3M (MMM) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, welcome to the to the CUNO second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, with instructions given at that time. If you should require assistance during the call, please press zero, then star.

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, CUNO's CFO, Mr. Fred Flynn. Please go ahead.

Thank you,

. Mark Kachur, our CEO,

is also here with me this morning. We appreciate all of you joining us for a review of our second quarter performance and outlook. I'll begin with any analysis of our recent financial results, then Mark will update you on our new products and business outlook. After that, we'll open the call for questions.

A Powerpoint slide summary of our remarks is available on our Web site if you go to cuno.com, investor info section, click live webcast, and click supporting materials, Q2 earnings. Also, to enhance our corporate disclosure practice, effective with yesterday's release,

we've begun simultaneously filing our 10Q for the quarter, so our second quarter 10-Q is electronically available on our Web site as well, under SEC filings.

Please keep in mind the forward-looking statements contained herein are subject to risks and uncertainties that could cause actual results or performance to materially differ.

As reported yesterday afternoon, we had a strong second quarter despite the continuing pressures of the weak global economy, and the strong dollar.

Our worldwide sales were a record $63.1 million in the quarter, up 5 percent from last year's record second quarter, and up 7 percent on a local currency basis.

Diluted earnings per share were a record 32 cents in the quarter, up 19 percent versus last year's reported results, and in line with the consensus estimate.

Excluding the approximate 2 cent favorable impact of adopting FAS-142, EPS were up 10 percent. Currency rates had an unfavorable impact of about $1.4 million on sales, and 2 cents in EPS in the quarter.

So, in addition to weak economic conditions, once again, when you take into account the negative impact of currency translation, our earnings in the quarter were quite strong.

Our gross margin increased 44.7 percent, from 44.3 percent last year,

primarily reflecting an improved sales mix, including increased healthcare volume, and higher potable water after market sales. SG&A spending of $16.2 million was relatively flat compared to last year.

Research, development, and engineering spending was $3.7 million, representing 5.9 percent of sales, up about 12 percent, reflecting our ongoing commitment to new product development.

Our operating margin was 13.2 percent, well above last year's record second quarter operating margin of 11.5 percent, which would have been 12.1 percent had FAS-142 been in effect then. Improved mix and effective cost management were the primary contributors.

Net

operating income was down slightly. Our effective tax rate was 34.5 percent, about 170 basis points lower than last year, reflecting the benefit of ongoing tax management initiatives, and the favorable effect of FAS-142. Net income was $5.4 million,

resulting in record EPS of 32 cents. Diluted shares outstanding were approximately 17 million. So, with sales up 7 percent in local currency, we again achieve record operating results, including excellent earnings quality, by improving our business mix, driving our new product programs, and closely managing our costs.

This marks our sixth consecutive quarter of record earnings. EBITDA was 10.6 million in the quarter, up about 10 percent from last year.

Our operating cash flow for the quarter was 6.8 million, comparable to last year. Cap ex of 4.4 million was up, due to expansion and modernization spending, while depreciation and amortization expenses of about 2 million were down slightly, primarily due to the effect of FAS-142.

Our financial condition remains very strong. We ended the quarter with $25 million in cash, compared to only $14 million in debt, and reduced our debt to capital ratio to 8.4 percent. Worldwide orders in the second quarter were 62.7 million,

up 5 percent in local currency, a positive sign in the current economy.

Looking at our results by major market, sales in our largest business, potable water, were up a record 29.5 million in the quarter, up 14 percent from last year's record second quarter sales of

25.9 million, and up 15 percent in local currency. We achieved record

sales and strong increases in both residential and food service.

Fluid processing sales were 16.5 million, down 9 percent from 18.2 million, and down 6 percent in local currency. Weak market conditions, particularly in the US and Japan, plus the strong US dollar, negatively affected results in this part of the business. However, fluid processing sales increased sequentially by 9 percent versus the first quarter, and the recent order trend has been somewhat encouraging.

Healthcare sales increased by 6 percent to 17.1 million,

and were up 10 percent in local currency, led by continued strong growth in our biopharma businesses. So, for the quarter, our sales mix included increased potable water volume, and strong health care sales, which more than offset lower fluid processing volume.

Looking at our business mix geographically, sales in our largest region, North America, totaled 36.9 million, up 12 percent from last year, reflecting strong growth in our US health care and potable water businesses,

which offset lower fluid processing sales. Although the Asia-Pacific region, which includes Japan, contributed sales of 13.7 million, the weak economy in Japan significantly impacted results.

Consequently, reported Asia-Pacific region sales were down 7 percent from last year, and down 2 percent in local currency, despite continued good performance in both Australia and Asia. Sales in Europe of 9.6 million were up 1 percent from last year's reported

9.5 million in sales, and up 4 percent in local currency, reflecting strong results in healthcare and potable water, which more than offset lower fluid processing sales.

Latin America contributed about 2.9 million, or nearly 5 percent of our total sales, and continued its strong operating performance. Reported sales were down 1 percent in Latin America, but up 12 percent in local currency, primarily reflecting strong growth in the healthcare market.

Overall, our worldwide sales were up 7 percent in local currency, versus last year's second quarter. We have reasonably good growth in all geographic areas except Japan. Recapping our first half results,

sales were 121.8 million, up 3 percent as reported, and up 6 percent in local currency. Net income was 9.9 million, up 18 percent, and fully diluted EPS of 59 cents were up 18 percent from last year's first half.

Excluding the favorable impact of adopting FAS-142 in fiscal 2002, net income and fully diluted EPS in the first half would have been up 11 percent and 9 percent, respectively. Further adjusting for

, which reduced reported earnings by 4 cents in the first half, our first half EPS would have been up 17 percent. Through six months, potable water sales were up 11 percent, as reported, and up 12 percent in local currency.

Fluid processing sales were down 14 percent, as reported, and down 10 percent in local currency. Healthcare sales were up 9 percent, as reported, and up a strong 14 percent in local currency. Through six months, sales geographically were concentrated in North America and Asia-Pacific.

Strong year-over-year growth of local currency was experienced in all regions, with the exception of Japan.

Latin America and Europe achieved the highest growth, with sales up 21 percent and 9 percent, respectively, in local currency.

Now let me turn it over to Mark.

Thank you, Fred, and good morning. Our new product programs continue to perform well, and despite the current economic environment, we are maintaining our commitment to R&D spending.

New products contributed approximately $9.7 million or 15 percent of our second quarter sales. As those of you who were in on our first quarter call may remember, the reported percentage is down somewhat from last year since at this point we are no longer counting unit shipments of the

original models of integrated refrigerator filtration systems, although in fiscal 2002, the results in replacement cartridge sales are included. Our new healthcare products, especially those with applications in the pharmaceutical and biopharmaceutical markets

are being very well received with our products specified on several new drugs now in clinical trials. In addition, our efforts to broaden our

customer base are progressing.

As to our business outlook, we expect continued performance improvement in the second half of the year.

Our business mix is developing as planned, our new product programs are on track, and our costs are well controlled.

Geographically, starting with North America, sales will be driven by continued growth in our healthcare and portable water businesses as was the case in the first half. But in addition, we are really encouraged by the sequential improvement achieved in our fluid processing business in the second quarter, and now expect similar sequential improvement in the second half.

In the Asia Pacific region, expect the continued strong performance in potable water and healthcare should help mitigate somewhat sluggish conditions in the fluid processing business in Japan.

In Europe, healthcare and water market

conditions remain favorable, and both segments should perform or should continue to perform well, while the fluid processing business is likely to remain flat.

In Latin America, we expect continued strong growth in the healthcare and portable water business in part driven by new products. And fluid processing is apt to be relatively flat.

Overall, our near-term growth should continue to be led by healthcare and portable water business. However, we are now seeing early signs of improvement in the fluid processing market and we are cautiously optimistic that fluid processing sales will modestly improve in the second half of fiscal 2002.

In the second quarter, we've met our performance targets despite the negative effects of the weak global economy and the adverse currency impact. We are encouraged by our strong order level of 62.7 million

in the second quarter and some signs of possible improvement in the economy. As a result, we expect continued strong performance in the second half and remain comfortable with $1.33 - $1.37 range of

analysts' earnings estimates for the full year.

Now, this completes our planned remarks, so let's open the call for questions

Thank you.

Ladies and gentlemen, if you wish to ask a question, please depress the one on your touch-tone phone. You will hear a tone indicating that you

have been placed in queue. You may remove yourself from queue at any time by pressing the pound key. If you are using a speakerphone, please pick up your handset before pressing the numbers.

We have a question from Alan Pavese with CSFB. Please go ahead.

Actually this is

asking questions on behalf of Alan.

A quick question for you on the portable water growth, which is very strong this quarter especially in North America - I was wondering if you could provide us with a little more detail on what the different groups contributed to the growth - mainly OEMS,

direct-marketing, appliance, end-markets - things like that - how much - and food service - and how much these contributed to the growth and what you see in each of these markets possibly going forward throughout the second half.

, we don't - excuse me - normally break out the specific details of each, but I can tell you it was strong across the board.

OK.

There was certainly a pickup - a little bit of help from the economy in the residential section which had been somewhat soft in the past, and we're very encouraged with our outlook for the remaining half of the year ...

OK.

...

segments should be strong.

On - second question - on increased insurance -

mentioned in the queue that insurance had been going up. I was wondering if you could give us a little bit of detail on what percentage increase or what types of increases you're seeing in the insurance rates, when these rates kicked in,

or when they are going to continue to kick in in the coming quarters.

We recently completed a renewal of some of our major coverages including property coverage full-year effect

beginning with May policy coverage we're looking at an order of magnitude increased in those various programs over the next 12 months of about $400,000, which was a substantial increase percentage

wise and unfortunately is reflective of what's happening in corporate America.

Definitely.

OK, last question - I was wondering if you could tell us a little bit more about the expansion of the manufacturing facilities in Brazil and in China, what product lines these might be focused on, when these might become operational, and where those materials are being

manufactured currently or if these are just totally new extensions.

Well, the expansion first in Brazil - actually it's not a total expansion because we've had manufacturing facilities in Brazil for some time.

OK.

We're putting a couple new things down there, which should be online shortly - I mean within 30 to 60 days, and so that's well underway.

Now, China, of course - of course, is new. We've just started manufacture there of a couple of our easier products to make and we've only been in production now for about 60 days.

OK.

In the long run, we expect China to be very, very important to us, not only as a growing economy but as a manufacturing source for worldwide products.

Is it focusing on any particular product line in particular?

You know it's going to have a full range of capability for all of our products

.

OK, thank you very much - great quarter.

Thanks,

.

We have a question from the line of Lorraine Maikis with Merrill Lynch. Please go ahead.

Good morning.

Good morning, Lorraine.

Could you elaborate a little bit on the signs of recovery that you're seeing as far as geography? Is it just domestically or worldwide?

Well, it's a - it's still early certainly. I know many of you are interested in this. And we saw in the U.S. in our fluid processing business from about mid-March to, you know, as we speak today, certainly a reasonable increase in activity -

an increase in orders and sales, you know, we've reported. We also saw in Japan a pretty good increase in about April. And our forecasts for the remainder of the year are very encouraging.

At the same time, we saw a bit of a slowing in Germany - or, I'm sorry, in Europe, primarily in Germany. We're not really sure how to interpret that.

But overall, it appears especially driven in the U.S. that we're seeing some positive signs of recovery in the fluid processing segment.

I will say in our businesses we include electronics and semiconductor in the electronics business or in the fluid processing business and we don't see that recovering to the same extent that we see the other parts of that business recovering.

OK. And is this increased demand primarily in new systems or are you seeing a pickup in after-market as well?

It's a combination of both, which we find encouraging.

Can you give us some information on the four new portable water initiatives that you announced I believe in Q4?

They're still progressing well. We expect that they'll all be in line or, you know, they'll certainly launch by the - oh, certainly by the end of this calendar year. And so they should start to have some reasonable impact if not in the first quarter of next year,

certainly something in the second quarter.

OK. And one last question - for portable water, your refrigerator filtration systems, are you still tracking on plan for the actual filtration units and for your after-market sales?

Yes, we are. We've very encouraged

.

OK, thank you.

We have a question from the line of Richard Eastman with Robert W. Baird. Please go ahead.

Hi, Mark, Fred. Could you just give a rough estimate in terms of your portable water business - how much of that overall business

is in North America, Europe, and Asia - just rough estimate?

You know, it's - we're looking at the numbers. You know, I think maybe

or so is still North America

.

OK.

Yes,

the majority is still

.

OK.

And, you know, the others are smaller splits

.

Yes.

OK. And again, in the potable water business overall, there seems to be an uptick on the residential side, you know, the plumbing wholesale channel.

Is that - do think that's seasonal, or is there any channel issue there? Or, is that - because that business had been running fairly soft for a while, and I'm just curious. We've seen it with some other companies as well, but I'm just curious if that's sustainable, or how you interpret that?

Well, that's a $64 question,

, but certainly the increase was very positive now for almost two months in that sector. You do see some seasonal adjustments here when people go to their summer homes, perhaps,

and open them up and you see some activity. But we're seeing it across the board, so we feel that it may have some legs now.

OK. And then, Mark, on the RD&E side,

fairly significant quarter-to-quarter jump in RD&E investment. Is there any particular near-term significance of that? Is there any products late-stage development, or is that going to be more the run rate here for the foreseeable future?

You know, it's more lumpy than anything,

. We have products that are coming out for later this year. We do have - you know, as you had mentioned in the earlier question, you know, some early expenses related to some of these

programs that we're working on.

But you do see a little bit of lumpiness in RD&E spending as a matter of course.

OK, all right. And then maybe just one last question. In terms of the order rate in the quarter, were there any late quarter trends, or perhaps early third quarter trends here of any significance to point to that are encouraging?

You know, it's hard to interpret. Overall, the quarter was pretty strong, and as expected. And we're still seeing that, but we're like everyone, we're watching and waiting, and just waiting to see what's going to happen.

OK. Very good, thank you.

Thanks.

We have a question from the line of

with First Analysis. Please go ahead.

Hi, guys, this is

, actually. I'm not

.

Hi. Congrats, by the way, on bringing your 10-Q

by quickly. I mean, it was really appreciated.

Oh, thank you.

Thank you.

We're glad to see people are reading it.

We were surprised to find it available!

Couple of quick questions. Regarding your electronic pick-up comments, was that related to North America, or was that worldwide? And particularly as far as China and Japan are concerned?

It was not only North America, but worldwide, including China and Japan, South Asia.

All right. And what exactly is -- I mean, what have you been seeing in Japan? What's going on there over the last couple of quarters as far as your businesses are concerned, versus the general economy in Japan?

Well, up through March it was terrible, with a capital "T." However, we did see some recovery in April, and that may be just the impact of the new fiscal year starting in Japan. It's too early to tell if April is a sign

of things getting better. But nonetheless, it was better. So we're cautiously optimistic that it may have at least bottomed, and starting to turn upward to some extent.

This is

.

As far as the extent of the impact on your business, was that driven by a particular industry that was worse off than the Japanese economy, like the microelectronics? Or, was there any structure to that?

Well, we saw a pretty reasonable pickup in our fluid processing business, except for the electronics side.

OK.

And finally, what are you seeing in the biopharm business, as opposed to what others are seeing around there?

We had a pretty healthy pickup, and the big effort for us is continuing to get specified on new drugs. And we were reasonably successful in doing that. So we still are very, very bullish on that. And we feel confident, going forward,

that that is a strong double digit growth segment for us. But that's working out very well for us.

All right, thanks, guys.

Thanks.

Thank you.

If there are any additional questions, please press the one at this time.

And we have a question from

with Schwab Capital Markets. Please go ahead.

Yes, good morning, guys. Just a little bit of follow-up. Again, trying to get a handle on what's going on in the residential water market.

Mark, you mentioned perhaps some seasonal impact. Is there any sort of inventory-building at any of your customers? I mean, I know it's kind of hard to get these trends early, but I also am finding it hard to get a sense of whether the market really is improving,

or whether we have some special factors here.

Yes, we can't tell you if there is inventory building. Typically there isn't in our channel. They keep relatively small amounts, at least of our product, because we do deliver in one or two days.

So there isn't a great need. I think it's still - the jury is still out as to whether or not we're seeing a fairly decent pickup or not. Partly what helped us was a launch of a couple new products

in that sector, which also, although the impact wasn't major, because they just were launched, you know, had the effect of driving up sales.

What new products?

We had a new water treatment valve that went out -- actually, it's a relaunch of an older one - that went out in March and April that was pretty well received. This is going out for water-softening equipment.

Yes, OK, that's helpful. And on the biopharm side, also to follow-up on the prior question. You had mentioned last quarter, and certainly we've seen this with other companies, too. It can be fairly lumpy from quarter to quarter, as you do come in and out of new drugs - or into new drugs. You had a great quarter last quarter, another great one. What's your relatively near term outlook for that for the rest of the year? You said a double digit grower.

Are you talking in biopharm

or in the total healthcare business?

Yes, well, both. But biopharm being a particular growth driver there.

Yes, biopharm next couple of quarters should be good, strong double digit growth.

Based on what you see in the pipeline now?

Yes, without a doubt.

OK.

And the overall healthcare business should continue to be reasonably strong as well.

Can you give us a little update on where you stand on the roll-out of the diagnostic products?

You know, we're having a lot of success in terms of acceptance, and we're into what I hope are later stages of development.

The outlook is still extremely encouraging for us. It's taking, I will admit, somewhat longer than expected. But I guess that's true of anything going through the FDA these days.

Yes.

The hang-up in many cases is not with the work being done between CUNO and the company, it's the FDA approval of the company's application.

But we still think we're on the right track. And we'll start seeing some impact probably mid-next-year.

In mid-fiscal '03?

Yes.

OK. Thank you.

If there are any additional questions, please press the one at this time.

And we have no further questions at this time; please continue.

OK. Well, we'd like to thank all of you for participating in our conference call. And if you have any additional questions, please feel free to contact me.

Thank you.

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That does conclude your conference for today. Thank you for your participation, and using AT&T Executive Teleconference. You may now disconnect.