Blount International Q4 2007 Earnings Call Transcript

Blount International (BLT)

Q4 2007 Earnings Call

March 4, 2008 1:00 pm ET

Executives

James S. Osterman – Chairman of the Board, President & Chief Executive Officer

Calvin E. Jenness – Chief Financial Officer & Senior Vice President

Analysts

Curtis Woodworth – JP Morgan

Dax Vlasss – Gates Capital Management

Peter Lisnic – Robert W. Baird & Co., Inc.

Bob Franklin – Prudential

Presentation

Operator

Good morning and welcome to the Blount International, Inc. teleconference with chairman and chief executive officer Mr. James Osterman and Mr. Calvin Jenness, Senior Vice President and Chief Financial Officer. My name is Terrance and I will be your facilitator today. The conference will begin with a brief overview of the fourth quarter followed by a question and answer session. All lines have been placed on mute to prevent any background noise. (Operator Instructions) At this time I would now like to turn the call over to Mr. Jenness. Mr. Jenness you may begin.

Calvin E. Jenness

Good afternoon everyone. This call is being broadcast live on the Internet and recorded for future transmission and use by Blount and third parties. Participants on the call including the Q&A session agree that their likeness and remarks may be stored and used as part of the earnings call.

Before Jim and I summarize performance, I’d like to remind everybody that the statements made in the course of this conference call regarding the company’s or management’s intentions, hopes, beliefs or expectations for the future are forward-looking statements as defined in the Securities Litigation Reform Act of 1995. These statements involve risk and uncertainties that could cause actual results to differ materially.

Now, I’d like to turn the call over to Jim Osterman our chairman and CEO.

James S. Osterman

Good morning everyone and thank you for joining us to review the results of the 2007 fiscal year. We finished the year on a strong note with both sales and operating income from continuing operations exceeding the guidance that Cal provided to you during the third quarter conference call. Sales for the full year were $515 million and operating income was $80.7 million. These amounts exclude the results of the forestry equipment division which was sold last November. The sale of the forestry equipment business has resulted in a smaller, but I think a much more focused company. The reduction of debt along with the elimination of the exposure caused by the cyclicality of the North America Timber harvesting equipment market will enable us to invest in our world leading brands on a more consistent basis.

We ended the year with under $300 million in debt over $50 million in cash on hand and a net debt leverage to ratio of 2.3 times EBIDTA. This is significant improvement from only four years ago when we had debt and leverage levels of more than double these 2007 year end measurements. Our core business in the outdoor products segment which now represents approximately 94% of the company’s total sales. For fiscal year 2007 the outdoor products segment achieved its fifth consecutive year of record revenues. This record performance was driven by solid growth in larger international markets offsetting a slight decline in domestic revenues. For the full year sales in international markets represented 68% of total segment sales up from 65% in 2006. For the fourth quarter the outdoor products segment recorded good year-over-year sales growth with a 9.6% increase over the fourth quarter of 2006.

Additionally, the segment ended the year with an improved order backlog compared to 2006. The order backlog for the segment was 63.3 million up 15.5% from the previous year end. The fourth quarter sales increase was more broadly based than in previous quarters since domestic sales were up 8% to compliment international growth of 10%. This is a change from the first three quarters of 2007 when we saw segment sales to domestic customers decline by 5% from 2006. The improvement in domestic sales is in part due to the lapping of a weak quarter from a year ago. Additionally, our domestic customers were more responsive to our normal fourth quarter promotional program than in the fourth quarter of 2006. International sales were up in all major markets during the fourth quarter. The strength in international sales in the fourth quarter reflects a weaker dollar which helps us with pricing from a competitive standpoint. We additionally achieved better product availability which allowed us to take advantage of favorable market conditions in Latin America and Europe. About one third of the 10% increase in year-over-year international sales can be attributed to changes in foreign currency exchange rates.

Sales to original equipment manufacturers were up 12% compared to the fourth quarter of 2006 and replacement sales were up 9%. Approximately 24% of fourth quarter segment sales were to OEM’s compared to 27% for the full year. Sales of concrete cutting products were down 3.4% from the previous year’s fourth quarter as weaker market conditions in the United States resulted in an 11% decline in domestic sales. Sales of concrete cutting products in the international markets were strong with a year-over-year growth of 9% recorded in the fourth quarter.

Contribution to operating income for the outdoor products segment was $24.5 million or 19.5% of sales in the fourth quarter of 2007. This is less than the 2006 fourth quarter amount of $26.4 million and 23% of sales. The decline in income and margins is primarily the result of the stronger Canadian and Brazilian currencies compared to the previous year period. The Canadian dollar was 16% stronger in the Brazilian Real was 21% stronger than in the fourth quarter of 2006. The foreign currency impact in the fourth quarter was approximately $2.7 million reduction to the segment contribution due to the effect on those facility’s manufacturing costs. Additional cost pressure on margins was caused by higher transportation cost throughout the year.

In 2008 we are planning another record year of revenue in the outdoor products segment. Segment sales are estimated to increase by between 3% and 4% from 2007 through both volume and selling price increases in certain channels. Market conditions are expected to be stronger in international markets than in the domestic market. Segment profitability will continue to be under pressure from relatively strong foreign currency. Additionally, we have increased our investment in new product development. The new investment consists of the dedicated organization that will focus on product innovation to accelerate revenue growth. Our renewed focus on one product development will be lead by James VanderZanden who has been in charge of the very successful concrete cutting line since its inception. I’m very excited about this new team as their clear mission is to deliver superior innovation to our customers which we expect to enhance on share and profitability in the outdoor products market.

Also, I have streamlined Blount’s organization to reflect smaller revenue base. We have eliminated duplication of certain functions that existed in both the outdoor products segment and corporate staff. This has reduced a number of senior managers and should improve decision making going forward. Now I’d like to turn the call back over to Cal for additional financial highlights. Cal.

Calvin E. Jenness

Let me start with a few comments on the presentation of Blount going forward. As illustrated in our release this morning we will be reporting one operating segment in the future, the outdoor products segment. The rest of the gear components business representing about 6% of our consolidated sales in 2007 will be included in combined corporate overhead expense. The results of the former forestry equipment division have been presented as discontinued operations for all periods reported. In the fourth quarter income from discontinued operations was $8.7 million. This consists of a $26 million gain on the sale of assets, operating loss for the period of ownership and income tax expense. In the fourth quarter we received approximately $67 million in net proceeds from the sale of the forestry equipment division. We estimate that we’ll use approximately $15 million of these proceeds in 2008 to pay income taxes, some outstanding fees and remaining severance amounts. As part of the transaction escrows in aggregate of $8 million were established and are classified as an asset on our balance sheet. The escrow amounts are subject to escrow agreements between Blount and the buyer and have provisions to return the money to Blount within the next three years if not needed for specific purposes.

We finish the year with $297 million debt outstanding down from $350.9 million at the end of 2006. The debt consists of $175 million of 8 7/8% bonds and $122 million of bank debt under our term facility. We had zero drawn on our $150 million revolving credit facility at the end of the year. Cash on hand was $57.6 million at the end of 2007 compared to $27.6 as of December, 2006. EBITDA as defined by our credit agreement was $25.7 million in the fourth quarter and $107.1 million for the full year. This yielded a leverage ratio of debt to EBITDA of 2.82 times and a net leverage ratio of 2.28 times.

In the fourth quarter of 2007 we generated $15.9 million of cash from continuing operations net of cap ex compared to $34 million in the fourth quarter 2006. The decrease is due to an increase in cash taxes paid as the company has fully utilized its available net operating losses during 2007 as well as an increase in fourth quarter inventory in 2007 compared to a reduction in fourth quarter inventories in 2006. The cap ex amounts for the fourth quarter 2007 were $4.8 million compared to $7.1 million in 2006. Full year cap ex was $18.5 million in 2007 compared to $21.7 million in 2006. We continue to make good progress on our pension funding in 2007. The combination of voluntary contributions and the effects of raising the plan up at the start of the year resulted in a slight surplus of the domestic defined benefit pension plan. This compares to the $23.7 million under funding at the end of 2006 and a $58.6 under funding as of the end of 2005.

Our current view for 2008 is that sales will range between $530 million and $540 million reflecting growth of between 3 and 5% from 2007. Our full year estimate for operating income is for between $78 million and $82 million. Profit growth will be limited by continued currency pressure especially in the first half of the year and the additional investment in new product development. As was the case last year, first quarter net income is expected to be the lowest of the year due to the timing of stock compensation expense recognition as well as some severance costs related to the streamlining of the organization that Jim spoke about earlier. We expect full year net income expense to be approximately $27 million and our income tax rate to be between 35% and 37%. Our capital budget for next year is $27.7 million. Cash flow available for debt repayment is expected to be between $25 million and $30 million. This amount includes the outstanding amount owed for the forestry equipment division sale.

I believe that covers all the highlights for the fourth quarter and full year 2007. So, at this time I’d like to open up the line for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Curt Woodworth, JP Morgan.

Curtis Woodworth – JP Morgan

In terms of the foreign exchange and the pretty dramatic impact its having on your cost structure, what percent of your costs are in Canadian dollars or the Brazilian currency? And, what was the fx sensitivity around it in terms of if we wanted to make our own views of where the currencies were going to go this year?

Calvin E. Jenness

A percent, just to give you an idea of the different currencies, a percent strength indicating dollars worth about $600,000 pre-tax.

Curtis Woodworth – JP Morgan

I’m sorry how much?

Calvin E. Jenness

$600,000 pre-tax.

Curtis Woodworth – JP Morgan

For what percent?

Calvin E. Jenness

1%.

Curtis Woodworth – JP Morgan

1%, okay.

Calvin E. Jenness

[Inaudible] 1% increments here Curtis. Then, the Brazilian Real is about $200,000 for every 1%. Then, the Euro which obviously is going the right way for us is about – it cost $200,000 for 1% movement there too.

Curtis Woodworth – JP Morgan

And what are the assumptions in your guidance for 2008 in terms of the negative currency impact?

Calvin E. Jenness

It’s about $5 million, say over 2007 negative.

Curtis Woodworth – JP Morgan

Okay. Then, in terms of the view that international markets are going to outperform the US market, can you remind us what your mix is US versus international and also what the dynamics are that are more favorable in the markets outside of the US?

James S. Osterman

Right now we’re doing about 68% of our business outside of the United States. The orders that we’re receiving in right now and our backlog clearly shows that the international markets remain very robust.

Curtis Woodworth – JP Morgan

And why is that? Is it just regional economics?

James S. Osterman

It’s regional economics. We’re seeing Latin America stay strong, we’re seeing a lot of growth in the eastern part of Europe and Europe remains strong. Right now the international markets totally seem quite robust for us.

Curtis Woodworth – JP Morgan

Okay. Great. Then, in terms of the new product development initiative that you’re launching at the company, can you talk about whether that’s going to be kind of brand new product sets or enhancements to your existing base of business? Are you trying to get in new markets with this job function you’ve created? Can you just give me a level of clarity there?

James S. Osterman

The new business development is both businesses, business opportunity, potential acquisitions, but the primary focus is on new innovative products that can be patented. We have a list and we’re looking at some, I think, some very exciting things with design review times set on them. So, it will be new innovative products that don’t exist in our current line. On the other side of the house our engineering is set do product upgrades on existing products. But, the new group is totally for new incremental business.

Curtis Woodworth – JP Morgan

That’s great. And Cal, what’s your forecast for depreciation and amortization this year?

Calvin E. Jenness

I think from continuing operations it’s running at about – fourth quarter was like $4.9 million so call it $20, right around $20 million. That’s just depreciation, you know there’s some amortization in our interest expense. That’s just depreciation.

Operator

Your next question comes from the line of Dax Vlassis with Gates Capital Management.

Dax Vlasss – Gates Capital Management

A couple of questions, the gear components business, do you consider that non-core? Are you shopping that?

Calvin E. Jenness

We are not shopping it but we do consider it non-core.

Dax Vlasss – Gates Capital Management

Okay. And, what is your appetite for acquisitions given your financial flexibility? And, what are the odds that you can make a meaningful acquisition? I assume that would be something involved with cutting, maybe concrete or something like that?

James S. Osterman

I’d say our asset type is pretty good. We’re actively kicking tires. We have brought our business to a position of where we have really two basic core businesses that we can drive off of and they’re attractive both on acquisitions in both areas.

Dax Vlasss – Gates Capital Management

Okay. Then Cal, I think I heard you say that interest expense you expected to be around $27.9 this year?

Calvin E. Jenness

Yeah.

Dax Vlasss – Gates Capital Management

Is part of the term loan, did you swap some of that out and if you did how much of it and at what rate?

Calvin E. Jenness

No we didn’t swap anything out in a while here. So we had $122 million drawn at the end of the year –

Dax Vlasss – Gates Capital Management

At LIBOR plus 175?

Calvin E. Jenness

Yeah, so it’s right above 5% right now.

Dax Vlasss – Gates Capital Management

Why would you have $27 million of interest then?

Calvin E. Jenness

There’s probably $3 million of non-cash in there too overall.

Dax Vlasss – Gates Capital Management

And then your cap ex –

Calvin E. Jenness

You have a note, the notes [inaudible] there’s $175 million in those.

Dax Vlasss – Gates Capital Management

I know, that’s $15 million, right?

Calvin E. Jenness

Yeah.

Dax Vlasss – Gates Capital Management

And if you take 5% of $122 that’s 8, that’s 23, not 27.

Calvin E. Jenness

But $3 million plus in non-cash. You’ve probably got some unused line fees in there too that will add a few odds and ends there.

Dax Vlasss – Gates Capital Management

And what are you spending all this money on? It seems like $27, $28 million is a lot higher than you’ve been spending on cap ex. What are you spending the money on?

Calvin E. Jenness

Well, it’s a budget for the year, $27 million. We haven’t spent our planned budget, we’ve always kind of run a little bit short overall. But it’s pretty much continuing to add capacity because we’re a growing business, productivity has always been a key part of our business where there is efficiency. There’s a little bit of maintenance, but not a lot for dyes and so forth and that’s not a huge part of it. So it’s geared toward productivity and capacity.

Dax Vlasss – Gates Capital Management

And what sort of return would you expect to get on the portion that’s not maintenance level? What would you consider your maintenance level?

Calvin E. Jenness

Oh it’s probably, if you added up everything, what we need to from a standpoint, a compliance standpoint, it’s probably $7 to $8 million a year, maybe a little bit higher some years.

Dax Vlasss – Gates Capital Management

So you have basically $20 million earmarked for productivity enhancement?

Calvin E. Jenness

Right.

Dax Vlasss – Gates Capital Management

And what sort of return do you expect on that money you’re spending?

Calvin E. Jenness

We’re investing it in our core business so we’re going to expect the same kind of margins coming out of that, hopefully a little bit better with the productivity overall. So it should enhance it.

Dax Vlasss – Gates Capital Management

And is your operating income number guidance, does that include any non-recurring charges for severance or any other non-recurring items?

Calvin E. Jenness

There’s probably as I said the first quarter we’ll probably have some severance costs, probably $500,000 or $600,000 I believe. The other thing is that it’s not recurred. Jim spoke about the new product development, we’ve got a couple million dollars earmarked for that this year. I don’t think you will have much of a sales benefit on any new products that are meaningful enough this year. There’s a mixed amount of cost in there for that this year. I don’t know if you want to call that non-recurring or not but it’s an investment that will go through our P&L.

Dax Vlasss – Gates Capital Management

And if I look at the taxes that your provision for taxes it looks like it’ll end up somewhere around $20 million. What portion of that would you expect to be deferred? In other words what is your cash taxes excluding the $15 million that you expect to pay or whatever portion of that –

Calvin E. Jenness

It’s not going to be dramatically different going forward from our P&L rate.

Dax Vlasss – Gates Capital Management

Did you expect to have some working capital recapture for this year?

Calvin E. Jenness

Yes, there’ll be some there overall.

Operator

(Operator Instructions)

Your next question comes from the line of Peter Lisnic with Robert Baird.

Peter Lisnic – Robert W. Baird & Co., Inc.

- your products kind of in addition to the currency because it looks like if you strip out currency there was still some margin degradation there year-on-year.

Calvin E. Jenness

John, you got cut off a little presenting here the first part of your question.

Peter Lisnic – Robert W. Baird & Co., Inc.

Could you just talk about the margin degradation – or if you strip out the currency impact what other cost pressures you’re seeing in the outdoor product segment?

Calvin E. Jenness

The biggest one is probably the fix out is transportation on the district cost. There was kind of a lag, a delay in terms of fuel costs going up. That’s probably the largest pressure and raw material was I think net-net for the whole year was okay, it was probably a little bit of pressure, not a lot in the fourth quarter. So it’s mostly logistics in the fourth quarter and then in the beginning of the year we had some costs to move the logistic facilities which was $1 million or so.

Peter Lisnic – Robert W. Baird & Co., Inc.

And if you look at raw materials, just given what we’ve been hearing from other people regarding kind of steel costs is that something for 08 that is going to be an issue?

Calvin E. Jenness

I think it’s been an issue over the last three years, enough to run up a couple years ago and it’s stabilized but yeah I think the view now is that it’s going to continue to be going up at least in the short term here. So yeah that is a concern this year.

Peter Lisnic – Robert W. Baird & Co., Inc.

Like in the last month or so kind of given steel costs your operating income forecast has probably been adjusted to reflect what’s going on in the market?

Calvin E. Jenness

That’s correct.

Peter Lisnic – Robert W. Baird & Co., Inc.

Kind of switching gears a little bit, the gear products business I understand it’s kind of being included with corporate expense but just how did results there happen? Because it looked like on the top line a drop off pretty heavily year-year and is this just something where we really can’t get at the numbers now the way you’re disclosing things.

Calvin E. Jenness

Yeah, for the year I believe they made about $2 million, sales wise for the year was about $29 million overall sales for gear products. So they were down probably 10% from the previous full year, their profitability was down by about $7 million, 8. Fourth quarter they made a little bit of money or they were down versus last year.

Operator

Your next question comes from the line of Bob Franklin with Prudential.

Bob Franklin – Prudential

When you said that your cash flow available for debt repayment would be 25 to 30, you said part of that is a carryover. Is that right?

Calvin E. Jenness

Carryover from some of the money for fiscal operations we have to pay.

Bob Franklin – Prudential

Without that, what would your real cash flow generation be?

Calvin E. Jenness

Probably, I’d say there’s 15 in there, so there’s probably 35, 40.

Bob Franklin – Prudential

Then in the absence of an acquisition would your intent be to continue to repay debt?

Calvin E. Jenness

Yes.

Operator

(Operator Instructions) Your next question comes from the line of Ryan Mcgaver with Capstone Investments.

Ryan Mcgaver – Capstone Investments

Last time on the call you had discussed at the end of the first quarter the China facility should be up and running at full capacity. Is that still on track?

Calvin E. Jenness

Yeah, I’d say so on the chain side we’re where we want to be as [inaudible] end of the year. On the bar side we’re probably two-thirds of the way there, where we want to be.

James S. Osterman

We’ll probably be doubling our bar capacity in China during the year. But chain as Cal mentioned we think we’re there now.

Dax Vlasss – Gates Capital Management

So then if we were to look into 2008 what do you think the percentage of manufacturing in China would be of total manufacturing? Or do you have any idea of what that might be?

Calvin E. Jenness

Under the bar production it’s 10% -

James S. Osterman

Yeah, but as our total production it would be small, probably 7, 8%.

Calvin E. Jenness

Yeah, probably 8%.

Operator

(Operator Instructions) There are no further questions at this time.

James S. Osterman

We’d like to thank everybody for their interest and wish everyone a good day.

Calvin E. Jenness

Thank you.

James S. Osterman

Thank you.

Operator

This concludes today’s Blount International, Inc. teleconference. Thank you for your participation. You may now disconnect.

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