Hillenbrand Inc (HI) 2008 Q3 法說會逐字稿

Good morning, and welcome to the Hillenbrand Incorporated Third Quarter 2008 Earnings Conference Call. Today's conference is being recorded and will be available for replay through August 21, 2008 domestically at 888-203-1112 and internationally at 719-457-0820. For the replay, callers will need to use confirmation code 4683815. If you are unable to listen to the live webcast or the replay, the call will be archived at www.hillenbrandinc.com through August 9, 2009.

If you choose to ask a question today, it will be included in any future use of this recording. Also note that any recording, transcript or other transmission of the text or audio is not permitted without the written consent of Hillenbrand, Inc.

Now at this time, it is my pleasure to turn the conference over to Mr. Mark Lanning, Vice President of Investor Relations and Treasurer. Mr. Lanning, please go ahead.

Thank you, Margaret, and good morning to everyone. With me today are Ken Camp, Chief Executive Officer and Cindy Lucchese, Chief Financial Officer. We would like to personally welcome you to our third quarter earnings call.

During the course of today's conference call and the question and answer session that follows, we may make projections or other forward-looking statements that are subject to the Safe Harbor provision of the securities laws regarding future events or the financial performance of the Company.

We caution you that these statements are only our view of the future and that actual results may differ materially. We also alert you to the risks described in the documents we file with the Securities and Exchange Commission, such as our annual an quarterly reports on Forms 10-K and 10-Q. We do not undertake any obligation to update or correct any forward-looking statements.

Now, let me provide some information regarding our call. We have scheduled an hour and we will start with prepared remarks that should last approximately 20 minutes. We will then move directly to Q-and-A. If you have any follow-up questions after the call ahs ended, please don't hesitate to phone me at 812-934-7256 or e-mail me at mrlanning@hillenbrand.com.

We have a lot to discuss today, so I will now turn the call over to Ken Camp, the President and CEO of Hillenbrand Inc. Ken?

Thank you, Mark. Hello, everyone, and thank you for joining us this morning. Today, I would like to start by sharing the highlights of our third quarter performance, including an update on our key initiatives. I will also briefly discuss our outlook for the remainder of 2008. Then I will turn the call over to Cindy, who is going to provide you with further details about our financial results, including guidance for fiscal 2008. I will wrap up the prepared portion of the call with some closing thoughts, then Cindy and I will respond to your questions.

As you can see form our press release, we posted respectable results in the third quarter. Revenues and margins were consistent with last year, despite challenges in both unit volume and costs for fuel and commodities. In addition, we achieved solid growth in earnings per share, operating profit and cash flow from operations. From a volume perspective, we experienced a 2.8% decline in units year-over-year. The primary cause was the prior year cancellation of a short-term supply contract, which was related to the termination of the planned acquisition of an independent distributor in 2007.

We also typically experience a seasonal slowdown in the third quarter, and this year, it was just a bit more pronounced because it followed a strong increase in influenza-related deaths in Q2. However, thanks to progress in our strategic initiatives, we were prepared to capitalize on the market conditions. For the next few minutes, I will give you a high level summary of those initiatives, which are helping to drive revenue and margins in a market with a declining volume in burials.

Our most significant initiative is helping our customers implement merchandising. In an environment where it is difficult for our customers to gain an additional funeral, implementing and utilizing a merchandising system provides them with financial rewards. The funeral director's total margins improved because families purchased a better mix of products when they receive product information and have a wide range of choices.

Our revenue and margins follow suit, and additionally, consumers also report higher satisfaction with their purchases. Particularly in times of economic uncertainty, Batesville's proprietary assist merchandising system provides our customers with a distinct advantage. Those who have implemented this system continue to see very good results. Conversely, in our experience, funeral homes that do not use a merchandising system generally have a declining average mix.

Despite the success we know takes place when the system is implemented, we are still in the early stages of what we expect will be a long adoption process. We are addressing this by ensuring our customers understand the benefits of this system and the success others have seen, as well as continuing to invest in sales force training, resources and tools that will increase our customers' use of this successful merchandising system.

Another key initiative is our focus on regional consolidators in key accounts. Batesville's historic strength has long been our relationships with thousands of small independent funeral homes in cities and towns all across the U.S. and Canada. Many funeral homes have been family businesses for generations, and as owners face retirement, the next generation sometimes chooses a different career path and the business may be sold.

Often the sale is to a growing number of what we call regional consolidators. Last year, we created a team of some of our best sales representatives to focus on bringing business solutions to this customer group. We have seen a strong increase in revenue year-over-year as a result of these efforts.

Remembering that we also sell to the majority of funeral homes, our sales representatives spend a great deal of time attending to the needs of existing long-term customers. We are continuing to further strengthen these relationships through systems that help our customers become more profitable, as well as by providing service that frees up their time so they can attend to the needs of their client families.

Our third initiative relates to cremation products. We are the industry leader in this area and our revenues are growing at a rate faster than the overall growth in cremations. Our Options line of cremation products is aptly named, representing a wide assortment of products ranging from traditional urns to cast bronze and Lucite sculptures, also to home accents and even jewelry.

To support this increasing consumer demand, including baby boomers' desire for personalized products, Batesville has been investing in a team that is singularly focused on creating new products and services for consumers who select cremation.

The fourth key initiative relates to our NorthStar products. This line, which is visually and functionally distinct from Batesville-branded caskets, is sold directly to casket distributors and manufacturers. The unique NorthStar models are generally in the lower price points and do not contain any of Batesville's proprietary features, such as life symbols, cathodic protection or memory safe. Our strategy is to provide these distributors, who have very strong customer relationships in their local markets, with products that meet their existing and anticipated needs.

Selling to these distributors provides them with a regular supply of well made, attractively priced caskets and provides Batesville with a growth opportunity. We remain pleased with the progress of the NorthStar initiative, while recognizing that it will take time to become a trusted contract manufacturer for some of those who have long viewed us only as a competitor.

As many of you know, our business is seasonal and historically, the second quarter is our strongest, while the third and fourth quarter are typically somewhat lower from a revenue standpoint. At this point, we see no reason why this market trend would deviate from past years, and in fact, that is exactly the pattern we saw in this quarter and expect also to see in Q4.

These are uncertain economic times and we, along with many other businesses, have been challenged with dramatically rising costs for fuel and certain other commodities. We expect these costs to continue to increase during the remainder of the year, especially for carbon steel, as steel suppliers have added very significant surcharges to existing supply contracts.

Over the past several months, some investors and customers have questioned the anticipated effect these unprecedented increases in fuel and commodity costs will have on future casket prices. They have asked whether we are going to follow suit with other industries and take an interim fuel -- price increase or fuel surcharge.

As we mentioned before, we believe that a price increase once per year, usually October 1, enables our customers to manage their businesses with a higher degree of predictability. We've chosen to maintain the long term nature of our relationships with these customers by absorbing some increased cost as they've occurred this year, rather than taking interim price hikes or fuel surcharges.

We will be communicating our annual price adjustments to our customers shortly in August, so I am not able to discuss that in detail on this call. However, we believe the price adjustment will be fair both to us and to our customers, as we contend with volatile and unprecedented fuel and commodity cost pressures.

In summary, this has been a solid quarter for us. The core Batesville casket business showed good resilience and stability as we compensated for some strong headwinds. We believe our continuous improvement initiatives in manufacturing and other parts of the Company help mitigate such effects, but they won't completely offset the cost impact we expect to see in Q4. That said, I remain optimistic about our ability to compete effectively and to continue to provide attractive shareholder returns.

Now I would like to turn over the discussion to our CFO, Cindy Lucchese. Cindy?

Thank you, Ken. I would like to touch on some of the drivers for our third quarter results. Sales for the quarter were $165 million, virtually unchanged from the $165.6 million in the same period a year ago. Our unit volume was down 2.8% compared to last year, primarily related to the canceled customer supplier contract Ken mentioned earlier.

Excluding the impact of this item, which was included in our prior year results, our revenues would have increased 2% over the prior year. This positive revenue growth, in an otherwise stagnant burial market, resulted from price realizations and the favorable impact of our sales and marketing initiatives. We also benefited from the strength of the Canadian dollar versus the U.S. dollar by about $1 million. These positives were partially offset by a negative mix impact, due to the introduction of units with lower price points as well as a continued downward trend in mix in some of our non-merchandised accounts.

Our gross profit margin percentage of 40.2% was essentially unchanged versus 40.4% a year ago. The good news with margins is that we were able to maintain our gross margin percentage despite some very adverse market conditions. Although we experienced $1.8 million of commodity cost increases, and $1.2 million of additional fuel costs in the quarter versus prior year, we were able to compensate for them with good results from our continuous improvement efforts. We believe CI is a core competency for us and was a key component in the $3 million of productivity and improvements we experienced in the quarter.

Operating expenses decreased $5.7 million year-over-year to $28.4 million. Prior year results included $6.8 million in costs related to the canceled acquisition. Excluding those costs, operating expenses grew modestly by $1.1 million. This growth was driven by increased compensation in healthcare costs, offset in part by lower legal fees. Legal fees related to our antitrust lawsuit declined $0.9 million in the quarter versus prior year, as we continue to wait on the court's ruling on class certification.

The cost to run ourselves as a standalone company were comparable to the prior year allocation from our former parent company. Interest expense for the quarter was $1.4 million, versus none in the prior year. Our average borrowings were $160.7 million for the quarter, bearing an average interest rate of 3.08%. As of today, our outstanding borrowings are down to $85 million, because we have been able to pay down debt with our significant cash flows.

Investment and other income was $4.4 million in the quarter, versus $1 million in the prior year, primarily reflecting income from the note receivable from Forethought, a former subsidiary of Hillenbrand Industries. This asset was transferred to us as part of the spin from our former parent. Our tax rate for the quarter was 34.9% versus 36.4% a year ago.

This marginal reduction in the rate was primarily due to an increase in the Section 199 manufacturing deduction this year. Net income for the third quarter was $26.7 million, or $0.42 per diluted share. This compares with net income of $21.5 million or $0.34 per diluted share in the same period a year ago. Excluding the impact of the canceled acquisition in the prior year, our net income and earnings per share would have grown 9.4% this year.

For the first nine months of the year, we generated cash flow from operations of $90.8 million, including $41.3 million in the third quarter. We continued to be very effective in turning revenues into cash and earnings. In terms of the balance sheet, we ended the quarter with cash and cash equivalents of $33 million and long-term investments of $52.7 million, which represent auction-rate securities. Although we collected 2.7 million of the auction-rate securities in the quarter, the auction-rate market remains challenged, so we have classified these investments as long-term as of June 30.

In terms of collectibility, our auction-rate securities, which we hold as available for sale securities, are all AAA-rated investments, primarily in state student loan funds. Despite these ratings, we provided for a 3% loss reserve due to the liquidity challenges resulting from failed auctions. We plan to hold these investments until they can be sold for full value and therefore, do not expect the loss reserve to be realized.

As of June 30th, we had outstanding borrowings on our $400 million revolving line of credit of $110 million. In July, we paid down $25 million of these borrowings, leaving a current outstanding debt balance of $85 million. We are reaffirming our revenue guidance for the year of $668 million to $686 million and increasing our guidance for GAAP net income from a range of $80 million to $93 million to a range of $86 million to $98 million as a result of lower than anticipated antitrust litigations and separation costs.

We also expect to have diluted shares outstanding of approximately 63 million and diluted net income per share of $1.36 to $1.56. On an adjusted basis, net income is expected to be $103 million to $111 million, or $1.64 to $1.79 diluted net income per share.

We now estimate antitrust litigation expenses at $4 million to $6 million for fiscal 2008, versus our previous estimate of $11 million to $13 million. The decline results from the timing of legal expenses, due to the delay in the court's ruling on class certification. One-time separation costs from our former parent are now estimated at $15 million for fiscal year 2008, versus our original estimate of $16 million to $18 million.

Now, I would like to turn the call back to Ken for his concluding remarks. Ken?

Thanks, Cindy. Since becoming a separate public company, we have demonstrated our commitment to returning cash to shareholders by paying our first quarterly dividend of $0.1825 per share on June 30. This equates to an annual dividend payout of more than $45 million. In addition, in July, our board authorized the Company to repurchase up to $100 million of our common stock on the open market. As we look to the future, we know that our current and potential investors have a great interest in how we plan to increase long-term shareholder value. This remains our number one priority.

We are working closely with our board to refine our future Hillenbrand strategy. To that end, we have completed a detailed assessment of the death care industry and our core competencies and now we are in the process of identifying a range of internal and external growth opportunities. We are also building some internal capabilities to help us identify and execute strategic initiatives. As these decisions are finalized, we will share them with you through timely and transparent communications.

Once again, thank you for joining us today and we look forward to seeing many of you as we visit investors around the country and host visits here in Batesville. Cindy and I will now be glad to take questions. Operator, will you please open the lines?

Thank you, sir.

(OPERATOR INSTRUCTIONS)

And we'll take our first question from Dax Vlassis, Gates Capital Management.

Yes, I am just wondering on this auction-rate securities, the loss reserve, was that in this quarter and if so -- was that taken in this quarter, and if so, where was that in the income statement?

It is actually reflected in the equity section. It is just a reserve and it was taken this quarter, 3%.

So it didn't flow through the income statement?

No, it did not, and Dax, let me correct that. We took that last quarter. This is the same 3% that we actually reflected last quarter.

Okay.

So we have not changed that.

Okay. Has any of the auction-rate securities that you hold then subject to some of the settlements we are reading about in the paper?

They have not yet to date. However, about 30 million of our auction-rate securities are with UBS, and you may have read their announcement yesterday that they plan to redeem those securities for everyone, which would include, I believe it is in June of 2010.

Okay. And your CapEx is running below what I think you thought expectations would be. Where do you think they will end up this year?

Yes, expectation-wise, we had thought they would be somewhere around 17 million. We think by the time the year is out, maybe 10 million to 12 million.

Okay. And then, did you reduce your tax rate estimate for this year, and if so, what is the ongoing tax rate of the Company?

We did not change our tax rate guidance. In terms of ongoing, remember this year in Q2, we had the unusual situation with our separation expenses, where a number of those were not deductible, so we had an unusually high rate in Q2. I would tell you as we are planning forward, we of course haven't given guidance, but I think the rate you see in this quarter is much more reflective of something you ought to anticipate going forward.

Okay. And then finally, the forethought operating income in the quarter, what would you expect that to be for the fourth quarter or for the full year? It seemed like a pretty big number in the third quarter. I guess that includes interest income as well.

It does. We are currently earning 6% on that investment and it is about $2.8 million per quarter. That rate will go up in a few years to 8% and then on up to 10%, but in the near term here, it will be at 6%.

Okay. And then actually, I have one more. The volume that you are -- is down in the quarter. Year-over-year in the fourth quarter, is there any carryover from that lost business or would you expect units to be up now that we are lapping the loss of that business?

Dax, this is Ken. There is no real carryover effect there. As volume fluctuates in our industry, I urge everyone to remember, we are a reorder business. And it's a function of the number of calls that our funeral directors have. That's what drives the seasonal volatility. As you look at the comparator of the prior year related to that contract on that distributor, that was washed through by Q3. If there is anything left in Q4, it would be far less than $1 million.

Okay. As a follow-on to that, have you seen Matthews at all competing in the channel? It seems like they had a pretty good quarter in their casket business. Have you seen any additional competition from them and do you think you are losing share at all?

Well, we -- Matthews is certainly a respected competitor and I think as you compare the two numbers between our companies, you are looking at us having a stable model in that we have always sold direct to funeral directors.

Matthews, I believe has stated that they are in the process from converting from a model of being a manufacturer that sold through distributors to also sell -- I believe they said a significant portion of their sales now are going direct. So they are picking up the sales and distribution margins over and above what has historically been merely the manufacturing margins. So it is a model change in that case and the comparison, I think is a bit different.

Okay, thank you very much.

You're welcome.

(OPERATOR INSTRUCTIONS)

And we'll go to Maharth Kapur with Credit Suisse.

Yes, hi, guys. I am not sure if this question was already asked, because I was a little late to the call, but basically, just wanted to get your take on the possible combination of, I guess, two large funeral home customers that is being thrown out there. I mean, obviously, SCI, the big customer of yours. How would that -- I mean, obviously this is hypothetical right now, but just given the example what happened with SCI and Alderwoods a few years ago, do you guys have any thoughts on this?

Maharth, I presume you are talking about SCI's interest in Stewart Enterprises.

Right.

And we are the supplier to both of those companies and we have good relationships with them. So I guess we would describe it as a situation where if they stay separate, our volume will continue, and if SCI acquires Stewart Enterprises, we would expect it to be the same. So we are not anticipating -- whichever way it goes, we are not anticipating, absent some very unusual event, any significant change in our business.

I guess what I was trying to get at was in terms of the pricing, because as far as I [remember] when Alderwoods was bought, their level of discount or pricing for them was obviously better for you guys versus what you were giving -- what you, I guess, sold to SCI at. And I presume that since Stewart is a much smaller company than SCI, Stewart will end up being the same price that SCI gets, which would be detrimental to you guys in terms of pricing.

Well, I will give you essentially the same answer when people ask me the question about Alderwoods, which is that we have confidentiality requirements in our contracts with everyone and we don't discuss or even hint to what that might be.

Okay, fair enough. Thanks.

Sure.

And with no further questions in the queue, I would like to turn it back to you, Mr. Lanning, for any closing remarks.

Well, thank you, conference Operator. We appreciate everyone's time in sitting in on the call this morning. Again, we will be around, both myself, Ken -- or all three of us, Ken, Cindy and myself, to talk to investors this morning. So if -- so please don't hesitate to give us a call at my number at 812-934-7256. Appreciate your time, and have a good day. Thank you.

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation. You may now disconnect.