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Columbus McKinnon Corporation (NASDAQ:CMCO)

Q2 2009 Earnings Call

October 24, 2008 10:00 am ET

Executives

Timothy T. Tevens - President, Chief Executive Officer, Director

Karen L. Howard - Chief Financial Officer, Vice President - Finance, Treasurer

Derwin R. Gilbreath - Chief Operating Officer, Vice President

Analysts

Ryan Jones - RBC Capital Markets

Joe Giamichael - Rodman & Renshaw LLC

Theodor Kundtz - Needham & Company

James Bank - Sidoti & Company

Analyst for [Arnold Erstiner - TJS Securities]

[Bob Franklin - Prudential]

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

Operator

Welcome to the Columbus McKinnon quarterly conference call. At this time all participants are in a listen-only mode. (Operator Instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now I’ll turn the meeting over to Mr. Tim Tevens, President and CEO of Columbus McKinnon.

Timothy T. Tevens

Welcome to the Columbus McKinnon conference call to review the results of our fiscal 2009 second quarter. Earlier this morning we issued a press release with the corresponding financials. On the call with me today is Karen Howard, our Chief Financial Officer, and Derwin Gilbreath, our Chief Operating Officer.

We want to remind you that the press release and this conference call may contain some forward-looking statements within the meaning of the Private Litigation Reform Act of 1995. These statements contain known and unknown risks and other factors that could cause the actual results to vary. You should in fact read the periodic reports that Columbus McKinnon files with the SEC to be sure you understand these risks.

We have made a significant step forward in executing our strategic plan with the acquisition of Pfaff earlier this month. We also have a very strong balance sheet with about $29 million in cash; this is after the Pfaff acquisition; and an untapped revolver that is available to support us in the event of an economic downturn. I will remind you that we are considerably stronger today than we have ever been especially when comparing us to the last economic downturn of ’01 to ’04.

We have only long-term debt in place today with approximately $100 million of net pro forma the Pfaff acquisition. Compared to 2000 we had in excess of $400 million.

I think many of you know that we have weathered significant storms in our 133-year history and will certainly weather this one as well, but this time unlike the last downturn and others, from a position of strength. We will continue to be mindful of investments and will be tempered by these economic conditions.

In an overview here, Columbus McKinnon performed very well this quarter notwithstanding the volatile commodity and currency markets as well as the impact on our business in the Gulf Coast area that was negatively affected by Hurricane Ike. Just as a reminder, the Pfaff acquisition that I just spoke about that we announced on October 1 does not affect the second quarter results.

Our revenues outpaced the same quarter last year by almost 7%; actually 6.7%. However we were unable to ship or deliver certain services or products for about one to two weeks in September as a result of Hurricane Ike. Our facilities in this area were without power for a week or so and our service technicians were unable to service our hoists and cranes for a similar period of time. Additionally, we were unable to secure open top oceangoing containers for certain international shipments.

These facts negatively impacted our revenue in the quarter by about $2 million or 1.4% but certainly we have recovered in October and many of those are up and running and doing fine now.

Sales outside the United States grew to over $50million, up nearly 11% over the same quarter last year including about 5% of volume growth. For the quarter international revenue represented about a third of our total revenue. Looking forward, we believe the Pfaff acquisition will increase the percentage to about 40%.

Our gross profit for the second quarter was up 9.5% but down 170 basis points as operations were negatively impacted by that Hurricane Ike that I mentioned earlier as well as an incredible spike in costs of raw materials. As we have done in the past and as a matter of fact for the last several years, as many of you know, we have expected and planned for an increase in raw material costs.

But in this quarter we did not expect the rapid and significant rise in steel and other commodity prices especially in the latter half of the quarter, particularly September. We now see commodity prices retreating to lower and certainly much more manageable levels; in fact the levels that we have experienced early in the first part of the second quarter.

As a result of the impact on gross margin, our income from operations was down about 4.5% this quarter.

But once again we’re very pleased with the strength of the company’s liquidity in terms of cash availability and an open revolver of $75 million which Karen will touch on in a moment here.

However having said that, you should know that we are actively preparing for potential and significant downturn and its impact on our company given the current condition of credit markets and the corresponding impact on the global economy. We are planning for the worst and hoping for the best, but regardless of the severity of this downturn we will be prepared.

Bookings for our business remained solid in Q2 and overall we’re up again in the mid-single-digit area over the same quarter last year. Backlog was up slightly as you can see from the first quarter and this is a reminder to you all that this backlog represents four to five weeks or so worth of shipments.

Cash from operations was strong in the quarter at about $19 million and [some of] that cash was down to $51 million at the end of the quarter. Please remember again that when we acquired Pfaff, the European-based material handling company, for $53 million in cash on October 1. So our cash position has been decreased by about this amount since the beginning of the quarter.

At the end of the second quarter we are about 30% total debt-to-capitalization and this did not materially change upon the acquisition of Pfaff.

With this let me just turn it over to Karen for a little more detail on our financials.

Karen L. Howard

I’m pleased to have the opportunity to review some of the financial highlights of Columbus McKinnon’s fiscal 2009 second quarter and year-to-date that ended on September 28, 2008. As a reminder, all the numbers reported here reflect our former Univeyor business as a discontinued operation divested on July 25, 2008. Accordingly, the reported numbers relate to ongoing operations unless otherwise noted.

Consolidated sales increased by 6.7% to $154.7 million in the second quarter of this year compared with last year’s second quarter. The increase was driven by strong double-digit sales increases reported by our Columbus McKinnon Europe group and mid-single-digit growth reported by the rest of the business.

Overall volume contributed a 0.3% increase over last year with international volume growing by 4.7% and US volumes declining by 1.7%. Unfortunately volume was negatively impacted by approximately $2 million due to Hurricane Ike that hit the US Gulf Coast region in September and deferred that revenue to October. However, pricing and currency translation favorably impacted the revenue growth by 5% and 1.4% respectively.

On a year-to-date basis consolidated sales increased $19.4 million or 6.8% over last year. The company’s quarterly sales pattern assuming a period of consistent economic conditions typically shows sales strongest in the fourth quarter and weakest in the third.

The recent quarter had 63 shipping days consistent with the year ago quarter and the next quarter will have 60 shipping days. Included in the press release is a table showing the number of shipping days in each of the quarter at fiscal ’09 and fiscal ’08.

Overall, second quarter consolidated gross profit increased $300,000 or 0.6% with gross margin contracting 170 basis points to 29.5%. The contraction was primarily due to two factors as follows.

First, our materials, freight and utilities costs increased quickly and dramatically during the quarter particularly in September. Despite proactive and successful surcharge and price increase activities, we weren’t able to react sufficiently to recover the full extent of those cost increases unfavorably impacting gross profit by approximately $1 million. However, we are relieved to have visibility on certain decreasing costs in our third fiscal quarter.

Secondly, margins of our crane building and tire shredder operations were unfavorably impacted by revenue that had to be deferred to our fiscal third quarter due to the effects of Hurricane Ike which hit the US Gulf Coast region in September and a lack of ocean-going containers. This $2 million revenue shortfall impacted gross profit by approximately $600,000.

On a year-to-date basis consolidated gross profit was up $5.5 million with gross margin contracting 10 basis points to 30.8%.

Consolidated selling expense as a percent of sales was 11.1% in the second quarter, down from 11.6% last year given the higher sales level this year and a reduction in spending as compared with the first quarter of fiscal ’09. On a year-to-date basis consolidated selling expenses were 11.6% of fiscal 2009 year-to-date sales compared with 11.3% for fiscal 2008 year-to-date.

Consistent with our growth strategy we continued to make investments to further grow global market share. Consolidated G&A expense was 6.1% of sales in the fiscal 2009 quarter compared with fiscal 2008’s 5.7%. Year-to-date G&A expenses followed a similar pattern at 6.3% of fiscal 2009 year-to-date sales compared with 5.8% for fiscal 2008 year-to-date. During fiscal 2009 SG&A is expected to approximate 17.5% to 18.5% of sales reflecting a modest reduction from previous estimates. However we are prepared to adjust our actual expenses accordingly in the event that we experience a sales level different from that currently experienced.

Driven by the gross margin contraction described above, operating income decreased by $900,000 or 4.6% with operating margin contracting 150 basis points to 12.1% for this year’s quarter compared with last year’s 13.6%. On a year-to-date basis operating margin contracted 90 basis points to 12.8%.

The restructuring charges reported this year relate to closure of one of our crane manufacturing facilities. These operations were consolidated into another existing facility saving $1.2 million of fixed costs going forward.

Interest and debt expense was down $200,000 or 7% over the prior year’s quarter and $1 million or 13.7% year-to-date due to lower debt levels.

We realized $100,000 of investment losses in our [Cassitive] Insurance Company assets this year and $300,000 of income in last year’s quarter.

Further, we recognized $900,000 of other income in this year’s quarter including interest on invested cash, gains on a property sale and net of offsetting foreign currency losses. Last year’s $400,000 of other income included interest on invested cash.

In last year’s quarter we incurred bond redemption costs of $1.4 million or $0.05 per diluted share upon calling our remaining $22.1 million of 10% notes which saved $2.2 million or $0.07 per diluted share of annual interest costs.

Regarding income taxes, the effective tax rates for the fiscal 2009 and fiscal 2008 second quarters were 35.9% and 36.6% respectively. On a year-to-date basis effective tax rates were 35.8% and 37.1% for fiscal ’09 and fiscal ’08 respectively. This year’s improvement is primarily due to changes in rates in certain international jurisdictions and improved mix. On a go-forward basis our expectations are for an effective tax rate in the 35% to 36% range.

As a result of the tax treatment of the Univeyor sale, we have a tax benefit available to be applied against US cash taxes that would otherwise be due during fiscal ’09. The remaining benefit at the end of September was $6.6 million.

Earnings per diluted share from continuing operations for the second quarter of fiscal ’09 were $0.54 versus $0.51 in the second quarter of fiscal ’08 reflecting an increase of 5.9%. Including the discontinued operations, earnings per diluted share for the second quarter of fiscal ’09 were $0.55 versus $0.49 in the second quarter of fiscal ’08, an increase of 12.2%. Year-to-date diluted EPS of $1.06 reflects a 7.1% increase from last year’s $0.99.

Depreciation was $2.3 million and $1.9 million for the fiscal ’09 and fiscal ’08 second quarters respectively. On a year-to-date basis it was $4.5 million compared with $4 million last year.

Capital expenditures were $2.9 million and $2.4 million for fiscal ’09 and ’08 second quarters respectively. Year-to-date cap ex was $5 million for each year. The spending included investments in our new product development activities, our growing low-cost international facilities, productivity improvement equipment as well as normal maintenance cap ex. We expect capital expenditures for fiscal ’09 to be in the $12 million to $14 million range.

Net cash provided by operating activities was $19.2 million in this year’s quarter or $1.00 per diluted share compared with $14.2 million in last year’s quarter or $0.74 per diluted share. On a year-to-date basis net cash provided by operating activities was $29 million this year or $1.51 per diluted share and $23.9 million last year or $1.25 per diluted share representing a 20.8% increase.

This year earnings contributed $35.4 million while operating assets and liabilities used $4.1 million and discontinued operations used $2.2 million. Within working capital increases in inventories were the primary users of cash. Last year earnings contributed $36.3 million while operating assets and liabilities used $8.8 million and discontinued operations used $3.6 million. We continue to focus attention on our working capital utilization.

At quarter’s end debt net of cash was $51.1 million and total gross debt was $133.1 million. To effect the Pfaff acquisition announced on October 2, 2008 we used $53 million of available cash subsequent to the end of the second quarter. Pro forma after the Pfaff acquisition we would have had $31 million of available cash providing sufficient liquidity for ongoing operations especially in light of the current global credit crisis.

Additionally at quarter end, availability on our $75 million revolver provided for under our senior credit agreement was $64.2 million representing $10.8 million of outstanding letters of credit and nothing drawn against the revolver. We were comfortably in full compliance with all financial covenants related to this agreement and it doesn’t expire until 2011.

While our strategy emphasizes profitable sales growth with international expansion, it continues to focus on capital structure stability which is serving us well especially in light of the current global credit crisis.

Gross debt-to-total-capitalization was 30.1% at the end of the quarter, down from 34.3% a year ago. Since we used cash to fund the Pfaff acquisition and acquired only a modest amount of its debt, debt metric will not change significantly on a pro forma basis. We’ve reached our 30% debt-to-total-cap ratio goal and we’re ultimately targeting an investment grade rating to give us flexibility to support our growth strategy which will include strategic bolt-on acquisitions regardless of the point in the economic cycle.

With that, I thank you and turn it over to Derwin.

Derwin R. Gilbreath

Both shipments and bookings continued to be solid throughout the second quarter as the majority of product categories showed healthy gains compared to the same period one year ago. Overall shipments gained 6.7% versus the same quarter in FY08.

We were particularly pleased with the US sales to the general distribution which increased 9.4%. This represents 65% of our US sales. A subset of general distribution is industrial distribution which was up 6.7%. Industrial distribution has been flat for several quarters so this was a good show of performance on the part of our refocused sales force which I will cover in a few minutes.

International sales were up 10.6% from the second quarter of fiscal ’08 which included 4.4% currency translation.

We had only one area of weakness which was CES, our crane builder group. CES was down 17%. 1/3 of this decline was due to the Hurricane that shut down a major facility in several service locations in the CES group. This will be made up in October. The other 2/3 of the decline was related to major crane builder projects shipped in the comparable quarter last year which made the comparison very difficult.

We continue to develop ways to aggressively target prime user markets while cultivating our relationships with our channel partners in order to increase business to our traditional markets. The most recent change in this area was the establishment of a single hoist screw to handle all brands and products under a single executive director. This will allow us to develop cohesive strategies for developing high growth markets while broadening the portfolio at the user level.

We have seen increased demand in areas such as offshore production, mining and construction due to our ability to offer a broad array of lifting products.

The construction market continued to show results during the second quarter with sales growing 9.7% to the rigging channel which is a supplier to the construction market. We have also organized our sales force around these rigging products. This channel typically carries everything that is needed to perform lifts in construction and the manufacturing markets. Additionally, our training programs dedicated to safe rigging practices have helped drive traffic to rigging shops as many of these programs are held in conjunction with a rigging channel partner.

While the second quarter was another solid one for Columbus McKinnon, we remain very cautious due to the ongoing global financial crisis. The effect of the crisis on our business is yet to be seen but could be very disruptive to our business.

Although there are forecasts concerning nonresidential construction slowing due to the credit crisis, the October Reed Construction Data Report shows heavy engineering projects faring the best at a 6% increase for ’09. This plays well for us given our strength in oil, gas and power as an example. The power segment of heavy engineering is forecast by Reed to grow by 12% and we expect our windmill lifting business to increase as well.

Yesterday Reed Construction Data downgraded the economic outlook from the earlier October outlook. However the heavy engineering segment continues to be well positioned compared to the other construction segments.

One of the strengths of Columbus McKinnon is that our products are used virtually anywhere that something needs to be lifted or positioned. Given our strong installed base we expect to continue even with the downturn in the economy to have a very solid stream of spare parts and replacement business in hoist. Lifting and positioning equipment is generally not an option for our customers who recognize the need for safety and productivity regardless of the economic climate.

Now let me turn to operations. The volatility of the steel market continued to be a challenge during the quarter as we dealt with cost changes from suppliers primarily due to escalating steel costs. To offset these cost changes we have continued our surcharge program on items with high steel content such as chains, shackles and hooks. We adjust these charges either up or down each month based on the analysis of the steel market as well as an examination of our sales for each product category. Our goal is to remain margin neutral while continuing to grow this segment of our business.

In the case of our hoist products we initiated a price increase that averaged 2.7% on August 4. The price increase within the hoist group did stick.

Despite all these activities September steel prices from our suppliers peaked and we did not recover all our costs, which is unusual for Columbus McKinnon. Our net miss was around $1 million in gross profit.

The good news is that the steel market costs from our suppliers started to fall, and as soon as the inventory works through the system this quarter our purchase costs will fall as well. We will also increase prices for hoist products to offset some of the material increases that we have seen recently. Hoist products will increase 3% to 5%. We will also raise prices on other products in different markets.

Our focus in operations continues to be toward the goal of superior customer satisfaction. This is supported with detailed initiatives in operational excellence, people excellence, new products and services, as well as new markets and geographies to drive sales growth. Investments in operational team projects in all these areas are ongoing.

Lean manufacturing continues to be a focus for our company. We are seeing an accelerated rate of improvement in most of our facilities and are encouraged by the work and improvements made to date. Our backlog continues to be strong at $63.8 million at the end of the quarter. This compares with $62.3 million and $57.7 million at the end of the fiscal ’08 second and fourth quarters respectively.

Despite all these positive activities, we are cognizant of our surroundings especially driven by the global credit crisis and the potential impact on Columbus McKinnon Corporation. Accordingly, as a prudent step we’re prepared to react to the changing markets and manage our business sin this volatile environment. Our lean processes will help us to be flexible to variable customer activities and we will manage our costs accordingly.

Further, we have positioned ourselves to participate in more emerging market growth than ever so as a whole we are helped by that diversity.

Now let me turn it over to Tim.

Timothy T. Tevens

We’ll take questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ryan Jones - RBC Capital Markets.

Ryan Jones - RBC Capital Markets

With China slowing to high single-digit growth and with emerging markets starting to rollover as well, what are your thoughts about international growth going forward?

Timothy T. Tevens

It seems to me that with this credit crisis that we’re all faced with the global markets are certainly going to be affected in the long term. I think it’s fair to say that we will not see the global build that we’ve seen in the past. Things are indeed slowing albeit still growing but just growing at a much slower rate than what we’ve seen. Our expectations are that it will indeed be slower so we’re planning for that level of growth.

Ryan Jones - RBC Capital Markets

On steel and some other commodities that you’ve talked about, how far along are you in instituting the price increases with your customers and what has their feedback been so far?

Timothy T. Tevens

I think you heard Derwin talk about an August price increase we just had for hoist products and we’re instituting another one toward the end of the year. I think November. Do we know the date?

Derwin R. Gilbreath

Yes. The end of November.

Timothy T. Tevens

The reaction from the distribution is I think there’s recognition that there’s certainly volatility in the commodity markets. We surcharge all of our steel-based products whether it be chain or attachments and we have been doing this now for a number of years so we actually move that price monthly. What we’ve seen this past couple of months is just something we’ve never seen before in terms of the volatility, the wild swings up and down that we’re seeing right now. We will adjust those surcharges accordingly.

We also have been impacted by the motors that we buy for example, which have been impacted by those commodities as well both up and down. But we’re also seeing higher utility costs for example coming at us. We’re trying to react as quickly as we can and be as fair as we can to all of our distribution channel partners but the reality is it’s so volatile right now it’s tough to [inaudible].

Ryan Jones - RBC Capital Markets

But the price increases you think will stick?

Timothy T. Tevens

Yes.

Operator

Our next question comes from Joe Giamichael - Rodman & Renshaw LLC.

Joe Giamichael - Rodman & Renshaw LLC

You’ve used very cautious language going forward in regards to the overall environment and given the backlog, it would seem that things aren’t that bad right now. Are you hedging yourself given the macro environment or have you started to see a more significant downturn than the backlog suggests?

Timothy T. Tevens

You’re right on. We’re sitting here probably like many other industrial companies with a fairly good backlog as you pointed out. Our bookings are fairly good today. We see a fair amount of activity in the markets we sell into. But the realities are we have to look beyond that and think about the long-term impact. If a slowing economy should occur given the credit debacle that’s going on right now, so we’re very cautious for the future. If you talk to our business leaders today, they’d say, “What recession? What problem?” They’re still seeing pretty good business activity.

Joe Giamichael - Rodman & Renshaw LLC

I’ve always thought of your business as less susceptible to the swings in the overall market and more so now since you’ve done such a good job reducing the leverage the company has relative to the last macro downturn that the company faced. I realize that this is not a great quarterly conference call question, but could you walk us through why you think your business can continue to perform well or outperform relative to peers in this environment?

Timothy T. Tevens

A couple areas that we look at. As you said earlier, we’re a much more global company. Going forward about 40% of our revenue will come from markets outside the US, a bunch of that in emerging markets which still are growing much faster than let’s say more Western markets are today. So that would be the first thing that comes to my mind.

The second thing is we won’t be paying back banks or have that much debt that we have to pay a lot of interest expense so that we would be able to keep most of that for our shareholders to reinvest back in our business.

We also have positioned the product portfolio to be much more global in nature and being able to be sold around the world which is very positive, and albeit even with the price of oil going into the $70 area, we still see some pretty good markets in the energy area which we spent a lot of our time and energy in selling to as well as nonresidential construction seems to be going pretty well.

I think as we look at it, it certainly may be slower. It’s tough to say how much slower in the future but I think that we’re pretty well positioned to take advantage of those markets that will be growing even at much higher rates than the rest of the world or at a slower shrink rate than the rest of the world.

Joe Giamichael - Rodman & Renshaw LLC

Given the current valuation of your stock and the free cash flow yields that you’re projected to have even if the business stays flat or turns down slightly, are you seeing opportunities out there that appear to be better uses of cash than say redeploying cash in a share buy-back or increasing dividend? Any of those potentially uses?

Timothy T. Tevens

They certainly would be potential uses. I think I’d really like to see how this credit mass is going to fall out and what kind of results that are going to come from it. As we mentioned, we have around $30 million of cash after the Pfaff acquisition and plenty of room on a revolver so we have some dry gunpowder that we can use going forward for some strategic acquisitions like we’ve done in this Pfaff acquisition we just did on October 1.

However, I think there’s a little more caution as we sit here today and look to the future because these markets are just really crazy and somewhat volatile in nature, and we’re trying to figure out where the direction is. We do have multiple conversations with multiple parties and we’ll continue to think about the acquisition process to continue to execute our strategic plan but we’re a little more cautious I would say today.

Having said all of that, our Board will certainly consider and has considered multiple options in terms of the use of our free cash flow going forward.

Joe Giamichael - Rodman & Renshaw LLC

Is it that the market is not rewarding you for making acquisitions such as Pfaff that you’re I guess more patient and cautious or is it that the opportunities haven’t been as plentiful or as potentially accretive?

Timothy T. Tevens

Neither one. We have plenty of opportunities. We’re certainly disappointed that the market hasn’t rewarded us for executing our strategic growth plans. That’s for sure. But I would say that we’re thinking about the long-term impact on the tightening of the credit markets and the lack of currency flow around the world, and that impact on our end user markets, our industrial markets around the world. What does that really mean to us? How slow could it get or will it get? So that’s where the caution comes from really is a more longer-term view of the end markets we sell to.

Operator

Our next question comes from Theodor Kundtz - Needham & Company.

Theodor Kundtz - Needham & Company

Could you talk a little bit about the Pfaff acquisition and how their business is doing? I know that they did like $90 million of revenues or annualized when you bought them. Is that business growing or is that seeing some weakness, I would expect because it’s a little more European oriented that it would but maybe you could comment on that?

Timothy T. Tevens

The Pfaff business is going along fine. It’s actually on plan to the plan of what we bought them to so we’re pretty pleased with that. They have a potential for a couple fairly large products that they’re still hoping to get by the end of the calendar year. Those are still open.

I would say that it’s growing but it’s not growing as fast as the other European business, the old Columbus McKinnon European business that you know us as. That’s actually growing a little bit better and I think that’s because our older business there is much more [Pan] European and into the emerging markets than Pfaff is today. Pfaff’s a little more Western European and predominantly German centric so maybe that’s why the growth isn’t as hot. But they’re on plan. They’re doing fine.

Theodor Kundtz - Needham & Company

Tim, do you think we’ve bottomed out here in gross margins? You didn’t really give us any kind of outlook. You talked about it but do you think this is the bottom in the gross margin picture and do you think you have much room on the upside here or is it just going to kind of be at this level for a while?

Timothy T. Tevens

Let’s hope not. That’s certainly not our plan. As we look to gross margins, this quarter was actually a little bit disappointing to us in this area predominantly because of this incredible volatility that we didn’t see coming in certain commodities, especially steel. As we look to the future, I think that it’s fair to say that we would expect gross margins to improve if we get decent revenue growth like we’ve been getting in this 5%, 6%, 7% area. So our expectations are that we would be able to control that a little bit better and improve that.

Theodor Kundtz - Needham & Company

How about on the fx side? How is that going to impact you guys? You benefited from it in the past; it’s turned around here. What kind of impact do you think that could have on your top line and bottom line?

Timothy T. Tevens

Good point. I’ll turn this over to Karen to talk about the translation effect but we buy in different denominations as well so on a sourcing basis it could improve. We also export some from the US market into Europe so that could have a negative effect. But at the end of the day I think Karen it’s fair to say that it’s a translation effect that might have the biggest impact.

Karen L. Howard

Yes. More on each of the lines I will say, so for example in this quarter you could see that foreign currency translation added about $2 million to the top line, about 1.4%, and it does impact each expense line as well. By the time you get down to operating income, net income, the impact is negligible.

Theodor Kundtz - Needham & Company

So that could hurt you a bit on the turnaround by the same amount?

Karen L. Howard

On each of the lines but not on a net basis.

Theodor Kundtz - Needham & Company

Any thoughts of a share buy-back here?

Timothy T. Tevens

Given where the stock has traded, I think it’s fair to say that we would consider all options of using our free cash flow including a share buy-back. At this point in time we don’t have Board approval but that would be the case.

Theodor Kundtz - Needham & Company

Looking at the capacity utilization rates in the US, they are continuing to come down. The US outlook, you indicated from what I gathered you thought it would be sort of flattish here. Is that a fair assessment of what you see right now?

Timothy T. Tevens

Yes. It feels like it’s somewhere in that 77% to 78% area and if it stays in that area, things will be fine in the US. Of course if it continues to migrate south, then we have a different situation.

Theodor Kundtz - Needham & Company

Yes, the manufacturing side seems to be migrating further down from that. So that was my concern where in September numbers were 74.5% on the manufacturing side, down from 77%. I’m just wondering if that continues to happen, I guess we would realistically expect somewhat of a decline in the US business? How do you avoid that?

Timothy T. Tevens

Just a reminder to you, we’re much broader than just manufacturing so we look at all [inaudible] other than high tech and/or software and looking at them together. Mining and oil exploration and things of that nature beyond manufacturing. Having said that, the 77% area seems good right now. Manufacturing dipping a little bit lower to 74% as you indicate, and I haven’t looked at those numbers in individual markets yet, but certainly in that sector we’d have a negative impact on us. It usually lags by about a quarter or two.

Theodor Kundtz - Needham & Company

Your stronger areas are still in the refinery business other than the storms hurting you. But other than that do you think that business is still robust?

Timothy T. Tevens

Yes, it’s moving right along. It’s pretty good.

Operator

Our next question comes from James Bank - Sidoti & Company.

James Bank - Sidoti & Company

I’m still a little confused on the margin pressure in the quarter year-over-year and especially sequentially. Given the divestiture of Univeyor, I’m a little confused how we’re below a 30% gross margin. I understand that the costs and the hurricane, but steel really since July has completely rolled over here. It’s back to the levels where it was in April so is it a lag effect from when those prices go up than when you guys get your price increases and then actually hits your line when your price increases finally come in? Is there just a tremendous lag there?

Timothy T. Tevens

You’re looking at different steel than we’re looking at. I think that’s the first thing to say. Our steel actually spiked dramatically in September which was up maybe 20% or 30% in one month. Now when we put our surcharges in, we’re always looking back a month of course. So we don’t have that visibility going forward and that’s probably the biggest impact. Maybe Karen or Derwin want to comment further on that.

Derwin R. Gilbreath

That’s correct. There is a lag effect that impacts it and Tim’s absolutely right about the steel that we’re buying is quite a bit different for the most part. We have a lot of specialty steel and those did go up about 20% to 30% in the month of September.

Timothy T. Tevens

But we have seen them come back down I think it’s fair to say, Derwin?

Derwin R. Gilbreath

That’s correct.

Timothy T. Tevens

Down in October.

Derwin R. Gilbreath

It’s coming down but there is a little bit of a lag because people are buying scrap to put into their inventory and of course they’re wanting to pass that on. Of course we go back and forth on that all the time. But we have contracts where what happens in the previous month rolls to the next month for us.

James Bank - Sidoti & Company

So that with the added effect from Pfaff and the fact that Univeyor is gone, this incremental margin drop-off I saw in September quarter shouldn’t happen again for the rest of the year?

Timothy T. Tevens

Yes. The Pfaff action did not affect the second quarter but if you’re looking to the future, it should have some of a negative impact because the gross margins were lower than the rest of the Columbus McKinnon business.

James Bank - Sidoti & Company

But it is assumed to be accretive though, right?

Timothy T. Tevens

That’s correct. You’re talking gross margins though. It’s accretive to the bottom line. We have shipped already the shipments in the downtime that we lost in our Gulf Coast business and our [inaudible] sorter tire shredder business. That’s already recovered. So we’ll see that in October. The key is to stay on top of this commodity cost increases and changes so that we can remain margin neutral which is as you know our policy.

James Bank - Sidoti & Company

So at this point you guys are still committed to the 12% to 14% operating margin goal by the end of this fiscal year?

Timothy T. Tevens

Yes, that’s correct.

Operator

Our next question comes from Analyst for [Arnold Erstiner - TJS Securities].

Analyst for [Arnold Erstiner - TJS Securities]

Five price increases? What other plans do you have to address costs and returning gross margins to desirable levels?

Timothy T. Tevens

I think that you might have heard us talk in the past on the cost side about lean manufacturing and something we’ve been working on since 2001. That is what I’ll call our primary driver for cost reduction productivity improvement. Maybe I’ll just turn it over to Derwin and you can comment on some of the activities we have going on in this area.

Derwin R. Gilbreath

We have a large number of projects in every plant that focuses on customer service costs and every plant has a lean coordinator. These projects are moving at an ever increasing rate. We’re very pleased with those activities. Some of them are giving us significant cost increases. In addition to that we’re also focusing very intensively on purchasing. What we’re doing there is we’re trying to find the lowest cost high quality supplier, we’re going to more global sources, and we’re certainly dealing with the day-to-day pressure on price increases and making sure that we’ve got the right level of productivity. It’s an every day every minute affair for us.

Analyst for [Arnold Erstiner - TJS Securities]

You also spoke about seeing a slowdown in orders during October and the expectation that businesses can delay purchase decisions. With replacement kind of dictated by OSHA, how much is it possible to really delay the purchases?

Timothy T. Tevens

OSHA doesn’t dictate replacement. What OSHA dictates is an annual inspection and that inspection typically drives either replacements and/or repair of units which drives then in turn our unit volume and/or our parts volume. Ultimately it comes back to us. The key there is or the way that we look at the business at least is industrial utilization, the more utilized the equipment is the more this activity has to occur in terms of replacement or repair.

Having said that, we would expect normally if there was a downturn coming, which I’m not going to project but I’m going to be cautious about, we would normally see our parts business grow and our unit volume come down because people have a tendency to repair more frequently. And ultimately when things turn around, the unit volume comes back up.

Operator

Our next question comes from [Bob Franklin - Prudential].

[Bob Franklin - Prudential]

It seems like every quarter you’re asked about share repurchases and you say, “Yes, we think about that.” But it seems like this time you’re a little bit more enthusiastic. I’m wondering where you’d be with respect to repurchasing your bonds?

Timothy T. Tevens

Karen, why don’t you touch on that one?

Karen L. Howard

As you may have noticed in the earnings release, we did repurchase about $5 million of our bonds in early October. We used some of our excess available cash. But quite honestly, at this moment, at this point in time given the concerns about the global liquidity availability and the credit crisis, we are choosing to sit tight for the time being until things stabilize. Thereafter we will consider repurchase of our bonds in the open market as a potential option for use of cash as we have indicated in the past. Admittedly right now we’re sitting tight.

[Bob Franklin - Prudential]

Would that then be true of share repurchases as well?

Karen L. Howard

That would need to be re-evaluated as well.

Operator

Our next question comes from Theodor Kundtz - Needham & Company.

Theodor Kundtz - Needham & Company

I just wanted to follow up with something. Tim or Derwin, this would be for you. Going back to the cost reduction efforts that you have in place, it sounds like it’s kind of two-fold. One is focusing on your existing plants. Do you have any plans for any further shutdowns of plants or you feel you’ve got the number of plants you’d like and now it’s just focusing on this lean effort you’ve talked about? Secondly, the global sourcing effort. Combining those two, what would be your target cost reduction efforts? Do you have a number?

Timothy T. Tevens

Let me see if I can touch on it and then turn it over to Derwin. You might have noticed in the press release, we did in fact close two smaller facilities this past quarter. The plant rationalization program is still going on and we’ll continue to challenge our roof lines if you will and our square footage around the world. Basically we move production from those facilities to other existing plants. We did get a pretty good bang I think. We sold one building for $1,350,000 I believe it was and the other building somewhat substantially lower than that, maybe $300,000 or $400,000 that we’re expecting from that.

But the key of course is the fixed cost reduction. There continues to be a couple of opportunities for us to work on and we are proceeding at pace with those in terms of plant consolidation. Nothing to announce just yet and actually we’ve not announced any targets but rest assured we will continue to do this kind of thing as we have in the past.

Relative to global sourcing, let me just ask Derwin to comment on that activity.

Derwin R. Gilbreath

On the global sourcing we have a very aggressive plan to look at sourcing. In fact we’re working on gears right now which represent a substantial amount of dollars, around $15 million to $16 million, and we’re looking at sourcing part of those out. We’re looking at other products that make sense. Of course as we do that it creates more space in factories and gives us more flexibility to do the kinds of things that Tim referred to before. We actually have someone that works for our operations in the US who works in purchasing but he lives in China so we have him focused on a lot of different projects for us right now.

Theodor Kundtz - Needham & Company

Do you have a dollar amount targeted or can’t you share that?

Timothy T. Tevens

No. Internally we do but we’ve not discussed that.

Theodor Kundtz - Needham & Company

You mentioned the lower margins at Pfaff. Could you mention what they are, the gross margins there and how much that would impact overall margins?

Karen L. Howard

We have commented that the overall margins are lower than Columbus McKinnon’s corporate average but we haven’t yet given a specific range. Admittedly, we are still going through and realigning their financial statements with Columbus McKinnon’s because they categorize things a little differently so we are still working through that process.

I think that when we had announced the acquisition we did indicate that the operating margin level that they are currently in the high single digits.

Operator

Our next question comes from Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

With taking down kind of selling expenses as a percent of sales for the year, can you kind of break that in to how much of it is [inaudible], how much of it is you guys reducing kind of the international growth initiatives you guys are doing and then how much is you behind the scenes kind of controlling costs given the environment?

Karen L. Howard

I’d say it’s really what you described, behind the scenes activities to control costs given the environment. We’ve still been moving forward with our international growth expansion activities so we have not scaled those back.

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

So that’s really intact despite all the uncertainty in the market right now?

Karen L. Howard

Yes it is.

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

Then just to clarify, the $1 million you pointed out, given that it sounded like a lot of that was just that steel surcharge, just steel staying flat in October would kind of mean that you guys would have that margin gap kind of bridged in October for the third quarter, right? Because your surcharge should be kind of on a trailing month basis?

Derwin R. Gilbreath

It’s definitely on a trailing month basis and I think it will be flat in November and December but with some carryover in to October so it’s not 100% taken care of in the month of October.

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

But relative to the second quarter you’d have at least kind of two months of coverage as opposed to-

Derwin R. Gilbreath

Absolutely and we’ll have the price increase going in to effect in November and then we’ve caught up on the surcharges so there’s a very good possibility that that will be more than taken care of.

Timothy T. Tevens

Let me just add to that, admittedly the surcharges on the steel most likely will have to be adjusted at some point in the not too distant future because steel has come down in October.

Derwin R. Gilbreath

Absolutely. That’s correct.

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

One question on pricing, it looks like since you guys have started providing some of the breakout domestically versus international but domestic pricing has been substantially stronger than kind of the four international pricing. Is that just because of your relative market shares or is the overseas environment just a little bit tougher to get price increases on?

Karen L. Howard

I’d say it’s really been not that the overseas market has been tougher but in the US market it’s been more driven by our mix of product. We sell more high steel content product in the US and do not in Europe for example. So, our surcharge program which falls in to this category of price is US based.

Analyst for Peter Lisnic – Robert W. Baird & Co., Inc.

So really as international becomes a bigger percentage of sales it doesn’t reflect different than other than just steel content?

Karen L. Howard

Yes, it really just reflects mix, what products are selling where.

Operator

At this time sir we have no further questions.

Timothy T. Tevens

Let me thank all of you for your time this morning as well as questions. We certainly appreciate the interest in our company. We also want to thank all the Columbus McKinnon associates around the world for their hard work and success and certainly helping this quarter be a success. Just a couple of announcements as well, you might have also noticed we added two new directors this past weekend.

Chris Ragot is the CEO of FreightCar America and Liam McCarthy, who is the President and Chief Operating Officer of Molex. Both fellows have a incredibly broad based operations, sales and marketing background as well as international experience in growing their various companies around the world. We welcome them to our company and hopefully you will do as well when you have a chance.

As you can probably tell, we’re fairly optimistic yet cautious at this point in time and we’re going to remain cautious until we find out where the global credit markets are headed. Please bear with us as we and probably the rest of industrial America tries to work its way through this debacle we’re in.

Thank you very much for your time and we look forward to talking to you in the future. Take care.

Operator

Thank you for participating in today’s conference call. You may disconnect your lines.

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Source: Columbus McKinnon Corporation F2Q09 (Qtr End 9/28/08) Earnings Call Transcript
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