

We had a really had a really serious weakness.

We typically have some summer seasonality or some summer weakness, but this was extreme.

And then we saw a similar surge for the last three weeks in September.

So it was a more radical swing then we typically see in a quarter.

It does happen to have been timed with Frontline, whether that was a contributor or not, as you well know, do, Frontline tended to be largely dedicated to RFID in terms of both the interests of the players, as well as the interests of the attendees.

And I guess in October you talked about a surge in September, but are things continuing in October, and can you quantify --?

Things have leveled out to normal in October.

We don't see the heavy traffic that we saw in the last three weeks in September, nor do we see the falloff that we saw in the summertime.

In a question for Michael Keane.

You got a big deferred cash asset out there.

And I wondered if you could split that between the IAS and ADS businesses?

And in 2004, what the tax rate might be given the breakeven levels that you're looking for?

Well, first of Walt, we file a consolidated tax return.

So when you look at the deferred tax assets, except for the fact that you have some overseas pockets and statutory entities, it essentially relates to the Corporation as a whole, so you don't break it between the two entities.

What kind of tax rate should we apply to our 2004 number?

Well, that is going to be very interesting, to be honest with you.

As we turn profitable, I think you'll see a relatively though rate, because as you are probably aware, we have been providing evaluation allowances against any deferred tax benefit related to operating losses over the last year and a half.

As we turn profitable, those valuation allowances will reverse themselves as is required, because we have visibility towards future profitability.

That being said, you'll have an unnaturally low rate for awhile, but then as we move forward you'll see a normalization towards the 32 to 35 percent type rate.

Mark Roberts of Wachovia Capital Markets.

Just a follow up, if I could.

I've been trying to crunch through the numbers here a bit based on your comments.

If I look at your segment reporting for ADS, for example, this quarter it was 178.7 million.

And if I am understanding your guidance correctly, on both the division and Intermec, in particular, it sounds like you're expecting that to be up sequentially again in the fourth quarter.

Yes, but you're using the number which includes the IP settlement, Mark.

And you've got to subtract that, because any time we talk about outlooks, we only talk products and service revenue.

We don't talk IP.

So it would be from the reduced base, once you take IP out of it, and which it would be up 4 to 8 percent sequentially.

And then I was also trying to do the math on the incremental margin here.

And so if I am doing the calculation on the base level revenues correctly, my math is showing that the operating margins for segment in the fourth quarter should be around 7 to 10 percent, if you exclude IP.

Is that --?

Well, let me be as specific as I can in a calculation.

If you take the sales number that you picked, and you subtract 145 from that number, you should get a number that is north of 30.

And then you multiply that number by .4, which is the upper end of our incremental profit range.

Then you should get the profit, the pretax or segment operating profit number, that we would have.

Eli Lustgarten, J.B.

Hanhouer (ph).

A couple of questions.

One, does your order patterns for the IAS business include -- was it the Hyundai order that you got, or the KIA order, I am not sure?

It was a big one.

Yes, last quarter we had an order which we described as north of 50 Hyundai, and that broke this sort of 115 plus or minus 10 pattern.

What we said we would still have been in the range had we not had the Hyundai order, and so we're just using that as our baseline.

Are there anymore orders of the nature that will finally drive this business to profitability next year, or are we still awaiting something?

We firstly believe that what will drive us to profitability continues to be cost reduction rather than a significant surge in orders.

But large orders can always help us out.

There is no doubt about that.

And it is just -- it is always difficult to build a business based on large orders as we found on the downside.

The other side of that, is that there is in there the DOD composite order coming for the fighter?

What we believe -- that is what I was referring to in that text, Eli.

If you look at all the programs, both commercial and defense, we're reaching a point where folks have got to commit.

That is, in 2004 they need to commit in order to get composite machines consistent with either the launch of the new Airbus units, the potential new Boeing 77, or joint strike fighter.

All of those programs will tend to culminate in their early orders happening in 2004.

So we could see a significant surge.

You know, composite is not a large portion of our total business, but it does, because of our position in the business, it does result in improved margins.

And we could see something in the range of a doubling of that business next year.

So that is a positive impact.

Every 50 million helps, or so.

As far as the Wal-Mart show next to the DOD, is that going to be an individual showcase by each company, or is that going to be a consortium showcase?

In other words, you would partner --.

It is an individual showcase, at least in terms of teams of folks.

The Wal-Mart folks have announced that they anticipate that their suppliers will adopt RFID,but it is the suppliers who have to adopt it, as you know.

So what they're trying to do is provide as much of a marriage broker capability, where they bring the suppliers together with the technology as they can.

And they are also setting up a whole bunch of baseline measurements so that they, in their distribution center environment down in Bentonville, recreate actual scenarios that have to be dealt with by RFID tags, so that they can report the success of those developments back to the supplier base.

But it will be you, not you with IBM Systems, or anything like that?

Well, because IBM is a part of our alliance group, IBM Global Services will also be there with us.

And is there a change -- who would you view the competitive systems to be there?

If I am walking around there, who would I be looking for besides you guys?

Who do you view as your most significant competition?

You know, Eli, that I don't think we have significant competition.

And the reason behind that is not that there aren't competing RFID systems, but it is our conclusion in that in order to be able to provide RFID to the customer base, you need to be and AIDC Company.

That is to say, you need to have a -- RFID will be a transition activity.

It won't be, let's stop what you're doing and put this new system in.

It will be a transition that uses a combination of AIDC systems.

And we think only an AIDC Company can provide that.

Currently if you look at the overlap between RFID providers and AIDC companies, it is a very thin population.

One final question.

Any more IP settlement coming in the fourth quarter or so?

Where are you in that process at this point?

We do not forecast IP settlements.

I've been coached on the wording of this terminology.

But the truth is they're getting real thin.

We have just about milked that for everything that is there.

The people that we continuing to deal with are the real combatants.

These are people that are just hostile by nature, and we will probably have to run the gamut with them.

Which says that probably we won't get any significant further settlements, but what we will get potentially are court conclusions that would be significantly larger, if we in fact win.

Steve McBoil (ph), Lord Abbot.

First, a question on compensate machinery capacity.

Could you just make some comments around that?

I understand that either a portion or all of Ingersol's compensate capacity may have been brought back into the marketplace.

Can you just update us on that and what that may mean from a competitive standpoint going forward?

I will give you an answer.

I'm going to ask Mike, who is handling the the transition to also comment.

When you say capacity, I think of our ability to manufacture as compared to market demand.

But it is definitely true that the market has historically been divided amongst two players, Cincinnati Machine and Ingersol Milling, not to be confused with Ingersol Rands, who apparently in the last six months have gotten a number of calls about going bankrupt.

But in any case, those two companies have been the players.

And the division of the share has been significantly directed towards Cincinnati.

With Ingersol's exit we still wait to see what the outcome of that will be, and whether there are other players who attempt to come back into the market, using or not using, Ingersol's technology.

But the fact is that for us, that is less of a factor.

It is an important factor because it is business right now.

And in fact we're delivering some Ingersol machines to DOD in this quarter that were the result of this process.

But the process that we just talked about with Eli, that is the fact that we're entering threshold for a number of these programs, is apt to give us more of a boost than Ingersol's going out of business.

Just because if you look at the relative shares, that would be a smaller increment than the new business.

I would also comment that it is true, our understanding is that there is a company that has bid, if not concluded, a purchase for Ingersol composite assets.

We have not seen them back in the marketplace to date.

That does not preclude them from that.

However, I will say that what we do know, and what we can comment on is, we've had significant dialogue with all the parties that have requirements for composite manufacturing.

And those have been significant discussions.

And we have presented our plans in terms of our ability to meet demand in the market over the next 5 to 10 years.

And we feel we've got sufficient capacity to meet all the requirements.

That's great.

Perhaps maybe you could -- can you get just give me a sense as to how much capacity Ingersol's compensate assets would represent?

Again presuming that they come back to the marketplace relative to your own?

Just to try to get a sense as to size, as to the competitive element here?

The space in Rockford, of course, was a very large space that accommodated machine tools of all kinds, including composite, that was highly vertically integrated.

But as far as their market share was concerned, it was under 20 percent.

Just turning back to this RFID issue, obviously there is a fairly healthy level of skepticism, I guess, amongst the vendor base in terms of whether compliance could be met on the timetable that Wal-Mart is dictating here.

I'm just curious from your perspective and what you may be hearing from vendors, A, do they a feel that the state is practical, if that is the appropriate word?

And it maybe also be interesting from your perspective to know if you have a sense at least as to Wal-Mart's commitment to the state, as to whether it has wavered at all as they have moved on here?

And maybe if they even talked about how many distribution centers they're talking about January '05?

There are a couple, I think, relevant comments.

The first is, six months ago when you said RFID you couldn't generate interest, and now you can't keep the folks away from the door.

There is a huge education process ongoing as to what can and can't be done.

And that it is at the fundamental level of does does this stuff cost, and how do we implement it, and who are players?

At a much more significant level there is the question of how does a tag or a series of tags get utilized in this particular application, and can it or can't it read, and how do you deal with that?

So there is a fair amount of tag development work that is going on at the same time.

My reaction is that Wal-Mart is very serious.

They will continue to be very serious, and that indeed, if they stop being very serious, they will lose their audience.

Secondarily, I think that when you introduce DOD into the play, you really make a significant change because now you've got two of the world's largest suppliers, and certainly two people that have major control over their supply chain, both working in the same direction, and indeed even incorporating in what they're doing.

Will it take a little do longer, an interesting question?

But I will also tell you, as is invariably the case with a group of suppliers, we're a major portion of their sales.

Read, maybe 25 percent are controlled by a single customer, you get a lot of attention from people.

And I have to tell you that right now, while I'm sure that there are folks saying, I don't know if I want to implement this or not, I will tell you that there is a queue of people in the next 100 that would love to step up to the mark in being able to supply that.

It may be a carrot and stick approach, but at this point the stick is equally influential, if you anticipate losing your position, and it represents that portion of your sales, because you weren't up to snuff on the appointed date.

I am certainly not to be surprised in the next 100 wanting to do whatever they can to satisfy God.

One other just clarifying question.

With respect to the reference to gross margins in Intermec, did you say they were at or above 40 percent in the quarter?

Yes.

Yes, we don't disclose what they are, but I would say yes to that question.

Is that up sequentially?

That is up -- that is up versus prior year.

We have continued to make that progress versus prior year, all year long.

What I said to you was that if you look at the sales increase in the quarter, and you look at it by product line, -- if you look at the sales increase by product line, the margin increased in that product line on both a sequential and prior year basis went up more than the sales increase.

So if the sales when up 4 percent, the margin when up more than that, etc.

Great.

And now I need this one last clarifying question with respect to the guidance in Q4 sales, I think you made mention, ought to be flat year-over-year.

I guess based on your earlier comments, let's just say that absent the challenging comps, the base core business has to be up 5 percent or greater to meet that guidance rate.

Is that correct?

I could have been confusing.

Let me try again to provide a little more clarification.

In the fourth quarter of last year two things happened.

The one thing that happened is I think we had some intellectual property settlements.

You have to take those out, Because we only talked about product and service revenues.

The other thing that happened is, as was true in the third quarter, we had a major enterprise sale which will not be repeated, which we have said for the third and fourth quarters represents over a 5 percent increase.

So that is not an adjustment you need to make.

It is just that that is the hill we have got to climb to get to a flat comparison.

Rick Reed (ph) of Robert Baird & Co.

Larry, you had alluded before to somewhat you described as extreme weakness in the Intermec area back in August.

Can you talk a little bit about what were the specific areas that you saw that weakness, and why you think that occurred?

I don't know why it occurred, except summer can be weak for us.

But it was too short a phenomenon to give you the contributing rationale.

We get a certain inbound order rate, we track that on a daily basis.

We understand that it translates in a very short period of time, measured in days to actual shipments.

And so it is habitual for us to, as in reading or e-mails, look at what happened to the order rate.

In late July and early August it truly sagged.

Was that because it was the summertime?

Was that because industrial data was coming in weak during that period, and we're seeing a manifestation?

Was it because the direct organization wasn't ordering as much?

I don't know.

All of those factors are at play, but when you get down to what was causal, as compared to was that just a coincidence that leveled out over the time period, I can't honestly tell you.

I can only say that it did level out, and therefore as far as we are concerned, it wasn't a phenomenon, just something that got our attention for a brief period.

Our final question today is from Mr. John Danicello.

I just wanted to follow up on Eli's question regarding the competition you see on the DOD side.

It would seem to me that if there was some (indiscernible) Wal-Mart side, there might even be less on the Department of Defense side.

Could you talk about that it, and also what your advantages are against the Savvy's, the TI's, other people playing in that space, and what the opportunity might be from your perspective?

Where do you think you are strongest in recognizing that opportunity and benefiting from it?

Sure.

Firstly, the difference in our mind with DOD versus Wal-Mart is not so much in control of their channel or their ability to achieve compliance, as in the DOD by virtue of historic tradition, which has nothing to do with RFID, is more committed to ISO standards.

They tend to gravitate toward that in other parts of their business.

And most of the DOD procurement reform that you have seen in the last 10 years has to do with, we ought to be using commercial standards versus specific standards created by DOD.

The two other players that you talked about, Savvy and TI and Intermec requires some technology discussions.

Savvy is not only a major player in our RFID with defense, but indeed they are the company that has the AIT contract for RFID.

The AIT contract is being the approved vendor selection process that they go through.

But Savvy makes active tags.

And Intermec makes passive tags.

And so you've got a different technology thrust.

And we see both of those as significant players.

Active tags, on the other hand, tend to be significantly more expensive, and that is probably a factor of like ten when you look at the differential.

So you've got different kinds of setups.

And TI has historically been a -- TI's expertise in our RFID, while considerable, is a lower frequency.

It's 13 5 6 technology versus the UHF technologies that you see Intermec playing in with its passive tags.

The things like mobile speed pass (ph) are the things that TI does.

And while they have done extremely well in the U.S. market with that technology, it is very limited technology in terms of what we're talking about because its read range is an inches measurement, not a feet and certainly not a yard measurement.

So what you have talked about are three applicable RFID technologies to DOD, who would probably embrace all three technologies, but it doesn't wind up with Intermec competing with either TI or Savvy.

But indeed, possibly aligned with them in order to deliver a full package.

Just because I can't resist a commercial, you should know that all systems shipments during Desert Storm have been scanned with Intermec systems.

So it is just a throwaway line.

Do you have any idea how big the opportunity might be either relative to Wal-Mart or just on its own at the DOD?

Have they given you guys any sense for what they're looking to do, and what size it might be in terms of revenue opportunity for the whole market?

No but you can -- I mean you are talking about billions of containers time some number that is bigger than 10 cents.

So it is a huge number.

That of course is the excitement of RFID.

We have almost none of it in terms of revenue now.

And within a period as predicated by these two guys, you are talking about huge revenues generated by RFID tagging, and the infrastructure that will be required in order to achieve that.

It is just too big number to talk about, what is the market going to be.

Okay, Missy, if there are no final calls, I think we can call it a day.

Thank you for your help.

Thanks (inaudible).

Thank you all.

Thank you for participating in today's conference.

This does conclude our call.

You may disconnect at this time.