Enovis Corporation (ENOV) Q2 2012 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Colfax Corporation Second Quarter 2012 Earnings Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct the question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder today’s conference call is being recorded. I’d now like to turn the call over to your host, Mr. Scott Brannan, Chief Financial Officer. Please go ahead, Sir.

Thanks Ally, and good morning everybody and thanks for joining us. My name is Scott Brannan, and I’m Chief Financial Officer of Colfax. With me on the call today is Steve Simms, our President and CEO. Our earnings release is available in the Investor section of our website colfaxcorp.com. We will also be using a slide presentation to supplement today’s call which is also found in the Investor section of our website. Both the audio of the call and the slide presentation will be archived on the website later today and will be available until the next quarterly call. During this call, we’ll be making some forward-looking statements about our beliefs and estimates regarding future events and results. These forward-looking statements are subject to risk and uncertainties including those enumerated in our SEC filings. Actual results might differ materially from any forward-looking statements we might make today. The forward-looking statements speak only as of today and we do not assume any obligation or intent to update them except as required by law. With respect to any non-GAAP financial measures used during the call today, the accompanying information required by SEC Reg G, relating to those measures can be found in our earnings press release and in the supplemental slide presentation, again, that’s in the Investor section of the Colfax website. As a reminder the comments from the last call, it is important to note that while we are able to report pro forma sales including Howden and ESAB for 2011, we do not have pro forma adjusted operating income, adjusted net income or adjusted net income per share available for 2011. As such we are not able to make comparison of results other than sales on a pro forma basis. Finally, the strengthening of the U.S. dollar had a material impact on this quarter’s result, relative to the assumptions in our previous guidance this resulted in approximately $15 million less in sales, and $0.01 per share less than adjusted ESP. And now I’d like to turn it over to Steve.

Good morning everyone. Today we are going to cover three topics. Our second quarter results, thoughts on the most recent economic trends and how they are impacting our business, and finally our updated earnings guidance for 2012. I’ll handle the first two and Scott will provide more detail on the financials and the updated 2012 guidance, and then we will open it up for Q&A. As we announced in our press release this morning, we are pleased with our second quarter results given the current economic environment. Our longer cycle business continues to perform well with sales in gas and fluid handling segment up 8% from the pro forma 2011 quarter. Our fabrication technology segment also turned in a solid performance with sales in line with expectations and margins improving as anticipated. As Scott mentioned, results in both segments were negatively impacted by the strengthening of the U.S. dollar against most currencies. We continue to progress as planned on our current cost initiatives and our backlog remains solid at $1.4 billion in sales. Now for a look at the specific results. Adjusted EPS for the 2012 quarter were $0.35 per share 21% higher than the $0.29 per share reported for the 2011 second quarter. Other than adjusted EPS, there is very little comparable between 2012 and 2011 due t the size of the acquired ESAB and Howden businesses. Net sales for the 2012 second quarter were 1.50 billion an increase of 9.5% organically compared to the 1.20 billion pro forma sales for 2011 second quarter. Turning now to our business segment. For gas and fluid handling, net sales for the second quarter were 497 million which represents an increase of 13% organically compared to 461 million pro forma revenue in last second quarter. With respect to our end markets please…

Thank you, Steve. For the second quarter sales were 1.05 billion up 10% organically compared to the pro forma 2011 second quarter sales. Adjusted operating income was $97 million which represents an operating margin of 9.3%. Fabrication technology adjusted operating margins were 8.3%. Gas and fluid handling adjusted operating margin were 12.6%. Gas and fluid handling margins were significantly higher than in the first quarter and in line with internal expectations. The significantly higher revenue levels at Howden are also in line with typical seasonal pattern and given Howden’s high fixed engineering cost resulted in substantial improvements in margins for the segment compared to the first quarter. Fluid handling margins were improved over the 2011 second quarter primarily as a result of restructuring cost savings and lower amortization expense. As Steve discussed ESAB made solid progress in achieving adjusted operating margin this quarter as margins increased to [28.3%] from 7.4% in the first quarter. And this performance is significantly better than the second quarter of 2011. Corporate and other cost reduced margins by 1% excluded from our adjusted operating income our restructuring cost of $19 million, $14 million of significant year one fair value adjustments related to inventory and contract backlog and $3 million of cost associated with their asbestos insurance coverage litigation. For the quarter, interest expense was $26 million and that includes approximately $4 million of non-cash amortization of debt discount and deferred issuance cost as well as facility fees and the cost of bank guarantees and letters of credit. We made $28.5 million of debt principle pay downs during the second quarter. Our effective tax rate on adjusted income was 31% for the quarter; we expect a 30% effective tax rate on adjusted income for the balance of 2012. Operating cash flow was much improved in the…

Thanks Scott. As Scott mentioned like many companies, the impact of FX represents the near-term headwind. However, this in no way alters our long-term view regarding the attractiveness of our businesses or their ability to perform in the near-term. Our cost reduction and restructuring activities are tracking well to initial plans and our organic growth of 10% suggest our businesses are performing well in their respective end markets. Furthermore, with over 60% of our revenues now in high growth regions and strong positions in attractive end markets such as power, energy and mining, we remain optimistic about the prospects for long-term growth. We just completed the strategic planning in two of our three key businesses, and I’m encouraged by the strength of our brand, our technical capabilities and our outstanding team of leaders. These factors plus the power of the Colfax business systems gives me confidence that we will deliver the margin and cash flow that we have spoken about in past calls. This means profit for ESAB in the low teens. Howden improved to mid teens and fluid handling in the high teens by the end of our strategic planning period. And we expect our cash flow to eventually exceed net earnings driven by process improvement activities like the example shared earlier today. Net-net we remain positive regarding the potential of our business and the balance of the year. With that I’ll open it up for Q&A.

(Operator Instructions) Our first question comes from Nathan Jones of Stifel Nicolaus. Please go ahead.

Can you talk about the progression of orders through the quarter specifically in your shorter cycle businesses?

I think we have basically achieved what we sort of expected to achieve. In the gas and fluid handling segment, the general industrial is the best indicator of the short cycle business that as you can see it achieved an order rate of 1% organic increase. So, I think that is essentially in line with what we were expecting most of the other end markets in that segment or more longer cycle. The ESAB business as you can see is being performing probably slightly better than expected as we have commented on the last couple of calls. Europe continues to be in line with our expectations; it has performed steadily over the first six months at essentially on a local currency basis at a flat rate. So, we are not seeing any significant change in the short cycle business from what we expected.

To that I’d add that, as Scott pointed out our consumable trend was quite positive globally and actually quite positive in Europe as well. But I think it also look at our after-market and service business to track that and they were quite strong throughout the quarter as well, and we expect that t continue through the second half.

And just a follow-up, I think a number of other industrial companies have talked about Europe being weaker than they had expected, can you talk about maybe why it's not coming through as week for you as it is for some others whether you are gaining share there or why you think Europe maybe not as wait for you as it for some other companies.

I couldn’t begin the comment for other companies but I can say that for our business and I mentioned that in the comments, on the ESAB side, Europe was is in the zone of what we had anticipated, we were not anticipating tremendous growth as an economy there. And I think we planned accordingly. And I think that will true through the entire business. I think Europe is about where we had anticipated when we put the overall plans together. Internally, this is to make sure I’m clear is that we did see some slowness on our fluid handling business in the oil and gas sector, and so we do feel that some of that is tracing to the softness in the European economy as well. So, we have seen some softness in parts of our business but generally we have been able to hang in there reasonably well.

Our next question comes from Jason Feldman of UBS. Please go ahead.

Couple clarifications I guess on guidance here, I guess I’m little confused. I thought when we saw the guidance slides from last quarter in May; they already included the new shares. It looks like that’s now (inaudible).

That’s correct. At the time of last quarter we had anticipated that, that we would be able to generate additional operating profit to offset the effect of the additional shares, either through various actions such as accelerated cost savings, we were seeing slightly positive growth trends at that time greater than what was within our initial guidance. And revisiting the operating profit assumptions for the balance of the year where without factoring in any acquisition activity, we feel the operating profit expectations that we put out in February are more consistent with where we are today.

Okay. And so, just to clarify, the Soldexa is not included in the guidance and when do you expect that to close, and so could that essentially generate some accretion later this year.

Yes it could, it's obviously subject to the regulatory clearance, so it's impossible for us to predict exactly when it's going to close. We do expect it to close in the near-term and we certainly expect it to close this year, and it should be accretive but given that the date is completely with the control of an outside agency, we just don’t feel comfortable putting out in the guidance.

You also said that one of the things you contemplated to offset the dilution from the incremental shares, (inaudible) restructuring. I notice that your restructuring cost this year are up by 13 million relative to your prior guidance. How does that restructuring actually being accelerated or is that something that won’t benefit really until 2013.

There is definitely accelerated restructuring, so you can see that clearly in the numbers. Some of the accelerated restructuring will benefit 2012 most of it the vast majority of it will benefit in 2013. There is a benefit from the accelerated restructuring has been offset by some other small market negative so net-net we feel like we are comfortable with the operating profit level guidance that we gave in February.

And then just lastly. When we think about the impact of FX, I mean from a translation perspective, I think it's pretty straight forward, but just to what degree does it affect the adjusted operating margin. So, when we see the kind of improvement that we saw from first quarter to second quarter. Is that kind of a clean comparison or did the currency move that up or down.

We are pretty well hedged either naturally through natural cost revenue matching or through forward contract. So, there is essentially no noise from transaction or FX in there. It's clearly proportional, so from a margin percentage basis there is really no effect from FX.

Our next question comes from Kevin Maczka of BB&T Capital Markets. Please go ahead. Kevin Maczka - BB&T Capital Markets: Scott, I’m going to beat the dead horse here I think on the guidance, but one more clarification. You said there is no material change in your EBIT guidance, but you have taken the midpoint of EPS down $0.15 and five of that is easily understandable that’s currency. So, you got $0.10 but no change in EBIT guidance, but you did comment on Howden growth expectations no longer double-digits, that’s looking a bit worse than it did before. And I think you were pointing primarily to the oil and gas market here. Can you just kind of square those things for us again?

The oil and gas orders are essentially going to affect 2013 revenue, they are going to have most of those projects are very large projects and they are going to have minimal impact on 2012. So, the revenue guidance is pretty much consistent with what we have small adjustment down for some of the shorter cycle fluid handling business. But the vast majority of the revenue adjustment is fully related to the currency. The order book is very strong overall and the only area, the only end market where we are seeing level of weaknesses in oil and gas and we don’t see that having a significant effect on 2012. Kevin Maczka - BB&T Capital Markets: So, when you look at the organic growth expectation you laid out previously by segment, do those still hold the 2 to 4 in ESAB and 4 to 8 in legacy Colfax still hold just 10 to 15 and Howden does not.

No, I think at this time we prefer to give the guidance by segment as appose to by the three groupings, but I think that the at this point Howden is tracking us right towards the range that you quoted. The fluid handling is tracking slightly below the range that you quoted and as you have noted ESAB has being 5 and 7%. So, ESAB has been tracking slightly above the range. I think for the full-year we would probably tweak ESAB up slightly, we would tweak gas and fluid handling, weighted down slightly but the overall weighted revenue forecast is pretty much right on target with the FX rates. Kevin Maczka - BB&T Capital Markets: And again just to be clear on the remaining $0.10 of the $0.15 guide down, 5 is currency the remaining 10. How much of that again are you pointing to share count versus other below the line thing.

There is a specific reconciliation in the slide deck, but $0.07 of it is related to the effect of the shares, the other two non-operational factors a couple of cents each are additional earnings attributable to non-controlling interest in our majority owned entities that I spoke about in the script and then a couple of cents for a slightly higher tax rate.

Our next question comes from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

How are you thinking about free cash flow for the year and what do you think the likely uses of that free cash flow generation as we look forward maybe just comment on pipeline and appetite.

As we said at the equity raise, where we raised approximately 300 million if were successful we would spend most of that on acquisitions. Obviously, the announced Soldexa acquisition takes about two-thirds of that, obviously we haven’t announced any other acquisition but we are still working a pipeline that could use something in that neighborhood for the balance of the year. As you saw this quarter we started to generate the level of cash flow that we know we can from this business, and we have sufficient cash on hand to take care of that entire acquisition appetite there. So, the cash flow we generate from operations we should be able to do some level of debt pay down towards the end of the year, but obviously we are being taken here and seeing how the pipeline works out.

The acquisition pipeline is robust and we are going to continue to focus on transactions that are going to meet our financial hurdles and also representing good strategic fit. In line with that, I just want to comment again on Soldexa, while we are waiting for anti-trust clearance here. This is an outstanding acquisition for us, because it reinforces our market strength in South America and it’s also going to increase our emerging market exposure. I think we are also going to see a stronger service based marketing model here for our portfolio that we can actually replicate around the world. So, the Soldexa acquisition is going to be a great addition to the team.

Soldexa regulatory issue is that what you anticipated or you have in sum hiccups there?

No hiccups, pretty much as anticipated. No significant issues at all.

Just on the fluid handling down tick and expectations that seems to be isolated to oil and gas, are there any other spots of weakness.

Significantly the issue for us is fluid handling. As I spoke to in the script, the way it cut, Jeff, is that for fluid handling we are more involved in the upstream and midstream application side of the business and that’s where we have seen a little bit of a softening in investment you may have seen that from some of the other companies around the world.

(Operator Instructions) Our next question comes from (inaudible) Janney Capital Markets. Please go ahead.

I was just wondering if you could talk a little bit more about the restructuring in ESAB, did you say that those high cost manufacturing locations and the SKU reduction was going to be complete by the end of the year?

I did they are either complete or well underway, yes.

And how much of that, I heard the overall comment on the restructuring benefits, but how much of that restructuring or those two actions are going to impact 2012?

Very little, for the most part as we said before we really don’t break it by specific event or activities, but we can see relatively little of that will hit the P&L this year. I’ll go back maybe to confirm what we said on fire coals and that is that, if you think about that $100 million target that we have established for ourselves, the way we think about it is somewhere between 55 to 65 million will hit the P&L next year. And then in the following years we will get the difference. And so we feel very good or comfortable with our ability to deliver that 55 to 65 which is ahead of us in 2013 and of course comfortable with the backend of that as well. But we get to that level of comfort by looking at the different components in that restructuring which is you point out five different facilities in Europe, one here in North America, one in China as well. So, we feel pretty good about the restructuring part of the equation. We also have taken a very hard look at a number of cost reduction opportunities and I alluded to that in terms of SG&A, corporate overhead and so forth, that’s tracking well.

On the facility closing, when we are doing the closing and we just recently completed one in North America, you typically have a time where you are transferring activity, because of that we are not seeing a significant benefit from these plant closing in the 2012 operations.

Question I had was just on your internal improvement efforts at the CBS, you talked about some new leaders in place in ESAB and I was just wondering are you adding your capabilities in your lean efforts as well, so that you can ramp up those CBS initiatives?

CBS was probably our highest theory in terms of additional talent that we brought in and so if we look at that over the last five month that was probably our number one area and probably the area quickest to move. So, we are in very strong position there from CBS standpoint, and that’s not just that at the corporate level, but it's really each business or each operation adding the appropriate level of resource within their operation. So, we track that on a weekly basis and we are making good progress. So, I say if anything that guys like Clay Kiefaber and Ian Brander and Bill Roller the team, they are actually running ahead of plan in terms of where I thought we realistically be in terms of the talent additions.

Our next question comes from Joe Mondillo of Sidoti & Company. Please go ahead. Joe Mondillo - Sidoti & Company: First question is going back to the cost cuts and your expectations. Given the accelerated restructuring, should that not improve or increase the outlook of the 55 to 65 million of benefits in 2013?

The accelerated activity had been anticipated at the time we made the last call. So, as I guide to that answer in the previous question, a lot of the activities are, although if you measure them individually they generate savings as there is also cost that are going against those items that make them only a small contributor to overall profitability for 2012. Once we have the new 100% in place and the old 100% shutdown, I think that’s when you will see the true savings on a net basis, small element of that in 2012 but the majority of it in 2013. Joe Mondillo - Sidoti & Company: And then in terms of what was the corporate expense line aside from the two segment?

It is specifically disclosed in the slide deck, I believe it's close to $11 million. Joe Mondillo - Sidoti & Company: And you said that it was higher than your expectations due to the Soldexa acquisition and maybe a couple other items?

Little over a $1 million higher than that, that we expected as we said on the last call we expect the corporate expense to drop a little bit from the first quarter level due to some headcount reductions that we have made between the redundancies between both Colfax and Charter’s Corporate headquarters. And we made those reductions we achieve the lower cost but then we had some additional cost on top of that that we had in plan which was some personnel cost as well as the primary item being the cost related to the Soldexa acquisition. Joe Mondillo - Sidoti & Company: So, going forward starting in the third quarter, we are looking at 10 million run rate?

I think that would be fair. Joe Mondillo - Sidoti & Company: And then in terms of the fabrication business, the volume you saw a pretty decent acceleration on a sequential basis from the first quarter. I missed your commentary, could you just talk about was that surprise you guys and where you are seeing the strength whether its end markets or geographic wise?

The second pointer is that, typically on the wielding side itself is typically better than the first quarter because of the weather and because of holidays. So, it's not a huge swing in seasonality like we have between the first and the fourth and the longer cycle businesses. Some of it we try not to do revenue comparisons on a sequential basis because there is a seasonality factor in there, but even compared to last year on a pro forma revenue basis as you noted we did have our organic growth rate with significantly better than our guidance assumptions. So, we are seeing some strength in (inaudible).

I think at the end of the day we had outstanding performance in consumables. I haven’t seen where our competition is yet, but I think the consumable growth was just exceptional. And equipment side is pretty much what we expected, and we had god growth there but more modes by comparison and consumables. And I think the key thing here is that you will see in some of our future reviews the major focus that we have from a product development standpoint is more intensely focused on the equipment side. And we are continuing to develop and progress on consumables returning the focus to the equipment part of our business. From a geographic standpoint, I wouldn’t go into a ton of detail, what I can tell you there is that as I mentioned in the script, in Europe it was sort of flat which is above what we expected maybe just a little bit better than that. In Europe we are really focusing on a number of things relative to deliveries in terms of also SG&A size and so overall we are very pleased with what we saw on Europe both on the top and bottom-line. The rest of the world was very strong.

Our next question comes from John Moore of CL King. Please go ahead. John Moore - CL King & Associates: Just to follow-up on the restructuring questions regarding ESAB, and I apologize if I didn’t get this before but last quarter you laid out basically $30 million in savings, you expected to realize this year. So, that number is still good. Is that right?

That’s correct. That’s absolutely unchanged that’s essentially projects that are completed. The largest ones having to do with corporate headquarter thing that I (inaudible) few minutes ago and then a couple of facility changes, the largest one being in North America that started before we own the business. Those projects are essentially complete. So, I think 30 million is a solid number. John Moore - CL King & Associates: I guess do you have an estimate as what you realized in the first half of this year. I think last quarter you laid out you realized at least 10 from the consolidation of the corporate headquarters?

It's not the full-year number. I mean we realized less than half of the 30, because we didn’t get all of that projects completed on day one and we are certainly right on track. We probably recognized at least 10 million of that 30 in the profit and loss account through the first half of the year and you will recognize the other 20 in third and fourth quarter. As I said, those projects are essentially, but I don’t think there is (inaudible). John Moore - CL King & Associates: Maybe just slicing at a different way here, the operating margin at ESAB or 7.4 in the first quarter 8.3 this quarter. I guessed I used that 30 million, it seems like you could exit the year at something around 9% assuming no volume growth. Is that the right way to think about it or do you think you can still get some volumes with the growth in the emerging regions to put you above that number in the fourth quarter?

I don’t really want to comment on margins by segment by quarter, that’s a little (inaudible) but I think directionally you are certainly headed on the right direction, we expect as I think we laid out clearly on the other calls, we expect margin improvement over the years for ESAB. The third quarter is bit of a pause, it's similar to the second quarter, but we do expect a tick up again in the fourth quarter. So, given that we are at 8.3, it's not reasonable assumption that certainly could do 9% in the fourth quarter.

Our next question comes from Mike Halloran of Robert W. Baird. Please go ahead.

So, just following up on the Europe side there, anyway that you guys can parse the difference between what you are seeing from an end market standpoint and then benefit that you are seeing there in Europe specifically related to reengaging the customer and getting more in front of them with the changes in more consistent operations that you are putting into place.

I don’t think we are going to split out end markets in a region at this point.

I was thinking more qualitatively as appose to quantitatively.

Most of the general industrial is a business got the largest proportion in Europe, when obviously mining is not a very big European business, Marine is mostly an Asian business, oil and gas and power most of the activity that is not in Europe. So, of the longer cycle businesses, the general industrial is really the only end market that provides so much of an inside into the European economy. And I think we tried to make clear in comment, ESAB is recently flat, the gas and fluid handling business is modestly up in Europe down in Southern Europe, stronger in the Northern and Eastern Europe. So, the revenue was very strong for the quarter which largely reflect bookings taken in earlier period, the order rate is flattening out. It’s up 1% this quarter it was down a little bit in the first quarter. So, I think as long as looking at the end market analysis for our longer cycle business, the general industrial market confirms that Europe is just marginally up with flattening order rate.

I think one other thing that’s important to keep in mind is that if you add Europe and North America together it's still south of 40% of our total. And Europe is important part of our business, but it's not the dominant part of the business that you might think for an ESAB and Howden which are headquarter or base, it's not the overwhelming fact that you might anticipate.

What I was trying to drive that is, when you think about [welding] or fabrication market growth in Europe from an industry perspective versus what you guys are seeing in marketplace which includes this reengagement of the customer experience. Is there any real differentiation, are you seeing benefits from that come through or is most of the flattish type trends you are seeing in the European business driven more by market dynamics at this point?

To be honest I’d say this is much market dynamic, it our own effort. I will say that Clay and the guys have done a wonderful job of refocusing the selling effort, the marketing effort in Europe and we are starting to get that positive feedback in interviews and work that we are doing in and around the industry with uses in the trade. So, I think we are seeing a list on that, but I don’t know this large or significant as we fully intent it to deal with the next 12 months. So, we are certainly seeing some traction being gained and success there, but it's probably combination of both factors.

I’m showing no further questions at this time, and I’d like to turn the conference back over to Scott Brannan for any closing remarks.

Thank you very much and thank everyone for attending and we look forward to speaking with you again next quarter. Thank you.

Ladies and gentlemen this does conclude today’s conference. You may all disconnect and have a wonderful day.