Hillenbrand Inc. (NYSE:HI)
Q3 2008 Earnings Call
August 12, 2008 8:00 am ET
Mark Lanning - Vice President of Investor Relations and Treasurer
Kenneth A. Camp - President and Chief Executive Officer
Cynthia Lucchese - Chief Financial Officer
Dax Vlassis - Gates Capital Management
Maharth Kapur - Credit Suisse
Good morning and welcome to the Hillenbrand Incorporated Third Quarter 2008 Earnings Conference Call. Today’s conference is being recorded and we’ll be available for reply through August 21, 2008 domestically at 888-203-1112 and internationally at 719-457-0820. For the replay callers will need to use confirmation code 4683815. If you are unable to listen to the live webcast or the replay the call will be archived at www.hillenbrandinc.com through August 09, 2009. If you choose to ask a question today it’ll be included in any future use of this recording. Also note that any recording, transcript or other transmission of the text or audio is not permitted without the written consent of Hillenbrand Inc.
Now at this time it’s my pleasure to turn the conference over to Mr. Mark Lanning, Vice President of Investor Relations and Treasurer. Mr. Lanning, please go ahead.
Mark R. Lanning - Vice President of Investor Relations and Treasurer
Thank you, Margaret and good morning to everyone. With me today are Ken Camp, Chief Executive Officer and Cindy Lucchese, Chief Financial Officer. We would like to personally welcome you to our third quarter earnings call. During the course of today’s conference call and a question and answer session that follows, we may make projections or other forward-looking statements that are subject to the Safe Harbor Provision of the Securities laws regarding future events or the financial performance of the company. We caution you that these statements are only our view of the future and that actual results may differ materially.
We also alert you to the risk described in the documents we filed with the Securities and Exchange Commission, such as our annual and quarterly reports on Forms 10-K and 10-Q. We do not undertake any obligation to update or correct any forward-looking statements.
Now let me provide some information regarding our call. We’ve scheduled an hour and we’ll start with prepared remarks that should last approximately 20 minutes, we’ll then move directly to Q&A, if you have any follow up questions after the call has ended, please don’t hesitate to phone me at 812-934-7256 or email me at firstname.lastname@example.org.
We have a lot to discuss today so I’ll now turn the call over to Ken Camp, the President and CEO of Hillenbrand Inc. Ken?
Kenneth A. Camp - President and Chief Executive Officer
Thank you, Mark. Hello everyone and thank you for joining us this morning. Today I would like to start by sharing the highlights of our third quarter performance including an update on our key initiatives and also briefly discuss our outlook for the remainder of 2008. Then I will turn the call over to Cindy who is going to provide you with further details about our financial results including guidance for fiscal 2008. I will wrap up the prepared portion of the call with some closing thoughts then Cindy and I will respond to your questions.
As you can see from our press release we’ve posted respectable results in the third quarter. Revenues and margins were consistent with last year despite challenges in both unit volumes and cost for fuel and commodities. In addition, we see a key solid growth and earnings per share operating profit and cash flow from operations. From a volume perspective we experienced a 2.8% decline in unit year-over-year. The primary cause was the prior year cancellation of a short-term supply contract, which was related to the termination of the planned acquisition of an independent distributor in 2007. We also typically experienced a seasonal slowdown in the third quarter and this year it was just a bit more pronounced because it followed a strong increase in enjoying the related debts in future.
However, thanks to progress in our strategic initiatives we were prepared to capitalize on the market conditions. Over the next few minutes, I will give you a high level summary of those initiatives, which are helping to drive revenue and margins in the market with a declining volume in burials. Our most significant initiative is helping our customers implement merchandizing in an environment where it’s difficult for our customers to gain an additional funeral, implementing and utilizing a merchandizing system provides some financial rewards. The funeral directors total margins improved because families purchase a better mix of products when they received product information and have a wide range of choices.
Our revenue and margins followed suit and additionally consumers also report higher satisfaction with their purchases. Particularly in times of economic uncertainties Batesville’s proprietary assist merchandizing system provides our customers with a distinct advantage. Those who have implemented this system continued to see very good results. Conversely, in our experience funeral homes that do not use the merchandizing system generally have a declining average mix. Despite the success we know takes place when assist is implemented, we are still in the early stages of what we except will be a long adoption process. We are addressing this by ensuring our customers understand the benefits of the system and the success others have seen, as well as continuing to invest in sales force training, resources and tools that will increase our customer’s use of this successful merchandizing system.
Another key initiative is our focus on regional consolidators and key accounts. Batesville’s historic strength has long been our relationships with thousands of small independent funeral homes in cities and towns all across the US and Canada. Many funeral homes have been family businesses for generations and as owners postretirement the next generation some times chooses a different career path and the business maybe sold.
Also for sale is to a growing number of what we call regional consolidators. Last year we created a team of some of our best sales representatives to focus on bringing business solutions to this customer group. We have seen a strong increase in revenue year-over-year as a result of these efforts. Remembering that we also sell to the majority of funeral homes, our sales representatives spend a great deal of time attending to the needs of existing long term customers. We are continuing to further strengthen these relationships through systems that help our customers become more profitable as well by providing service that frees up their time so that they can attend to the needs of their client families.
A third initiative relates to cremation products, with the industry leader in this area and our revenues are growing at a rate faster than the overall growth in cremations. Our options line of cremation products is aptly named representing a wide assortment of products ranging from traditional orderings to (inaudible) sculptures also the home accents and even jewelry. To support this increasing consumer demand including baby boomers desire for personalized products, Batesville has been investing in a team that is similarly focused on creating new products and services for consumers’ to select cremation.
The fourth key initiative relates to our newer store products, this line which visually and functionally distinct from Batesville branded caskets is sold directly to caskets distributors and manufacturers.
The unique newer store models are generally in the lower price points and do not contain any of Batesville's proprietary features such as life symbols, cathodic protection or [member safe]. Our strategy is to provide these distributors who have very strong customer relationships in the local markets with products that need for existing and anticipated needs. Selling to these distributors provides them with a regular supply of well made attractively priced caskets and provides Batesville with the growth opportunity. We remain pleased with the progress of the newer start initiative while recognizing that it will take time to become a trusted contract manufacturer where some of those who have long viewed us only as a competitor.
It may be now our business is seasonal. And historically, the second quarters are strongest while the third and fourth quarters are typically somewhat lower from our revenue standpoint. At this point we see no reason why this market trend would deviate from past years and in fact that is exactly the pattern we saw in this quarter and expect also the same in Q4. These are uncertain economic times and we along with many other businesses have been challenged with dramatic utilizing cost for fuel and certain other commodities. We expect these costs to continue to increase during the reminder of the year especially for carbon steel as fuel suppliers have added very significant surcharges to existing supply contracts.
Over the past several months some investors and customers have questioned the anticipated effect these unprecedented increases in fuel and commodity costs will have on future casket prices whether we’re going to follow suit with other industries and take internal fuel and price increase or fuel surcharge. As we mentioned before we believe that a price increase once per year usually October 1st enables our customers to manage their businesses with a higher degree of predictability. We’ve chosen to maintain the long-term nature of our relationships with these customers by absorbing some increased cost as they have occurred this year rather than taking interim price hikes or fuel surcharges.
We’ll be communicating our annual price adjustments to our customers shortly in August so I’m not able to discuss that in detail on this call. However, we believe the price adjustment will be favorable to us and to our customers as we contend with volatile and unprecedented fuels and commodity cost pressures.
In summary, this has been a solid quarter for us. The core Batesville casket business showed good resilience and stability as we compensate for some strong headwinds. We believe our continued improvement initiatives in manufacturing and other parts of the company help mitigate such effects but they won’t completely offset the cost impact we expect to see in Q4. That said I remain optimistic about our ability to compete effectively and to continue to provide attractive shareholder returns.
And now I would like to turn over the discussion to our CFO, Cindy Lucchese. Cindy?
Cynthia L. Lucchese - Chief Financial Officer
Thank you, Ken. I’d like to touch on some of the drivers for our third quarter results. Sales for the quarter were $165 million virtually unchanged from the $165.6 million in the same period a year ago. Our unit volume was down 2.8% compared to last year, primarily related to the customer supplier contract Ken mentioned earlier. Excluding the impact of this item, which was included in our prior year results our revenues would have increased 2% over the prior year. This positive revenue growth and in otherwise stagnant burial market resulted from price realization and the favorable impacts of our sales and marketing initiative. We also benefited from the strength of the Canadian versus the US dollar by about a million dollars. These positives were partially offset by a negative mix impact due to the introduction of units with lower price point as well as the continued downward trend in mix in some of our non-merchandized account.
Our gross profit margin percentage of 40.2% was essentially unchanged versus 40.4% a year ago. A good news with margins is that we were able to maintain our gross margin percentage despite some very adverse market condition. Although we experienced $1.8 million of commodity cost increases and $1.2 of additional fuel cost in the quarter versus prior we were able to compensate for them with good results from our continuous improvement efforts.
We believe GI is a core competency for us and was a key component in the $3 million productivity and improvements we experienced in the quarter. Operating expenses decreased $5.7 million year-over-year to $28.4 million. Prior year results included $6.8 million in cost related to the cancelled acquisition, excluding those costs operating expenses grew modestly by $1.1 million. This growth was driven by increased compensation and healthcare cost offset in part by lower legal fees.
Legal fees related our anti-trust losses declined $0.9 million in the quarter versus prior year as we continued to wait on the courts ruling on class certification. The costs to run ourselves as a standalone company were comparable to the prior year allocation from our former parent company.
Interest expense for the quarter was $1.4 million versus none in the prior year. Our average borrowings were $160.7 million for the quarter bearing an average interest rate of 3.08%. As of today our outstanding borrowings are down to $85 million because we have been able to pay down debt with our significant cash flow.
Investment and other income was $4.4 million in the quarter versus $1 million in the prior year primarily reflecting income from the note receivable from Forethought, a former subsidiary of Hillenbrand industry. This asset was transferred to us as part of the spend from our former parent.
Our tax rate for the quarter was 34.9% versus 36.4% a year ago, this marginal reduction in the rate was primarily due to an increase in the Section 199 manufacturing deduction this year.
Net income for the third quarter was $26.7 million or $0.42 per diluted share, this compares with net income of $21.5 million or $0.34 per diluted share in the same period a year ago. Excluding the impact of the cancelled acquisition in the prior year our net income and earnings per share would have grown 9.4% this year.
For the first nine months of the year we generated cash flow from operations of $90.8 million including $41.3 million in the third quarter. We continue to be very effective in turning revenues into cash and earning.
In terms of the balance sheet we ended the quarter with cash and cash equivalents of $33 million, a long term investment of $52.7 million, which represent auction rate security. Although we collected $2.7 million of the auction rate securities in the quarter, the auction rate market remains challenged but we classified these investments as long term as of June 30th.
In terms of collectibility our auction rate security, which we hold as available for sale security are all AAA rated investments primarily in states student loan funds. Despite these ratings we provided for a 3% loss reserve due to the liquidity challenges resulting from failed auction. We plan to hold these investments until they can be sold for full value and therefore do not expect the loss reserve to be realized.
As of June 30th, we had outstanding borrowing of $400 million revolving line of credit of a $110 million. In July we paid down $25 million of these borrowings leaving a current outstanding debt balance of $85 million. We are reaffirming our revenue guidance for the year of $668 million to $686 million and increasing our guidance for GAAP net income from a range of $80 million to $93 million to a range of $86 million to $98 million as a result of lower than anticipated anti-trust litigation and separation costs. We also expect to have diluted shares outstanding of approximately $63 million and diluted net income per share of $1.36 to $1.56. On an adjusted basis net income is expected to be $103 million to $111 million or $1.64 to a $1.79 diluted net income per share.
We now estimate anti-trust litigation expenses at $4 million to $6 million for fiscal 2008 versus our previous estimates of $11 million to $13 million. The declined results from the timing of legal expenses to the delay in the courts ruling on class certification. One time separation cost from our former parent are now estimated at $15 million for fiscal year 2008 versus our original estimate of about $16 million to $18 million.
Now I would like to turn the call back to Ken for his concluding remarks. Ken?
Kenneth A. Camp - President and Chief Executive Officer
Thanks Cindy. Since becoming a separate public company we demonstrated our commitment to returning cash to the shareholders by paying our first quarterly dividend of $18.25 per share on June 30th. This equates to an annual dividend payout of more than $45 million. In addition in July our board authorized the company to repurchase up to $100 million of our common stock on the open market.
As we look to the future we know that our current and potential investors have a great and how we plan to increase long term shareholder value, this remains our number one priority. We are working closely with our board to refine our future Hillenbrand strategy.
To that end we have completed a detailed assessment of the death care industry and our core competencies and now we are in the process of identifying a range of internal and external growth opportunities. We are also building some internal capabilities to help us to identify and execute strategic initiatives. As these decisions are finalized we will share them with you through timely and transparent communications.
Once again thank you for joining us today and we look forward to seeing many of you as we visit investors around the country and host business year in Batesville. Cindy and I will now be glad to take questions. Operator will you please open the line.
[Operator instructions]. And we’ll take our first question from Dax Vlassis, Gates Capital Management.
Yes. I’m just wondering on these auction rate securities, the loss reserve was that in this quarter and if so -- was that taken in this quarter and if so where was that in the income statement?
It’s actually reflected in the equity section it’s just a reserve and it was taken this quarter 3%.
So, it didn’t fall through the income statement?
No, it did not and Dax let me correct that we took that last quarter, this is the same 3% that we actually reflected last quarter.
So, we’ve not changed that.
As any other auction rate securities that you hold been subject to some of the settlements we’re reading about in the paper?
They have not yet -- they however about $30 million of our auction securities are with UBS and you may have read their announcement yesterday that they plan to redeem those securities for everyone which would include, I believe it’s in June of 2010.
Okay. And your CapEx is running below what I think you thought expectations would be, where do you think it will end up this year?
Yeah, expectations wise we’ve started with somewhere around $17 million and we think by the time of the year it’s about maybe $10 million to $12 million.
Okay. And then did you reduce your tax rate estimate for this year and if so what’s the ongoing tax rate of the company?
We did not change our tax rate guidance, in terms of ongoing remember this year in Q2 we had the unusual situation with our separation expenses were a number of those were not deductible so we had an unusually high rate in Q2. I would tell you as we planning forward we of course having given guidance, but I think the way you see in this quarter as much more reflective or something you’re to anticipate going forward.
Okay. And then finally the Forethought operating income in the quarter where would you expect that to be for the fourth quarter, for the full year it seem like a pretty big number in the third quarter. I guess that includes operating income – I guess that includes interest income as well?
It does. We’re currently earning 6% on that investment and it’s about $2.8 million per quarter. That rate will go up in a few years to 8% and then on up to ten, in the near term here it will be at 6%.
Okay, and then actually I have one more, the volume that you are -- was down in the quarter year-over-year in the forth quarter, is there any carry over from net loss business or do you expect units to be up now that we are ramping the loss of that business?
Kenneth A. Camp
Dax, this is Ken. There’s no real carry over effects there, as volume fluctuates in our industry, everyone remember were reorder business and it’s a function of the number of calls that our funeral directors have. That’s what drives this seasonal volatility. As you look at the comparator of the prior year related to that contract on that distributor that was washed through FY Q3. If there anything left in Q4, it would be quarter less to the million dollars.
Okay, as a follow on to that, have you seen Mathews at all competing in the channel. It seems like they had a pretty good order in their casket business, have you seen any additional competition from them and do you think you are losing share at all?
Kenneth A. Camp
Well, we -- the Mathews is certainly a respected competitor and I think as you compare the two numbers between our companies here looking at us having a stable model and that we have always sold direct to funeral directors, Mathews I believe has stated that they were in the process of converting from a model of being a manufacturer that sold through distributors to also sell -- I believe they said a significant portion of their sales now are going direct. So, they are picking up the sales and distribution margins over and above what has historically been merely the manufacturing part. So, it’s the model change in that case and the comparison I think is a bit different.
Okay, thank you very much.
Kenneth A. Camp
[Operator Instructions]. And we will go to Maharth Kapur with Credit Suisse.
Yeah, hi guys. I am not sure if this question was already asked because I was little late for the call, but basically just wanted to get your take on possible combination of I guess to and large Funeral home customers that’s being thrown out there, you know, obviously SCI is a big customers of yours. How would that -- I mean, obviously this is hypothetical right now, but just given the example what happened with SCI and Alderwoods a few years ago. Do you guys have any thoughts on this?
Kenneth A. Camp
Maharth, I presume you are talking about SCI’s interest in Stewart Enterprises and we are the supplier to both of those companies and we have good relationships with them. So, I guess, we would describe it as a situation where if they stay separate, our volume will continue and if SCI acquires Stewart Enterprise, we would expect it to be the same. So, we are not anticipating -- whichever way it goes, we are not anticipating absence of very unusual event, any significant change in our business.
I guess in what I am trying to get at was in terms of the pricing, because as far as I remember when Alderwoods was bought their level of discount or the pricing for them was obviously better in turn for you guys versus what you were giving, which you I guess sell to SCIA. I am going to assume that the Stewart is a much smaller company then SCI that Stewart would end up gaining up the same price that SCI get, which would be detrimental to you guys and to the price?
Kenneth A. Camp
Well, I will give you a sense of the same answer when people ask me the question about Alderwoods, which is we have confidential requirements in our contracts with everyone and we don’t discuss or even hint what that might be.
Okay, fair enough. Thanks.
And with no further questions in the queue, I would like to turn it back to Mr. Lanning for any closing remarks.
Mark R. Lanning
Thank you, conference operator. We appreciate everyone’s time and sitting in on the call this morning, again we’ll be around both myself, Ken or all three of us Ken, Cindy and myself to talk to investors this morning. So, please don’t hesitate to give us a call at my number 812-934-7256. Appreciate your time and have a good day. Thank you.
Ladies and gentlemen that does conclude today’s conference, we thank you for your participation, you may now disconnect.
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