Columbus McKinnon Corporation
Q4 2012 Earnings Call Transcript

Published: 13 Mar 2013

[Operator:]

Welcome to the Magnetek Q4 Fiscal Year 2012 Earnings Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Lynn Bostrom, Director of Communications. Ms. Bostrom, you may begin.

[Lynn Bostrom:]

Good morning. Thank you for joining us today. I trust everyone has received Magnetek's fourth quarter and fiscal year 2012 results. This information is available under Financial News in the Investor Relations section of our website at magnetek.com. As the operator said, this conference call is being recorded today, March 13, 2013, and is being webcast live on Magnetek's website. Throughout the call, we'll refer to slides, which are available on our website as well. Listeners are encouraged to view these materials in conjunction with the call. The webcast will be available for replay on our website following the call for at least 3 months or as long as the content remains timely. As stated on Slide 2, statements made during this conference call are intended to come within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and may be forward-looking and subject to risks. Factors that could cause actual events to differ materially from these statements are discussed in the company's press releases and periodic filings with the SEC, including our Form 10-K. Magnetek's President and Chief Executive Officer, Peter McCormick; and our Vice President and Chief Financial Officer, Marty Schwenner, will be speaking today. Mr. McCormick will provide the opening remarks.

[Peter M. McCormick:]

Thanks, Lynn, and good morning. During fiscal 2012, we renewed our focus on our core businesses, power and motion controls for material handling, elevator and mining applications. These are markets in which we hold sustainable competitive advantages and our application expertise is highly valued by our customer base. In fact, many of those blue-chip customers have been our valued partners for over 30 years and our proven ability to add value to their operations is a primary reason for the success we've had in growing our business over time. Taking a look at our fiscal 2012 results. Our total company sales dropped slightly, mainly due to a sizable year-over-year reduction in sales into renewable energy markets, which I'll address momentarily. Our gross profit and gross margin grew year-over-year as our material handling sales growth rate exceeded our stated 10% objective. We are well positioned for future growth in that part of our business as we continue to introduce new products, penetrate new markets and expand strategic partnerships. Cash flow generation was also a key accomplishment in fiscal 2012. In addition to investing in R&D and plant improvements, we contributed substantially to our pension plan while increasing our cash balances during the year. We also added strategic selling resources to help drive future growth in our business. As many of you are aware, in recent years, we've designed and built inverters for renewable energy applications, primarily wind turbines. The renewable energy market is one in which product requirements change rapidly, a high-level of investment is required and government support fluctuates. As a result, the sales and profitability of renewable energy product lines have declined for many companies, including Magnetek. We responded to the steep decline in our renewable energy sales by reducing our cost structure throughout the year, and as we announced towards the end of fiscal 2012, by writing down the value of our assets in this part of our business. While we don't plan to pursue new opportunities in renewable energy markets, we are committed to providing parts and repair services to our installed base of inverters, which can provide us with a source of profitable revenue going forward. We believe our best prospects for growth will come from focusing our efforts and investments on our core served industries

[Marty J. Schwenner:]

Thanks, Pete, and good morning. I'd like to briefly cover our fourth quarter and 2012 results, our first quarter outlook and then close today with the pension update, focusing on our potential to enhance value going forward. We had a strong performance in the fourth quarter, particularly in terms of adjusted EBITDA and cash flow. Turning to the slide titled Q4 Results of Continuing Operations. Our material handling sales increased to nearly $23 million for the quarter, our highest level ever. Offsetting that were lower sales into energy delivery markets, comprised of renewable energy inverters and mining products. Gross profit and related margin percentage were impacted by the $1.2 million nonrecurring impairment charge that Pete mentioned. Absent that noncash charge, our gross margin would have exceeded 35% and been very comparable to the prior year quarter. While our operating income was down about $1.5 million year-over-year, the decline was entirely due to the impairment charge and a higher pension expense we recorded in the current-year quarter. Despite these issues, our continuing operations remained firmly profitable, with diluted earnings per share of $0.25 while fourth quarter adjusted EBITDA was $4.7 million or nearly 16% of sales. Fourth quarter cash balances increased to more than $1.5 million after contributing approximately $4 million to our pension plan. Turning to the next slide. Our year-to-date results match up fairly well with the prior year figures despite the sales decline we experienced in renewable energy, as throughout the year we were able to offset most of the renewable sales declines with growth in the material handling area. Note also that gross margins are up more than 300 basis points year-over-year, operating expenses are mostly flat despite the increase in pension expense and our full year operating income of $8 million is comparable to last year. As a final point on the full year results, we were able to successfully resolve several issues accounted for in discontinued operations, which enabled us to report full year net income of $12.6 million or $3.90 per share. So overall, we were pleased with our performance in fiscal 2012. Moving to the balance sheet. Our liquidity remains strong despite ongoing pension contributions. We closed the year with $29 million in cash and we believe we can continue to improve our working capital velocity to benefit future cash flow. Regarding our 2013 first quarter outlook, we really need to look back to our fourth quarter bookings. Incoming orders held up very well in October and through most of November but dropped off later in the quarter due to holiday periods, growing economic uncertainties related to, among other things, the fiscal cliff, and seasonality in material handling markets. This seasonality is an even greater factor than in past years due to the decline in our mining volume and the absence of renewable energy sales, resulting in a greater share of our business coming from material handling markets. As a result, we can expect this seasonality to be more evident in our figures going forward. Quotations and orders received in 2013 to date remain at high levels. However, the average dollar value of incoming orders is less than we've experienced in the past. Given the recent softness in bookings and the mix change in dollars per order received, we're projecting a decline in sales and profitability in the first quarter of 2013 on both a sequential and year-over-year basis. As we stated in our release, we believe this is temporary and that we'll begin to receive orders for larger projects in higher dollar amounts in the near future. As a result, after the first quarter, we expect to achieve results that are more in line with our fiscal 2012 figures over the remainder of 2013. Next, I'd like to provide an update on our pension. We measured our liability at year end using a discount rate of 3.5%, the lowest rate in our history. And as a result, our pension liability increased to $102 million. However, we have $29 million in cash so, in our view, the pension obligation, net of cash, is closer to $73 million. If we add to that our market cap of about $38 million, we get an enterprise value of about $110 million in round numbers. So the company is currently being valued at about 6x our fiscal 2012 adjusted EBITDA of approximately $18 million. One of our mid- to long-term objectives is to fund our pension obligation with cash generated from operations. As we stated in our release, our funding obligations for the next 3 years are estimated at about $54 million in total, so it's not an insignificant amount. However, if we can achieve even modest sales growth and continue to manage our cost structure effectively, we believe we can generate sufficient cash over the next 3 years to fund the pension and close fiscal year 2015 with approximately the same cash balance that we have today. Looking beyond 2015, our estimated annual funding amounts decline substantially. In fact, the net present value of our total future funding obligations discounted at 3.5% is $82 million, so the majority of our pension funding is expected to occur over the next 3 years. We believe the majority of interest rate declines are behind us and we further believe that the pension liability on our balance sheet peaked at the end of fiscal 2012. In fact, if we were to measure our pension obligation today in real-time, interest rates would be about 25 basis points higher and our assets, excluding 2013 contributions to date, are about $7 million higher. So our liability today would be closer to $90 million, not $102 million. Looking forward, if interest rates were to increase at some point in 2014 or 2015, that could certainly have a very favorable impact on our funding situation, although I want to stress that we are not relying on rate increases. Rather, we are planning on reducing our pension through contributions. If interest rates stay flat for the next 3 years, then we make our required contributions and we can earn even 5% on our assets over that time. Current projections indicate that our pension liability would decline by more than 50%, to about $50 million. In summary then, we believe that with even modest growth in sales and profits over the next several years, we can generate sufficient cash to meaningfully reduce our pension obligation, ultimately enhancing shareholder value in an equally meaningful magnitude. At this point, I'll turn it back over to Pete for some closing remarks.

[Peter M. McCormick:]

Thanks, Marty. As I mentioned earlier, we are committed to building on our competitive strengths in our core served industries, as well as marketing our existing products for use in new applications and in new geographies. We continue to see increased demand for products that save energy or increase operational efficiency. Magnetek offered one of the first energy-regenerating drives in the elevator industry and now we're seeing energy regeneration become more of a priority for our material handling customers as well. We recently introduced 2 new regenerative systems for use in reducing the energy costs associated with overhead material handling crane control. We intend to broaden our portfolio of energy-saving products for material handling applications going forward. Radio control provides an important area of growth for us, as well. In addition to wireless control of material handling applications, customers in a variety of industries are beginning to see the safety and efficiency benefits of wirelessly controlling their specific processes. We're also working on expanding the channel for our radio-controlled products outside North America. Turning to our elevator business. The market for AC elevator controls continues to grow and we're working on increasing our share of it through new product development, the formation of strategic partnerships and the expansion of our international presence. And finally, in our mining business, we are working on penetrating the hard rock and surface mining markets with both new and existing products. While we believe traditional coal-based sources will continue to meet a portion of the growing global demand for energy, broadening our customer base beyond traditional coal is an important part of our strategy in mining. I would like to close today by focusing on the investment opportunity provided by the combination of our business fundamentals and our legacy issues. To begin, we recognize that we are a thinly traded, micro-cap company, so investment in companies of this type typically require a longer holding period, perhaps a 3- to 5-year time horizon. While we are a public company, the magnitude of our pension liability gives us a profile similar to that of a private equity company. Therefore, if the pension liability were eliminated over time, we believe one could reasonably expect private-equity-like returns. We have an established history of consistently strong cash generation from our business. In our view, as we use this cash to reduce our pension obligation and other legacy issues, that part of our enterprise value attributed to those liabilities should shift to equity value moving forward. In addition, if economic conditions remain favorable, we believe we could grow our adjusted EBITDA by 40% over the next 5 years to about $25 million. We further believe that the potential combination of a growing business, higher EBITDA and a sizable reduction in our pension could result in a higher enterprise value to EBITDA multiple than the current multiple of 6x. One could view these as ambitious targets. It's not certain that we will grow our EBITDA by 40% over 5 years, it's not certain that our pension will decrease by 50% or more and there's no guarantee that the equity value of Magnetek will increase over time. However, we believe there is an opportunity for very favorable returns for our investors even if all of these things don't happen. And we further believe there is an opportunity for substantial returns for shareholders in the event most of these things do, in fact, come to pass. Thank you for your attention this morning. And now we'd be glad to take your questions.

[Operator:]

[Operator Instructions] Our first question comes from Tristan Barr from MTB Asset Management.

[Tristan Barr:]

I apologize, I'm on the cellphone. I hope you can hear me okay. I have a question that's more of a comment than a question. I think both Marty and Pete, you guys have done an incredibly good job managing the company through a difficult economic environment. I wish I could say the same for your Board of Directors. I'm kind of wondering, are they asleep at the switch? Are you getting any help from the board whatsoever? Because I think, as you said appropriately, I mean, the company is more of a private equity play at this point than a public company. And I'm just wondering if the board is acting in the fiduciary responsibility through its shareholders in terms of pursuing a state public strategy versus being part of a larger company that could leverage the pension cost against a much larger asset base, take out some of the public company costs, et cetera, et cetera.

[Marty J. Schwenner:]

Tristan, this is Marty. I think in response to your question, we've tried for the past several quarters and the past several calls now to communicate clearly what our strategy is over the mid- to long-term here, given the fact that if you look at our enterprise value it's roughly 1/3 equity and 2/3 pension, given the magnitude of the pension today which, of course, is mainly driven by the declining interest rate environment over the past 10 years. Over the past couple of years, we have done a good job in growing the business and generating fairly significant amounts of cash. We have made some pretty healthy contributions to the plan, which can help us in the future, particularly in the event that rates rise. Now what we've stated is we're not counting on that happening, so we're planning to fund with cash on hand and cash from operations. And we really believe over the next 3 years we can finally make meaningful progress in reducing this liability. As that liability comes down, the portion of our enterprise value attributed to the pension, all other things being equal, would have to be realized in the form of a higher equity value of the company. And I think the board is fully aware of that and is fully onboard with our strategy to continue to grow the business, fund the pension over time, reduce that obligation, and then all shareholders can realize probably what we believe would be outsized returns given the fact that it is similar to this private equity profile. That's where we made the statement about you might be able to expect private-equity-like returns going forward even if a lot of the things that Pete talked about don't happen. But we're very confident in our ability to pay the pension down. We've got a fair amount of cash and we can generate sufficient cash going forward. And as we do that, we think there's great opportunity for substantial returns for shareholders over the next 3 years remaining public.

[Tristan Barr:]

Okay. Look, I don't disagree. Obviously, I'm a decent-size holder of the company. I believe in you guys. And again, I think operationally you've done a great job in a difficult period. I do question whether or not the board is acting in its fiduciary responsibility to the shareholders. The board -- as public company boards go, particularly as micro-cap company boards go, has a very, very low percentage of equity ownership. So I just wonder, and while I do have confidence in your ability to pay down the debt with cash flow, whether the board is making appropriate decisions. There are some uncertainties in your outlook, there are certainly uncertainties in the overall economic environment. And I think it's pretty clear to everybody involved that should be worth a heck of a lot more than where you're trading currently as part of a larger organization.

[Marty J. Schwenner:]

Well, I think now you're getting into a more theoretical discussion about what type of premium we could realize today, which would be, in your mind a certain premium. So I don't want to debate where we think we could transact today. But I think the management is in alignment with the board on this issue. We have a good mid- to long-term path to value and we see a substantial upside here going forward.

[Tristan Barr:]

Okay. I look forward to seeing management and the board purchase some shares in the open market in the future.

[Marty J. Schwenner:]

Fair enough, Tristan.

[Operator:]

[Operator Instructions] We have no further questions at this time. I will now turn the call back to Lynn Bostrom for closing remarks.

[Lynn Bostrom:]

Thank you for joining us today. We look forward to your participation on our next quarterly call.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.