漢威聯合 (HON) 2004 Q2 法說會逐字稿

Welcome to the UNOVA second-quarter 2004 financial release results teleconference.

Following today's presentation there will be a formal question-and-answer session. (OPERATOR INSTRUCTIONS) Until then, all lines will remain in a listen-only mode.

At the request of the Company today's conference is being recorded.

If anyone has any objections, you may disconnect at this time.

I would now like to introduce today's conference host, the Director of Investor Relations and Analysis, Mr. Kevin McCarty.

Sir, you may begin.

Good morning everyone and welcome to UNOVA's second-quarter fiscal year 2004 earnings release conference call.

Joining me on the call this morning is Larry Brady, our Chairman and Chief Executive Officer;

Michael Keane, our Chief Financial Officer;

Tom Miller, President of Intermec Technologies; and Robert Smith, our President of our Industrial Automation Systems.

Once we conclude our remarks this morning, we will open up the call for a question and answer period.

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

It is also 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 releases and in its filings with the Securities and Exchange Commission including but non limited to the Company's annual report on Form 10 day for the year ending December 31, 2003 and the Company's report filed on Form 10-Q for the quarter ending March 31, 2004.

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

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

Good morning everybody.

We are again glad to be with you and happy to report that we have overachieved the near-term outlook that we provided at our last conference call.

For this morning's meeting we will change the format that we have historically followed.

As Kevin said, Tom Miller, President of Intermec and Bob Smith, President of Industrial Automation Systems have joined the call this morning.

Versus our previous approach, I would like to lead off with an overview and an outlook commentary, Mike Keane will follow with a detailed analysis of operating and financial performance and then Tom and Bob will join Mike and me in responding to your questions.

Now for an overview of our performance.

Total corporate revenue of $304 million was up 9 percent over prior year and up for the second quarter in a row confirming our belief in an upturn in our industrial markets.

While Intermec bottomed a long time ago, actually in the first quarter of 2002 and has been growing well ever since that time, it was not until the third quarter of last year that our IAS business bottomed.

Even in the fourth quarter of last year, the IAS prior year comparison was down.

At Intermec, product and service revenue of 8.6 percent in the second quarter was about in the middle of the 7 to 10 percent growth range that we had projected during our last call.

From a profit standpoint, achievements at both Intermec and Industrial Automation exceeded our guidance with total segment operating profit from product and services more than doubling over the prior year period.

Mike Keane will break all of this down in a moment.

Activity during the second quarter was at a high-level with a number of notable achievements and events.

Probably first on that list was the award of the AIT III contract announced in late June.

This $200 million plus 5-year contract win returned Intermec to its historical relationship with the Department of Defense.

Strategically the contract win is significant in several ways.

It is initial evidence of the success of our more aggressive R&D investment which we announced in late 2003 designed to fuel above market growth next year.

The 3 areas which were targeted for incremental R&D investment were 1, RFID; 2, enterprise accounts in nontraditional markets of retail and health care; and 3, government, specifically AIT III.

In addition to providing incremental sales, the development programs in AIT will advance the availability of several commercial enhancements which would have occurred later in our product development schedule.

The financial impact of the contract is quite attractive.

Our prime contractor position on the contract, the incremental nature of the sale and the dual application of the development should allow improvement of current operating margins.

We also believe that AIT is further confirmation of our strategy of fielding the broadest product offering in the industry.

The superiority of inner connectivity and compatibility for Intermec products in the total system offering was a significant advantage in the AIT demonstrations, much as it is in the pursuit of the growing SME or small to medium-size enterprise market where in-house IT departments are not available to overcome the incompatibility of different Company offerings within the same system.

The second area of high activity during the quarter was in RFID.

Intermec has actively participated within EPC workgroups in bringing the development of the EPC generation 2 standard to some form of closure and adoption.

In early April, Intermec identified those portions of its intellectual property that were relevant to UHF generation 2 as well as the Class 0 and Class 1 standards.

In late April, Intermec communicated its intentions to make its comprehensive RFID intellectual property available to other industry suppliers on a combination of contributory access and licensing on a reasonable and non discriminatory basis.

We're currently in conversation with a number of companies to complete licensing agreements.

In May, we found it necessary to bring suit against one of our competitors, Matrix, for the appropriation of our patents without license.

However we did not pursue an injunction against practice by Matrix in an effort to allow ongoing customer trials and adoption of RFID to proceed.

Finally, in early July we participated in an effort to bring consensus to the various competitive proposals for a generation 2 standard in what has become known as the Chicago Accord.

We continue to hope that EPCglobal can achieve its objective of a generation 2 Standard Accord by October 2004.

In June, Metro AG, a German Company and the fourth-largest retail trade company in the world with operations in over 26 countries, announced that it is on track to begin implementation of RFID in its distribution centers, stores and top suppliers in November.

Last year, Intermec participated in the Metro AG Future Store and in June was the primary RFID contributor to the Metro innovation center which demonstrates end-to-end RFID supply chain applications.

We also installed RFID in the Verona (ph) Distribution Center.

In June, Intermec was designated 1 of 2 qualified suppliers in 4 of the 5 product categories.

Metro AG has begun its implementation with a combination of an ISO/EPC data structure protocol and will migrate to the Gen 2 standard when it is finalized.

This is illustrative of the global nature of supply chains and the need for harmonized worldwide standards, taking into consideration not only the U.S. requirements but also Japan and China where the majority of products are sourced today.

The third area I would like to cover is the inbound order activity in our industrial automation business.

IAS had a good quarter in both profit performance and bookings.

After 2 quarters below trend, we recorded a $138 million of inbound in the second quarter confirming our earlier commentary in previous calls that we saw an improving industrial market.

The surge in orders also continues the trend of improved product margins in the backlog.

The make up of new bookings provides a confirmation of improved margins as well as a confirmation of our strategic approach.

New orders included significant new retool jobs from our traditional customer base as we projected last quarter.

As we also observed, those tend to be higher margin jobs because our preferred position in the bidding.

Also included were orders for new composite equipment to support both the Boeing 7E7 and the Airbus A-380 programs.

Boeing has recently begun hiring after a long period of layoffs and has said that 277 currently carry customer deposits.

This represents a 3-year backlog of production.

Also our strategic efforts in Asia are paying off as we booked 2 customer orders for diesel (ph) engine block lines in China.

I would like to close with a brief commentary on outlook for our 2 business segments.

Based on the strength of current business we have become more optimistic at Intermec.

We believe that revenue growth in the third quarter should be and a range of 12 to 15 percent over last year's third quarter.

This projected growth and the implied sequential growth over our current quarter are strategically meaningful.

While our third quarter is historically 1 of our 2 weakest, growing strength in our North American systems and solutions business should yield higher growth than previously anticipated for Intermec as a whole.

Profit should follow our previously discussed business model which Mike Keane will review specifically.

At Industrial Automation, we will see a falloff in performance in the short-term.

Below our bookings level of last year's Q4 and this year's Q1, will result in some weakness in quarter 3 performance as will the lower margins associated with the Hyundai deliveries.

These items should largely be flushed through the system in Q3 with a return to profitability in the fourth quarter.

Now I'd like to turn it over to Michael Keane who will cover the operating and financial performance analysis as well as the specifics of our outlook.

We already commented on consolidated revenues so at this point I would like to discuss our segment performance beginning with Intermec first.

Total sales revenues at Intermec of 187 million increased 4 percent over the prior year quarter and declined 3 percent sequentially over the first quarter.

However, both the prior year quarter and the first quarter of this year included the effect of IP settlements.

There were no IP settlements in the second quarter.

Eliminating IP impact from the comparison, Intermec sales from products and services increased 8.6 percent over the prior year product and service sales of 172 million and 8 percent sequentially over the first quarter.

Year-to-date product and service sales also increased 8 percent compared the prior year first half period.

Product and service profits of 15.6 million in the quarter were comparable to the prior year quarter.

The operating profit percentage was lower at 8.4 percent versus 9.4 percent in the prior year; however, the ability to leverage our growth and to increase margins also supported an increase in R&D spending in excess of 5 million or approximately 2 points above our normal R&D spending baseline at 7 percent of sales.

Larry previously outlined the target areas of investment and our first significant evidence of success with securing AIT III.

Our ability to leverage our growth is also apparent in the first half comparison where our year-to-date product and service operating profit percentage at 7.7 percent of sales is equal to the prior year despite incremental R&D spending of over 9 million.

Incremental R&D spending between 2 to 3 points over the baseline is anticipated to continue in the third quarter to further support these targeted growth opportunities.

Our sales growth for the quarter was largely attributable to our core systems and solutions business which grew approximately 15 percent versus the prior year.

Service revenues grew approximately 2 percent while printer or printer media revenues grew 1 percent.

Our model 700 product continues to be a popular choice for mobile computing applications as unit sales increased in excess of 30 percent over the prior year.

Geographically, North America showed improvement over the prior period growth rates as sales during the quarter grew approximately 9 percent compared with the prior year.

The favorable comparison reflects very good performance within our indirect channels as the greater acceptance of our Intermec honors partner program and continued enhancement of our productline allowed us to achieve greater traction with both existing and new partners.

The region benefited from increased growth in field service, transportation, logistics and retail applications.

More specifically, in Q2, Therogas (ph) the nation's leading retail distributor of propane began automating its 4000 truck privately with Intermec and AgenTech (ph), our honors partner and software provider believed to be 1 of the most comprehensive wireless deployments in the industry.

The system consists of Intermec 700 series mobile computer equipped with 802.11B GPRS satellite communications and printing capabilities.

Our European revenues grew 5 percent compared to an excellent prior year quarter that had compared to the 2002 second quarter, exhibited growth of 40 percent.

In the 2003 quarter, there were a number of significant large rollouts including Tesco.

In contrast, the current quarter strength was supported by a broader base of business.

Latin America was up 10 percent as Intermec continues its traditional leadership in DSD (ph) applications and Asia-Pacific continued to show strength with an increase of 30 percent over last year's second quarter on broader expansion throughout the region.

Sequentially all regions in the second quarter were up versus the first quarter as North America increased 7 percent;

EMEA, 3 percent;

Latin America, 9 percent; and Asia-Pacific, 59 percent.

The quarter also benefited from increased interest by its industrial markets in our recently introduced EK-30 (ph) keypad hand-held and CV-60 (ph) vehicle mount terminals.

The next area for discussion is the performance of our industrial automation segment where our restructuring efforts have allowed us to achieve profitability in the second quarter a continued to trend at quarterly favorable comparisons to the prior year.

Revenues of 118 million were up 17 percent over the prior year quarter and segment profit of 3 million was an improvement of over $11 million.

The favorable comparisons are largely attributable to improvements achieved within the Cincinnati Lamb business and the lower breakeven levels achieved by the merger of our divisions.

Favorable comparison to the prior year were achieved both in gross margin and SG&A spending relative to sales.

Contributing to the quarter performance was our aftermarket parts and service business achieving high levels of daily run rates that have not been achieved since prior to the 9-11 tragedy in 2001.

Segment profit also included a gain of approximately 700,000 on asset sales as we continue our effort to monetize idle or excess fixed assets.

Continuing further down the income statement, corporate and other expenses of 5.7 million were equivalent to the prior year quarter.

Overhead savings evident in prior quarter were offset by spending related to Sarbanes-Oxley 404 compliance activities.

This pattern should continue at least through the end of this year.

The income tax rate at just under 40 percent was in line with our expected range of 38 to 40 percent for the remainder of the year.

Turning now to a review of our balance sheet and cash flows, during the first half, the Company was a net user of cash for approximately 47 million.

Of that amount, 36 million was used in the second quarter.

This cash flow trend was in line with our expectations and was driven primarily by working capital requirements to support certain long-term contracts within the IAS segment.

These requirements are evidenced by growth in both of the Company's accounts receivable and at inventories levels.

As these programs are delivered to our customers in the second half of the year, we expect the cash flow trends will become positive again.

Capital expenditures for the quarter were 2.7 million compared to depreciation and amortization expense of 4.6 million.

Asset sales contributed an additional 3.7 million.

Despite the near-term cash usage, our liquidity remains strong with cash in marketable securities of 191 million.

Both our strong liquidity and operational improvements were further recognized recently when SMP upgraded our debt 2 levels from B- to B+.

Let me conclude with some commentary on our outlook for the next quarter.

We continue to expect an improving gross profile for Intermec.

As Larry has previously indicated, Intermec revenue for the next quarter should be in a range of 12 to 15 percent increase over product and service revenues in the prior year's third quarter.

That would imply a range of 187 to 192 million.

Entering that range into our forecasting model, we would anticipate an increased profit contribution of 40 percent from incremental quarterly sales over our 145 million breakeven level to provide contribution to profit and incremental R&D over our 7 percent baseline.

Incremental R&D spending over the baseline is expected to be approximately 4 to 5 million, similar to our second quarter.

Accordingly our third quarter ADS segment operating profit is expected to be in a range of 12 to 14 million.

Our outlook for our IAS segment is tempered by the timing of the previous 6 months bookings.

Although revenues are expected to be in the 120 to 130 million range, there will be a higher mix of lower margin business than originally anticipated.

The lower-than-expected bookings rate of 85 million in the first quarter and subsequent second-quarter acceleration of 138 million has shifted previously expected higher margin business into the fourth quarter and early 2005.

Therefore, our earlier expectations of small profit in the third quarter -- that now changed to a forecasted segment loss between 2 to 3 million for IAS continuing operations.

At this point, I would like to turn this back over to Kevin.

At this time, we would like to open up the call to questions, please.

(OPERATOR INSTRUCTIONS) Mark Roberts of Wachovia Securities.

Good morning.

A couple of questions.

Can you talk a little bit about your IP strategy that you discussed earlier and how that kind of relates to the discussions within EPCglobal where they and Wal-Mart have been pretty adamant about the generation 2 standard and trying to put a lot of pressure on different intellectual property holders to not charge royalties or sort of assert their IP positions?

I would like to hear what the update is on this discussion.

This is Tom Miller.

Intermec is very unique within the industry in that over a period of the last several years we have accumulated a very strong and comprehensive intellectual property portfolio, some of it due to acquisitions, some of it due to development and research and innovation.

That portfolio is an excess of 130 patents and it is really pretty much centered around UHF passive RFID tag technology.

If we look at it and if you go back in history when the auto ID center was originally founded, it was set up -- originally it was the goal to have low-cost RFID as well as to the IP free.

We have been saying for several years that when it comes to passive RFID in particular we have a very strong intellectual property portfolio that needs to be looked at.

We joined EPC.

We have worked within the process -- working hard within the group to develop a Gen 2 specification.

Within the provisions of EPC, while the goal may be to be IP royalty free, there are provisions there for companies to disclose their IP and also what they call the RAND, the reasonable non-discriminatory license program.

What we have done is we have actually donated more patents in that IP royalty free mode than any other company.

These are not insignificant patents.

I mean these deal with things like group select, it deals with the ability to store (indiscernible) data from RF transponders; so they are very key and crucial patents.

On the other hand, because we have the broad base RFID which goes beyond any standard whether it is an EPC standard, it gets to the core and the foundation and the practice of passive RFID.

What we have done, we have taken the unprecedented step of offering our entire patent portfolio on a reasonable non-discriminatory basis.

Part of it has been donated on royalty free; the other part of the portfolio is being offered on a licensing basis and not just a few patents, the entire portfolio.

That licensing program is in the process of being finalized and we are in discussions with a number of companies and that is unrelated to any particular standard.

Thank you.

If I could ask 2 follow up questions.

The first 1 is you have indicated in the past that you may want to spin out or sell the industrial segment of the Company.

Can you give us an update as to whether that process has been formalized and timing of when you might do that?

The process has not been formalized, Mark.

The timing, we don't know because it hasn't been formalized.

We have indicated that there are a couple of parameters that are important relative to establishing those, including a clear trend of improved bookings which at least we're starting off in the right direction with the second quarter.

The advent of composite equipment ordering which did happen in the second quarter; the strengthening of our Asian program so we can reduce dependence on our big 3 of traditional alliances of customer base.

And finally, the solid profitability of the business which -- whether we talk -- regardless of what mechanism we talk about separating the business is going to be important aspect.

We're making progress on all those fronts and we're just looking at timing and methodology and we will pull the trigger when it is right.

Because of the uncertainty of that, it is hard to tell when that is going to occur.

My last question is for modeling purposes here, I am looking at the different segments of the business and your general corporate overhead expenses are running about $17 million a year.

If I am factoring in the sale of the industrial part of the business, can you talk about how much of that 17 million would go away if and when the industrial part of the business is sold?

That is an exercise way beyond the activity, Mark.

I think you can do a conventional activity as we do and allocate and divide.

But we've had a significant effort underway for a long time to reduce our corporate headquarters expenses.

You can tell by either looking at the officer list of UNOVA and its reduced size or alternatively by looking at those expenses over time.

I think we have come down from something north of 30 million to our current level.

We will continue to be industrious in our pursuit but making a forecast of that is a degree of detail that we haven't arrived at yet.

Great, thank you.

Walter Liptak of KeyBanc McDonald.

I guess going back to the first question that was asked, just in the last month or so has there been any incremental pushback from anyone in the industry that would suggest that you might be unsuccessful with your IP strategy with relation to RFID?

Walt, this is Tom.

Obviously as you look at it if companies at one time held a belief that RFID could be achieved without any IP and/or without any potential licensing and then a company comes along and says wait a minute we have substantial IP and while we are making a large portion of that available, there has been some pushback quite frankly.

Somebody had a choice between getting it without or with and they would like it without.

On the other hand, it really is a little bit misplaced and I think we are losing sight of a view key things.

One thing is obviously whatever you buy today in the form of electronics, there is some sort of cross-licensing or effort that goes on between manufacturers of those products.

In general, users are not pulled into the process of as part of those licensing discussions.

It's really transparent.

Second, the real cost drivers associated with RFID will be the volume, the technology advancements, particularly in the area of manufacturing processes, as well as in the area of it if you look at a tag, for example, you have the chip, you have the insert, you have the label.

A lot of cost reductions or potential associated with the insert.

And in order to do that there needs to be innovation and it needs to be encouraged, it needs to drive costs down and some sort of royalty amongst manufacturers is relatively insignificant in the ultimate cost associated with RFID.

And then the third area that I would really point out is one of the things Intermec had done, and a lot of companies will use their intellectual property to promote a proprietary standard or they will use it to lock people out or they will use it to gain an unfair advantage.

What Intermec has done is we have taken our patent portfolio, 130 plus patents, we have grouped it according to RFID product category, and we are making that entire portfolio both what is today and what is in the future available to companies to license and we are in very positive discussions with companies early in the process of the licensing of the technology and again that is regardless or irrespective of any standard that may be out there.

Let me just make another comment, Walt, to summarize what Tom said.

You ask the question -- will we change our strategy?

I think we are in useful dialogue with lots of people and I hope we are getting a 2-way exchange.

Our strategy which we talked about a long time ago is to provide the appropriate balance between the customers' need to have multiple suppliers which we understand and respect, and the industry's need to have an incentive for innovation.

We don't think the far end of that continuum is appropriate in either instance, i.e., if we go as Tom said, fully toward supporting innovation through proprietary technology, that is inappropriate.

If we go fully toward open access and we don't reward people who come up with innovation versus those who stand on the sidelines, we will rapidly lose any future for innovation in an emerging technology.

We tried very hard to balance that and to listen to the folks who have a dog in the fight to understand what their position is.

I think we will work hard to accommodate those interests but we will do it in the spirit of the strategy that I just outlined.

It sounds like you are in the middle ground.

We're trying to be.

You mentioned that you are in discussions and maybe this is a little bit early to start talking about it but what would be the timing on getting the first licensing agreement and if you did get some income from it, would you strip that out from your Intermec operating profit?

As far as the timing, Walt, I would anticipate there will be licensing agreements signed through the second half of this year.

Because in some cases and what we have also said, there is potentially things that other companies have that are very valuable to us.

It is not just an outright license.

There could be involved cross licensing associated with it and so that is an important goal of ours also.

In terms of breaking it out -- Mike or Larry?

I think that is more of an accounting question, Walt.

But you know the 10 percent, Mike.

Basically, if we are more than 10 percent revenues per quarter a year, we would have to break it out.

And that would be our intention despite the fact that other folks don't break out licensing.

In the machinery segment, the heavy-duty truck industry is booming and I know that Cummins and Navistar are customers and they have a good outlook for '06, is there any indications that the truck industry, the engine industry is spending again for equipment?

They are certainly looking at various projects right now, both comments and Navistar are in pursuit of customers and when they line up customers, we expect that they will then be looking at ordering equipment to meet those needs.

Okay, great.

Thank you.

Reik Read of Robert W. Baird and Company.

Could you guys talk a little bit more about the systems and solutions business?

Very good strength there; particularly after last quarter.

Can you talk a little bit about where that strength is coming from; what are the sources?

Can you comment on what you're seeing in the industry markets?

And can you also comment on the other 2 segments, the printing, the media, the services which seem to be lagging?

If we look at our systems and solutions business, we are very encouraged by the growth and the outlook for that business continues to be strong.

If you go back in time a couple of years, Intermec was very heavily weighted in the industrial sector for handhelds and direct store delivery.

We have worked very hard over the last couple of years to have a broader business model, as you know.

We are seeing the growth come from a nontraditional business field service in particular has been very strong for us the last 6 months.

Transportational logistics with accounts such as Federal Express and Federal Express Freight -- the retail -- we continue to make significant progress both in Europe with customers like Tesco and Saintsbury (ph), Office Depot in the U.S., Hallmark.

It is really a reflection, Reek, of a broader business model and also the fact that there was some significant pent-up demand that had occurred in the first part of the decade with where purchase decisions have been delayed.

In terms of the printer and media.

As we look at that, that is an area where it has been impacted still.

It hasn't recovered to the extent it should.

Within the printer sector there are 2 components within our printers which is receipt printing as well as bar-code labeling.

The bar-code labeling printing, especially our new product, PM4I (ph) has been doing quite well.

The receipt printing is really tied to DSD (ph) type rollouts and we are not in any large-scale DSD rollout at the present time.

That has impacted that.

Then in terms of media, that is a business that is still highly fragmented.

It has not fully recovered and we are working to improve performance in that area.

Tom, you are suggesting that you are seeing some good growth in these non-traditional areas.

Does that mean that industrial which still seems to be a pretty core piece of your business -- really hasn't participated and does that seem like it is starting to gain at least a little bit of momentum?

Yes, it is.

In fact, this past quarter we started to see some increased activity within the industrial business particularly in automotive whereas you know, Intermec has been quite strong and we are seeing a pick up within the automotive industry as well as within aerospace and within chemicals, too.

And in fact, Larry referred to the AIT contract, some of the products that are spinning off that contract will be targeted at the industrial market.

I just want to go back to the RFID question one more time and to the extent that you guys can, you are working on this new intellectual property set of agreements in policy.

Can you talk a little bit about how many agreements that you might see?

What are the areas?

Are these with chip manufacturers; with tag manufacturers; with readers?

What specific types of technology are you talking about?

What we have done is we have taken our IT portfolio and it is roughly 130 plus and we have grouped them according to chips, tags, readers, printers and we are in the process of having meetings and having discussions with manufacturers within those product categories.

For example, if I'm a manufacture of readers, they would have access to our reader portfolio and if I'm a printer manufacturer, they would have access to our RFID that is associated with printers.

And if you look at it, we are focusing on more of the sizable companies first as you can imagine.

It is a process that takes time to develop.

We are having some very useful dialogue and as far as number of license, I would hesitate to put a number there.

It is just too premature with that.

That is helpful.

Thank you.

Mike, just 1 quick last question for you.

Can you give us a ballpark idea if Intermec were on a stand-alone basis, what the inventory turns and DSO's might look like?

What I can say is that we have a capital utilization figure that we use at the segment level and they are turning that capital utilization base greater than 5 times a year.

Thanks very much.

Just a quick addition.

I think in support of what Tom said, you saw some strength in North America in the second quarter which is more related to industrial markets than Europe which has a broader base of activities, so it is just a supportive statement that says that also reflects that strengthening market in industrial.

Great.

Thanks, Larry.

Ajit Pai of Thomas Weisel Partners.

A couple of quick questions.

The first one is just looking at your guidance on the Intermec side of things, the guidance in operating margin of about 6.4 percent to about 7.3 percent, that would be the approximate range.

What would the -- on higher revenues, why would you be having a lower operating margin?

I think that we have to factor in the incremental R&D spending which we indicated is 2 to 3 points above the normal baseline spending, which is -- normal baseline being 7 percent of sales.

So if you were to add that to the calculated operating margin you are achieving, you would see that you are really in the high single digits to maybe even approaching low double-digit.

Right.

And when you are looking at the second-quarter results and you look at the $5.7 million corporate overhead?

What contributed the most to that increase sequentially from the first quarter?

Sarbanes-Oxley.

Sarbanes-Oxley.

So can we assume that it is going to be an ongoing capital overhead of about the same magnitude?

Probably for the rest of this year and then it is really too early to tell until next year.

We are in a documentation testing mode as most companies are at this point in time and then next year we will be more into an annual maintenance mode.

So then we can assume that part of that operating margin decline is also related to some of these corporate overheads?

At the corporate and other line, I mean there is some other internal costs that are being experienced throughout the entire company, although I don't think it is as significant.

Okay.

Just in terms of competitive dynamics in the service revenues and the printer and media side, some of your competitors have been growing pretty rapidly in printer media side of things.

What is happening out there in terms of competitive dynamics and in the AIT III contract, it seems you will be actually supplying 1 of those 3 printers from 1 of your competitors.

Can you give us some more color over there and describe whether its a business you want to be focusing on or reduce focus on long term?

Printer media is an absolutely core part of our overall strategy.

In many cases when a company is buying a handheld computer they are buying printers along with it.

Particularly some of our large enterprise accounts.

If you look at our printer business we have played in a fairly narrow segment of that business and that business has largely been associated with higher and middle range industrial bar-code label printers.

What we are working on is to expand that focus into broader categories.

So for example, you mentioned the AIT III contract, one of the areas that came out of the AIT contract which is part of the increased R&D spending is a new printer that Intermec is developing and it will be a rugged heavyweight, smaller portable printer which we think will find a lot of use in the commercial sector.

Also we are expanding our printer investment to include the design development of (indiscernible) accounting printers versus simply OEM'ing a printer from another company.

We believe there is differentiation that can be involved there and better margins.

So we look at our strategy printer as a key part of this strategy and then as we also believe that compatible with that is the media and as the printer sales will develop it brings along, media.

Media has been very competitive over the last few years but we believe that some of the strategies we have in place in media particularly outside the U.S. will expand that business.

And on the service side, what is going to be a catalyst to get the service revenues growing again?

First off, our service component of our total revenue picture is higher than most other companies in the industry and there are couple of things that drive the service revenue.

One is signing up and getting customers on the front-end to multiple year contracts.

So it becomes more of annuities so you don't see a big spike one quarter to the other.

What you will see is some gradual improvement of that service business.

The second area is increasing our levels of integration services.

We now have the ability to do wireless network certifications for our systems as well as competitors.

We are putting in place an RFID services practice where we will provide services not only to our type of technologies but competitors technologies.

And then the third component there is a big service content associated with the government business and there traditionally has been and with the AIT contract a big portion of that contract will be associated with services that we provide.

Also, Ajit, remember that the growth isn't synonymous in the 2 cases, because we are talking about on the install basis and service versus on the sale in the quarter so we've got a larger base.

As Tom said, it is a higher percentage of our business.

I think we convert more to contracts than other folks and we have more in our base as a percent of the total than other folks.

So, in part, service is suffering from a larger base in the calculation of percent growth.

The last area -- most service warranty is around a year so you will see, for example, if we seeing -- we saw a 15 percent growth in Systems Solutions in Q2, it will be a year before some of that gets embedded into the service base business and shows up as service growth.

Right.

And the profitability of the services business, is it equivalent to the other segments of ADS?

Yes, it is a slightly smaller gross margin but it doesn't have very many expenses below the gross margin line so it is more profitable, but less gross margin.

One last question on Intermec before we move on to industrial automation segment and that is that currently you have an agreement with Philips as well as other licensing agreements on some of your RFID technology that you obtained some revenue from.

Could you just give us a rough idea of what that revenue stream is and when you have your new scheme come out and finally get negotiated, whether it be percentage -- whether those revenues will go down or whether they will go up if the end volumes stay flat?

At this point it is really insignificant revenue in terms of the overall contribution so it is really commenting as to what it has been really isn't worthwhile.

Commenting on what it could be, it will definitely be related to the adoption of RFID and as that matures and the business takes off and as we see success in RFID in the market and the timing on that is anybody's guess.

I think everybody is enthusiastic about it.

I think it will be significant but at this point, it is really speculative.

Moving on to IAS segment.

A couple of things over there. 1, is that your Cincinnati facility -- the real estate that you have over there, is there a timeline now for your being able to get it off your books to actually sell that property?

What would be the gross margins of that business because this quarter your gross margins for the overall Company have not expanded significantly and I think that is partially because of strength in IAS (ph)?

What we should we expect in gross margins in the third quarter now that that business will be slightly slower?

First on the Cincinnati campus sales, as you probably heard, we didn't hear anything regarding that because we are really stalled at this point in time because there is tax financing issues with the City of Cincinnati relative to infrastructure around the project.

So the project itself is still alive.

The sale is still alive.

We are still in contract with the buyer but we are basically sitting there with city politics.

We would expect that those with clear up eventually and we will move forward with that.

But we don't have a timeline at this point in time.

To predict anything, I would probably be inaccurate and would not attempt it.

Regarding gross margins in the industrial automation business, what we can say, we don't disclose those specifically, but what we can say is that they have been improving over the prior year and even more importantly, the quality of the business that we're seeing in the current bookings haven't showed increasing margins as well.

So with that it give us a little better predictability in terms as we look out over the next year.

Potentially, could that be a business that might have operating margins in the double-digits at that some point next year?

This is Bob Smith.

Just a quick response going back to the general comments about the margins.

In the third quarter, however, we will have a heavy portion of the shipments will be in some lower margin mix of business so in the short-term that could adversely impact us.

In terms of going forward, again, we don't disclose those margins but we see improving margins on the mix of the business coming in.

You asked released the question, will we see double-digit on operating margin?

The only comment I think we would make with this, in the recovery of any cyclical business, particularly one with a cost structure as revised as ours has been, that expectation is an interesting one at least.

What we can say is in the past, we have seen double-digit margins in a business.

That is complicated a bit by the fact that in the past we have had pension income of maybe 2 points of sales where as now we have pension expense which is small but still an expense number.

So that would mitigate that to some extent but I think our expectation is that we would be performing exceptionally well at 10 percent operating margins in that business.

Do think you could get that in mid '05?

No.

I mean -- it depends on how much of a sales rebound we get and whether we continue to book the kind of business we did in the second quarter or whether we have more traditional business.

One last question which is your bank facility that was extended to October -- is there any further color of a longer set of duration for that?

What are your options in terms of that right now are you considering?

Yes.

The reason for the extension was just to facilitate the negotiation of a new credit facility.

We are in great shape with our current facility and we are currently in negotiations with a different lead bank on a new facility that will be more cash flow in nature rather than asset-based lending.

Still secured but we just wanted to make sure that we had an orderly process and everybody was in agreement to that extension.

Thank you so much.

Kevin Starke of Imperial Capital.

In previous releases you sometimes provided magnitude of gross margin change in the Intermec division -- say up 3 points, down 3 points.

Are you able to do that this time?

Over the prior year, our gross margins quarter to quarter comparison were increased and it was just under a 2 point increase.

Great, okay.

I think I might have missed something but given the guidance for the third quarter in IAS, what it implied for fourth quarter roughly?

What we said is that we see a return to probability in the fourth quarter.

We've got this -- the way we load our plants impacts our profitability because the fourth quarter of last year and the first quarter of this year had bookings that were below 100 million; we have got a little bit of a sag in the production access.

Also as you know, on our percent completion contracts, we tend to back end load the margin recognition.

For both of those reasons as well as the fact that when we booked Hyundai over a year ago, we told you that it was a low margin contract but that for strategic reasons we were taking the bookings.

Those reasons being, it was an attractive proposition in a very difficult market to retain some of our engineering talent during the merger of the businesses.

It was a flexible contract that allowed the introduction of new concepts as well as the further demonstration of Lamb’s (ph) capability of finding perhaps most importantly, it was solidifying that link with Asia that we have been working on for a couple of years now.

So Hyundai will be largely through the pipe in the third quarter and that is an impact as well.

Okay.

The 200 planes that Boeing has on order, have you given some thought to how many composite machines that would require and what the time frame would be (indiscernible) and that sort of thing?

This is Bob Smith.

We are in discussions with all of the major subcontractors, tier 1 contractors to Boeing right now for the 7E7.

We have laid that out.

We have gotten initial orders this past quarter.

We expect activity to be reasonably strong in the second half of this year.

And then there will be a period of demonstrating that equipping capability which will lead to subsequent and healthier orders in subsequent years.

Okay.

In the press lately, I think you have been getting some attention because of a relationship with Federal Express.

I was wondering if there is anything you can say publicly about that in terms of what you are shipping for them for what purposes?

Sure, Kevin.

There is 2 things we can talk about. 1, Federal Express did an announcement of the China -- we equipped their China operation with hand-held computers and wireless systems and that is the same system that they will be deploying internationally at other location.

Second, we have a contract with Federal Express Freight and last year we rolled out the eastern half of the U.S. and we are in the roll out of the western half of the U.S. right now and that would be their LTL division.

And again, that is a very comprehensive wireless system.

It incorporates 802.11 Bluetooth as well as White area (ph) and it has been -- and that rollout continues and it should be completed by the end of a year.

Okay, thank you all very much.

Dennis Delafield of Delafield Asset Management.

All of my questions have been answered.

Keep up the good work.

Andrew O'Connor (ph) of Strong Capital (ph).

Congratulations on your quarter.

I wanted to know, can you update me; what CapEx do you estimate you will need in the second half and are we in a position to guess-timate CapEx for 2005?

I think the CapEx will run pretty much for the rest of the year similar to what we saw the run rate in the first half of the year where we are ran a little higher in the first quarter, a little lower in the second quarter but I think if we average that out, that is a good proxy for the second half of year.

So we're running just slightly under the depreciation rate.

As far as next year, I think it is a little premature and we tend to do a detailed scrub of that number in the second half of the year, but I don't see anything on the horizon that would cause the pattern to change significantly.

I think -- you know that basically our fixed capital expenditures support tooling for new product introductions and basically our internal software purchases.

Very little requirements for IAS because it is largely an assembly of pieces business because of a large amount of outsourcing.

So it would be really surprising if there were a dramatic change because there is just no source for that.

Okay, thanks for that.

And then secondly, with this kind of CapEx in mind then for '04, what free cash flow would you guys estimate for the second half or the full year '04?

Can you walk us through how we would get there?

Thanks so much.

We tend not to get as granular as giving an exact cash flow number but we had said at the beginning of a year that we would be a net cash user during the course here.

Of course that could change if receipts change by a week because we get lumpy payments on the industrial side of the business.

So all of a sudden at the end of the year, I could be a positive cash generator and you would say "gee, you told us that you are a user."

You have to understand that there is some volatility in that number because of return of working capital.

That being said, when you are trying to model it, it is pretty straightforward.

You look at the basically the EBITDAs of the business as you would anywhere else but then the question mark is what is the working capital change?

It is fairly consistent on the Intermec side of the business.

As I said, we are turning the capital base about 5 times a year.

What that implies is as you are growing incremental sales, you're going to use about 20 cents on these incremental sales dollar working capital.

On the industrial automation side, we tend to have incremental working capital of anywhere from 35 to 40 cents and that profile has been improving over the prior years.

But it is not a -- in any 1 quarter that could be volatile.

So let me just conclude by saying that by the end of a year, we still look at being a slight net cash user since the beginning of the year and if we improve that profile it is really because we are able to pull in some customer receipts toward the end of the year.

Thanks very much.

Seth Wonder (ph) of Tracor Capital (ph) .

Can you go through first -- I just have a quick question on the automation business.

I know you wouldn't talk to specific profitability in Q4 but if you take out the asset sale from this quarter, is if fair to say that the Q4 profitability would be somewhere between -- somewhere less than this quarter's I guess core operating profit or is there potential to exceed that in the December quarter?

I think we're somewhere between zero and 5.

It should be higher than zero; it should be around what we had this quarter with the asset -- $700,000 asset sale removed but it will depend on to some extent what we get out the back door in the quarter.

Also just as a point of clarification, your EBITDA guidance by operating segment is exclusive of corporate overhead such that are taken in the midpoint of the range, we should look for about 5 million of EBITDA given you said overhead will stay around 5.5 million for the balance of the year?

Well, what we said was that 12 to 14 million on the ADS segment; 2 to $3 million loss on IAS and corporate spending about equivalent to what we saw this quarter.

Is there any change to the taxes for next quarter (indiscernible)?

Earnings that are in the mid single digits, and I just wanted to make sure that they are below the line there -- I'm not missing anything that would change the earnings number?

We indicated that the effective tax rate should be in the 38 to 40 percent range.

Okay, I didn't hear that if that is read.

Thanks so much.

Mike Whitfield of Wachovia Capital Markets.

This question is for Tom.

On AIT III, have you received any orders yet and what is your expected timing of material impact?

The AIT III contract its administered by the U.S.

Army and it will provide equipment systems and services to all branches of the Department of Defense.

The contract was signed in Q2 but deliveries will not begin until the fall.

It will be somewhat -- it will be a ramp up type contract and the bigger impact will be built in 2005 and beyond.

It is also probably important just for historic reasons to say that we were the -- we did not hold the AIT contract for the last 5 years but we did hold it before that.

We have a substantial install base.

Because we had a substantial install base going to the prior 5 years, we managed to maintain a fair amount of business through GSA and that business that has been previously installed and added is also due for a refresh.

So we are pretty optimistic about the impact of AIT.

So on that end, Larry, would you expect the government fiscal year end could have potential impact on that GSA --?

I think that's early.

It is true that we tend to see a surge in the September -- in the third quarter in government for just the reason you're talking about.

But this is just early days and as you know, a lot of the AIT is development work that we have to do and so we would see the larger surge being post September.

Caller: Okay, great.

Thank you very much.

(OPERATOR INSTRUCTIONS) Mark Roberts of Wachovia Securities.

Actually my follow-up question has already been answered.

Thanks.

Eli Lustgarten of JB Hanauer.

We thought we weren't going to hear from you Eli.

I've gotten cut off twice so it is one of those things.

I have a couple of follow up things. 1, IAS loses money in the third quarter, the profitability return in the fourth quarter matched the second or are we still below it?

In and around.

As you know, we spend a lot of energy on the next 90 days in and around is what we would say.

The volume would be a little bit higher in the fourth quarter?

About the same.

We are relatively close.

When we get into 2005, we are starting to get some of the kick from the higher volume level which it sounds like its continuing in the third quarter.

Is that fair?

Yes, this is Bob Smith, Eli.

In bound (ph) in the third quarter we expect to be above the norm -- what has been the recent norm, but it is not likely to be quite as strong as the second quarter.

We are sort of dealing with elephants there and for 4 years now, they have managed to be pushed out beyond our expectations.

So we may see more of it but it definitely feels like the baseline activity is going up.

There is some transmission program from the Big 3 that are supposed to be up for bid, are you part of that?

We have been looking at a number of transmission projects.

When you go to Intermec with the AIT hitting in the fourth quarter, how much incremental volume would we have over the market growth?

Is that a 10 or $20 million phenomenon or is it less than that?

I would see that really each year.

So in other words, what we projected is somewhere around 15 to 25 million per year incremental to our government business, but that that really doesn't begin until 2005.

There are deliverables in the fall and there are shipments that are being made in the fall associated with some of the products, but as far as the full benefit of the contract, we don't see that until 2005 and then we would anticipate that type of activity and run rate over the next 5 years.

Should we expect a bit of profitability recovery at Intermec in the fourth versus the third?

Fourth quarter as you know tends to be our blowout quarter.

We get all of the advantages from volume.

If you take that same formula, you would probably be right in the right ballpark.

Because we have already covered the R&D nut over the third quarter, the increased spending then, all of that 40 percent tends to get to the bottom line.

Yes, but when you are guiding us to less than a nickel in the third quarter, we sort of look at it (inaudible).

Our guidance has historically been conservative.

That is of course highly dependent on continued targeting of R&D investments and programs.

If we see opportunities where we can invest and continue the out year's growth, we will communicate that at such time.

Larry's guidance for fourth quarter was returning back to a normal baseline R&D spending of 7 percent of sales.

There won't be any incremental Intermec spending in the fourth quarter over baseline?

There will be R&D spending over baseline.

What I was trying to say is relative to the third quarter guidance, all of the incremental sales having already covered R&D at about that level would be covered at about a 40 percent level.

Okay.

Then if you go out to 2005, is there anything that would stop AIT (ph) at this point from returning to the low to mid single digit profitability that you had before this debacle occurred the last couple of years?

I think just volume recovery, Eli.

I think we are running the business right now for low single digits and volume will drive any -- we're not going to change the cost structure materially, so it will simply be a volume play.

Indeed, much as we've operated Intermec for the past couple of years, where we are getting the gross margin pretty much to the bottom line and because of volume efficiencies in manufacturing actually getting more than gross margin to the bottom line.

Are there any more charges coming in the rest of the year?

Relatively minor.

We do have some remnant costs from our discontinued operations and as far as other special charges there, is just some period expenses that have to flow through, but they are very minor.

All right, thank you, guys.

At this time, there are no further questions.

Thank you all.

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