Enovis Corp (ENOV) 2008 Q2 法說會逐字稿

Good morning, and welcome to the Colfax Corporation Second Quarter Earnings conference. This conference is being recorded. At this time I would like to turn the conference over to Ms. Mitzi Reynolds, Vice President of Investor Relations. Please go ahead.

Thanks, Teresa. Good morning, everyone, and thanks for joining us. My name is Mitzi Reynolds and I am the Vice President of Investor Relations. On the call today we have John Young, our President and CEO, and Scott Faison, Colfax' Chief Financial Officer.

I'd like to point out that our earnings release and 10-Q are available in the Investor section of our website, colfaxcorp.com. We will also be using a slide presentation to supplement today's call which can also be found on the Investor section of our website. Both the audio of this call and the slide presentation will be archived on the website later today and will be available until the next quarterly call. In addition, a replay of this call will be available until approximately August 22. The replay number in the US is 888-203-1112, and internationally it is 719-457-0820. And the access code is 8865744. This information is also listed in the press release.

I would also like to note that in order to help you understand the Company's direction, we may be making some forward-looking statements during the call including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties including those set forth in our SEC filings. It is possible that actual results might differ materially from any forward-looking statements that we might make today. The forward-looking statements speak only as of the date that they are made and we do not assume any obligation or intent to update any forward-looking statements except as required by law.

During the presentation we will describe certain of the more significant factors that impacted our year over year performance. Please refer to the accompanying slide presentation in the MD&A section of our second quarter 10-Q for details regarding additional factors that impacted year over year performance. With respect to any non-GAAP financial measures during the call today, the accompanying information required by SEC Regulation G relating to those measures can be found in our earnings press release under the Investor section of the Colfax website. References to adjusted net income, adjusted net income per share, adjusted operating income, and adjusted EBITDA are all non-GAAP measures and they exclude asbestos liability and defense costs, income, and asbestos coverage litigation expense as well as a legacy legal adjustment and one-time initial public offering related costs. Adjusted net income also reflects interest expense as if the offering had occurred at the beginning of the period and presents income taxes at an effective tax rate of 34%.

Organic sales growth and organic order growth, also non-GAAP measures, exclude the impact of acquisitions and foreign exchange rate fluctuations. Now I'd like to turn it over to John.

Thank you, Mitzi. Before I get started, I'd like to formally introduce Mitzi Reynolds who is our new Vice President of Investor Relations. Welcome to the Colfax team, Mitzi.

Thanks, John.

Good morning, everyone. This is our second quarterly earnings call since we began trading on the New York Stock Exchange on May 8. Today I will start by covering some of the second quarter's more significant highlights and some of the key performance measures that we achieved. I'll follow that with a review of our strategic end markets. Finally, I will review the financial results and then we'll open it up for a question and answer session.

As we announced in the press release issued this morning, Colfax had a strong second quarter. Adjusted net income was $13.9 million or $0.32 per share, a 53% increase over last year's second quarter. Net sales for the quarter were $161.4 million, an increase of 32% including organic growth of over 18%. Organic sales growth was particularly robust in the Power Generation end market which was up 61% as well as the General Industrial market which was up 26%.

Adjusted operating income increased 42% to $23.6 million. Driven by the increase in sales, adjusted operating profit margin increased 110 basis points to 14.6%. Adjusted EBITDA increased by 32% to $27.5 million.

Turning now to year to date numbers, for the first six months adjusted net income was $24 million or $0.55 per share, an increase of over 48% [sic - see press release] over the first six months of 2007. Net sales for the six months were up 23% to $292.1 million. Organic sales grew just over 10%. Adjusted operating income increased 34% to $41.9 million while adjusted EBITDA increased 27% to $49.5 million.

We continued to see strong growth in our order rates and backlog during the quarter. Order rates have grown steadily on an organic basis over the past several years and into the first half of this year. Year to date orders were up 36% with organic growth of 21%. Backlog was $384 million at the end of the second quarter and is at an all time high.

We participate in five strategic and diverse end markets which are Commercial Marine, Power Generation, Oil & Gas, Global Navy, and General Industrial. The Commercial Marine market is our largest single end market and was 21% of our second quarter sales. Organically, Commercial Marine's order growth was 6% for the quarter and 37% year to date. Organic sales grew 14% and 6% for the quarter and year to date respectively. We expect that growth in international trade, regulatory changes, and high demand for oil and commodities will continue to drive demand for container ships, tankers, bulkers, supply vessels, and FPSOs. We also continue to see incremental aftermarket activity in the Commercial Marine market.

Oil & Gas sales were 11% of our total sales for the quarter while comprising 14% of our orders. Year to date sales were down 15% on an organic basis due to an unusually large project that was delivered in the second quarter of 2007. On an organic basis, orders were up 63% for the quarter and 11% for the first six months. We expect activity in the oil and gas markets to remain favorable as capacity constraints and continued growth in global demand keep oil prices elevated. We believe that the high oil prices will continue to drive development of heavy oil reserves and that project size will continue to increase.

In the Power Generation market, we expect activity in Asia and the Middle East to continue to be robust as economic growth continues to drive significant investment in energy infrastructure projects. For the second quarter, sales into the Power Generation market were 15% of our sales and 10% of our orders. On an organic basis, sales were up 61% for the quarter and are 47% higher year to date. Similarly, orders were up 31% for the quarter and 19% year to date.

Finally, sales into the Global Navy market for the quarter were 4% of our total sales and orders were 7% of our total orders. Organic sales were down 31% year to date while organic orders were up 20%. We anticipate increased Navy revenue in the second half of this year in support of the US Navy's new ship construction program. Despite the recent announcement that the DDG-1000 program will be terminated after the initial two ships, we expect the US to continue to appropriate funds for construction of naval vessels as older classes are decommissioned. As an example, this past week it was announced that the US Navy will recommend to Congress that 8 more units of the DDG-51 Class Destroyer be built between the years 2010 and 2015.

We also believe that demand will increase for integrated fluid handling systems such as our Smart Bounce system that reduce operating costs and improve efficiencies. In addition, we expect nations outside of the United States to continue to expand their fleets to address national security concerns.

We believe continued infrastructure developments throughout the world will drive capital expenditures and our sales in the General Industrial market. General Industrial sales were 48% of our sales in the second quarter and were 42% of our orders. On an organic basis, sales increased 26% for the quarter and 19% year to date while orders increased about 20% and 15% for the same periods. The growth in sales in this market for the quarter was broad based across several sub markets with the chemical market being particularly strong.

Turning to a more detailed review of our financial results, sales for the second quarter were particularly robust to our OEM customers in Europe driving an organic sales increase of 22% in that region. Sales also remained strong in the US with an organic increase of 9%. Power Generation and General Industrial sales were also very strong. Through the first six months, consolidated organic growth was 10% which met our expectations.

Gross profit margins for the quarter were flat when compared to prior year but are up 140 basis points year to date. The year to date margin improvement was driven by increased profitability in our Commercial Marine business by driving price and lowering costs, through improvement in manufacturing productivity in our European operations, and incremental production from our Wuxi, China facility. For the quarter, the heavier mix of system shipments offset continued margin improvement in our European operations resulting in a flat gross profit margin.

Selling, general and administrative expense increased $10.4 million during the quarter including a $4.1 million charge related to a non-asbestos product liability case that is further detailed in our 10-Q, and $2.6 million due to the impact of foreign exchange rates. Excluding the effect of the $4.1 million legal charge, SG&A decreased as a percentage of sales by 120 basis points to 19.6% for the quarter even though the current quarter contains $700,000 of public company operating costs. Without these costs, the decline would have been 170 basis points. Through the first six months, excluding the impact of the $4.1 million charge, SG&A expense were flat as a percentage of sales. However, in 2007, these expenses had the one-time benefit of $1 million gain related to sales securities that the Company received in insurance demutualization. Removing this gain as well as the 2008 public company costs results in a decline as percentage of sales of 50 points in SG&A expense.

On asbestos expense, dissent and indemnity expense related to our asbestos claims was $1.2 million for the quarter. Year to date effective tax rate on a pro forma basis, excluding nonrecurring certain asbestos, certain legal and restated interest costs, would be approximately 34%. Based on current operations, subject to FIN48 and excluding the aforementioned items, the approximate effective tax rate is expected to be 34% or less for the remainder of 2008.

Inventory increased an additional $4.1 million during the quarter which results in a total increase in the first six months of $22.3 million. While on a normalized basis we would be very uncomfortable with such a large increase in inventory, we believe it is appropriate given the anticipated large project growth for the balance of the year.

Net cash flow from operations was a use of $57 million for the first six months. One-time cash outflows related to the IPO were $42.4 million, while asbestos related cash outflows were $16.3 million. If matters proceed as we expect, we will enter into a settlement with one of our large insurers and its affiliate shortly which will provide for a significant reimbursement of past costs during the third and fourth quarters of 2008. We believe these insurers will also begin to pay a significant portion of our current costs as well.

The Company's proceeds from the IPO on May 8th, were approximately $193 million which we used primarily to repay debt, pay dividends to then existing preferred shareholders, and further corporate purposes. We have $115 million of availability on our credit facility and our net debt to adjusted EBITDA ratio is just over 0.75 times at the quarter end. We believe we are well positioned financially to continue to execute our growth strategies.

In summary, we had a strong second quarter from a booking, sales, and profit perspective. Both sales and profitability have exceeded our expectations through the first half of the year. We continue to see strong order growth across our end strategic markets and across each of our geographic regions. While it is possible that there may be some shifting of sales from the third quarter to the fourth quarter due to the timing of project shipments and the European summer holiday period, with our existing backlog and robust order rates, we believe we are on track to deliver low double digit organic sales growth for the balance of the year.

With that, I will open up the floor for Q&A.

(Operator Instructions). Our first question comes from John Inch with Merrill Lynch.

Thank you. Good morning. So I guess the obvious question, Oil & Gas, if I remember, I thought from the first quarter you had thought that was going to rebound a little bit in the second quarter and it really didn't, but you think it's going to improve in the second half. A little bit of color there perhaps, Scott and John, in terms of what happened and sort of why you think that's going to come back in the second half?

Sure. Yes, I think the comment was related to orders, John. We anticipate a large influx of Oil & Gas orders in the second quarter which we did receive. Orders were up 61% in that end market. We tend to be somewhat backend loaded in the third and fourth quarters on Oil & Gas shipments this year related to some of the project business that we had. So we feel pretty comfortable with our Oil & Gas revenue in the back half of the year.

John, is that sort of a large project that you're looking at in terms of Oil & Gas or is it -- is there just broader based activity that's going to weight itself to the back half?

No, it would be broader based activity. Last year we had one extremely large project that created some lumpiness in our comparison. That's why the revenue on a quarter to quarter basis was down this year. But this year it's a series of projects but tend to be shipment dates in the third and fourth quarters.

Then did the order trends for the quarter sort of progress on a linear basis or did they tend to pick up as the quarter progressed or actually drop off? I mean, a little bit more color as the quarter progressed would actually be helpful.

Sure, it was fairly linear. We came out of the blocks very strong in April and May. June continued to be at a pretty high pace, so it was reasonably linear.

And then I guess just lastly, US versus sort of rest of the world and perhaps even emerging markets. There's a little bit of consternation around sort of the trend line of emerging markets. What do you guys see there? I know that a lot of say your European business ultimately ends up there, but do you have any kind of read through in terms of just end market demand?

Sure. I think our emerging market business continues to be very strong. As you had mentioned, a large percentage of our OEM business in Europe ultimately ends up in the Middle East and Asia. We also have a reasonable percentage of our sales direct into the Asian region and that business continues to be pretty strong. So we haven't seen any I would say sort of any material change in velocity in that particular market.

Thanks very much.

We'll go next to Jeff Hammond, KeyBanc Capital Markets.

Hi, good morning, guys. So pretty good momentum in your businesses. I wanted to see if you're seeing any capacity constraints in any of your plants where you need to bring on more capacity on a near term basis.

Yes, we are running at a pretty good clip right now. In fact, we invested a fair, a larger percentage of capital in the first half of the year as a result of that to increase our capacity. I would say we are still in a position to meet our customer needs from a capacity perspective. I think our bigger issues surround the availability and supply of raw materials and lead times associated with some of the, for example, drives and castings, etc. I think that probably more than anything is putting pressure on our delivery schedules.

Okay. And then just a follow on to the order trends, I think you said on the call last quarter that through I guess April, May you had organic order growth of 28. That's versus I guess 19 for the whole quarter. So it seems-- obviously I can't see the monthly numbers, but it seems like you had a fairly sizable downtick in the growth rate. Can you just speak to that?

Sure. Yes, I mean, our orders are pretty lumpy month to month and the month of June in particular in '07 was particularly strong so it was a tougher comparison I think. If you look at the gross amount of bookings month to month, June in comparison to April and May were very-- was a very strong month as well. So no, I would say no change in the velocity of order intake at this point.

Okay, that's helpful. Thanks, guys.

We'll go next to Mike Schneider with Robert W. Baird.

Good morning, Scott and John. Maybe first we can just talk about your comment about growth in the second half. You had expressed that you would expect low double digit growth organically to continue in the second half. I'm curious just why you would expect a deceleration from the Q2 rate of 18% because backlog rates-- I'm sorry, orders, at least year to date, are up 21% organically and I believe the comparisons the second half of last year get easier from here. What is it you see in any particularly market or geography that would cause the deceleration?

Sure. I think we need to look at the first half in total. If you remember, the first quarter was relatively low on an organic growth basis. So there was some timing differences between the first quarter and the second quarter. So I think we were a little over 2% in the first quarter and then 18% in the second quarter. If you look at the back half of the year from a revenue perspective, we actually had pretty strong third and fourth quarter last year, so the comparisons clearly are higher in the second half of the year versus the first half of the year. So I don't really view it as a deceleration. Our business sometimes is a little bit lumpy quarter to quarter. I think it will be really a continuation of what we've seen for the first half of the year.

Okay. And then just maybe some color on the General Industrial sector. You called out that chemical was particularly strong. Can you maybe dive into additional end markets and trends there, up or down, and then also geographies? Because at least investors seem to have the most concerns around that sub segment of your business based on what we read in the headlines.

Sure. I think chemical obviously was very strong and that will continue to be strong in the back half of the year. A fairly significant percentage of what is classified under General Industrial goes to distribution and we don't get exact read on the end markets. But based on the type of product we're selling to distribution, it's probably pretty heavy Oil & Gas weighting to that particular end market, to that particular channel. So it's a little bit of a misnomer that ends up getting classified in General Industrial but that's just how our systems pick it up when it goes to distribution. So I think if you look really in each of the sub segments in General Industrial, which we have about eight different sub segments, the growth was very broad based in all the sub segments. Building products, diesel engine, waste water, really across the board it was very strong and that was on a global basis, not just in emerging markets, but our European business and our US business as well. We had a good quarter in General Industrial.

And then were there any particular deceleration or was there a particular deceleration that occurred in the US General Industrial portion?

No, not that we saw.

Okay, and then just final question, on Commercial Marine, there's a lot of press about slower shipping trends, globally. Do you have or have you seen any cancellations in the order book related to Commercial Marine or any more cautious commentary from the shipbuilders themselves?

No. We have not had any cancellations in our new-- either in our new ship construction or any aftermarket activity. Certainly we read the same press that you do related to Commercial Marine, and we do a fairly aggressive vetting out in that particular market and are on the lookout for any type of change in activity level or cancellations. But so far, we haven't seen any. Our customers tend to be large European ship owners and we're selling through very large, well capitalized shipyards. So as of yet, we certainly haven't seen any change in order rate or any cancellations.

Okay. Thank you.

(Operator Instructions) We'll go next to Shannon O'Callaghan with Lehman Brothers.

Maybe just help us out with a little bit of the lumpiness as we think about it for the rest of the year. The organic growth first quarter, 2%, now 18%. And you mentioned some projects may be shifting from 3Q to 4Q. So could we be seeing that kind of variability in the organic growth pattern in the second half, too? Or what kind of variance might we see?

Yes, I think from a second half perspective in total, we feel very comfortable with the guidance overall. The question is whether it hits in the third quarter or the fourth quarter and that's just a factor of our project related business that tends to move around a little bit on delivery dates. I think at this point we feel pretty comfortable about the overall growth level of the second half of the year.

Okay, but it feels like fourth quarter is going to be the strongest of the two is basically what you're saying?

Yes. And that's our normal seasonal pattern. Fourth quarter is definitely the largest overall quarter of the year for us, year in and year out.

But even on a growth year over year perspective it sounds like more of it maybe comes in the fourth? Based on these project push outs you mentioned?

Yes. Potentially we could see that.

And then on the gross margins, you mentioned the systems impact. Can you either size that for us or give us a sense? You had a really strong gross margin the first quarter, a little less this quarter. Can you talk through the factors there and how you're thinking about that for the second half?

Sure. That's related to very large systems business which, again, tends to be a little bit lumpy business. And there's a higher buyout content on those very large systems, so the gross margins tend to be a little bit lower than our average gross margin and the fact that they're very large sort of skews the mix number a little bit. I think for the balance of the year, I think from a gross margin perspective we should see some moderate increase in our gross profit in the back half of the year.

Yes, this is Scott. I think it's a situation similar to sale. We had very good mix and positive impact in the first quarter and I think the blending of the two quarters was more indicative of what our underlying rates are.

Okay. Thanks. And just last one, how's the acquisition environment out there and how are you guys thinking about progressing towards that goal?

Sure. Certainly acquisition is a big part of our growth strategy in building the business and we're actively looking at transactions right now. The pipeline seems to be pretty good, so I think while we certainly won't comment specifically on any transactions at this point, we continue to see pretty good activity in the M&A market in our sector.

Okay, thanks a lot.

And we have a follow up question from Jeff Hammond, KeyBanc Capital Markets.

Two finer point questions. Could you just speak to how you're seeing price in the quarter on a go forward basis? And how you're thinking about working capital, source use for a full year basis?

I think price, on the price question, Jeff, I think we continue to be pretty successful at passing along raw material price increases in the marketplace given the engineer to order type business that we have. We continue to be pretty effective in passing price along. On the working capital, I think we certainly have a pretty big buildup in the first half of the year, particularly on the inventory side. We'll certainly convert a fair amount of that inventory to receivables in the back half of the year. We tend to be more working capital positive in the first quarter of the year as the receivables are collected. But we will see certainly a reduction in the inventory in the back half of the year.

Okay, thanks a lot.

And it does appear there are no further questions at this time. I'd like to turn the conference back to management for additional or closing remarks.

Okay. Well, again, thank you for joining us this morning. I guess that ends the second quarter call. We'll speak to you again at the end of the third quarter. Thanks very much.

That does conclude today's conference. Thank you for your participation. You may disconnect at this time.