Columbus McKinnon Corporation
Q3 2014 Earnings Call Transcript

Published: 10 Nov 2014

[Operator:]

Welcome to Magnetek Third Quarter Fiscal Year 2014 Earnings Call. My name is Alex and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Lynn Bostrom, Director of Communications. Lynn, you may begin.

[Lynn Bostrom:]

Good morning. Thank you for joining us today for Magnetek’s Third Quarter 2014 Earnings Conference Call. As the operator said, this conference call is being recorded today, November 10, 2014 and is being webcast live on Magnetek’s website at magnetek.com. During the call, we may refer to slides which are available on our website as well. The webcast will be available for replay on our website for 1 year. The results of our 2014 third fiscal quarter were released this morning and the press release and charts have been posted to Magnetek’s website. Please note that reconciliations to non-GAAP measures may be discussed and are included in the press release, charts and slides. Speaking on the call today are Magnetek’s President and Chief Executive Officer, Peter McCormick, and our Vice President and Chief Financial Officer, Marty Schwenner. Before turning the call over to Pete, I would like to remind you that as reflected on Slide 2, statements made during this conference call maybe forward-looking in nature. 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. And now, I will turn the call over to Pete to provide the opening remarks.

[Peter McCormick:]

Thanks, Lynn and good morning. We had an outstanding performance in the third quarter and our business continues to have strong momentum in terms of sales and incoming orders. We achieved double-digit year-over-year and sequential sales growth in the quarter posting the highest sales to-date in our business since our 2012 withdrawal from renewable energy markets. This revenue growth combined with strong execution, effective cost control and lower pension expense enable us to post exceptional third quarter gross margins and operating profit and significantly improved our earnings per share. We continue to benefit from the ongoing U.S. economic expansion and accelerating growth in U.S. manufacturing. More recently, we have also seen somewhat of a shift in our mix to larger projects. For example, in the third quarter, we shipped a large, heavily engineered project for new core steel. Also in October, we received an order valued at more than $1 million from the Bureau of Reclamation to modernize the powerhouse crane controls at the Hoover Dam. This is an exciting high-profile project and illustrates the type of larger projects that are starting to get funding. Marty will get into details of our pension during the financial reports, but I just wanted to remind everyone that our strategy for sometime now has been focused on increasing the value of the company by growing our sales organically generating healthy levels of profit and cash flow and meaningfully reducing our pension obligation. During the year, we have taken a number of actions aimed at closing our pension funding gap and reducing our pension expense and funding amounts. So, we are very pleased with the progress we have made there as well. I will turn it over to Marty now to discuss the third quarter financial report.

[Marty Schwenner:]

Good morning. Thanks, Pete. I’d like to briefly cover the quarter and then provide a pension update along with some insights into value creation beyond 2014. Overall, we had an exceptional quarter by nearly every metric we monitor. Turning to Slide 3 titled Q3 Results of Continuing Operations, sales were up nearly 14% over last year’s third quarter and given the leverage in our current business model, we saw a strong pull-through to both gross profit and operating profit of about 50% of the sales increase. We also had bookings of $29.6 million in the quarter with indications of strength both in terms of some larger project work as well as the higher rate of book and bill business within the quarter, saw upticks in both short lead time business as well as some larger longer term projects. Gross margins in the third quarter approached 37% due to higher volume, labor efficiencies and control of overhead costs. Third quarter operating expenses on the whole were roughly flat with last year as lower pension expense was offset by increased incentive compensation provisions and higher variable selling expenses. Our operating income of $3.3 million represented more than 11% of sales and our earnings per share of $0.88 is the highest quarterly figure we have posted in years. Note that our tax provision in the quarter was about half of our previous run-rate and we expect a further decline in our tax provision going forward, which I will discuss later in a bit more detail. To summarize the quarter, we experienced substantial growth in the business over last year and leverage that growth into tremendous profitability. Next, I would like to provide an update on our pension as it’s been one of the critical factors in our value creation over the past couple of years and we continued to have positive developments this year. On the funding side, we contributed $7 million in cash to the pension plan during the third quarter bringing year-to-date contributions to $11 million. Subsequent to the end of the third quarter in October, we contributed an additional $4 million in cash to the pension plan, which represented the final required contribution of 2014. In addition in September, we made a voluntary excess contribution of 250,000 shares of company common stock to the pension plan valued at more than $7 million bringing the total value of our funding for the year to more than $22 million. Also during the third quarter, Congress passed extended pension funding relief, which gave us a very favorable impact in our future required funding amounts. Based on what we know today, we are required to make a $4 million contribution in January 2015 with contributions for the remainder of 2015 estimated at zero. The required contributions for fiscal years 2016 through 2018 are currently estimated at between $2 million and $3 million per year. What this means of course is that we are entering a period where most of our cash flow should accrue to the company as opposed to the pension plan. Interest rates have a material impact on our pension liability and while rates have declined throughout 2014, the impact of that has been largely offset by benefit payments and changes in interest crediting assumptions on account balances. Based on current actuarial assumptions, we estimate our total pension obligation at about $210 million and our pension assets at about $180 million for a net pension liability of about $30 million, down from $48 million at the beginning of the year despite a roughly 70 basis point drop in interest rates. Finally, we are in the process of completing the lump-sum buyout program for certain of our pension plan participants. We have offered a one-time opportunity to 3,000 deferred vested participants in our pension plan to collect a lump-sum amount now as opposed to waiting until retirement age to receive a benefit. We are still processing applications, but estimates are that approximately 2,100 people have accepted the buyout offer with a total liability value of about $43 million. Payments will be made in December out of our pension plan assets and we expect the program to be slightly favorable in terms of the funded status of the plan. In other words, the liability reduction will be slightly greater than the reduction in our pension assets. As part of the lump-sum program, we will be recording a one-time non-cash settlement charge in the fourth quarter. While the amount of the charge is yet to be finalized, we expect it will be in the range of $30 million to $35 million, but again will be non-cash and will actually reduce pension expense going forward. The charge is effectively accelerated amortization of previous pension losses currently recorded in equity in other comprehensive loss. The impact of the charge on our cash flow and balance sheet is zero as the amount of the charge will be reclassified within equity from comprehensive loss to retained earnings through the income statement. The charge would otherwise have been amortized to the income statement over the next 25 years roughly. So recognizing the expense now should provide us with some benefit in the form of reduced pension expense beyond 2014. As a result of all these developments during 2014, again using current actuarial assumptions, we expect that pension expense next year will decline to an estimated amount in the range of $2 million to $2.5 million from the current year projection of about $3.7 million. This improvement alone represents an estimated $0.35 to $0.45 on a per share basis. In summary, our pension expense should be materially lower next year and is converging with significantly lower required pension funding amounts which should result not only in improved earnings, but also in greater cash flow available to the company. I would like to close today with a brief update on our tax situation. As I stated earlier our tax provision declined in the third quarter and we expect a further decline going forward. The majority of our tax provision has resulted from amortization of goodwill for tax purposes which is a bit complicated, but has effectively resulted in increased deferred tax liabilities that likely will never be paid. Most of this tax amortization is now behind us such that our tax provision in 2015 is projected at approximately $250,000 for the full year, as compared to our historical run rate of more than $1 million, which represents an improvement of more than $0.20 on an annualized per share basis. In addition, we have deferred tax benefits from net operating loss carry-forwards of $225 million, so we likely won’t be paying any taxes on our income other than alternative minimum tax at 2% for the foreseeable future. With the lower pension expense and favorable tax situation effectively most of our pretax income should convert to cash and with lower pension funding amounts the majority of that cash will no longer be required to fund pension contributions. As Pete mentioned earlier our path to value has focused on organic growth in sales and profit combined with a reduction in our pension liability. And we have continued to make outstanding progress over time with these initiatives. We believe higher sales and profits along with lower pension expense and funding obligations combined with favorable tax treatment has us very well-positioned to further increase the value of our company in 2015 and beyond. At this point, I will turn it back over to Pete for some closing remarks.

[Peter McCormick:]

Thanks Marty, great report. Given the current momentum and leverage in our business, we expect to finish the year strong, achieving year-over-year revenue growth. Our adjusted operating profit margin should exceed our goal of 10%. As Marty explained, we anticipate our earnings will grow next year given our lower pension expense and lower tax provisions, provided business conditions are similar to those of 2014. So we are poised for another successful year in 2015, as well. Looking at our largest business material handling, we see opportunities for growth in wireless controls and automation as well as for market share gains. We also believe we will continue to see the kind of larger system projects come online that we have realized in the third quarter. In wireless controls our new Hazardous Location Certifications are starting to provide us with revenue from the oil and gas market and our new line of mini transmitters are creating opportunities for smaller equipment applications. We are also actively quoting mining projects for our radio controls. Turning to our mining drive product lines, we are currently in qualification testing on our first traction drive system operating in a gold mine. Adoption of our products into this type of hard rock application will allow us to weather the current downturn in coal mining and should reduce our reliance on the coal industry. And while the coal market remains soft, we, like our OEM partners, are working on product development activities that will position us for growth when the market rebounds. We are also expanding sales of our mining products in China as our drives are now approved for use on a growing number of our OEM partners’ machines. Finally, in our elevator business, our message about the benefits of modernizing existing DC systems is resonating globally with building owners who are looking for cost effective upgrades that help them save energy and money. In fact, sales of our energy regenerating drives have increased 15% year-to-date to nearly $6 million. We see the Asia-Pacific market as providing us with a great deal of opportunity. During the 90s, more tall buildings were installed in Asia than in the rest of the world and these buildings are now at a point, where modernization of their DC controls provides building owners with a significant ROI. We have recently been awarded several large elevator modernization projects in Asia and anticipate this could be an important growth area for us going forward. We are also working with our OEM partners to provide drop-in replacements for their obsolete products. Another example of the increase in modernization projects we are seeing. In summary, it’s an exciting time for our company. We expect to have more options in our business going forward resulting from the significant progress we have made in addressing our pension. Our business remains very healthy and we see areas for further growth in a number of markets. As we explore these opportunities, we will remain disciplined in our resource allocations and committed to increasing the value of the company for all of our stakeholders. Thank you for your attention. And now, we would be happy to take your questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And we do have a question from Brad Evans from Heartland. Please go ahead.

[Brad Evans:]

Hey, good morning buddy.

[Peter McCormick:]

Hi, Brad. How are you doing?

[Brad Evans:]

Doing great, thanks. Congrats on the solid quarter.

[Peter McCormick:]

Thank you.

[Brad Evans:]

I am just curious, Marty, you said that the requirement of $4 million for January 15, does that include the impact of the lump-sum event?

[Marty Schwenner:]

Yes. Those two events are fairly unconnected in terms of our cash funding, because the amount will be contributed in January of 2015, which is really considered a 2014 pension plan in your contribution, so….

[Brad Evans:]

Okay, very good. How are you thinking – can you just amplify in terms of how you are thinking about the pension in 2015 in terms of what other steps you might be – what other options you have to perhaps more permanently address this issue?

[Marty Schwenner:]

Sure. I think one of the interesting things about the release today is the timing of it in the completion of the lump-sum. These two events are kind of happening simultaneously and we are not quite done with the lump-sum program yet. What we really need to do is finalize that and cleanup our database, finalize the actual amount of the settlement charge then we will be approaching year end. So, the timing from that standpoint works well. So, we will have a new discount rate. We will have new asset values. We will be able to re-measure the pension at that time and then really firm up the pension expense in the future funding amounts. Although we feel pretty comfortable, it will be close to what we said today. At that point, Brad, we will have a fairly clean database of participants and we can go out early in 2015 and probably get a quote for annuitization and understand how far apart we are in terms of what is the cost to finally remove the liability from our balance sheet, because I think we would all like to see that happen at some point here in the future. We are still working toward that end. And that was one of the reasons why we put the stock in there as well. So, I think that’s going to continue to be a focal part of our strategy going forward.

[Brad Evans:]

Okay. Well, good luck with that.

[Peter McCormick:]

Yes. We really need more information, which should be forthcoming in the next couple of months to have a clear picture.

[Brad Evans:]

That’s super. Thank you. The 3.65 million shares that does include the full effect of contribution of shares from the – to the pension plan, correct?

[Marty Schwenner:]

Correct.

[Brad Evans:]

Okay. And just on to the business for a second Pete, with the improvement in terms of obviously the pension and profitability and cash flows for Magnetek are you feeling less constrained I would assume in terms of being able to invest on the R&D side in terms of internal growth initiatives, is that fair?

[Peter McCormick:]

Well, we have continued to invest in R&D throughout that process. So I don’t think that we have limited our self on the R&D. It’s one area that is obviously very critical to the business and so I don’t think we have held back there at all. I think what it does do is obviously gives us a lot more options as a company. As Marty had talked about moving forward with the changes here, there will be very limited pension contributions that we would have to make. So moving forward, obviously we will have a lot more options on where we can go.

[Brad Evans:]

So I guess I just asked that question because I think in the past you have had R&D that’s been upwards of $4 million, I know that was a different time and different place with where those dollars are being spent and you have pulled it back down to a little over $3 million is that an area where – a line item where you might be able to be more – a little more aggressive to fund internal growth initiatives?

[Peter McCormick:]

Yes. I think we could be a little more aggressive if as we identify the opportunities and if they require more funding obviously we will have the ability to do that. Keep in mind in the past when we were in the renewable energy we were investing pretty heavily in the renewable energy and so part of that drop is when we exited the renewable energy that’s part of why the drop in the R&D number.

[Brad Evans:]

Right, that’s what I was alluding to in terms of different time, different place relative to that number. So can you just speak to the visibility you have in the business today versus say six months ago has it demonstrably improved or changed?

[Peter McCormick:]

Well, one thing I guess, we had very little visibility, if you would look back to last few years. And one the best gauges for us is what our bookings are doing. So I would say I think our visibility has improved, in that our bookings are strong and it would appear that the end markets are strong, in the manufacturing sector specifically. So we have a higher confidence going forward of what we see happening in the business.

[Marty Schwenner:]

Yes. Brad, this is Marty if I can just add to that it’s we are always fairly confident if we look out one quarter and maybe even two, but if you start to go out beyond that, it gets a little less certain because as you know we carry a backlog of typically $15 million or thereabouts. But what’s the thing that has happened recently that’s encouraging is we are starting to see some of the bigger projects. And also the book to bill, business had been averaging about just a little over 400,000 per week in material handling for the first half and that number jumped up to nearly 500,000 per week in the third quarter, so both short-term and longer-term business prospects seem to be very strong right now.

[Brad Evans:]

That’s great and the shift to larger projects from a geographic perspective is that more – is that phenomenon more pronounced in North America or is that more of a global phenomenon?

[Peter McCormick:]

Well, from our perspective it’s a North American based phenomenon. And mainly in the material handling business as you know we are primarily a North American based business. So the projects that we are seeing there are typical – they are North American based projects for the most part.

[Brad Evans:]

Okay.

[Peter McCormick:]

And so – yes we have seen strength there. Although in the elevator businesses as I had mentioned, what we are seeing there is a stronger push towards energy conservation around the world. And we are seeing a lot of projects in Asia. And a lot of those buildings that were built 15 years, 20 years ago that have our drives in them they are now looking to upgrade those with regenerative drives like our Quattro DC drives. And so we are seeing an increased interest there as well.

[Brad Evans:]

Super. Congrats on the great quarter. Thank you very much.

[Peter McCormick:]

Alright. Thanks Brad.

[Operator:]

Thank you. 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.