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Columbus McKinnon Corp. (NASDAQ:CMCO)

F3Q09 Earnings Call

January 22, 2009; 10:00 am ET

Executives

Tim Tevens - President and Chief Executive Officer

Karen Howard - Vice President of Finance; Chief Financial Officer

Analysts

Jason Ursaner - CJS Securities

Ted Kundtz - Needham & Company

James Bank - Sidoti & Company

Peter Lisnic - Robert W. Baird

Joe Giamichael - Rodman & Renshaw

Holden Lewis - BB&T Capital Markets

Operator

Welcome to the Columbus McKinnon quarterly conference call. At this time, all participants have been placed on a listen-only mode until the question-and-answer session. (Operator Instructions)

I would now like to introduce Mr. Tim Tevens.

Tim Tevens

Thank you, Wendy. Good morning everyone and welcome to the Columbus McKinnon conference call to review the results of our fiscal 2009 third quarter. Earlier this morning we issued a press release with corresponding financials and hopefully you have that. With me here today in our headquarters is Karen Howard, our Vice President of Finance and Chief Financial Officer.

We do want to remind you that the press release and 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 we file with the SEC to make sure you understand these risks.

Our revenue outpaced the same quarter last year by $18.9 million, almost 13% up and was clearly positively affected by Pfaff in this quarter. About $26.8 million of revenue came from Pfaff, as well as increases in other European, Asian and Latin American markets. This increase was offset by currency translation and weaknesses in many U.S. markets.

Revenues outside the United States grew to 42% of our total revenue in the quarter. This is a continuation of the execution of our strategic plan to grow in geographies dispersed around the world. Clearly, we are beginning to see slowing in these global industrial markets, most notably in the United States.

The U.S. seems to be the first market to reveal a downturn, with Europe, Latin America and Asia still growing but at a less rapid pace. This is a reminder to you that U.S. industrial capacity utilization is an important figure for our company and in December it was 70% or down 900 basis points since January 2008. This is the lowest since 1982.

A little commentary about our channels of distribution: In industrial distribution, which is the bulk of our business, as well as large industrial distributors; you may know them as the large catalog houses, are down in the quarter mid to high single digits. With crane builders, another important channel for our company, up high single digits and material handling partners are up a low single digit; about 1% in fact.

The rigging channels which provide tools for heavy lifting to manufacture and construction markets, is down in the low double-digit area. We have an entertainment business; these are hoist that help people lift speakers and lighting systems in concerts and live theater, is up a considerable amount from last year, actually almost double. The good news is that our company today, as compared to the last several recessions, our revenue is much more geographically dispersed and very broad across the entire economy.

Europe continues to grow for us, with Germany being the only country to report a decline year-over-year; by the way, this was in the mid single digit area. We have now seen a year-on-year decline in industrial production in the Euro zone for the fourth quarter of calendar 2008 and obviously this is going to impact our business on a go-forward basis.

Reports from the ProMat show in Chicago were mixed. ProMat is the largest material handling show in North America. We observed lower activity level, but there seemed to be real interest from what I call real buyers, not just tired kickers. So we were impressed with the quality of the commentary coming from the show.

The integration of Pfaff and Columbus McKinnon is proceeding apace and we are on target to actually exceed our expectations. Our companies are working well together and executing the integration plan with over 40 dedicated associates on 12 different implementation teams.

We have now identified more synergies than originally planned and our outlook remains very positive for this acquisition to produce failure for our shareholders. In fact, Pfaff just received and fulfilled an order in the quarter from the Chinese government for a high speed lifting system. This was about EUR 4 million in revenue. The transaction was for lifting technology and they are now preparing to bid on the manufacturing of the system.

From an earnings perspective, there was a number of different items that occurred in the quarter which impacted our results. Pfaff clearly produced positive results for us in the quarter. From an operating perspective, we continued to see high prices of raw materials such as steel, which impacted us negatively in the quarter by about $0.05. These prices are now moderating in our fourth quarter and are in the process of returning to a more normal level.

We also had some onetime adjustments associated with the Pfaff acquisition which impacted negatively our EPS by $0.04 and we had a restructuring charge in the quarter of $0.03. As previously mentioned we are prepared for a downturn and have implemented some measure to offset our lower demand.

Our net income from continuing operations was negatively affected by a loss in our Columbus McKinnon captive insurance company, CMIC. These assets were negatively impacted as a result of a downturn in the market to the tune of $0.12 in the quarter and a currency translation loss of $0.06, associated with an inter-company loan for the Pfaff acquisition.

In total, these extraordinary items amounted to about $0.30 of earnings, negative impact on our profit in the quarter. Gross profit was down slightly, impacted by the previously described steel prices and onetime inventory evaluation, accounting charge related to the Pfaff acquisition, and offset by positive results at Pfaff.

Bookings in the quarter were down mid to high single digits. As you might imagine, we’re very concerned over this lower booking activity and are monitoring it very closely. We, as a management team, have managed through these difficult economic times before and we’ll do it again. Downturns, in my opinion are a great opportunity to improve the structural costs from our businesses and dramatically improve the overall activity and productivity in our business.

During the last recession as an example, we were able to remove 1 million square feet of manufacturing space and a significant amount of fixed costs. Although we may not have the same size opportunity, there are clearly significant opportunities to attack these structural costs and we have begun them. Backlog for our business is up to $79 million. They are up about $15 million driven primarily by Pfaff. As a reminder this backlog still represents about four to five weeks of our total shipments.

We announced in December our restructuring plans and eliminated the position of the Chief Operating Officer. As a result, Derwin Gilbreath has left the company at the end of the quarter. You should know that he made a very positive impact in our company in the almost four years he was with us and we wish him well in his new endeavors.

As a result of this reorganization, Gene Buer will run our Hoist America Group; Chuck Giesige, our Rigging America’s group; Wolfgang Wegener, Columbus McKinnon Europe; and Joe Owen, the Global Supply Chain and they will all now directly report to me.

Now let me turn it over to Karen who will lead us through more details and results of the quarter.

Karen Howard

Thank you Tim and good morning everyone. I’m pleased to have the opportunity to review some of the financial highlights of Columbus McKinnon’s fiscal 2009 third quarter and year-to-date that ended on December 28, 2008.

As a reminder, this is the first quarter that includes our new German-based Pfaff silberblau business that we acquired on October 1, 2008. Further, all of the numbers reported here reflect our former Univeyor business as a discontinued operation divested on July 25, 2008 and accordingly the prior year reported numbers relate to ongoing operations unless otherwise noted.

Consolidated sales increased by 12.9% to $165.1 million in the third quarter of this year, compared with last year’s third quarter. The Pfaff business added $26.8 million and we realized expansion in our existing European, South American and Asian markets, offsetting declines in our U.S. and Canadian markets.

Excluding Pfaff, overall volume decreased 6.2% from last year, with international volume growing by 5.7%, but U.S. volume declining by 9.5%. Further, given the volatility of the currency markets during this timeframe, foreign currency translation negatively impacted revenue by 3.2%, compared with the prior year’s quarter. However, pricing favorably impacted the revenue growth by 4.0%.

On a year-to-date basis, consolidated sales increased $38.3 million or 8.9% over last year, of which $26.8 million or 6.2%, of the increase was attributable to the newly acquired Pfaff business. The company’s quarterly sales pattern, assuming a period of consistent economic conditions, which we’re not currently seeing obviously, typically shows sales strongest in the fourth quarter and weakest in the third quarter.

The recent quarter has 60 shipping days, consistent with the year ago quarter and the next quarter will have 65 shipping days. Included in the press release is a table showing the number of shipping days in each of the quarters of fiscal 2009 and fiscal ‘08 and we have also added the upcoming year, fiscal 2010.

Overall third quarter consolidated gross profit decreased $700,000 or 1.5%, with gross margin contracting 400 basis points to 27.1%. The contraction is primarily due to four factors as follows: First, we recorded $1.3 million of purchase accounting charges relating to inventory valuation for the Pfaff acquisition in accordance with US GAAP, which impacted this December quarter only.

Second, as carried over from the September quarter, our material costs, particularly steel, continued to be higher than we could recover. Despite our proactive and successful surcharge and price increase activities, we weren’t able to recover the full extent of those cost increases, unfavorably impacting gross profit by approximately $1.4 million.

For example, during the December quarter, our cost for steel wire which is used for chain, at the end of the quarter came down 44% compared with the beginning of the quarter. However, our cost for forging bar, which is used for hooks and shackles and things, went up 22% compared with costs in September, representing a 69% increase over costs a year ago. The good news is that our cost for forging bar came back down 33% in January.

Third, as previously disclosed, margins of the Pfaff business are currently lower than Columbus McKinnon’s historical corporate average, pressuring the now-consolidated average margin. We believe we have opportunity to improve Pfaff’s margins over time through the integration activities that have begun and then as to follow in future periods.

The final factor which is pressured goods margins during this quarter is the lower volume in our U.S. businesses. Rest assure that many activities have been undertaken and will follow to effectively manage costs during this economic downturn.

On a year-to-date basis, consolidated gross profit is up $4.8 million, with gross margin contracting 150 basis points to 29.5%. Consolidated selling expense as a percent of sales was 12% in the third quarter, up from 11.8% last year, due to the addition of the Pfaff business offsetting a reduction in spending for the historical business, as compared with the first and second quarters of fiscal ‘09.

On a year-to-date basis, consolidated selling expenses were 11.7% of fiscal 2009 year-to-date sales, compared with 11.5% for fiscal 2008 year-to-date. Consistent with our growth strategy, we continue to make investments to further grow global market share, but reduce base costs given the economic climate.

Consolidated G&A expense is 5.2% of sales in the fiscal 2009 quarter, compared with fiscal 2008’s 5.9%. The fiscal 2009 quarter benefited from the Pfaff business having lower G&A relative to revenue, as well as cost reductions in light of the current economic climate.

Year-to-date G&A expenses were 5.9% of fiscal 2009 year-to-date sales, compared with 5.8% for fiscal 2008 year-to-date. During fiscal ‘09, SG&A is expected to approximate 17.5% to 18.5% of sales. We are taking action to adjust our actual expenses to be in alignment with the lower sales level, while continuing to invest in accordance with our growth strategy.

During December, we adjusted staffing and reorganized our global leadership responsibilities, incurring approximately $1 million of restructuring charges, for which we anticipate beginning to recognize approximately $4 million of annualized cost saving beginning in our fiscal 2009 fourth quarter.

Driven by the gross margin contraction and restructuring charges described above, as well as a currently-lower operating margin profile of the Pfaff business, operating income decreased by $4.5 million or 23.2%, with operating margin contracting 430 basis points to 9.0% for this year’s quarter, compared with last year’s 13.3%. On a year-to-date basis, operating margin contracted 200 basis points to 11.5%.

Interest and debt expenses are up $500,000 or 14.5% over the prior year’s quarter, but down $0.5 million dollars or 5.2%, year-to-date. The increase in the quarter is due to the assumption of some previously existing Pfaff debt.

Given the reduction in valuations of the marketable securities of our captive insurance company investments, we recorded a $3.3 million unrealized other-than-temporary loss on those assets in this year’s third quarter, compared with $300,000 of income in last year’s quarter. Further, we recognized $1.8 million of foreign currency exchange losses in this year’s quarter, relating to inter-company loans impacted by significant volatility of the currency market.

In last year’s year-to-date period, we incurred bond redemption costs of $1.6 million or $0.05 per diluted share, upon calling our remaining $22.1 million of 10% notes and some of our 8 to 7/8 notes, which saved $2.5 million or $0.08 per diluted share of annual interest costs.

Regarding income taxes, the effective tax rates for the fiscal 2009 and fiscal 2008 third quarters were 35.3% and 40.3% respectively. On a year-to-date basis, effective tax rates were 35.7% and 38.2% 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 U.S. cash taxes that would otherwise be due during fiscal 2009. The remaining benefit at the end of December was $4.4 million.

Earnings per diluted share from continuing operations for the third quarter of fiscal ‘09 were $0.24 versus $0.53 in the third quarter of fiscal ‘08. Including the discontinued operations, earnings per diluted share for the third quarter of fiscal ‘09 were $0.20 versus $0.52 in the third quarter of fiscal ‘08.

Year-to-date, diluted EPS of $1.26 reflects a 16.6% decrease from last year’s $1.51. We’ve included tables in the earnings release delineating the significant items impacting comparisons between the two years, as I have previously described. Depreciation was $2.6 million and $1.9 million for the fiscal ‘09 and ‘08 third quarters, respectively. On a year-to-date basis, it was $7 million compared with $5.9 million last year.

Capital expenditures were $3.5 million and $2.4 million for the fiscal ‘09 and ‘08 third quarters, respectively. Year-to-date CapEx was $8.5 million and $7.4 million for fiscal 2009 and ‘08 respectively. The spending included investments in our new product development activities, our growing low-cost international facilities, productivity improvement equipment, as well as normal maintenance CapEx. We expect capital expenditures for fiscal ‘09 to be in the $11 million to $12 million range, reflecting reduction in our expectations from the end of the fiscal second quarter.

Net cash provided by operating activity from continuing operations was $13.1 million in this year’s quarter or $0.69 per diluted share, compared with $10.7 million in last year’s quarter or $0.56 per diluted share. On a year-to-date basis, net cash provided by operating activities from continuing operations was $44.4 million this year or $2.32 per diluted share and $38.2 million last year or $2.00 even per diluted share, representing a 16% increase.

This year, earnings contributed $47.1 million while operating assets and liabilities used $2.7 million. Last year, earnings contributed $53.5 million while operating assets and liabilities used $15.3 million. We continue to focus attention on our working capital utilization.

At quarter’s end, debt net of cash was $113.1 million and total gross debt was $135.1 million. To effect the Pfaff acquisition, we used $53 million of excess cash this quarter and we continue to have excess cash. Additionally at quarter end, availability on the $75 million revolver provided for under our senior credit agreement was $63.4 million, representing $11.6 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, which doesn’t expire until 2011.

Gross debt to total capitalization was 30.4% at the end of the quarter, down from 32.8% a year ago and in line with our 30% debt to total capitalization ratio goal. 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 back to Tim.

Tim Tevens

Thanks Karen. Okay Wendy, we’d be open for any questions that people might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jason Ursaner - CJS Securities.

Jason Ursaner – CJS Securities

Komatsu and Manitowoc both had very cautious views for their end market demand going forward. I realize it’s not a direct comparison for Columbus McKinnon, but do you expect to see further volume declines from your end markets in the U.S. and possibly a switch to declining volume from slower growth in Europe as you catch up utilization?

Tim Tevens

I think we would have the same view from the end markets. As you know, we follow industrial capacity utilization which is a number that’s published here in the States and that number did hit 70%; in December it hit 70%. We’d lag it by a quarter or two.

Actually, I think it’s a little tighter than two quarters, probably closer to one quarter given the lack of inventory in the channel, generally speaking, but I would say that our channel partners are feeling it and directly, very shortly thereafter we feel it and given the lack of activity and the bookings that we’re seeing right now, that’s a fair statement that it’s probably going to get weaker. I also think that Europe will get weaker, especially given a negative industrial production number that we’ve just seen in December. Although we saw some good growth in most of the European economies, they’re clearly slowing.

Jason Ursaner – CJS Securities

Okay and when you acquired Pfaff at the end of Q2, you spoke to a $90 million annual revenue number. Effective $26.8 million in Q3, even with currency as a headwind and Germany, I think you said was the only country in Europe to actually already see volume declines. So is their unusual seasonality in Pfaff or should we be extrapolating this number out?

Tim Tevens

Yes. I mentioned a Chinese order that they received in the fourth quarter. This is for an actuator lifting system that lifts high-speed trains for maintenance purposes. They got that order and they fulfilled the order, because it was basically a transfer of technology drawings and other things in the quarter which we can call that abnormal; that was EUR 4 million or so. So US $6 million, five point something million U.S. dollars.

So we’re still going to be most likely on a go-forward basis in the $90 million area. However, their overall business in Germany is slowing as well as the old Columbus McKinnon business is slowing. I would expect that to be a touch less than the $90 million we originally thought it would be for the full fiscal year of ‘09.

Jason Ursaner – CJS Securities

Okay, you also spoke about the measurable cost cutting reductions. Is there any way to quantify it or can you outline the additional action management is prepared to implement?

Tim Tevens

Sure. As we have been saying, we have been preparing for the last several months to restructure the company and to take the costs out in anticipation of a slower demand, which we’re now beginning to see. I think it is fair to say that from a headcount reduction standpoint, we’re in the so far 200 person headcount area, which is the cost of a savings of about $10 million or so and that cost is probably around $2 million or $3 million to get to that level. That’s what I consider to be an initial cut.

If we continue to see further sliding of our volume and our bookings being softer, there are more structural changes that we would take, including some additional plant closures. We have identified several that are candidates at this point. We have nothing to announce in that regard just yet. We still have some planning to do around how we would migrate the equipment and change products, etc, but there clearly would be more cuts, including things like wage freezes, hiring freezes and we would look clearly at some of the benefits that we all get at the company, including health care and 401-K matches, etc.

Operator

Your next question comes form Ted Kundtz - Needham & Company.

Ted Kundtz - Needham & Company

A question for you, can you go back to the gross profit issue in the third quarter, what would have it been Ex the extraordinary items?

Karen Howard

Well, I’ll take that Ted. If you isolate the onetime accounting adjustment, which was associated with inventory valuation for U.S. GAAP purposes for Pfaff; that amounted to about $1.3 million and we quantified the steel costs that we weren’t able to recover through pricing to pass us through the channel.

Ted Kundtz - Needham & Company

Was $1.4 million?

Karen Howard

Yes, that amounted to about $1.4 million.

Ted Kundtz - Needham & Company

Okay, so that would get you back to close to the 29%.

Karen Howard

Yes, those are the two that we cited, and then of course we commented on the Pfaff business having lower margins than the historical Columbus McKinnon business. We have not disclosed separate margins for that business, but know that they are lower than the Columbus McKinnon historical average.

Ted Kundtz - Needham & Company

But that doesn’t seem like it impacted you that much, the mix issue.

Karen Howard

It certainly did.

Ted Kundtz - Needham & Company

It did? So margins would have been above 29%.

Karen Howard

I think that’s fair to say.

Tim Tevens

If you remove Pfaff.

Ted Kundtz - Needham & Company

If you remove Pfaff, right. Yes. Okay. So going forward, you could assume the 29% target, is actually what we have going forward, is a good target, at least near-term; unless you’ve got a lot more contraction on the volume side, which could negatively affect margins.

Karen Howard

Yes. I was going to say; certainly the top line level will impact the margins because, while we’ve got a lot of work underway to control the costs, there is certainly some level of negative operating leverage with sales coming down and we did feel some of that in the U.S. operations this winter.

Ted Kundtz - Needham & Company

Right, okay, so we could expect a little bit of that going forward. The G&A expenses were nicely lower and I guess some of that reflects getting rid of Univeyor right. So I guess that reflects that. Is this a level that you could probably sustain?

Karen Howard

First of all, let me just clarify. The comparison numbers, the prior year numbers that we’ve reflected in the release, remove …

Ted Kundtz - Needham & Company

Remove that, I know. I’m looking at my old numbers, but your numbers are basically the same.

Karen Howard

Just to clarify that for you.

Ted Kundtz - Needham & Company

And that’s pretty good with Pfaff coming in.

Karen Howard

The Pfaff G&A as a percent of revenues is lower than the historical Columbus McKinnon, but their selling is a little higher. So, as we had indicated, their current margin profile, their margins are lower than the current Columbus McKinnon. We see opportunity to get them up to Columbus McKinnon’s average, but it takes some time.

Operator

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

James Bank - Sidoti & Company

I’m just trying to get back into all the adjustments that were made in the quarter. The mark-to-market adjustment on your self insurance portfolio, I’m not familiar with that. Is that a one-time or can we reasonably assume that’s one-time?

Karen Howard

I hope so, but it’s not fair to say it’s a onetime. I’d like to think that the extent of it in this quarter was quite unusual. What happens is that you have to take these investments and mark them to market each month or each quarter, but when it’s a significant loss and significant is not clearly defined by the SEC, but when it’s a loss of some magnitude that you don’t necessarily see recovery or at least have visibility of it, that charge gets reported in the income statement, which is what happened in this quarter. Let me assure you, I guess from a mix standpoint, those investments, the majority of that is fixed income. It’s like 80% fixed income and 20% equities. So the good news is there is limited exposure to the equities market.

James Bank - Sidoti & Company

What would be a normal charge?

Karen Howard

You barely see it.

James Bank - Sidoti & Company

Okay, so that we could probably reasonably add back.

Karen Howard

It was quite unusual, obviously for this quarter.

James Bank - Sidoti & Company

So the adjustment with Pfaff, the restructuring charges, the self-insurance mark-to-market and I guess the discontinued operations. So it looks like it was an adjusted $0.43?

Karen Howard

We added a table to the press release. I hope that might help you out. We quantified the mark-to-market adjustments.

James Bank - Sidoti & Company

Right. No, I do understand that, but material costs, clearly that’s just normal operations. I don’t think that’s reasonably added back. I’m just trying to get through here on a flow. So it looks like you did about $0.43 adjusted, is that fair?

Karen Howard

I guess I’m not exactly sure. I think it’s a little better than that. I think the mark-to-market adjustments obviously are significant and fortunately it doesn’t happen every quarter. Similarly, the currency translation losses, I’d throw into that category as well. Restructuring charges, I think I would isolate from normal ongoing operations. They’re certainly part of the business, but then we’ll get the future benefit of them and those onetime accounting adjustments for the inventory valuation on Pfaff, that’s just per GAAP accounting and those go away.

Tim Tevens

You want to talk about the currency translation?

Karen Howard

Sure, we can touch on the currency translation adjustment; that was about $0.06. Given the volatility again in the currency markets, particularly at the beginning of the quarter, it really is when this really occurred as a result of transferring funds basically from the U.S. to Germany to fund the Pfaff acquisition and the timing was such that we weren’t able to hedge it quickly enough, given the movement in the market. That is now hedged, so our expectation going forward is that fluctuations associated with that would be minimized.

James Bank - Sidoti & Company

So, sort of a net neutral translation going forward.

Karen Howard

There’s potentially some modest impact if we revalue the hedges, but we cannot anticipate anything to this magnitude, to be honest with you. I mean I can understand; we quantified for you the unrecovered material costs, just so you were aware, but if you’d call that normal, ongoing operations stuff, certainly it happens, but if you adjust for all the other things, our actual EPS was $0.20, instead of adding back 34, if you only add back 29, that gets you to $0.49.

James Bank - Sidoti & Company

For Pfaff, are the employees at Pfaff going to be paid on a commission base, similar to what Univeyor used to be? Because that was something when Univeyor actually had an excellent quarter, you saw a huge up-tick in the G&A. I’m just trying to gather if that’s going to be sort of a similar type model.

Karen Howard

It’s nothing like the Univeyor business. I think we don’t quite understand the question. I think it’s just simply because the Pfaff business is nothing like the Univeyor business. The Pfaff business is more like the traditional Columbus McKinnon business.

James Bank - Sidoti & Company

So product to order; no engineer to order type?

Tim Tevens

There is some engineer to order, but it’s relatively modest, and when they say engineer to order James, we’re really talking about using fairly standard product and configuring them uniquely to the order, which is very similar to what we do for hoists.

Karen Howard

And if there is, there are certainly sales commissions that are variable to sales; so if there is a large order, the selling expense could be higher related to that order for example, but it’s nothing like the Univeyor business.

James Bank - Sidoti & Company

I’m sorry, what month was Pfaff acquired in?

Karen Howard

It was acquired October 1, the year beginning this.

James Bank - Sidoti & Company

So it’s a full quarter; okay, great and then lastly, the further cost-cutting measures you mentioned, it seemed like they were about a handful. If you did have to go down that road, how quickly would that affect your P&L’s to benefit you?

Tim Tevens

Our thinking would be, is that we would be evaluating as the quarter goes on, but as soon as we pull the trigger to implement them, it would be pretty close to immediate.

James Bank - Sidoti & Company

Okay, so no reason to precautionary go ahead and take those measures now until, I guess, you’d assume that there are further declines.

Tim Tevens

That’s right.

Operator

Your next question comes from Peter Lisnic - Robert W. Baird.

Peter Lisnic - Robert W. Baird

The first question I guess I had Tim, the restructuring that you talked about and the things that you’ve accomplished in the past; if you could give us a sense as to, as we kind of look and make our own volume assumptions going forward, can you give us a sense as to what you think the detrimental margins might look like going forward relative to previous downturns?

Tim Tevens

I think and you’ve probably heard me say this before, is that our operating margin should be higher than the last downturn operating margin; the last trough, which I think was fiscal ‘03 or ‘04, something like that. The trough last time Pete was in the 6% area. It will be our goal to be a pretty good measure above that and we don’t give guidance as you know, but think about the fact that we don’t have the 10 manufacturing plants that we had back then and structurally we’ve moved a lot of that to fixed costs. We have opportunity to do that again, maybe not to the same degree in this downturn, but in my expectations it would be my expectation that we would be more toward the higher end of the single-digit area.

Peter Lisnic - Robert W. Baird

That helps, because it’s hard to cipher some of those numbers in the past. It looks like incrementals or decrementals are in the 20% to 30% range and I’m guessing that’s a reasonable figure to use going forward.

Tim Tevens

That would be reasonable.

Peter Lisnic - Robert W. Baird

Fair enough. If you could just maybe give us an update on Pfaff and the potential to reach Columbus level gross margins, any change in what your thinking there is or potential timeline to where we could see some more significant margin improvement in that business?

Tim Tevens

We’ve been at it for three months now in terms of the integration of the two companies, and in my opinion, it’s going very well. I think culturally we fit pretty well, as well as people are really working hard together to accomplish the targets that we set out. It will take us one to two years to fully recognize the synergies that we identified early on during our due diligence and by the way we weren’t planning on an economic downturn maybe to the degree that we’re going to see here shortly, when we did the due diligence, of course.

So that would negatively impact our synergies and we may not get them as high as we’d like to because the business would have been softer or down more, but I suspect it’s still going to be in that couple year area, and then I would think the margins would be reasonably close to what you know us as the normal Columbus McKinnon margins there in the 12% to 13% area, which we’re not seeing today because of the downturn.

Peter Lisnic - Robert W. Baird

I guess Karen, I hate to harp on this one, but on the mark to market write-down that you took in the quarter, I just want to make sure I understand this correctly. I understand the third quarter impact, but leading up to that, I’m assuming that there was either income or loss recorded every quarter as a result or derived from those investments, is that the right way to think about this?

Karen Howard

Yes, absolutely. There is realized incremental loss relating to those investments every quarter and of course there’s also unrealized and generally unrealized fluctuations as they get mark-to-market get recorded in other comprehensive income and equity, unless they are more significant losses that are deemed other than temporary. So it’s not considered permanent, but other than temporary, from the standpoint that they are more significant and you don’t have visibility that you’ll see them come back anytime soon.

So, given the current market environment, these valuations were in fact deemed other than temporary and in that instance the charge instead of getting recorded against equity and other comprehensive income, it gets recorded in the income statement.

Peter Lisnic - Robert W. Baird

But in theory, if the market totally turned around on those securities, in theory you could book income in the next quarter if that actually did happen.

Karen Howard

That’s absolutely right.

Operator

Your next question comes from Joe Giamichael - Rodman & Renshaw.

Joe Giamichael - Rodman & Renshaw

A lot of the questions have been answered already, but just to touch upon a couple simple things. As it relates to steel, can you remind us the specific types of steel that you buy? I know it’s relatively varied, but just to give us a better sense so we understand the pricing lag and then with that, just sort of how many suppliers do you have, and going forward if you do see this continuation of your raw materials’ prices continuing to soften, would you consider committing some capital to build the raw material inventories?

Tim Tevens

Good question Joe. Let me see if I can take that and ask Karen to add on if I miss something. There is three primary types of steel we buy. Forging bar, which is rod for all intents and purposes, and it is a special alloy rod. The bulk of our purchases at least are special alloy rod.

When we make lifting tools out of these forging bars, they have to have certain tensile strength to accomplish a certain working load limit for lifting. So it’s kind of a unique alloy that we actually use, which makes it a little more problematic to explain to someone, because when you see hot-rolled going down 30%, it doesn’t correlate very well to Columbus McKinnon, because that’s not what we’re buying. That’s a big number, and that’s the one that’s been actually up quite a bit. There is one primary supplier for that product.

The second category is coil stock and this is typically either alloy or carbon steel. It’s actually rod that’s rolled in a coil, smaller diameter; typically anywhere from quarter inch up to three quarters of an inch in diameter and that one might vary a little more closely with some of the numbers that you might see. By the way, both of these two categories are based upon scrap steel prices. To a large degree they’re linked to that metric and the rod, the coil stock that we buy today typically comes from one primary supplier as well. There’s a couple of others that we use globally, but there is one that seems to be doing the best job for us at the right price.

Then the last one really comes from steel service centers, people like Jorgensen and Ryerson and it’s a mixed bag of structurals and flats and framework for hoists that sometimes we need for our larger hoists, and that’s actually the lowest commodity and that one would probably correlate mostly to some of the metrics that you might see in steel.

To be perfectly honest with you, relative to your inventory question, we have indeed bought in advance when we anticipate rises in prices. For the forging bar for example, we get a one month notification of a price increase and typically we will buy two to three months of product in advance and that’s true with all of them. We do get a little bit of advance notice and we try to pre-buy.

Joe Giamichael - Rodman & Renshaw

Then just a two part question focused on the gross margins. You’ve now just began to see the decline in steel costs. I am assuming you’re anticipating these costs continue to soften given the macro environment we’re in. You mentioned the November and the January price increases have been passed through. Can we assume that that pricing should remain sticky even as volumes soften?

Tim Tevens

It’s tough to say at this point given the softer volumes. We’re working hard to keep the price as you well know, but the reality is we also want to get orders and we certainly have competition that mounts in as well, so we’re fighting for that. It’s probably not as sticky as it normally is, in a normal economic environment; would be my feel for it.

The other thing is we are seeing some significant decline in some of our raw material steel, which would be helpful. The forging bar as Karen mentioned is down 33% from last quarter to this quarter, so that’s going to be helpful going forward, but the other two categories of steel we just talked about are actually up in the mid single digit area.

Joe Giamichael - Rodman & Renshaw

If you are to get pushed back on prices given the fact that you do sell almost all of your products through distributors, is it sort of a delayed process where customers push back on the distributors, who then come back to you to try and gain back some pricing?

Tim Tevens

Typically. That’s exactly what happens.

Joe Giamichael - Rodman & Renshaw

Then just last, just a bookkeeping question. I saw that the fully diluted share count declined, while the basic share count increased a bit. Can you just give us an explanation as to what occurred; were there some option expiration or --

Karen Howard

It’s really due to the valuation of the options, given the stock price.

Operator

Your next question comes from Holden Lewis - BB&T Capital Markets.

Holden Lewis - BB&T Capital Markets

I may have misheard this, but I thought that when you were talking about the restructuring actions before, you were talking about like a $4 million savings, but then when you went into the personnel cuts, I thought you talked about $3 million or $4 million in cost to implement and then $10 million in annual savings. What did I miss?

Tim Tevens

Let me clarify. Great question! It did get a little confusing there, I apologize for that. In the past quarter we have implemented already savings that represent $4 million and the cost was $1 million to get that savings. On a go-forward basis now looking down the road through the fourth quarter, we would expect to have additional costs over and above the $1 million; another couple or three or so of restructuring costs that would get us another $6 million of benefit.

Holden Lewis - BB&T Capital Markets

So in the quarter, you’re now at a $4 million run rate in the quarter in terms of annual savings, and that cost you $1 million and then you’ll add another $2 million in costs and another $6 million in savings; over what period of time?

Tim Tevens

We would plan to implement it this quarter, which is our fourth quarter and we would get that savings obviously over the next year. It starts immediately, but you don’t get the ramp until the full year.

Holden Lewis - BB&T Capital Markets

So in fiscal Q4, we’re going to see another $2 million in restructuring expenses?

Tim Tevens

I don’t want to give you the exact number because we’re not done putting pen to paper just yet, but it is going to be in the $2 million to $3 million area probably.

Holden Lewis - BB&T Capital Markets

And this is all just a function of cutting heads; and that 200 heads, was that in Q3 or was that through the entire reduction program?

Tim Tevens

No, that’s in Q3 and it is severance cost which I would say is the bulk of the cost, but we are looking at plant consolidation as well, so there’s other structural cost that we need to move things around, move equipment around, which is part of the restructuring, which is the smaller part of the cost.

Holden Lewis - BB&T Capital Markets

But if you were to do that, then we’d be talking about additional annual benefits and additional quarterly costs.

Tim Tevens

That’s correct.

Holden Lewis - BB&T Capital Markets

The balance of the 200 that you’ve identified so far, ultimately how many are you reducing the headcount?

Tim Tevens

Hard to say at this point, but we’re still working on that right now, but 200 is about 6% or 7% of our total workforce. It could easily double, but we don’t have the final numbers just yet. Actually, that will be forthcoming here shortly.

Holden Lewis - BB&T Capital Markets

And then just touching I guess on Pfaff, what was the impact at the bottom line, the EPS line? I guess if you strip out that onetime accounting adjustment, that’s not going to be ongoing. If you strip that out, what was the bottom-line impact to your earnings?

Karen Howard

I’ll take that one Holden. I don’t think it’s fair because we don’t disclose the contribution of separate businesses, but I think it’s fair to say that it was accretive and in line with our expectations. We had previously disclosed our operating margins were in the mid to high single digits area and they performed consistent with that.

Holden Lewis - BB&T Capital Markets

Also when you look your debt really didn’t change, but your interest expense went up. If I understand correctly, that’s because you took on higher cost Pfaff debt and retired debt that was somewhat lower cost relative, so the mix kind of was a higher cost of capital. Are you going to refinance the Pfaff debt? Is that something which goes on and on or is there some way we could sort of move the cost of debt down?

Karen Howard

We are addressing the Pfaff debt, really the whole picture, to get some efficiencies on a global basis.

Holden Lewis - BB&T Capital Markets

Okay. So you will be trying to sort of move that cost of debt down? Does that seem like something which is reasonably near term and possible to do?

Karen Howard

Yes.

Holden Lewis - BB&T Capital Markets

Okay and then talk a little bit more about pricing if we could. Only because I think you put in the October November price increase, I guess it was late November. At least sequentially the contribution from price is 400 basis points versus 500 basis points last quarter, so it seemed like it stepped down a bit even though I would’ve thought that we would be seeing a little bit of contribution begin to leak in for November and December.

Are we losing something somewhere else or is it a timing issue, and can you give any color? I know there’s not a lot of long-term color, but even for the March quarter, can you give us some color on what you expect the pricing to come in at?

Tim Tevens

The price increase last quarter was effective November 24, I believe the date was. So it was two months into the quarter in essence and basically we accelerated our normal January 1 increase into November. Then there’s another increase in the fourth quarter that happened at the beginning of January for our European business and that’s in the tune of 3% to 4%, somewhere around there.

Holden Lewis - BB&T Capital Markets

And when was that, I’m sorry?

Tim Tevens

January 1.

Holden Lewis - BB&T Capital Markets

Okay, but again just getting to the sequential change in pricing, quarter to quarter, did something anniversary? Did we lose some that we haven’t recaptured in the new price increases yet or is it just noise?

Karen Howard

I think maybe what you’re seeing Holden is the fluctuation due to surcharges, because we had been surcharged and we started surcharging in April of ‘08 for our high steel content product in the U.S. So our chain and our forged attachments, we would adjust the surcharges that we would pass through the channel on a monthly basis; so there’s certainly some fluctuation quarter-to-quarter relating to that.

Tim Tevens

I wouldn’t read too much into that though.

Holden Lewis - BB&T Capital Markets

But otherwise you feel that that November increase went into place, that has stuck and you put in an increase in both Europe as well as North America here in early January, which so far you also believe is sticking; is that the way to price.

Tim Tevens

The January increase was just Europe, because we did the November increase in the States instead of the normal January increase, so it’s just the November increase in the States.

Holden Lewis - BB&T Capital Markets

That was 300, 400 basis points?

Tim Tevens

Yes.

Holden Lewis - BB&T Capital Markets

And then, the late November was just the U.S., and how much was that again?

Karen Howard

About 3%.

Holden Lewis - BB&T Capital Markets

So when you look at it, would you expect given the surcharges are in there and some costs are coming down, so the surcharges probably coming down; are you expecting that pricing of 400 to 500 basis points to remain stable in the fiscal Q3 or is there some stuff anniversarying or do we see an increase because of the new price increase. I mean just directionally what should we be looking for in the near term?

Tim Tevens

I think this area of 3% or 4% is what you might see on the go-forward basis.

Karen Howard

But having said that Holden, I think it is somewhat of a crazy time out there and there may be pricing pressure given the demand environment. So I just want to caution you with that dynamic.

Holden Lewis - BB&T Capital Markets

But you’re not seeing it now.

Tim Tevens

I think it’s probably fair to say we are beginning to see it.

Karen Howard

I think it’s early to say.

Holden Lewis - BB&T Capital Markets

The fact that you go through distribution channels -- my appearance to distribution is that pricing and distribution channels tend to be much more stable than if you are selling direct to OEMs.

Karen Howard

Yes.

Tim Tevens

Correct.

Holden Lewis - BB&T Capital Markets

So I mean the fact that you’re selling to distribution, isn’t that you having the likes of Grainger and those guys coming back to you and demanding price concessions?

Tim Tevens

Well, when steel prices come down they will want our surcharges lifted and that’s to a degree less priced.

Holden Lewis - BB&T Capital Markets

Right, but the surcharges are supposedly neutral, right? I mean, price is actually a benefit, and surcharges are set to be able to rapidly react to increases that are anticipated to neutralize. So as long as the surcharges are moving with raw materials, that going up and down shouldn’t matter that much, right? It’s really the base price that’s key.

Karen Howard

Yes and that is what we’re talking about here Holden. We rolled the surcharges into the actual price for the chain or the forging product at the end of November. That was part of the whole price increase and I think it’s fair to say while it’s early in the cycle in terms of its impact on us, that we are cautious about whether the full extent of the price increases will stick.

Holden Lewis - BB&T Capital Markets

And then lastly can you just comment first on any pension risks going forward and then secondly, the inventories on the balance sheet look like they were up a bit. I don’t know if that was a function of pre-buying, but if you can just sort of address that as well.

Karen Howard

Sure, so pension and inventories. With respect to pension, we do have defined benefit pension plans and like everyone we have seen downward pressure or downward valuation of the assets in the plan; that we’ve been working closely with our actuaries in terms of assessing that impact. There is potentially a near-term increase in costs associated with that, just the way the accounting works for those, until the asset valuations come back.

With respect to the inventory, certainly the addition of Pfaff has resulted in an increase in the inventory balances as you know and with respect to the non-Pfaff businesses, we did see a modest increase in the inventory balances compared to the end of September, primarily due to some projects that were in process, that weren’t complete at the end of the quarter at some of our larger businesses, including our tire shredder operation and our crane businesses.

Holden Lewis - BB&T Capital Markets

So that will go away pretty quickly.

Karen Howard

Yes. It’s just kind of a little lumpy.

Holden Lewis - BB&T Capital Markets

Back to the pension, do you have a sense of what sort of the EPS impact would be on maybe fiscal ‘10 as you look through all that?

Karen Howard

No, we don’t yet. Holden we’re working through that with our actuary because we are planning for that year and as the markets continue to move.

Operator

Your next question comes from Jason Ursaner - CJS Securities.

Jason Ursaner - CJS Securities

I just had a follow-up. When you acquired Pfaff, you had talked about having challenges; you had trouble getting the Duff Norton actuators into Europe. I was just wondering if you’ve seen any success in cross selling the Duff Norton actuators.

Tim Tevens

Yes actually, that’s going pretty well. The Duff Norton business and the Pfaff business have combined their actuator sales and marketing teams and it actually looks very promising. We haven’t seen sales just yet, but the rollout is going well and we would expect to hit some pretty good numbers in that regard.

Operator

Your next question comes from Holden Lewis - BB&T Capital Markets.

Holden Lewis - BB&T Capital Markets

You also to this point have been making significant investments in people and offices outside of North America, building up the European presence, Asian presence, etc. Have you continued running forward with all of those? Have you slowed those down in light of what you’re seeing or maybe in light of the Pfaff acquisition? I guess I’m just curious about whether or not we’re still spending into a downturn or whether that’s probably of gone away.

Tim Tevens

It’s not gone away, but it’s being measured more directly. I would say that we need to continue to make investments in products and markets to execute our strategic plan long term, but we’re doing it in a much more cautious way and much more measured way, prioritizing the markets that will really give us some short-term demand immediately and then maybe delaying some entry into markets where it might be a more longer-term venture. So, if I use the word cautious Holden, I think you’ll understand.

Holden Lewis - BB&T Capital Markets

And so, can you talk about what would have been a typical sort of investment spending nut in prior quarters and maybe where that’s going to? Is that a discussion you’re able to have?

Tim Tevens

No, not at that level of detail.

Operator

Thank you and at this time I show no further questions.

Tim Tevens

Thank you, Wendy. Let me summarize by saying we have made a significant step forward executing our strategic plan with the acquisition of Pfaff in the quarter and the clear indication of a successful integration which is well under way. Even after the acquisition we remain well capitalized with $22 million in cash and a $75 million untapped revolver that matures in 2011. The remaining $124 million of subordinated notes mature in November of ‘13.

We are considerably stronger today than we have ever been, especially when comparing us to the last economic downturn of ‘01 to ‘04. This management team has weathered significant storms before, especially the last recession and I’m happy to say that we’re in a much better position to weather this economic downturn than we were in the last one.

We will attack waste in all forms and position our company to be much stronger as we emerge from this current economic malaise. I do want to thank all of the Columbus McKinnon associates around the world for their hard work and ultimate success in making this quarter a good one and as always, we appreciated all of your time today. Have a good day.

Operator

Thank you. This concludes today’s conference. Thank you for participating. You may disconnect at this time.

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Source: Columbus McKinnon Corp. F3Q09 (Qtr End 12/28/08) Earnings Call Transcript
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