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Hardinge (NASDAQ:HDNG)

Q1 2013 Earnings Call

May 09, 2013 11:00 am ET

Executives

Deborah K. Pawlowski - Director

Richard L. Simons - Chairman, Chief Executive Officer and President

Edward J. Gaio - Chief Financial Officer and Vice President

Analysts

Robert A. Kosowsky - Sidoti & Company, LLC

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

Operator

Greetings, and welcome to the Hardinge Incorporated First Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Deborah Pawlowski, Investor Relations for Hardinge Incorporated. Thank you. You may begin.

Deborah K. Pawlowski

Thank you, Diego, and good morning, everyone. We certainly appreciate your interest in Hardinge today. On the call with me, I have Rick Simons, Chairman, President and CEO; and Ed Gaio, Vice President and CFO. Rick and Ed will review the results for the first quarter and also give an update on the company's outlook and strategic progress.

You should have a copy of the financial results that were released this morning before the market opened. And if not, you can access it at the company's website, www.hardinge.com. You will also find on our website slides that accompany the discussion to which Rick and Ed will be referring. They can be found on the homepage next to the link for the webcast.

This morning, we separately announced that we have signed a definitive agreement for the acquisition of Forkardt Workholding Group from ITW. This release is also available on our website and Rick will discuss this on the call.

As you look then at the slide deck, on Page 2, you will find our Safe Harbor statement. As you are aware, we may make some forward-looking statements during the formal discussions as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ from what is stated in today's call. These risks and uncertainties and other factors are provided in an earnings release, as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can be found on the company's website or at sec.gov.

So with that, let me turn it over to you, Rick.

Richard L. Simons

Thank you, Debbie. Good morning, everyone, and thank you for joining us for our first quarter 2013 financial review. The financial results that we reported this morning were in line with our expectation, and as we discussed during our fourth quarter call, reflective of the declining order rates we had seen in the latter half of 2012. At the $67 million sales level, we expected roughly $600,000 of net income, which we would have achieved if we were not spending that amount on acquisition costs in the first quarter.

As Debbie mentioned, we also announced today that we have acquired the Forkardt Workholding Group from ITW. We are exceptionally pleased with this acquisition as it positions us as one of the largest workholding solutions providers in the world. I'll go into further details regarding the acquisition after we've reviewed the quarter.

Allow me to first provide a brief overview of our top line results and then turn it over to Ed, who will provide more details on the financials for the quarter.

Please turn to Slide 3 of the presentation. Sales were clearly down in the first quarter compared with last year, especially in Asia. Sales to Asia were down by 32% to $21 million when compared with last year's first quarter. The $10 million decline reflected the deceleration of growth in China throughout 2012 which, in particular, impacted orders for grinding machines. That trend began to turn around in the fourth quarter of 2012 and has continued to improve so far during 2013.

I was recently at the China International Machine Tool Show, CIMT, and was encouraged with the activity there. While there, I heard unofficial estimates of over 400,000 people in attendance. If in fact true, that would make it over 4x the size of the comparable show here in the U.S., the IMTS show held in even years in Chicago. I do know that the CIMT took up over 1.3 million square feet of space in 14 separate halls, with over 1,500 companies exhibiting machine tools, related accessories and machine tool components.

We had a very successful week, exhibiting 7 different machines showcasing our turning, milling and grinding solutions for our customers. Although we expect the demand will not overheat as it did back in 2011, the environment was clearly more energized than it was at the tail end of last year.

Europe was weaker in the quarter, with sales down 15%, as Germany, which has been holding up well over the last couple of years despite the overall weakness in Europe, began to slow down in the latter half of last year as well.

North America quarterly sales of $24.8 million were up 33% and was at the highest level that region has experienced since the fourth quarter of 2011. Timing of shipments primarily drove the increase, as we expect organic sales for the full year in North America to be relatively comparable with 2012. Including sales for Usach and Forkardt, we expect sales in North America to exceed the levels of last year.

Now I'll turn it over to Ed who will provide more detail on our operating and financial results.

Edward J. Gaio

Thank you, Rick, and good morning, everyone. If you would, please turn to Slide 4.

Gross margin for the first quarter was 28.2%. Margin declined by 0.2 points as a direct result of lower volumes and product mix. These were the same impacts to margin when compared with the trailing fourth quarter of 2012. Of note, however, we believe gross margin held up quite well relative to the significant decline in revenue and is a direct reflection of the changes we made in the organization over the last several years to improve our business model.

If you turn to Slide 5, you can see our operating margin for the quarter which was down to 0.7% compared to 4.5% during the first quarter of 2012. Higher SG&A in the quarter included $0.4 million of incremental SG&A associated with Usach, which was acquired in the fourth quarter of 2012. This was somewhat offset by some changes we made in our sales structure in Europe that I will review later.

There was also $0.6 million of costs associated with the acquisition of the Forkardt businesses.

As I noted, we continue to fine-tune our business. During the quarter, we made changes to our European sales channels, shifting our direct sales network to a distributor network in the U.K. As a result, we have reduced our fixed cost structure in that region and expect approximately $5.5 million reduction in SG&A. Given this change, we would also see lower gross margins reflecting the distributor discounts.

This will make our costs to serve the U.K. market variable with sales at -- and lower our fixed cost structure.

On Slide 6, we show our net income for the quarter, which was just above breakeven at about $40,000. We are fairly pleased that despite the dramatic drop in sales, we achieved breakeven with the incremental investments made in our growth strategy.

Non-GAAP trailing 12-month net income at the end of the first quarter of $12.8 million is adjusted to exclude a $2.7 million tax benefit from the fourth quarter of 2012.

On Slide 7, our metrics have demonstrated our focus on productivity and cash generation. Our working capital requirements as a percent of sales were 41%, which is well below our historical average.

As I've said in the past, the machine tool industry has inherently had working capital needs as our customers require that we maintain high levels of finished capital goods, repair parts and accessories on hand. Our inventory turns have held at 1.8x, and we believe we remained in the upper quartile of the industry. We are also managing our receivables very carefully.

Please turn to Slide 8. Our balance sheet remains strong, with $19.4 million of cash and cash equivalents at the end of the first quarter. Timing of payments resulted in cash used in the operations of $6.7 million. We expect to generate cash from operations during 2013 as the effects of payments and receivables' timing will be mitigated over a longer time frame.

Capital expenditures during the first quarter were $0.9 million. We continue to expect capital expenditures of $4 million to $5 million for 2013, primarily for general maintenance requirements.

We used approximately $10 million in cash and the remainder of borrowings to purchase Forkardt for a total purchase price of $34 million. We expect the acquisition to be both accretive and to contribute cash flow from operations in the year.

That concludes my remarks. And now I'd like to turn the call back to Rick.

Richard L. Simons

Thanks, Ed. On Slide 9 is the summary of the Forkardt acquisition.

Forkardt is a well-established provider of high-quality, specialty and custom-designed workholding devices for machine tools. As Ed mentioned, total purchase consideration was $34 million, which was funded with a combination of cash and debt.

We believe Forkardt is an ideal strategic fit as it establishes us as the global leader in workholding products while improving our revenue and margin profile. Workholding products are sometimes sold along with new machines but, in more cases, directly to end-users who are replacing older products or retooling for new projects. Therefore, they do follow general manufacturing cycles, but because they can be of a more consumable nature, the cycles tend to be less dramatic than for machine tools, which are large capital investments for businesses.

Also, these products tend to command higher margins usually due to their unique characteristics versus competition.

Historically, repair parts and accessories represented approximately 22% to 25% of total revenue, and with this addition, we expect about 1/3 of our revenue from those product lines.

Forkardt sells specialty workholding products globally, with about 1/3 of their revenue in 2012 in North America and most of the remaining revenue in Europe.

Forkardt has a broad product line and has engineered and produced more than 100,000 specialty products in addition to its base of standard products. Almost 60% of their sales are for custom design and manufactured solutions. They also have a strong reputation for their on-site repair services and highly-skilled technicians.

The culture of the organization is similar to ours and we are expecting a smooth integration. We will be operating this business separate and distinct from our machine tool operations as many customers and relationships are with other machine tool manufacturers.

Bill Sepanik, who is Group General Manager of Forkardt, has been appointed Vice President of Forkardt and will continue to manage the operations, reporting directly to me.

This acquisition, along with the acquisition of Usach late last year, are consistent with our strategic direction to provide unique custom solutions for our global customers.

With that, let's turn to Slide 10 and discuss what we are seeing in our markets.

We experienced a sequential uptick in orders from all regions in the first quarter. Following a particularly weak fourth quarter of 2012, total orders increased by 15% to $67 million, although orders were down by 18% when compared with last year's first quarter.

In North America, activity appears to be steady as our distributors have indicated they expect 2013 to fairly well replicate 2012.

In Asia, as I mentioned earlier, we are seeing what appeared to be a return to increasing economic growth. We expect by the end of this quarter we will have a better handle on where this market can go for 2013.

The sequential uptick in Europe was a pleasant surprise as that region continues to be slow as they deal with the recessionary environment. This has now hit Germany, as I noted earlier. We don't expect Europe to be a strong market for the foreseeable future.

On Slide 11 is the most recent global machine tool consumption outlook as estimated by Oxford Economics, published in their Spring 2013 Global Machine Tool Outlook Report. They have revised their global growth outlook for 2013 down to 2%. In 2014, they are forecasting machine tool consumption to increase globally by 10%. What is also important to us, since 30% of our sales are from China, they're expecting growth in that region of 14% and 15% in 2013 and 2014, respectively. Oxford expects global machine tool consumption to increase to over $120 billion in 2016 from $89 billion in 2012. That represents an 8% compound annual growth rate.

Asia is expected to be the leading growth region, with total consumption of over $85 billion in 2016, more than the previous cycle's total world peak of $74 billion in 2008 and representing a 10% CAGR.

In conclusion, on Slide 12, I will recap our outlook. Our long-term outlook for the machine tool industry remains positive, but the subdued order levels over the last few quarters and our current backlog levels point to a weak first half of 2013. We continue to expect the organic sales in 2013 to be lower than what we reported for 2012, but the incremental sales from Usach and the strong backlog they have and the addition of Forkardt will offset part of that decline.

Excluding Usach's backlog, grinding machine sales will be down for the year as orders throughout the second half of last year were very light. And as you know, grinding machines have a 6- to 9-month lead time.

Product development is a focus of ours and helps us continue to be a go-to choice when our customers need machines, workholding products and accessories, which are capable of increasingly complex applications where high challenges [ph] are required. The 7 machines exhibited at CIMT each represented advancements in machining solutions for our customers.

On the productivity front, we have progressed with a rollout of our HIPEx operational excellence program in the first quarter and will continue to educate our team on how to drive the long-term returns associated with improved productivity and efficiency. The continued success and growth of Hardinge relies on our company-wide value system, which creates a culture of success and individual accountability through coordination, development and ongoing improvement at every level of the company.

So with that now, Diego, we'd now like to open the call for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Rob Kosowsky with Sidoti.

Robert A. Kosowsky - Sidoti & Company, LLC

Regarding the breakdown of Forkardt acquisition, can you just tell me what the cash and the debt will be?

Edward J. Gaio

Yes. The cash was $10 million and $24 million in borrowings.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. And then Steve, you mentioned it was $47 million of revenue breakdown over 2012. Is this kind of expected rate we would expect from Forkardt or would you translate some of those sales to perhaps something that you do now and that we can see a little bit of a decrease in that?

Richard L. Simons

No, we don't see any overlap with our products with them. As a matter of fact, we see opportunities to cross-sell some of our products. On the other hand, certainly, the market, they do go with manufacturing cycles. And as I went through region-by-region, there are areas of softness, certainly, in Europe. And of course, keep in mind, obviously, we're only going to own them for effectively half a year.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. So that would translate to kind of, let's say, $47 million over 4 -- or perhaps, maybe a little bit more over 4 quarters, correct?

Richard L. Simons

Well, again, I think right now with the softness in Europe, I think a 4-quarter rate might be slightly less than that.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. All right. And then you mentioned positive momentum in Asia, with sales in Asia at $21 million. Last year, it was about $31 million. So do you expect this quarter was kind of at the lower end and things will pick up from here?

Richard L. Simons

We think the orders are picking up. Now, obviously, sales will lag by a quarter or so. But certainly, we have seen stronger order activity so far this year, in China, specifically.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. And you did mention North America, kind of the run rate and orders to be expected and possibly grow?

Richard L. Simons

Yes, we believe that.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. And just one thing about your tax rate. I assume there might have been some -- a little bit of a prepayment this quarter. Anything you can add on it? It's averaging about, what was it, 7.7% last year. What can we expect on the tax rate?

Edward J. Gaio

Yes. As you might expect, tax rate is complicated based upon the earnings around the world by country. But I would expect 10% to 12% tax rate for 2013.

Operator

[Operator instructions] Our next question comes from John Deysher with Pinnacle.

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

I guess a couple of questions on the acquisition. You're suggesting that sales might be below the $47 million that they booked in 2012. Let's assume they're 10% or 15% lower. I'm just trying to get a handle in terms of what kind of EBIT margins this business is capable of earning on a lower sales level.

Richard L. Simons

I mean, I think your number is probably correct. I would say nearly 10% down. But certainly on an EBIT level, we're looking at double-digit EBIT returns, certainly mid-teens -- mid-to-low teens EBITDA returns.

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

Okay. What would the EBIT margin be, Rick? Not EBITDA?

Richard L. Simons

Probably right around 10%, I would guess.

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

10%, okay. So 10% on a sales base of -- for down 10%, $42 million or so. Okay, that's not bad. Do you plan to segment out those results in the financial statements since it...?

Richard L. Simons

No, we don't at this point, John, but we'll continue to look at that.

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

Okay, good. Then finally, how did this deal fall into your basket? I mean, could you give us a little background in terms of the sourcing of the deal and how it all unfolded?

Richard L. Simons

Actually, this is a company that we've known about and considered for a long time. And obviously, it's part of ITW. And we knew that they had bought a couple of chuck companies over the past 2 decades for that matter. And it's always been one that we had always talked about. We had actually contacted them years ago, looking to see if they were looking to divest it. The lead this time came through one of our Board members that happened to have a relationship with a customer of theirs and had heard that ITW was considering divesting the company. And our understanding is they have been doing that with a lot of their smaller companies. So as always, we know people in the industry and some of our Board members are in the industry and so on, so we tend to hear about these things when they're available.

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

All right, that makes sense. Would you know if there were any other bidders?

Richard L. Simons

Yes, there were other bidders.

John Eric Deysher - Bertolet Capital Trust - Pinnacle Value Fund

There were other bidders, okay. Strategic or financial, or do you know?

Richard L. Simons

I don't know, John.

Operator

[Operator Instructions] There appear to be no further questions at this time. I'll turn it back to management for closing remarks. Thank you.

Richard L. Simons

Thank you, Diego. To close, I'd like to thank you, all, for joining us for our first quarter 2013 financial and business review, and we look forward to updating you on our second quarter results in August. Thank you and have a good day.

Operator

Thank you. This concludes today's conference. All the parties may disconnect.

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