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Hardinge (NASDAQ:HDNG)

Q3 2013 Earnings Call

November 07, 2013 11:00 am ET

Executives

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

Edward J. Gaio - Chief Financial Officer and Vice President

Analysts

Les Sulewski - Sidoti & Company, LLC

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

Operator

Greetings, and welcome to the Hardinge Inc. Third 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, Garret Goff [ph], Investor Relations for Hardinge Inc. Thank you Mr. Goff [ph], you may begin.

Unknown Executive

Thank you, David, and good morning, everyone. We appreciate your interest in Hardinge. On the call with me today, I have Rick Simons, Chairman, President and CEO; and Ed Gaio, Vice President and CFO. Rick and Ed will review the third quarter results 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 that at the company's website, www.hardinge.com. You will also find on our website slides that accompany the discussion to which Ed and Rick will be referring.

As you look that at the slide deck, on Slide 2, you'll find our Safe Harbor statement. As you are aware, we may make some forward-looking statements during the formal discussion, 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 the earnings release, as well as the other documents filed by the company with the SEC. These documents can be found on the company's website or at the sec.gov.

With that, let me turn it over to you, Rick.

Richard L. Simons

Thank you, Garret [ph]. Good morning, everyone, and thank you for joining us today. Let me start by saying that our quarter results are pretty straightforward and came in as we expected, with the exception of the tax rate, which Ed will explain later.

Revenue from our acquisitions offset the softness in our organic business. Gross margin was within our normal range influenced by product mix and spending was in line with our plan. We generated $6.4 million in cash from operations and paid down $10 million of debt during the quarter.

Please turn to Slide 3, and I'll provide some color on our sales. Sales of $82.3 million, included $10.5 million of sales from the acquired businesses. Sales from Forkardt, Usach offset lower organic sales, which was expected given the level of orders we've seen over the last year or so, as the uncertainty in the macroeconomic environment has reduced capital investments in manufacturing.

We have seen demand trend upward over the last couple of quarters for our products in Asia, specifically, China. Despite the daily mix messages about their economy, our organization in China has found the pockets of activity where investments are being made. We continue to believe that market will present strong growth opportunities for us over the long term.

The worst appears to be behind us in Europe. Base business sales there have improved somewhat over the year, while Forkardt has added to the trend. Organic sales in North America have been softer moving throughout the year. We believe sales have been influenced negatively by inventory management by our distribution network, but this has stabilized. Forkardt has also been been a strong addition for us in this market.

As you will note on the slide, although the mix between regions can modulate over time, we believe our global exposure helps to reduce the impact of economic changes within specific region. Before I turn the call over to Ed, I'd like to update you on the progress we've made on the integration of the Forkardt operations, which we acquired in May. Recall that Forkardt is a workholding business headquartered in Michigan with operations in Europe and a sales office in China.

Culturally, our organizations have come together very nicely, which I believe is one of the most important criteria for a successful acquisition. We have been sharing knowledge of best practices to improve service and broaden solutions for our customers. As you can see in our results, financially, this is a good strategic fit for Hardinge, supporting profitability and reducing volatility as orders tend to be less cyclical and less volatile from quarter to quarter.

We are very pleased with our progress thus far. With that, I'll turn it over to Ed, who will provide more details on our operating financial results for the third quarter.

Edward J. Gaio

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

Adjusted gross margin for the third quarter was 28.5% after being adjusted for $400,000 inventory valuation step-up associated with the Forkardt acquisition. This represents a decrease of 0.4 percentage points from last year's third quarter, due to a less favorable product mix.

When compared with the trailing quarter, adjusted gross margin decreased by 1.4 percentage points due to product mix. Our expectations are that gross margins would continue to be around 29%, plus or minus a point, highly dependent upon product mix.

If you turn to Slide 5, you can see that our adjusted operating margin was 4.5% for the quarter, which excludes $300,000 of acquisition transaction expenses and the $400,000 inventory step-up charge I just mentioned. That reflects the decline of 1.9 percentage points from the prior year quarter and 1.3 percentage points from the trailing quarter.

$3.7 million of SG&A expenses of the acquired businesses were partially offset by savings of approximately $1.5 million from the restructuring of our U.K. sales organization, which we completed in the first quarter.

We continue to expect SG&A to be in the range of $20 million to $21 million per quarter. With that said, variable expenses associated with the high projected fourth quarter sales volume could take it just outside that range for the fourth quarter.

Slide 6 shows adjusted net income for the quarter of $2.4 million or $0.20 per diluted share, excluding the acquisition-related expenses, the inventory step-up charges and the discrete tax charge related to a change in Swiss tax rates. This quarter's tax rate was higher than usual, at 44%, compared with 21% last year. The change in rate in Switzerland and necessary-related adjustments impacted the tax rate by 7 percentage points, while geographic mix and interim tax accounting rules also had a sizable impact, as well.

We now expect the tax rate for the full year of 2013 to be in the range of 18% to 20%, as a heavier weighting of income from the United States should result in a lower effective fourth quarter tax rate.

On Slide 7, we provide some key metrics that we track to evaluate our working capital management. The trends, we believe, are a strong indication of the success of our efforts to restructure our business model to improve cash flow.

In general, our industry requires high levels of inventory in order to be responsive to customers' need. So there are higher levels of working capital compared with other industries. We differentiate ourselves from our competition through our ability to deliver high-quality product within our customers' time requirement while driving cash generation through our productivity initiatives and inventory management processes.

Our working capital as a percent of sales of 42% is up slightly from 2012, but remains well below historical levels. Our inventory turned up 1.8x are at the upper quartile performance, well above the industry.

We managed receivable days outstanding below 60 and we continue to carefully manage our receivables.

Turning to Slide 8. You can see some metrics demonstrating the strength of our balance sheet. Operating free cash flow for the third quarter was $5.8 million, as our inventory management and timing of customer payments has a favorable impact on operating cash flow. During the third quarter, we paid down $10 million of debt and our debt level now stands at $37.2 million or 18% of total capitalization.

Capital expenditures in the first 9 months of 2013 were $2.2 million, and we now expect to have capital expenditures of approximately $4 million for the full year.

That concludes my remarks. And, I'll now turn the call back to Rick.

Richard L. Simons

Thanks, Ed. Please turn to Slide 9 where I'll discuss what we are currently seeing in our end markets.

Our orders in Europe improved sequentially and year-over-year as the economic improvements in Europe helped our base business and we had incremental orders from the acquired Forkardt business. In September, I attended the 2013 EMO Machine Tool Show in Hannover, Germany. Over a 6-day span, EMO featured over 2,100 exhibitors in nearly 2 million square feet of space and attracted 145,000 attendees from around the globe. Attendance from Europe was reported to have increased significantly this year and the high levels of interest in activity at EMO confirms our perspective that Europe has stabilized and is in fact showing signs of life.

North American and Asian orders were fairly comparable to prior year period while down from the trailing quarter. In Asia, unusually hot summer weather in China caused work stoppages for many of our customers and resulted in lower order levels. I believe that this pause in Asian orders was a temporary one, as we are sensing more robust quoting activity.

North American orders declined from the trailing quarter as our distributors have been selling from inventory but we do believe that channel inventory has cleared and order growth is starting to resume.

On Slide 10, we break out our comparative backlog by product line. Looking back over the periods presented, you can see the change in mix in our backlog, specifically, the addition of workholding parts and accessories from the Forkardt acquisition. There's also about $20 million in the grinding machine backlog that will ship in the fourth quarter from our Usach operation.

Quarterly orders are generally a good predictor of next quarter shipment levels, except when we have an unusual amount of large dollar long-lead time grinding product shipping for backlog as we are this quarter.

Slide 11 shows the summary of the updated Oxford Economics machine tool consumption forecast that was published in October. The overall global market in 2013 is expected to be down by 8%, while 2014 is expected to be up by 5%. Oxford expects that worldwide machine tool consumption will increase at an 8% compound annual growth rate from 2013 through 2017, with Asia experiencing the most growth among regions, largely expansion in China.

The chart provides a relatively steady linear upward progression. In reality, customer confidence about the future of the economy among other things, impacts the timing of investment in capital goods on a yearly, and especially, in China quarterly basis. From what we're seeing in our markets, we do agree with the long-term upward trend in demand by region. We have the capacity to support this demand and we believe we have competitive advantages that enable us to win a greater share of the growth.

We believe we mitigated somewhat the severity of the short-term ups and downs of the capital equipment purchasing cycle through the addition of Forkardt's workholding business and the continued diversity of our sales between the 3 major consuming areas in the world, which has helped us in the past.

Please turn to Slide 12, while I provide an updated outlook for 2013 and our initial impressions about 2014 business conditions. On a consolidated basis for 2013, we continue to expect full year sales to be at a similar level as 2012 sales, which were $334 million. The acquisitions are expected, as you saw in this quarter, to offset most or all of the lower sales from our organic business for the year. The outlook implies a very strong fourth quarter with revenue in the area of $95 million. We can vary by a few million in sales either side of that number based on final customer instructions and logistical issues at the end of December. The quarter will be driven by our expectation of shipment of approximately $20 million from Usach's backlog, as I mentioned earlier.

The order profile and the shipment timing for the Usach business generally includes larger orders that can create a lumpier result from quarter to quarter. We are very positive about the long-term outlook for our business. We have an improved mix of business with less volatile sales from the workholding business and we have a strong market position around the world.

For 2014, we are anticipating and planning for some growth in all regions of the world. In the U.S., continually improving effectiveness of -- by our distributors and selling our products and a steadier flow of orders reflecting a better-tuned ordering and stocking process should generate growth.

In Europe, we're expecting a modest recovery in sales as Western Europe comes out of recession. We expect the first quarter to be lower due to the typical impact of the Lunar New Year holiday shutdowns by our customers and our own factories in China, Taiwan and other Southeastern -- Southeast Asian countries. We then expect momentum to build throughout the year.

We are driving stronger earnings power and stabilization through innovation and sales channel rationalization. We continue to develop new, more advanced products to address the increasingly complex needs of our customers, and we're always working to increase the value we provide to our customers through new product engineering and development effort.

Additionally, the education on our HIPEx Operational Excellence program continue to be rolled out across our global organization and we're excited about -- by the feedback we received on the program from various Hardinge team members around world.

With a focus on individual productivity and efficiency goals at every level could drive long-term results, this program will help each employee understand the importance of their role and empower them to drive improvement in alignment with our strategic goals.

I'd like to thank all of our team members for embracing this initiative, and for their continued hard work to achieve our strategic goals.

With that, David, we'd now like to open the call up for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Les Sulewski from Sidoti & Company.

Les Sulewski - Sidoti & Company, LLC

A question regarding end users, what kind of activity are you seeing in each end market? Any industry stronger than the other?

Richard L. Simons

Well, of course, we end up [ph] going around the world and commenting on that. Here in the United States, certainly, we are seeing some of the large equipment manufacturers, John Deere and Caterpillar, and people like that pulling back on any machine tool acquisitions. And so we don't know how long that's going to go. But that's certainly we're seeing here. On the other side, automotive is fairly strong. Our other major market, if you will, is China. And in China, we actually are seeing the automotive area still generating some good activity for us. But the 3C as we call it, Communications, Computer and Consumer electronics business areas have certainly pulled back some.

Les Sulewski - Sidoti & Company, LLC

And, are you seeing more of the shift to -- on focus to grinding from milling, is that due to -- if so, is that due to higher margin or stronger demand?

Richard L. Simons

That's a good question. I mean, I think, obviously, we are going to ship a bunch out in the fourth quarter for Usach, which is about grinding. But over time, I mean, they are related, it's all machine tools and they're really the same sort of customers that the products are going to. But grinding does tend to be a higher dollar amount and so when people start getting nervous, I think that they pull back on grinding faster than they might pull back on milling and turning where the products are at a lower price point. So I would say, yes, I think in uncertain times, grinding may pull back. I think the timing of it as well is sometimes impacted, because when things turn around again, people kind of hold off on ordering grinding machines until they feel very, very confident, whereas milling and turning they hold off till they're very confident, 1 variance [ph] instead of 2.

Les Sulewski - Sidoti & Company, LLC

Great. And maybe if you could actually kind of go back onto the large order from Usach coming in this first quarter. Was this an order that was acquired with the acquisition or is this something that came in after and...

Richard L. Simons

Yes. If you remember, actually, when we did the acquisition, we commented. We bought it and they had $27 million in backlog. So this is all coming from that original backlog.

Les Sulewski - Sidoti & Company, LLC

Okay, I see. Great. So this is more of a onetime kind of putting that out there and then fully -- more of a breakdown for the remaining years as you go along. Is that so?

Richard L. Simons

Yes. As I've said, they are large dollar items. It was a timing of when customers required the machines. I mean, some of the machines were done ahead of this, but we really have to go by when the customer wants the machines. And so, absolutely, an unusual quarter to have $20 million. We'll over time see it being fairly lumpy, as I say, different from quarter to quarter but this one was extremely unusual.

Edward J. Gaio

Yes. Les, just to be clear, that's not a single order. There's just -- there are several different orders that happen to all be scheduled to ship in the fourth quarter.

Operator

Our next question is from Chris Bamman from Ascendiant Capital.

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

I was curious, can you just repeat, I didn't hear what the weakness in Asia was? You thought it was a onetime issue kind of...

Richard L. Simons

There's -- the temperatures got really hot over there. Of course, they measure in centigrade, 35 to 40, which is effectively is over 100 degrees Fahrenheit. And during July, and actually extending some in the August, it was just so hot that, especially, state-run factories with -- by government decree were shutting down, because it was just too hot for people to work. And it kind of affected everybody over there. So even the people that typically would negotiate an order with it, they were not working. It's actually the hottest July, we understand, in China's -- in 140 years. So it really did affect us over there. And, of course, a lot of factories over there are not air-conditioned, like we're used to here so...

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

And have you seen of that, sort of pick up as we move here into the fourth quarters in September and in October. Have you seen some of that come back?

Richard L. Simons

Our sales organization over there, of course, we're direct in most cases and they certainly has seen that activity pick back up and we're feeling good about the fourth quarter.

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

And just going back to the orders, the weakness that you've experienced in the second half of 2012, has most of that been, all that worked off and starting to look at the pickup in orders that you've got through the first half of the year now?

Richard L. Simons

I'm not sure I understand that one, Chris. Could you...

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

The orders were down in the second and third or fourth quarter of last year.

Richard L. Simons

Oh, last year. Okay.

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

Yes. So has all of that been worked off for the most part?

Richard L. Simons

Yes. I mean, I think that was -- actually back to China, for instance, fourth quarter in China last year was very, very low. It started in the third quarter and as I've said in my script, I mean we've seen an improvement there. I mean people talk about China and all the uncertainty and so on, but we've had a much better year order-wise in China this year than what we had last year because that was very low at the end of the second half. So that's correct that it's up [ph].

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

Okay. And just with regards to North America, have you seen order rates starting to pick up in North America, just given the slow economy, but are you really starting to see just gradual increases sort of moving along with this slow-growth economy?

Richard L. Simons

Yes. I think we have to recognize that the entire machine tool consumption, according to our trade association, is down about 8% year-on-year in North America. So clearly, there is worse conditions this year than last year. But 8%, I mean, meaningful but it's not a tragedy, if you will. But for us, we really have had the impact of -- our distributors did have quite a few machines on the ground at the start of this year and they've been selling those off. Realistically, if you looked at end user purchases of Hardinge equipment, it's been an okay year for them. Actually, probably, a comparable year to the prior year. We just didn't see the benefit of that because they were actually selling machines that we took as sales in the prior year. But United States is a good market still, and although down if you look at the metrics, I think everyone is still feeling this is a good solid market going forward.

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

Okay. And I noticed that you guys sold some stock during the quarter. I was curious to know what you applied [ph] the proceeds for or how you see acquisition pipeline opportunities?

Richard L. Simons

Yes. That clearly -- you hit on it. The reason we're doing it is we want to be -- have our balance sheet ready for other acquisitions. Acquisitions are a strategy of ours. We talked about it. You've seen over the last few years, we've done a couple of acquisitions in grinding. We've done an acquisition in workholding. Our acquisitions, typically, become a bit opportunistic. They end up being privately held companies. Of course, Forkardt came out of ITW. But generally, privately held companies. And when someone is ready to sell, they're kind of ready to sell and we want to have our balance sheet ready to react very, very quickly so that we can do that. So it's an important part of our overall strategic plan.

Operator

[Operator Instructions] Gentlemen, there are no questions at this time. I'd turn it back over to you for closing comments.

Richard L. Simons

Okay. Thank you, David. To close, I'd like to thank you, all, for joining us for this review of our financial and business. We look forward to updating you in February on our fourth quarter and full year 2013 results, and certainly, we will provide an updated outlook for 2014. Thank you, all, for listening and have a good day.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.

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