Hillenbrand Inc (HI) 2015 Q1 法說會逐字稿

Good morning, everyone, and welcome to Hillenbrand's earnings teleconference for the first quarter of fiscal 2015. A replay of this call will be available until midnight Eastern Time, Thursday, February 19 by dialing 1-855-859-2056 toll-free in the United States and Canada or 1-404-537-3406 internationally and using the conference ID number 60438544. This webcast will be archived on the Company's website at www.hillenbrand.com through March 5, 2015. If you ask a question during today's call, 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.

At this time, it is my pleasure to turn the conference over to Joe Raver, Hillenbrand's President and Chief Executive Officer. Mr. Raver, please go ahead.

Thank you, Lisa, and good morning, everyone. We appreciate you joining us this morning to discuss Hillenbrand's results for the first quarter of fiscal 2015, which ended December 31. I'm joined in the prepared remarks portion of our call today by our CFO, Kristina Cerniglia. During the Q&A portion of our call, we will be joined by Thomas Kehl, President of Coperion. Kim Ryan, President of Batesville, is traveling out of the country and will not be joining us on the call, but we do expect her back next quarter.

Prior to beginning our prepared remarks about the business, I'd like to briefly remind you that during this call we may use certain forward-looking statements that are subject to the Safe Harbor provisions of the Securities Laws. These statements are not guarantees of future performance and our actual results could differ materially. Also, during the course of this call, we will be discussing certain non-GAAP operating performance measures. I encourage you to take a look at our 10-Q, which can be found on our website, for a deeper discussion of forward-looking statements, the risk factors that could impact our actual results, and more information on our use of non-GAAP operating measures and their reconciliation to GAAP financial measures.

Let me begin by reminding you of Hillenbrand's strategy. It's a strategy we crafted at the very beginning of our journey as a public company and our objectives remain unchanged. We seek to leverage our strong financial foundation to deliver sustainable profit growth, revenue expansion, and robust free cash flow. Over the past several years, we've made strategic investment in a number of acquisitions as well as in organic growth initiatives to create value for our shareholders. We continually seek opportunities to make our businesses better by expanding globally, penetrating growing end markets, and improving margins through the application of our Hillenbrand business systems, which includes management practices such strategy, lean, and talent development. As result, we've transformed Hillenbrand from a strong resilient North American funeral products business to a growing global diversified industrial company.

We are excited about the potential we have to continue our growth and transformation to become truly world-class. Now, let me turn to the results for the first quarter. As you saw in the press release last night, consolidated revenue for the quarter increased 4% to approximately $402 million and adjusted EPS was $0.49, about 44% higher than the prior year. Topline growth was consistent with our expectations for the quarter despite some headwind from currency fluctuations. We continually look for opportunities to improve our businesses and I am pleased with the progress we continue to make in reducing costs and capitalizing on synergies with our acquired companies. We were able to expand gross margins and adjusted EBITDA margins in the Process Equipment Group once again this quarter compared to the prior year.

One area where we did not perform as well was operating cash flow. We used $42 million in the quarter largely due to the timing of working capital driven by a couple of very large Process Equipment Group projects. We expect to see cash flow improve throughout the year as those projects are delivered and we receive payment. Overall, we had a solid first quarter. Now, I'll focus more specifically on segment performance beginning with the Process Equipment Group. As many of you know, our Process Equipment Group brings industry-leading applications expertise and core technologies that improve mission-critical processes for our customers. Today, we serve a diversified group of industries with attractive near and long-term growth prospects supported by population growth and in particular, an expanding middle class in a number of geographies.

Revenue for the quarter increased $14 million or about 6% over the prior year. Orders bounced back from the low level we saw last quarter finishing 17% higher than the prior year. However, while our pipeline remains healthy, order intake in the quarter fell short of our expectation. In particular, several large orders moved out and we experienced continued softness in our base business in Europe and across Asia. We continue to pursue opportunities to make our businesses more profitable. Our goal is to drive year-over-year adjusted EBITDA margin improvement of 100 basis points in the Process Equipment Group. In addition to a number of lean projects to reduce costs and improve efficiency, we are beginning to see some benefit from improved price realization in areas where our products demonstrate significant added value.

Process Equipment Group gross margin percentage improved by 190 basis points over the prior year and adjusted EBITDA margin percentage was up 390 basis points. Sequential backlog grew slightly over the fourth quarter to $590 million, slightly below the level we had at the end of the first quarter last year. As I mentioned earlier, order intake for the first quarter although an improvement over Q4 was considerably lower than our expectation. As a result, we still have a gap to close in our backlog to fully recover the order weakness we experienced in the fourth quarter of fiscal year 2014. As we push to close this gap, the timing of new orders will be an important factor in minimizing the pressure on revenue for the second half of the year. The recent drastic drop in oil prices has created uncertainty among some of our largest customers and consequently, we are seeing the timing of some large projects push out as customers are re-evaluating their portfolio of projects and capital spending plan.

With that said, we remain optimistic that the compelling economics of US natural gas as a feedstock for polyolefin production will remain intact and projects will continue to move forward over the short to medium term. We are talking with our customers and industry experts to better understand the ramifications of lower oil prices on overall demand for plastics over the long term. In the meantime, our project pipeline remained strong particularly for North American shale gas related polyolefin projects. From a global perspective, recent developments in Russia have caused delays in a couple of large projects there and as I mentioned earlier, we are seeing continued softness in Europe and a general slowdown in projects in Asia. One area that has developed nicely for us over the past several quarters is the proppant market in North America.

As you know, we provide high precision screening equipment that is used to process high value proppants mostly sand for hydraulic fracturing. This is an area of our business that continues to be very cyclical, began to pick back up during our last fiscal year and the momentum has persisted through the first quarter. However, I would caution you that lower oil and gas prices may have an effect on the demand for the equipment we sell in this area in the near term, but we continue to see potential for long-term growth in this industry. Overall, we have a cautiously optimistic outlook supported by a healthy project pipeline for our Process Equipment business. Before I move on to Batesville, I would like to briefly touch upon the decoupling of the Swiss franc from the euro that happened a few weeks back. The subsequent appreciation of the Swiss franc compared to the euro is having an impact on the Coperion business, which has operations based in Switzerland.

While in the context of the overall business the activity in Switzerland is relatively modest, we will feel the impact of increased costs due to the stronger franc going forward. Now, let me turn to the Batesville segment. Batesville revenue was up 2% year-over-year. Both the burial casket and cremation product businesses experienced higher volume this quarter due in part to a more severe flu season this year compared to last. The volume increase was offset partially by a decrease in average selling price of burial caskets. For the quarter, adjusted gross margin was down 110 basis points due in large part to a decrease in average selling price. As always, Batesville's focused on implementing improvement initiatives throughout the organization, take costs out, and right size its manufacturing and distribution footprint while maintaining the flexibility to take advantage of upswings in the market.

As we think about the longer-term trends for Batesville, healthcare is clearly getting better and people are living longer and that's a good thing. And while the demographics of an aging generation of baby boomers are expected to be a factor in the future, it's impossible to predict with any measure of certainty what's in store for the North American death rates. As the funeral industry continues to evolve, Batesville will be as lean, flexible as possible, (technical difficulty) continue generating solid financial results for our shareholders.

At this time, I'll turn the call over to Kristina Cerniglia, our CFO. Kristina?

Thanks, Joe. As we reported in our filings yesterday, consolidated revenue of $402 million for the first quarter was up 4% year-over-year or 8% on a constant currency basis. The Process Equipment Group delivered 6% growth on higher volume of capital projects and Batesville contributed 2% growth driven by increased burial volume. Adjusted gross margin for the quarter was 34.8% or 70 basis points higher than prior year. The improved margin was driven by the Process Equipment Group where we continued to pursue opportunities, become more efficient, and promote business lines where our ability to add value yields better margins. Adjusted EBITDA increased 19% over the first quarter of last year to $63 million, an increase of 200 basis points to finish the quarter at 15.8% of revenue.

As a key element of our strategy, we will continue to target further improvements to this metric through the continuation of lean efforts across the businesses and ongoing efforts to drive margin improvements in the businesses that we have acquired. Looking at our bottom line for the quarter, adjusted net income grew 43% to $31.4 million resulting in an adjusted earnings per share of $0.49 or 44% earnings growth. Once again, the increased profitability in the Process Equipment Group propelled the earnings growth. Our adjusted effective tax rate for the quarter was 28.5%. We anticipate our tax rate will be approximately 30% for the full year, which is in line with historical levels. Operating cash flow in the quarter was negative $42 million. This includes the payments of approximately $19 million related to the settlement of the Matthews litigation that we discussed on our last call.

The other significant factor affecting cash flow was the use of working capital for large projects in our Process Equipment Group. We are very focused on managing our working capital as efficiently as possible. However, for some large projects, we incur obligations to pay our suppliers relatively early in the process in comparison to the timing of delivery and payments from our customers. That gap was amplified in the first quarter by delays in the delivery timeline on a couple of significant projects. As those projects are delivered over the next three quarters, we will see the positive cash impact to help recover from the low number this quarter. While the impact on cash was especially large in Q1, working capital fluctuations are inherent in this part of the business and are affected by factors like project timing and advance payment schedules.

You may recall that cash was very strong last quarter as working capital changes worked in our favor. Additionally, during the quarter we paid over $12 million of cash dividends. We also repurchased approximately 200,000 shares of our common stock to offset dilution for a total cost of about $7 million. We regularly review the optimal mix of fixed rate and variable rate debt and last quarter, we shared our plans to take advantage of the historically low interest rates and fix out a portion of our debt. We executed on this plan in the first quarter by fixing $100 million of our debt. Turning to the next slide, I will discuss segment performance beginning with the Process Equipment Group. The Process Equipment Group delivered $256 million of revenue in the first quarter representing 6% growth.

Foreign currency fluctuations, especially the decline of the euro relative to the dollar, had a negative impact on the result as growth was 12% measured on a constant currency basis. The revenue increase over prior year was supported by a higher volume of capital projects as well as continued momentum in our sales into the proppant market of equipment and replacement parts. Order backlog inched higher in the quarter to $590 million, which is about $20 million lower than its level from a year ago or $25 million higher when adjusted for the impact of currency. As Joe mentioned, order intake improved compared to last quarter and we are cautiously optimistic that our order pipeline, particularly in the shale gas and polyolefin projects, will help that become a trend.

The Process Equipment Group gross margin grew 190 basis points to 32.9% and the adjusted EBITDA margin of 14.9% was 390 basis points better than last year. We were pleased by operating expense discipline in the quarter. As we have said, this group is very focused on profitability and we expect those efforts will continue to support improved operating margins over time. In our Batesville business, revenue for the quarter was $145 million, up about 2% from the prior year. Burial volume was slightly higher year-over-year helping to offset a decrease in average selling price. Batesville delivered an adjusted gross margin of 38.1%, which was lower than last year by 110 basis points. Before moving to guidance, let me briefly add to Joe's comments on the currency situation. Obviously, the continued weakening of the euro hurts our reported results because of translation.

When we think about currency flows in our business, behind the dollar, the euro is by far the most significant. We actively hedge those transactions to protect the profitability of our backlog, but of course, we cannot fully immunize ourselves to the effects of translations. On the other hand, a weaker euro helps our sizable German operations to be more globally competitive on price. As Joe mentioned, the abrupt decoupling of the Swiss franc from the euro does create some business challenges for us. Although small in relation to our total enterprise, we anticipate margin pressure and are seeking to mitigate that by sourcing production [imports] from other markets when appropriate. We are maintaining our full-year outlook for fiscal 2015 with sales anticipated to grow 2% to 4% on a constant currency basis and earnings per share expected to be between $2.05 and $2.15 per share.

We are still forecasting revenue from the Process Equipment Group to grow 4% to 6% in constant currency. As you know, this business is comprised of large systems, equipment, replacement parts, components, and service. Our revenue can fluctuate as a result of the timing of order placement as well as the cyclicality of the market. Given that, we expect growth to be higher in the first half of the year versus prior year and revenue growth to smooth out a bit in the back half. Batesville is expected to deliver revenue in line with 2014. Given current volatility in foreign exchange rates, we expect a 4% to 6% negative translation impact to the revenue compared to 2013.

In summary, our results for the first quarter were solid. We believe our continued efforts to control cost and improve operating leverage will help offset global economic uncertainty. As a result, we remain confident that we are well positioned to deliver on our plan, including building on our trends of revenue growth and margin expansion. Now, I'll turn the call back to Joe for his concluding remarks. Joe?

Thanks, Kristina. Overall, I'm pleased with our first quarter performance. In the midst of some challenging macroeconomic conditions; we grew revenue and expanded margins, we made progress on lean and productivity initiatives across the organization, and are well positioned to continue those trends. Our management team will continue to execute the strategy that has served us well that is to transform Hillenbrand into a global diversified industrial company, to grow the business both organically and through acquisitions while improving overall profitability and ultimately providing meaningful value for our shareholders.

This concludes our prepared remarks. For today's Q&A session, we're joined by Coperion President, Thomas Kehl. We're ready to take your questions. Lisa, would you please open the phone lines?

(Operator Instructions) Daniel Moore, CJS Securities.

Joe and Kristina, performance in Q1 obviously very strong, but the commentary was rather cautious. Maybe given all the various moving parts in oil and FX, just talk about your confidence around the guidance range for the full year relative to where we were perhaps two months ago.

Dan, this is Joe. I'll take the first part of this and then I'll let Kristina make some comments around the implications of foreign exchange. We did have a strong first quarter, we're very pleased with the first quarter. As you know, backlog came down in the fourth quarter as we had a little bit softer order intake than we had expected. Some of those orders moved into Q1. Quite frankly we expected a stronger order intake in Q1 than we received. So, we have visibility to those projects. We don't think those projects are canceled, they've just moved out a little bit I think as the market has gotten a bit more cautious and some of our larger customers that operate both in the polyolefin business as well as the energy business re-evaluate some of their capital projects. So, we expect some of those projects to move out a little bit and that will be the key to our year.

Batesville had a solid first quarter, we expect a solid second quarter out of Batesville. Our base businesses are in very good shape and it's really going to be the timing of some large projects that will be the driver for the balance of the year. And as I said, we believe those projects are still going to happen, it's a matter of timing. But overall, the businesses are running well as you can see in the profit improvement. So, the businesses are running well. It's really the large projects that will drive really the balance of the year and that timing sometimes, as you know, is difficult to predict. So, we have good confidence. We have confidence right now in our guidance other than the large projects, which are always difficult to predict.

Dan, as we mentioned, guidance is on a constant currency basis so 2% to 4% growth, we're sticking with that for the reasons Joe just described. In guidance last quarter, we did assume a 4% negative translation impact. It might be 4% to 6% given the volatility in the FX rates at this point so on an as reported basis, you can consider it really flat to slightly negative.

Very helpful. I'll jump back in queue. Thank you.

(Operator Instructions) John Franzreb, Sidoti & Company.

Just back to the guidance, Kristina, I think you touched on it or at least where I was going. On current currency rates, are we looking for revenues to be down 2% to up 2% for the full year?

I would look at it as down to flat.

Down to flat.

At the current currency rate, yes.

Okay. And there's still no implications on EPS at the current currency rates?

At this point, no. If you recall in our guidance, we had incorporated about $0.07 of FX impact for EPS and that has not changed.

Okay. And regarding the backlog weakness, Joe, and the certainty of it, can you just provide a little color? Are these projects already started at your customers' locations and you're providing equipment to a project that's already underway that's why you have some certainty or are these new projects for your customers that haven't started and they're delaying the decisions because they want to conserve cash or they don't know if they need it? Do you have any kind of clarity of what kind of timeline we are on the projects for the customers?

Some of these projects, the ones that we're talking about are really big projects so we're in really close communications with our customers and I will put them in a couple of buckets. One is once we get an order, the project has already started and there is a really low likelihood that the project is going to be canceled or to push out significantly. So for example, this quarter we had some customers that had some site issues so their whole project delays a bit and it takes us a little while then to ship; but we have the equipment ready, it's sitting ready to be shipped. You saw cash flow this month, we had to pay some vendors for that, but the customer just isn't ready to accept the equipment. And so that will happen to us, but again that's just some timing as it moves from quarter-to-quarter and that can move both directions to be honest with you.

The second part is projects that are already started. When we haven't received an order yet or they haven't awarded the order yet, they are unlikely to be canceled. They may move a little bit as customers look to shift some capital spending from quarter-to-quarter et cetera or projects get delayed, but those projects will come, it's a matter of when. And then the third category is a little bit longer term so we see projects in the pipeline; they haven't really broken ground, they haven't spent a ton of money on the project. Those are the projects that have the potential to be moved out more significantly based on global macroeconomic issues, end market issues, those kinds of things.

Okay. And in those three buckets, the ones that give you certainty I imagine are falling into the first two mostly and you're not really relying on the third bucket or do you need that third bucket to come in to hit the full-year number?

No, you're right. So, the first one is just some movement from quarter-to-quarter. The second one, if you think about our revenue and hitting guidance for the year, it's really that second bucket. So we know the projects are out there, it's very highly likely that the customers will execute on the full project. It's really a question of the timing and how they're viewing the timing of those projects and when those projects will be awarded.

And in your prepared remarks, you said PEG had some pricing that it can push into the market. Can you just talk a little bit of what product lines or what end markets that you have pricing power in?

Well, so I think it's a couple of things. We've taken actions across the board to realize better pricing where we create significant value. And maybe I didn't describe it very well, I think Kristina did a better job, it's also we're very focused on those product lines where we add lots of value and consequently get better margins. So it's not just pricing, it's also the mix of business that we're focused on. Very focused on that part of the business where we have the most value, where we can create the most value for customers, and where we tend to get better margins because we can serve our customers better than our competitors and so you started to see that shift. If you look back at our EBITDA margins in the Process Equipment Group, you really started to see that shift in the third quarter of last year as we put some programs in place to focus on improved profitability. So, we're trying to get it from every level. There's some price, there's a lot of cost out activity going on, and then we're focused on those product lines and lines of business where we get the best margins as we get a increased mix as well.

And just shifting over to Batesville, I was surprised by the magnitude of the gross margin degradation. You mentioned average selling price, it seems rather significant especially given the time of year. I always felt the early summer months were when you're most susceptible to price decreases at least. Can you just talk about what's going on there? The competitive landscape, what's driving that?

So, there are a couple of issues. One is as you know, customers buy ahead of our price increase. So, we have a well-established annual price increase that happens at the beginning of our fiscal year and customers buy ahead of that. We saw a slightly larger buy ahead than we normally do than we did last year, this year and so those tend to be a higher mix of products. And so as we flow into the first quarter after that price increase, it flips the other way and while volume was good because of the market because customers buy ahead on higher end products, the mix shifts a bit lower end. We expect that trend to disappear as we head into the second quarter and have our normal mix trends. So, that's one issue. It's not really price pressure per se, it's the mix of business in terms of average selling price.

And then the second part of it is as volume goes up, customers hit higher rebate tiers and so we have volume-based rebate tiers and we saw some of that hit us in the quarter. So it's a positive thing from a volume perspective, but those two things came together to give us a slightly lower gross margin. And then just finally, there was a very small impact in the quarter, but some people talk to us about lower commodity prices. We actually had slightly unfavorable commodity prices in the first quarter because while gasoline prices have declined, diesel fuel hasn't declined much and we've seen year-over-year increases in steel and particularly hardwoods that the industry is seeing. And so as that flows through, we expect to have a more normal mix and more normal and strong gross margins as we head into the second quarter.

Okay. So, therefore a rebound the margins in the next quarter?

Yes. At the bottom line, the Batesville machine is running well so we don't have operational issues that are causing margin issues.

Perfect, okay. I'll get back into queue, guys. Thank you very much.

(Operator Instructions) Daniel Moore, CJS Securities.

Going out beyond current guidance, just talk about, Joe, what is the volatility in oil and more specifically the rise in the dollar? Do you see that having any impact on the longer-term opportunity in plastic manufacturing in North America from a competitive standpoint?

That's a question that we're really working hard to answer right now. The Coperion folks have been talking to their customers to try to get a sense of what the decline in oil prices means for the long-term demand in plastics. We've seen the price of plastics come down, base resins come down in the marketplace. And so, we firmly believe at least in the medium term that the North American shale gas phenomenon, the difference between the price of oil and the price of natural gas is still big enough that natural gas is a still compelling feedstock for the production particularly of polyethylene. So, we don't think that that there will be a big downturn in production and capacity going into North America related to the shale gas phenomenon.

I mean my personal belief is over the longer run, declining plastics prices in general will create better demand over the long run as plastic continues to replace more expensive and difficult to work with materials in housing, automobiles, all sorts of products as it's been doing for a couple of decades. So what the long-term impact of oil prices are, I think generally it's going to be good for the economy, It might take a little while so I think that's good, that improves consumption. I think plastic prices will remain lower, that I think it will be good for consumption, which then in turn I think will be good for investment in capacity over the long run.

Very helpful. And maybe just shifting gears. The current quarter sort of cash generation notwithstanding, leverage continued to come down and relatively quickly and will likely come down once again this year as you generate more cash. Talk about the uses of capital, the acquisition pipeline, and if you're not able to find something over the next sort of 12 months to 24 months, would you just continue to hammer away and pay down debt or is there other alternative uses you consider?

Well, so as we think about capital; we return about $50 million a year to shareholders in dividends, we buy shares back to offset dilution each year typically. And then if we don't find an acquisition that meets both our strategic criteria and that gets a good financial returns for our shareholders, we use excess cash to pay down debt or invest in organic opportunities. And so thus far, we haven't done an acquisition in a number of quarters. We've used excess cash to pay down debt. Certainly for the next few quarters, we would expect to continue that same strategy of using excess cash to pay down debt. And then at some point as we go forward, we'll re-evaluate. We are constantly evaluating, but we'll re-evaluate more significantly if that's still the right strategy for the use of excess cash that we're generating.

Related to the acquisition environment in our pipeline, we're very active looking for acquisitions. We get visibility to lots of interesting and good deals. As you may know, particularly in the mid-market right now, multiples are extremely high and so I think the end of 2014 one of the highest levels in history in terms of that mid-market acquisition. Sometimes by acquisitions from like $100 million to $500 million, multiples are very high so we're being very disciplined in our approach to acquisitions. We've seen a number of businesses we've really liked, but we need to make sure that it provides the right return to shareholders. So, we're still active and we don't make any comments about where we are in the pipeline and when we have something to announce, we'll announce it.

Very helpful. Thank you.

Liam Burke, Wunderlich Securities.

Joe, one of the priorities that you had laid out was the margin improvement on the Coperion front. During the quarter, how would you rate the progress you've made in moving those operating margins up?

So, if you think about our Process Equipment Group in total and Coperion is obviously the largest part of that and is really the driver in many ways of what you've seen in the results. I think if you go back now for three quarters in a row, we've had very nice expansion in our EBITDA margins and quite frankly we finished the year last year, the fourth quarter is a very strong EBITDA margin quarter for us, again strong this quarter. And so, we've actually been slightly ahead of expectations in terms of margin improvement across the entire Process Equipment business and that includes the Coperion business. If you look at our EBITDA margins in the Process Equipment Group, the comparables start to get a little bit more difficult in the next few quarters, particularly in the third and the fourth quarter. But we continue to drive the business for improved margins and use as many levers as we can to get there. Thomas Kehl and his team is certainly focused on improving margins and we're starting to see some sustained evidence of that at this point.

And you did talk about pricing on acquisitions being relatively high. Are you seeing any directional easing of that or are they still pretty stubborn at these levels?

What we're seeing right now is they remain pretty high and of course it varies from deal to deal and those sorts of things, but it remains pretty high. I think if you talk to others out in the marketplace and we talk consistently with our corporate development group and they're very active in the market, multiples are high which makes it a bit more difficult to find the right fit financially. But we're determined to continue to do acquisitions, but will remain disciplined.

Great. Thank you, Joe.

We have no further questions in queue. I'd like to turn the call back to the presenters for closing remarks.

Once again, I just like to thank everyone for joining us today. We really appreciate your time. We look forward to speaking with you again for our second quarter earnings call in April. Have a great rest of the day. Thank you, everyone.

This concludes today's conference call. You may now disconnect.