Baldor Electric Company Q2 2008 Earnings Call Transcript

Baldor Electric Company (BEZ)

Q2 2008 Earnings Call

July 25, 2008 11:00 am ET

Executives

John McFarland - Chairman and Chief Executive Officer

Ron Tucker - President and COO

Analysts

Steve Sanders - Stephens Inc

Kristine Kubacki - Avondale partners

Michael Schneider - Robert W. Baird

Arun Seshadri - Credit Suisse

Fla Lewis - Weybosset

Chris Terry - Hodges Capital Management

Presentation

Operator

Welcome to Baldor Electric Company's second quarter 2008 Earnings Conference Call. (Operator Instructions) . I would now turn the call over to Tracy Long, Baldor's Vice President of Investor Relations.

Tracy Long

John McFarland, our Chairman and CEO and Ron Tucker, our President and COO are on the call with us this morning and we all appreciate you attendance today. Our press release was issued last night and a copy could be found on the website. One correction to the release is the total assets number, which should have been stated as $2 billion, $843million, $515,000. I need to remind you that some of the comments we make today, maybe forward-looking statements, those statements are not grantee and actual results could be materially different.

With that, I'll turn the call over to John McFarland.

John McFarland

We are pleased to report a solid quarter with record sales of nearly $504 during the quarter with record net income of $29.4 million and record earnings per share $0.63. Our business was consistent throughout the quarter and that consistency has continued into July. We remain on track to achieve our debt reduction goal for 2008 of $125 million.

During the quarter we reduced our debt by $40 million, bring us to a total debt reduction this year of $60 million and a total of $236 million in the last 15 months. Lower interest rate and less debt resulted in $6 million less interest expenses during the quarter. Total sales increased on 5% during the quarter when adjusted for the sale of the service business which occurred during the second quarter of last year.

International sales increased by 10% during the quarter and improvement from the first quarter growth on 6%. International sales grew on all regions with over 20% growth in the Asia Pacific region. Also our customers appear to be having some good success in the international market with their products, as the number of 50 Hz motors we made increased by more than 30%.

50 Hz motors are not used in the United State, so all 50 Hz motors that we produce go on equipment that is been exported. One of our goals during the quarter was to improve the availability of our products from inventory. We made good progress at improving our inventory availability during the quarter and we expect to make some additional progress during the current quarter.

We were also able to reduce the lead time in two of our largest motor manufacturing plants during the quarter. We believe these reduce lead times and better inventory availability will benefit sales going forward and help manufacturing productivity. There were also some disappointments during the quarter. The biggest of which was the increase cost of raw materials and transportation.

While we expected the cost to increase, and we increased motor prices by 4.5% in April, we did not expect as much inflation as we experienced. Increased cost of materials were mostly offset at motors, but not in our Dodge product lines. As a result of greater than anticipated inflation especially in the steel, cast iron and transportation, and the expected increase during the current quarter, we have increased our prices in a range of 5% to 8% for all products effective last July 13. Our strategy with price increases has been to cover the increased cost of material in dollars and we believed this increase will do so.

The strategy does put some pressure on margins as we have seen during the quarter, and we are disappointed that we didn’t do a better job of controlling these costs during the quarter. If we had been able to fully offset them, operating margins would have been up and SG&A would have been down.

Probably the biggest question many of you have, concerns our outlook for the future. The incoming order rate we currently have along with the backlog of orders that now exceeds $235 million, causes us to feel that our sales will increase over the balance of the year in the mid-single digit range similar to the second quarter when sales were up 5% when adjusted for the sale of the service business.

There are some in our company, and some of you who feel we are somewhat conservative with this estimate in light of the price increase and the extra few days we will have in the fourth quarter. There are others who, in light of the current economic news feel that we might be too optimistic and that we are going too far out on the limb. We feel our guidance of mid-single digit growth for the balance of the year is appropriate and achievable, giving the current condition. We also expect to continue receiving benefits from lower interest rates throughout the balance of the year and our lower debt balance.

This combined with the cost reductions we continue to pursue and achieve, gives us confident that we will be able achieve our goals during the balance of this year, and with that I will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Steve Sanders with Stephens Incorporated.

Steve Sanders - Stephens Inc

John, just coming back to your comments about the commodities. You highlighted steel, iron ore and freight. Can you kind of rank those in terms of relative pressure you felt during the quarter?

John McFarland

Well steel is the largest commodity that we buy and so the biggest pressure in dollars was with steel. The highest increase as a percent was with outgoing freight, but the biggest impact was on steel and cast iron would have third.

Steve Sanders - Stephens Inc

I think you said, I may have misunderstood, that you expect upward pricing trends to continue during 3Q. Is that correct and is that the assumption you’ve made with regard to the price increases?

John McFarland

Yes, our steel prices are based on indexes, so we know what we are going to pay for steel in the third quarter. We’ll know what we pay for in fourth quarter, later in the quarter because it’s based on a monthly index. So we know what increase we are going to have in the third quarter. The two things that cause some problem in the last quarter are not based on indexes and that’s transportation cost and cast iron, either of those is based on an index. So, we kind of know month-to-month where we are on those, but based on what we know with steel, based on what we know with respect to our copper prices and based on what we expect with regard to some of these other commodities.

We feel our products increase will cover, at least in the near-term will cover those increase cost. If it doesn’t then we will take addition action. We certainly don’t want to, our customers of course don’t want us to raise prices every, but if we are unable to cover those costs we’ll take additional price action.

Steve Sanders - Stephens Inc

And the price increases of 5% to 8% look to certainly be on the high-end of what we’ve seen over the past couple of years. You’re confident that you’ll get those through any big customer pushback at this point. How would you characterize that?

John McFarland

Well that’s a good question. Yes, actually the 8%, which is on the motor part of the business, 5% is on drives and generators and dodge, but the price increase has been implemented, it was implemented on the 13, and we had pushback obviously but as we have talked to customers they seen to realize the need for the price increase none of them really like it, but they realize and understand the need for the price increase.

Everything our motors are mounted on is made as steel. Our customers realized what’s happening in the steel market. So, we’ve had no, I would say no unusual amount of pushback and we’ve implemented the price increase effective the 13^th.

Steve Sanders - Stephens Inc

And the distributor business was certainly better, it sounds like the small motor inventory side helped. How would you characterize your discussions with key distributors in terms of their outlook for the back half of the year?

John McFarland

Well that’s a great question. We just had distributor here, the day before yesterday fairly significant distributor and we’ve been talking to a number of distributors and I would characterize their mood as optimistic, they are optimistic about the future and about business but pessimistic or least conservative when it comes to their inventories and our distributor business was quite a bit better actually in the second quarter than it was in the first quarter. We suffered a decline in business in the first quarter, so the positive growth in the second quarter was better, but to sum up I would say they are optimistic, we are not seeing huge changes in their business, but they are very conservative with their inventory dollars, and our improved inventory benefits has been in that regard because a lot of distributors do work out of our inventories.

Steve Sanders - Stephens Inc

Okay and then just couple of final questions for Ron. CapEx looks to be running below the annual rate, I think we are expecting in the $40 million to $45 million range and then the second part is, other income look high. Did you have any one timers in there?

Ron Tucker

Yes, only other income. There was one item that was a one time type items. It was about $900,000 that was a gain and it was associated with the merger of the Reliance Germany and the Baldor Germany entities, but that will occur moving ahead. So let’s take that back out, other income was very similar to last year. On the CapEx as usual its more back half loaded, so we’ll probably be right out at the $45 million this year.

Operator

We’ll now take our next question from Kristine Kubacki with Avondale partners.

Kristine Kubacki - Avondale Partners

I just wanted you to talk a little about the international expansion that you completed during the quarter and talk about, in terms of what products you are making over there and kind of how you see that unfolding in the penetration into the market coming online particularly with the motor production I believe later this year or early next year?

John McFarland

Okay. In China we doubled the size of our plant there during the quarter and we moved into the new facility. It wasn’t a doubling of the building we were in it was a new building, so during the quarter we moved from the old facility to the new facility. We are currently producing products, Dodge products there specifically a product for the coal mining industry to, a product that’s use to self-start coal mining conveyors and those of you that follow the mining industry know that China is pretty hot market for coal mining.

We have a very strong order book in China, and in fact in June we booked a record amount of orders for that affiliate. The products that we’re making there are the Dodge products. Later in the year we do expect to make, in a very limited way begin making a few special types of motors that we want to sell in China and then next year we’ll be more active in increasing the motor output, but currently we are producing primarily Dodge products and beginning to produce a few limited motors. Our business on these Dodge products is very strong in China and we have a very good order book there with record input during June.

Kristine Kubacki - Avondale Partners

Just wanted to understand a little bit about the backlog in terms of - will that mostly be filled in this kind of rolling 12-months?

John McFarland

It will mostly be filled in it in the current 12-months and of course we would expect the backlog to grow over the coming quarter and part because of the price increase. We do re-price orders that are in our backlog when we have a price increase so, the backlog could grow during the quarter and part because of the price increase.

Kristine Kubacki - Avondale Partners

Final question, I was just wondering you guys have made some adjustments to your sale organization and it’s kind of starting to unfold in this quarter and how that’s gone and how those adjustments are in and if you see anymore going forward from here?

John McFarland

We don’t see any major changes in our sales organization going forward. We have increased the size of our sales organization, both for motors and for the Dodge products, and we think we are following a very aggressive strategy that will lead us to faster sales growth thickly on the Dodge side of the business, where we have really increased the focus of the salespeople and the number of salespeople that are out there in the field, but at the same time we have done much the same in the motor side of business.

The two sales organizations are different, that motor organization as a straight commission group and so, were as the Dodge organization are employees that work on a salary plus commission. We are really happy with where we are with the sales group, then we think that in a market that might get more competitive in the future depending on your outlook for the economy. I think that the stronger sales organization has better shot of success than one that’s not so strong.

Operator

(Operator Instructions) We’ll take our next question from Mike Schneider, with Robert Baird.

Michael Schneider - Robert W. Baird

I was wondering, first if we could just start with kind of the 2Q trends. Did you see as a result of the July 15 or 13 price increase, you think you saw any pre-buying in 2Q John?

John McFarland

No, I don’t think we saw very much. I mean I would characterize any pre-buying as probably less than a million bucks.

Michael Schneider - Robert W. Baird

And then the, some of the deliver in production challenges that you had in first half, it sounds like you made a lot of progress there. To what extent did that help the second quarter as well, just so we don’t extrapolate erroneously from the second quarter trend?

John McFarland

Well we did increase our inventory sum in the second quarter, but a good amount of that increase was accomplished by working Saturdays in a couple of the plans where we needed to increase the inventory. We are in a much better shape now to take care of our customers with respect to inventory and I’ve been talking to a number of them about that are we doing a better job for you know, and I’m getting a very positive feedback and I think that will help our sales, but it will also help manufacturing productivity in the third quarter and that we don’t expect to be working as many Saturdays as we have been and so we would expect a lower overtime that what we’ve had on the first half of the year.

Michael Schneider - Robert W. Baird

And tell me how that puts and takes in the second half and presumably you would have less overtime expense, but also a lower absorption in the fixed assets. Is that a net positive or negative for margins in the second half?

John McFarland

I think I having a better – I’ll let Ron comment on that as well, but I think having a better inventory is a net positive and that the orders we typically lose, because our inventory was not up to what it normally is. The orders we lose tend to be on the distributor side of the business and so I think having a better inventory is a net positive, having shorter lead times it is a net positives for our customers and one of the competitive advantages that Baldor has had for many, many years over our competitors is shorter lead times, and when our lead times get extended like they were in the first and second quarter, there is lesser a difference. I don’t want to say - there is still a lot of differences between us and our competitors and I could speak all morning on that, but when our lead times are more similar to our competitors that’s not the competitive advantage it is when they are a lot shorter, so I think on average it’s a net positive.

Ron Tucker

I would agree with that. Given the inventory situation and given the reduction in overtime and just the better efficiencies you get in the plans by having that stable schedule, it should be a net positive to the margin.

Michael Schneider - Robert W. Baird

And then when you look at the backlog increase or the order increase during the quarter, is there now a divergence occurring where a disproportionate amount of the growth is coming out of the higher horsepower presumably more of reliance type motor tide to machining and mining or is that business still, call it a stable part of the mix.

John McFarland

The large motor business is a significant portion of the backlog, but during the quarter we actually had a little bit better growth in small motors than we did in large motors, but we do carry in the backlog the large motors that we make, many of them that are more than a 1000 horsepower in size. Most of those motors are custom designed and our lead times are longer for those types of motors. So a good portion or dis-portionate amount of our backlog is large motors, but from a growth point of view our growth in smaller and medium motors was a little bit higher during the quarter than in large motors.

Michael Schneider - Robert W. Baird

And were you surprised by that John?

John McFarland

Yes, I was.

Michael Schneider - Robert W. Baird

What do you read into that?

John McFarland

Well part of it, I think Michel is that they are the high efficiency motors which of course we get a premium for and there is a shift from standard motors to high efficiency motors and that’s is in the smaller and medium sized motors. So that was part of the better inventories that we had especially in the last part of the quarter, so I would attribute it primarily to those two things.

Michael Schneider - Robert W. Baird

In the small motor category, you mentioned - while in the motor category you mention that distributor sales were up 2% in the quarter, am I right that’s probably all or more price at this point and unit volumes were probably down slightly in the quarter?

John McFarland

Well our unit volumes overall, we don’t really analyze them by distributor OEM but our unit volumes overall in the quarter were up from the sales point of view, but the distributor business you recall in the first quarter was down 1% or 2%. I don’t remember the exact number but it was a negative number. It’s a positive number in the second quarter. Don’t forget that the price increase that occurred in the second quarter, at the beginning of the quarter was only on motors.

In the motor business we have about 40% of our total volumes is to distributors. We did not have a price increase, we should have but we didn’t have a price increase at Dodge in the quarter and there we have about 80% of our volume through distributors. So if you look at the distributor business overall, I would describe it during the quarter as flat with the first quarter taken out the price increase.

Michael Schneider - Robert W. Baird

Okay so, the 5% motor growth during the quarter, just in total from motors. What percentage point contribution, do you think pricing made to that? Was it half of the five?

John McFarland

Well, the price increase that we had was 4.5% it was effective with orders on the 1^st of April and effective with shipments two week later. So, it would have made, probably I think our total unit volume was up 2% or so, just under 2% on motor. So it probably made up 3%.

Michael Schneider - Robert W. Baird

Okay and then on the high efficiency market, have you discerned any notable acceleration in the appeal of the Super-E motors as energy prices reserves. We’ve had other companies report actually significant gains on some of there products going into geothermal, into solar systems things of that nature. I am wondering if you’ve actually seen it in your business. I know the business has being growing north at 25% but was there even a mark to acceleration during the quarter.

John McFarland

I wouldn’t call it a marked to acceleration, but on a year-over-year basis the growth picked up a little bit starting in about March compared to what it had been in the previous couple of years, but we’ve seeing good strong growth in high efficiency markets for quite a long time. We have introduced some new products at Dodge that we think we’ll get good growth out of and we are beginning to sell and those are high efficiency gear motors.

There is an unusually good opportunity for us in that area, and then around the end of the year we’ve got a product that we are going to introduce and I really don’t want to get into it, but we’ve got a product that we are going to introduce towards the end of the year that we thank will also give us some good growth and it’s a high efficiency motor for a specific application where you just really get a – and it’s a very common application were you really get a good payback.

So we continue to invest in the high efficiency motors and customers continue to switch to them from standard motors, I can’t help but thank of anything, but that’s just going to continue happening. We were notified this week, last week by our utility here in Fort Smith where, of course we have several plants, that our electricity cost here are going to go up by 25% in August. So that’s happening nationwide, that makes high efficiency motors that much more compelling and so I believe our sales of those products will continue to increase.

Michael Schneider - Robert W. Baird

Do you have 50 Hz offering as well in the Super-E category?

John McFarland

Yes, we do.

Operator

(Operator Instructions) We will go next to Tom Gallagher with Credit Suisse.

Arun Seshadri - Credit Suisse

Good morning, this is actually Arun Seshadri for Tom. Just a couple of really general high levels questions, you made a big acquisition over a year ago but it looks like at least this quarter your operating income is pretty much flat and looks like most of the EPS improvement is coming from lower interest expenses. So I don’t know if you can give us a little bit of your thoughts on, what are all the puts and takes that let you here and what your plans are?

John McFarland

You’re right about that, if you look at the operating margins and operating income and that was really a function of two things that was the function of the increases in raw material like steel and copper and also (Inaudible) transportation. So, it did impact our margins, as John said earlier we had a price increase on motors that covered a part of that. We did not have a price increase on dodge, so have increased prices on July 13^th, between 5% and 8%, but that was - the difference you saw in the margin and in the operating income was fully due to the raw materials and transportation increases.

Ron Tucker

And let me just add to that, had our shipping costs remain stable during the quarter, we would have a pretty nice increase or decrease in SG&A expense, had our raw material costs remain stable, we would had a pretty nice gross margin increase and both of course were resulted in operating, both actually would have resulted in record operating cost, but we didn’t have those things and we were disappoint that we were caught by this headwind and we’re not going to allow that to happen in the future.

John McFarland

I think it also does show to, that are focus on reducing debt quickly, something we are going to continue and accelerate if we can because you’re right. The increase in our earnings was really due to our focus on debt reduction.

Arun Seshadri - Credit Suisse

I appreciate the color there. The other kind of general question that I have, John and I, you mentioned portion of this before, breaking out the volume versus pricing on the motor side, just overall on your top-line adjusted for the sale of your repair business looks like you were up 5%. How much of that overall is volume versus pricing?

John McFarland

We don’t study units as much probably as you all do. I mean we report our sales in dollars, we report our earnings in dollars we are paid in dollars. So, what we are concerned about mostly are dollars and if we could figure out how to make fewer units at more dollars that will be our - but units were up in the quarter a little under 2% against the 5% sale increase, so about 3% or so of the increase was probably related to price.

Arun Seshadri - Credit Suisse

And then about the higher kind of growth in markets like energy, mining etc, some of your competitors -- broadly they target those markets that has been showing slightly higher unit growth and I guess I wanted to get your sense for what you can do, are you kind of running into a more difficult environment now. Unit growth this is kind of harder to expect.

John McFarland

We have a fairly significant and its growing in significance; participation in the mining business and the oil and gas business and we’ve not seen really a falloff in that area. When I look at the number of explosion-proof motors that we’ve made for example in the last quarter, I mean it was way up. Most of these going in there, a lot of these go into the energy markets and our customers that are in the mining business are having strong growth and the orders from those customers are up strongly from last year.

Operator

We’ll take our next question from Fla Lewis with Weybosset.

Fla Lewis – Weybosset

Just wanted to get a little more detail on the nature of your business that’s down for export; I gather these are domestic customers that are shipping their products abroad. Just a little more detail; what kinds of motors are being shipped and where are they going to, do you know?

John McFarland

We don’t have a good handle on that. I’ll just say that our domestic OEM customers, which is about half of our business would normally buy for a sale in the U.S. a 60 Hz motor and so we’ve began just this quarter tracking our production of 50 Hz motors because we know there is no 50 Hz used in the United States or anywhere in North America. So, we know that any 50 Hz motor that we make is going to be shipped outside the United States. We don’t really have to handle on, where these things are going outside the United States, but we do know where they’re going and that production was up about 30% during the quarter over last year.

There is also a few countries in the world and of course countries in North America like Canada and Mexico are 60 Hz and we’re seeing our business in both Canada and Mexico grow a little above our average over the last couple of -- in the last quarter, and so I would assume the same is happening for our customers and those we wouldn’t be able to track because there they’re using a 60 Hz motor, but to answer to your question, we can track the 50 Hz motors that we produce; we know they’re going to be shipped outside the United State and we know that that business is very strong right now. Not a lot of people choose to buy those from us, because we have shorter lean times than our competitors and a better motor but we really can’t track where they’re going.

Operator

(Operator Instructions) We’ll go next to Chris Terry with Hodges Capital Management.

Chris Terry - Hodges Capital Management

John, a quick question, can you give us an update on how the integration efforts are progressing here and is it still realistic to expect maybe $30 million in savings for this year?

John McFarland

Yes, I believe it is realistic. Our goal was to be at that run rate or that level at the end of the year, we believe that’s realistic. The integration efforts are going fine; we really are kind of almost -- I don’t want to say we’ve gotten beyond that because I mean we continue to always look for every opportunity to reduce our cost, but I think that I can speak for the employees about it.

We’ve kind of gotten beyond as an employee group, the acquisition and we no longer, we don’t longer think of ourselves as a reliance guys or Baldor guys were all part of Baldor Dodge reliance and so in that respect and that’s in my mind the most important part of an acquisition like this is how you handle the people aspects and we are in really good shape I think in that area and we continue to realize cost savings from combining the two motor businesses and we will continue to have a strong focus on achieving what we’ve said publicly we could achieve and incidentally those remind everybody that we originally said we would achieve that in three years and then revised it to two years.

Chris Terry - Hodges Capital Management

Great, thank you and for my understanding, the focus is still on consolidation of purchasing groups, product integration, where you’ve got two designs and moving down to one on an over lapping product, things like that?

John McFarland

Yes that’s correct.

Operator

(Operator Instructions) and we have no more questions in the queue. I’d like to turn the call back over to our speaker’s for any closing or additional comments.

John McFarland

Okay. Well, thank you very much, thanks to all of you for joining our call this morning. The last year and a half has been a really exciting time for all of us here in Baldor. During this period we’ve doubled the size of the company, we’ve double our profits. We put the two leading North American motor producers together into a single company. We’ve improved our margins; we’ve increased our presence in foreign markets, we’ve added long cycle products to our product line; we reduced our debt $236 million in only 15-months and we’ve really positioned ourselves well, I think to take advantage of the rising energy cost that create a great opportunity for us at Baldor Electric.

I’m really proud of what the employees at Baldor Dodge and reliance have accomplished by working together as a team over the last 15 months. I’m proud of the way everything has come together into a very competitive and strong company. So, there is a lot of uncertainties in the current economy and you always kind of wonder what the morning news is going to bring, but we’re really confident that we’ll be able to achieve our goals over the balance of the year and we feel quite good about where we are today.

I just like to conclude by thanking everyone on the call. For being on the call this morning and also for the confidence you have in all of us and everyone in Baldor Electric Company. Thank you for joining us today.

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