Astec Industries Inc (ASTE) 2012 Q4 法說會逐字稿

Greetings. Welcome to the Astec Industry's fourth quarter 2012 conference call. (Operator Instructions) As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Mr. Steve Anderson, Director of Investor Relations. Please go ahead, sir.

Thank you, Stacy. Good morning, welcome to the Astec Industries conference call for the fourth quarter and fiscal year ended December 31st, 2012. As Stacy mentioned my name is Steve Anderson and I am the Director of Investor Relations for the Company. Also on today's call are Dr. J. Don Brock, our Chairman and Chief Executive Officer, and David Silvius, our Chief Financial Officer.

In just a moment I will turn the call over to David to summarize our financial results and then to Don to review our business activity during the fourth quarter. Before we begin I will remind you that our discussion may contain forward-looking statements that relate to the future performance of the Company and that these statements are intended to qualify for the Safe Harbor liability established by the Private Securities Litigation Reform Act. Any such statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions. Factors that can influence our results are highlighted in today's financial news release and others contained in our annual report and our filings with the SEC. As usual we ask that you familiarize yourself with those factors.

So at this point I will turn the call over to David to summarize our financial results for the fourth quarter of 2012.

Thanks, Steve, and good morning to everyone. Let me first preface my comments by saying that as we previously announced, we sold American Augers as of November 30th and as a result we have recast the financial information presented in your press release and in the segment portion of your press release to reflect the required presentation for discontinued operations. Therefore my comments today will be in reference to the financial statements as they are presented unless otherwise noted.

So let's begin with net sales for the quarter . We at $227.6 million in the fourth quarter of 2012 compared to $253.3 million in the fourth quarter of 2011. They were down 10.1% or $25.7 million.

International sales for the quarter were $98.6 million compared to $110.4 million in the fourth quarter of last year so 10.7% decrease or $11.8 million.

The decrease in dollars for international sales occurred primarily in the post Soviet states, and in South America, and in the Middle East offset by increases in international sales in Mexico and Asia during the quarter. International sales were 43.3% of Q4's net sales versus 43.6% of Q4 of 2011's net sales.

Domestic sales for the fourth quarter of 2012 were $129 million compared to $142.9 million in the fourth quarter of 2011That's a 9.7% decrease or $13.9 million decrease.

Domestic sales were 56.7% of sales in Q4 of 2012 compared to 56.4% of sales in Q4 of 2011.

Parts sales for the fourth quarter of 2012 were $58.1 million compared to $55.4 million for the fourth quarter of 2011. That's an increase of 5% or $2.7 million.

Parts sales were 25.5% of the fourth quarter 2012 sales compared to 21.9% in the fourth quarter of 2011. The segment revenues for the fourth quarter are attached to your press release.

Including American Augers sales for the fourth quarter were $242.3 million compared to $263.2 million in the fourth quarter of 2011. That would have been a 7.9% decrease or $20.8 million.

Included in those sales you also note that we have sold the Trencor product line of our Astec underground operation, and we previously announced that as well. We sold them as of November 30 and included in sales not in the discontinued, but in the sales revenues for the quarter is $7.7 million related to that transaction as well.

Net sales on a year-to-date basis are $936.3 million compared to $908.6 million for the 2011 year. It is a 3% increase or $27.7 million dollars.

International sales for the year-to-date basis are $363.8 million compared to $365.1 million. They are down just barely at 0.4% or $1.3 million.

The decrease in dollars for the year in international sales occurred primarily in the South American countries excluding Brazil, the Middle East, and Africa. These were offset by increases in those sales in Australia, in Mexico, in Russia, and in Brazil.

International sales were 38.9% of sales year-to-date for 2012 compared to 40.2% of year-to-date sales for 2011. Domestic sales for 2012 were $572.5 million compared to $543.5 for 2011. That's an increase of $29 million or 5.3% increase.

Year-to-date domestic sales were 61.1% of total sales for 2012 compared to 59.8% of total sales for 2011 .

Parts sales in 2012 were $245.9 million compared to $220 million for 2011. That's an increase of 11.8% or $25.9 million. Parts sales were 26.3% of the current year's total sales compared to 24.2% of 2011's total sales.

Again sales by segment for the year are attached to your press release. Including American Augers for the year, sales would have been $989.9 million compared to $955.7 million in 2011. That's an increase of 3.6% or $34.2 million .

GEFCO sales. We bought GEFCO early in the fourth quarter of 2011 and so the GEFCO sales for 2011 as we have previously discussed were about $10.9 million for that quarter . GEFCO for this year of 2012 is $45.5 million , and that's an increase of about $34.6 million for GEFCO.

Gross profit for the quarter was $48.1 million compared to $54 million for the fourth quarter of 2011. A decrease of $5.9 million or 10.9%. The gross profit percentage was 21.1% for the quarter compared to 21.3% for the fourth quarter of 2011.

One of the drivers of that gross profit during the quarter was the absorption variance. We had a negative change in absorption of about $3.3 million during the quarter and that was driven primarily by both the Asphalt and the Aggregate Group.

During the fourth quarter of 2011, recall that we had charges of about $2.2 million that were recognized in gross profit related to the sale of the utility product line in the underground group. Consolidated gross profit for the year was $206.9 million compared to $210.5million for 2011 or down 1.7% or $3.6 million.

The percentage was 22.1% for 2012 compared to 23.2% for 2011. That's 110 basis point decrease. Big driver there was a negative change in absorption of about $11.5 million driven again primarily by the Asphalt Group or by the aggregate group and the mobile group.

SGA&E for the quarter was $39.8 million or 17.5% of sales compared to $41.4 million for the fourth quarter of 2011 or 16.4% of sales. That's a $1.6 million decrease in dollar terms, but an increase of 110 basis points (inaudible) percent of sales.

Some of the drivers there, payroll and related were part of the increases. We had decreases in profit sharing and a slight decrease in Research & Development spending.

For the year SGA&E was $156.8 million or 16.8% of sales compared to $151 million for the year of 2011. 16.6% of sales then. That's a $5.8 million increase.

Some of the drivers of the increase were health insurance and payroll and some of the detractors or the items that reduce that change were -- remember we had the CONEXPO show early in 2011. We had a reduction also in profit sharing expense and other expenses related to long-term incentive plans.

During 2011 we also had an impairment charge as we have disclosed early in 2011 of $2.2 million related to some aviation equipment. Then that shows up on a separate line item in 2011.

Operating income for the quarter was $8.2 million compared to $12.6 million in the fourth quarter of 2011. That's a $4.4 million decrease or 34.9% decrease.

For the year operating income was $5.1 million compared to $57.4 million in 2011. That's a decrease of $7.3 million or 12.7%. Income by segment is attached to your press release as well.

Other income was about $621,000 for the fourth quarter compared to $930,000 for the fourth quarter of last year and was $2.9 million for the year compared to $2 million last year. The primary driver of that is license fee income and investment income related to our captive insurance company.

Income from continuing operations before income taxes for the quarter was $8.8 million in the fourth quarter compared to $13.5 million in the fourth quarter of 2011. It is a decrease of 34.8% or $4.7 million.

For the year that same item was $52.7 million compared to $59.1 million for 2011. That's a decrease of 10.8% or $6.4 million.

The effective tax rate on continuing operations for the quarter remain relatively flat. It was 38.3% this year for the fourth quarter compared to the fourth quarter of 2011 at 38.1%. And for the year it was 36.2% in 2012 compared to 32.7% in 2011.

The primary driver of that is the R&D tax credit which was not approved until January of 2013, and therefore we couldn't recognize that in 2012.

Net income attributable to controlling interest from continuing operations in the fourth quarter was $5.4 million compared to $8.3 million for the fourth quarter of 2011. 35.5% decrease or a $2.9 million decrease.

Earnings per share for the quarter related to net income attributable to controlling interest from continuing operations was 23% -- $0.23 cents in the fourth quarter compared to $0.36 cents per share in the fourth quarter of 2011 a 36% decrease. The same item for the year was $33.4 million compared to 2011 year-to-date income of $39.7 million. That's a $6.3 million decrease or 16% decrease.

EPS related to that item was $1.45 for the year of 2012 compared to $1.73 for the year of 2011, a 16% decrease.

The results of our discontinued operations net of tax which is American Augers for the fourth quarter of 2012 was income of $2 million compared to a loss of about $357,000 for the fourth quarter of 2011. On a year-to-date basis, net of tax, the 2012 income from discontinued operations was $3.4 million compared to $225,000 for 2011. The gain recognized on the sale of American Augers net of tax was $3.4 million.

Our backlog at December 31, 2012 was $263.8 million compared to $268.6 million at December 31 of 2011, a $4.8 million decrease or just under 2% decrease.

The international backlog at December 31of 2012 was $107.2 million compared to $123.6 million at December 31 of 2011 . That's a $16.4 million decrease or 13% decrease.

The domestic backlog for this year is $156.6 million compared to $145 million last year for an increase of $11.6 million or 8%. Again backlog by segment is in your press release.

Schedule for the segments. The December 31 backlog of $263.8 compared to the September 30 backlog was $230.7 million . That's a $33 million increase or 14.3% increase.

On our balance sheet -- we have a very strong balance sheet and continue to. Our receivables are $89 million at December 31 of 2012 compared to $102 million for December 31 of 2011 . That's a $13.1 million decrease.

Our days outstanding are 33.5 which are slightly down from the 35.4 that we had in the prior year.

Inventory is at $308.6 million this year versus $299.1 million for December 31 of 2011. That's an increase of $9.5 million or 3.2%.

We are turning inventory at two-and-a-half turns, and last year we were turning it slightly above that at 2.7 turns.

We don't have anything owed on our $100 million credit facility, but we have $80.9 million in cash and cash equivalents at December 31. Our letters of credit outstanding are $13.1 million and we have borrowing availability of $86.9 million right now.

Capital expenditures for the quarter were $8.7 million. And for the year to date period were $26 million without American Augers. Budgeted for 2013 we are planning on spending $43.6 million, but that does include $12.1 million in there for construction in Brazil of our facility there.

Depreciation for the quarter was $4.9 million and on a year-to-date basis was $20.9 million and without American Augers going forward it was $18.8 million. Budgeted for 2013 we are looking at about $22 million of depreciation, and amortization for 2012 was about $2 million and we are budgeting slightly less than that at about $1.3

million going forward for 2013. Well that concludes my prepared remarks, but we will be around to answer any questions you may have.

Thank you, David. Don will now provide some comments regarding the fourth quarter of this year's operations and offer some thoughts going forward. Don?

Thank you, Steve. During the fourth quarter we completed our exit from the underground business for selling our American Augers subsidiary to Charles Machine Works out of Perry, Oklahoma. We also sold the Trencor large trencher line to them.

Earlier in the year as David said, we sold a small utility line of drills and trenchers to Toro. We will complete our manufacturing agreement with Toro building these small trenchers during the first quarter . We expect to complete a manufacturing agreement on the Trencor line in the second quarter of this year.

We maintain the vertical augering line and related mud systems, pump trailers, and other used in oil and gas drilling from the American Auger subsidiary and our Loudon subsidiary.

Our revenues for the fourth quarter including the two months of American Augers that we owned them, were $242.3 million versus $263.2 millionin the fourth quarter of 2011.

Without Augers our revenues were $227.6 million compared to $253.3 million. Including the 11 months of American Auger sales, our annual sales for 2012 were $990 million versus $955.7 millionfor 2011.

Revenues from continued operations were $936.3 million versus $908.6 million.

With the exit of these businesses our Loudon, Tennessee and Enid Oklahoma facilities will be devoted strictly to oil, and gas, and water well manufacturing of that type of equipment. We intend to expand our equipment offering in this field so that we can furnish complete drill rig packages including all of the surrounding equipment that goes with drilling and oil or gas wells. We received our first complete system order for approximately $15 million for a drill rig going to Kazakhstan in the first quarter.

Parts sales grew from $233 million to $262 million, an increase of 12%.

During the fourth quarter with the uncertainty that -- by -- created by Washington regarding taxes, spending cuts, the sequester and other items made our customers very reluctant to order equipment. With the many highway extensions during the first and second quarter and finally the passage of a 27-month bill with flat funding, this was basically too little, too late. You can say 2012 was a year of uncertainty. This uncertainty somewhat paralyzed the purchases of equipment by our customers.

Due to our aggressive R&D expenditures we have benefited in the past from R&D tax credits. Congress extended the bill for R&D credits finally on January 1, 2013 and made it retroactive for all of 2012. However, we cannot use this tax credit in 2012 and will use it in the first quarter of 2013. These credits were $1.9 million in 2010, $1.7 million in 2011, and basically zero in 2012.

We expect 2012 credit to be $1.2 million which will substantially lower our taxes in the first quarter of 2013. Our net income of $4.2 million or $1.74 a share would have been $41,000 two -- 400 -- $41.4 million or $1.79 a share had we been able to take the credit in 2012. versus $39.9 million or $1.74 on a comparative basis.

Our slippage in revenues in 2012 was primarily related to international sales which dropped to 39% of our revenues. Our EBITDA for the year was $85.4 million versus $80.0 million or an increase of 6.8%. Considering the uncertainty and volatility of 2012 , we are pleased with our results.

Our Asphalt and Mobile Groups were the most affected -- were much more affected than our other groups and we are very pleased by the improvement in performance in our aggregate and mining groups. Looking forward to the first quarter in 2013 we started the year with a backlog of $263.8 million versus $268.6 million, a 2% decrease.

However, after clarity related to taxes occurred although it wasn't that great particularly, but at least we saw a pick-up in orders especially in the Asphalt and Mobile Groups in the early part of 2013. With the changes we have made in our Company in 2012 we have positioned the Company to focus on infrastructure, mining and energy markets. We will continue to broaden our offering of equipment in these areas. We are receiving orders for many of the new products we have developed over the last five years. These products should allow us to grow while our core business remains flat we see growth in oil drilling rigs, pump trailers, water heaters for fracking, pellet plants in the energy market, and large crushers for the mining industry.

In December returned $1 per share dividend to our stockholders and a one-time dividend offering. Our balance sheet is strong with no debt. We continue to see both -- bolt-on acquisitions while our main objective is to grow our Company both organically and by acquisition. If we are unable to acquire companies at a price that will be accretive, we will look for a return in cash from to our stockholders through stock repurchases or dividends.

We expect 2013 to be better than 2012 with less uncertainty to highway spending, improvement in home building, and expected improvement in the energy market. With our expected growth in the top line we also see an improvement in our gross margins during 2013 and hope to return them to the levels of 2011 and before.

With that we will answer any questions that you have.

Thank you. Our first question comes from Morris Ajzenman with Griffin Securities. Please go ahead.

Hi, guys.

Good morning.

First question, the fourth quarter, can you talk about the [linearity] from October, to November, to December if there is any change in pace? You mentioned the first quarter -- I mean the month of the -- of the first quarter improvement for orders for -- in Asphalt and the Mobile Group. Can you talk about the [linearity] and then I just have one follow-up to the question.

Morris, I guess we saw paralysis in the fourth quarter. The sequester talk in Washington the uncertainty related to taxes , all of that seemed to stop people from buying things in the fourth quarter. We did see in certain segments a little improvement, but basically overall we were down about 10% in the fourth quarter . I guess a lot of uncertainty that was related to what Washington was going to do and what the damage would be based on what they did.

We also had -- we always have in the fourth quarter a problem with getting man hours through the shop due to the Thanksgiving, Christmas and New Year's holidays , but we had an unusually large number of shipments both domestically and internationally that we were unable to ship because of people. A lot related to the uncertainty, just didn't want to take it. It was a -- weather affected that somewhat, but fourth quarter was a very weak quarter for us.

One other question here, talking about gross margins for the quarter, the Asphalt group, revenues were down 12% yet gross margins were actually up 190 basis points. On the flip side, Mobile Asphalt, revenues were down almost double the amount of Asphalt Group, down 24%, yet gross margins were down 480 basis points. So in one group you had an increase in gross margins and decline in revenues, the other group had an implosion of gross profits. I just wanted to talk about the two groups and how one differs from the other as far as the gross margins.

We put a lot of emphasis. We have seen our margins deteriorate this year , it has been a very competitive market. Really just in many cases a lack of volume. Astec, particularly in the Asphalt Group, has made a lot of effort to improving their gross margin and they have continued during the first quarter to see an improvement, and that's driven by a lot more focus on our manufacturing and trying to get a little more for our product.

The Mobile side of it, we were hurt last year by the tier 4 introduction of the tier 4 engines, totally redesigned all models of machines we had at Roadtec, and we also had a major competitor that was able -- an international competitor that was able to ship in tier 3 engines or tier 3 products. They were able to stockpile a lot of engines ahead of time where a domestic manufacturer like us was unable to do that. And due to that we were at a very price disadvantage over them, and the third competitor in that market seemed to want to match them, so it really hurt our margins , so part was the new models and part was the pricing.

We have and are turning that around . More and more, they are having to bring in the tier 4s now, and secondly as we have gotten to building the tier 4 models and we got jigs and fixtures made for our man hours going back down to a more reasonable level. We see that problem being fixed during this year in the Mobile side. Overall (multiple speakers) I would say we are expecting our margins in 2013 to be improved at least a hundred basis points and maybe more than that. And particularly in the mobile we expect quite a bit improvement there.

Thank you.

Thank you. Our next question comes from Mig Dobre from Robert W. Baird. Please proceed with your question.

Thank you for taking my questions. Good morning.

Good morning.

My first question is on the Asphalt Group. I am trying to understand a little bit what is going on with the backlog there. Have you seen any orders in the quarter for pellet plants?

We have a $21 million order that could expand to a $52 million order. It is for a plant that will be shipping pellets to -- primarily to England. They have not at this point passed that law. The customer went ahead and gave us the order for one line on that plant, and as soon as the Parliament passes that law they will add two more lines to it .

We have a couple of other potential orders that should happen in the first quarter for plants in the $40 million to $45 million range. In that backlog you will see -- being here on the call you will see the $21 million is in that backlog. We have also seen a slight pick-up in asphalt plant business. People have been very cautious to spend over the last four years, and as I spend time with the customers they are not very bullish, but they are more bullish than they have been.

They do seem to see a slight pick-up in work and there is a certain amount of pent up demand and we are seeing quite a bit of talk of replacing existing equipment with more modern equipment that will run more recycle and basically reduce their costs. I wouldn't say I am not real bullish, but we see probably a 10% to 15% pick up in the domestic market just in our basic business , particularly for asphalt plants.

So I'm sorry, but I want to be clear on this. You are saying that the backlog in the quarter includes a $21 million order for the pellet plant?

That's correct.

And if the British Parliament passes that particular incentive we are talking about another $20 some million dollar potential order that could come whenever that happens. But you are saying in addition to that, we could be talking a couple of other orders in a $40 million to $45 million range?

That's correct.

Great, thank you.

You're going to get more than we can build if you keep going here, but we could probably see $80 million to $100 million in pellet plants this year if everything worked like it should.

And when we are looking at Asphalt Group numbers again, I do recall that you had some orders from the U.S. army, and I'm wondering how those play through in the quarter, and I am also wondering if you also have some of that business in backlog or in orders in the quarter as well?

We have about -- Ben is here-- how many dollars? There are eight orders and we built two of them?

That's right. We've had two --They still haven't taken delivery. They are testing at Aberdeen. Seems like it takes forever, but we have two plants that will go probably in the second quarter based on how fast they are working, and then we have the other plants that are in our backlog right now.

So all eight are in a backlog and two that will be delivered potentially second quarter impacting revenue then?

That's correct.

Excellent. Thank you. My last question would be on R&D. Can you give us a sense for what the R&D spend was in 2012 for the whole year and where you see R&D in 2013?

David is looking .

$7 million range.

Yes, $7 million range . And we typically run on average . You look back over the five to seven years, we run on average the $4 million to $5 million R&D spend. We have been running in the $8 million to $9 million range over the past couple of years. That has come down slightly in 2012 and that will be reflected in the R&D credit . So that's where it is.

And your expectations for 2013?

It is going to be back down more in the $5 million to $6 million range.

I would expect that.

Thank you for taking my question.

Thank you. Our next question comes from Ted Grace with Susquehanna. Please proceed.

Thanks, guys, how are you doing?

Okay. How are you, Ted?

Great. Don, I just wanted to come back to the framework you provided on 2013 revenue guidance. If I heard you correctly, the core business flat in the group coming from the new products.

Right.

And it sounds like if I heard you correctly the domestic side of Asphalt should be up 10% to 15%. We typically thought of that business being probably 70% to 75% domestic . So could we just walk through the other businesses and can you give us how we should think about the organic growth in the other segments?

We expect Aggregate to probably be flat. We expect Mobile -- Mobile and Asphalt really go together, and that's 45% of our volume . I think those will be up about 15% . The international side of those businesses, I think from zero to 5%

Internationally it has slowed down some. The major growth in new products will be in the pellet plants. And that waits -- everything is hinged just about on the Parliament in the UK and passing that big tax credit for burning wood pellets. I guess being the $40 million plant, $40 something million dollar plant, they plan to go on regardless of the utility use.

That's correct.

The utility is saying they are going on regardless. They going to convert to burning wood. The utilities in Britain have a problem that they either have to put scrubbers on the plant to continue to burn coal or switch to wood, so some of those are driven by the tax credits, some of them are going to change anyway. And I think their supply contract is with one that is definitely going on. And we should know about that order in the next two or three weeks.

When we think about underground and other -- (inaudible) provide a similar framework and more from an organic growth perspective, because you've obviously got some M&A activity that's skewing the numbers.

In the oil and gas side of it, that market is slow at this point. There is a general consensus that it is going to kick back up toward -- in March or April. We haven't seen that much yet. We still have most of our prospects for the drill rigs and the bigger , complete packages are international on that. Domestically there seems to be a consensus that there is going to be a lot of drilling and oil well servicing business going on. Domestically it is somewhat slowed from what we have seen and most of our prospects that we see for the big drill rigs are going to be international.

Okay. So I guess just trying to think about the revenue commentary also from the perspective of parts and new equipment . I am assuming -- was the commentary for 10%, 15% growth domestically in Asphalt and Mobile Asphalt paving, is that on the OEM side or is that total and would you think parts is a drag on relative growth in 2013?

We see parts continuing to grow, and that is primarily driven by our efforts to put more parts -- put more feet on the ground and really make more effort toward parts. But we see an overall growth probably if you take everything considered probably 15% , and parts would be about the same.

It would? Okay. And then the last question before I get back in queue, just in terms of thinking about the impact of the dollar on your business and especially in the pellet business where it seems like a strong dollar could be a headwind, how should we think about that?

I don't see where the dollar is right now affecting us that much. It varies with anything I say -- if you pick a certain country in South Africa, it is hurting us, in Australia it's helping us. The dollar is weak compared to the Australian dollar. In Europe it is somewhat hurting us. The Euro is still strong, but overall our best markets are Canada, Mexico, Australia, for most of this equipment, and then those markets it is not bothering us.

But the pellet press if I am not mistaken is mostly a European-centric product, or am I off base with that?

It will be a U.S. -- it is going to be used in the U.S., but shipping what it makes to Europe. And those contracts that our customers have , they basically are fixed-price contacts with an escalator. Our customers make -- I think with the contracts they got they are safe. As far as we are concerned all of these plants that we are building, the pellet plants will be operated in Georgia and North Carolina in the southeast .

That's really helpful. I appreciate that clarity. Best of luck this quarter.

Thank you.

Thank you. Our next question comes from Jason Ursaner with CJS Securities. Please proceed.

Good morning.

Good morning.

The first question is a follow-up on the Mobile segment because it really has become a significant drag on profitability. Have you set the table to work through -- the timetable to work through that inventory of the machines , the tier 3s. is it some time this year? Can you be anymore specific on that?

I don't know how many more our competitor in Germany has got . We are seeing a slight improvement in pricing and we are seeing a pretty good improvement from what we can do about it and our manufacturing. We are seeing the man hours go back down to the levels like they were . And again it was just all new machines and all new designs and we had to get the jigs and fixtures, and the people familiar with it. So we are seeing a recovery in our manufacturing cost and somewhat recovery in the sales price. I think you will see the first quarter looking better there and the second quarter looking even better.

And besides the competitive pricing with the tier 3, tier 4, can you also talk about whether you think there is some mismatch from the project demand and the available capacity given all the machines put in place in that Mobile segment from the recovery act stimulus spending because it was so focused on paving?

No, I don't -- from what I am seeing I was with a group of customers yesterday down in Alabama and Mississippi, and the one area that the Mobile is quite different from the other parts of the business is one of the customers said the paving machine, the shuttle buggy and the paver is the most critical piece of equipment in their entire fleet , and they were basically talking, this particular customer in Mississippi, trades machines with us every 3,000 hours. The other customer that was with us said why in the world would you do that, and he said because it is such a critical component.

That machine has got to run or it is going to back up 20 trucks and an asphalt plant and everything else. We see them continuing to stay with modern machinery in the mobile side and we have a deal with a number of our customers that trade in 3,000 hours to 5,000 hours. That gives us the opportunity to have to sell the used equipment too, but generally there is a pretty good market for that particularly at that lower hour. So I see a continuation in that business being okay.

And just a follow-up on the gross margin question in Asphalt, you mentioned manufacturing efficiency and pricing . Just what level of price increases have you gotten this year and on the other side of it , how are your major raw materials costs trending year-over-year? Are you getting a benefit on both sides there from a gross margin perspective?

We have seen increases of 3% to 4% . I think on the cost side of it probably -- Ben do you want to answer that one?

What we have seen on the Asphalt plant side is that the cost is staying about level. It's not -- there are some areas up and some areas down, but it is balancing out about level.

We haven't seen steel go up like we anticipated. The overall of market for steel is very soft. They haven't been able to push through prices that would stick.

So you are capturing most of the pricing increase?

Yes.

And then the wood pellet systems, besides the $21 million order that is in backlog , do you also have anything with the 10-ton prototype? Is that also on backlog or spoken for at this point.

We do have a signed order for that , but we don't have any money. It is in backlog , and we are still waiting. It is in our backlog.

And then generally on the wood pellet systems, what is the gross margin probably going to look like on these first few orders and how much did you have to give on the pricing side to lock in those first couple?

We haven't given on the pricing side. We expect a gross margin in the 25% range. That may be -- You want to agree or disagree?

That's our target.

Is it a target for once you get going with them or really on those first couple orders?

Anytime we do a first it is probably going to be a little bit lower. We do meet every week on it to make sure where we are. We've got to just now get into our shop. We are probably 5% to 8% finished. But we are meeting every week and we are doing our best to stay at a margin level that is where we want it. Normal margins. A target would be 25% long range, but I think it would be a stretch to say we are going to be that or above on the first one.

Appreciate --

closer to 20 on the first one . I think it is -- they have managed that better than any new product -- well, we did more R&D on that product than anything we have ever built. We think we are good on that.

Great. Appreciate the detail, thanks.

Thank you. Our next question comes from Jack Kasprzak with BB&T Capital Markets. Please proceed.

Hi, Jack.

Good morning, Don. How are you?

I'm okay.

Good. I wanted to ask just generally about an area of your business demand that we haven't seen much from for the last four or five years and that is private development activity , but it looks like housing is on the mend and perhaps non-res will follow housing as it usually does. Are you getting a sense out there that private sector development could be picking up in 2013 into 2014? You guys haven't had much benefit -- really any probably for a number of years now.

Jack, I am seeing that. I was with two different groups of customers yesterday, and they both said they at least had some backlog this year, and their comments was it was all small jobs which is exactly what are you talking about. -- what you are talking about. They are seeing that come back. Not great, not gang busters, but it is up from zero so to speak.

They feel their margin on that is better than it is on the state and highway work. The other thing as that comes back, they are a little less aggressive on bidding on highway work which will help their margins . One of the contractors commented to me yesterday he lost a job a $600,000 job by $3,700, but he said it didn't bother me because I had some money in. He said I been bidding last year with no money in it. At least my competitor's raising their price and I'm raising mine.

The effect of the residential and the commercial coming back somewhat really has some legs. It helps their profitability. But I am seeing that. We are still a long way from the $1.4 million to $1.5 million starts in home building which is average. But it is sure a lot better than $400,000.

Right.

Yes to answer your question. The other unusual thing I have seen that I have never seen in the past is a lot of the subdivisions that were built, getting ready to build houses to put a 2200 square foot house on it had been bought up and they are downsizing the lots and putting more of a 1500 square foot or 1600 square foot house on it that is $150,000 to $180,000 price range, and as a result where you would normally see a lot of vacant land sitting around waiting on development, a lot of that has been picked up, and they are starting to restart looking at new subdivisions. Which is a very positive thing for our customers which normally after a downturn like this you would see a couple more year lag on that.

Looks like the inventory of houses in general has been whittled down pretty far already. Perhaps we are starting to see the need to do some of that development activity. As you say we are coming off such a low-level there will be fits and starts and a while before we feel it, but maybe it is more of a situation where you build momentum into 2014. 2014 if this pace continues probably a better year for that than 2013 would you say?

I think are you dead on it. The rest of the story, the highway spending, the sequester is not going to affect that. It will have a slight negative effect. $35 billion of the $40 billion, $41 billion they will be spending is from the trust fund, it's not touched.

The sequester will affect the other $5 billion by maybe 8%, but it is relatively flat, that's about what it amounts to. So highway spending is about flat. Any improvement this these areas we are talking about will be positive for our customers.

The other thing I would point out is we are seeing the states -- basically a number of states raising additional revenues. Kansas, Indiana, various ones are raising additional highway revenues that is helpful. So while I don't see a boom, I do see a positive increase.

Great, very good. Always appreciate your comments, Don. Thanks.

Thank you, Jack.

Thank you. Our next question is from Brian Rafn with Sparta Capital. Please proceed.

Good morning, guys.

Good morning.

Don, talk a little bit about -- we finally got an extension you mentioned a three-year bill that was flat funding off safety [low and tee at] 21. At some point there was some talk -- there's been a big issue on infrastructure, we were going to get a $600 billion program. Army Corp of Engineers has had -- they do that annual grading on infrastructure, and it is always Ds and Fs. What is your sense going out the next five years plus? Are we ever going to get that type of substantial focus or will we continue to stumble along with these flat funding programs?

Unfortunately my opinion is we are going to continue to stumble along. We were -- Norman, Ben and I were at the National Asphalt Pavement Association meeting the week before last, and they had a couple of lobbyists there. Their opinion is the only way you will get any improvement in highway spending is going to be including in some big bill of some kind where it is a grand program that is going to include a lot of other stuff. I met with, at a meeting last week with our Senator Corker from Tennessee here and Bob basically said the same thing. When I stood up to ask questions he said you are going to ask me about dedicated truck lanes? I said no I 'm just asking you about when you're going to give more revenues for it.

He said everybody in the country and in Washington agreed we need more highway spending and we needed to fix our infrastructure. But he said there is nobody willing to touch the gas tax and raise the revenues. The one bright spot I see that is helping this, there seems to be a slip of the hand where many of the states -- Virginia is looking at dropping the gas tax , but putting a sales tax on gasoline that would increase the revenues. And if you play that slip of the hand with the federal money, it would go from -- you can have a five-year bill instead of being $240 billion it would go to about $360 billion. They can argue they haven't raised the tax.

Something like that might happen. It seems to, at a state level they are looking at more switching to sales tax on gasoline instead of a price per gallon. Without that we are running our business based on it being flat for the next few years for the roads and bridges.

Yes, okay. Are you seeing on the mobile side are you seeing any differences in -- two questions. One is there any difference between the [sediment] or credit financing between some of your regional players versus the big national heavy civil design build players? And then two, from that standpoint with these -- 2012 being fairly poor, do you see any latent pent up demand, or exhausted equipment, broken equipment and would that be a positive going forward on the Mobile side?

One of the customers I was with yesterday was talking about a couple of pavers and they have 1400 hours on their machines -- 14,000, excuse me which is pretty darn high for that type of machine versus the other one that is trading every 3,000 hours. There is a certain pent up demand in regard to the big players versus the small ones, the small ones have generally got -- the family owned companies have got cash, and they buy for cash.

It is not a big deal. The major players, the large ones are keeping all of their money for looking at acquisitions and they are squeezing the heck out of CapEx and as a result RPOs are very important to them. Rent-to-own deals and the 36-month lease purchase deals. We are doing a lot of that stuff just because that's what you have to do with the big guys.

You talked a little bit about these guys the trade in at 3,000 and 5,000 hours. Has that been a business that has been expanding and is that picking up some interest and is that a regional type or is that a national or is it -- are there areas in the country where you tend to have road builders do more of that?

I think it is a trend we see coming . More and more it is hard to get mechanics and the old way of doing it you would run 15,000 hours to 20,000 hours and one of the guys I was with yesterday , they had spent $55,000 on a paver and was about to spend another $55,000. When you trade at 3,000 hours to 5,000 hours they don't spend anything. The problem is a change in -- there is not mechanics available.

Secondly the price of rebuilding and the reliability is not as good , and so we see a shift of that with a lot of these major players just not having their own shops and the ability to rebuild and going more to -- staying with more modern new equipment. The other advantage is the new equipment we have today on our paving machines basically satellite control where we can basically troubleshoot a paver or a milling machine anywhere in the U.S. We can basically by satellite we can dial into it and see where the problem is and actually make changes on the way the machine operates. The modernization of the electronics today is allowing you to do things where you don't need the mechanics.

Okay. All right. You talked a little about commodity costs. How do you see head count for Astec going forward ? And then what do you see in wage and salary payroll inflation and maybe health care benefits?

Typically we are seeing about a 3% increase in wages and in benefits. Health care is a wild card . God only knows what that is going to do. We saw the worst increase probably right after the Obama bill came out . Insurance companies were basically getting theirs ahead of time so to speak. It is a continuing -- that's one uncontrolled problem that we have , but in wages we see probably 3%.

All right. Fairs enough. You talked a little about the wood pellet plants, Don, and you said again it levers a lot on the UK. How is that, given the saw ferocity of Obama with his non-fossil fuel and his wind and turbine and solar, how is wood pellets viewed in the U.S. energy portfolio from the standpoint of the current administration?

It is a renewable fuel. Basically it is looked upon as being carbon neutral and it is a base load fuel where wind and solar is not. If it is not raining or wind not blowing you are not generating any power. It is a definite substitute for coal. The problems in the U.S. is strictly economic.

$150 wood pellets which is what they are shipping out of the east coast for $150, $160 is about equivalent to $8.50 a thousandof natural gas. We're $4 a thousand here. It won't compete with natural gas. In Europe natural gas is $12.50 a thousand. Coal in Europe is more in the $200 range and it is $100 here. Wood pellets basically will compete with coal and gas over there, but they won't compete here.

The only way you would drive wood in the U.S. is if you don't have natural gas, in areas where they don't they burn wood. It is cheaper. If you can't burn gas or coal, then it is the next cheapest fuel. If you can get either one of those are you not going to burn wood.

Fair enough. When you look across your manufacturing lines what are you guys running shift labor? And any pockets of capacity constraint? And what are you doing on overtime pay?

We typically do a lot of overtime the first two quarters of the year just to keep from adding too many people . We have about 4,000 employees. We don't like to lay them off, so we will work -- overtime is not that expensive to a point. You don't have the additional fringes for the overtime , but we are working probably in every company full first shifts, probably high second shifts. We have more capacity to up the seconds and the third shifts. It is hard to get people to work on those shifts. The only place that we have problems with labor -- skilled labor in Milwaukee, and Yankton, and Eugene, Oregon, skilled machinists and people like that. The unemployment may be high, but the unemployment is very low on skilled people.

And then one final one, what are you seeing the M&A side? Niche bolt-on acquisitions, multiples of EBITDA, how fertile is that area?

There is not that many left out there . If we can compete most of the ones that we acquire we have a certain amount of courtship with them, and we know them . There is not that many available right now. It is difficult for us to compete with a private equity outfit that has a different objective than ours . We see probably more opportunity for us to organically grow and make bolt-on acquisitions as they come available. Most acquisitions we make they come to us .

How do you see the -- good question. How do you see the organic product development? What has it been the last three or four years and what do you see going forward? Your product development would you say are newer iterations or are you doing anything with a real turnkey new design in different areas?

We are doing iterations or improvements in all of our equipment. It really differentiates when we see a lot of opportunity of the new products and probably the biggest major new things would be the complete oil drilling packages where we've got a revolutionary new type of design there and we see a lot of opportunity to furnish all the equipment that goes with it. The wood pellet plants are major facilities and we see a lot of opportunity there. We see opportunity of growing in the process time for the energy business of our [etech] operation. We are selling the heaters for gas plant forums and can expand that. So there is probably half of it would be in newer total systems products versus niche improvements.

Superb job, guys, thanks much.

There are no further questions at this time. I would like to turn the floor back over to management for closing comments

Thank you. We appreciate your participation on this fourth quarter conference call and thank you for your interest in Astec. As our news release indicates today's conference call has been recorded. A replay of the conference call will be available through March 12th, and an archive webcast will be available for 90 days. The transcript will be available under the Investor Relations section of the Astec Industries website within the next seven days.

All of that information is contained in the news release that was sent out earlier today . Thank you. This concludes our call. Have a good week.

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