Hillenbrand Inc (HI) 2011 Q3 法說會逐字稿

Good morning, everyone and welcome to Hillenbrand's earnings call for the third fiscal quarter of 2011. A replay of the call will be available until midnight Eastern Time Tuesday, August 23, 2011 by dialing 1-888-203-1112 in the United States and Canada or 1-719-457-0820 internationally and using the passcode 7914711. This webcast will be archived at www.HillenbrandInc.com through August 9, 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 Chris Gordon, Investor Relations director. Mr. Gordon, please go ahead.

Thank you, Yolanda and good morning. Welcome to our earnings call for the third quarter of fiscal 2011, which ended June 30. With me on the call today are Hillenbrand President and CEO, Ken Camp; Hillenbrand Chief Financial Officer, Cindy Lucchese.

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 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 filed 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 statement.

Now let me provide some information regarding our call. First, when the Rotex transaction is complete, here is how our organization will look. Just as we do now, Hillenbrand will have two platforms -- Batesville, which includes the casket, vault, cremation and e-business division and the Process Equipment Group, which will include the K-Tron, Size Reduction Group and Rotex businesses and their respective brands.

We are also making some modifications to the way we describe the K-Tron platform. Today and in the future, we will talk about the Process Equipment Group. We will be referring to the top-level company led by Joe Raver that we previously called K-Tron International. This group will consist of three operating companies -- first, K-Tron, the feeding and pneumatic conveying businesses that were previously called the Process Group; second, Rotex our newest acquisition; and third, the Size Reduction Group, made up of Pennsylvania Crusher, Gundlach and Jeffrey Rader. While the Size Reduction Group remains the same for now, we will likely change it in the near future.

We scheduled one hour for the call and we will start with prepared remarks from Ken and Cindy that should last approximately 40 minutes. We will start with a review of the third-quarter earnings, then we will give you more insight into the Rotex acquisition we announced last Friday. After that, we will move directly to Q&A. If you have any follow-up questions after the call has ended, please don't hesitate to call me at 812-931-5001 or e-mail me at Chris.Gordon@Hillenbrand.com.

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

Thanks, Chris. Good morning, everyone and thanks for joining us today. I am sure we all had an exciting time yesterday. Actually, in most cases, more excitement than we all needed and hopefully today will be better, but today is the day we picked for this call, so here we are.

As you saw in our press release and 10-Q filings after the market closed yesterday, the Process Equipment Group grew revenue 19% over the prior period while Batesville experienced a decline of 2.8%, resulting in overall revenue growth for Hillenbrand of 3%.

This morning, I will focus on how our business platforms are performing and Cindy will talk about specific drivers of the Company's results. Then we will get to the subject about which you may have some questions, the Rotex acquisition we announced last Friday.

I will begin with an update on the Process Equipment Group. As a reminder, we are now referring to the operations of the previous K-Tron company as the Process Equipment Group. Going forward, Rotex will be added to the reported results of that platform.

We knew that the success of the K-Tron acquisition approximately 15 months ago would depend on our ability to deliver additional growth and profitability. As we expected, that acquisition is providing a strong growth component to Batesville's solid foundation with substantial increases in revenue, operating profit and backlog. These results are driven partly by customer demand and partly as a result of the growth initiatives, which we launched this year.

Our most significant growth initiative is geographic expansion. During the past year, we have invested to increase our presence in selected markets of opportunity. We are well into this process and expect to enlarge our footprint in China where we can capitalize on the growing demand for coal-fired electric generation facilities and plastics and food processing operations as well.

Our expansion into Russia is already producing results in the potash and coal mining businesses. As many of you know, we have a strong record of using lean business practices to reduce costs, improve margins and shorten time to market. Both of the businesses in the existing Process Equipment Group are developing their skills and applying the principles of lean business to improve their future results.

In short, we continue to be very pleased with the Process Equipment Group's performance and with the early success of their growth initiatives, efforts which we will now expand with the addition of Rotex.

Now I will talk for just a moment or two about Batesville's results. As you know, Batesville's primary role within Hillenbrand is to generate strong predictable cash flows to see both organic growth initiatives and accretive acquisitions.

In the third quarter, they continued to meet this objective despite the volume and commodity cost challenges we experienced this year. The North American burial demand declined some 2% to 3% during the quarter, driven by the continued increase in cremation and our sales in the quarter were down similarly.

As we mentioned in the last call, gross profit margins are historically somewhat lower in the second half of the year with Batesville posted 39.4% in the third quarter of 2011. Had we not had the effects of steel prices and fuel prices, which we chose to absorb, the core engine, we would have been running at about 41% gross margin for this quarter. So that gives you an opportunity to size that effect. So in short, the core engine at Batesville continues to perform effectively as we expected.

I have highlighted on past calls declining burial volumes continue to place consolidation pressures on the casket industry, forcing competitors, in some cases, to seek volume at nearly any cost, especially at the lower price points. We have continued to focus our efforts on differentiated high-quality products and services designed to help customers remain profitable in the face of economic challenges and changing consumer preferences.

We also drive results by providing funeral home customers with opportunities for new revenue and profit streams. There are three growth businesses, including our growing options cremation products and services, Batesville Interactive, which is the largest creator and host of funeral home websites, which is beginning to expand into additional revenue opportunities on those sites for our customers and for us and our new Endura line of burial vaults.

We are excited about these initiatives and we are pleased with the momentum they are gaining. As you know, commodities have remained significantly higher than a year ago, including, as I mentioned, steel and fuel. Most of you are also aware that Batesville has long had a practice to take one price increase at the beginning of the fiscal year and maintain that throughout the entire period.

When commodity prices began to escalate, Batesville continued to use our lean capabilities to eliminate waste and we made a tactical decision to absorb the remainder of the expense. This decision was based both on competitive conditions and our desire to help our funeral home customers, many of whom are struggling to serve their families in an uncertain economy. Now I will turn the call over to our CFO, Cindy Lucchese.

Thank you, Ken. As Ken mentioned earlier, our third-quarter performance was in line with expectations. The Process Equipment Group posted strong results for both the top and bottom line and Batesville continued to produce solid results generating the cash flow needed to pursue our growth strategy.

Turning to the details, consolidated revenue for the third quarter was $211 million, a 3% increase over the prior year. Process Equipment Group revenue was $61 million, an increase of more than 19% over the $51 million they reported a year ago. Year-over-year revenue growth on a constant currency basis was 10%. At the end of our third quarter, the Process Equipment Group had order backlog of $94 million, a 19% sequential increase compared to the second quarter.

Batesville's revenue of $151 million decreased about 3% compared to the prior year. Burial unit volume decreased 5%, partially offset by a modest increase in the average selling price, as well as favorable foreign currency translation.

Now our adjusted consolidated gross margin for the third quarter was 40.8% compared to 42.4% in the prior year. The Process Equipment Group posted consistent margins with the current year's third-quarter adjusted gross margin of 44.2% compared to 43.8% in the prior year.

Now remember that the Process Equipment Group is somewhat insulated from rising commodity costs as current costs are considered when jobs are priced to customers. However, that is not the case with Batesville where prices have historically been set on an annual basis typically around the first part of the new fiscal year.

So while successful lean efforts have helped somewhat, Batesville continues to be impacted by rising commodity costs, especially for fuel and steel. The gross margin for the third quarter for Batesville was 39.4% compared to 41.9% in the prior year. And as Ken mentioned earlier, absent the effects of the fuel and fuel alone, gross margin would have been at 41%.

Total adjusted operating expenses were $49.4 million for the third quarter of the current year compared to $46.5 million in the prior year. The increase was largely due to commissions paid on increasing Process Equipment Group revenues. Now in addition, compensation expense increased in our corporate segment as we continue to execute on our global growth strategy. This includes investments in our corporate infrastructure, as well as the continued development of our international footprint.

Now from a leverage spending point of view, we are very pleased with the discipline shown at both of our business platforms. The Process Equipment Group adjusted operating expenses on a percentage of revenue basis declined 120 basis points to 28.9% and Batesville's adjusted operating expenses remained flat at 16.2% of sales. Interest expense was $3 million in the third quarter, an increase of $1.6 million over the prior year due to our long-term fixed-rate notes issued in July 2010 that carry a higher rate of interest than our revolving credit facility. Now you will recall that we used the proceeds from those notes to pay down our revolver last year.

Investment income and other was about $3 million lower than the prior year, primarily due to a $2.3 million decrease in interest income on the Forethought note. We received full value, full payment for this note in April 2011.

We continue to deliver strong cash flows from operations with $102 million in the third quarter compared to about $28 million in the prior year. The increase was primarily due to the $60 million of interest from the early collection of the Forethought note.

Our third-quarter tax rate was 31.8% compared to 41.2% in the prior year. The primary drivers of the improvement were the nondeductible transaction costs incurred in the prior year and the current period reconciliations to our recently filed tax returns.

Adjusted EBITDA was $45 million compared to $50 million in the prior year. The strong results from the Process Group were more than offset by the decrease for Batesville driven by lower revenue and increasing commodity costs.

GAAP net income was $22.5 million, an increase of $9 million, or 69% over the prior year. GAAP earnings per share were $0.36 compared to $0.22 in 2010. On an adjusted basis, net income was $23.7 million compared to $28.1 million in the prior year. Adjusted EPS was $0.38 compared to $0.45 in the prior year. The decline is due to the loss of interest income from the Forethought note, as well as lower revenue and increased commodity costs at Batesville.

And now I would like to turn to guidance. We are reaffirming our revenue guidance of $855 million to $875 million on a constant currency basis and our adjusted EPS range remains at $1.72 to $1.78. Now this guidance does not include the effects of the pending acquisition of Rotex Global or any of our related business acquisition and transaction costs. So note that we will provide 2012 guidance, including expectations for Rotex, during our earnings call in November. Now I will turn the call back to Ken to provide more details around our acquisition of Rotex. Ken?

Thanks. As we mentioned at the beginning of the call, we are going to give you some color around Friday's announcement that we have entered into a definitive agreement to acquire Rotex Global. When we defined our growth through acquisition strategy a few years ago, we identified two types of acquisitions that we expected to pursue. The first is to drive strategic acquisitions within our current business platforms that further their growth initiatives. The second is to find, fund and execute acquisitions, which would be the core of a new growth platform. Both pathways are essential to helping us reach our future state as a diversified industrial growth company.

As the leader in dry material screening separation equipment, Rotex provides an opportunity for us within the Process Equipment Group platform, an opportunity that aligns very well with our global growth strategy.

This acquisition gives us added capabilities to meet the needs of some of our existing customers and accelerates our and the Rotex Global expansion plans. We talked a great deal in the past about using our core competencies in strategy management, lean business and talent development to help good companies become even more successful. Rotex has a robust strategic planning process that we can build on and they are ready and eager to go to the next level in lean business.

They are also a very strong cultural fit with us. They have a seasoned and proven management team that, as we do, puts a very high priority on top-quality manufacturing, excellent service and strong cash generation. We were attracted to Rotex because of their very balanced and successful business profile, one that will seem familiar if you consider the Process Equipment Group acquisition last year.

Rotex has strong positions in a variety of substantial industries and their footprint is diversified by the end markets and geographies they serve. In addition to original equipment sales, Rotex has a substantial recurring revenue stream from replacement consumable parts. Typically, Rotex generates more than $3 in consumable parts revenue for every $1 in machine sales price over the life of a given installation.

We think that is a very powerful dynamic that we can build on. As part of our initial evaluation of Rotex, we surveyed a number of their customers and found that they have leading positions in eight end markets and 38 SIC codes. We also found that the Rotex brand is very highly regarded and is rewarded, therefore, by significant repeat sales rates.

Their success has been based upon their unique and extensive experience in handling materials that range from crushed minerals and metal powders to salt and sugar. They are a leader in screening and separating processes for agricultural, potash, phosphate and a brand-new and growing category, frac sand. This is finely sized industrial sand that is used in the burgeoning horizontal oil and gas drilling applications. It is injected into shale or other fossil fuel-bearing rock at high speeds to create and hold open cracks. This allows more oil or gas to be extracted from the rock.

As you can see by this slide, the Company is named for their original machine, which uses a unique gyratory motion to stratify materials allowing the fine particulates to sift down through the screen. In dry separation, gyratory technology at this point has approximately 30% of the market. Competing machines often use a vibratory or centrifugal motion that can cause those particulates to become airborne reducing the quality of the end product. Rotex manufactures a number of other separation and screening products, including the Megatex minerals separator designed for the growing industrial mineral industry.

The Rotex company has an installed base of more than 10,000 machines across the world. Those machines cost from as little as $10,000 to some $250,000 depending upon the model. While Rotex equipment generally represents a modest percentage of the total capital cost of a customer's processing operation, Rotex equipment is viewed by their customers as mission-critical in an environment where downtime is very expensive.

As the sales leader in North America, Rotex generates more than 40% of their revenue outside the US and Canada and this is a result not only of their own targeted efforts to grow worldwide, but also because many of their customers are blue-chip multinational companies that are growing globally and they expect Rotex products in their foreign locations, as well as in their North American locations.

We mentioned earlier that the Process Equipment Group is seeing progress from its strategic initiatives, particularly in China and Russia. Rotex has plans to expand in these areas just as the Process Equipment Group is doing. Combining those expansion efforts will allow us to leverage our resources and increase the Process Equipment Group's efficiency and effectiveness.

One of the primary drivers behind growth at Rotex is a series of megatrends led by global population growth. The expanding population leads to a rising demand for food and energy and all their attendant industries and raw material needs. An expanding international middle class is increasingly looking for higher quality foods, seeking access to more pharmaceuticals and consuming natural resources at record rates. If this sounds familiar it is because these are the same trends driving the Process Equipment Group's global growth with increased demand for food and related industries such as fertilizers, mining and biofuels for energy generation and consumables such as plastics and chemicals.

The success and thriving strategic initiatives at Rotex are the result of an experienced management team led by President and CEO, Bill Herkamp. We have been meeting and working with his team over the past months and our respect for the Rotex team continues to grow. We are thrilled that this group will stay on and continue to lead the growth of their business.

Two years ago, all of our revenue came from Batesville. With the addition of K-Tron and now Rotex, the Process Equipment Group results for the trailing 12 months would represent more than $300 million in annual revenue and more than $70 million in EBITDA. That equates to approximately one-third of Hillenbrand's total revenue at a very attractive EBITDA margin.

Finally, I hope it is clear how the strategy we outlined in April 2008 is unfolding. When we acquired K-Tron, we had a clear vision of what we could accomplish as a diversified industrial company. As you can see from our combined results and the upcoming acquisition of Rotex, we are delivering on that vision. And this is only the beginning. We will continue to identify new ways to grow and build value for all those who put their trust in us as stewards of Hillenbrand. Now we are ready to take your questions. Operator, would you please open the lines?

(Operator Instructions). Clint Fendley, Davenport.

Thank you. Good morning, Ken, Cindy, Chris. First question here on the Batesville business and the volume, I wondered if the downtrend that you guys saw was fairly consistent throughout the quarter or just any color on how that trended throughout the period.

I think it was relatively consistent and if you look at the, as I am sure you have, the other public companies in the same space as Batesville, they were describing very similar kinds of numbers. A couple of them are our very large customers, so it is sort of natural that our trend there would be quite similar.

Yes, okay. And then on K-Tron, the backlog, up again very nicely on a sequential basis, nearly 72% year-over-year. I just wondered is there any one particular project that really contributed to the growth that you guys saw or are you still fairly well diversified within that backlog?

Hey, Clint, it's Cindy. We are still fairly well diversified. As you know, quarter-by-quarter, we can have some large orders that get in and there are a couple of large orders that came in the backlog this quarter, but we also see that -- that is a consistent thing that we see over time. So nothing unusual.

And any color from just a geographic basis on the backlog? Has it remained the same?

Yes, it has remained the same. We have seen really a strong interest or strong backlog outside the US.

Do you feel like you are beginning to see some of the benefits from the investments that you have made in Asia earlier this spring?

This is Ken. Yes, we are. K-Tron had some operations there to start with, but we are increasing our footprint there. We are making it easier for customers to buy replacement parts from us, especially. We have gotten approval for our [fice] there and we expect that will take us to a new level in serving customers in replacement parts, which is a very strong and stable part of the K-Tron business as it is the Rotex business.

Okay, thanks. And then finally, on Rotex, I mean this looks like just a very well-run business, I mean very similar to what you guys had bought earlier with K-Tron. I am just wondering, when you made the K-Tron purchase originally, you had identified areas that you thought would help the business perform better after you had acquired it, and we have seen progress on that front. Do you see similar areas with Rotex and if so, what might they be?

Good question. Both companies -- we got what we sought, which is really first-class companies that are well-managed and have tremendous brand recognition and brand respect in their business. So that is a great similarity. K-Tron had not embarked upon the lean practices journey. So we were really starting from a clean sheet there. That is going very well and we are finding people continue to adapt, but, as you well know, that is a multiyear journey. In fact, Batesville has been on it since the early '90s and we still find more to do to make ourselves more efficient and eliminate waste. So we don't expect that to end.

On the subject of lean, I would say that the Rotex group is lean eager. They have done some of the groundwork, they have got a couple of people in the organization with significant lean experience, so that is a bit of a headstart. We expect to take that about a year perhaps ahead, probably equal to K-Tron now, but about a year ahead of what K-Tron was at the time of the acquisition.

Rotex also has a very robust strategy planning process, so that is a little bit of a leap forward. But broadly, if you look at both companies, very strong, which is what we pursue. It is easy to apply the strategy process, talent development and lean on companies with such great brands and that makes life a lot better.

Are there any areas or geographies that Rotex serves where you foresee additional investment in order to possibly accelerate the growth in those regions?

Yes, you may recall that we set out to invest about $0.04 a share this year in the K-Tron businesses and that was pretty heavily geographic expansion in some cases into a new industry or two. Rotex plans are very similar. They also are a global business, but they can benefit from the scale that will come from matching up with K-Tron business.

So for example, in our China operation, we see Rotex -- although they would operate separately -- having a parts depot as an example in the same location. Rotex is a little stronger in South America than K-Tron is, so K-Tron can benefit from that combination. We really like the way the math worked out between the two and we will be very careful to not duplicate investments. We think we can get some scale there.

Great, thank you, guys and congrats on the Rotex.

Thanks.

John McDonald.

First of all, I'd like to congratulate you on the operational improvements and results, and particularly the strategic acquisition growth programs reflected in Rotex. I have got basically three types of questions. Number one, given the importance of the steel and fuel price increases, do you use hedging and is there an opportunity there?

Yes, John. This is Cindy. In terms of hedging from a fuel standpoint, that is a very difficult thing to do without introducing volatility into your income statement. So the major airlines, as an example, do hedge. That does actually often times result in volatility in their income statement. So we have looked at that and decided not to take that route.

However, we focus very much on conserving our fuel. It is a key thing, a key focus for us and something that we are relentless about. So we choose to direct that that way.

With regard to steel, we do have contracts with our two major steel producers and basically that gives us the annual pricing. There are opportunities, however, for price increases to happen during the year, but we do do what we can in that arena as well.

Thank you, Cindy. Second question, given that your comment about price increases, Batesville beginning at the -- beginning of each annual year and the market conditions in that segment, what, if any, price increases would you expect or what order of magnitude might that be going forward because we are soon going to approach the beginning of a new year?

John, it's Ken. We are approaching the beginning of a new year and I will tell you, first of all, we don't forecast or we do a lot of forecasting, but we don't divulge what we intend to do with pricing obviously for competitive reasons, as well as for antitrust reasons given our leadership position in the industry.

However, I can tell you a little bit about how we think about it, which is our customers, by the nature of the way funeral directors do their pricelist and respond to Federal Trade Commission rules regarding the kinds of price lists they must disseminate, it is a lot easier for them to do this once a year. They accept us shouldering the burden and in some years, I guess maybe our price increases are such that we get a little gain on it. But given that many of our customers have been buying from us for generations, they accept us shouldering the burden and they are willing to live with that as the year goes on.

We are right now in the phase where we are doing our best to define what is likely to happen. Now if we were really perfect at that, probably we would all be phoning in our buy/sell orders instead of just making caskets and machinery. But we are working on it and whatever decision we finally make and put forth will be with an eye toward making sure that we take care of our customers yet at the same time can recoup the costs that are involved in making and delivering our products.

Good response and thank you, Ken. Third question relates to tax rates. Now you have got a lot of moving parts both internally and with acquisitions and it is probably difficult to accurately forecast your tax rates, but what are your views as to how that might play out over the next 12 to 18 months?

Okay, so we had in our guidance said 33.5% to 34.5% for the year and we have been within that range. I think as you think forward 12 to 14 months that we would be in that range, maybe a bit lower, but I would say right in that range just given the acquisition of Rotex. They do have some more international exposure, which may reduce that rate. As you are aware, I am sure, the US has the highest corporate tax rates in the world. So that should help a little bit. But I am thinking in the 33.5% to 34.5% range would be a good thing to do.

Thank you, Cindy. Congratulations to all of you.

Thanks, John.

(Operator Instructions). Charlie Carter, [Ceradex].

I have a question on your guidance. It sort of implies if you just take the midpoint of your annual guidance that you will see a better year-over-year earnings performance in the fiscal fourth quarter than you did in Q3. And I just wanted to get a little bit more color on that assumption given you chose to absorb some of the input cost inflation. You have held pricing. So can you sort of speak to what the implicit driver is of the better earnings performance year-over-year if I'm just taking the midpoint of your guidance? Thanks.

Sure. What we have done obviously -- we do now have three of our four quarters under the belt, which makes it a little bit easier for us to think about the remainder of the year. We are confident in the guidance that we have provided. We expect K-Tron to continue to post their good earnings, as you have seen and Batesville to be steady like they have been. So we feel a lot of confidence in those numbers.

Charlie, it's Ken. I don't know that you and I have talked before, but one of the challenges that you have is, in the Process Equipment business, we have orders that are in process right now. We have a lot of visibility into the next quarter there and in fact, even visibility into a good part of the next year.

In the casket business, it has to happen every day and the challenge there is that the casket business can never tell what is likely to happen with regard to death rates and cremation rates, especially in volatile times. So that is where the potential volatility comes.

Our strategy is to reduce that level of volatility as we continue to grow, become a more diversified industrial company, but there is still some element there. But I certainly support what Cindy said that we have a pretty good look into it toward year-end and absent something very unusual, although these are unusual times, we expect to be where we have guided to.

So not to put words in your mouth, but it sounds like it is primarily driven off of K-Tron's backlog versus any sort of benefit you are getting quarter-over-quarter on fuel costs coming down. That is probably more accurate?

Yes, we don't bet on fuel cost moves. That is really hard to tell at this point. So we do our best to -- we have services who provide that for us, what they think is going to happen. But this is not a function of someone else. This is more a function of the business that we can see from this point. Still a fair number of things that have to happen.

Hey, thanks.

I am seeing no further questions in our queue at this time. I will turn the conference back over to Mr. Gordon for any additional or closing remarks.

Thank you all for joining us on today's call. As you noticed, I am a new voice on these calls and new in the role of Director of Investor Relations at Hillenbrand. I am very much looking forward to working with you all in more detail over the coming months and hope we can meet in person soon. Take care and have a great rest of the day.

That does conclude today's conference. Thank you all once again for your participation.