Pall's CEO Hosts Investor Update Conference (Transcript)

Apr.30.12 | About: Pall Corporation (PLL)

Pall Corporation (NYSE:PLL)

Investor Update Conference

April 30, 2012 10:00 am ET

Executives

Lawrence D. Kingsley - Chief Executive Officer, President and Director

Lisa McDermott - Chief Financial Officer and Treasurer

Analysts

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Kevin R. Maczka - BB&T Capital Markets, Research Division

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Christopher S. Parkinson - Crédit Suisse AG, Research Division

Jonathan P. Groberg - Macquarie Research

David L. Rose - Wedbush Securities Inc., Research Division

Brian Drab - William Blair & Company L.L.C., Research Division

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Operator

Good day, ladies and gentlemen. Welcome to Pall Corp.'s Investor Update Conference Call. My name is Holly, and I will be your coordinator for today. Today's call is being recorded and simultaneously webcast. [Operator Instructions]

We'd like to remind you that the company's press release announcing its agreement with Haemonetics is available at www.pall.com. Management remarks this morning will include forward-looking statements. Please refer to Slide 2 or request a copy of the specific wording of this qualification of the company's remarks.

At this time, I will turn the call over to Mr. Larry Kingsley, Pall Corp.'s President and CEO. Please go ahead, sir.

Lawrence D. Kingsley

Good morning, and thank you for joining us here today. I'm with Lisa McDermott, our CFO. Yesterday we announced that we entered into a definitive agreement to sell certain assets of our blood filtration business for approximately $550 million, and the purpose of our call today is to review what we're selling -- that's including the economics and the strategic rationale for the transaction; and review the impact to the P&L and the actions that we're taking to offset EPS dilution in fiscal year '13; and finally, to address our current thinking and the options for the use of the proceeds associated with the transaction. And I'll refer you to the presentation slides that Holly just mentioned. Following that, though, we'll be happy to take your questions.

So let's start with the transaction terms, which are on Slide 4. The agreement entails certain business assets of our blood collection, filtration and processing product lines, including related blood filter media manufacturing capability. Haemonetics is the acquirer of the product line, as you know. Our customers in this market are the blood bankers using the Pall filters to prepare donor blood for transfusion.

And so included in the transaction are the associated customer lists, the manufacturing plants and the know-how. The transaction involves the transfer of manufacturing facilities in California, in Mexico and Italy and a portion of our operations on our campus in Puerto Rico. Once the transaction closes, approximately 1,300 Pall employees, or about 10% of our total headcount, will transition over to Haemonetics.

Pall and Haemonetics have had a long-standing commercial relationship and this will continue. We will be supplying them blood filter media, while we work through the transfer of that manufacturing capability that I mentioned. And that will be within a period of about 4 years.

The sale price, as I said, is about $550 million, of which $535 million will be paid upon closing. We estimate the after-tax proceeds on this thing [ph] will be about $430 million. We expect to record an after-tax gain of $230 million to $240 million or $1.95 to $2.04 per share.

Final determination of the proceeds, the gain on the sale and the tax impact is subject to working capital and other certain adjustments and final allocation of proceeds by jurisdiction.

The transaction is subject to certain closing conditions, regulatory approvals and labor-related notifications. We expect that, that will close at the beginning of our new fiscal year or approximately August 1.

So those are the salient facts related to the transaction. I'm going to turn to Slide 5. Why are we doing it? What's the rationale? It's after careful consideration, we decided to take this action to sharpen our strategic focus. We believe that it is the best fit for our customers, our employees and our shareholders. Customers will benefit from Haemonetics' comprehensive product offering and commitment to supporting them through the entire blood collection process.

We think it's a great opportunity for employees, who will become part of an organization where blood handling is the core business. Our shareholders benefit because we believe that the strategic value assigned to the transaction now, coupled with the resulting structural actions that it enables, maximizes both short- and long-term value.

And at the same time, this move enables us to focus on markets and opportunities where we are best positioned for growth such various life science and industrial end markets, where we are either #1 or we're very well positioned. And let me just reinforce that we do not intend to divest other businesses or product lines. And certainly, we're investing in life science in general and the other medical products as well within life science.

Our blood filtration technologies will definitely complement Haemonetics' strategy. And with the addition of our blood transfusion product line, we believe that they will be well positioned for future success. We also think that they'll be an excellent owner of these assets.

So in summary, this divestiture has significant strategic merit. We ultimately expect it to improve our profitability and enhance our long-term growth rate.

And now what are the short- and longer-term impacts to the P&L. I'm on Slide 6. As the transaction will not close until FY '13, we do not expect it to have any material impacts on the current year -- other than our presentation as a discontinued operation, that is. As shown on Slide 6, so you can see for purposes of modeling next year, in the future, we expect about $230 million of revenue for the blood business for fiscal '12. Operating profit is expected to be about $60 million, and we're assuming $0.38 of EPS contribution for this year.

And we expect to offset the earnings dilution through some structural cost actions and ongoing supply agreements with Haemonetics. We're currently evaluating various options for the use of the proceeds. Our priority capital allocation strategy is directed at growth, particularly acquisitive growth. And having said that, we are considering share repurchase and dividend enhancement as well.

The simple math would be, if we were just to repurchase shares at today's price over the next few months and continue to receive the benefit of a supply agreement with Haemonetics and not take any structural action, the net impact of the transaction would be about $0.14 dilutive to EPS. If we were to do this, we would still have, obviously, ample liquidity to fund growth.

So in closing, we believe this move will be beneficial for our customers, our employees and our shareholders. It allows us to focus on markets where we have competitive advantage, and it sets the stage for strategic growth, better operational execution and improves our overall profile.

So that's going to conclude my brief prepared remarks. We do intend to answer more of your questions on our third quarter call, which is scheduled for June 7. And I'll take your questions now but may defer some of them until we close our Q3 and again, we have our call on June 7.

So operator if you would, do we have any questions?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jeff Zekauskas, JPMorgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Just a couple of questions of clarification. When you talked about the operating profit subtraction being $60 million, is that exclusive of corporate overhead that applies to the business, or that includes that?

Lawrence D. Kingsley

No, it's exclusive of both segment overhead and corporate overhead. So to kind of give you a rough idea, the segment overhead would be -- the unallocated portion would be roughly $24 million, $25 million.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Great, okay. And in terms of the products that you'll sell to Haemonetics on an ongoing basis, I guess, until 2016, order of magnitude, what are the annual revenues? And I assume they will go away in 2016, is that correct?

Lawrence D. Kingsley

Yes, I mean, think about it this way. It's between $0.01 and $0.02 a share for those 4 years, and probably some revenue and relative profit beyond that, too.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Okay. And then lastly, the difference between $0.38 and the $0.14 dilution you talked about is $0.24. Can you just sort of explain how you can make up that gap and sort of what the timeframe is that you'll make that gap up?

Lawrence D. Kingsley

Well, the math that we spoke to there in the script basically assumes full dilution impact of $0.38. If we were to repurchase shares with the proceeds, that would have about a $0.23 or $0.24 positive impact. That -- we have about -- assume just $0.01 associated with that supply agreement, that gets you to a net $0.14. And then, again, we're thinking through and we'll talk in more detail about a number of structural actions that we're considering that we'll talk about in the June 7 call. But before you think through that $25 million or any form of other structural action, you're at a net $0.14.

Operator

Your next question comes from the line of Kevin Maczka, B&B [BB&T] Capital Markets.

Kevin R. Maczka - BB&T Capital Markets, Research Division

Can you talk about -- I guess we're talking about a multiple here on EBITDA of about 8x or slightly over 8x. Can you just talk about what kind of valuations you're seeing in the marketplace generally? I guess we've seen many filtration applications in the double digits and some well north of that. I'm just wondering if you can give any more color on how you arrived at 8x.

Lawrence D. Kingsley

Kevin, you have to decide first in terms of construct. Is this a business that you're comparing it to in terms of open market acquisitions? And so this is a carve-out of a product line. And that relative operating profit that we spoke to -- or really what is a proxy for EBITDA is before you attach the fixed cost to operating debt product line. And so the product line EBITDA multiple here would be your 8x. And then per the last set of questions that I just walked through, you'd have to think through what allocated overhead makes sense to attach to that product line. And in the Pall structure, as it is today, that's the $25 million that I just spoke to.

Kevin R. Maczka - BB&T Capital Markets, Research Division

So just to follow on that. Based on the numbers you gave, the $60 million EBIT, $230 million profit, that implies 26% margin. But you're suggesting it's more like a 15% margin business when you include this $24 million or $25 million in overhead.

Lawrence D. Kingsley

Within the Pall structure, that's right.

Kevin R. Maczka - BB&T Capital Markets, Research Division

Got it, okay. And did I hear you right, Larry, you have not identified any other non-core assets that you may be considering divesting as well? Or is that not correct?

Lawrence D. Kingsley

That's absolutely correct. That's absolutely correct.

Operator

Your next question comes from the line of Jon Wood, Jefferies.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

This is Brandon Couillard actually, in for Jon. Larry, how should we think about the short-term and long-term effects or nature of those cost-saving opportunities and, I guess, the potential to bring down that internal segment overhead that you'll, I guess, continue to run with here, near-term, at least.

Lawrence D. Kingsley

Yes, Brandon, you know what we're going to do on June 7 is walk the audience through a more comprehensive understanding of how we intend to transform the profile of the company, including these structural actions, but also not limited to these and how we get to the position that we spoke to, frankly, in our last call, where we can deliver consistent incremental profitability on whatever top line growth we're forecasting.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Okay. And then maybe this one might be better for Lisa. But can you speak to the capital efficiency of the divested assets and to the degree that this may enhance your -- the overall cash conversion cycle of the core Pall business?

Lisa McDermott

I think we will defer to our next call, our third quarter earnings call to talk about that more because I think you need to have the bigger picture of the structural actions that we're taking to measure our capital efficiency.

Lawrence D. Kingsley

But just in big picture form, this is not more or less capital efficient than the Pall business, as a whole, is today.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Okay. And then lastly, can you just give us a reminder of the remaining parts of that medical business and how you'll expect to report that on a go-forward basis? And then, perhaps, if you can comment on the expected revenue contribution from the ForteBio acquisition now that, that deal has been closed.

Lawrence D. Kingsley

Well, ForteBio reports up through Life Science, and it will be -- revenue and profit recognized within Life Science. It wouldn't be called out specifically as such. It's not a sub-segment. It's within our lab business, within the overall segment. The other product lines within medical as a sub-segment within Life Science are -- there's several, but it's the products like the Aquasafe; the water filters; some of the breathing circuit and IV filters; cardiac bypass; surgery products; cell therapy and regenerative medicine products, which is a the high growth area for us; and others. But there's quite a few other products that -- within that medical portion of Life Science that we'll -- incrementally investing in where we think we've got a great growth opportunity.

Operator

Your next question comes from the line of Hamzah Mazari, Credit Suisse.

Christopher S. Parkinson - Crédit Suisse AG, Research Division

This is Chris Parkinson on behalf of Hamzah. You touched on this a little, but can you give a little more color on the potential -- the acquisitive landscape, and just very generally, on what size you're viewing and what you think is your sweet spot and how deals would basically fit in your strategic rationale? Is it bolt-ons? Is it complementary businesses? Just any color there would be appreciated.

Lawrence D. Kingsley

Yes, Chris. Look, we've been making the comment, I hope, pretty consistently on the earnings calls of recent, and you'll hear more of this to come. But as our capital allocation strategy takes further shape, it's certainly got acquisitions as the most important priority or use of our cash that we generate, and for something of this sort as well. At the same time, we're implementing a very disciplined M&A strategy. And we're going to be adding businesses that make good strategic sense, both Life Science as well as Industrial, and we're looking at them. We've got a more dedicated approach toward the opportunities that will be both bolt-on, as well as ones that would be considered larger than bolt-on. We are not assuming or planning for a specific event that's timed to coordinate with this particular transaction, but we do think that the landscape is going to be fruitful. There's going to be plenty of opportunity and obviously, the balance sheet can support quite a bit.

Operator

Your next question comes from line of Jon Groberg, Macquarie Capital.

Jonathan P. Groberg - Macquarie Research

I guess, Larry, big picture question for you. If you think about the last few years, where Pall would run into some issues in terms of the consistency that you're talking about, it seems that most of the issues would center on more of the Industrial businesses and some of the problems on the capital equipment side of that business. And so I think a number of investors have thought maybe that's where you might look, to say, "Look, do we maybe need to be in some of these capital-intensive businesses?" and focus maybe more on the -- on just the filters. So can maybe just talk about in the context of your broader comments, I mean, is this -- in terms of pruning the portfolio, this is kind of it, as you've looked at it? Or are there other actions outside of Life Sciences that you're still considering?

Lawrence D. Kingsley

Well, we're looking at other organic actions. I'll call them that. We're going to be more or less involved in certain portions of the business as we go forward. When we talk about, let's call it mix or lack of visibility of the mix in some of the more recent quarters, and some of that justification having been around systems content, we are taking a more critical eye toward which systems opportunities on organic basis we're going to continue to pursue. But that's not necessarily a portfolio management decision. It's more about sales force direction and execution. And within what we cover in the way of capital equipment, we can get a lot better at pricing and execution, which is a big portion of what we'll be doing over the next couple of years. So there's not really an equivalent portfolio decision set, but there is a lot of execution elements for how we can improve, how we get the better predictability. All that said, we're always going to operate a business that in a given quarter will have a gross margin range as a function of revenue mix that is several points, at a minimum.

Jonathan P. Groberg - Macquarie Research

And then if I could just follow up. As you looked again at the Life Science businesses and you saw this particular asset, and you said was really a carve-out of an asset, is this -- is it -- not all carve-outs are equal, in terms of the complexity and executing on them. So is this a pretty -- is it pretty obvious in terms of the things of that need to be carved out? Or are there some risks inherent in kind of how you're trying to pull on just these particular pieces of the business?

Lawrence D. Kingsley

No, from a market-facing standpoint, there really aren't any real risks. It delineates pretty nicely. Internally, we think we've worked very hard. And the teams, both the Pall and Haemonetics teams, have worked very hard to make sure that we're carefully considering how this will be managed in the short- and long-term, and I think we've arrived at a good plan. The work that's been done has been very complex to-date. And we've got, between the 2 companies, a fair amount of work to do between now and close, but we're both committed. And I think that there's very little risk from an internal perspective. The -- I think the customers for the blood collection associated products will certainly benefit from having the combination of our manual whole blood collection devices coupled with some of the automation that Haemonetics can bring to the table. And I think that customers will see this certainly as a win-win for them. So we're pretty confident that we won't have either internal complexity that puts execution at risk or, frankly, that there will be any kind of market-induced concern. And for that matter, we've got the typical post-filing -- or post-announcement filing regulatory issues to work through, but not the -- anything that would be HSR-associated that would be concerning, relative to deal completion.

Jonathan P. Groberg - Macquarie Research

And then if I could, just one last other. Internally, is the message -- on the Life Science side of the business, I mean, is this -- is there any -- I know you said you're still investing in the biopharma manufacturing and in the other pieces. But is there any kind of -- I guess, internally, how you're positioning the focus now -- a new CEO coming in, kind of your view about the Life Science business, its strategic importance and how you anticipate investing in that business going forward?

Lawrence D. Kingsley

The Life Science businesses are incredibly important. They really form the nucleus of our strategy going forward. Biopharm, the bioprocessing applications represent the biggest growth opportunity for us on a global basis, both organically and acquisitively and front and center, frankly. The strategic rationale applied to this decision was more about focus and making sure that we can do the things that are necessary to get after the biggest growth opportunities even more effectively than we have. And so just because we're pulling revenue out of the reported Life Science segment, it has nothing to do with, in any way, de-emphasizing Life Science. And in fact, the reverse is the case.

Operator

[Operator Instructions] And your next question comes from the line of David Rose, Wedbush Securities.

David L. Rose - Wedbush Securities Inc., Research Division

Three quick ones. Are there any onetime discrete cost associated with these cost reductions? I don't know if Lisa can bracket this or not, any type of personnel reduction?

Lisa McDermott

Well, the cost reductions that we've talked about, we will talk more fully about on the call. But yes, there will be some onetime discrete costs to be incurred in connection with those, and we'll button it up a bit for everybody publicly in June.

David L. Rose - Wedbush Securities Inc., Research Division

Given that you're talking about $25 million in segment-related SG&A, is that kind of the number we should be looking at, sort of a onetime payback? I mean, is that $20 million number kind of a reasonable number from which to start?

Lisa McDermott

Well, what we've said is that our -- at a minimum, our cost reduction opportunity and target will offset -- as well as the supply agreement, offset this dilution, not accounting for capital allocation.

David L. Rose - Wedbush Securities Inc., Research Division

Okay. But there will be some cash outlays for these upcoming discrete items?

Lisa McDermott

Yes, there will be.

David L. Rose - Wedbush Securities Inc., Research Division

Okay. And then on the supply agreement, can you explain a little bit more? It's not quite clear to me what you'll be supplying given that they -- Haemonetics will have factories, IT, everything else. What exactly will you be supplying?

Lawrence D. Kingsley

The way the products are produced, filters in particular, is that the core filtration capabilities around the filtration media, of which -- you've been following Pall for a while. We have probably the largest estate and one of the deepest capabilities around filtration media on the globe. And associated with blood, there are a couple of which -- we make that media in 2 locations in specific form. We will be continuing to make that and supplying it as the core ingredient to the filter to Haemonetics for a period of up to 4 years. And then at some point, they will, along that timeline, take over that responsibility. They'll work for the regulatory approvals -- the FDA that is, and some of the things associated with so that they'll have vertical integration capability for all of the product associated with the blood applications.

David L. Rose - Wedbush Securities Inc., Research Division

Okay. And you have a number of relationships with people such as GE as well. None of this affects those relationships, correct?

Lawrence D. Kingsley

That's right.

David L. Rose - Wedbush Securities Inc., Research Division

Okay. And then lastly, in the last quarter, the company suggested that acquisitions would be really back-burnered to focus on execution, and you've obviously made some changes. Is there anything meaningful that has changed from the last quarter such that the tone has changed now, where you're a little bit more comfortable with acquisitions being more near-term than next-year driven?

Lawrence D. Kingsley

Well, really there's 2 questions embedded into one. First, we've got a lot of work to do around operational execution, which -- we're making progress, but we've still got a lot of work to do. And that's first and foremost on the plate. We are ramping up a business development capability such that, in parallel to sharpening our operational execution, that we have a built-in funnel, frankly, that we can begin to cultivate acquisitions so that we don't have a delay once we have the ability to integrate acquisitions in place. So I wouldn't stray from the timeline of the remarks that I made last quarter.

Operator

Your next question comes from line of Brian Drab, William Blair.

Brian Drab - William Blair & Company L.L.C., Research Division

I apologize for missing the beginning of the call. I'm trying to calling in here from road. But if you haven't said -- or if you have said already, I'm sorry, but the growth and margins for this business that you're divesting, my understanding is that the margins for the medical segments were in the low double-digit range in terms of operating margin. And is that the case? And if so, surprised to see 26% operating margin for this business in 2012, and is that unusually high margin for this business.

Lawrence D. Kingsley

Again, it's a little bit of apples and oranges, and I'd kind of refer you back to the call. But the margins that were released relate to EBITDA associated with blood, with not all the allocated overhead costs within segment, as should be applied -- within the Pall structure, that is. So you'd get back to that low- to mid-double-digit operating margin once you think about that fixed cost allocation. Relative to your growth question, for the 2 quarters of our fiscal year, we reported growth in the business of about 5% organically.

Operator

Your next question comes from line of Tracy Marshbanks, First Analysis.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

And I'll make the same apology if I missed a bit, I've been in and out. But I heard you -- how much of the rationale and analysis really was you're looking to build a company that has leading -- or ways to get to leading positions and when you looked at this product line, or even market, that it just didn't make sense that you could get there or get there economically, and so it made sense to go elsewhere?

Lawrence D. Kingsley

All of it, to answer your question in short form. So we've done a fair amount of work in the last few months looking at the strategic merits of the various end markets that we operate in, and our position today. And we've ranked and stacked them as a function of where we think the market growth opportunity is for us; where we think we have a differentiated position and/or not; and what we need to do to capture the best possible portfolio for the future. And when we did all that and looked at where we play in blood, which is mainly around the manual collection applications, and what was necessary for us to compete with a mature set of players in the space, we thought that some form of partnership with someone as good and strong as a Haemonetics made sense. We thought through various relationship opportunities and at the end of the day, with multiple -- obviously, many conversations internally and with Haemonetics, decided that this made the most sense.

Operator

Your next question comes from line of Richard Eastman, Robert W. Baird.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Larry, what percentage of that $230 million of revenue on a trailing basis went to or came from Haemonetics?

Lawrence D. Kingsley

About 10% of it.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

10%?

Lawrence D. Kingsley

Yes.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

And just who initiated the discussions about a possible transaction?

Lawrence D. Kingsley

Well, we've been friends in the marketplace for a number of years and at the top of the company for multiple leadership generations have had conversation, but couldn't -- or couldn't make sense of it strategically.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay, okay. And is it -- would it be your intent -- I mean, I think when you called out the corporate overhead that was allocated to this piece of the business, so as you sit here today, is your intent to retain that piece of corporate overhead to be absorbed through acquisitions?

Lawrence D. Kingsley

Well, I think you should think about the fact that we've been operating an integrated business model with product lines. And as we go forward and think about the portfolio, both organically and what we want to have in terms of P&L profile, so fixed cost actions that make sense for us to make sure that we can represent the right leverage or right profile for us to grow from organically, but then also to incorporate what the best structure is for us to acquire and integrate into, the opportunity, frankly, is there for us to think through a transformational set of actions on a little bit larger basis than just are what implied by this transaction. We'll talk more in our call on June 7.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then just one last question. If I assume the media supply agreement going forward and maybe I make an assumption on the EBIT contribution from what would typically be a higher-margin piece of business, would that supply agreement on a go-forward basis be kind of in the single-digit millions in revenue per year? Is that about the right number?

Lawrence D. Kingsley

Yes.

Operator

At this time, there are no further questions. I'll turn the call back over to you, Mr. Kingsley, for closing remarks.

Lawrence D. Kingsley

Okay. Well, thank you for joining. And again, we'll talk more and be in a position to answer some more of your questions on our June 7 call, our Q3 earnings call, and obviously again then, thereafter, our intended close of the business toward the end of our fiscal year. I want to thank the internal teams, both the Pall and Haemonetics teams, for the good work done. We've got a lot to do in front of us, but we're well on our way. And we think, again, that this benefits both our employees, our shareholders but also, most importantly, our customers. So thanks to all, and we'll talk to you in a month.

Operator

Thank you. This does conclude today's conference call. You may now disconnect.

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