Hardinge, Inc. (NASDAQ:HDNG) Q2 2016 Earnings Call August 5, 2016 11:00 AM ET
Garett Gough - Investor Relations
Richard Simons - President and Chief Executive Officer
Douglas Malone - Vice President and Chief Financial Officer
Bruce Baughman - Franklin
Sheldon Grodsky - Grodsky Associates
Good day, ladies and gentlemen, and welcome to the Hardinge, Inc., Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded.
I would now like to introduce your host for today’s program Garett Gough, Investor Relations. Please go ahead.
Thank you, Jonathan, and good morning, everyone. We appreciate your joining us here today. I have with me Rick Simons, our President and CEO, and Doug Malone, Vice President and CFO. Rick will be discussing the results for the second quarter and will also be reviewing the company's initiatives and progress in our markets and our observations, our strategies.
You should have a copy of the financial results that were released this morning before the market opened, if not, you can access them on the company's website at, www.hardinge.com. You should also have the slides that will accompany our discussion here today, and you can find them on the website as well.
As you look at the slide deck, if you turn to slide two, you will find our Safe Harbor statement. As you are aware, we may make some forward-looking statements during the formal discussions as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause the actual results to differ from what we talk about on today's call. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. You can find those documents on our website or sec.gov.
I’d also like to point out that we will use some non-GAAP financial measures in our discussion today. You should not use those non-GAAP measures independent from the GAAP numbers that we provide, and the release and then the slides and there is a reconciliation table at the back of the slide deck for your reference as well.
With that, I’ll now turn the call over to Rick to begin.
Thanks Garett and good morning, everyone. Thank you for joining us. As usual, I'll give some comments on the slide deck and then we'll open up the lineup for questions and answers. But first before we get started on slide deck, let me make some overall comments.
Our quarterly results reflect the state of the global machine tool industry right now. The geopolitical events are negatively affecting peoples’ confidence and peoples’ need to feel good to pay hundreds of thousands to millions of dollars on capital goods. Globally they seem to be taking somewhat of a breather. Industry demand and virtually every major market is down from last year. These are not good times for our industry. But our quarterly results reflect actions we’ve taken to reduce our cost structure to add products and companies over the years to offset some of that softness in general markets and to position ourselves for better results when things turnaround. Let’s go to the slide to discuss further details.
If you go to slide three, you’ll see that second quarter sales were down from the prior year about a $10 million or about 12% when you remove the negative impact of $2 million on foreign exchange translation. You can see from the graph that our biggest problem area in U.S. where we’ve done $8 million is due to very low shipments of grinding machines in this year’s quarter versus strong shipments in last year’s quarter and also general softness is in this market being experienced by all machine tool suppliers.
Year-on-year industry wide orders for machine tools were down 17% based on statistics from our trade association. However, sequentially you see we had a slightly better quarter than the first. Based on our strong orders in the second quarter, and the backlog entering the second half, we expect second half sales level to be much higher than the first.
The annual sales graph on the right illustrates a fairly stagnant level of sales level for the company over the past five years. Globally industry wide machine tool orders are actually down 20% from 2012 and even down on a higher percentage in some of our specific markets. We’ve been fortunate to be able to offset some of that short-fall through the acquisitions of Forkardt and Usach over that period as well as development of new products.
Going to slide four and looking at gross margin, you can see that a 33.6% gross margin was up 0.8 point despite a 15% reduction in sales over the prior year. Restructuring activities provided 300,000 in savings in the quarter and by the way, these are permanent savings in the way we do business and will benefit our margins going forward as well. But certainly product mix helped our margins in the quarter too.
The graph illustrates our ability to achieve higher margins at higher sales levels if you look at some historical quarters as we can leverage the fixed cost portions of our manufacturing operations. Because of our restructuring efforts now we would expect higher than traditional margins when demand brings us back to those higher quarterly sales levels.
Moving to slide five, our strategy to adapt has reduced to our operating income break even sales level. In the last 12 months, we’ve saved over $2 million due to the restructuring efforts and are on target to achieve annual savings of over $4 million going forward. Now I will mention we continue to invest in R&D which is running at approximately 5% of sales at today’s sales levels. These expenditures for people and prototypes are critical to continue to develop new products, to make technological upgrades to existing products driven by new market demands and efforts to provide even longer machine life for our customers and to engineer cost reductions on existing products to remain competitive.
Going to slide six, EBITDA obviously has a similar pattern to that of operating income with our depreciation and amortization staying fairly constant. I will say it’s the measure we provide here and it’s the measurement we use internally to keep our company focused on cash generation for the income statement, no matter what the sales level. We’re confident now with our structure and with the cost reductions we’ve done that we can achieve better than traditional percentages when the markets approve and we get to those historical sales levels and even higher.
On slide seven, even at the low level sales we experience, we generated normalized income in the second quarter and again chose how we’ve lowered our breakeven. And importantly sales being up $2 million from the prior quarter with net income up $1 million shows the 50% incremental fall through on margin to the bottom line.
Slide eight is orders that the indicator of future sales and we were pleased to record $81 million of orders in the quarter, the highest in the past five quarters and actually even that was slightly impacted by exchange translations. You can see that the improvement over the run rate was primarily in Europe where we were able to turn quote activity we talked about prior quarters and high-tech of grinding machines and the book-to-orders. Importantly, orders increased over prior year despite the t$2 million of negative foreign exchange translation.
Going around the world I’ll comment on the activity levels. The China market for us which comprises most of our Asian sales continues to be very depressed for the industry as a whole. But we’ve enabled to leverage our ability to specialize our machines for particular industries, our flexible factory there in our strong sales and support organization to keep our order levels fairly flat into difficult market.
Despite an economy that’s not growing as fast as it was in the past, there are industries they’re growing and we are servicing and done well.
Europe is another market in stagnation but we experience orders that were the highest in over a year. These are mainly for grinding products and being sold to companies working on long-term projects and projects that we have been working on quotes than on for quite some time. We have to admit Brexit has caused a hit to confidence over there, especially in our strong market in the UK which we are concerned about.
As I mentioned before, the industry wide machine tool demand in the U.S. is down 17% and that’s after being down 17% the prior year so accumulative over 30% reduction from 2014. With a significant portion of our sales being comprised of ATA business and bigger project raining sales, we’ve been able to stay fairly confident despite some of those trade wins.
I’m hearing from our trade association and participation from suppliers and registrations for attendance of the upcoming IMTS show in Chicago in September is above the same number as of 2014 which that indicates to me that there is a lot of people out there still with a strong interest in machine tool of technology employees to take advantage of what we have to offer. The show is attended by over a 100,000 people each year, we’re expecting that many again this year and they have an opportunity to see over 1.2 million square feet of machine tools and related accessories and supplies.
We’ll be exhibiting seven new machine manuals along with innovative new work holding solutions and our boost at the show. For us, this show is about interacting with customers and generating leads that will turn into orders in the months following. We believe we’ll have the right products in the – and an interesting display that will maximize our ability to interact with existing and potential new customers.
Going to slide nine, our sales each quarter made up of machines and custom solution work holding shipping out of backlog. They’re made up of orders taken for machines that we have in inventory or a close to finished state that we can book and bill in the same quarter. And the normal run rate of ATA products and repair products sold from inventory.
The backlog number is a meaningful one for one portion of the quarterly sales, but you can see from the table below it, it will play out over a period of several months. In fact, we book orders in the second quarter for complex machine systems that won’t ship until 2017.
Going to slide 10, we’re going to continue to show this long-term forecast slide from Oxford Economics, even though we admit they’ve not been particularly good at short-term forecasting. But truthfully in our – the history of our industry no one has been able to forecast with accuracy in the short-term basis. The graph do illustrates the historical trends which I think is helpful to understand our industry as a whole, and I believe their long-term vision is meaningful as we see global growth being focused so significantly on Asia.
The four drivers of demand that we listed here are true everywhere in the world but I have to say it’s an increasing velocity in Asia. While the near term outlook for machine tool seems weak and there will be peaks and drops. We believe their long-term growth expectations seem reasonable.
On slide – excuse me. To conclude, backlog in second quarter momentum are the drivers of our expectation for a stronger second half of sales and profitability. We believe the fourth quarter is going to be our strongest of the year which seems to be our pattern. We know that we have several large dial orders scheduled for delivery in the fourth quarter and so we look forward to that.
This concludes our remarks on the quarter. I’ll turn it over back to Jon to coordinate any questions.
Certainly. [Operator Instructions] Our first question comes from the line of Bruce Baughman from Franklin. Your question please.
Hey, good morning.
Good morning, Bruce.
Good morning, Bruce.
A couple of questions. As you just mentioned the fourth quarter, are you projecting the fourth quarter to be better than the fourth quarter of 2015?
No, no we’re just saying it’s going to be stronger than the first half of this year.
Okay. And then the – even though sales are down, the free cash flow is negative and it’s really because of working capital components. Can you talk about that a little bit?
Well, I mean inventory will go down in the second half with the stronger shipment level. We do have – it’s back to some of the bigger projects. The reason we’re confident of fourth quarter will be stronger as we have some big projects, big ticket items that are in the build schedule right now and obviously have become part of that inventory growth and as they clear out unless we have other ones that are replacing it and we would certainly see inventory going down in the second half.
But then receivables would go up presumably?
Yeah, depending on the timing. You’re right, not all of them ship in December.
Okay. Has the company made the cash pension contributions year-to-date?
Yes we have, total year-to-date is been around $700,000.
Okay, but the – on the cash flow statement – okay, okay. All right, and then just – we’re talking about the cash generation and asset turnover. During the long period of analyzing operations considering strategic alternatives and so on, have you come up with anyway to improve asset turnover consistently?
Well as you know, I mean obviously we made major step function in 2010, 2011 when before that our inventory turns were 1.4 and now they’re up to 1.8, receivables were up into 70s and now they’re down around the high 50s or 60.
But certainly that is one of our initiatives that we are working on and I’m hoping – we’ve talked before about our high packs, our Lean Six Sigma process in the education and so we are getting better using those tools and that’s one of the things that I really want to turn our attention to in 2017. And it’s complex, as you know, we need inventory to meet demand, we need inventory for repair parts but we also need to find ways that we can improve that even further, so we will be focused on that.
Receivable side is really kind of driven primarily by the market place and what our competition is offering in terms and so a little harder for us to make changes there that won’t lose up in order but we’ll continue to work on those as well.
Okay. And is there a simplification drive underway around new products, are you looking for ways to design products so that they – you get a more efficient cash generation as they’re sold?
Well I think right now…
Or is that just part of the plan?
We actually have a demand project going on and trying to improve the speed with what we introduce products. But no, that’s a good point, we don’t – I mean because we manufacture different products and different factories around the world and there is discreetly made in one place and not everywhere. I can’t say that your specific question we’re addressing right now but it’s a good question we’ll look out.
Okay, thank you.
Thank you. Our next question comes from the line of Sheldon Grodsky from Grodsky Associates. Your question please.
My question was basically, you said that the inventories were up to meet the orders that are coming in the next couple of quarters, right?
Correct, gentlemen. Yeah.
That was basically it. Thank you.
Thank you. [Operator Instructions] And I’m not showing any further questions at this time. I’d like to hand the program back to Rick Simons.
Thank you, Jon. We believe we position the company to sustain profitability in the slow machine tool market and as you’ve seen in the results and to provide improved returns when the market does recover. We’ll continue our focus on providing new and better products for our customers, maintaining our flexibility to adapt our customers’ product and geographic needs. Adjust our cost structure to improve efficiency and to take advantage of our global footprint in manufacturing engineering and customer support.
We look forward to our next quarterly update in November and thank you again for listening and have a good day.
Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.
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