Hillenbrand Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: Hillenbrand, Inc. (HI)

Hillenbrand (NYSE:HI)

Q3 2013 Earnings Call

August 06, 2013 8:00 am ET


Chris Gordon - Director of Investor Relations

Kenneth A. Camp - Chief Executive Officer, President, Director, Chairman of K-Tron International and Chief Executive Officer of K-Tron International

Cynthia L. Lucchese - Chief Financial Officer and Senior Vice President

Joe A. Raver - Senior Vice President and President of Process Equipment Group


Daniel Moore - CJS Securities, Inc.


Good day, ladies and gentlemen, and welcome to the Hillenbrand Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. I'd now like to turn the conference over to your host, Mr. Chris Gordon, Director of Investor Relations. Please go ahead.

Chris Gordon

Thank you, Ally, and good morning. Welcome to our earnings call for the third quarter of fiscal 2013, which ended on June 30. After the market closed yesterday, we issued our earnings press release and filed our 10-Q for the fiscal third quarter. Both of these documents are available on our website. With me on today's call are Hillenbrand President and Chief Executive Officer, Ken Camp; and Chief Financial Officer, Cindy Lucchese.

Some of the information you will your today will consist of forward-looking statements within the Safe Harbor provisions of the securities laws. These statements are not guarantees of future performance, and our actual results could differ materially from what is presented in any forward-looking statements. Please see our latest Form 10-Q filed with the SEC for a more in-depth discussion of forward-looking statements and the risks and other factors that could affect them.

During the course of the call, we will be discussing certain non-GAAP operating performance measures. For more information on those measures and their reconciliation to GAAP financial measures, we refer you to our earnings press release and our Form 10-Q on the Investor Relations tab of our website at www.hillenbrand.com.

Now let me provide some information regarding our call. We've scheduled one hour, and we'll start with prepared remarks from Ken and Cindy that should last approximately 20 minutes. Ken will start with an overview of the business for the past quarter and Cindy will follow with financial results, and then Ken will wrap up the prepared portion of the call with some closing comments. After that, we'll move directly to Q&A where we'll be joined by Process Equipment Group President Joe Raver and Batesville President Kim Ryan. If you have follow-up questions after the call has ended, please feel free to call me at (812) 931-5001 or email me at chris.gordon@hillenbrand.com.

Now it's my pleasure to turn the call over to Ken Camp, Hillenbrand's President and Chief Executive Officer. Ken?

Kenneth A. Camp

Thanks, Chris, and good morning, everyone. We appreciate you joining us today.

As many of you know, we started our journey as a separate public company a bit more than 5 years ago after the spin-off from our previous parent company. At the time, our sole business was Batesville Casket Company, the leader in the North American funeral products business. That business was and still is characterized by a terrific brand, substantial profit margins, robust cash flow and very valuable core competencies. The funeral products industry had minimum volatility. It was also characterized by a slow, but steady, increase in the rate of cremations. Over time, these conditions led to excess industry capacity and resulting price competition, circumstances that we expect to continue.

It became clear to us that these conditions require that we diversify into new areas, which had industry characteristics with greater growth opportunities. The strategy we created was to leverage our strong financial foundation and our exportable core competencies to deliver sustainable growth and long-term value for our shareholders. Starting with the acquisition of K-Tron in 2010, we have used Batesville's strong cash flow and invested it in good businesses we can make even better by effectively leveraging those core competencies.

At the outset, we recognized that the task of transformation wouldn't be easy, and it was obvious that we would be on a steep learning curve about new industries and doing business in new parts of the world. We added new talent at the executive and board levels to bolster the critical skills that we just didn't have. Perhaps most exciting, although not necessarily in a positive way, we embarked on this journey just weeks before the beginning of the 2008 economic crash. Despite the challenging times, the results have been very positive. Over the ensuing 5 years, we've grown revenue at a 25% compound annual growth rate.

At the beginning, only a few percent of our revenue came from outside North America, and 100% of it came from funeral products. This year, we expect that nearly half of our revenue will come from outside North America and 2/3 of it will come from our Process Equipment Group platform. In our most recent quarter, consolidated revenue increased more than 70% with both Batesville and Process Equipment Group platforms growing over the last year. We also had respectable increases on the bottom line with adjusted EBITDA up over 40% and adjusted earnings per share 30% higher than last year.

In addition to making 3 high-quality acquisitions since 2008, we've invested cash in positioning our operating companies to grow in new markets, preparing these businesses for successful expansion into new geographies and new customer segments. These growth investments, along with the cost of acquisition, have put some downward pressure on near-term earnings but are preparing us for greater future earnings and cash generation.

I'd like to spend just a few minutes updating you on the strategy of our newest and now largest business platform, the Process Equipment Group. The secret sauce in this segment is the ability to use our industry-leading applications expertise, along with core technologies, to improve mission-critical processes for our customers. The industries we serve, plastics, energy, food, minerals, chemicals, are not only diversified but have attractive near- and long-term growth prospects as they are geared toward responding to the needs of a growing world population and the resulting expanding middle class in a growing number of geographies.

Our strategy is to expand globally, penetrate underserved end markets and grow on both the top and bottom lines through the application of Lean principles and practices. The strategy is, of course, accelerated by our recent acquisition of Coperion. The continuing integration of Coperion and K-Tron is enabling K-Tron products to be specified on Coperion projects and the ability to use the worldwide Coperion network of parts and service facilities, which is enabling other Process Equipment businesses to expand more quickly and at lower costs.

Throughout the Process Equipment Group, we've made good progress in improving results through their developing Lean skills. Coperion is progressing up the learning curve, and they're focusing on a number of key Lean projects aimed at higher on-time delivery rates, increased first fast yield, procurement savings and other waste elimination projects, all elements that will increase gross margins in the future. The remainder of the Process Equipment Group continues to focus on Lean projects that are based on improving their existing processes, lowering costs and shortening the time from the initial quote to on-time delivery.

As many of you know, the Lean journey is never ending, and we're willing to go slow at the outset to enable each of our companies to go faster later. That said, we're very pleased with the early results from our efforts, and we see improvements in both the gross profit percentage and the operating expense ratio.

Turning now to a brief summary of the results for the quarter. Cindy Lucchese will cover things in much greater detail in a few minutes. With the acquisition of Coperion, the Process Equipment Group delivered strong revenue growth, increasing more than 180% over the third quarter of last year. Additionally, and very importantly, due to increased bookings in the quarter, backlog grew 5% sequentially to over $500 million. Coperion results are in line with our expectations, and we remain very encouraged by the growth in their order pipeline. As mentioned a moment ago, this is having a synergistic effect for us since K-Tron equipment is already being included in their quotes.

For the remainder of the Process Equipment Group, excluding capital equipment related to proppants or frac sand, revenue grew 11% versus the prior year. This was primarily driven by solid growth in our global parts and service business and increased sales in China for both Rotex and TerraSource.

A quick note on frac-ing equipment business is in order. As you may recall from our previous calls, 2012 was a super heated year for our Rotex equipment sold to producers of frac-ing proppants. It almost felt like the gold rush days with especially strong quarters in the second half of 2012. As expected, this yielded a sharp reduction in demand for that line of equipment as we entered 2013. Although this product line represents only a few percent of the Process Equipment Group revenue, it nonetheless created a bit of a hole with the sharp downturn. Although we will continue to see a reduced year-over-year demand in the fourth quarter of this year related to the proppants, we remain very bullish on the frac-ing business in the future.

In addition to the challenges we faced in the proppants industry, we've also seen a general tentativeness in the market that has led to some longer decision cycles on some projects, especially in Europe and Asia. Despite this uncertainty, we also remain optimistic for our non-Coperion Process Equipment Group companies as we're seeing an increase in our order pipeline for customer quotes over the past few months. We've also seen the order intake or bookings trend up during recent weeks. While it's difficult to say with just a few stronger weeks under our belt, it seems like market confidence in Europe and Asia are showing some signs of potential improvement.

Now for a couple of brief words on Batesville. The strategy for the Batesville platform is to leverage its industry leadership position and its advanced expertise in Lean to continue to provide both cash, earnings and talent for the company's expansion efforts.

Looking at their third quarter performance, Kim Ryan and her team have again turned in very solid results with revenue increasing about 1.5% and a significant improvement in their gross margin percentage. Much of their performance is due to the great work on structural changes that they put into place over the last 12 to 18 months in efforts to rightsize their organization, to maintain market position, improve mix and generate increased bottom line results.

As we think about the longer-term trends for Batesville, health care continues to improve and people are living longer, thank goodness for us all. And while these demographics of an aging generation of baby boomers are expected to be a factor in the future, it's just impossible to predict with any measure of certainty what's in store in the near term for the North American death rate.

As the funeral industry continues to evolve, Batesville will be as lean and flexible as possible to continue generating solid financial results for Hillenbrand. A previous Hillenbrand Chairman used to tell me fairly often when I was the CEO of Batesville, that it was a finely tuned humming machine. I don't think he necessarily took into account how hard everyone in that company paddle beneath the surface to make it look calm and steady, and my compliments to that team for the things that they do in a very challenging marketplace.

Now I'll turn the call over to our CFO, Cindy Lucchese. Cindy?

Cynthia L. Lucchese

Thank you, Ken. We're pleased with the performance of both our business platforms this quarter. Revenue exceeded $400 million, which is a record high for us, by the way, and grew more than 70% year-over-year, and we saw a nice growth at the bottom line, too. Adjusted EBITDA grew 43% to $64 million, and adjusted net income increased more than 30% to $30 million or $0.48 per share.

The 72% revenue growth was largely due to the strong performance of the Process Equipment Group. Their revenue grew more than 180% to $261 million, driven by the acquisition of Coperion. And if you exclude the impact of frac sand, the non-Coperion portion of the group saw nice growth in the quarter, an increase of 11% year-over-year. Including the impact of frac sand, this group declined 2%.

And as Ken just mentioned, Batesville had a solid quarter once again, and their revenue was growing. It grew 2% to $148 million. This has been a good year for Batesville with the number of deaths in North America returning to more normal historical levels. And quarterly revenue growth was driven by an increase in the average selling price, offset in part by decreased volume as the burial market reverted to normal historical declines.

Turning to margins. Our gross margin percentage for the third quarter was 33% or a bit more than 35% on an adjusted basis, and this is versus 38.1% or 38.6% on an adjusted basis in the prior year. Now let me start by saying that everyone across-the-board improved this metric year-over-year, and most notable was the 450-basis-point increase at Batesville as the actions taken by Kim and her team to rightsize the organization, coupled with more normal volumes, resulted in a gross margin percentage of nearly 40%. So while everyone improved year-over-year, our actual overall gross margin percentage declined due to the impact of Coperion's lower margins relative to the rest of Hillenbrand. You can also see that impact in the Process Equipment Group as their percentage decreased to 29.3% or 32.5% on an adjusted basis.

Now although we discussed this on every call, I feel it's important to continue to explain how Coperion has changed our gross margin and EBITDA percentages. The Coperion business model includes large system projects, where their strong application and processing engineering expertise is used to create an entire system for customers. These projects include Coperion manufactured proprietary equipment, such as extruders and compounders, as well as components manufactured by third party, such as gears and motors.

Coperion earns attractive gross margin percentages, similar to the rest of the Process Equipment Group, in fact, on their proprietary equipment and replacement parts and service. And combined, that represents about 2/3 of their revenue. The other third of their revenue is generated from third-party-sourced products that carry only a small upcharge, resulting in low single-digit gross margin percentages on these products. As a result, adjusted gross margin percentages for Coperion, overall, had been in the mid to high 20% range.

So factoring in the impact of Coperion, adjusted gross margin percentages for the Process Equipment Group are expected to be in the low-30% range. Now we do expect these percentages to increase over time as the integration of Coperion continues and Lean business practices become fully implemented.

Our adjusted effective tax rate this quarter was 30% compared to 29.1% in the prior year, and our 2012 rate was favorably impacted by the release of some tax accrual.

Operating cash flow was $51 million year-to-date compared to $110 million last year. The decrease is primarily due to the same situation we discussed in the last earnings call, our investment in Coperion's net working capital, along with about $14 million of acquisition costs related to Coperion and about $13 million more in payments to fund pension plans, along with $5 million of payments related to antitrust litigations earlier this year.

So I'd like to remind you about the working capital requirements for Coperion. They've historically ranged from an optimal negative working capital position, where cash received from customers is more heavily weighted towards the beginning of the projects, to our current position, where a larger portion of the cash will be received in later stages of manufacturing. Certain projects now underway at Coperion have payment schedules where a large portion of the cash will be received in later stages of manufacturing.

Now we do expect Coperion's working capital to fluctuate in the future based on the mix of projects and process at any point in time, and we think it's unlikely that additional significant working capital investments will be required for the remainder of the year. It's also important to note that Coperion's working capital balance has remained at about the same level that it was last quarter.

Another important use of cash is the payment of dividends to shareholders. And to date this year, we've returned nearly $37 million to Hillenbrand shareholders in the form of quarterly dividend.

Turning to bottom line results for the quarter. Net income decreased 38% to $13 million with earnings per share of $0.21. The decrease was driven by the costs associated with the Coperion acquisition. On an adjusted basis, net income increased 32% to $30 million with earnings per share of $0.48. Also, the prior year benefited by about $1 million of gains for a limited partnership investments, and it does include $3 million of additional recurring amortization expense related to Coperion.

Adjusted EBITDA increased 43% to $64 million. And this is an important measure we use to monitor our ongoing operations -- operating performance because it removes the impact of amortization and interest, which naturally results from our acquisition strategy. Adjusted EBITDA, as a percentage of revenue for Hillenbrand overall, was 15.6% versus 18.8% last year, and the decline was expected and it results from the Coperion's business model, as I discussed earlier. Coperion's adjusted EBITDA, as a percentage of revenue, has been about 9% compared to the higher margins in the rest of our business. And again, our overall adjusted EBITDA percentage is expected to increase over time as the integration of Coperion continues and Lean business practices become fully implemented.

Turning to guidance. We are reaffirming the guidance we shared with you in early December. We continue to expect 2013 global revenue to be approximately $1.6 billion and adjusted diluted EPS to be in the range of $1.82 to $1.92 with the midpoint of $1.87. We also expect the Process Equipment Group to deliver about $1 billion in revenue and Batesville about $600 million in revenue. The fourth quarter will be our largest from both a revenue and earnings perspective due to the performance of the Process Equipment Group overall based on our visibility into backlog.

And just a quick note, as you know, our non-Coperion Process Equipment Group can experience occasional lumpiness from large orders moving through a particular quarter. We experienced that last year in the fourth quarter. It was the biggest ever for that group. And in addition, we still have some revenue from frac sand equipment. So as a result, we expect the non-Coperion Process Equipment Group to perform below the prior year in Q4.

Now I'll turn the call back to Ken for his concluding remarks. Ken?

Kenneth A. Camp

Thanks, Cindy. As many of you may know, this is my last earnings call as CEO. I will be turning the chair over to Joe Raver on September 6 as part of our long-planned transition schedule, and I will be retiring from the company as of December 31.

And as I reflect on -- upon our transformation over the past 5 years, in my view, it's truly remarkable. We began as a well-known, market-leading casket company in an industry with relatively limited growth prospects. Most of our then $650 million in revenue came from the U.S. and Canada. And today, we're a global diversified industrial company and have more than doubled our revenue, and I believe the journey has just begun.

We now have a solid foundation upon which to build our Process Equipment platform with its attractive fundamentals and multiple pathways for growth and our Batesville platform with its steady and reliable cash flow and a great source of leadership talent that will continue to support and fund our growth strategy. In short, going forward, you will have a great team, a great strategy and great talented leadership for the future. I have to say I'm personally more excited than ever about our company's prospects for the future and the growth and value this effort will bring to our shareholders.

And I guess in summary, if you are a Hillenbrand shareholder, you should be very encouraged about your company's future. If you're not a shareholder, you should be.

Now for the Q&A session, we'll be joined today by Batesville President Kim Ryan and Process Equipment Group President Joe Raver, who is officially now back to Batesville after his 2-year stint leading our businesses from Europe.

Ally, we're ready to take questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from Daniel Moore of CJS Securities.

Daniel Moore - CJS Securities, Inc.

First off, Ken, congratulations, not only on a good quarter, but obviously on the transformations taking place over the last few years. Also wanted to ask the -- Cindy, one of the things impacting GAAP earnings this year is the big increase in amortization expense. Do you have a -- give us a sense or picture of what amortization expense should look like in fiscal '14 and going forward.

Cynthia L. Lucchese

Yes, Dan, absolutely. You should expect it to be around $25 million on an ongoing basis. But what we saw this year, clearly, we had the backlog amortization and the inventory step-up, which has added, so far, about 55 -- or add about $56 million for this year. But on an ongoing basis, you should expect about $25 million.

Daniel Moore - CJS Securities, Inc.

Perfect. And you mentioned bookings, obviously, increased and some increased activity. Can you talk about whether it's K-Tron or Rotex or Coperion driving that or both, and what end markets are driving the increased order activity over the last few weeks?

Joe A. Raver

Dan, this is Joe. We saw bookings up kind of across-the-board. I'll tell you, we've had strong spare parts business. And so both in the mining businesses, the power business, as well as Rotex, we've had strong spare parts business. And we've seen -- for a long time, we saw very few $500,000-and-up projects, particularly on the K-Tron side of the business. We've seen increasing quotes in that category of projects, so these are kind of small system projects. And so we've seen uptick in bookings there as well. So generally, a strong parts business and then those somewhat medium-sized orders for the K-Tron business have grown as well.

Daniel Moore - CJS Securities, Inc.

And lastly, one of the areas that had been a little bit more mixed recently is potash as well. Talk about what you're seeing in that end market. And with some of the discussion around breakup of a cartel, what you think could the effect be, positive, negative or impact in the short to medium term?

Joe A. Raver

That's a great question, and there has been just -- for the last 6 months, there's been a lot of positioning in news in this industry. And as you know, over the last few days, it's been especially fast and furious in terms of comments from some of the larger potash producers. We're still working through what that means. We've seen some delays in projects this year that have pushed out into '14 and '15. We expect though that regardless of the outcome, that will -- many of those projects will move forward. I think the question is, over the longer run, what happens with prices? And with lower prices, does demand go up? And that would actually lead to more equipment being sold as demand from -- for potash around the world goes up. The other is there's a lot of speculation as to whether new mines will go into production or not, and so there's a lot of moving parts here. But we feel pretty good about the potash business in late '14, '15. It's a little bit harder to see the impact of all this, though, further out than that.


[Operator Instructions] Our next question is a follow-up from Daniel Moore of CJS securities.

Daniel Moore - CJS Securities, Inc.

So talk a little bit about -- obviously, you saw a -- one of the things that we looked at in the first half of the year was a little bit disappointing, cash from operations. That improved in the quarter. What are your expectations for the full year? If you might share those with us, Cindy.

Cynthia L. Lucchese

Sure. Well, obviously, this year, in particular, with the Coperion acquisition, we have a lot of uses for the cash. We had $30 million of cash flow in the quarter, and we would expect to do that or better in the fourth quarter. And also, one thing I'll mention, I mentioned it in my script, we had a big pension payment of $15 million this quarter. We certainly don't expect that to repeat in Q4.

Daniel Moore - CJS Securities, Inc.

Very good. And the backlog increased about 5%. Can you -- you talked about some of the end markets, Joe, but maybe break that out between the Coperion and K-Tron and Rotex and what your expectations for growth are within the segments.

Joe A. Raver

Sure. We saw backlog -- a nice increase in backlog in this quarter, and that was largely due to strong orders at Coperion. We've seen backlog in the other Process Equipment Group companies decline on a sequential basis just a bit. And so we expect that to continue into the fourth quarter and then turn around in early 2014, where we'll continue to see, we believe, strong orders on the Coperion side and then stronger orders on the Process Equipment Group, excluding Coperion, those businesses as well.

Daniel Moore - CJS Securities, Inc.

Very good. And maybe I'll take a step back and move up to 20,000 feet. One of the key strategic opportunities for the Coperion acquisition was looking at a potential manufacturing renaissance in North America long term. What can -- or are you doing at this stage to drive that and be ready for that? And I know it's early, but when would you expect to start to see some benefit of that type of opportunity?

Joe A. Raver

Dan, we have -- we will first see the benefits of the shale gas revolution in the United States in the Coperion business. So we'll start to see increasing orders or expectations as we start to see increasing orders for large base resins plants in North America. These will utilize our big extrusion systems, as well as our material handling systems. We've seen -- as we've talked about in the past, there are a number of projects in the U.S. by large customers. We feel good about our prospects regarding those projects. And so that's the first place that we'll see the impact of the shale gas revolution in the U.S. Then over time, that will churn. We expect that to turn into more compounding business as more engineered plastics are made locally. And then that in turn should lower cost to help manufacturing, both from an energy perspective, but also from a input cost perspective in the U.S. So right now, we've seen good activity on a number of the base resins plants in United States and remain very optimistic about our potential there over the next few quarters to book some relatively large deals.

Daniel Moore - CJS Securities, Inc.

And not -- obviously, not pinning you down the guidance. But based on those -- if those orders come through in the next few quarters, would the initial revenue impact be '15 or maybe slightly beyond that?

Joe A. Raver

I think those kinds of orders are about 5 quarters out, so they're 4 or 5 quarters out. So if we book these in the fourth quarter, they're at the very end of '14 and 2015 as when those will be delivered. The other comment that is -- that's a little bit different with the Coperion business, we'll start to see revenue from those earlier, though, because we use percentage -- or they use percentage of completion accounting. So we'll start to see revenue faster even though the equipment isn't delivered for another 4 or 5 quarters. So just as reminder, that' different than the rest of our Process Equipment business where we don't use percentage of completion accounting.


And with no further questions at this time, I would like to turn the conference back over to Mr. Chris Gordon for any closing remarks.

Chris Gordon

Once again, thank you for joining us today. A quick note on some upcoming events. We will be in New York on August 14, presenting at the industrial conference hosted by Jefferies & Company. And additionally, as part of our 5-year anniversary, we are ringing the closing bell on the New York Stock Exchange on Friday, August 23. Please check our website for more information about these events, and we hope to see some of you in New York. Our next quarterly earnings call will be in November when we will discuss our fourth quarter and full year results.

Have a good rest of the day, everyone.


Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day.

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