Hillenbrand Inc (HI) 2011 Q1 法說會逐字稿

Good morning, everyone, and welcome to Hillenbrand's earnings call for the first fiscal quarter of 2011. A replay of the call will be available until midnight Eastern Time, Thursday, February 17th, 2011 by dialing 1-888-203-1112 in the United States and Canada or 1-719-457-0820 internationally, and using the replay pass code 3811400. This webcast will be archived at www.HillenbrandInc.com through February 3rd, 2012. If you 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 Hillenbrand's written consent.

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

Thank you, Erin, and good morning, everyone. Welcome to our earnings call for the first quarter of our fiscal 2011 which ended December 31st of 2010.

On the call today are Hillenbrand President and Chief Executive Officer, Ken Camp, Batesville President, Joe Raver, and Hillenbrand Chief Financial Officer, Cindy Lucchese. For the Q&A session at the end of the call we will be joined by Lukas Guenthardt, President of the K-Tron Size Reduction Group.

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 provisions 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 and quarterly reports on Forms 10-K and 10-Q. We do not undertake any obligations to update or correct any forward-looking statements.

Now let me provide some information regarding our call. We've scheduled an hour and we will start with prepared remarks from Ken, Joe, and Cindy that should last approximately 25 minutes or so. We will then move directly to Q&A. If you do have follow-up questions after the call has ended please don't hesitate to call me at 812-934-7256 or e-mail me at mrlanning@Hillebrand.com.

Now it's my pleasure to turn the call over to Ken Camp, Hillenbrand's President and CEO. Ken?

Thanks, Mark. Good morning, everyone, and thank you for joining us this morning. I'm sure you saw our press release and 10-Q filings after the market closed yesterday, and in the spirit of continuous improvement we're trying to help make our call more efficient and effective for you by providing detailed financial information in advance. This should allow us to focus on providing some color and discussion around the results rather than reciting too many detailed numbers to you. We hope you find this helpful in understanding how we think about the business. So let's get started.

Our results for the first quarter of 2011 were solidly in line with our expectations. Both operating companies, Batesville and K-Tron, are fulfilling their roles at Hillenbrand to provide steady cash flow and profitability with innovative and sustainable strategies for growth.

As you know, Batesville is a highly predictable domestic business with the largest part of the largest segment of the death care products industry. It is strongly ingrained Lean business skills and a focus on cash generation that can fund growth throughout the enterprise. We do expect growth from Batesville and the Company is diligently working to increase its share of the funeral products industry by creating new profit streams in such areas as e-business, burial vaults, and others.

While the casket and cremation products business is stable and profitable and it generates substantial amounts of cash for future growth, the growth opportunities within the funeral products industry are largely a function of demographic trends and timing and the growth rate of cremation. That's why our strategy is to pursue most acquisition opportunities generally outside death care where the growth runway is much more robust.

K-Tron, which has been a part of Hillenbrand since last April 1st, is a leader in the bulk solids materials handling industry. And the industry served by the K-Tron businesses, primarily plastics, food, pharma, and the processing of soft minerals and biomass, have strong global growth potential. Obviously, a significant objective of today's presentation is to report on the financial effect K-Tron is having on Hillenbrand's results this quarter.

Our second objective is to clearly describe to you how we look at Hillenbrand as we transition from a Company with one line of business, Batesville, with a very stable history, to a growing enterprise with two distinct but somewhat complementary lines of business.

As you know, we manage the Company to increase long-term shareholder value and we view the generation of free cash flow as a primary driver of this growth. Previously because we had very little debt and our previously $10 million to $15 million per year in CapEx was a bit less than depreciation, our GAAP financial results needed very little explanation. However, we now have some complicating elements as we have a targeted capital structure to support a growing business where acquisitions are part of the model. This has added new elements to the GAAP net income story and created a challenge in making clear comparisons to the previous and somewhat simpler results.

For these reasons we're adding a new dimension to our earnings discussions by talking about EBITDA, which was included in our release and in greater detail in the 10-Q we filed yesterday. We believe this is critical in helping you understand how our business is performing exclusive of acquisition-related charges that are included in GAAP results.

In a few minutes Cindy Lucchese will talk to you about EBITDA as one additional element to help provide greater insight into Hillenbrand and how our strategy is evolving. But let's first take a look at how the operating companies are doing, starting with Joe Raver at Batesville. Joe had a previously planned business trip so he's joining us from the road today. Joe?

Thanks, Ken.

Batesville's first quarter results demonstrated that the business continues to run well despite a very challenging demand environment. We have a strong history of operational excellence that enables us to consistently deliver stable earnings and cash flow.

As we discussed in last quarter's call, our 2011 strategy has three main components. First, the Company plans to profitably grow the core burial business by introducing innovative new products, by helping our customers improve their business results through merchandising, and by offering the most comprehensive sales and service support in the industry.

Second, we're working to grow beyond the core business by offering our customers an expanded range of products and services, including cremation products, online technology products and, most recently, burial vaults.

And, finally, we work to constantly improve our cost structure through Lean business practices.

I'll start the discussion today by focusing on our core burial business. Company revenue was down just under 1% for the quarter compared to last year, even though we estimate that burials were down approximately 4% for the same period. The decline in burials was driven by a decline in the total number of deaths, combined with a steadily rising cremation rate. The growth in the cremation rate, which spiked in 2009, seems to be returning to historical norms. We've observed a more typical year-over-year growth rate of about 110 to 120 basis points.

While the selling price was stable compared to the same period a year ago, we believe that our recent new product introductions, which by the way are selling very well, along with the continued focus on merchandising have helped us maintain our average selling price despite the focus of many in the industry on lower priced products.

Our second strategic focus is actively pursuing growth beyond the burial casket business, primarily in three areas. The first is related to helping our customers improve their cremation business. One of the biggest challenges for funeral homes is direct cremations. A direct cremation is when families don't have funeral services and don't purchase urns or keepsake products to keep their loved one's memory alive, [decisions] they often regret later.

Our Options Team has developed solutions for funeral directors that help them explain to families the importance of a service in the grieving process, as well as the importance of creating a lasting memorial for their loved one. Our research shows that when families choose services that appropriately memorialize their loved ones they have higher levels of satisfaction. This is truly beneficial to the family, to the funeral home, and to Batesville.

One of our most exciting and fastest growing product lines is Batesville Interactive. We've been known for some time for providing attractive, easy-to-use websites to funeral homes across North America. We've expanded our range of offerings, and that gives us the ability to provide more customized [designs] at higher price points. These have been very well received by customers and we continue to add sites and features such as our recently announced partnership with FTD.

And, finally, we continue to be cautiously optimistic about the current [beta tests] for a stronger, lighter, more durable next-generation burial vault. The vault (inaudible) at a very high level from the outset. We'll hear more about this product line as this initiative progresses.

So that brings us to our third strategic initiative, which is to continue to develop and institutionalize Lean business practices across the organization. Our focus on Lean initiatives helped us partially mitigate the recent cost spikes in certain commodities, particularly steel and fuel, that caused the gross profit margin to dip this quarter compared to last year. The Sean initiatives in the supply chain improved our cost structure by approximately $1 million in the quarter, and we continue to make solid gains in quality at each of our production facilities.

As I near the end of my prepared remarks I'd like to talk for just a moment about the competitive environment. In past calls we've discussed the ongoing struggle for volume, particularly at the lower price points in the casket industry where customers are more price sensitive and margins are tight. Aggressive deal making and pricing promotions have become more common as the level of competition, again, especially at the lower price points, becomes more a part of the value offering of some of our competitors.

However, Batesville continues to find ways to provide our customers with merchandising support and training and their client families with innovative new products. So despite the industry challenges, Batesville is best positioned to thrive in the current environment and in the future as demographic trends increase market demand.

We'll continue to build upon the strength of the Batesville brands in death care, in our core burial business, and our newer and higher growth businesses, and by improving our cost structure through Lean business practices.

Now I'll turn the discussion back over to Ken for an overview of K-Tron's results.

Thanks, Joe.

The first fiscal quarter of 2011 was a success for K-Tron. Transition activities are continuing with management for each business line experiencing their first full cycle of the Hillenbrand strategy management process and gaining knowledge that they are applying across their organizations.

Lean business processes are also taking root, and although it's still early in the never-ending learning process of Lean business, we expect significant and continued improvements in efficiency and effectiveness in years to come.

Financially, both the K-Tron businesses posted excellent results in the first quarter increasing year-over-year revenue by approximately 17%. In addition, the consolidated order backlog rose 19% sequentially and 33% over the same period in 2010. K-Tron's focus has been to position their operating businesses more effectively in global growth markets and already they are seeing some of the early fruits of these growth initiatives.

Both the Process Group and the Size Reduction Groups are progressing with their plans to have strong local presence and more effective supply chains in those countries that represent the greatest opportunity for growth over the next 10 to 20 years, particularly in Eastern Europe, China, and India.

The Size Reduction Group maintains a very strong base in coal-powered energy production in the US and replaceable components remain a significant and steady part of their business model. Their future growth of new machine sales is expected to be heavily oriented towards those global markets where new coal-fired power generation plants are being built at a rapid pace. Additionally, K-Tron is expanding their presence in markets for mineral mining and in Western Europe for biomass processing.

The Process Group also continues to increase their sales and service presence in global markets, primarily in the plastics and food industries, both of which are expected to grow as the worldwide economy continues its recovery.

In summary, K-Tron is off to a strong start in its first full fiscal year as part of Hillenbrand. Its leaders are talented, energized, and extremely knowledgeable about their respective businesses. I continue to be very pleased with K-Tron's progress at implementing an aggressive, long-term plan for global growth, and Hillenbrand is willing to fund these initiatives as significant drivers of increased shareholder value.

Now I'll turn the call over to our CFO, Cindy Lucchese.

Thank you, Ken.

As Ken alluded to earlier, we're pleased with our first quarter performance. Batesville continued to produce solid results and K-Tron showed a substantial increase in revenue, as well as bottom line results when acquisition accounting amortization is excluded. In short, our core operating businesses performed well. However, as we expected and have discussed in the past, a couple of big things, unrelated to the underlying performance of our business units, resulted in net income declining over the prior year even though revenue increased more than 30%.

First, certain costs relating to the K-Tron acquisition increased expense by a net $3 million. $2.7 million in incremental amortization and $2.8 million in interest expense was partially offset by a $2.5 million reduction in acquisition costs.

Second, the impact of the unusual benefit from the sales tax recovery increased expense by a net $3.5 million. The benefit was only $600,000 in Q1 versus $4.1 million in 2010. This benefit is not expected to recur in future years although there could be small amounts recovered throughout the remainder of 2011.

Third, our tax rate for the quarter increased 200 basis points over the prior year. The rate for the first quarter of fiscal 2011 was 36% versus 34% in the prior year. We had a favorable adjustment in 2010 as a result of the normal reconciliation to file tax returns. We anticipate that our rate for the next two quarters will be at levels similar to this quarter and will be much lower in Q4 when certain discrete items are expected to favorably affect the rate. We expect our full-year rate to be in line with the guidance we provided in November of 33.5% to 34.5%.

So to sum it up, K-Tron's strong performance and Batesville's solid results were muddied by the nonoperational effects of the acquisition, the comparison with 2010 sales tax recoveries, and a higher quarterly tax rate that will be in line with guidance by year end.

Our total revenue for the first quarter was $211 million, a 31% increase over the prior year. The increase was largely driven by the inclusion of K-Tron revenue in our results this quarter. Their revenue of $51 million increased by 17% over their prior year, reflecting a 15% increase in volume as well as a 2% favorable impact from foreign currency.

Keep in mind that while the fiscal quarters for K-Tron prior to our ownership don't align precisely with our reporting periods they provide a good comparative to understand the positive growth in K-Tron revenue.

Batesville's revenue of $160 million remained relatively stable, showing a 1% decline over the prior year. This was driven by lower burial unit volume, offset in part by favorable currency fluctuations.

During the quarter our gross profit margin declined about 140 basis points to just over 43% compared to the prior year. The key drivers were rising costs for steel and fuel in the Batesville segment, which we expected and discussed in our last earnings call. Both K-Tron and Batesville have relatively similar profit margins, with Batesville reporting in at nearly 43% and K-Tron at just above 44.5% this quarter.

Note that K-Tron's gross profit margin for the quarter was 160 basis points below the unusually high profit margin in the prior year, driven heavily by the mix of a few unique projects. As we mentioned in our last call, we expect K-Tron's annual gross profit margins to remain in line with historical trends in the 40%-plus range, although they can vary quarter by quarter.

Operating expenses were $49 million for the first quarter, an increase of $18 million, largely due to the addition of K-Tron expenses in our results this quarter. Adjusted year-over-year spending for both business units was relatively flat, but the key drivers to this increase were related to the K-Tron transaction and the sales tax recoveries in 2010. We've provided complete reconciliations in our earnings release, but let me speak to you about these to provide a backdrop.

First, as a result of adding K-Tron we increased operating expenses by nearly $16 million which includes almost $3 million related to the incremental amortization of intangible assets. Remember that we guided you to these numbers during our last call and amortization for the K-Tron acquisition should remain fairly consistent for quite some time. The important point is that while K-Tron's revenue grew 17%, operating expenses were flat to prior year. Batesville's operating expenses were mostly flat to prior year, excluding the impact of sales tax recoveries.

I noted previously that our gross margins are very similar for Batesville and K-Tron. However, K-Tron does have a higher operating expense to sales ratio due to the technical nature of their products and related customer support. In the near term the ratio may increase slightly as we make our planned $4 million investment in K-Tron's growth initiatives. There are few businesses that have the operating profit ratio that Batesville has, however, and we will expect K-Tron to continue to pursue improvements in their operating profit ratio.

Interest expense was approximately $3 million in the first quarter, an increase of just over $2.5 million over the prior year due to increased borrowings to fund the K-Tron acquisition.

Cash flow from operations for the quarter was $28 million compared to nearly $36.5 million in the prior year. The decline was primarily due to the timing of vendor payments last year and an increase in incentive compensation earned in 2010 but paid in the first quarter of 2011. This was partially offset by operating cash from K-Tron and lower income tax payments.

GAAP net income was $27 million for our first quarter of 2011 compared to nearly $30 million in the prior year. EPS for the first quarter of 2011 was $0.44 compared to $0.48 in 2010.

Our strategy to grow through prudent acquisitions results in charges for acquisition-related amortization and interest on borrowings, both of which mask the underlying performance of our businesses. Therefore, as Ken mentioned earlier, in an effort to help investors better understand the operating performance of our business we will be discussing EBITDA as an additional metric. We'll also provide adjusted EBITDA results that exclude nonrecurring items.

Currently for Hillenbrand those items include sales tax recoveries, antitrust litigation expenses, and business acquisition costs. Our goal is to provide you with the metrics that we, ourselves, use to evaluate the performance of the business.

EBITDA for the first quarter of 2011 was $50.5 million, an increase of nearly $5 million or 11% over the prior year, and a 13% increase, or nearly $6 million, on an adjusted basis. Batesville EBITDA margin was 29% versus 21% for K-Tron. A result of adding the relatively low margin K-Tron business to our mix is that our adjusted EBITDA growth of 13% is lower than the revenue growth of 31%. For even more detail on our EBITDA I will refer you to the 10-Q we filed yesterday.

In summary, notwithstanding the impact from the acquisition and sales tax recoveries in 2010 our base businesses are performing well.

Turning to guidance, in our earnings release this morning we reaffirmed our full-year revenue and adjusted EPS guidance. As planned, we expect to increase our capital expenditures in the latter half of the year when most of our growth initiatives will be in full swing. This will keep us on track to invest $22 million to $26 million in fiscal year 2011.

Now I'll turn the call back to Ken for his concluding remarks. Ken?

Thanks, Cindy.

Now, in summary, we're pleased with the results but certainly not satisfied. There's a lot before us. There are a number of things we can do and things you will be seeing in upcoming periods. That said, we believe our investment story is compelling. Batesville provides consistent cash flow to fund our attractive dividend and growth initiatives, while K-Tron gives us the opportunity for substantial global growth. Our management team is experienced and highly committed to delivering superior results to our shareholders. These are all key to our growth strategy for 2011 and subsequent years.

Another element that makes Hillenbrand an attractive investment is the meaningful dividend. Our current yield is 3.5%, which represents a payout ratio of 42% of adjusted 2010 net income. Both the Batesville and K-Tron engines are running well. They generate attractive returns on invested capital that will increase shareholder value as we continue our transition from being solely a death care products company to being a company with additional substantial growth opportunities in industrial manufacturing. And we expect that value to increase as the year progresses and we continue to execute on our growth initiatives.

Before we turn to the question segment I'd like to welcome Lukas Guenthardt to the call. Lukas, as you may know, is President of the K-Tron Size Reduction Group, and he's going to be available today to help Joe, Cindy, Mark, and me answer your questions. Operator?

Thank you. (Operator instructions.)

And we'll take our first question from Clint Fendley with Davenport.

Thanks. Good morning, everyone.

Good morning, Clint.

A question on the nice backlog increase at K-Tron, was this on the size reduction or the process side?

Actually, it was in both. Both are progressing nicely in building their backlog as the shipment schedules with customers that are coming online. And this pattern is similar to what the K-Tron team has seen in past years where they've had recessions. Although this recession was a bit more pronounced, and we're -- early indications are, we're certainly hoping that the recovery will be even more pronounced, as well.

Could you remind us, Ken, there's really not any seasonality to the backlog moves, are there?

I'm going to let Lukas -- not broadly, but I'll let Lukas provide some color to that question.

Yes, hi, Clint. This is Lukas. No, there is no seasonality to our business. There are occasions where we tend to send more spare parts [towards] year end because [boxes] are running out or people want to use-up their boxes. But generally there is no seasonality to our backlog or bookings inflow for that matter.

And how has the pricing been on the work that's in the backlog? Should we expect the margins to be consistent with what we've historically seen for K-Tron?

Yes, Clint, we continue our policy of not discounting or discounting very little if we have to. Prices are good. We're happy with the pricing and the margins on the projects that we're booking, and we don't anticipate any changes in that respect.

And I guess, finally, could you guys just update us on the sales office in China? Are we still on track to have that opened by around March or so?

The China office is a very important initiative to us. Actually, we've done -- we've completed the market research in December that has shown us that the import is even higher than what we thought it would be.

We are a little, somewhat delayed, maybe a couple months, because we're changing the city that we're going to put the office in, from Tianjin]to Beijing. We have -- we are convinced now that we need to be in Beijing. All the design institutes are there, a lot of contacts are there, customers live in Beijing. And so that's a change in our imitative. But we expect to open the office probably by the middle of this year, end of June, somewhere around then.

Great. Thank you, guys.

(Operator instructions.)

And we'll go next to Jamie Clement of Sidoti.

Morning.

Morning, Jamie.

Hey, Ken, I'm curious if you can give us your thoughts on -- or a little bit of a description on how you get to an estimate of about a 4% decline in the burial market during the quarter? As you know, the CDC data sort of makes the overall mortality environment -- would suggest that it was a lot better. I think a lot of your peers have suggested, or people in your industry have suggested, that those data may be a little bit overstated. Can you help reconcile some of this for us?

I can at the risk of letting the analyst [wonk] from my past history come to the fore. So (inaudible) elbow me if I make this too much of a [meal] of it. We have been, as you know well, we've been concentrating on this data and how it's developed over a great number of years. And what we've found over time is that the CDC is usually very accurate a year later. But, and I have to give them some credit, remember their primary job is not tracking deaths, it's [tracking cause of] deaths and trying to fix it. So this is sort of a secondary item for them.

They use the 122 cities data, but those cities don't all report with the same level of frequency or accuracy. Over the years we've developed a number of algorithms on the accuracy of the cities. When we apply those algorithms to this period and adjusting for the cities that didn't report and then run our algorithms we actually see a decline in the number of deaths, which comes to about a 2.4% decline.

When you then adjust that for what we believe is the slow but steady growth rate in cremations, which by the way seems to have gone back to its historic growth rate from like what we saw in '09, then we end up with a variance of about 4% in the total size of the burial market. Remembering, of course, that all markets in our industry -- funerals are local businesses. They're all marketed by local. But -- and this is the only case where we describe it as one aggregate market.

Okay, now, Ken, if -- without getting into anything that's too proprietary on your end, when you talk about the algorithms that you guys have used or developed, I mean are you -- and the comment that you said where it's -- the CDC data is usually pretty good a year later, I mean are you implying that sort of your algorithms kind of look at a trailing average? Is that the implication there?

We use some trailing averages but I'd say the biggest driver there is we use historical accuracy where we track what CDC reports on a -- at a given period. We look back in history and then find out a year later when the corrections come in what it turned out to be. And we do that for each of the 122 cities that build-up the model.

Okay.

So from that we've determined which locations that report now have a high accuracy rate and which ones do not. And, frankly, we have a smaller number than the 122 that we rely on, and we've tested that and it gives us a high degree of accuracy. It's not perfect but it's much better than the other system.

Okay, and one -- just a question, a clarification, when you guys refer to business mix are you talking about both of your brands or are you just talking about the Batesville brand?

When we talked about the business mix of the two companies we talked about the relative profitability of K-Tron which is about 20% of the --

Oh, I was actually -- I was talking about within the Casket, within the Casket Division.

Yes, within the Casket Division, I'm going to let Joe answer how he aggregates that. I believe you're talking about NorthStar --

That's correct.

-- and the casket business. And Joe also mentioned how cremation may or may not affect that.

Sure.

Hi, Jamie, it's Joe.

Hey, Joe.

Hey, a couple of things. One is I just want to, if it's all right, just step back to Ken's comments on the death rates. He's exactly right. And as he pointed out, one of the biggest factors is whether the city actually reports or not in a given week, and we go back and adjust for that. So it's not just the accuracy of the specific number of deaths. It's whether they actually filed the report or not and that can cause some big fluctuations, as Ken mentioned.

Okay.

And then secondly, related to mix, typically when we talk about mix within the business we're talking about average selling price mix across our burial casket business. The bulk of our revenue is our core burial casket business, and so when we talk about mix inside the casket business that's the mix that we're referring to.

Okay, and, Joe, what I was getting at specifically was your NorthStar line is relatively newer so I didn't -- I don't know if the, you know, as you market that a little bit more I don't know if just because you're going off of a lower base. I didn't know whether the growth rate of that segment might be higher than the Batesville segment just because it's newer and you're marketing it and whether that would have just a natural downward pressure on the consolidated mix of caskets as a whole? You get my drift?

Yes, and you're accurate there, although it's really not a big enough number to [drop it back] --

Not big enough, okay.

-- significantly. But we do see that business as growing a bit faster. Now to counter that, some of our other businesses, particularly the Options business, which is growing faster than the core burial business based on initiatives and just the size of those markets, that also impacts the mix of our business. And on the other side our -- base on our [active] business is growing rather rapidly, too. Again, those are relatively small things compared to the core burial business, but all those weigh-in on the mix of our business.

Okay, and, Joe, a final question. I mean in your opinion has the -- as you look at the families that are customers of your customers is your -- I mean is your impression that the American death care consumer is starting to spend more again or not yet?

Well, I think we've clearly seen an improved spending environment compared to 2009, our fiscal 2009. I think from 2010 to 2011 we've seen pretty stable average selling prices for the last couple of quarters. And so I think that some stability has clearly returned to the consumer spending market, although I would caution that that is probably, as it is in every business, a rather tenuous thing. I think there's still a lot of uncertainty related to consumer spending, but clearly improved from where we were in 2009.

Okay, very fair. Thank you very much.

(Operator instructions.)

And it appears we have no further questions so I'd like to turn the call back over to Mark Lanning for final comments.

Thank you, Erin.

Once again, we would like to thank everyone for joining us on our call today. We do apologize for the poor sound quality earlier during part of Joe's section. But prior travel commitments necessitated Joe calling in on a cell phone which obviously gave us a little bit of an issue on the technology on that this morning. But other than that we hope everyone had a great call, and have a great day. Thank you very much.

And, once again, ladies and gentlemen, that concludes our conference. Thank you, all, for your participation.