Actuant Corporation F3Q08 (Qtr End 05/31/08) Earnings Call Transcript

Jun.30.08 | About: Actuant Corporation (ATU)

Actuant Corporation (NYSE:ATU)

F3Q08 Earnings Call

June 19, 2008 11:00 am ET

Executives

Bob Arzbaecher - Chairman, President and Chief Executive Officer

Andy Lampereur - Executive Vice President and Chief Financial Officer

Analysts

Curt Woodworth - JP Morgan

Amit Daryanani - RBC Capital Markets

Deane Dray - Goldman Sachs

Charles Brady - BMO Capital Markets

Wendy Caplan – Wachovia

Chris Weltzer – Robert W. Baird

Steve Fisher – UBS

Operator

Welcome to the Actuant Corporation’s third quarter fiscal 2008 earnings conference call. Today’s speakers are Bob Arzbaecher, President and CEO, and Andy Lampereur, Executive Vice President and Chief Financial Officer. (Operator Instructions) It is now my pleasure to turn the conference over to Mr. Arzbaecher.

Bob Arzbaecher

Today we reported our third quarter results at the high end of both our sales and earnings guidance. The highlights included EPS of $0.60 a share, which included a $0.04 tax gain. Excluding this gain and the restructuring charges in the prior year, we had EPS growth of 17% for the quarter and are now up 22% on a year-to-date basis.

EBITDA margins expanded 50 basis points to 16.4. Sales were $445 million. That’s Actuant’s highest ever, reflecting a 15% year-over-year growth. If you exclude acquisitions and currency, core growth was 2%. Strong cash flow of $49 million, in line with our expectations for the quarter and on track for $140 million free cash flow target for the year.

This was a quarter where you see the benefits of our diversified business model. Actuant continued to deliver strong sales, EBITDA, earnings and cash flow. Diversity by a customer, end market and geography helped cushion certain weaknesses in some of our end markets. This same diversity has allowed us to deliver 27 consecutive quarters of EPS improvement.

With that, I’ll turn it over to Andy to go through the numbers.

Andy Lampereur

First quarter, as Bob mentioned, came together well and you can see it on this slide. We generated 15% sales growth. EBITDA grew 19%, more than sales, meaning we expanded our margins during the quarter, and we had another great quarter of cash flow.

In summary, 17% EPS growth, excluding the special items Bob mentioned. The increased earnings reflected the combination of sales growth and margin expansion with contributions coming from both our base businesses and acquisitions.

On a GAAP basis, we reported second quarter diluted earnings per share of $0.60 a share. This includes a $0.04 a share income tax gain relating to 2007 tax return to book provision adjustments. Last year’s third quarter, meanwhile, included some European Electrical restructuring costs. If we backed both of these items out of our comparison of third quarter results, our diluted EPS increased 17% from $0.48 a share last year to $0.56 this year.

As you can see on this slide, the 15% sales growth was comprised of 2% core growth; 6% from foreign currency changes and the remaining 7% from acquisitions. Now, similar to the past several quarters, the industrial segment led the way with 38% sales growth, including 14% core growth in the quarter. Two of our other three segments also reported core sales growth, Actuation Systems at 1%, and Engineered Products with 5%.

The Electrical segment felt the impact of weaker consumer demand during the third quarter and reported a 10% core sales decline. The Electrical segment market conditions have become more challenging due to weaker consumer spending. I’ll hold off on providing more color on sales until I review segment by segment results in a few minutes.

Now, in addition to sales growth, our third quarter earnings were driven by profit margin expansion. You can see that on this slide, which is a comparison of some of our key operating metrics for each of the last four quarters. Our third quarter EBITDA margins increased 50 basis points year-over-year from 15.9% to 16.4%. This was primarily driven by favorable segment sales mix and nice margin improvement from the Actuation Systems segment.

Among the factors that worked against our margins this quarter were higher investments in growth initiatives in our Industrial segment; higher incentive compensation accruals in a number of the units, including corporate; unfavorable product mix within certain of the segments; and higher corporate expenses, which included personnel and start-up costs for our new plant in Taicang, China.

While there were some puts and takes between the segments and businesses within each of the segments, I was pretty happy overall with the segments with Actuant’s margin performance this quarter.

Now, if we look on a year-to-date basis through the first nine months, our EBITDA margins are up above 80 basis points, better than the original 40 to 60 basis points of expansion we projected at one year ago. At that time, we had mentioned that our second half margin’s expansion would be lower than the first half on account of tougher second half comps, and that’s still in line with our current thinking.

Now I’m going to step down a level from our consolidated results, and I’ll cover segment level results for each of the four business segments, starting first with our Industrial segment.

The Industrial segment had another big quarter with better than 30% growth in both sales and operating profit. Core sales, the weaker U.S. dollar, and acquisitions all contributed to the record quarter. Our core sales growth for the segment was very robust at 14% with Enerpac and Hydratight businesses each generating 14% core sales growth.

In the case of Enerpac, that was the highest growth of the year, and for Hydratight, its sixth consecutive quarter of double-digit core sales growth. Underlying market demand in Hydratight’s core oil and gas, and power generation maintenance markets continues strong and shows no sign of slowing. Meanwhile, Enerpac continues to do very well in pursuing wealthy industrial market niches such as shipbuilding, infrastructure, and mining.

Industrial profit margins remained strong during the quarter, although slightly lower than the prior year. This is more due to targeted investments in growth initiatives, incentive compensation accruals, and unfavorable mix within both Enerpac and Hydratight during the quarter, really more so than any other change in the underlying profit trends of the businesses. Both units are executing extremely well.

Additionally, during the quarter within this segment, solid progress was made in acquisition integration for both the Templeton, Kenly and the Superior Plant Services acquisitions. The sales forces at TK and Enerpac will combine during the quarter, while integration kick-off meetings and LEAD training sessions and events were completed at Superior Plant services. We’re encouraged by the early financial result for both of these acquisitions, and feel there is additional synergies to be realized over the next year.

Now, turning to our Electrical segment, we had overall sales growth of 1% due to acquisitions and the weaker U.S. dollar. Core sales, however, declined 10%, with reductions in each of the Electrical segments for reportable product lines.

In addition to weak consumer demand, we also had sales headwinds due to the SKU reduction in European Electrical and the GB market share lost at Lowe’s we discussed last quarter. Weak consumer confidence and spending was evident in the 6% to 8% same-store sales declines reported by both Home Depot and Lowe’s in their most recent quarter, which was a sequential deterioration from the prior quarter.

We also saw similar negative retail trends in Europe, and from the marine and transformer markets. Since our Electrical segment is more U.S.-centric than our Actuation Systems and Industrial segments, as well as more consumer-facing, conditions became more challenging as the quarter and the year progressed.

Now, unfortunately, this core sales decline adversely impacted the Electrical segment margins, as did the unfavorable sales mix. These two more than offset the decent margin expansion we enjoyed during the quarter in our European Electrical business. Given our expectations of continued weakness in the Electrical segment due to weaker consumer confidence and the full year impact of SKU reductions in Europe, we are actively reducing cost to counter the lower volume.

In addition to a 15% year-over-year headcount reduction already in place in this segment, we’ve raised prices in all four Electrical product lines to offset recent commodity cost inflation. We’ve moved to four-day workweeks in certain of the businesses. We’re transferring additional production out of the U.S. and into Mexico in the fourth quarter for transformers, and we recently divested a small Kopp circuit breaker plant and product line in the former East Germany.

On top of this, we’ve aggressively raised prices on certain product lines in Europe in order to increase profitability to an acceptable level or to just get out of these product lines. To date, we’ve accomplished some of both. All of these actions will reduce our cost structure in Electrical and better position the segment for margin expansion as we go forward.

Next is the Actuation Systems segment, which other than a very weak RV OEM demand had a really strong third quarter. Truck continued to enjoy strong demand with core sales growth at 20%, with both North America and Europe participating, while auto core sales were up in low single digits. Unfortunately, the core sales in RV were down 27%, much worse than the 15% to 18% decline we had discussed in our forecast for last quarter.

Motorhome retail sales and underlying OEM production rates fell significantly during the quarter as did consumer confidence, and are expected to remain very weak for some time. At current levels today, motorhome build rates are running about half what they were back in 2004.

Despite the profit margin drag from the lower RV production levels, the overall Actuation Systems segment operating profit margins improved 140 basis points in the quarter, benefiting from improved auto margins and favorable sales mix within the segment. We expect that the consumer-driven RV weakness will continue to be a headwind for the balance of the calendar year, but remain very bullish on the longer-term prospects of the Actuation Systems segment in total over the next several years.

Our confidence in doubling the Gits business’ revenue to $100 million by 2011 only grew stronger during the quarter, with solid progress on a number of emissions-related projects. Additionally, the outlook for convertible tops remains strong, including 10% to 15% core growth next year. In summary, there are a lot of good things happening in this segment.

I will wrap up my comments on segment level results with a couple of comments on the Engineered Products segment. Sales growth in this segment continues strong with a respectable 6% core growth during the quarter. While segment operating profit margins declined modestly year-over-year, the entire reduction was due to higher incentive compensation provisions this quarter. The underlying performance in this segment also was very good.

Well, that’s it for my comments on sales, earnings, and margins for the quarter. However, before turning it back to Bob, I just wanted to make a couple more comments on cash flow and debt.

I was pretty happy with the third quarter cash flow and working capital management. As Bob mentioned, we had generated $49 million of free cash flow and we now have $91 million of cash on the balance sheet and our entire $250 million revolver available. So, funding capacity for future growth, including acquisitions is in great shape. Our free cash flow focus and conversion of free cash flow remains strong, and we are projecting current-year free cash flow of approximately $140 million.

Bob Arzbaecher

As you can probably tell, we feel pretty good about our third quarter results. Core growth at 2% margin expansion, completion of the SPS acquisition, and strong cash flow all contributed to another great quarter.

What we’re finding is that in this economic slowdown we’re experiencing now, the results are not linear. If you look at our businesses that serve commodity markets, like oil and gas with Hydratight, the growth has really been excellent. I’d put a piece of Enerpac into this category, also.

If you look at North American industrial markets, while growth rates have been positive, they have been moderating. We see this with some of Enerpac, with Elliott, Gits, Turner, portions of the Pro/E business and Specialty Electrical.

If you look at our consumer-facing businesses, it’s a recession. We’ve seen this in our DIY Electrical business, RV, marine, North American convertible tops, and some parts of the Pro/E business. For Actuant, these slowdowns today are only affecting our North American businesses. European core growth was solidly in the mid-single digits for the quarter, and we generated high teens growth in Asia.

The reason for mentioning this is Actuant’s diversity. We continue to believe that Actuant’s diversity is a huge asset for shareholders. It creates more consistent results. It limits our single customer risk, with only 17% of our revenue with our top 10 customers. Our diverse markets allow us to find lots of opportunities to do niche acquisitions, and finally, the diversity allows us to leverage our global opportunities by sharing facilities, cross-selling customers, and sharing best practices across businesses, segments, and markets.

We have a “feed the eagles” mentality at Actuant. That means we preferentially feed our growth-year businesses in the form of both acquisition capital and internal investments. Today, that’s the entire Industrial segment, the Gits business within Actuation Systems, and the Maxima business within Engineered Products, just to name the highlights. Market diversity and selectively investing in capital where it gets the highest returns, these are the hallmarks that have made Actuant successful since the spin-off in 2000.

Now, let’s talk about acquisitions. To date, we’ve completed two acquisitions in fiscal 2008, Templeton, Kenly and Superior Plant Services, deploying about a little over $100 million in capital. As Andy mentioned, both of these acquisitions are performing well.

We continue to have a full funnel of activity that we’re working on. A key focus continues to be smaller transactions, $25 million to $75 million in size, and acquisitions that leverage our key markets of industrial tools, electrical products, Actuation Systems, and other Engineered Products and systems.

One area that we’ve made a lot of progress on in the past few years has been M&A idea generation that comes from the business unit level. About half of our acquisitions over the last few years have been privately negotiated, non-auctioned deals that were identified at our business unit level.

Going a little deeper into these tuck-in acquisitions and talk about some of the key areas we’re focusing on. We’re very focused on expanding Enerpac’s product line within industrial tools. The Templeton, Kenly acquisition was a great example of this. We added railroad tools that we previously didn’t offer, and we’ve been able to leverage our existing global distribution channels.

Another area of high focus is our Hydratight platform. The deeper we get into the joint integrity markets, the more we realize the untapped potential we have for growth in this market opportunity.

Shifting to Electrical, we see good opportunities with our three-pronged approach of serving harsh environment electrical, the professional electrical channel, and retail channels. We believe there are excellent opportunities to leverage acquisitions across these end markets, and in fact, have found synergies outside of the Electrical segment to other segments within Actuant.

An example of this is our BH Electronics acquisition. We were able to leverage our harsh environment electrical product line, but we were also able to bring Maxima in for a growth opportunity with the bulk market in terms of gauges and sensors.

Lastly, let me talk about bigger acquisitions. Currently, we are pursuing a few ideas in the $200 million to $600 million weight, what we would define as new platforms. As a point of reference, we regularly have one to two ideas of this size in our acquisition funnel over the last couple of years, so this really isn’t a big change from what we’ve been operating under.

What we’ve come to recognize, as we’ve pursued these larger deals, is that while the ones we pursue are bigger deals, many of them serve the same markets that we serve today. So, while we call them a new platform, investors could come to the conclusion that they’re really just expansions of currently served markets.

The other phenomenon is that transactions larger than $100 million tend to get a lot of attention from other strategic buyers. While private equity groups have largely been on the sideline, strategics have closed this gap. We have seen no reduction in valuation multiples on bigger deals, although we do seem to have peaked in terms of valuation. So, they’re not going up, but they’re not going down.

Against this backdrop, we continue to be very disciplined in terms of valuation metrics. We continue to spend most of our time looking at smaller transactions that have made up our acquisition activity over the last three years. We believe smaller transactions are less risky, tend to have lower valuation metrics, and have more potential synergies with our existing businesses.

Now let’s turn to guidance. As you see in our press release this morning, we’ve provided EPS guidance of $0.51 to $0.55 per share for the fourth quarter on sales of $410 million to $420 million. As a reminder, the fourth quarter is seasonably weaker than the third at Actuant, on account of European holiday shutdowns at many of the OEMs. This fourth quarter outlook results in full year EPS guidance of $2.02 to $2.06, excluding the tax gain and the Europe Electrical restructuring.

Assuming we hit the midpoint of this EPS range, Actuant will have generated 15% growth in sales and 18% growth in EPS over fiscal 2007, and have met and/or exceeded our long-term goal of 15% to 20% EPS growth for the seventh consecutive year. Further, if we hit our projected $140 million of free cash flow that I referred to earlier, we will have generated free cash flow conversion in excess of net income for the eighth consecutive year.

Moving to fiscal 2009, which for Actuant begins September 1, we are providing initial EPS guidance of $2.25 to $2.35 per share on sales of $1.75 billion. Some additional color on this guidance, we would expect our core growth to be in the low single digit neighborhood. As we saw in 2008, Industrial will lead the pack with high single digit growth, Engineered Products and Actuation Systems with mid single digit growth, and Electrical negative, due to the consumer confidence exposure that we talked about earlier.

At $1.75 billion estimate is done in current FX dollars, so we do not expect any material strengthening or weakening of the U.S. dollars. We would expect margin expansion at both the operating profit and EBITDA level in the range of 50 to 75 basis points, partially driven by operating improvements and also the favorable mix of industrial sales. Our effective tax rate for fiscal ‘09 should be around 30%, and our capital expenditures should be around $45 million. That would equate to free cash flow of $150 million to $155 million.

We would expect in 2009 to use this cash flow to fund future acquisitions. These are not included in the sales and earnings guidance. In the past two years, we have been targeting to complete $150 million to $200 million of acquisitions annually. We plan to expand this range slightly in 2009 to $150 million to $250 million in terms of acquisitions. This does not necessarily mean bigger deals; probably more deals or more velocity deals. Given our ROIC and cash flow focus, future deals, when completed, should be accretive to today’s 2009 earnings guidance.

When you’re thinking about 2009, I want you to remember that this is pretty consistent with our initial look over the last two years. As you see on this slide, we normally come out with guidance growth in the 10% to 15% area, and then we increase this guidance on acquisitions or as results dictate. If you look at our 2008 preliminary guidance as it shows here on this slide, we’ve raised that guidance three times due to these factors.

That’s it for today’s prepared remarks.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Curt Woodworth - JP Morgan.

Curt Woodworth - JP Morgan

Can you talk a little bit deeper dive into the Industrial segment for fiscal 2009? Maybe what you’re seeing for Enerpac and what you’re thinking you’re going to see for Hydratight?

Do you think you can get margin expansion in that segment looking out in 2009, even though you’ve had some mix issues. I know Hydratight is a little bit lower margin; it’s probably going to grow faster. And then you also mentioned that you had some incremental costs, I think for product development and things like that this year. So, looking at your incremental margins, would you expect them to potentially be higher in 2009?

Bob Arzbaecher

But I think you are correct that when we look at 2009, our expectation would be Hydratight would grow faster core growth than Enerpac. And this quarter, they were equal, but I think our belief is, as you look forward for the next 12 months, 18 months, Hydratight would be faster. So, I think that guidance is correct.

When you talk about margins, I’d make a couple of comments. One is I don’t think we’re at a point that we want to talk about the granularity between the two businesses. They really are a single segment and that’s the way we report it with the SEC, etc.

In terms of can we grow the margin range, what I would tell you is that this segment really operates at a very high level. And our view is 200 basis points plus or minus 30% at the EBITDA range is within the circle of acceptable behavior for us. I think we saw that this quarter, where it was done a little bit from the prior year. We don’t view that negatively at all. It’s just a business that does have certain orders that are a little higher, certain mixes of businesses.

So, would I expect that we can grow it? We always are moving for continuous improvement. But if I stayed in that 28% to 32% EBITDA range for this segment, knowing that it will bounce a little bit quarter-to-quarter, I’d be happy for the year.

Andy Lampereur

The other item I would comment on, Curt, regarding margins is that we are really starting to plow more of the improvement that we’re seeing in profitability in these businesses right back into the businesses. An example is geographic expansion within Hydratight. We have moved into Norway in the last 90 or 120 days. There are those other geographic areas we will be moving into.

So clearly, the profit margin is starting out in areas like that are nowhere near where they are in more mature areas or developed areas of the world. So I think we are saying the margins are so strong here, let’s just continue to do whatever we can to keep generating top line growth, which will bring through already very good margins. But I think that’s our approach.

Bob Arzbaecher

It’s a great comment. We challenge the business, go get the growth. Because, as I said in my prepared remarks, the untapped potential in Hydratight and in some of the geographic expansion we can do in Enerpac, we want them to invest in going after those opportunities.

You also have to build the management teams of these four future acquisitions. I’m a big believer that you’ve got to get the horses before you get the cart. These both had very strong growth in these businesses. We need them to keep fueling those management teams, bringing in new talent, and keep growing the size, so when we do the acquisitions, we’ve got the teams to integrate them.

Curt Woodworth - JP Morgan

Moving on to Electrical, it seems like you definitely have adopted a continually bearish view on this segment going forward. You mentioned a couple of the additional cost-down items that you’re looking at, specifically, I think, more along the lines of Gardner Bender. But do you still feel like you can attain this 100, 200 basis point margin improvement rate for the segment, even though clearly the operating leverage is going against you probably in a more dramatic fashion than you anticipated?

Bob Arzbaecher

It’s a challenge because the parts of the business that are down are the higher profit parts. So, Gardner Bender and the marine parts tend to be a better mix of margins. So it’s tough sledding there. I think our view is a couple hundred basis points over a few years is a more realistic target for this segment. Again, you do need some balancing of the North American consumer coming back online.

I don’t particularly believe that there’s any long-term issues associated with the Lowe’s, Depot, Menards model. I think these are good segments that the avid DIY-er does a lot of stuff there. It’s just they have traffic issues right now with the consumer confidence.

Curt Woodworth - JP Morgan

In terms of thinking about ‘09, if you’re lapping the market share loss at Lowe’s, I know you picked up some business at Depot. You’re getting a full run rate year savings in Europe. Is that enough to offset the sales weakness? Could you potentially grow EBITDA in that segment in ‘09? Are you modeling that?

Andy Lampereur

I believe that we can squeeze out some EBITDA margin expansion in this thing. It’s going to be very lumpy, when you look at that. Just looking over the next four, five quarters, an example coming up here in this quarter that we’re in right now, we will be taking a charge that’s included in our guidance. That’s going to weigh against the segment profit margins because we’re moving some manufacturing down to Mexico. So there’s going to be items like that. So that and the volume will weight against what we’re trying to do.

But there are definitely margin improvement things going on. It’s a matter of, I think, what is happening in a given quarter, from a core growth standpoint, what’s driving it through. But we certainly are not writing off the year that we’re not going to see margin improvement. We believe we will.

Bob Arzbaecher

Yes, I definitely believe we will. The other thing just to add to Andy’s comments, the Europe restructuring that we completed in February, that part of the business is meeting our expectations from a margin point of view. We took the costs out; that restructuring happened on budget. And our belief is that’s coming through. It’s being muted by other things going on within the segment. But the Europe Electrical restructuring as we envisioned it and the savings associated with it are tracking.

Curt Woodworth - JP Morgan

On the larger transaction possibility, you mentioned a deal size potential of $600 million. It seems like those types of deals are going for much higher multiples than the smaller size transactions. So, for something like that to get done, would it really be a matter of you would be able to get it at a decent price? Or for that type of size, would you be willing to maybe go above your hurdle rates, if you will, maybe in the near-term, for a pretty strategic asset?

Bob Arzbaecher

Well, that’s a very difficult question to answer. When we look at our hurdle rates, we have an expectation to try to be in double digits ROIC out of the box. And then through efficiencies, through synergies, through growth of the business, to try to move it to the 20% CMM ROIC that we have talked about at length.

How long does that take? It’s in the three to five year time horizon that we try to get to those numbers. Hydratight, we got there a little faster. We don’t even look at KCI that way; it’s hard to look at it because it goes in all these different segments.

So the answer is, would we pay up more than the eight to nine times EBITDA? We would, but if you saw that, you should expect to see good growth, robust growth, going forward. You should expect to see that we have good synergies, that there’s something, some cost reduction that we can take out, or that we believe our LEAD process will add a lot of margin expansion. So, it’s no change in anything. I think we would swing at a little higher range of valuation, but it would be because we see other elements that drive that ROIC.

Operator

Your next question comes from Amit Daryanani - RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

The Electrical segment, you talked about a whole list of initiatives that we’re taking, including cost reduction, headcount reduction, and transferring work to Mexico. How much of a one-time restructuring charges will that eventually lead to that’s built into your guidance? And what payback would we expect out of it from a margin perspective?

Andy Lampereur

Some of those items have already taken place. And I mentioned the 15% headcount reduction, that’s already happened. That’s done. That’s happened over the course of the last year. So, it points to how aggressively we’ve gone after costs. We’ve already paid for the majority of that with some of the actions that we’ve done.

Now, there will be other things coming at us. As I mentioned here in the fourth quarter, there is a move of product down to Mexico and whatnot. Probably $1 million a quarter or so, that’s in our guidance. That’s already embedded in our guidance for a quarter as we roll out.

Bob Arzbaecher

I want to be clear because we try not to do and don’t do major restructurings. We did our Europe, this is not of the magnitude of a $20 million restructuring. Those are the only ones we call out. We are doing cost-down initiatives. Our LEAD program identifies things all the time.

When we’re talking these things that Andy said, a million bucks, we would look for a payback one to two years at max on a lot of those things. It’s a very accretive ROIC-type adjustment. We’ll call them out to you because they usually do affect margins, but we’re not calling that restructuring. We’re not adding it back in a GAAP table, like we do for the year restructuring.

Amit Daryanani - RBC Capital Markets

Could you talk about the brighter side of things at Actuant on the Industrial segment. You are talking about mid to high single digit organic growth at this point. And I was looking at my notes from this time last year, and that’s exactly what you talked about for fiscal ‘08, and it looks like it’s going to be like 12%, 13% growth on the Industrial side.

So, maybe if you look back at the Industrial segment, could you just talk about what surprised you from the 8% to 9% that you initially guided to, to the 12% to 13% you ended up at? Was it demand? Was it cross-selling opportunities? And is the reason why those upside surprises would not carry on to the fiscal ‘09 guidance you have?

Bob Arzbaecher

I think the surprise has primarily been in a couple of places. One is Hydratight has just been a great business, a lot of demand for the MRO nature of that business. And we haven’t owned that that long, so we are still learning the ropes, so to speak, in terms of the guidance there. But it’s had great results.

The second place is Enerpac North America, I think. We endorsed and expected a bigger slowdown in Enerpac North America, just finished a great quarter. And we will probably incorporate it in our guidance for next year, is continuing moderation in North America., I’ve had this discussion with you a lot of times. We have to be conservative in forecasting that business because of the profitability. I can’t make that up in other place if I miss it. So, we will deliberately be conservative there. And I would say those two pieces are what drove it.

Andy Lampereur

That’s consistent. I would say, the North American piece, certainly we expect it to continue to slow down. I would expect Europe to slow, in line with the cycle. Typically we see a two or three, about a two year lag between Europe and North America, and I expect Europe to moderate a little bit next year, as well. But I hope we’ve got the same luxury as we did this year, of results coming in better. But as Bob said, we’re not going to stick our neck out on this thing. The margins are just too big and the visibility, this is a short cycle business, right.

Bob Arzbaecher

And you can say I’m being conservative there, but I was too optimistic in Electrical. So, for the year, we started the year thinking 4% to 5% quarter, this economy has gotten worse than that. So, it’s a question of trying to balance the positives and the negatives. Happily for us, the mix has been powerfully in our favor. Industrial is doing great. It carries quite a bit more margin than the other segments. It creates a huge weight that the other businesses tuck under. That’s the nature of Actuant right now.

Amit Daryanani - RBC Capital Markets

The Actuation margins improved pretty nicely, 11.2%. I think the highest level we’ve seen since Q1 ‘06 plus all the new segments we have had. Where do you see this trend over the next few quarters? And do you think there’s room for further upside from a margin perspective in that segment?

Andy Lampereur

If we could isolate the RV piece from this and just look at what is happening at the other businesses within there, absolutely, I would expect margins to continue to improve in here. In this quarter year-over-year, we had significant improvement coming in out of automotive. And then that was one of the laggards, if you will, in 2007, from margins coming down. Margins are up significantly there. They’re doing well elsewhere, as well.

The wild card here is RV, in terms of the drag that that thing creates, when you’re down 30% or so in revenue. I do expect margins to improve and to expand next year in this segment. The question is how far can they go? I think it’s largely driven by what happens or what’s going to happen in a given quarter with RV, because it’s tough to make up that volume shortfall.

Bob Arzbaecher

The other thing I would mention to Andy’s line is the “feed the eagles” mentality I talked about earlier. We are investing a ton in Gits in terms of engineering. And there is no revenue attached with that, that revenue is coming in 2010, 2011. So those margins will have a ways to run. You invest in that engineering at the front end. It gets basically expensed, and then you get the revenue down the road. So, take a little longer horizon rather than just ‘09 and look two or three years out, this business has got excellent margin potential.

Amit Daryanani - RBC Capital Markets

It sounds like from the Gits side, it’s going to be more the emissions standard changes in 2010, 2011 that would help us out quite a bit on that side.

Andy Lampereur

The volume gains, part of it due to that emissions change, part of it due to geographic expansion, part of it due to market share wins, that sort of thing.

Bob Arzbaecher

But it’s emissions, it’s horsepower, it’s fuel economy, all three we’re solving. Some other people solve the emissions issue, but you drastically reduce the horsepower of a diesel engine. The Gits product would work with a turbocharger, bring back that horsepower. So it’s a very broad-based solution, engineered solution application.

Operator

Your next question comes from Deane Dray - Goldman Sachs.

Deane Dray - Goldman Sachs

If you just take us through the segments and give us a sense of how much pricing power you’ve been able to exercise here. How much of Industrial of that core revenue is pricing? And related on Electrical, the fact you are going after price in a weak market, and what gives you confidence that you think you’ll get that?

Andy Lampereur

From a pricing standpoint, where we’ve got the most power I would say, again, is with the eagles. It’s our Industrial segment, probably would have the strongest pricing power. In this past quarter, in terms of the growth year-over-year, certainly there’s a couple of points in there for pricing coming through.

I would say in Electrical, certainly it’s more difficult when revenues are going down. And you’ve got to go in and ask for price, but we’re absolutely doing that, and we are getting price literally in each of the four reportable product lines. In some cases, we are actually losing business because we’re saying, take the price increase or we are walking. And that’s some of what’s happening in Europe, as I mentioned in my comments.

Actuation Systems, we have gotten pricing this year, I would say, in each of the segments. In RV, we have; in truck, we have; and in auto, we have, those are the big three. Engineered Products, it’s coming through a little bit less impact there. But that’s the way I would summarize it.

Bob Arzbaecher

We don’t see any margin degradation associated with that either in the quarter we just completed or in the foreseeable future, Deane. I think we view that as we’ve captured the costs, so we got a better system to do that than we used to. And we’re aggressive at getting the price, so that’s been favorable in terms of this area.

The other thing is, we do have a number of either OEM customers, mostly OEM customers, who have things that are already indexed to commodities. And so some of this price is not a negotiation, it’s following the contract.

Deane Dray - Goldman Sachs

The idea of the raw material cost headwinds that Actuant is facing today you take us across steel, copper, aluminum. How much of the price that you’re going after today is just to recoup the raw material costs? And based upon what you know so far in the commodities today, how does that equation work out in ‘09? Are you going to be ahead of the game or what are the offsets?

Bob Arzbaecher

I would say almost all of our price increase is related to raw material. Most of the markets we serve do not have the luxury of raising prices just to raise prices, if you don’t have raw material. OEM markets, electrical markets that just doesn’t exist.

Hydratight and Enerpac, maybe a little more because it’s a very short cycle business you’re not locking in the long term contracts. If you’re doing field work with a service technician in Hydratight, that’s a little more flexible type of arrangement, depending on where you’re going and what type of level person you’re taking. The answer is, I don’t think there’s much at all, I don’t know if you feel differently, Andy, much at all in price increases that is not related to raw material inflation.

Andy Lampereur

I would agree. And I think the other two points that I would add to it, Deane, just to clarify is the, when we’re going out with price increases, we have gone out, especially I would say in mid-May to July 1 window is when most of these are taking effect. We are going out not just to recoup, we’re trying to maintain our margins in this thing, as well, as we go forward so we’re not actually bringing the margins down.

And I would echo what Bob said. I think we’ve done a much better job this time around in going out and trying to get those price increases on the front end as opposed to being 90 days behind the window, behind the tail.

Bob Arzbaecher

The last comment just to plug into this is our LEAD office. In addition to price increases, we have very aggressive efforts within the businesses to lower four-wall costs every year. We shoot for 5%; we don’t get there, but we shoot for that, and we aggressively go after that.

Our Asian sourcing operations is an Actuant only group. It’s up to 120 people, somewhere around $150 million running rate. That was, just to put in context, maybe $50 million two or three years ago. So, you’re talking about aggressive globalization of our cost structure.

The Taicang facility that Andy referred to in his remarks is the next leg of trying to do that; do more of the assembly operation over there, not just the sourcing. So I don’t think you can just pull apart pricing and look at it on its own. There’s so many different pieces to it.

Deane Dray - Goldman Sachs

Non-residential construction, just give us some data points and evidence in terms of how the cycle looks today? Are you seeing cancellations? How does all this infrastructure spending look today the way Actuant touches this sector?

Andy Lampereur

Deane, when we look at our businesses, certainly the segment that sees a commercial construction is the Electrical segment. It’s a little bit of Gardner Bender; it’s a little bit more professional electrical out there. That business has been trending down. We have seen a slowdown, especially I would say in the transformer business that’s impacting it. We read some of the same stuff you are, that the signs look bad, but people aren’t seeing it in their rates. We are definitely seeing it. I would say we’ve seen it more in the last 45 days than we have before then.

Bob Arzbaecher

It’s not a major market for us not a big piece of the revenue.

Andy Lampereur

From a revenue basis, it’s probably $75 million of revenue, so it’s probably less, it’s about 4% of our revenue in total. But it’s in Electrical. That explains part of what you’re seeing Electrical, what our view is there.

Deane Dray - Goldman Sachs

And away from Electrical, some of the big infrastructure bridge building and so forth, any cancellations, push outs, anything at the margin there?

Andy Lampereur

No.

Bob Arzbaecher

Nothing at all Deane.

Operator

Your next question comes from Charles Brady - BMO Capital Markets.

Charles Brady - BMO Capital Markets

With regard to the acquisitions, you’ve done a $100 million year-to-date, one quarter left. Still comfortable with the $150 to $200 a year figure.

Bob Arzbaecher

Yes, we are. Obviously, you could have things that slip into early next year instead of fourth quarter, but we still are comfortable with that range. The number of things in the funnel that are in that $25 to $75 million range, you need one deal to close and you’re there, maybe two small ones. So, we are still comfortable. And in fact, as you heard in my guidance, I’m bumping the high end of that range up another $50 million for next year.

Charles Brady - BMO Capital Markets

With regard to Enerpac, how much of that is tied into the really high growth end markets we’re seeing, energy, oil and gas, mining; you’ve talked getting into shipbuilding. I know that business does a little bit of wind. Can you talk about some of these non-typical industrial markets for that business?

Bob Arzbaecher

It is very hard for us to see Charlie because all that business goes through 1200 independent distributors. Our best guess number I saw recently was around $75 million of the $375.

Operator

Your next question comes from Wendy Caplan - Wachovia.

Wendy Caplan - Wachovia

If we look at your balance sheet and your cash flow statements, clearly you have financial capacity in terms of additional acquisitions. But I’m guessing that one of the things that we’ve talked about historically is still an issue, which is management capacity. Can you talk about your thoughts, Bob, in terms of the current management capacity? Whether – what moves you’ve taken? For example, filling the COO spot with Mr. Goldstein, and that sort of thing, that prepares you for some of these larger acquisitions you’ve been talking about or in fact, some of the bolt-ons going forward.

Bob Arzbaecher

I probably spend a third of my time with organizational development now just trying, to use my vernacular, get the horses in front of the carts. And the COO move is about a year old now. In fact, we announced it I think right before your Wachovia conference last year. And we’ve been very happy with how it’s transcended. The organization has settled down. We didn’t have any flight risk to speak of that affected from any changes there. Everybody seems to be focused and driving forward.

Since that structure, Mark has created a number of things. He created the LEAD office, which is a new way for us to try to aggressively push some of the LEAD initiatives that we talked about. We’ve added Bill Axline at the Electrical Segment position, and that’s been important. Brian Kobylinski has been elevated to the Industrial segment leader. That’s working well.

We added a new leader in China, a man called John Shay, who runs all of our China operations; replaced Raymond Shaw, who actually left prior to the COO thing. And I’ve been very happy with that one and what we’re doing with the Taicang facility.

I think our challenge is now to drive the next level down and to really get our business presidents to make sure they’re filling their teams. So, the Enerpac leader, make sure we’re getting people below that level to really drive and get horsepower so we can start, we can integrate these acquisitions. We have a new, what we call H Cap Process, which is Human Capital Process, we just got done going through in the last 60 days, specifically focused on that next level down. So, I really feel like the organization compared to a year ago is in a much better position to do bigger things.

Wendy Caplan - Wachovia

I’m not sure with all your comments about profitability in Electrical/European, whether I understand whether Kopp is profitable yet. Can you tell us if it is?

Bob Arzbaecher

No, we can’t, Wendy. From a segment point of view, we’re not going into that level of detail. What I can tell you is Europe Electrical, Kopp and Dresco had significant improvement in profitability for the quarter we just completed.

Andy Lampereur

We are pretty pleased with the improvement.

Wendy Caplan - Wachovia

To talk about Asia for a minute, you said that it was growing in the high teens. Specifically China, can you talk about the new facility coming online, you said that you thought you could add some assembly work to that. And what impact you are assuming for the new facility for ‘09?

Bob Arzbaecher

We’re building a facility in Taicang, China. It’s a $15 to $20 million facility, and then there will be equipment dropped in on top of that. Taicang is about an hour and half out of Shanghai on the Yangtze River. And it’s a place that has what we think pretty competitive labor rates in terms of office people. The big problem in Shanghai is trying to hold on to the office people. And Taicang got its own university and a number of things that I think fit well for us.

That facility is going to open in August, right around the Olympics. I think we showed a couple of pictures on the slides; we didn’t. There’s one in our lobby. But that we’ve broken, the roof is overhead. The concrete has been poured. They’re doing all the office renovation, as we speak, starting to bring power into the unit. We expect to move our first product lines in there in late to mid-July, and so most of that is just inner-China transfer, things that were already in our China locations that will be moving on to that campus.

The hope of this campus is to try to balance. We’ve had decent sales efforts. We’ve had decent sourcing efforts. What we want to do is add competencies in our assembly operations, to be able to do that within China rather than bringing components back here and then assembling it either in Europe or the U.S. The goal is really to balance that. The facility is about 300,000 square feet. It’s got plenty of capacity for the next three to five years for us with some room outside of that if we need it.

Andy Lampereur

I think the key thing that we’re seeing, Wendy, is if we want to grow our OEM business in China, we have to be there. We have to assemble the product there. So, you’ll see our truck footprint there get bigger, certainly with Power-Packer or Maxima, we’ll be producing product within that plant within six months. And Gits will be moving in, and certainly that will be a big part of its growth as we move out as well. [

So, from a footprint standpoint, it’s about a 300,000 square foot facility, what we have today aggregate is probably about 100,000 square feet. So obviously a lot of room for growth here and that’s the goal.

Bob Arzbaecher

That’s a big chunk of the CapEx that you’re seeing that’s been rolling through 2008. And there will be some of that rolling into 2009.

Operator

Your next question comes from Chris Weltzer – Robert W. Baird.

Chris Weltzer – Robert W. Baird

Could you give us a little more detail on the magnitude of the organic revenue declines in your different electrical businesses. I noticed we’ve lost one of my favorite charts in your presentation.

Andy Lampereur

The declines, when you look at the four product lines, within Electrical, we were down, I believe, all four of them were down in the range of, I think, 6% to 11%. They were all in that zip code. North America was down the most because of the market share shift within Gardner Bender at Lowe’s.

Chris Weltzer – Robert W. Baird

In your $45 million of CapEx, for the FY ‘09, I know you talked about some of the China spending is going over. But is there any other large projects in that number.

Andy Lampereur

There’s definitely ERP projects. We are putting in a system, a global system for Enerpac. We’ll be starting one for Gardner Bender. The new China facility is getting one. Professional Electrical is getting one in addition to ERP’s, so there’s a fair amount of spending there. We will continue to really spend more than normal from a rental fleet within the Hydratight business, as we continue to put dollars or put rental fleet ahead of the business, just build it and they will come, with that business as we expand geographically.

Operator

Your next question comes from Steve Fisher - UBS.

Steve Fisher - UBS

On the industrial side, what was the unfavorable mix shift that you mentioned? And then, is that something that you’ve assumed continues to sustain in the guidance you have for next year?

Andy Lampereur

A couple different things from an industrial, it was really within the individual businesses. It was because Hydratight and Enerpac were both up on a core basis, 14% obviously mix didn’t come into play there. It was where within Hydratight, we do one-third rental, one-third product, one-third service. Our service was a little bit heavier this quarter. And we had less of the subsea the big more grip type connectors going through this quarter, and less of the rental, which tend to be a little bit more profit.

Within Enerpac, it was product lines within Enerpac, a little bit more innovative solutions work, a little bit more lower margin. Certainly there’s variations in margins across Enerpac’s product line. So it was within the individual businesses, not really across the segment between Hydratight and Enerpac.

Steve Fisher - UBS

And within your range of 28% to 32% margins, is that assumption include that this trend could continue?

Bob Arzbaecher

It’s precisely why I give the range. I don’t think you should react to a quarterly swing of 60 or 80 basis points in one quarter and try draw a line that that’s heading in one direction or another. It’s such a high class problem to have. It’s a great segment. We’re reinvesting in it as fast as we humanly can.

I will gladly take incremental margins at 25 in terms of growth. I challenge the business to look at it that way, capture what you have today, but go get incremental business and keep the top line growth going. And that’s precisely what we are doing. And if you, as the investment community, are going to react to a business with this profitability, either positive or negative, it jumps around. It’s just the nature of the beast.

Andy Lampereur

I know this and certainly, Steve, everyone is asking this question ahead of time, can the margins go up, what happens? I can emphatically say there is nothing, nothing wrong with the margins or the profitabilities of these two businesses. This is purely what we talked about. This is higher bonus expense coming through our mix within here. That’s really why Bob is trying to establish this range. There’s going to be some lumpiness as we go forward. But we are as positive as we have ever been on the profitability and how these businesses are doing. You should not read into this.

Steve Fisher - UBS

On the Actuation margins, it sounds like they were helped by the automotive side. And I’m just wondering if there’s any reason to believe that that shouldn’t be sustained? And if I remember correctly, you get some margin volatility from the big swings in business you’ve seen historically as programs ramp up and down. But it sounds like that experience is expected to flatten out.

Andy Lampereur

I would expect the margins to continue to continue to be at an improved level year-over-year in this business over the next year. There are a couple of platforms that come on. We actually had one come on this past quarter and it didn’t derail the margins here. So I think we’re going to see decent improvement going forward.

Steve Fisher - UBS

What was the organic growth by your major regions in North America, Europe and Asia in the quarter?

Bob Arzbaecher

I don’t think we really want to give that data out. We haven’t in the past. What I would tell you is what we quoted in the comment that Europe was in the mid-single digits zip code and that Asia was in the teens.

Steve Fisher - UBS

And North America, back into it basically.

Bob Arzbaecher

You’re going to have to try to compute that. But obviously with RV in there, as RV is all of North America, GB we talked about. So you can probably draw my conclusion.

Operator

Your last question is a follow-up from Amit Daryanani.

Amit Daryanani - RBC Capital Markets

The tax rate is it in the 30% to 30.5% for Q4 in fiscal ’09.

Andy Lampereur

No, we talked last quarter that our tax rate in the back half of the year would probably be closer to 30%. Part of that actually was some of the benefit that we got through this past quarter. We anticipated some of that. I think going forward we’re looking at 30%, 30.5%, in the next couple of quarters here.

Amit Daryanani - RBC Capital Markets

Looking at your AP days and that’s stretched pretty well, two, three years ago it used to be in the 40, 41 day range, now it’s in the low 50s. Is there room for more, stretching those days out further to boost your cash flow? Or you think you’ve hit a limit on there?

Andy Lampereur

I think there is always improvement opportunities in the working capital. And we clearly have focused a lot on that. Some of that is also shifting more to a call it a DPATS model, more procured components and that sort of thing. So you’re going to have more payables out there as opposed to more payroll out there, so it’s going to happen naturally. But I think the biggest move has taken place for the business. I think the bigger opportunities within working capital right now is probably inventory.

Bob Arzbaecher

The other comment I would make on that is almost every acquisition we buy is miles behind us in terms of working capital efficiency. And that’s one of the synergies that we go after immediately. So payables is a chunk of that; inventory is probably a bigger chunk; receivables, even a bigger chunk. So, yes, our working capital performance and a lot of the things you’re seeing in improvement are a direct relation to acquisitions.

Amit Daryanani - RBC Capital Markets

Andy, I think you talked about exiting or selling one of the Kopp manufacturing sites and product line. How much revenues did you generate from that site and so just so I can know what headwind you may have from not having the site going forward?

Andy Lampereur

Yes. The product line, we probably generated about $20 million a year on it. Some of that will continue on where we’ll do a buy/sell with that party but the majority of it will go away. This was an example of one of the product lines where we said, look, if we cannot make enough money in this product line, we will exit it.

If you look at core sales decline in Electrical, all is not bad. Part of this is, it’s good stuff. We will knowingly walk away from low margin business on it. So, it’s a headwind and it’s baked into our guidance next year. It’s probably $10 million or so related to this next year. Some of it will trickle out in the fourth quarter as well.

Operator

Sir, there are no further questions at this time.

Bob Arzbaecher

I would like to quickly draw your attention to a future key date information that we have on the slide that you see now. We expect to release our year-end results on October 1 of this year, and we will be hosting our annual Analysts Day in New York City on the next day, October 2. We’d hope you’d be able to join us for both of these events.

We appreciate your participation on the call and your interest in Actuant. If you have any other follow-up questions, Karen, Andy and I will be available the rest of the week. Thank you and good bye.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!