Columbus McKinnon Corp (CMCO) 2008 Q2 法說會逐字稿

Good morning and welcome to Columbus McKinnon's fiscal 2008 second-quarter earnings conference call. (Operator Instructions). Today's conference is being recorded. If anyone has any objections, you may disconnect at this time.

Now I will turn the meeting over to Mr. Timothy Tevens, President and CEO. Sir, you may begin.

Thank you, Crystal. Good morning and welcome to the Columbus McKinnon conference call to review the results of our fiscal '08 second quarter. And earlier this morning, we did issue a press release with the corresponding financials, which hopefully you have all received.

With me here today is Karen Howard, our Chief Financial Officer; Derwin Gilbreath, our Chief Operating Officer; and Joe Owen, our Vice President of our Hoist Group.

We do want to remind you that the press release and this conference call may contain some forward-looking statements within the meaning of the Private Litigation Reform Act of '95. These statements contain known and unknown risks and other factors that could cause the actual results to vary. You should, in fact, read the periodic reports that CMCO files with the SEC to be sure you understand these risks.

Generally, overall, our revenue for the second quarter exceeded same quarter last year by 5%. This was led by our Products segment, which was up 8.7%, and negatively impacted by the focus on profitable revenue of our Univeyor business, which is part of our Solutions segment. That was down -- the Solutions segment was down 27%. If you add that, plus the divestiture of Larco, which we did in the fourth quarter of fiscal '07, it did offset to a degree the very positive Products segment.

We continue to experience a very strong global industrial economy. I also want to touch on gross profit, which was up 18%. Operating income increased almost 19%. This led to an operating leverage of 42%. Our natural net income was up 14% over last year, and I think you can tell it was a very solid quarter for Columbus McKinnon.

Relative to the Products segment group, which was 93% of our business this past quarter, we were up 8.7% compared to last year and up 2.6% from our first quarter of fiscal '08. The increase from the same quarter last year is driven by increased demand from end-users. And this is basically through all of our distribution channels. We did have a foreign currency translation and a price increase effect, and it also was offset, as I mentioned earlier, by our Larco divestiture.

Our international sales continue to be very robust, were up 21% over last year. And this was driven by very strong European -- pan-European and Latin American economies, as well as from investments that we've made in products and our market presence over the last several years.

Products segment gross profit was up 16.7% over the same quarter last year and the gross margin was a very strong 31.5%. Operating income was up about 15% in the Products segment and the margin was very strong at 14%. The operating leverage continues to be very positive for this segment at 23%.

Relative to bookings in the quarter, in specifically the Products segment, they continued to be very good and very positive, and overall, we were up in the mid- to high-single-digit level over the same quarter last year. Backlog was up compared to the first quarter, representing these strong bookings. As a reminder to you all, the cycle time for most of these items in our Products segment is a day or several weeks. And therefore, this back number represents somewhere around five weeks' worth of shipments.

Let me turn your attention to our Solutions segment. Sales were down 27% from the same quarter last year, and as we have been reporting to you, we have refocused Univeyor, the largest business in this segment, on profitable revenue, which continues to have a negative effect on the revenue in this segment. This quarter was the first clear sign that this segment, led by Univeyor, is indeed improving. Considering that we have had a restructuring charge in the segment in the quarter, operating income is basically breakeven and gross profit improved 61%. Backlog was up about $10 million, reflecting a very strong bookings in the quarter for Univeyor. The other businesses in this segment outside of Univeyor continued to perform well.

As a reminder to you all, we are aggressively pursuing changing the Univeyor operating model, migrating from a broad material handling systems provider to a more standard proprietary products and maintenance contracts, and also only those products where we can demonstrate and be paid for our unique value-added abilities. As you can see, the strategy is beginning to take hold. We will also continue to evaluate all of our strategic alternatives with regard to Univeyor, as promised, and will report our decision shortly after the end of the calendar year.

Cash flow from operations was very strong at almost $24 million, and our funded debt, net of cash, is down to about $100 million at the end of the quarter. We have achieved 27% net debt of total cap.

And with that overview, let me turn it over to Karen, who will lead us through more details on the financials.

Thanks, Tim, and good morning, everyone. I'm pleased to have the opportunity to review some of the financial highlights of Columbus McKinnon's fiscal '08 second quarter and half year that ended on September 30, 2007.

Consolidated sales increased by 5% to $151.4 million in the second quarter of this year compared with last year's second quarter. Products segment sales, which accounted for approximately 93% of total sales in the quarter, increased by $11.3 million or 8.7%, with strong double-digit sales increases reported by our Columbus McKinnon Europe and our domestic crane groups. Our Larco Canadian crane business, which contributed $2.4 million of revenue to last year's quarter, was divested on March 1 of this year, resulting in a 1.9% reduction in segment revenues. Accordingly, volume contributed a 6.9 percentage point increase for this segment over last year. Further, pricing and foreign currency translation favorably impacted the change by 1.9 and 1.8 percentage points, respectively.

Solutions segment sales decreased $4.1 million or 26.7% compared with the second quarter of fiscal '07, driven by the decision to transition the business model of our Univeyor operation. As previously indicated, we are transforming this material handling systems business to be more products and service maintenance oriented, with future growth and profit expectations. On a year-to-date basis, consolidated sales increased $8.6 million or 3% over last year.

Products segment sales were up 7.7%, while Solutions segment sales were down 33.5%. The Company's quarterly sales pattern, assuming a period of consistent economic conditions, typically shows sales strongest in the fourth quarter and weakest in the third quarter and will be impacted during fiscal '08 by the March '07 Larco divestiture. The recent second quarter had 63 shipping days, the same as the year-ago quarter, and the next quarter will have only 60 shipping days. Included in the press release is a table showing the number of shipping days in each of the quarters of fiscal '08 and fiscal '07 for your reference.

Overall, second-quarter consolidated gross profit increased $7 million or 18%, with gross margin expanding 330 basis points to 30.4%. Products segment contributed an incremental $6.3 million or 16.7%, with its gross margin expanding 210 basis points to 31.5% from 29.4% in the year-ago quarter.

During this quarter, we started to realize the relief from our previously announced September 4 price increase that affected our steel-intensive rigging products. We also realized margin expansion, and volume and productivity improvements. The Solutions segment contributed $700,000 of incremental gross profit on $4.1 million lower revenues for the fiscal '08 quarter, realizing a 16.3% gross margin compared with 7.4% in the fiscal '07 quarter. This gross margin represents the highest level in the past seven quarters.

Favorably contributing to these results, Univeyor is realizing the benefits of its restructuring activities and focus on more of a products and services orientation. We're pleased with the significant progress made. We also continue to evaluate strategic alternatives relative to this business.

On a year-to-date basis, consolidated gross profit is up $8.6 million, with gross margin expansion of 210 basis points to 30%. Consolidated selling expense as a percent of sales was 11.4% in the second quarter, up from 10.2% last year, due to the continued investments in both our domestic and international markets in accordance with our strategic growth initiatives. On a year-to-date basis, consolidated selling expenses followed a similar pattern at 11.1% of fiscal '08 year-to-date sales compared with 10.3% for fiscal '07 year to date. Consolidated G&A expense was 6% of sales in the fiscal '08 quarter, relatively comparable to fiscal '07's 5.9%. Year-to-date G&A expenses were also relatively consistent year over year at 6.1% of sales.

With operating income increasing by $3 million or 18.9%, our operating margin expanding 140 basis points, improving to 12.6% for this year's quarter compared with last year's 11.2%. The consolidated operating leverage contributed 42% to income from operations for each incremental sales dollar in the quarter, exceeding our stated sustainable 20% to 30% goal.

On a year-to-date basis, operating margin expanded 90 basis points to 12.5%, realizing 41% operating leverage over the prior year. With steady revenue growth, we see further sustainable opportunity for operating leverage growth.

Interest and debt expense was down $500,000 or 13.1% over the prior year's quarter and $900,000 or 10.2% year to date due to lower debt levels. We incurred bond redemption costs of $1.4 million pretax, representing $0.05 per diluted share, effective August 1 of '07, upon calling our remaining $22.1 million of 10% notes, which will save $2.2 million or $0.07 per diluted share of annual interest costs going forward. The fiscal '07 year-to-date results reflect $4.6 million of pretax or $0.16 per diluted share of bond redemption costs.

We realized $300,000 of investment income on our captive insurance company assets this quarter, comparable with last year's $300,000. Further, we recognized $500,000 of miscellaneous other income in this year's quarter compared with $800,000 last year.

Regarding income taxes, the effective tax rates for the fiscal '08 and fiscal '07 second quarters were 37.3% and 37.7%, respectively. This year's quarter was favorably impacted by a change in German tax laws, which lowered corporate tax rates. On a year-to-date basis, effective tax rates were 38.1% and 40.4% for fiscal '08 and fiscal '07, respectively.

On a go-forward basis, our expectations are for an effective tax rate in the 38% to 39% range, which continues to include a noncash portion relating to the utilization of U.S. federal net operating losses, or NOLs. The NOL carryforward currently amounts to approximately $16.8 million, representing approximately $5.9 million of future cash tax savings. Therefore, the cash tax payment savings for U.S. federal tax will continue to be available until the NOL is fully utilized, which will likely be in the fourth quarter of fiscal '08.

Earnings per diluted share for the second quarter of fiscal '08 were $0.49 versus $0.44 in the second quarter of fiscal '07. After adjusting for the tax-affected bond financing costs in this year's quarter, the pro forma non-GAAP EPS for the fiscal '08 second quarter of $0.54 compares with the actual EPS for the fiscal '07 second quarter of $0.44, reflecting a 22.7% improvement. Year to date, actual EPS of $0.99 reflects a 35.6% increase from last year's $0.73. Upon removing the tax-affected refinancing costs from both periods, the fiscal '08 year-to-date pro forma non-GAAP EPS of $1.04 compares favorably to the fiscal '07 year-to-date pro forma non-GAAP EPS of $0.89 or a 16.9% improvement.

Depreciation was $2.1 million for both the fiscal '08 and '07 quarters. On a year-to-date basis, it was $4.3 million, compared with $4.1 million last year. Capital expenditures were $2.4 million for both the fiscal '08 and '07 second quarter. Year-to-date CapEx was $5 million, with last year being $4.3 million. The spending included investments in our new product development activities, our growing low-cost international facilities, productivity improvement equipment, as well as normal maintenance CapEx. Looking forward, we expect capital expenditures for fiscal '08 to be in the $11 million to $12 million range.

Net cash provided by operating activities was $14.2 million in the quarter, with earnings contributing $17.2 million and operating assets and liabilities utilizing $3 million. Within working capital, reductions in receivables generated cash, but were partially offset by increases in inventory and decreases in payables, which utilize cash. We continue to focus on our working capital utilization. Our long-term target remains 15% working capital as a percentage of revenues.

At quarter's end, debt net of cash was $100.7 million and total gross debt was $154.3 million. At quarter end, availability on the $75 million revolver provided for under our senior credit agreement was $63.4 million, representing $11.6 million of outstanding letters of credit and nothing drawn against the revolver. We were comfortably in full compliance with all financial covenants related to this agreement.

While our strategy emphasizes profitable sales growth with international expansion, it continues to include focus on debt and interest expense reduction to further improve our profitability and provide capital structure stability. During the quarter, net debt decreased by $12.1 million, reflecting continued improvement in our net debt to total capitalization percentage to 27.3%. Gross debt to total capitalization improved to 36.6% at the end of the quarter, down from 44% a year ago.

Reflecting improvement in our credit statistics and overall capital structure, during the quarter, Standard & Poor's updated our overall corporate credit rating to BB- and Moody's updated our B1 outlook to positive. Ultimately, we're targeting a sustained 30% to 40% debt to total cap ratio with an investment-grade rating to give us flexibility to support our growth strategy, which will include strategic bolt-on acquisitions regardless of the point in the economic cycle.

With that, I thank you and turn it over to Derwin.

Thank you, Karen, and good morning to everyone. Products segment sales, representing 93% of our total business, continue to show strength globally, with an 8.7% increase in quarter two of FY '08 compared to the prior year. Solutions segment sales were managed down, 27% for the quarter, as Univeyor conveyor business continues to work through its transition to a more products- and service-focused company. The net result was a 5% increase in sales overall for quarter two of FY '08 compared with FY '07.

Domestically, our crane builder channel grew 14% for the quarter. Capital spending for large-scale energy and public works construction projects is driving this growth and is expected to remain strong throughout the fiscal year. Rigging products used for overhead lifting applications also showed strong growth of 13%, representing 11% of domestic sales.

By sales channel, rigging shops and material handling specialists representing 10% of sales grew 20% for the quarter. An increased emphasis on value-added services such as training, as well as new product introductions, contributed to this growth. General industrial distributors and catalog houses grew modestly in the second quarter, representing that slower-than-normal summer. Contrasting this, September orders were much stronger than normal. These channels represented 39% of domestic sales. The entertainment channel is booming and was 37% over last year. U.S. industrial capacity utilization continues to be above 80%, which bodes well for our business.

Excluding Univeyor and the March 2007 divestiture of Larco in Canada, international sales growth was 31% at actual exchange rates or 24% at constant exchange rates. Continued geographic and market expansion in Eastern Europe and Latin America, combined with a generally robust economy, is fueling this growth.

Products segment sales are expected to remain solid both domestically and internationally throughout the remainder of the fiscal year. We will continue to focus on end-user markets in the energy and nonresidential construction sectors, as well as continue to expand internationally.

Relative to operations, our operating leverage continues to be strong at 42% in the quarter. Our employees continue to pull together all the dimensions of our strategy to achieve this range of success quarter after quarter. Our strategic goal of superior customer excellence is supported with detailed initiatives in operational excellence, people development, new products and services, as well as new markets to drive sales growth.

Investments in all of these areas are occurring throughout the Company. For example, for the new products initiative, we have added a number of engineers this year for product development and have plans to add more the remainder of the year. These additions are both for the long term and the short term. An example of a short term project was the reintroduction this quarter of our 50-year-plus Lodestar Hoist, with features that raise the product quality levels even higher than before, as well as to offer improved features desired by our customers.

Our Products segment backlog fell by 7%, primarily because some of the large infrastructure projects with long leadtimes due to customer construction schedules were finally required by our customers to ship. On a very positive note, Univeyor backlog, as reported by Karen, was up substantially. This represents a good transition from a primarily solutions-based business to a higher mix of products.

Turning to inventory growth that occurred this quarter, 56% of inventory growth was due to customers delaying projects by a few days to a few months. All these orders will be shipped in quarter three. Additionally, 27% was due to foreign exchange. The remainder was primarily due to some new products inventory build and a few supplier problems delivering parts to us.

Our [linked] process received a more intense focus during the quarter. The management training meeting -- the efforts will be increased many times over the past during the next few years, which will help us continue to service our customers and reduce our costs. Processes like this will help us continue to achieve the strong operating leverage reported this quarter.

Now let me turn it over to Tim.

Thank you, Derwin. Crystal, we will open it up to questions now.

(Operator Instructions). Holden Lewis, BB&T.

Just building on the balance sheet commentary of a moment ago, inventories looked like they were up a little bit, but receivables looked like they came down a pretty good amount. Can you just sort of comment as to what is behind that trend in that working capital?

Sure. That fluctuation is really driven primarily by our Univeyor business. It spiked up a bit last quarter and I really actually consider it down more to a normal level.

Great. I appreciate that. And then when you talk -- you've talked I guess variably about new products and sort of their impact on inventories. Can you update us on sort of where the FEM products are? Have you rolled out the third tranche yet, introduced it to Europe? Can you just give us a sense of what we've achieved there now?

Sure. Why don't I ask Joe to comment on that, since he's [definitely] responsible for it.

The next set of FEM wire rope products, which is the one- through three-ton range, is planned to be launched around the December/January time frame.

Did that get pushed out a little bit?

Pardon me?

Did that get pushed out a little bit?

Get pushed out?

Yes. It's slightly delayed from October of this month, it was planned for. So it's a couple months behind.

Any reason behind that?

Well, just through the testing process, we wanted to make sure that everything is all set.

There's nothing major here, Holden.

Okay. And then, when you talk about the new product engineers that you are adding, can you give us a sense of how much you want to sort of bolster that group by, and is that related to FEM or is there some other sort of new generation of products that you are sort of eyeing that is causing you to increase your product engineers and your product development staffing?

Yes. One of the things -- maybe I will take this one, Joe -- that we have focused on strategically is to increase the revenue coming from products that were introduced in the last three years or so. We have been okay in this area, but we think to be the global leaders in the hoist business and material handling business, we need to have more options available for our customer base.

So this is a strategic initiative that we started back, I guess, a couple of years ago that's been ramping up over time now. We have an engineering department in the hoist group with a leader, and he has been adding some resources. There are a number of initiatives, Holden, that were very numerous to round out our product offering, specifically in the hoist group, but in addition to that, create some new-to-market kind of products that would help us in the future as well.

We will also be doing the same thing in our rigging business, to a larger degree than we have in the past. So there will be some resources added there. And we're talking about, too, our target is something like doubling the number of engineers that we have had. So we're going from somewhere in the 10 to 20 area, just to give you a sense of how big it will be.

Okay. And when you talked about increasing your percentage of sales from products that were introduced in the last three years, do you have a number that you are at and where you were at and sort of where you want to go with that?

Yes, we are in the mid -- like the 15% area now. And we probably want to be more like 20% in the next several years. And that's why the investment in processes -- by the way, I should tell you we also have engaged StageGate as a process to help us manage these projects as they come to fruition as well, and also the engineers that we mentioned.

Joe Giamichael, Rodman & Renshaw.

This is actually Greg standing in for Joe. But first question is just focused on the balance sheet. Now that you have taken out the remaining expense of debt and your NOL is remaining, that should augment your already-strong cash flows. With the CapEx program, it sounds like it should be close to flatline year over year. Broadly speaking, how do you intend to redeploy the free cash flow that your business should be generating over the balance of the year?

A couple ways. Number one, as we have mentioned now for a while, we do have an M&A activity under way, that we're searching worldwide for global partners that we could acquire and add to our portfolio of products. They will be typically $50 million in revenue and under. That typically would give us a presence in a market that we're not strong in. That's our goal. And also, they might have some hoisting or lifting products that we could add to our portfolio and bring into markets where we have a great presence, like North America and Europe as well.

So that's a use of cash going forward. At this point in time, we have nothing to report other than the fact that we've been working in this area, and as you might know, Greg, the M&A business is one that you don't control necessarily 100%.

The other use of cash would be to repay or buy back from the market the other subordinated note we have, the 8 7/8% note. So we do have some debt to buy back, in that case.

Great. We look forward to hearing progress on your potential pipeline of partners.

Second, looking at the international, obviously growth there has been an emphasis now. You're allocating more dollars to support the effort from a marketing standpoint. Can you give us a quick overview as to where you think the Company is in the share capture process and maybe what needs to be done as this continues?

Market share capture process internationally? Is that what you are referring to?

Correct.

You know, we have leading market share in North America relative to Western Europe, which is our next-largest market that we participate in. The predominant growth has been economic. It is a pan-European economic growth. It's all the Western economies, generally growing very nicely, and in addition, the Eastern portion of Europe is growing even faster.

We have also in the last several years extended our presence in those markets by actually opening up sales offices in locations that we have not previously been at, places like Hungary, we just opened up Italy last month, and prior to that, Spain, and prior to that, Northern Ireland, and those economies are going well, number one, but also, because of our new presence there, we're gaining market share. We estimate that probably around a third of the growth -- this is a tough number to get, quite honestly, because there's no published data like we have here in the States. But we estimate that somewhere around a third is market penetration and two-thirds of the growth would be economic. That's a very gross estimate.

Okay. And as we looked at the on the products side, it looks like pricing is only modestly down. Do you foresee some positive pricing leverage going forward from this point?

Sure. I would say that we normally see somewhere around 1.5% to 2% growth as a result of pricing overall. And so I think we reported 1.9%, if I'm not mistaken, for pricing for this quarter, and that falls in the range, and I would expect that kind of level to continue.

And last question here before I jump in the queue. It sounds like the future of the Solutions business continues to be up in the air, at least until the end of the year, and I know that you have been excited about the EmptiCon product for some time now. It seems to be gaining some traction. If I missed it, did you break out how much of the Solutions revenue business that accounted for?

No, we did not. We have not, but I can give you, if you don't mind, I would like to give you a little bit of color around that.

Sure, that would be great.

The EmptiCon machine has been developed and launched. We've just sold our first five units into the market over the last several years. One of those units isn't really a sale. It's really a device that we move from company to company to test it, if you will, to try it out. So four are actual sales and one is a demo unit, so to speak.

So we are in production for the next five. I will tell you that interest has been keen in this area. It is a really neat piece of equipment that adds a fair amount of productivity and safety measures for people who need to unload oceangoing containers, and there's a number of them. We're just now beginning to see some U.S. interest in it as well. So we continue to be very positive on it. It's also nice to get some sales, as you might imagine, to bolster that positive feeling we have. So we look for that to continue to grow as the months go by here, especially given the level of movement of the demo machine and the number of people that are seeing it.

Great. Thanks, and congratulations on a great quarter.

Ted Kundtz, Needham & Company.

A couple of questions for you guys. First of all, are you seeing any -- what kind of inflationary pressures are you guys seeing on your cost of goods? Is that changing, and could you just sort of clarify a bit on that?

Yes. Let me start off and then I will ask my team here to comment in addition. We did see some steel inflation on certain alloy grades. In fact, we saw some price decreases on some carbon grades over the past summer. So we're seeing a mixed bag in that regard, and steel is our largest commodity that we purchase as a company. It represents about 10% of our cost of sales or so.

We have raised prices to offset the increases, and they are holding at this point in time. We feel pretty comfortable with that level right now. Most of our other purchased commodities are under contract and are limited to the amount of increases that we can see. So we're not seeing much inflation beyond that. Another commodity that we buy is health care. That continues to go up, not at the same rate that we've seen in the last several years, but it still is inflationary, in my book, and needs to be controlled beyond Columbus McKinnon into the entire industry. But there is some there. And beyond that, I don't think we're seeing much inflation. Derwin, any comment?

No, I think you covered it.

So you would say that any inflationary pressure you are seeing will not affect your margins because you have been able to offset it?

For the most part, that's correct, yes.

And going forward, that would be the case?

That's our plan, that's right.

Okay. Could you comment a little bit about just maybe the environment that you are looking at both in the U.S. and Europe? I see the backlog's moved down a little bit in the Products side. But you explained that from some large shipments. I just want to get your tone of the business out there going forward, both in the U.S. and Europe. I know utilization rates are remaining fairly high. But do you see any tone change out there, you know, any kind of slowing? I mean, people are concerned about a slowing coming up, obviously, so --

You know, I get this question a lot, as you might imagine. I always have the same answer. It's incredibly solid business out there around the world. We had a little bit of a soft summer in a couple of our channels. I wouldn't say soft. It just didn't grow as much as the other channels. But they have rebounded wonderfully in September and October so far. And that is not only in the United States, but around the world, we're seeing a good activity -- good quotation activity, good strong bookings. We're not seeing any sector that is taking a dive. I know there's this concern about residential construction and the subprime mortgage business, but those are not areas that we participate in to any great -- or at least directly, maybe certainly indirectly. But we're not feeling any of that. We continue to see bookings to be very strong, and this mid- to high-single-digit kind of booking activity. So we feel fairly positive about the general economy around the world.

Because I guess there is concern about commercial constructional following the residential market downward. But you are not seeing any of that on the commercial side?

We're not feeling that at all.

At all. So no indications of that?

No. And every time I'm out there in the field talking with our channel partners, our distributors, they are all very positive. I just got back from a Board meeting of a trade association and everyone I spoke to is trying to figure out how to make everything that they have orders for, let alone worried about a slowdown.

Okay, that's good to hear. The final question would be, looking at your Univeyor decision coming up at the end of the year, is that a separate decision from the EmptiCon rollout product -- the rollout of that effort? Could you separate those two or are they bound together?

Well, the EmptiCon is part of the Univeyor business.

I know that. But, going forward, say you wanted to keep EmptiCon, but wanted to get rid of Univeyor. Could you do that, or is this a one-decision situation for you?

I think it's fair to say that we will and are evaluating all of those alternatives, including, if it makes sense, to separate or not.

Okay, and do you still see continued progress on the Univeyor margin line? What can we look forward to that in the next quarter or two if you kept it?

Well, as you know, we don't give you an outlook, but I can give you a feel for it. I think from this quarter, beginning last quarter and now a little stronger this quarter, I think we're past restructuring. I think that the business is sized appropriately and focused on products and profitable business and the maintenance service contracts. And our expectation is the trend in improving margins would continue into the future here.

Peter Lisnic, Robert W. Baird.

Tim, I guess can you give us a sense as to how you are generating the profitability improvement in the Products business that you are generating? Because if I look at the quarter, with the numbers reported the way they are, it was a relatively strong quarter. But if you take out some of these costs for growth, for lack of a better term, the margin improvement would be substantially better. So I guess I'm just wondering how you are generating that. And then the second part of the question would be, how should we think about some of these incremental growth costs for the second half of the year and then into the next fiscal year?

Okay. So the first question really is how we are generating the profit, and the second question is the investments continuing into the future.

Yes.

Okay. Let me take the first one. Profit -- basically, going back into the early 2000s, you might recall, Pete, we closed 10 manufacturing facilities in North America. And then we took out a million square feet of operating space and the cost associated with it. And the growth in revenue through that smaller footprint is creating a fair amount of leverage, which is giving us this incredible operating leverage, this 42% we reported, which is the profitability that you're seeing and feeling.

Now, you are right. We are making investments in new markets and new products over and above, let's say, a normal activity, and that is to continue the growth that we see -- the opportunity for growth that we've seen in the future, which is in domestic markets like in energy and construction, but it's also in international markets as well. So we have this investment going on, which is certainly taking up some of our profits, but with this great leverage we have, it's a wonderful thing.

So I think it's predominantly lower fixed costs with the same volume. Lean manufacturing has helped us get the productivity and more output as a result of the work we've done there with a smaller footprint, which is good news for everyone. But I will also say that a couple of our troubled businesses have -- we had some less profitable business in our crane group, and our crane group has really focused dramatically on improving that. They've done a wonderful job. So some of the let's say very low-profit crane business has now turned into a fairly decent profit level for us, and you're seeing some of that come through as well.

Our hoist business as well, just to give you a little more detail, you might recall that we migrated to this FEM-rated wire rope hoist line and removed some of the higher-cost ANSI -- the American National Standards Institute -- hoists. And that has given us a bit of a profit improvement as well. This migration has, for the most part, taken place. Once Joe launches the one- to three-ton coming up in a couple months here, it will be fairly well done. And as a result, our higher-cost hoists are migrated to lower-cost hoists. We also make the bulk of those components in our Chinese business, which has removed cost from the FEM wire rope hoist as well. So that has given us some additional profit bump.

Can you quantify how much FEM has helped the mix -- the profitability mix?

I cannot. There's a lot of things going on here. I would say that the leverage is predominantly driven by the lower footprint fixed cost base. But certainly, if you look at our hoist business, this FEM translation that has happened, we probably sell quite a few wire rope hoists, so it certainly is an impact, but not a great one. Relative to --

I guess another way of asking this question is, if I just exclude some of these costs that you booked in the quarter, the second-quarter operating margin would've been, I don't know, 200 or 300 basis points higher in the Products business, which is a significant acceleration from what we've seen over the past several quarters.

Right.

So I'm just trying to figure out, A., what's generating that, and you've done a good job of explaining that, and B., how sustainable is that? Do we start to think about the Products business as more of a -- instead of doing 13.5% or 13.6% OM like they did last year, is this a 15%-plus kind of business?

I certainly think that it has that potential. But you have to allow us to continue to grow here for a while and use those profits to invest in new markets and new products, so we can continue the topline growth and also the profit growth.

Okay, and that was Part B of my question, I guess, is how long those investments continue, and to what -- can you quantify the dollars associated with that?

I think the rate that we are at now is a reasonable rate, especially given our profitability, and you can expect to see it continue to be in this area going forward, I would say for the foreseeable future. We don't want to slow down growing in Eastern Europe or in China, for example.

Derwin just hired a business development fellow to head up our Chinese business, and those are relatively new investments for us. But I expect to be spending more there in the future, because that's where a lot of industrial growth is coming from. We have to be in that market. So if you think about the current rate that we're spending at from an SG&A standpoint, Pete, that is a reasonable level to be at.

Very good clarification. Thanks for that. And then, unrelated follow-up, I guess, can you talk a little bit about October specifically? It sounds like September and October moved up pretty well from August. But in terms of October, is it still another month where we're looking at kind of mid- to high-single-digit order growth?

Yes, you're right in that area, Pete. It continues to be very, very solid growth.

James Bank, Sidoti & Company.

Karen, this first question, I think, is for you. When I look at your operating leverage, it's sort of been in between in the past two years between a 30% and 40%. I know in the past, you have referenced operating leverage being able to be sustainable in the 20% to 30% range. But now it looks like you are on track to be over 40% by the end of the year. Is there any way we can maybe update this operating leverage range of what is sustainable to maybe 30% and 40% as we look forward?

It's a good question, James. But I think at this point, there are a lot of variables, as you know, impacting the operating leverage. In addition to the nice performance by our Products segment that Tim described, we are of course also seeing nice improvement in the Solutions segment, driven by the Univeyor restructuring. So the goal that we laid out, the 20% to 30%, was really intended to be a long-term sustainable view as opposed to a short-term hurdle or a short-term guidance level. So while we are certainly pleased when we exceed that, and from quarter to quarter there may be opportunities to exceed that for a variety of reasons, we think it appropriate to continue with that 20% to 30% goal.

Okay, so you are looking very far out in terms of at one point in time we will hit some sort of a cyclical downturn. So then if I could ask this, would we then be able to be or let's say safe to assume a 30% to 40% range, at least in the near to medium term?

We don't give guidance, as you know (multiple speakers). So I really wouldn't comment on that.

Could I just have the sales breakdown between international and domestic? Unless, Joe, you might have given that -- you did break down a number of sales, but I didn't quite get that.

Products?

No, excuse me. Overall, the breakdown between international versus domestic, total sales overall.

International is about 35% of the consolidated revenues.

Okay, so it hasn't changed at all.

No, it runs relatively consistently. The domestic business has grown, as the international has as well. Our Products segment international has grown at a faster rate, driven by our Columbus McKinnon Europe business, but that's been -- when we think about the Company on a consolidated basis, that's been somewhat offset by these managed reductions in the Univeyor business.

Yes, if you remove that, obviously, it would be much higher. The Univeyor business has shrunk the international growth, to a degree.

Okay, I see. Now, the selling expense in the quarter was the highest I've seen in the past seven years. And I understand why you are doing this, to expand internationally. You explained it very well in the call and also in the release. Is this sort of a run rate we could look at going forward and would this number maybe taper off or stay flat as we head into the next fiscal year?

You know, I would say, as I answered -- Pete had a similar question -- the level of investments we're making. We have the normal base business selling expense and then we have a level of investment on top of that. I say that I think we're somewhere in the 11-ish percent area for selling. That is probably a reasonable rate for the foreseeable future. And I would actually stretch that probably into next year. And I'm only thinking, by the way, of the investments over the normal selling that goes on. And I think that it would be prudent for us and our investor community for us to invest in markets where we see some great opportunities.

And sort of reflecting on the comment you had in the press release, you are targeting high-growth U.S. markets. I think you covered this pretty well on your prepared remarks. The one market, if you could elaborate on further, commercial construction, clearly, as I've seen this in every indicator that I track, seems to be pretty good. It seems like it's going to be continue to be pretty good in the foreseeable future. However, my comments and what you guys have also said contradict Caterpillar's release from last Friday. Is there anything that you guys might be seeing that's maybe different from what they are seeing, and maybe if you could just elaborate on that?

That's tough for me to comment on. I didn't read the Caterpillar release. They are a very good customer of ours, but I didn't have time to get through that. So I can't give you any details or any thoughts around that just yet.

And of the Solutions segment backlog at $15.7 million, could you give me an idea of what percent of that would be this new product to order direction you're heading in?

Probably pretty modest right now. It might be -- I don't know, Karen, unless you have that.

I don't have an exact number. But I would agree, it would be pretty modest, because the thing is, with those types of things, we had -- we did a production run of five of them, and then we -- and we've shipped, I think, most of those. So the actual backlog number -- and they sell for about $175,000 or so. So it's not a significant number in backlogs as they turn.

Just yet.

At this point.

And then one question on FEM. The one- to three-ton hoists will be coming out December to January. Now, this will be the last of the wire rope hoist series. What is the next line? Are we going to expect maybe some chain hoists going forward?

Yes, there is -- actually, Joe has up to 50 tons coming out right after the three-ton. And that's due in the spring.

Okay, and that's another wire rope hoist?

That's another -- hang on a second. Let Joe give us (multiple speakers)

We've got some other projects underway. We're looking at some of the components that are sold with those wire rope hoists that we sell to that channel, crane builders. These are typically called end trucks. We have a design effort underway to modernize that line into more of a global line. We're currently working on that. We also have on the plate, but we have not formally started some larger-capacity hoists that would be in the let's say 40- to 60-, maybe even 75-ton wire rope hoists. But that's currently not underway, but it is contemplated. And we have a series of some new electric chain hoists that are being developed. They will be (technical difficulty) for the world-type market, and we are looking at that as well.

Thank you, Joe. Very helpful. And last question on Solutions. Are you -- it seems like there was considerable improvement in the quarter stemming from the first quarter sequentially with Solutions profitability as you guys migrate toward this now product to order business. Are you actively marketing Univeyor, however?

No.

Beth Lilly, Gabelli.

I have a couple questions. If we can talk about the Solutions business for a second, if you look at the results this quarter, it seems to me that you are getting this business very close to breakeven. And so, is there a level of revenues that this business needs to be at in order for you to start earning money?

Sure. But more important than revenues, Beth, would be mix of the revenue. So it's the focus on the type of project and/or product that we add our expertise that we can receive decent selling prices and therefore decent margins on. And that's more important than a level. I think the level that we are at now in terms of just total dollars for our Univeyor business we can make money at if it's the right kind of projects.

And going forward, as you've restructured this business and repositioned this business, do you anticipate, then, that this business will earn money going forward?

Yes.

Okay, so next quarter, it's possible that we will see Solutions generate positive operating income.

Yes, that would be our goal and our target, our expectation.

Okay, great. Now, my second question is something that we've talked about in the past and I just wanted to get a little clarification, and that is, Tim, you talked about at some point, and there was a questioner earlier in the call that talked about operating margins and where you think you can take the business. I think in the past, you have discussed maybe at some point rolling out new targets for the next three to five years and where you think Columbus McKinnon can get in terms of overall operating profitability on a margin level. And I'm wondering if there is -- is it going to be at the end of this year, or when can you give us a sense that you are going to roll out your new plan?

Boy, Beth, you have a great memory.

No, I'm just consistent, Tim.

Yes, you are. Let me tell you that we have done a fair amount of discussion here at Columbus McKinnon with our advisors as well. And in fact, I had a nice conversation with our Board last week at our Board meeting on this exact topic. I think it is fair to say that we are still in the planning phases -- stages of this work. But it would be our intention that sometime next calendar year, we would be back to you with the next level of operating performance for Columbus McKinnon.

Okay. And then my last question is, Karen, you mentioned that the target for working capital as a percentage of sales is 15%. And in this most recent quarter, it was 21%. So how long do you think it will take you to get to that target level of 15%?

We wish it were tomorrow. But unfortunately, things just don't happen that quickly. We have not -- we have stated the 15% as a long-term target. We currently, as we track our metrics relative to peer companies, we consider ourselves average. We had been better. We have slipped up some and we're working hard to get it back down to where we were and to surpass that. But we do see that as a long-term goal, Beth. It's not something that we would see in the next year or so.

Yes. So maybe when you roll out the next calendar year, when you roll out kind of the overall strategic goal in terms of where you can take the business, you might be willing to commit to when you think you can get to that 15%?

I think we can give you a better feel for what we're doing around that activity. I'm not sure that we'll give you a date.

Because if you're able to drive that number down to 15%, that frees up close to $40 million.

Yes, that's a lot of cash tied up in working capital.

Yes. And I assume, just following along on our earlier questioner, that a lot of that is in the Solutions business?

Yes, while relatively speaking, when you think of the relative size of the Solutions business compared to the Products segment, there is an inordinate amount of working capital tied up in that segment.

Terrific quarter, and congratulations.

Mark Grzymski, RBC Capital Markets.

Great quarter. Just sticking to the balance sheet, and if you do free up all this cash, and I know you are obviously -- well, not also freeing up, but you have a lot of cash too, and you're looking for acquisitions under $50 million or around that, if you don't find them, and you do have that 8 7/8 note out there, are you going to look to go out and get those bonds and get some of the bonds off the balance sheet? I know you're going to have to pay, I guess, 108 until next year.

Well, whatever they trade at.

Yes. The coupon is 8 7/8. So we are currently paying interest. We're currently trading in the 104.5 area. And we have said before and we continue to monitor the market for opportunities to take those out. They are callable in November of '09.

Yes, I guess that's what I meant. They were -- yes, '09. Okay, because it seems -- I guess from a shareholder's standpoint, the last thing -- if you can't find an acquisition, something has got to give with the cash.

Yes, there's no question.

Yes, we understand.

We would be opportunistic in the market with those bonds until '09, the first call date.

Fair enough. Tim, the weak dollar, obviously that has got to be helping your business. I'm just -- I know it's hard to quantify, but what are your thoughts on it?

I think you are right. I think that we are seeing some increased demand on our U.S. facilities for product made here, produced here, being shipped to other parts of the world, in particular Europe. So actually our strategy is to launch the CM brand into Europe, and that's going well. It started. We've got training done. We've got literature. We have product into the market now. And I think that the currency situation certainly does help that.

Right, okay. And an earlier question regarding growth -- I mean, if you are at 8.7% year over year, is there any way to break down volume as opposed to the price increases that you did talk about?

Yes. We have a breakdown in the press release. Let me just pull it out here.

Okay, I see the pricing. I've got it. 1.9%.

(multiple speakers) 6.9.

Okay. And do you expect the price improvements to continue? I mean, is there a need to continue to pass on pricing? It sounds like you've got a better grip on raw materials right now.

Yes. Well, you know, our normal practice historically is an annual price increase. We've averaged over this time period somewhere between 1.5% and 2%. So, going forward, Mark, our expectations would be it would be similar.

Last question -- in Europe, there are some signs or I've heard some slowing in some regions. And obviously, you're not seeing that. I'm just wondering if you can comment on why you are not only outpacing the growth here domestically, but I would even argue that in Europe, you're growing faster than others.

You know, it's hard to say other than we are seeing fairly good demand. It's coming directly from end-user markets. Construction is one of those markets. Energy is another one. It's kind of the same as the U.S. But I also think that you had such a pent-up demand in Europe, where Germany has been in a slump for 15 years. They haven't done much for a long time in terms of investments other than a reunification process that they've gone through.

We think that there's just this demand out there that's going to be going for quite a while, and economically speaking, they're doing some smart things, reducing tax rates, reinvesting back in their economies, which I think is a good thing to do. But I also think that we're well positioned in the market and probably to a degree taking share.

That's great. And now, this sounds like Eastern Europe is -- obviously, you know, is very strong. Any signs of slowdown that you are seeing on the Western front?

No, none of the Western markets have changed in terms of going downward. The trendline continues.

Okay. And same thing in the Western portion? You believe you're also taking market share there as well?

Oh, I'm sorry, I thought your first question was Western.

Excuse me, I meant on the -- yes, on the Western front, you're also taking market share as well?

Yes. We are also expanding the product breadth. We pretty much do manual hoists in Europe today, which is where we're strong, and we're doing a good job with. We need to also push powered hoist products to a larger extent, and that's where the CM line comes in, as well as some other products. So there's multiple opportunities in Europe. It's not just good economics, it's not just market presence, it's also new products that we will be introducing there as well.

Holden Lewis, BB&T.

Just to clarify a little bit more on this question of what you are investing and whether it's leverageable, when you talked about being satisfied with the level of investment that you're making now, and assuming that that's on sort of a good run rate, are you talking about kind of the dollars of investment is probably a good run rate; therefore, as revenues grow, we can actually begin to leverage those dollars of investment, or are you talking about the percentage of investment is sort of where you want to keep it?

It's probably the dollars.

Okay, so presumably, then, you should be able to -- as revenues grow, you should be able to lever that?

Right. Once you make the investment, as you might imagine, the revenue doesn't immediately follow the investment. It's a lag. But over time, as long as you keep making investments, the ones you made several years ago are beginning to bear fruit, which is what we're seeing now from places like -- from Hungary, for example. We made the investment three years ago and we're seeing some pretty good benefits now. So, eventually, you'd expect to get a little bit more leverage on a forward-looking.

Right. And you kind of think we're there. That's one of the contributors to your expectation that margin potential is greater.

That's correct.

And then in the Solutions business, to be clear, your losses in the quarter were reasonably similar to what they were last quarter. But you're saying that those were entirely due to restructuring, that outside of a restructuring charge, that would be breakeven, and then you are suggesting that those restructurings are done?

Yes, you've got it. If you remove the restructuring in the quarter, which is about $500,000, basically a breakeven quarter for the Solutions segment.

Okay, all right. And so what should we take from your tone about Solutions? I mean, obviously, you are evaluating all the options, as you have been, and you're still sort of intent on giving sort of an update on your intentions by the end of the year. But I think your feeling about Solutions, and it sounds like you feel better about it this quarter than you did last quarter, when it felt like you were behind a little bit, does that sort of sway your orientation towards maybe trying to make a go of it rather than maybe divesting it? Did we skew your feelings on it any?

We are going to continue to evaluate all options. Our expectations were this business would improve. That has always been the case. So, no, my opinion in terms of the evaluation is unchanged based upon these results.

And then also on the profitability question, you listed off a number of great things that have been driving your profitability over the past couple of quarters and past couple of years. But again, it does seem like the incremental profitability in Products alone got better in Q2 versus Q1. Is that just pricing or was there some other delta or incremental contributor to making the Q2 look better than the Q1?

Higher volume -- higher volume over the prior year than the first quarter recognized. That gave us the better leverage through a fixed cost footprint.

Okay. And then lastly, the cash flow question -- have you considered dividends or anything of that sort, given the improving cash position?

I think on a go-forward basis, if we had our druthers, we would love to find an acquisition that could fit the strategic mold that we've presented. If that doesn't work, we would consider all forms of capital reallocation to the benefit of our shareholders.

At this time, there are no further questions.

Thank you, Crystal. Let me just summarize for you all, and I'm a bit reiterative because I think it's good to view how we have unchanged our view of what's going on at Columbus McKinnon, I still think we're very poised to grow profitably with a very strong balance sheet, with solid and growing markets, a very strong market position in North America, excellent cash flows. Our use of free cash flow will continue to be applied to reducing debt, but we're also very focused in our attention on products-oriented bolt-on acquisitions that can add market presence where we have small or no presence and add to our product portfolio, where we can leverage our existing distribution channels and brand-name strengths.

Combine this with our lean initiatives, cost reduction activities, investments in new products and in new markets, as well as addressing some of our nonperforming businesses such as Univeyor, and I think we're very well positioned to have a solid 2008 fiscal year and beyond.

I'd like to thank all of our associates around the world for their hard work and ultimate success in making this quarter wonderful. As always, we appreciate your time today, and we will look forward to talking to you again. Thank you.

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