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Actuant Corp. (NYSE:ATU)

F1Q09 (Qtr End 11/30/08) Earnings Call

December 18, 2008 10:00 am ET

Executives

Bob Arzbaecher - President and CEO

Andy Lampereur - EVP and CFO

Analysts

Steven Fisher - UBS

Wendy Caplan - Wachovia Securities

Jeff Hammond - KeyBanc Capital Markets

Scott Graham - Ladenburg

Chris DeYoung - Schroeder

Chris Weltzer - Robert W. Baird

Phyllis Kamera - Pax World Funds

Jimmy Kim - RBC Capital Markets

Charles Brady - BMO Capital Markets

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Actuant Corporation's first quarter fiscal 2009 earnings conference call. Today's speakers are Bob Arzbaecher, President and CEO and Andy Lampereur, Executive Vice President and CFO.

As a reminder this call contains forward-looking statements that are subject to the safe harbor language in Actuant's press release issued today and in Actuant's filing with the SEC. We are conducting a live meeting to coincide with the audio conference.

If you would like to view the presentation online, please refer to your meeting invitation for details. During the presentation all participants will be in the listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions).

As a reminder this conference call is being recorded, Thursday, December 18, 2008. It is now my pleasure to turn the conference over to Mr. Arzbaecher. Please go ahead sir.

Bob Arzbaecher

Thank you operator and good morning. Sorry for the little bit of a delay there. That was our telecommunications provider not ourselves. It's been eight years since the creation of Actuant from the spin-off of Applied Power in 2000. And this is one of the first earnings call where regrettably, I can't report increasing sales in earnings per share.

But, the many markets that we serve are in a severe contraction mode and that contraction accelerated as the quarter went along. Given our diversity, we usually can offset weakness in a few markets. In the current economic environment, however, we are seeing customer slowdowns in almost all of our end markets, and in all of the geographies we serve.

Andy is going to go through the financial results and guidance with you in detail, and then I'll will come back and cover a number of other topics affecting Actuant. Andy?

Andy Lampereur

Good morning everyone. Our first quarter results included a $0.26 a share asset impairment charge, which I will cover in a minute. While last years results included a $0.09 a share European Electrical restructuring charge. As a result EPS for both years for the first quarter contains special items. If we remove these for comparability purposes, our EPS for fiscal '09 first quarter was $0.45 a share or 13% lower than last year's comparable $0.52 a share EPS.

Now the details of the impairment charge. We wrote off approximately $26 million of long lived assets from the RV business, as a result of the sustained shrinking of the RV motorhome market, as well as its weak outlook. Motorhome industry shipments have declined dramatically over the last three years and expected to continue in 2009.

Declining consumer confidence, the credit crunch and the spate of recent dealer supplier, as well as OEM bankruptcies in the industry have led us to reassess our carrying value of this business. This led to the 26.6 million non-cash asset impairment charge we booked in the quarter. Against this charge, we recorded a non-cash income tax benefit based on a 38% blended state and domestic tax rate.

This tax benefit led to a strange looking overall 11% effective tax rate for Actuant. If we exclude the impairment charge, it would have been 29%, which is pretty much in line with our forecast. Now I'll move on to cover our actual operating results, which you see on this slide. It compares our first quarter results for this year to last excluding the special items I just covered.

First quarter sales declined 8% year-over year, and I will provide more color on that shortly. EBITDA declined 5% on account of the lower sales volume, but at a lower rate than sales because of the 70 basis point EBITDA margin expansion to 17% during the quarter. As you will hear shortly, our EBITDA margins declined in each of the four segments, but increased on a consolidated basis is due to lower corporate expenses as well as favorable mix between our segments.

This mix resulted from the core growth in the high margins in the industrial segment. Meanwhile, the decline in corporate expenses primarily resulted from lower incentive compensation expense this year as well as a host of other spending cuts. On the bottom line, our adjusted EPS declined 13% from $0.52 to $0.45 resulting from the combination of today's weak economic conditions, currency translation resulting from the strong US dollar, as well as higher interest expense.

Now let me provide a little bit more color on our results versus our original guidance for the quarter. Currency was a big factor in both the sales and earnings line. Our guidance from October was based on a euro being worth $1.44 US and the UK pound being worth about $1.85.

The actual average rate for the quarter for the euro was a $1.35 and for the pound it was a $1.68. This strengthening created a $17 million sales and $0.03 to share EPS headwind. During the quarter, we refinanced our bank credit facility and we unwound our interest rate swap agreement, which resulted in the $0.02 share of additional financing cost.

If we exclude both the financing cost as well as the currency increment here, our adjusted EPS guidance would have been $0.43 to $0.47 a share. That means that the $0.45 a share first quarter EPS that we reported was in the midpoint of the range. The remaining sales and earnings shortfall to the top end of the guidance range was caused by a significant weakening in several end markets beginning in October, and accelerating in November.

The hardest hit relative to our October 1 guidance were the marine truck auto and vehicle oriented markets. To illustrate the speed of the deceleration in these markets, we saw our core sales in the European truck market change from positive 5% core in September to minus 7% in October, and then to minus 33% in November.

Similarly, our core growth at Maxima went from positive 10% core growth in the fourth quarter to minus 16% in the first quarter, again reflecting the vehicle market changes. As a result of these rapid changes, we quickly went into cost down mode and Bob will provide some color on that later in the call.

Now I'm going to shift away from comparing results with the guidance and provide more color on sales during the quarter. On a consolidated basis, first-quarter sales declined 8% year-over-year consisting of 11% core decline and 3% currency headwind, which were partially offset by a 6% benefit from acquisitions.

Sequentially, this 11% core decline compares to a year-over-year decline of 4% in the fourth quarter. So where did it take place? Quick answer is almost everywhere. This slide illustrates that core sales declined in eight of our 10 reportable product lines year-over-year. The only two product lines that did not go down year-over-year were in our industrial segment being Enerpac and Hydratight.

The biggest year-over-year core sale changes compared to those in the fourth quarters, so the sequential changes, the biggest changes there were in Specialty Electrical driven by Marine, which was down 37% year-over-year. Global truck driven by the fall off in Europe, I just described was down by 7% year-over-year, auto down 34% year-over-year caused by a sharp decline in global auto sales and finally in Engineered Products down 9% driven primarily by the Maxima business, which I just went through.

So the key takeaways are that the economic weakness is widespread across a lot of industrial markets and geographic regions and secondly that accelerated as the quarter progressed. However, the news was not all bad, as our industrial segment had another very good quarter. It generated core growth of 12% compared to 14% in the fourth quarter.

As expected, we saw some moderation including Enerpac, which moderated to 9% in the first quarter. It weakened late in the quarter in Europe as well as in the US, but the US was off set by some price increases. Hydratight also did well in core growth with 18% core benefiting from continued growth in maintenance work.

We didn't see a meaningful impact from lower oil prices during the quarter, but we do expect some modest impact in the third and fourth quarters of this year. Our segment margins declined year-over-year by 200 basis points to 25.3% largely on account of unfavorable sales mix Enerpac, as well as the impact of the Cortland acquisition, which came in at a lower margin.

Moving on now to our Electrical segment. It's it is minus 22% core growth or core sales decline in the quarter was slightly worse than both what we had expected and the 19% from last quarter. The most notable change in demand in electrical was the Specialty Electrical product line due to a substantially weaker Marine market with industry power boat sales in the US down 40% year-over-year.

Our operating margins here were poor at 3.7%, which was caused by the impact of lower sales volumes on fixed overheads on favorable sales mix away from our higher margin businesses within the segments, as well as some downsize in costs. While it's very frustrating to report these kinds of results for the segment, we do believe we're doing the right things to attack cost.

Beyond the previously announced impact of SKU reductions in Europe and the loss of some Home Depot business -- Lowe's business, I'm sorry, a year ago, we believe the top line issue is market driven rather than an indicator of share loss. In fact, we actually picked up some business in market share at Home Depot during the quarter.

Bill Axline and his business leaders continue to be aggressive in taking cost out of the segment with year-over-year headcount down 28%, as compared to the 22% year-over-year core sales decline. So, costs are definitely being attacked.

All three of our major product lines in the Actuation Systems segment were impacted by the deceleration I discussed earlier in the vehicle markets, leading to a 24% core sales decline in this segment. Not surprisingly, our margins were impacted by the volume declines. Unfortunately, the quarter ended weaker than it started, and we think the second quarter will be especially challenging given the extended plant shutdowns at many customers until mid January in order to rebalance their inventory.

Yesterday's announcement by Chrysler was just one of many customers that are going to be doing this. We know we are not alone in feeling this pain, and we are doing everything we can to reduce costs in the short-term, until a more consistent order pattern is re-established.

Lastly turning to our fourth and final segment, Engineered Products, it also felt a slowdown in OEM production of off-highway vehicles, notably in the Maxima business. Segment's core sales declined 9% year-over-year. The larger decline at Maxima was somewhat muted by better performance at some of the smaller business in the segment.

EBITDA margins in this segment declined 250 basis points again on account of lower volume and some downsize in costs. So that's it for my prepared comments on earnings. And I'll now move over to cash flow and capitalization.

Our first quarter is traditionally the seasonally weakest quarter of the year for us, in terms of free cash flow, on account of bonus payments, seasonal working capital builds and our dividend. This year was no exception, as we generated about $11 million of free cash flow in the quarter.

Our net debt for the quarter increased about $218 million, now standing at $670 million with the increase attributable to the $230 million Cortland deal. The highlight of the quarter from a capitalization perspective clearly was amending and extending our bank credit agreement, which we completed in early November, right smack in the teeth of the credit crisis.

Our prior bank credit facility included a $250 million revolver that had been set to expire in February of 2009, which therefore was the impetus for refinancing. We expanded this $405 million facility to $515 million, including increasing the revolver capacity from $250 million to $450 million. We also extended the maturity of the agreement by three years and it now matures in November of 2011.

With this new bank credit facility in place, our capital structure is in good shape. This slide summarizes the principal repayments for all of our debt. Over the next two years, our required debt payments are only about $10 million in aggregate. Plus, we are expecting strong cash flow during the balance of this year, which will create more room.

For all of fiscal '09, we're estimating free cash in $140 to $150 million range. So while business conditions are not ideal, we are in great shape today with $240 million of liquidity and little in terms of near-term principal repayments and clearly have the capital to weather this economic downturn.

In our pre-announcement press release last week, we updated our fiscal 2009 full year guidance. That included revenue guidance in the $1.5 to $1.55 billion range and corresponding EPS in the $1.60 to $1.80 a share range. This guidance excluded the first quarter asset impairment charge and represented a 7 to 10% top line sales decline from a year ago, as well as a 12 to 22% EPS decline.

As I warned earlier, we're expecting a rough second quarter as a result of rapidly decelerating demand in most markets and the impact of extended shutdowns at many OEMs. Unfortunately, given the fact that our second quarter is seasonally our weakest sales and earnings quarter even in normal times, this softness will also mean we expect larger decremental margin impacts from this lower sales volume.

We also are expecting that our downsize in costs to step up in the second quarter, bidding a little bit more headwind. When we take all of these factors into account, we're projecting a core sales decline in the second quarter in the 14 to 18% decline range. We anticipate second quarter revenue to be $335 to $355 million driving EPS guidance of $0.20 to $0.28 a share of EPS.

Looking at both, our full year guidance last week and our second quarter guidance has really been a challenge, giving the speed of customer demand changes and more recently the sudden weakening of the US dollar again. Our visibility today is the poorest I have seen since my tenure here at Actuant as CFO.

While it'll be easier to suspend guidance as others have done that hasn't been our approach. We'd like to tell you what we know and what our assumptions are and we'll leave it up to you to judge if they are reasonable or not. The first assumption I will review is currency. Our guidance for the full year assumes the euro at a $1.25 to a $1.30 and the pound at $1.50 to $1.55.

With the weakening dollar in the last week, there may be a little upside in our guidance, if the dollar doesn't makeup this decline. From a core growth standpoint you can see on this slide both our original guidance assumptions for the full year, as well as our updated guidance assumptions. I will provide a little color for each of the segments.

Starting first with industrial, we lowered our core growth assumptions to a positive 4 to 8% for the fiscal year to reflect the economic slowdown. While we haven't seen this kind of softening globally in either Hydratight or Enerpac, yet we expect it will moderate more than our previous estimates.

We expect segment core growth will slow up from about 12% in the first quarter to roughly 6% in the second, and then moderate to mid to low single-digits in the back half of the year. Within Electrical, we're projecting core growth to be down 15 to 20% based on weaker consumer confidence in spending in retail and marine, as well as the impact of the credit crunch in other markets including commercial construction activities.

We expect core sales in Electrical to slip a bit sequentially in the second quarter. We expect the back half still to be negative, but less so, once we have anniversaries last years Lowe's loss, the European SKU reduction, and the start of the Marine market decline last year.

The biggest change from a segment standpoint in our core growth outlook took place in Actuation Systems for the reasons I previously covered. We are now projecting core sales to be down 20 to 24% for the full year and in the second quarter down 30 to 35%. Lastly, Engineered Product segment core sales will be down at minus 10% for the full year also bottoming out in the second quarter given the vehicle shutdowns and be a little bit less negative there after.

A few other concluding assumptions on our guidance for you to consider. Corporate expenses will be $5 to $5.5 million a quarter for each of the next three quarters. We also expect to reduce our effective tax rate each quarter toward a target of 27.5% for the year, excluding the asset impairment charge. And lastly, our guidance today assumes no future acquisitions.

So, that's my in depth review of the assumptions and our guidance. I will turn it over to Bob for his comments on the guidance, as well as being covering a few other topics.

Bob Arzbaecher

Thank you Andy. Today I want to spend a little time explaining why we believe Actuant is a good stock for you to own in this recessionary environment. The first reason is the diversity of our end markets. As this slide shows, we have tremendous diversity of customers, geography, and end markets. At a time, where everyone has concerns about customer and supplier viability, Actuant's diversity is a huge plus. Consider our top ten customers only represent 18% of sales, and our largest customer is less than 3%.

The next attribute is cash flow. There are many reasons why Actuant produces superior cash flow, and each of these contributes to our eight year track record of cash flow and access of earnings, but I wanted to highlight a few here. The first is our DPATS model. DPATS stands for design procures assemble test and service and is how the majority of our businesses are configured.

The big component missing here is manufacture or vertical integration. By relying on our supply base to do this for us, we have less fixed cost absorption in terms of machinery, people and buildings than most industrial companies. Another advantage of the DPATS model is our limited CapEx requirements. Less machining means less equipment, buildings, and real estate.

In addition, we tend to lease versus own most of our major facilities. So, we don't have cash tied up in our fixed assets. And lastly, but certainly not least is our focus on ROIC. Simply stated, all major business and economic decisions at Actuant are driven by what it means to a return on invested capital calculation. Having this mind set is especially important today. In fact, if there is a single message we want to leave you with today, it's that Actuant is focused on delivering the $140 to $150 million of free cash flow that Andy discussed earlier.

It's over $2.15 to $2.30 a share. It's a free cash flow conversion of about 130% of net income, and it would result in a free cash flow yield based on our current stock price of 13% to 14%. In times of economic uncertainty, it's good to rally leadership around a common goal, and for Actuant, that's delivering the 2009 free cash flow guidance.

In addition to diversity and free cash flow, another reason to own Actuant in a recession is our leadership positions in the markets we serve. Our experience and history of owning these businesses over the last few business cycles indicates they get stronger when the going gets tough.

Enerpac for example gained market share in the 2000 to 2001 recession as customers gravitated toward the leading brand and established distribution that's the hallmark of Enerpac. We believe our current profile of businesses will exit this economic downturn with stronger market positions than it entered.

Actuant has strategically overtime invested in a flexible workforce driven by our global diverse business profile. We have minimal legacy costs, limited defined benefit pension plans and limited unionized workers. We utilize temporary workers at many locations allowing us to flex our operations up or down as demand rises or falls.

Our ability to downsize in the current economic environment has been swift and substantial. Over the past quarter, we've downsized approximately 500 people or 7% of our workforce excluding acquisitions. Over the past 12 months it is a 9% reduction. As we communicated earlier, we have a $10 million to $15 million downsizing cost for the full year. So it's logical for you to assume, further 2009 headcount reductions.

I think in addition to the headcount reductions what's interesting about the chart in front of you is how we've been adding resources to our growth opportunities, particularly in industrial and in China while we are cutting back elsewhere.

Now let me elaborate on the cost reductions that we are working on and to align our costs inline with forecasted revenue. We are projecting $10 to $15 million of downsizing costs for the full year guidance, including general reductions in force, production shifts to low cost regions, and additional facility consolidations.

Most of these actions are in segments other than industrial. So far this year we have moved a product line from North Carolina to Mexico. We are consolidating Sanlo's China facility into Taicang. We are shifting another domestic product line to China and we are consolidating back office support functions across multiple businesses.

There are additional actions both approved and under review and we will communicate these as they are implemented. But I also want to cover some growth initiatives. There are two major growth initiatives I would like to call out today. The first is in our industrial segment, where we've got new product launches in Enerpac and we have geographic expansion opportunities going on at Hydratight; namely new facilities in Norway, Brazil and Angola.

The second major growth area to call out is China, where our new facility in Taicang is supporting both internal supply chain growth for ATU business units, and also sales initiatives for the China market. We are expanding our third party sales efforts in China beyond our existing Enerpac, Hydratight, Power-Packer or Gits units, and it now includes Maxima, Elliott and Sanlo.

During the quarter, both Maxima and Elliott started production lines at Taicang to support sales initiatives within China. The third area of growth I would like to highlight is the acquisition growth. While most of our larger M&A opportunities are on ice due to the given credit crisis and sellers not willing to divest at fire-sale prices, we continue to pursue a number of small tuck-in transactions that fit our core businesses.

Given our success of internally generating acquisition ideas, we remain convinced that we will find a few more deals this year to add to the Cortland acquisition we completed in September.

Just to give you a quick update on Cortland. We have owned this business since the end of September and are well into our 90-day integration process. While we have seen some slowing sales at Sanlo, the larger cable, umbilical and rope businesses within the industrial segment continue to show solid growth.

While we have gone through a lot of significant amount of detail with you today in order to provide you transparency, before opening it up to your questions, I wanted to summarize a few thoughts. Clearly the global economy has thrown everyone a huge curve ball, and it is difficult to predict where it will all end. At Actuant, we have positioned the business to take on whatever challenges the economy brings us.

We have leading market positions, a talented and motivated management team, and a flexible business model that allows us to react quickly. We can and will manage our cost structure to meet the demand the markets gives us.

We have strong liquidity today that Andy went through to drive our internal and external growth initiatives and we are focused on delivering the superior cash flow even in this difficult market.

Operator, I would now like to open it up to the phone lines for the question-and-answer session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from the line of Steven Fisher from UBS. Please proceed with your question.

Steven Fisher - UBS

Hi, good morning.

Bob Arzbaecher

Good Morning Steve.

Steven Fisher - UBS

Just a few clarifications. Andy, did you say that your expense is going to be about $5 million to $5.5 million per quarter for the rest of the year?

Andy Lampereur

That's correct, yes.

Steven Fisher- UBS

So that would be a ramp back up, and what would be driving that? It sounds like you took some permanent costs out?

Andy Lampereur

Yes, the first quarter included lower bonus expense year-over-year. We were expecting that to continue for the year. The second item in there is our Long-Term Incentive Plan, the LTIP Plan that we have out there. We had to essentially write-down the value of that or write-down the reserve that we had accrued of that to-date and that was a one-time credit that came through in the first quarter. That will not repeat as we go forward. So that's the primary driver as you look forward.

Bob Arzbaecher

If you recollect that LTIP Plan, that's the plan that has some compensation if the stock gets to $50 a share, so there is a mark-to-market or fair value that goes on in that calculation which caused that.

Andy Lampereur

Right.

Steven Fisher - UBS

Okay, great. And then did I hear you say that you had some pricing benefit in industrial?

Andy Lampereur

Domestically, definitely yes.

Steven Fisher - UBS

Okay. Have you seen that holding as kind of the business that has decelerated throughout the quarter?

Andy Lampereur

Yes we have. It was primarily in North America. The biggest portion was in North America. We put in a price increase last June-July, and we actually put another one in November. It has stuck, I mean, we are definitely realizing benefit from it.

Steven Fisher - UBS

Okay, and then just to confirm that you are not currently taking any restructuring action in the industrial segment?

Bob Arzbaecher

I wouldn't say that. There are a number of opportunities within industrial as we have bought things to consolidate facilities for example in the Houston area with the SPS acquisition. We picked up a few facilities and we are consolidating around that. The same is true in Europe at a couple of small locations.

So I think our comment there though is that, as that business has been growing, we've really been deploying capital towards that growth at the expense of other places, and in general that's the statement. But there is some cost down actions going on within industrial.

Steven Fisher - UBS

Okay. And then just lastly, you talked about acquisitions. Are you seeing the multiples come down enough to off set your higher borrowing costs?

Bob Arzbaecher

Yeah, I mean the answer is yes we are. But one of the things you run into Steve is the fact that an owner of a business 90-days ago thought an 8 to 10 multiple was a reasonable valuation for his business, and he's having to wake up to the reality that that's a difficult set of economics 90 days later. So it's not like we've got a ton of things that are right at the finish line ready to sprint out at old valuations based on our new borrowing costs. The two work in tandem.

Andy Lampereur

The other comment I will make there Steven just to put it in perspective; today our increased borrowing costs are on a 3% to 4% basis all-in. So, obviously, they are quite a bit lower than what you'd think.

Steven Fisher - UBS

Okay. Great. Thanks a lot.

Bob Arzbaecher

Thanks Steve.

Operator

And our next question comes from the line of Wendy Caplan from Wachovia Securities. Please proceed with your question.

Wendy Caplan - Wachovia Securities

Good morning.

Bob Arzbaecher

Good morning Wendy.

Wendy Caplan - Wachovia Securities

Well, I guess not surprisingly industrial remained the star, but surprisingly it was up 12% core. Given your expectations of slowing related to the OEM business versus maintenance and your comments that you think you can maintain a mid single-digit core growth level or range for the balance of the year.

And the lack of visibility; how confident are you in that? And you did mention you are taking some costs out selectively. How bad at this point if you think about your kind of worst-case scenario, how bad could that be sub segment?

Bob Arzbaecher

It's a good question, Wendy, and I have more confidence in Enerpac than I do in Hydratight, because we haven't owned that through a whole down cycle. I don't know exactly how that asset will do straight through a cycle.

I think a couple things that we feel very strong on. Number one, when Enerpac slows, and we saw slowing. We have seen moderation for a couple years now, but it comes from so many different distribution points that it doesn't sneak up on you like we saw in vehicles or as Andy says, you can go from minus 7 to minus 33 in a month.

You just don't see that from the global 1200 distributors that support that, and all the markets that those guys are supporting. So, one thing that gets me confident on Enerpac is just that multiple visibility from spots. Yes, we will have weakness in certain markets, but across the whole platform, I just don't believe it's going to sneak up on us in any way. Even though we brought down, and we've brought down our guidance to try to take that into account. Okay.

When you move to Hydratight, I think we had a lot of shareholders concerned over the last six months about oil going from over a $100 to $40. This is going to be a disaster for Hydratight. I really think they don't appreciate how much of a maintenance and repair business this is, and how much, if you are going to produce anything you need that. Clearly, some of the frontend deep water exploration, Cortland type things; we will feel some of that.

And I think that's factored into our guidance. But so much of Hydratight is power generation facility. Well, we are still running all the power plants in the US. They are still going to need that maintenance. So, again, I'm less confident because I haven't owned it the full cycle but I have confidence that our guidance has taken that into account in a moderating way.

Wendy Caplan - Wachovia Securities

So, I guess Bob to get to the bottom line here in terms of your outlook for the balance of '09, do you feel confident that you have scrubbed the numbers to a degree that unless we see another 35% decline in vehicle sales or some other event like that that your numbers are appropriately conservative?

Bob Arzbaecher

We believe that Wendy. You've been covering us for a long time, and I think Andy's comments said it. We are giving you guys the facts that we have. And we are not forecasting the business any different than we ever have. Every quarter we get a bottoms up rollup from all the business segments. We have monthly meetings with all the businesses and segment leaders.

The process we followed that's allowed us to deliver, prior to this quarter 24-straight quarters of meeting or beating guidance, the same process is in place. It is just incredibly dynamic. So I am comfortable that there is nothing different based on the information we know.

Andy is absolutely right; it is a crazy time to try to predict the future, but based on what we know, we haven't changed our methodology. It should be the same conservative Actuant forecasting philosophy that has been successful in the past.

Wendy Caplan - Wachovia Securities

Okay. Thanks very much.

Operator

Our next question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Please proceed with your question.

Jeff Hammond - KeyBanc Capital Markets

Hi. Good morning guys.

Bob Arzbaecher

Good morning Jeff.

Jeff Hammond - KeyBanc Capital Markets

Maybe just to flush out the industrial, your 4% to 8% growth, how should we think about that Hydratight versus Enerpac?

Andy Lampereur

The majority of the growth is Hydratight. On our Enerpac assumption and maybe we should have commented on this earlier, our Enerpac assumption is flat to down in the back half of the year. And that would mean that Hydratight is growing at a decent rate in the back half of the year, not as strong as the 18% we just disclosed for the first quarter.

Jeff Hammond - KeyBanc Capital Markets

Okay. And is that flat to down? I mean, you mentioned slowing in Enerpac late in the quarter. I mean is that kind of the new trend line you are seeing now or is it still a little healthier than that?

Andy Lampereur

The most recent data we have is November. The weakness we saw in November was primarily Europe. I wouldn't say there was a noticeable change within Enerpac for the quarter. Again, the 12% we reported overall for the industrial segment was dead on the internal forecast.

Bob Arzbaecher

Enerpac hit its four corners; its internal forecast. And we are creating some cushion or hedge against their forecast going forward which brings that flat number that Andy talked about.

Andy Lampereur

Yes.

Jeff Hammond - KeyBanc Capital Markets

Okay, great. And then can you give us a better sense of this $10 million to $15 million restructuring? How does that flush out by quarter? Does that kind of exacerbate the downside in the second quarter or does that flush out through the year may be just a little more?

Andy Lampereur

Yes, it is definitely not a big bath, the way you could book restructuring reserves in the old days. I mean this will be coming in over the balance of the year. I would say, it's going to be more in the third and fourth quarter than what you would see in the second, but there will be some in the second. The more facility oriented projects will be back half of the year, and that's where the bigger dollars are.

Jeff Hammond - KeyBanc Capital Markets

Okay, great. And then just finally, Bob, you mentioned the Hydratight business and the maintenance aspect, and then I think you touched on Cortland. Just as you get to know Cortland a little bit better, and as we've seen this big drop off in oil and gas prices, I mean, what's your sense of the cyclicality of that business around these dramatic moves in this pricing environment?

Bob Arzbaecher

Well, Cortland's got a pretty diverse profile in its own right. It's more diverse than Hydratight. So it does some mooring type stuff for ships that really isn't energy related. It does some stuff for the Space Shuttle and kind of a lot of goofy applications that are outside of oil and gas, so, it also has more frontend exploration.

Some of the tow cables, what's called a skinny tow cable used for seismic which is exploration related, and those are the ones we're paying a little more attention to from a slowdown point of view.

The rest of Cortland, you know, you have a fairly good replacement revenue stream that comes from replacing an umbilical that either got damaged or needs to get changed as a rig moves, so it's probably going to be a little more volatile than Hydratight, but I don't think materially so, and as Andy and we talked about in our prepared comments, it met its expectations for the two and a half months we owned it.

Andy Lampereur

Take this one anecdote, we just had an operations meeting and talked through the results. They have not seen a falloff yet in the exploration, the E&P side of the business with the skinny tow cables. In the seismic side of it, we definitely expect it to happen in the balance of the year, but there are still new business that's coming through, still quoting that is going on in that area. So, it is not shutdown the way some of the articles you are reading in the Wall Street Journal.

Bob Arzbaecher

I think just to summarize the industrial comment, and it affects both Enerpac and Hydratight. The businesses in the first quarter did not see this slowdown. We did not see any change in ordering patterns, okay? Yeah, they hit their forecast as Andy said.

We are deliberately at the corporate level hedging that back saying it's got to moderate, okay? So, you know, we think there is a level of conservatism in there already. It is not like, this is an ordinary pattern that it's already below this, and we have a stretch to get to. We are trying to be conservative about the future in these businesses, saying, even though we haven't seen it, it's probably going to happen. So, I think it's important people understand that that is the dynamic of the forecasting that happened.

Jeff Hammond - KeyBanc Capital Markets

Great, just Cortland, can you remind me how much is replacement in nature?

Bob Arzbaecher

I don't even have that number, probably 15 to 20.

Andy Lampereur

There is a replacement cycle on a lot of the stuff. But it's probably a three-year cycle. Half of it is oil and gas and…

Bob Arzbaecher

Why don't we try to do a little homework and come back to you on that?

Jeff Hammond - KeyBanc Capital Markets

Okay.

Bob Arzbaecher

I don't think we have an intelligent answer today.

Jeff Hammond - KeyBanc Capital Markets

Okay. Thanks guys.

Operator

And our next question comes from the line of Scott Graham from Ladenburg. Please proceed with your question.

Scott Graham - Ladenburg

Hey, good morning you guys. And once again thanks for being so straight forward with things, things are what they are, right? Couple of questions that I had were, first on the restructuring the $10 to $15 million is would you be able to tell us what number was in the first quarter results and maybe what you are assuming for second quarter? Is that something we can ask you?

Andy Lampereur

First quarter was a $1 million or $2, second quarter will probably be in the $2 to $3 million range. The back half will step up from there.

Scott Graham - Ladenburg

On your assumption for Enerpac flat-to-down in the second half of the year, is that US and European sort of general industry driven or is this something else that you are seeing there above and beyond what I think we all know is slower infrastructure spending on. Is it something more specific to you?

Andy Lampereur

No. Really, again we have not seen this thing slowdown. With the slowdown in all of the other…

Bob Arzbaecher

We have seen it slowdown. We have not seen it slowdown outside of our forecast.

Andy Lampereur

Outside of our forecast, correct. It moderated that this correct quarter-to-quarter, but we have not seen like a triggering event within Enerpac itself that suddenly sales are coming down quickly. We are anticipating that because of the rapid slowdown and other end markets out there, it's bound to impact Enerpac. That's why we have put out what we believe to be conservative guidance, flattish within the middle of our range.

Scott Graham - Ladenburg

Right. So, to the extent that your budgets, which end market or is it just you are just taking a best guess across end markets is would be the contributing end market or end markets to the potential of a down second half in Enerpac?

Bob Arzbaecher

It would be the industrial production type sales that go through Enerpac. So, I think Grainger, you guys I think knows about a $6 million customer within Enerpac. You can read Grainger's announcements. They're talking about slowing activity in that MRO type environment, so that would be a chunk of it Scott.

They, clearly ship building is a chunk where Enerpac does a lot of work. There has been a lot of delays and deferrals there. So that would pick up. As Andy talked about, Europe distribution seemed slower or a little more dramatic than we expected in the quarter, so that would be a chunk. So, it'd be all of that kind of stuff.

Scott Graham - Ladenburg

Got you. My last question relates to some of the liquidity. I thought it was interesting that you put that as one of your main bullet points as far as accomplishments this quarter. I guess my question is, can you explain a little bit more what you mean by this accordion feature?

If you got $240 million right now of cash available to invest in say acquisitions off of your new facility, how is this accordion feature work exactly?

Andy Lampereur

Sure Scott. Well the accordion feature essentially is an ability to expand the size of the facility without having to go out and formerly amend the facility and pay additional fees to do it. Now, you have to secure, you have to go out and find the new credit to tack on the essentially existing participants and the bank would have to increase their commitment to the facility or go out and find some other banks that would add to it. But that's essentially what a accordion is.

So, it's not sitting on the shelf ready to go committed. But, you can move a lot faster and cheaper than not having it.

Bob Arzbaecher

I'll put it in this lingo Scott. You can't force the bank to drawdown on that money. But, it's accelerated, because it's under the same credit terms as others. So, there is no paperwork, no lawyers or anything that has to be done to go get the piece of paper. When we did the most recent credit facility, one of the things you always try to do is leave some borrowing capacity within the existing banks to try to have that availability in the accordion feature.

We had three lead banks on this deal and we think there is additional accordion capability within those three. And that's what you always try to do. You try to get it over subscribed, where you have got capacity, people wanted more of the paper than they got, and so now they're willing to look at the accordion.

The only time you would use it would be a big acquisition. As Andy went through the cash flow with 140 to 150 plus the over 200 we have today, the only time we'd be tapping that accordion would be on a bigger deal.

Scott Graham - Ladenburg

Understood. So, then the 3.5 max leverage that would of course be annualized EBITDA plus the acquisition holiday and to the extent that you can explain, I mean is there a period of time that you're allowed to be essentially at 4 or what's the sort of, I guess accordion feature in that 3.5 as well?

Andy Lampereur

Yes. The acquisition holiday is a new feature that we added to the facility we had in accordion in the past. Essentially what it allows you to do is, if you were to do a larger transaction and again there is nothing we're planning on doing right now, if you would do a larger deal the banks would allow you to actually go above three and a half times leverage I believe to a maximum of four times for two quarters that facilities. If you got additional details on it Scott, I can take it off line.

Scott Graham - Ladenburg

I'm good. Thanks.

Operator

Our next question comes from the line of [Chris DeYoung from Schroeder]. Please proceed with your question.

Chris DeYoung - Schroeder

Hi. Good morning, guys. Just to piggyback on the leverage question where the leverage issue we were just talking about. I was distracted for a moment and I think you told me that the bank agreement requires leverage to be at or not above 3.5 times, is that correct?

Andy Lampereur

Yes. Maximum leverage covenant is 3.5, yes.

Chris DeYoung - Schroeder

Okay. With the potential for it to go up for two quarters under certain circumstances with an acquisition, but as you think about doing additional acquisitions, I mean you mentioned that you'd look opportunistically for additional tuck-ins. How sensitive are you to your BB credit rating? I mean, does longer-term opportunity and equity value take first place with that BB with your potentially letting it slip to B?

Bob Arzbaecher

Well you have hit a sore point, because we continue to gain credit given to us by banks at much better rates than BB would lend. So you're getting into a very sensitive area for me, which is the rating agencies don't get it right.

Okay. The answer to your question now is, the acquisitions we're talking about with the $140 million of free cash flow, our leverage is dropping from 2.4 to back down to 2 or below just throughout the year. So, it's nothing we're doing would change the leverage profile of the company above what we're doing, unless we really did something big.

If we did something big, we've been fairly consistent. We want to stay in the two to three times fairway, don't want to go outside of that. So, I don't see anything that would change, nothing has changed our profile. If anything, I think the credit crisis has kept me at the lower end of the two to three times debt to EBITDA [theory] versus the higher end.

So, I don't see anything there that would put that BB at risk.

Andy Lampereur

Right. And I'll add it, we definitely don't anticipate doing anything that would move us down.

Chris DeYoung - Schroeder

Okay, thanks.

Operator

And, our next question comes from the line of Chris Weltzer from Robert W. Baird. Please proceed with your question.

Chris Weltzer - Robert W. Baird

Good morning guys.

Bob Arzbaecher

Good morning Chris.

Chris Weltzer - Robert W. Baird

Just wanted to follow up on Steve's question actually. Even though we have seen copper prices fall off significantly, I imagine, and correct me if I am wrong that you've had to give back some price back on the DIY Electrical area. Can you just talk about what sort of a headwind you're looking at from price there?

Andy Lampereur

Yes. We definitely have given up price to our customers that are buying copper. I'd say most of it is not DIY in the US, a little more in Europe. Copper is more in the Marine space, as well as our transformer. The magnitude of what we are talking, I believe we're buying in the neighborhood of 500,000 pounds of copper a month. So, we're probably talking 12 million a year. You know $8 to $10 million from where we were two years ago. I'm sorry, where we were two quarters ago to where we're at right now. It's that kind of change…

Bob Arzbaecher

Pretty immaterial.

Andy Lampereur

Yes. In the scheme of things that's and a lot of that's already been passed through, because we have automatic price escalators and de-escalators built into some our larger both supply as well as our customer contracts.

Chris Weltzer - Robert W. Baird

Okay.

Bob Arzbaecher

It's the same way on the way down as it is on the way up Chris. We were aggressive in passing it through on the way up, and we're going be as aggressive as we can, making sure that if we're giving it away on the way down, we are getting it from the vendor on the other side. So, we are just moving our point of pressure from the customer to the vendor.

We are the guy in the middle and our goal is just to keep the stuff balanced.

Chris Weltzer - Robert W. Baird

Understood. You must get some sort of sell through numbers for your DIY Electrical business. Can you give us a sense of how much of the weak demand you're seeing now is or might be inventory de-stocking versus actual underlying demand?

Bob Arzbaecher

Most of our DIY is delivered to the store not to central warehouses, and is sitting on the peg. So, you do not have major inventory in the system within the Electrical DIY markets. So, I would say what you are seeing in terms of our orders is what is passing through, what the store and the aisle see. There is some anecdotal evidence that our product is doing a little better than some of the other electrical products in the aisle, its anecdotal would be the best I'd say.

Andy Lampereur

A lot I would say is the sell through and POS is probably down high single-digits on that stuff. The one caveat I will say is, we are expecting based on what we have been told here the second quarter both Home Depot and Lowe's are cutting way back on their purchases just to bring down inventory

Chris Weltzer - Robert W. Baird

For their year end?

Andy Lampereur

In the year end, you know a real heavyweight here, so that also goes into our guidance for the second quarter, but, I would say to-date here, we haven't seen any kind of real difference. And what we are seeing through is a sell through relative to what you have been reading at Home Depot and Lowe's.

Chris Weltzer - Robert W. Baird

Okay. Thank you.

Bob Arzbaecher

Again, I think, if you are a big power tool, if you are more of an aisle type product, these are much more high profile issues for you than it is for something that tends to be a consumable-type product like a cable tie. So, I'll just put you at alert on that.

Chris Weltzer - Robert W. Baird

Got you. And we haven't talked about Gits for a while, and I know the outlook for overall heavy duty truck market has gone a lot worse. Can you give us an update on your progress with your new business wins and winning new applications?

Bob Arzbaecher

Yeah, I mean, if you follow the Gits business, you'll understand that its emission law related. We don't see any change in our government changing its emissions policy with that 2010 changes standard. In fact, I would argue with a change at administration that there is almost no chance you're going to see any change in the emission standards that are coming in 2010.

So regardless of what's getting sold in 2008 and 2009, these guys have to meet this standard in 2010. So that bodes well for the Gits business. If we had something to announce this quarter we would have but there is no change in our optimism and the backlog of projects that we're working on, the amount of engine testing and mule vehicle testing that is going on. We continue to be excited about that opportunity.

Chris Weltzer - Robert W. Baird

All right, thank you guys.

Operator

And our next question comes from the line of [Phyllis Kamera from Pax World Funds]. Please proceed with your question.

Phyllis Kamera - Pax World Funds

Hi, thanks so much. I just was curious; you said you were a little surprised at how the energy sector continued to be good during the quarter. Do you think that had anything to do, I know a lot of what you do you said is maintenance and repair, how much of that had to do with the hurricanes possibly during the summer in the gulf, and then maybe there was some maintenance in comparison, and I was wondering if you started to see a drop off in that too much so far this quarter?

Bob Arzbaecher

The business unit didn't identify any of it to be hurricane related. If anything we had a little bit of a slowdown in the summer, and maybe a project or two that we're going to get done in the summer get done now, but not a material enough thing that anybody brought into our attention.

Andy Lampereur

Our volume in the gulf on a relative basis is smaller. Our sweet spot is up in the North Sea in the real deepwater type applications.

Phyllis Kamera - Pax World Funds

Okay, great. And then can you talk about the margin differentials between the Cortland business and the other industrial business. Is it 5%, 10% core amount?

Andy Lampereur

We disclose this when we announced that deal. From an EBITDA standpoint it's probably 700 basis points differential between the base industrial business and where Cortland is, on a normal basis it was more than that in the first quarter because we are manufacturing purchase accounting that we took on, purchasing accounting charges coming through in the first quarter that widened that out a little bit. So, it's meaningful.

Phyllis Kamera - Pax World Funds

Yes, okay. And I'm sure now is probably not the time that you are going to be able to do anything about that, but were you able to possible see how you can make some changes and increase that going forward for the year or you think it is going to stay at that differential?

Bob Arzbaecher

No, it's right in the middle of the 90-day integration process that includes a heavy dose of what we call LEAD, Lean Enterprise Across Discipline, and we believe Cortland's margins have a decent amount of growth probably better than the other two that are in that segment because they have been part of the family longer and the low hanging fruit has been picked.

So, I think margins will go up there. But, you have to recognize when we pay on a multiple of EBITDA, its not like you paid for something that had the same, you are not going to find acquisitions that have the kind of EBITDA that Enerpac and Hydratight have. You are going to have some narrow fairway of businesses. So, we were thrilled with Cortland's profitability going in and we think we have great opportunity to take it up.

Phyllis Kamera - Pax World Funds

Okay. Thank you.

Operator

And our next question comes from the line of Jimmy Kim from RBC Capital Markets. Please proceed with your question.

Jimmy Kim - RBC Capital Markets

Good Morning. My question is following up on the Cortland question from earlier, how is that business weathered the current downturn versus the rest of your industrial segment? I guess specifically, are sales up year-over-year down year-over-year or flat?

Andy Lampereur

There is two different pieces of Cortland. There was the Sanlo business and more of the energy related umbilical and cable and tow rope business which was primarily serving oil and gas. That part of the business is doing very well. Its growth was certainly not that far different than what we saw in the rest of the industrial business on a year-over-year basis.

The Sanlo business is more industrial [feeling], it is hitting a lot of end markets outside of oil and gas. We did see moderation there in its growth rate where it had been in the prior couple of quarters. So, as expected.

Jimmy Kim - RBC Capital Markets

So it came in below the 12% organic for the overall industrial segment?

Andy Lampereur

No.

Bob Arzbaecher

It's not in that.

Andy Lampereur

The Sanlo business is not in the industrial segment. The piece that is in the industrial segment which is about 70% or 80% of Cortland grew fine. It was up double-digits. The Sanlo piece is in the Actuation Systems Segment.

Jimmy Kim - RBC Capital Markets

Okay.

Andy Lampereur

That was the piece that moderated.

Bob Arzbaecher

I don't want there to be any confusion. It met its forecast. So it did what we expected it to do, and it was double-digit growth. Although that is not in our calculation because we haven't owned it a year, so it doesn't enter the core calculation for a while. If you pro-forma for a period that we didn't own it, it was in the double-digits. It's very similar to our other energy and industrial assets.

Jimmy Kim - RBC Capital Markets

Got it. Okay, thank you.

Operator

And our next question comes from the line of Charles Brady from BMO Capital Markets.

Charles Brady - BMO Capital Markets

Hi, thanks. Good morning Guys or afternoon, sorry.

Andy Lampereur

Good morning, Charles.

Charles Brady - BMO Capital Markets

As you look to the Enerpac, you know, the distributor base out there do you have a sense of the inventory levels within that distribution base?

Andy Lampereur

Charlie, we don't have visibility on a real time basis because our typical distributor out there might do $0.5 million in sales with us a year and they might carry $30,000 of back inventory or maybe a little bit more. They are not stocking most of what they sell. It is, you know ordering it, and it comes through that way. So we don't have real good visibility.

We don't sense that there is big change. We had a distributor meeting in the last three or four months. We are not seeing feedback from them any kind of material change there.

Charles Brady - BMO Capital Markets

Okay. And what are your thoughts as far as repurchasing shares as maybe opposed to acquisitions using the cash for that?

Andy Lampereur

Certainly, it has never been something we have really considered seriously. Certainly at the price that is today, you looks at it and say, it looks interesting but our focus is, just conserving the cash looking for better growth opportunities, whether they are organic or tuck-ins that's kind of our strategy going forward.

Charles Brady - BMO Capital Markets

Okay. And then the last one is in your core sales growth, just so I'm clear on that. That the core sales obviously would not include Cortland that would be part of acquisition growth, correct?

Andy Lampereur

That's correct.

Bob Arzbaecher

Correct.

Charles Brady - BMO Capital Markets

Okay, thanks.

Operator

Mr. Arzbaecher, there are no further questions at this time. I will turn the call back to you. Please continue with your presentation or closing remarks.

Bob Arzbaecher

All right. Well thank you operator. There is no more presentation, but I do have a couple of closing remarks. To summarize, we're navigating some tough economic environment right now. But, as Andy went through, our debt and liquidity, cash flow are very strong, more than ample to pursue the growth opportunities we are doing with little redemption's over the next couple years.

We are aggressively pursuing cost reductions every where and we are focused on the $140 to $150 million of free cash flow for 2009 with also a focus on trying to continue to grow for the long-term, the investing in our initiatives that make Actuant stronger. I think, I talked about Gits on this call is a great example. Hydratight, Enerpac, China all are great examples of how we're also investing for the future.

Thank you for your continued interest in Actuant. Please have a happy and safe holiday season and we'll talk to you again in March. Good bye.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and I ask that you please disconnect your line.

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Source: Actuant Corp.F1Q09 (Qtr End 11/30/08) Earnings Call Transcript
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