Joe A. Raver - Chief Executive Officer, President and Director Kristina Cerniglia - Chief Financial Officer and Senior Vice President Elizabeth E. Dreyer - Former Interim Chief Financial Officer, Chief Accounting Officer, Vice President and Controller Kimberly K. Ryan - President.

John Franzreb - Sidoti & Company, LLC Daniel Moore - CJS Securities, Inc..

Good morning, everyone, and welcome to the Hillenbrand's earnings teleconference for the third quarter of fiscal 2014.

A replay of this call will be available until midnight, Eastern time, Thursday, August 21, 2014, by dialing 1 (855) 859-2056, toll-free in the United States and Canada, or plus 1 (404) 537-3406 internationally, and by using conference ID number 52610479.

This webcast will be archived in the company's website at www.hillenbrand.com through September 7, 2014. If you ask a question during today's call, it will be included in any future use of this recording. Also note that any recording, transcript or other transmission of the text or audio is not permitted without the Hillenbrand's written consent.

At this time, it is my pleasure to turn the conference over to Joe Raver, Hillenbrand's President and Chief Executive Officer. Mr. Raver, please go ahead, sir..

Thank you, Shelly, and good morning, everyone. I appreciate you joining us this morning to discuss Hillenbrand's results for the third quarter of fiscal 2014, which ended June 30. I'm joined in the prepared remarks portion of our call today by Elizabeth Dreyer, our Chief Accounting Officer and Interim CFO.

And on her first day of work at Hillenbrand, Kristina Cerniglia, our new CFO, is here with us too. During the Q&A portion of our call, we'll be joined by Kim Ryan, President of Batesville.

Thomas Kehl, who normally joins us for the Q&A portion of the call, is out of the office this week and in a location with pretty unreliable connectivity, so he'll not be joining us on the call this quarter, but we do expect him to be back on in next quarter call.

Prior to getting into our prepared remarks about the business, I'd like to briefly remind you that during this call, we may use certain forward-looking statements that are subject to the Safe Harbor provisions of the security laws. These statements are not guarantees of future performance, and our actual results could differ materially.

Also, during the course of this call, we will be discussing certain non-GAAP operating performance measures.

I encourage you to take a look at our 10-Q, which can be found on our website for a deeper discussion of forward-looking statements, the risk factors that could impact our actual results, and more information on our use of non-GAAP operating measures and their reconciliation to GAAP financial measures.

I also want to take a few seconds up front to introduce you to our new CFO, Kristina Cerniglia.

Kristina?.

Thanks, Joe, and hello to everyone. I'm very excited to be joining the Hillenbrand team and look forward to driving the strategy and operational performance of the company. Over the next 90 days, I'll be learning as much as I can about the company, meeting the team and meeting many of the analysts and investors.

Again, I'm excited by the opportunity and look forward to driving the long-term strategy of the company. I'm going to turn the call back to Joe to review the results of the third quarter..

Thanks, Kristina. It's great to have you here.

Let me start off with a quick reminder of our overall strategy, which is pretty straightforward, is to leverage the strong financial foundation of Batesville, acquire good businesses in growing markets and make them better through the application of the Hillenbrand business system, which includes our strategy management process, Lean business practices and intentional talent development.

Over the past several years, we've done a number of acquisitions, and now participate in a variety of large and growing end markets around the world, such as plastics, fertilizers, processed food and energy.

As we stated before, we expect to continue on this path for the foreseeable future and continue the transformation of Hillenbrand into a global diversified industrial company. As you saw in the release last night, consolidated revenue for the quarter increased 2% to $417 million, and adjusted EPS was $0.57.

Revenue growth was a bit lower than we expected, as the burial casket market continued to remain lower on a year-over-year basis and our slower-than-expected start to the year for some projects like Coperion pushed out the related revenue into future quarters.

Operationally, the business is running well, and both gross margins and EBITDA margins were a bit stronger than expected. This is reflected in our adjusted earnings per share number of $0.57, representing nearly 20% growth over the prior year. Overall, we're very pleased with the solid results in the quarter.

Now I'll focus more specifically on segment's performance and start with the Process Equipment Group. As you know, our strategy in this segment is to expand globally, penetrate growing end markets, and expand margins by applying Lean across the board.

Our Process Equipment Group businesses tend to be leaders in their respective market segments, and it's characterized by the ability to solve difficult customer problems through strong technical and applications expertise.

Revenue for the quarter increased $13 million or about 5% over prior year, and while a bit lower than expected, demonstrated nice sequential growth over the second quarter. Orders in the second quarter were solid, as indicated by the slight uptick in backlog on a sequential basis. Our global expansion efforts continue to go well.

Rotex and TerraSource are both leveraging the global footprint of Coperion, primarily to source and warehouse parts, and they're nice seeing quote and booking activities in these new locations.

Coperion and Coperion K-Tron are working well together in North America, where demand in the petrochemical and polyolefin market, driven by the abundance of inexpensive shale gas remains strong. We believe we're continuing to get our fair share of that business. Europe's economy remains sluggish.

However, we've seen some improvements in bookings there, mainly driven by Germany. Unlike most everyone else, we are seeing overall demand slowing in China. However, the slowdown does not appear to be drastic, and we'll continue to believe in the long-term importance of the market. Let me briefly touch on the situation in Russia and the Ukraine.

As I discussed last quarter, we are monitoring the situation from a few different perspectives, including making sure that we are in compliance with all of the latest U.S. and EU sanctions. We're assessing the impact on our large projects in the region, and generally, we're monitoring the impact on regional economies.

Where things currently stand, we expect less than $10 million in revenue from the area in the fourth quarter. We believe these projects remain viable under the current sanctions, but are mindful that the situation is volatile and difficult to predict. We'll continue to keep you informed as the situation continues to unfold.

We're pleased with the margin expansion we're seeing across the Process Equipment Group. You saw the benefits of a better-than-expected mix, as we've been focusing on selling higher value products designed to meet our customers' evolving needs.

Efficiency gains also had a positive impact on the quarter, and we continue to see the benefits of our focus on Lean and other operational initiatives to improve bottom line performance. The outlook for the Process Equipment Group in the fourth quarter is positive.

Our backlog is high, and overall market conditions appear to be slowly improving as indicated by the recent Purchasing Managers Index trend.

And while our ability to close and ship larger orders in the last quarter will influence year-end results, we expect to deliver our largest revenue quarter of the year, representing high-single digit constant currency quarterly revenue growth over the prior year. Let me now turn to the Batesville segment.

Revenue for Batesville was down almost 4% for the quarter on a year-over-year basis. The decline was driven primarily by lower average selling price and to a lesser extent, volume, which we believe was generally in line with the market decline. Despite the lower revenue, Batesville's adjusted gross margins remain solid.

As we look forward, we expect Batesville to deliver a fourth quarter that looks very similar to the fourth quarter of last year from both a top and bottom line perspective. And as a reminder, this is a business that requires a relatively low CapEx investment.

And with the management team focused on working capital, we expect Batesville to continue consistently generating significant cash to support the execution of the Hillenbrand strategy.

I'll close my comments about the Batesville business as I routinely do by reminding you that the longer-term trends for Batesville show that health care continues to improve and people are living longer. The demographics of an aging generation of baby boomers are expected to be a positive factor in the future.

However, it continues to be impossible to predict with any measure of certainty what's in store for North American death rates in the near to medium term. Now I'll turn the call over to Elizabeth Dreyer, our interim CFO, for a bit more financial detail.

Elizabeth?.

Thank you, Joe. As we reported in our filings yesterday, consolidated revenue of $417 million for the third quarter was up 2% year-over-year and was consistent with the prior year on a constant currency basis. The Process Equipment Group delivered 5% growth, which was partially offset by a 4% decrease for Batesville.

Adjusted EBITDA grew 11% to $71 million and our adjusted EPS increased 19% to $0.57. The Process Equipment Group delivered $274 million of revenue in the quarter, representing 5% growth or 2% growth on a constant currency basis. Looking at the businesses that comprise this group, we continue to see growth across the board.

Order backlog reached a new high for the second successive quarter at $731 million, representing a $14 million sequential increase over the second quarter and a $159 million increase over the prior year.

Given our insight into backlog and current exchange rates, we now expect the Process Equipment Group to deliver low-single digit organic constant currency revenue growth for the full year.

As a reminder, we calculate organic constant currency revenue growth as if all acquired companies were owned for the entire year, in both the base year and current year, and then we remove the impact of changes in currency rates.

As discussed on previous earnings calls, we continue to expect the Process Equipment Group to achieve its highest level of revenue in the fourth quarter of this year. Remember that this business is comprised of large systems, equipment, replacement parts, components and service.

Future revenue for this group can be heavily influenced by the timing of order placement. In particular, the timing of when large systems bookings are finalized is very much driven by customer requirements and can shift those forward and backward.

The large projects that were booked towards the end of the quarter positively impacted our third quarter revenue. You may recall that these large projects are accounted for by the percentage of completion accounting method, which requires revenue to be recognized as progress is made on the project. Turning now to Batesville.

Revenue for the quarter was $143 million, down about 4% from the prior year or 3% on a constant currency basis. The decrease was due to lower volume and a lower average selling price. Volume was impacted by the decrease in the number of North American burials, primarily due to the rate at which consumers opted for cremation.

Hillenbrand's consolidated gross margin dollars increased by $16.5 million or $8 million on an adjusted basis to $149 million, representing a record high for us. As a percentage of revenue, adjusted gross margin was 36% or 120 basis points higher than prior year.

Batesville delivered 38% adjusted gross margin, which was 150 basis points below last year, largely due to lower volume and lower average selling prices. We saw significant improvement at the Process Equipment Group, where their adjusted gross margin grew 280 basis points to 34%.

There's been a keen focus by this group on profitability, and a portion of this margin growth can be attributed to those efforts. In addition, the mix of projects from a margin perspective was especially strong this quarter.

For the fourth quarter, we expect adjusted gross margins for this group to be in line with our year-to-date adjusted gross margins. Turning to our tax rate. Our third quarter adjusted effective tax rate was 27.6%, which was lower than last year by 240 basis points, primarily due to current year discrete tax benefits.

For the full year, we expect our adjusted effective tax rate to be about 29%. Operating cash flow was $137 million for the first 3 quarters of the year, an increase of $86 million compared to the same period last year. The increase was due to higher net income and significant improvement in working capital, particularly at Coperion.

During the quarter, we returned over $12 million to Hillenbrand shareholders in a form of quarterly dividends, and we've paid nearly $40 million in dividends year-to-date. Looking at our bottom line results for the quarter, net income increased 147% over the prior year to $33 million, resulting in diluted earnings per share of $0.51.

On an adjusted basis, net income increased 19% to $36 million, resulting in adjusted diluted earnings per share of $0.57. The increase was driven by increased profitability in the Process Equipment Group, which more than offset the impact of lower volume at Batesville.

Adjusted EBITDA is an important measure we use to monitor our ongoing operating performance since it removes the impact of amortization and interest, which naturally results from our acquisition strategy. Adjusted EBITDA increased 11% to $71 million over the third quarter of the prior year.

Adjusted EBITDA as a percentage of revenue increased by 140 basis points to 17%. Our overall adjusted EBITDA percentage is expected to continue to increase over time as the integration of Coperion continues and the results of fully implementing Lean are realized. Turning to guidance. We are affirming our full year 2014 guidance.

We continue to expect revenue of approximately $1.7 billion for the year, and given current exchange rates, we expect about 1% of favorable translation impact to revenue when compared to 2013.

Revenues from the Process Equipment Group is expected to be approximately $1.1 billion, and Batesville is anticipated to deliver approximately $600 million in revenue. Before turning to our EPS guidance, I'd like to provide some detail about how we set our revenue target.

Prior to owning Coperion, we provided relatively narrow guidance ranges, either in terms of dollars or growth rates. As you know, Coperion's business includes large projects, some in the $40-plus million dollars range. The fine-tuning of revenue estimate for the year became more difficult when we added Coperion.

For the past 2 years, we've elected to provide an estimated revenue number versus a range. So for this year, revenue guidance of $1.7 billion indicated an underlying range of approximately $1.65 billion, up to $1.75 billion.

We believe this approach is appropriate, given the volatility that can occur as a result of project wins or losses as well as changes to project timing. Based on our backlog, we expect our Q4 revenue to be our highest quarter of the year and we affirm our original estimate.

To provide further insight into our expectations for the fourth quarter, we now believe our full year revenue will fall into the lower half of the revenue range between $1.65 billion and $1.7 billion. Turning to our EPS guidance, we continue to expect adjusted EPS to be in a range from $2 to $2.10, with Q4 being our largest quarter of the year.

We expect our full year adjusted EPS to approximate the midpoint of our EPS range. Now I'll turn the call back to Joe for his concluding remarks.

Joe?.

Thanks, Elizabeth. As I said earlier, we remain encouraged by our strong backlog, and our gross margin and cash generation were again strong for the quarter. As we look forward to the last quarter of the fiscal year, we believe we're well positioned to deliver our largest quarter of the year in terms of revenue and earnings.

Our management, including our new CFO, is committed to the long-term strategy that is transforming Hillenbrand into a global diversified industrial company, and we remain committed to providing meaningful value to our shareholders. That concludes our prepared remarks. For today's Q&A session, we're joined by Batesville President, Kim Ryan.

We're ready to take your questions.

Shelly, would you please open the lines?.

[Operator Instructions] Our first question comes from the line of John Franzreb from Sidoti & Company..

I guess I wanted to start a little bit with the revenue guide. It was very helpful that you tapped it down. It seemed like it was a bit of a stretch number to hit that high end of that guide. But it also implies that you didn't have a significant margin profile in the process group in the fourth quarter.

Can you talk a little bit about the margin profile and what your expectations are on the continuing of that kind of a margin profile going forward?.

Yes, sure, John. As you mentioned, for the full year, we -- as you saw last quarter, we had sort of a difficult first half of the year, particularly on the Process Equipment Group side, which is a bit lower, well, significantly lower than we expected in the second quarter. The third quarter revenues were nice.

We expect in -- we have good visibility in the fourth quarter, feel good about the fourth quarter. From a margin perspective, you saw that the third quarter margins in the Process Equipment Group were quite strong, both at the gross margin level as well as the EBITDA margin level.

So as we go into the fourth quarter, we expect gross margins to moderate a little bit. We had a strong mix in the third quarter, and so we expect those to sort of settle more into the year-to-date level at the gross margin level.

And then we'll get some operating leverage, and we expect costs and the operating costs -- operating expenses to be in line, and so you'll see that improvement flow through to the bottom line nicely in the fourth quarter. So we do expect a good margin profile and EBITDA margin profile in the fourth quarter for the Process Equipment Group..

Okay.

Now Joe, how should we think about the revenue profile of PEG going forward next year? Is the fourth quarter always going to be the most heavily weighted quarter in revenue? Or was this an anomaly this year?.

No. So we've seen the fourth quarter be the heaviest revenue quarter over the last few years, both in the businesses that we've owned for a few years as well as Coperion's history shows that they have a pretty strong fourth quarter.

That's a combination of the timing of projects, as well as when our fiscal year ends and different parts of the business trying to make their annual goals. So we do expect that the fourth quarter will be our biggest quarter this year. I anticipate we'll have the same kind of profile next year.

And so as part of that, as I think we discussed on the last call, as part of that, you'll see our backlog, we expect our backlog to come down in the fourth quarter because it will be a very big shipping quarter for us this year, and we'd expect the same thing going forward..

Okay. You touched on the backlog. There's some discussion in the commentary about currency.

I was wondering if there's any currency impact, favorable currency impact, on the inventory -- I'm sorry, on the backlog in the quarter?.

Again, let me -- let Elizabeth take that question..

Sure. So if you're looking sequentially, we had about a $14 million sequential increase over Q2. Looking at what the piece of FX for that, we think that was probably 1% to 2%. If you're looking at year-over-year, it was probably more in the 2% to 3% range from an FX standpoint..

Perfect. And one last question on Batesville.

Could you just walk me through what the pricing issue was in the quarter? And do you expect that to continue in coming quarters?.

So in terms of the pricing -- this is Kim.

In terms of the pricing, as you -- there are -- depending on the different programs and promotions we run at any quarter in the year, and depending on the specific customers that we're targeting, certain parts of our line go faster or we see more volume and other some lower parts of our line as opposed to the higher parts of our line.

So that's what we typically see in terms of the average selling price, and that just happened to be a bit lower in quarter 3 based on the promotions we're running.

In quarter 4, where we have our year-end promotions, we typically see us return to a more normal ASP, even slightly ticks up as customers are trying to buy mid and high end of the line before the normal annual price increase goes into effect. So I would expect it would be normal ASP in the fourth quarter.

And as we continue to move through the quarter, that is what we typically see year-over-year..

Kim, just a follow-up, what drives the promotional activity for you in Q3 versus other quarters?.

Well, we plan our promotional activity throughout the year, depending on where we're at and our volume goals.

So in the third quarter, there were certain programs that we are running for a certain segment of customers, and we choose which customers and which products we're going to target, based on inventory levels, based on customers that we are in contact with, all those types of things..

Our next question comes from the line of Daniel Moore from CJS Securities..

Joe, I think you mentioned about $10 million of revenue from Russia and Ukraine in Q4. What is that on a full year basis? And maybe just give us a little bit more color around your exposure and how you're managing the risk in that area..

So that's probably a typical quarter for us, maybe a little bit higher. When we look at Russia, we have a number of projects. So we have -- as we're new in Russia and getting ourselves established in Russia. We have less kind of recurring business and small orders in Russia, as you'd see in North America, in Europe.

And so they tend to be relatively big orders that can move around based on when the customer wants to take them and when mines go into operation, for example.

So it's a little bit hard to predict, but I think the $10 million number, if you look forward, we were probably talking about, on an annual basis, somewhere in that $40 million to $50 million or $30 million to $50 million range in terms of expectations of shipments into that Russia marketplace over the next 4 quarters or so, maybe next -- yes, so in 2015, that's probably a good number to use, $10 million a quarter, a little bit less than that..

Very good, I appreciate it. And obviously, showing pretty good margin improvement on the process equipment side, particularly in maybe a little bit later revenue environment. You've talked in the past about a goal of around 100 basis points of annual EBITDA improvement.

Maybe describe how you're trending towards that goal and how much additional room there is to continue to move margins higher over the next year or 2?.

Sure. We're very pleased with the progress, particularly in EBITDA margins. We're ahead of -- tracking ahead of the 100 basis points on an apples-to-apples comparison for our full year. Expect to continue to end the year above 100 basis points of improvement on the process equipment side of the business.

And just as a note, we've seen nice improvement across all the business lines, and so, it's not just been in one place, and it's been a number of activities. And we've really focused on margin in that part of the business, and we'll continue to do so in 2015.

We expect the same kind of margin expansion in 2015, and we're targeting that 100 basis points of EBITDA margin, again, across the Process Equipment Group as we go forward..

Very good. And just 1 or 2 kind of focus on revenue. Taking a step back a year or 2, initially, I think your goals for the process equipment were close to double-digit organic revenue growth, temper that a bit kind of mid- to high-single digits, running a bit lower than that this year.

What's the biggest surprise and maybe just talk about your outlook, and what we need to see, either in terms of backlog or new projects to get back to that sort of mid-single digit organic growth in '15 and beyond?.

Yes. So I think we expected from a surprise perspective, I don't know if I call it a surprise, but I think we did expect stronger demand in some of the emerging markets than what we're seeing right now.

I mean, we expected Europe to be relatively flat, but for its economy to have picked up by now, if you go back a couple of years, I think everyone expected Europe to accelerate faster than it is now, and it continues to be very sluggish in Europe.

And quite frankly, China slowed more than we had expected, and as you recall, we've got significant expansion efforts going on in China with all of our businesses.

And so I think that's probably been the toughest market in terms of -- compared to expectations, we still believe we're doing quite well in China, but those 2 markets in particular have been slower than we'd expected.

On the flip side, the United States has been a very solid market and has met expectations, and as we've talked about the North American shale gas, the benefit of some of those big projects, we've seen the benefit of some of those larger projects, particularly at the Coperion business.

And so I think, generally, just the macroeconomic environment has been slower than most expected it to be a year or 2 ago..

And just in terms of North America, you've just described, as far as the shale gas projects are concerned, are they coming online at this stage as quickly as you would've expected and in terms of market share over the next 2 to 3 years? Should we see a similar run rate in terms of new projects? Is there more opportunity coming up? Just sort of a second derivative trajectory in terms of the opportunity there..

Right. So if I think about the initial slug of projects, right, we're a good way through those projects, particularly as it relates to the large machinery, the extrusion systems. The majority of those projects have been awarded. We feel like we've gotten our fair share of those.

The material handling portion of those, so the big pneumatic conveying systems tends to come a little bit later, and then the smaller refill systems come a little bit after that. So we see continued benefit from North American shale gas. We'll probably peak from a revenue perspective some time in 2016.

Most of these projects will come online between 2016, '17, '18, '19. And then the second quarter derivative, we expect to sell more equipment into the North American market that's doing engineered plastics and compounding.

And so as the materials, the base resins are made here, demand here is pretty consistent, but we bring a lot of plastics in from the rest of the world. We expect to see more investment in North America on the engineered plastics side of things.

We don't know exactly what that looks like right now, but that's the second order effect that we expect to see come online in the next couple of years, particularly for our compounding machinery and equipment and then the material handling that goes around those machines..

Great color.

Lastly, in terms of capital deployment, just talk about your priorities, what does the acquisition landscape look like? And if you don't find anything over the next year or so, balance sheet, would you look to continue to delever significantly? Are share repurchases an option that you're considering in the sort of short to midterm as well?.

Sure let me start with the stuff that we do on a regular basis. As you know, we pay a dividend and have our typical capital expense that we spend. It's a relatively small percentage of revenue, less than 2% of revenue on an annual basis, so we'll see those continue. We intend to buy shares back to offset dilution.

That's kind of our stated policy or not a policy, but kind of our stated guideline around share buybacks. We did that this year. And if things roll out, we'd expect to do something similar next year as well.

And then so that leaves the bulk of the capital, and we are active in the acquisition market, and in lieu of finding something that really meets our investment criteria and is a good fit for us, we've been paying down debt, and we expect to continue to do so. So we've delevered relatively significantly this year.

But that's really how we're thinking about using our excess capital is we're clearly active in the acquisition market. But if we don't find something, we'd just continue to pay down debt going forward. So I'll answer your question then about the market. I think the market is -- it's an interesting market. There are lots of opportunities out there.

Our pipeline is pretty full, so we're seeing lots of deals. It's a difficult environment right now, given the abundance of inexpensive capital out there. And so we certainly don't want to overpay and very selective about what we want to buy.

And probably right now is a difficult time where sellers want a pretty high multiple, private equity firms are able to go get money pretty inexpensively. And so it's a little bit more difficult for strategic buyers, and we want to be make sure we're prudent and don't overpay for an acquisition.

So we're looking, but that's the kind of environment we're in right now..

Great color. I would simply say that continue to stay disciplined and at 12x next year's cash earnings, your own stock is maybe as attractive as anything you can find out there..

Good advice..

[Operator Instructions] We have no more questions. So I'd now like to turn the call back over to Joe Raver for final comments..

Once again, I just want to say thank you for everyone, who joined the call today, and we look forward to speaking with you again when we review our results for the fourth quarter and the full year, and that call will be in November, and we'll also issue guidance for 2015 in that call. Thanks, everyone, and have a great day..