Columbus McKinnon Corporation (NASDAQ:CMCO) Q3 2023 Earnings Call Transcript

Columbus McKinnon Corporation (NASDAQ:CMCO) Q3 2023 Earnings Call Transcript February 1, 2023

Operator: Greetings, and welcome to the Columbus McKinnon Corporation Third Quarter Fiscal Year 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah Pawlowski, Investor Relations for CMCO. Thank you, Ms. Pawlowski. Please go ahead.

Deborah Pawlowski: Thank you, Donna, and good morning, everyone. We certainly appreciate your time today and your interest in Columbus McKinnon. Joining me here for the quarterly conference call are David Wilson, our President and CEO; and Greg Rustowicz, our Chief Financial Officer. You should have a copy of the third quarter fiscal '23 financial results, which we released earlier this morning, and if not, you can access the release as well as the slides that will accompany our conversation today on our Website at investors.columbusmckinnon.com. David and Greg will provide their formal remarks, after which we will open the line for questions. If you will turn to Slide 2 in the deck, I will review the Safe Harbor statement. You should be aware that we may make some forward-looking statements during the formal discussions, as well as during the Q&A session.

These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ materially from what is stated here today. 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 at sec.gov. During today's call, we will also discuss some non-GAAP financial measures. We believe these will be useful in evaluating our performance. However, you should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliation of non-GAAP measures with comparable GAAP measures in the tables that accompany today's release and slides.

So, with that, please advance to Slide 3 and I will turn the call over to David to begin.

David Wilson: Thanks, Deb, and good morning, everyone. Our results for the quarter demonstrate the steady progress we are making as we execute our plan to transform Columbus McKinnon into a higher margin, higher growth business. There were several highlights in the quarter. Sales were up a 11% on a constant currency basis as we captured price, increased volume to meet demand and the team successfully reduced past due backlog. Past due backlog was reduced by $16 million or 28% as we continued efforts to improve our customers experience. We expanded operating margins by 170 basis points on a GAAP basis and 70 basis points on an adjusted basis. Q3 daily order rates increased 3% sequentially, and order rates in January through last Friday are up nearly 6%.

Finally, we are seeing project activity that had stalled in Q3 begin to advance this month. We remain bullish on megatrends that we expect will continue to drive opportunities for us even against the softening economic backdrop. Global shifts, or I should say geopolitical shifts, transportation and logistics challenges, insufficient supply and the limitations of available labor are driving investment decisions that support automation, the reshoring of manufacturing, facility upgrades and expanded operational investment. We continue to strengthen our balance sheet and improve our financial flexibility to execute our strategy. We paid down $30 million in debt through the first 9 months of our fiscal year and have brought our net debt leverage ratio to 2.7x.

We also repurchased approximately 31,000 shares at an average price of $32.17 in the quarter. On Slide 4, I will update you on our strategic progress. As mentioned earlier, growth in the quarter on a constant currency basis was 11%. I believe our new regional leader teams -- leadership team structure contributed to this success. In fact, sales in EMEA were up nearly 12% excluding the impact of FX driven by both pricing and volume. We also continue to innovate to drive growth, and we introduced three new products in the quarter, a new medium duty belted conveyor that fills the gap between our current flagship products and capacity and capabilities. The new line includes many features that provide competitive advantages including flow accuracy tracking, and slim profile; a new 4.5 tonnes hand chain hoist for the general industrial markets and we pre-launched the next generation wire rope hoist with available frequency drive controlled motion for better speed and position control.

This solution offers an easy upgrade path to a digitally connected footprint for diagnostics and remote monitoring. Our NPD N-3 revenue, which we use to measure vitality was 5% of total revenue on a year-to-date basis and remains ahead of plan. Our most immediate opportunity is improving our customer experience in North America to gain market share and to grow our customer base. We have improved our performance relative to internal customer service metrics, including call wait times, quotation lead times, order entry times, engineer drawing lead times, lead time accuracy, delivery status update accuracy, and past due backlog reduction. We are laser focused on reducing delivery lead times and have created plans for each product that will reduce lead times to competitively advantaged levels.

While we are making progress on these initiatives, we are not yet satisfied with the results. I should also mention that in December, we successfully launched and went live with our new ERP system in Mexico. This is consistent with our digital initiatives roadmap and is expected to improve efficiency and enable our teams to be more effectively -- to be more effective as they address both internal and external customer needs. This also provides the foundation for future enterprise simplification efforts. Despite supply chain headwinds and related production impacts, we continue to expand margins. We have now extracted $7.2 million in annualized costs through the business realignment efforts we initiated earlier this fiscal year. We realized $4.7 million of these savings in fiscal year '23 and expect the balance to help offset further inflationary pressures in fiscal '24.

Rest assured, we're also taking actions to identify additional costs that we can take action on in fiscal '24. We generated $6.5 million in free cash flow in the quarter and are expecting a significant increase in cash from operations in the fourth quarter, as we reduce inventory and improve working capital. Slide 5 depicts our adjusted gross margin progression over the last several years. Since fiscal '18, we have improved gross margin by 310 basis points, and we believe we are on track to achieve our fiscal '27 objectives. As you can see on this slide, there are several levers we will address to achieve our targeted level of approximately 40%. I want to remind you on Slide 6, that we were heading and why. We're transforming Columbus McKinnon into a leading motion control enterprise for material handling by leveraging our product portfolio and expanding into secular growth markets.

We expect our strategy to shift our mix of business into our product platforms that command higher margins and have greater growth potential. By organizing around these platforms, we are also identifying larger addressable markets, creating more opportunities for us to grow and succeed. With that, let me turn the call over to Greg to discuss our financial results in greater detail. Greg?

Greg Rustowicz: Thank you, David. Good morning, everyone. Slide 7, net sales in the third quarter were $230.4 million, up 10.5% from the prior year period on a constant currency basis, and above the midpoint of the guidance we provided last quarter. As you know, the third quarter is impacted the most from a seasonality perspective as we had four less workdays in most geographies around the world compared with the previous quarter. Overall, we are pleased that we were able to reduce past due backlog by $16 million despite persistent supply chain challenges for motors, drives and other components that we purchase. We also had delays in certain rail projects for various reasons that impacted revenue by about $4 million in Q3. This revenue is expected to be recognized in Q4.

Looking at our sales bridge, pricing gains of $11.9 million or 5.5% accelerated as we converted orders to revenue at more current prices. This was up 60 basis points from our Q2 level. Volume increased by 2.7% or 5.9 million, which we will cover in the regional update. Acquisition revenue represents 2 months of sales from the Garvey acquisition, which closed on December 1st of 2021. This provided $4.9 million of incremental growth in the quarter. Foreign currency translation reduced sales by $8.4 million or 3.9% of sales. Let me provide a little color on sales by region. For the third quarter, the 9.9% growth we saw in the U.S was driven by a 5.8% improvement in pricing. Acquired revenue from Garvey added 3.5% growth in the U.S. Sales volume was up .6%.

Outside of the U.S., sales grew 11.4% on a constant currency basis. Pricing improved by 5.1% and sales volume increased by 5.9%. We were encouraged with the volume increases we saw, which were approximately 12% in Latin America, 9% in Asia, 5% in Europe, the Middle East and Africa or EMEA and 3% in Canada. We are especially encouraged by the volume gains in EMEA, which represents 25% of our business. The region has proven to be resilient in the face of the war in the Ukraine and an energy crisis. Both our project business and short cycle business in Europe saw meaningful volume growth. On Slide 8, gross margin of 35.6% was up 90 basis points from the prior year. On an adjusted basis, gross margin was lower by 110 basis points compared with the prior year.

Last year's third quarter was unusually strong because we didn't see our typical seasonal dip of roughly 100 basis points in gross margin. In the prior year, we benefited from a strong month from the Garvey acquisition, as they delivered an exceptionally strong margin on a large project they shipped right after we acquired them. This quarter we saw a more normal sequential dip in margins. Third quarter gross profit increased $6.9 million compared with the prior year and was driven by several factors which you can see in the table. Let me comment on a few highlights on our gross profit bridge. Pricing net of material inflation added $5.9 million of gross profit, which includes $6 million of material inflation in the quarter. We see material inflation decelerating as we enter Q4.

We also had an unusual product liability settlement last year that did not repeat. The two incremental months in the quarter from the Garvey acquisition provided $1.9 million of gross profit and $4.9 million of revenue. Offsetting these items was foreign currency translation, which reduced gross profit by $2.8 million and lower factory productivity compared with the prior year of $3.7 million. The lower factory productivity was primarily at our Künzelsau facility, as volume picked up for engineered to order production activity as our mix shifted to more ETL product which is more complex than standard product. This disrupted our planning and execution processes. This has been addressed as we had a new planning tool to increase the efficiency of this process.

Moving to Slide 9, our SG&A expense was $55.4 million in the quarter or 24.1% of sales. This includes a purchase accounting item for $1.2 million related to contingent consideration paid to the owners of Garvey. The acquisition was structured with an earn out provision based on delivering certain levels of EBITDA in the first year, which was achieved this quarter. The $1.2 million represents the excess of what was estimated during purchase accounting. The total earn out of $2 million was placed in escrow when the deal closed, so there will not be a cash impact when it is paid in Q1 of next fiscal year. In addition, the sequential increase in our SG&A included $500,000 of incremental business realignment and headquarters relocation costs. The remainder of the sequential increase was due to adjustments to our annual incentive plan accruals and stock compensation.

Compared with the prior year, our SG&A costs were higher by $1.9 million which includes the $1.2 million of contingent consideration for the Garvey acquisition, which I just discussed. We also incurred $1.1 million of incremental business realignment costs related to our commercial reorganization, and the incremental 2 months of the Garvey acquisition added $900,000 to our SG&A cost as well. Offsetting these increases were foreign currency translation, which reduced our cost by $1.8 million. For the fiscal fourth quarter, we expect our SG&A expense to approximate $54 million. We are assessing further cost reduction opportunities as we plan for fiscal '24. Turning to Slide 10, operating income in the quarter increased 32% to $20.2 million and adjusted operating income was $23.5 million.

Operating margin expanded 170 basis points reflecting pricing, acquisition performance and higher volumes. Adjusted operating margin was 10.2% of sales, a 70 basis point increase over the prior year. As you can see on Slide 11, we recorded GAAP earnings per diluted share for the quarter of $0.42, up $0.08 versus the prior year. Our tax rate on a GAAP basis was 28% in the quarter. For the full year, the tax rate is expected to be between 30% and 32%, which reflects a 6 percentage point impact from the two discrete items that we discussed in our Q1 earnings call. Adjusted earnings per diluted share of $0.72 was up $0.12 from the prior year. While EPS was negatively impacted by $0.08 per share from higher interest expense versus the prior year, we had favorable impact from FX gains as well as mark-to-market investment gains, which together favorably impacted EPS by $0.12 per share year-over-year.

Even though we are 60% hedged to interest rate exposure, interest expense is expected to increase to $7.6 million in the fourth quarter. Weighted average diluted shares outstanding will approximate $29 million and our pro forma tax rate is 22% for calculating non-GAAP adjusted earnings per share. On Slide 12, our trailing 12-month adjusted EBITDA margin is 15.7%. We are making steady progress towards our target of $1.5 billion in revenue with a 21% EBITDA margin in fiscal '27. A return on invested capital of 6.9% was impacted by the Garvey acquisition. ROIC is a key metric in our long-term incentive plan and we expect to see this improve over time. We continue to advance our efforts to reduce overhead, improve productivity and simplify both our product lines and factories.

We will also drive the top line as well. These are the key elements to delivering on our growth and profit goals. Moving to Slide 13, we had positive free cash flow of $6.5 million in the third quarter. This includes cash inflows from operating activities of $10.8 million and CapEx of $4.2 million. Third quarter cash flow was impacted by approximately $15 million of higher cash interest and cash tax payments compared to the prior year. As we turn to the fiscal fourth quarter, we expect strong free cash flow as we drive earnings and reduce working capital investments. Full year capital expenditures are expected to be in the range of $13 million to $15 million, or between $3.5 million to $5.5 million of CapEx in the fourth quarter. Turning to Slide 14, we have a strong and flexible capital structure comprised of the term loan B, which requires $5.3 million of the annual principal payments as well as an excess cash flow sweep depending on our total leverage ratio.

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We have been actively paying down our borrowings and made another $10 million payment in the quarter, bringing the total debt payments year-to-date to $30 million. We expect to pay an additional $10 million in the fourth quarter. The term loan B is 60% hedged with interest rate swaps that blend to a swap rate of approximately 2.08%. As of December 31, our net debt leverage ratio was 2.7x. We have prioritized debt repayment in the current environment and expect to see our leverage ratio dropped to under 2.5x next quarter. As David noted, we took advantage of market conditions to repurchase about a $1 million of stock in the quarter. Finally, our liquidity which includes our cash on hand and revolver availability remains strong and was approximately $166 million at the end of December.

Please advance to Slide 15 and I will turn it back over to David.

David Wilson: Thanks, Greg. As I mentioned earlier, daily order rates improved 3% sequentially in Q3. On a year-over-year basis, there were two major impacts that affected our Q3 order levels. First, FX had a $9 million negative impact in the period. Additionally, there was a $9 million impact to orders resulting from the curtailment in new warehouse investment by a large e-commerce customer. Year-to-date, orders for this customer are down approximately $25 million. While current order activity with this customer is paused, we are highly engaged with them on other promising and innovative new projects. I should also highlight that we're excited about additional e-commerce applications that we are winning. We are working with several integrators that are serving end users who are looking for increased production efficiencies within their intra logistics systems.

Our backlog remained stable at $329 million in the quarter, and was more current given the 28% reduction in past due orders we achieved in the period. Let me wrap up on Slide 16 with some thoughts regarding our outlook. First, looking to the fourth quarter, we expect to deliver quarterly revenue of about $240 million to $250 million. This implies fiscal '23 growth of 6% for the full year on a constant currency basis, which is in line with our strategic plan. As I mentioned earlier, we are planning for a measurable improvement in cash generation in the quarter through a reduction in working capital. We are encouraged with the developing view of fiscal '24 as well. We anticipate that we can deliver growth on the order of low to mid-single digits for the year.

While quotation to order conversion timing has been extended customer activity and quotation levels have held up well and we are not seeing indications of an industrial recession. We also think that a stabilizing environment will help advance projects that have been held up in decision making processes. There's actually quite a lot of number of our markets. For example, we see continued strength in the EV market, whether it be for vehicle or battery production. Energy and utilities around the world are also very active. From water treatment, wastewater management and waste to energy power facilities to active oil production in the Middle East. Utilities are adding new plants and upgrading older facilities to drive improved efficiencies. Defense has also been active with missile elevation devices and chain hoists to erect mobile tents.

In Life sciences, we're providing automated pharmaceutical packaging and delivery systems for prescription fulfillment. Finally, I'd be remiss if I didn't mention that demand for our entertainment solutions continues to be solid. We are hyper focused on improving our customers experience and are executing plans to do so. This will enable improved market share and expanding addressable markets. We also look -- as we look beyond fiscal '23, given the activity we're seeing in our markets, our efforts to improve customer experience and our strong backlog, we expect to continue to grow even as the economy moderates. We are committed to achieving our longer term goals and expect to deliver additional steady proof points as we advance. Donna, with that, I'll open up the call for questions.

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