Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Colfax Corporation (NYSE:CFX)

Q2 2008 Earnings Call

August 5, 2008 8:00 am ET

Executives

Missy Reynolds - Vice President, Investor Relations

John Young - President, Chief Executive Officer

Scott Faison - Chief Financial Officer

Analysts

John Inch – Merrill Lynch

Jeffrey Hammond – KeyBanc Capital Markets

Michael Schneider – Robert W. Baird

Shannon O'Callahan – Lehman Brothers

Operator

Welcome to the Colfax Corporation's second quarter earnings conference. (Operator Instructions) At this time, I would like to turn the conference over to Missy Reynolds, Vice President of Investor Relations.

Missy Reynolds

On the call today we have John Young, our President and CEO and Scott Faison, Colfax's Chief Financial Officer.

I'd like to point out that our earnings release and Form 10-Q are available on the investor section of our website, colfaxcorp.com. We will also be using a slide presentation to supplement today's call which can also be found on the investor section of our website. Both the audio of the call and the slide presentation will be archived on the web site later today and will be available until the next quarterly call.

In addition, a replay of this call will be available until approximately August 22. The replay number in the U.S. is 888-203-1112 and internationally, it is 719-457-0820 and the access code is 8865744. This information is also listed in the press release.

I would also like to note that in order to help you understand the company's direction we may be making some forward-looking statements during the call, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties including those set forth in our SEC filing.

It is possible that actual results might differ materially from any forward-looking statements that we might make today. The forward-looking statements speak only as of the day that they are made and we do not assume any obligation or intend to update any forward-looking statements except as required by law.

During the presentation we will describe certain of the more significant factors that impacted our year over year performance. Please refer to the company's slide presentation and the MD&A portion of our second quarter section of 10-Q for details regarding additional factors that impacted year over year performance.

With respect to any non-GAAP financial measures during the call today, the company information required by SEC regulation G relating to those measures can be found in our earnings press release under the investor section of the Colfax web site. References to adjusted net income, adjusted net income per share, adjusted operating income and adjusted EBITDA are all non-GAAP measures and they exclude asbestos liability and defense costs, income and asbestos coverage litigation expense as well as the Legacy legal adjustment and one time initial public offering related costs.

Adjusted net income also reflects interest expense as if the offering had occurred at the beginning of the period and presents income taxes at an effective tax rate of 34%. Organic sales growth and organic order growth also non-GAAP measures exclude the impact of acquisitions and foreign exchange rate fluctuations.

Now I'd like to turn it over to John.

John Young

Before I get started I'd like to formally introduce Missy Reynolds as our new Vice President of Investor Relations. Welcome to the Colfax team.

This is our second quarterly earnings call since we began trading on the New York Stock Exchange on May 8. Today, I'll start by covering some of the second quarter's more significant highlights and some of the key performance measures that we achieved. I'll follow that with a review of our strategic end markets. Finally, I will review the financial results and then we'll open it up for a question and answer session.

As we announced in the press release issued this morning, Colfax has a strong second quarter. Adjusted net income was $13.9 million or $0.32 per share, a 53% increase over last years second quarter. Net sales for the quarter were $161.4 million, an increase of 32% including organic growth of over 18%. Organic sales growth was particularly robust in the power generation end market which was up 61% as well as the industrial market which was up 26%.

Adjusted operating income increased 42% to $23.6 million driven by the increase in sales. Adjusted operating profit margin increased 110 basis points to 14.6%. Adjusted EBITDA increased by 32% to $27.5 million.

Turning now to year to date numbers, for the first six months adjusted net income was $24 million of $0.55 per share, an increase of over 48% over the first six months of 2007. Net sales for the six months were up 23% to $292.1 million. Organic sales grew just over 10%. Adjusted operating income increased 34% to $41.9 million, while adjusted EBITDA increased 27% to $49.5 million.

We continue to see strong growth in our order rates and back log during the quarter. Order rates have grown steadily under an organic basis over the past several years and into the first half of this year. Year to date orders were up 36% with organic growth of 21%. Back log was $384 million at the end of the second quarter and is at an all time high.

We participate in five strategic diverse end markets which are commercial marine, power generation, wind gas, global navy and general industrial. The commercial marine market is our largest single end market. It was 21% of our second quarter sales. Organically, commercial marines order growth was 6% for the quarter and 37% year to date. Organic sales grew 14% and 6% for the quarter and year to date respectively.

We expect that growth and international trade, regulatory changes and high demand for oil and commodities will continue to drive demand for container ships, tankers, bulkers, supply vessels and FBSO's. We also continue to see incremental aftermarket activity in the commercial marine market.

Oil and gas sales were 11% of our total sales for the quarter while comprising 14% of our orders. Year to date sales were down 15% on an organic basis due to an unusually large project that was delivered in the second quarter of 2007. On an organic basis orders were up 63% for the quarter and 11% for the first six months. We expect that activity in the oil and gas markets to remain favorable as capacity and strength continue to grow in global demand keep oil prices elevated.

We believe that these high oil prices will continue to drive development of heavy oil reserves and that project size will continue to increase.

In the power generation market we expect activity in Asia and the Middle East to continue to be robust as economic growth continues to drive significant investment and energy infrastructure projects. For the second quarter sales in the power generation market were 15% of our sales and 10% of our orders. On an organic basis, sales were up 61% for the quarter and are 47% higher year to date. Similarly orders were up 30% for the quarter and 19% year to date.

Finally, sales into the global navy market for the quarter were 4% of our total sales and orders were 7% of our total orders. Organic sales were down 31% year to date while organic orders were up 20%. We anticipate increased navy revenue in the second half of this year in support of the U.S. Navy's new ship construction program.

Despite the recent announcement that the DDG1000 program will be terminated after the initial two ships, we expect the U.S. to continue to appropriate funds for new construction of naval vessels as older classes are decommissioned. As an example, this past week it was announced that the U.S. Navy will recommend to Congress that eight more units of the DDG51 class destroyer be built between the years 2010 and 2015.

We also believe that demand will increase for integrated fluid handling systems such as our smart valve system that reduce operating costs and improve efficiencies. In addition we expect nations outside of the United States to continue to expand their fleets to address national security concerns.

We believe continued infrastructure development throughout the world will drive capital expenditures and our sales in the general industrial market. General industrial sales were 48% of our sales in the second quarter and were 42% of our orders. On an organic basis, sales increased 26% for the quarter and 19% year to date while orders increased about 20% and 15% for the same periods. The growth in sales in this market for the quarter was broad based across several sub markets with the chemical market being particularly strong.

Turning to a more detailed review of our financial results, sales for the second quarter were particularly robust to our customers in Europe driving an organic sales increase of 22% in that region. Sales also remained strong in the U.S. with an organic increase of 9%. Power generation and general industrial sales were also very strong. For the first six months consolidated organic growth was 10% which met our expectations.

Gross profit margins for the quarter were flat when compared to prior year, but are up 140 basis points year to date. The year to date margin improvement was driven by increased profitability in our commercial marine business by driving price and lowering costs to improvement in manufacturing productivity and our European operations, and incremental production from our Wuxi, China facility. For the quarter, a heavier mix of system shipments offset continued margin improvement in our European operations resulting in a flat gross profit margin.

Selling, general and administrative expense increased $10.4 million during the quarter including a $4.1 million charge related to a non asbestos liability case that is further detailed in our 10-Q and $2.6 million due to impact of foreign exchange rates. Excluding the effect of the $4.1 million legal charge SG&A decreased as a percentage of sales by 120 basis points to 19.6% for the quarter even though the current quarter contains $700,000 of public company operating costs.

Without these costs, the decline would have been 170 basis points.

Through the first six months, excluding the impact to the $4.1 million charge, SG&A expenses were flat as a percentage of sales. However, in 2007 these expenses had the one time benefit of a $1 million gain related to sales securities, but the company received an insurance demutualization. Removing this gain, as well at the 2008 public company costs, results in a decline in a percentage of sales of 50 basis points in SG&A expense.

On asbestos expense, [inaudible] indemnity expense related to our asbestos claims was $1.2 million for the quarter. Year to date effective tax rate on a pro forma basis excluding non recurring certain asbestos, certain legal and state interest costs would be approximately 34%. Based on current operations subject to 1048 and excluding the aforementioned items, the approximate effective tax rate is expected to be 34% or less for the remainder of 2008.

Inventory increased an additional $4.1 million during the quarter which results in a total increase for the first six months of $22.3 million. While on a normalized basis we would be very uncomfortable with such a large increase in inventory, we believe that it is appropriate given the anticipated large project growth for the balance of the year.

Net cash from operations were $57 million for the first six months. One time cash outputs related to the IPO were $42.4 million. Asbestos related outflows were $16.3 million. If matters proceed as we expect we will enter into a settlement with one of our large insurers and affiliates shortly which will provide for a significant reimburse of tax costs during the third and fourth quarters of 2008. We believe these insurers will also begin to pay a significant portion of our currents costs as well.

The company's proceeds from the IPO on May 8 were approximately $193 million which we used primarily to repay debt, pay dividends to existing preferred shareholders and further corporate purposes. We have $115 million of availability in our credit facility and our net debt to adjusted EBITDA ratio is just over .75 times at the quarter end. We believe we are well positioned financially to continue to execute our growth strategies.

In summary, we had a strong second quarter from a booking, sales and profit perspective but sales and profitability has succeeded our expectations for the first half of the year. We continue to see strong order growth across our end strategic and across each of our geographic regions. While it is possible there may be some shifting sales from the third quarter to the fourth quarter, it is a timing of project shipment from the European summer holiday period with our existing back log and robust order rates, we believe we are on track to deliver low double digit organic sales growth for the balance of the year.

With that, I'll open up the floor for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Inch – Merrill Lynch.

John Inch – Merrill Lynch

The obvious question, oil and gas; if I remember, I thought from the first quarter you had thought that was going to rebound a little bit in the second quarter and it really didn't but you think it's going to improve in the second half. A little bit of color there perhaps in terms of what happened and why you think it's going to come back in the second half.

John Young

I think at the time it was related to orders. We anticipated a large influx of oil and gas orders in the second quarter which we did receive orders for. We're up 61% in that end market. We tend to be somewhat back end loaded in the third and fourth quarters on the oil and gas shipments this year related to some of the project business that we had, so we feel pretty comfortable with our oil and gas revenue in the back half of the year.

John Inch – Merrill Lynch

Is that a large project that you're looking at in terms of oil and gas or is it just broader based activity that's going to weight itself to the back half?

John Young

It would be broader based activity. Last year we had one extremely large project that created some lumpiness in our comparisons. That's why the revenue on a quarter to quarter basis was down this year. But this year it's a series of projects that tend to be toward shipment dates in the third and fourth quarters.

John Inch – Merrill Lynch

Did the order trends for the quarter progress on a linear basis or do they tend to pick up as the quarter progressed or actually drop off? A little bit more color as the quarter progressed would be helpful.

John Young

It was fairly linear. We came out of the blocks very strong in April and May. June continued to be at a pretty high pace, so it was reasonably linear.

John Inch – Merrill Lynch

U.S. versus rest of world and perhaps even emerging markets, there's a little bit of consternation around trend line of emerging markets. What are you guys seeing there? I know a lot of European business ultimately ends up there, but do you have any kind of a read in terms of just end market demand?

John Young

I think our emerging market business continues to be very strong. As you had mentioned, a large percentage of our OEM business in Europe ultimately ends up in the Middle East and Asia. We also have a reasonable percentage of our sales direct into the Asian region, and that business continues to be pretty strong. So we haven't seen any material change in velocity in that particular market.

Operator

Your next question comes from Jeffrey Hammond – KeyBanc Capital Markets.

Jeffrey Hammond – KeyBanc Capital Markets

I wanted to see if you're seeing any capacity constraints in any of your plants where you need to bring on more capacity on a near term basis.

John Young

We are running at a pretty good clip right now. In fact we invested a larger percentage of capital in the first half of the year as a result of that to increase our capacity. I would say we are still in a position to meet our customer needs from a capacity perspective. I think our bigger issues surround the availability and supply of raw materials and lead times associated with some of the for example [drive] and captains etc. I think that probably more than anything is putting pressure on our delivery schedules.

Jeffrey Hammond – KeyBanc Capital Markets

I think you said on the call last quarter that through April, May you had organic order growth of 28 versus 19 for the whole quarter. It seems like you had a fairly sizeable down tick in the growth rate. Can you just speak to that?

John Young

Our orders are pretty lumpy month to month and the month of June in particular in '07 was particularly strong, so it was a tougher comparison. I think if you look at the gross amount of bookings month to month June in comparison with April and May was a very strong month as well. I would say no change in the velocity of order intake at this point.

Operator

Your next question comes from Michael Schneider – Robert W. Baird.

Michael Schneider – Robert W. Baird

Maybe first we could talk about your comment about growth in the second half. You had expressed that you would expect a low double digit growth organically to continue in the second half. I'm curious why you would expect a deceleration of the Q2 percent of 18% because orders at least year to date are up 21% organically and I believe the comparisons, the second half of last year get easier from here. What is it you see in any particular market or geography that would cause the deceleration?

John Young

We need to look at the first half in total. If you remember, the first quarter was relatively low on an organic growth basis so there were some timing differences between the first quarter and the second quarter. I think we were a little over 2% in the first quarter and then 18% in the second quarter.

If you look at the back half of the year from a revenue perspective, we actually had pretty strong third and fourth quarter last year, so the comparisons clearly are higher in the second half of the year versus the first half of the year. So I don't really view it as a deceleration of business. Sometimes it's just a bit of a lumpy quarter. I think it will be a continuation of what we've seen for the first half of the year.

Michael Schneider – Robert W. Baird

Just maybe some color on the general industrial sector. You called out that chemical was particularly strong. Can you dive into some additional end markets and trends there up or down and also geographies, because investors seem to have the most concerns around that sub segment of your business based on what we read in the headlines.

John Young

Chemical obviously was very strong and I think that will continue to be strong in the back half of the year. A fairly significant percentage of what is classified under general industrial distribution, and we don't get an exact read on the end markets, but based on the type of product we're selling to distribution, it's probably pretty heavy oil and gas weighting to that particular channel.

So it's a little bit of a misnomer. It ends up getting classified in general industrial, but that's just how our systems pick it up when it goes to distribution. So I think if you look in each of the sub segments in general industrial, which we have about eight different sub segments, the growth was very broad based in all the sub segments, building products, diesel engine, waste water. Really across the board it was very strong and that was on a global basis, not just in emerging markets but our European business and our U.S. business as well. We had a good quarter in general industrial.

Michael Schneider – Robert W. Baird

Were there any particular deceleration or was there particular deceleration that occurred in the U.S. in the general industrial portion?

John Young

No, not that we saw.

Michael Schneider – Robert W. Baird

A final question in commercial marine, there's a lot of press now about slower shipping trends globally. Have you seen any cancellations in the order book related to commercial marine or any more cautious commentary from the ship builders themselves?

John Young

We have not had any cancellations either in our new ship construction or in any after market activity. Certainly we read the same press that you do related to commercial marine and we do a fairly aggressive vetting out in that particular market and are on the look out for any type of change in activity level or cancellations. But so far, we haven't seen any. Our customers tend to be large European ship owners and we're selling to very large, well capitalized shipyards, so as of yet, we certainly haven't seen any change in order rate or any cancellations.

Operator

Your next call comes from Shannon O'Callahan – Lehman Brothers.

Shannon O'Callahan – Lehman Brothers

Maybe help us out with a little bit of the lumpiness as we think about it for the rest of the year. The organic growth first quarter 2%, now 18% and you mentioned some projects may be shifting from 3Q to 4Q, so could we be seeing that kind of variability in the organic growth pattern in the second half too or what kind of variance might we see?

John Young

I think from a second half perspective in total we feel very comfortable with the guidance overall. The question is whether it hits in the third quarter or fourth quarter. And that's just a factor of our project related business. It tends to move around a little bit on delivery gates. I think at this point we feel pretty comfortable about the overall growth level in the second half of the year.

Shannon O'Callahan – Lehman Brothers

It feels like fourth quarter is going to be the strongest of the two, is basically what you're saying?

John Young

And that's our normal seasonal pattern. Fourth quarter is definitely the largest overall quarter of the year for us, year in and year out.

Shannon O'Callahan – Lehman Brothers

But even on a growth year over year perspective, it sounds like more of it maybe comes in the fourth based on these project push outs that you mentioned?

John Young

Potentially, we could see that.

Shannon O'Callahan – Lehman Brothers

On the gross margins, you mentioned the systems impact. Can you either size that for us or give us a sense of you had a really strong gross margin the first quarter, a little less this quarter. Can you talk through the factors there and how you're thinking about that for the second half?

John Young

That's related to a very large systems business which tends to be a little bit lumpy business, and there's a higher buy out content on those very large systems, so the gross margins tend to be a little bit lower than our average gross margin, and the fact that they're pretty large. It sort of skews the mix number a little bit.

I think for the balance of the year I think from a gross margin perspective we should see some moderate increase in our gross profit in the back half of the year.

Scott Faison

I think it's a situation similar to sales. We had very good mix and positive impact in the first quarter, and I think the blending of the two quarter was more indicative of what our underlying rates are.

Shannon O'Callahan – Lehman Brothers

How's the acquisition environment out there? How are you thinking about progressing towards that goal?

John Young

Certainly acquisition is a big part of our growth strategy in building the business and we're actively looking at transactions right now. The pipeline seems to be pretty good. I won't comment specifically on any transactions. At this point we continue to see pretty good activity in the M&A market in our sector.

Operator

You have a follow up question from Jeffrey Hammond – KeyBanc Capital Markets.

Jeffrey Hammond – KeyBanc Capital Markets

Can you speak to how you're seeing price in the quarter on a going forward basis and how you're thinking about working capital source use for a full year basis?

John Young

I think on the price question, I think we continue to be pretty successful with passing along raw material price increases in the marketplace given the engineer to order type business that we have. We continue to be pretty effective in passing price along.

On the working capital, I think we certainly had a pretty big build up in the first half of the year, particularly on the inventory side. We'll certainly convert a fair amount of that inventory to receivables in the back half of the year. We tend to be more working capital positive in the first quarter of the year as the receivables are collected, but we will see certainly a reduction in the inventory in the back half of the year.

Operator

There are no further questions at this time.

John Young

Thank you for joining us this morning. That ends the second quarter call. We'll speak to you again at the end of the third quarter. Thanks very much.

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!

Source: Colfax Corporation Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts