Altra Industrial Motion Corp (AIMC) 2014 Q4 法說會逐字稿

Greetings, ladies and gentlemen and welcome to the Altra Industrial Motion Corp. fourth quarter 2014 financial results conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.

(Operator Instructions)

This conference is being recorded. I would now like to turn the conference over to your host, Mr. Andrew Blazier of Sharon Merrill. Thank you, sir, you may begin.

Thank you, Jen. Welcome to the call. With me today are Chief Executive Officer, Carl Christenson; and Chief Financial Officer, Christian Storch. To help you follow management's discussion on this call, they will be referencing slides that are posted to the altramotion.com website under events and presentations in the investor relations section. Please turn to slide 1.

During the call, management will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are inherently uncertain and investors must recognize that events could differ significantly from management's expectations. Please refer to the risks, uncertainties and other factors described in the Company's quarterly reports on form 10-Q and annual report on form 10-K and in the Company's other filings with the US Securities and Exchange Commission.

Except as required by applicable law, Altra does not intend to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. On today's call, management will refer to non-GAAP diluted earnings per share, non-GAAP income from operations, non-GAAP net income and non-GAAP free cash flow.

These metrics exclude certain items discussed in our slide presentation and in our press release under the heading discussion of non-GAAP financial measures and any other items that management believes should be excluded when reviewing continuing operations. The reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available on the financial tables of the Q4 2014 financial results press release on Altra's website.

I will now turn the call over to Altra's CEO, Carl Christenson.

Thank you, Andrew. Please turn to slide 2. Our progress on executing on our acquisition and organic growth strategies, as well as implementing profit improvement initiatives, contributed to our solid performance in 2014 amid a mixed end-market environment and a weakening global economy. We finished 2014 strongly as our fourth quarter performance exceeded our expectations on a number of fronts. Revenues increased 6.3% from the fourth quarter of 2013 to $192 million.

Net of acquisitions, net sales were $164.8 million in Q4 2014. We continued to see gross margin expansion primarily as a result of our strategic pricing initiative. Total pricing added 120 basis points to our top line for the quarter. Operating income also increased from the prior year quarter. The change we made in our tax structure in the third quarter delivered significant improvement on our tax rate, and we increased non-GAAP earnings 10.9% year over year to $11.2 million, or $0.42 per share.

These were significant achievements in the face of a challenging global economic environment and sluggishness in several of our most significant end markets. As we discussed on previous calls, a significant increase in medical claims resulted in higher expenses. In the fourth quarter, these medical claims costs continued, but to a slightly lesser extent. We made planned design changes effective January 1st, that we believe will help to mitigate such higher cost claims in the future.

Please turn to slide 3. As I mentioned, we saw more prevalent weakness toward the end of the year in several of our significant end markets as well as in international geographies, and the global industrial forecast for 2015 suggests a continuation of this trend. I will go through an overview of our end markets now. I'll then turn the call to Christian for his financial review and we'll follow up after that with our plans to address this new environment.

Let's begin with our distribution channel, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. In the fourth quarter, distribution revenues were essentially unchanged year over year, as sales to the aftermarket were offset by a slight decline among OEMs. In turf and garden, where we have a significant share of the market, sales were basically flat from the fourth quarter of 2013. This market is expected to grow in the low- to mid-single digits in 2015 on improved housing starts and an expected increase in US disposable income as a result of lower commodities and fuel prices.

The weakness we've seen in the ag market deteriorated further in the fourth quarter. Just as lower commodities have boosted consumer demand, they've reduced investments in new commercial agricultural equipment. We expect this trend to continue in 2015. We're working on a few new product programs, but these are still not far enough along to offset the market decline.

Transportation was up modestly in the quarter, led by stronger automotive sales. We expect this market to be flat to up slightly in 2015 as a result of general economic growth and greater disposable consumer income. The materials handling market was down from the fourth quarter of 2013, primarily on a decline in demand for elevators in the developing world. However, we expect this market to flatten out in 2015.

Looking at our late-cycle markets, we'll begin with energy. Not quite three months ago, we were talking about the possibility of oil breaking $80 a barrel and what that might mean for demand among oil producers. Since then, the price of crude has dropped below $50 a barrel and now is hovering just above that mark. This has had a significant effect on demand for our oil and gas related products. Drilling rig counts have already declined, small operators are ceasing operations, and OEMs are delaying or cancelling orders.

We began to feel the impact of these events in the fourth quarter, and we now project Altra's revenue from oil and gas will be down by approximately 25% in 2015. That's our best estimate currently, but our visibility into the second half of the year is not clear, so there is an opportunity for improvement in our forecast should oil prices rebound later in the year. Alternative energy, on the other hand, performed well during the quarter, driven by demand in the wind market, primarily in Asia.

Power generation revenue was essentially unchanged from the fourth quarter of 2013. We expect alternative energy will perform well in 2015, particularly in China. In the metals market, sales were down somewhat from a year ago. However, we expect this market to be up slightly in the low single digits in 2015.

One caveat in metals, demand for some of our products in this market is tied to pipe use in oil fields and it remains unclear what impact, if any, reduced drilling will have on steel and when that impact could flow through to our product demand.

Mining continued to be weak and was down year over year, although flat sequentially. We have seen an increase in the number of proposal requests in this market during the past two quarters and we expect sales to be essentially unchanged in 2015 from 2014.

Sales in aerospace and defense were up strongly in the fourth quarter from a year ago, as we eliminated a bottleneck that occurred during the third quarter. We expect 2015 to be largely unchanged from 2014, as our sales in this market stem more from demand in defense than in commercial aerospace.

In terms of geography, excluding the effect of recent acquisitions, North America was down slightly from a year ago, while sales in Europe and Asia were down more substantially. The outlook for the global economy has softened with deteriorating conditions in Europe and Russia, but relative strength in North America.

With that I will hand the call over to Christian, then close with a discussion of our outlook for 2015 and strategic actions we are implementing to confront the shifting global economic landscape. Christian?

Thank you, Carl and good afternoon, everyone. Please turn to slide 4. Overall, we had a better 2014 than 2013, with record full-year non-GAAP earnings per share of $1.83, an increase of 11.6% over the prior year. Highlights for the quarter are looking at the top line, excluding acquisitions; foreign exchange had a negative impact of approximately 270 basis points driven by the recent strength in the US dollar.

Price added 120 basis points, as we continue to benefit from our strategic pricing initiatives. Volume declined 500 basis points, as a result of the slowdown in oil and gas, ag, and to some extent, in mining. Therefore, sales declined to 6.5% year over year when impact of acquisitions is excluded.

Geographically, excluding acquisitions, North American revenues declined 1.2% year over year. European revenues decreased by 14.8%. Half of this impact is due to foreign exchange rates. The balance was driven by declines in end markets such as elevators and oil and gas. Sales to the Asia-Pacific region declined by 16.8% or 13.2% without the impact of foreign exchange.

Interest expense was $3 million, up $200,000 from the prior year due to the financing costs related to the Svendborg acquisition. During the quarter, the average price of the Company's common stock exceeded $26.71, which represents the current per share conversion price of the Company's convertible notes. This resulted in additional 300,000 shares being included in the diluted earnings per share calculation, causing less than 1% reduction in diluted net income per share. This was largely offset by our repurchase of 162,500 shares in the quarter.

We recorded a tax rate of 31.1% during the quarter compared with a tax rate of 34.1% in the fourth quarter of 2013. The foreign subsidiary reorganization we made during the third quarter had a direct impact on our lower tax rate for the fourth quarter. We expect this effect to continue going forward.

Please turn to slide 5. To enhance the information Altra provides to its investors, beginning with the fourth quarter of 2014, we are reporting our results of operations in three segments: clutches and brakes; couplings; and gearing and other power transmission components. I'll now provide a brief review of each segment's performance during the quarter.

For the fourth quarter of 2014, net sales in clutches and brakes were $101.4 million, an increase of 15.8% from the year-ago quarter. The increase was primarily the result of growth from the Svendborg acquisition, which was partially offset by the declines in the agricultural, oil and gas, and mining markets. Segment operating income grew by $1.9 million due to the addition of Svendborg, partially offset by the negative end-market trends. Svendborg's profitability profile also enhanced segment performance.

Net sales in the coupling segment were $33.3 million, an increase of 13.3% from the year-ago quarter. The increase was primarily due to the growth from the Guardian acquisition, gas turbine machinery, and for the oil and gas and power generation markets, and projects related to steel mill repairs in the metals market. These factors were partially offset by economic weakness in Brazil. Segment reporting income increased $400,000. Segment performance continues to be negatively impacted by the start-up cost of our couplings facility in China.

Net sales in gearing and power transmission components were $58.3 million, compared with $64.7 million in the year-ago quarter. It's important to note that this segment has a significant European exposure, including exposure to Russia through the Bauer brand. Therefore, the decline was primarily the result of unfavorable foreign exchange translation, economic weakness in Europe, and headwinds in Russia. Additionally, a large one-time transit project in the fourth quarter of 2013 did not repeat in 2014. Segment operating income, as a result, declined $2 million.

Slide 6 is a reconciliation of our non-GAAP measures.

Please turn to slide 7. Our balance sheet remains strong. Book equity was $259 million, and our cash balance was $48 million. During the quarter, we repurchased 162,500 shares of Altra stock, for a total of $4.8 million under our $50 million stock buyback program that expires at the end of 2016. For the year, we repurchased 545,000 shares totaling $17.6 million. We are actively in the market and will continue to repurchase Altra shares from time to time as market conditions warrant it.

Slide 8 reviews our working capital performance. Svendborg was a significant contributor to our improving inventory levels, as the business reduced its inventory levels by EUR5 million throughout 2014. Our working capital improvement efforts continue to contribute to the Company's strong operating and free cash flow performance. For the year, Altra generated free cash flow of $56 million, which was 140% of our net income. Capital investments during the quarter totaled $11.6 million and depreciation and amortization was $8 million, in line with our expectations.

Please turn to slide 9 and our guidance for 2015. In 2015, we face sizeable headwinds from foreign currency translation, weakness in Europe and Russia, and challenging dynamics in our oil and gas, agriculture, and mining end markets. As a result of these headwinds, Altra is currently forecasting sales in the range of $765 million to $800 million and non-GAAP diluted EPS in the range of $1.65 to $1.85. The Company expects its tax rate for the full year to be approximately 30% to 32% before discrete items. We also expect capital expenditures in the range of $24 million to $26 million and depreciation and amortization in the range of $30 million to $32 million.

Please turn to slide 10. The midpoint of our guidance range assumes the following: a negative year-over-year impact from foreign exchange of $40 million on revenues and $0.10 on adjusted EPS. We are using January month end spot rates and are comparing that to the average rates in 2014. The major currencies are the Euro, the British pound, and the Danish krone. A revenue decline of $17 million, assuming oil prices continue at current levels, which reflects a market decline of approximately 25%. This will have an estimated negative impact on EPS of $0.17 a share. Our guidance assumes weak demand in ag and mining, continued weakness in parts of Europe and Russia.

We're also planning on start-up costs in Brazil for Svendborg brake assembly operation of approximately $1.5 million as we continue to invest in our business. These effects are partially offset by the elimination of SAP implementation costs of $2.5 million when compared to the prior year and the positive contribution of our strategic pricing initiative. While we are facing a challenging 2015, we're driving cost management actions throughout the organization.

With that, I will turn the discussion back to Carl.

Thank you, Christian. Please turn to slide 11. I would like to add some detail to the challenges we are seeing in the global economy and specific end markets and the actions we are taking to counteract the adverse impact we're experiencing on our financial performance.

First and foremost is energy. As both Christian and I have discussed, the more than 35% decline in the price of oil, since our previous earnings call, is impacting both large and small energy companies, and that directly translates to reduced demand for our products in the oil and gas market.

Second is foreign exchange. While the growing strength of the US dollar is good for domestic consumption, it has a negative effect on revenues for companies with an international presence. For Altra, that exposure is primarily in Europe, owing largely to our Bauer and Svendborg operations.

Third is the agriculture market. The deep decline in commodity prices, coupled with the recent significant investments in equipment have left farmers with less cash to invest. This dynamic has precipitated the softening we experienced in the second half of 2014, and we expect this to continue into 2015.

And finally, Russia; our exposure in Russia is less significant than the effect of the other factors. Still, the deterioration of that economy has weighed on our performance and we do not expect that to change in 2015.

To offset these challenges to organic growth, Altra is focusing on a number of substantive initiatives to reduce expenses. I won't list all of them now, but they include facility consolidations, discretionary expense reduction, supplier cost negotiations and other actions to bring SG&A expense in line with expected decline in revenues. We're also looking to rationalize our product offerings, which would reduce the number of line items we produce. We're evaluating and prioritizing these potential actions and expect that the results of some of these actions will gradually contribute to our performance as we proceed through 2015.

Obviously, some of the actions are long-term in nature and will have a permanent impact on our cost structure in 2016 and beyond. In terms of M&A, our balance sheet is solid, and we continue to pursue strategic acquisitions, with the emphasis on strategic in this market.

In summary, I want to thank our employees for their diligent work, which has produced solid results for Altra. Even in the current environment, our consistent execution on our profit improvement initiatives has driven robust cash generation, which enabled Altra to return more than $32 million to shareholders through quarterly dividends and our stock repurchase program in 2014. Thank you for your continued support of Altra and we will now open the call to your questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Jeff Hammond with KeyBanc. Please proceed with your question.

Hey, good afternoon, guys.

Good afternoon.

Hey, Jeff.

Good color on 2015. Just a couple of follow-ups on the internal initiatives. Can you quantify how you're thinking about Europe restructuring in 2015 and strategic pricing, and then also the abatement of some of these one-time health care and supply chain costs?

We are not going to quantify the restructuring yet, but the strategic pricing, we still plan to have that contribute 50 basis points. And then the health care issue, we have seen a decline in the fourth quarter, compared to the third quarter, and we've seen a further decline in January, a rather significant decline. While it's not a trend yet, we think that the plan changes we made will have a significant benefit, but again, Jeff, we can't quantify that yet in that kind of detail.

The strategic initiatives that we have previously talked about, like SAP implementation cost, strategic pricing and so forth, will have a positive impact next year of somewhere between $0.15 to $0.18 a share, is what we're forecasting at the midpoint of the range. Which then will be offset by the FX and the oil and gas and the softness or weakness in Russia and the start-up costs in Brazil. It kind of reconciles, I think, our 2014 performance to the midpoint of our guidance.

Okay, but just to be clear, the midpoint of the guidance, does that consider that these one-time health care and supply chain costs abate?

The midpoint of the guidance assumes that the health care costs are flat year over year.

Okay. Okay, and then good color on the segment data. Can you go through rationale for breaking it out, and then structurally, where you think the margins can go on a segment basis? In particular, focus on the gearing piece within that, given the lower margin rate?

Yes, so essentially, the rationale behind the segmentation is that, essentially, what we make, we make clutches and brakes, gearing and couplings. So we thought that was a logical way to provide more color on our results. If we look at the lowest-performing business, which is gearing, Bauer, with its European exposure, with its Russia exposure is inside of that, is dragging down the performance of that segment. That's the biggest, I think, contributor to our performance levels.

If you look at the couplings group, the China start-up costs are weighing on that segment's performance, probably magnitude about 150 basis-points drag on that segment's performance.

And then inside of the remaining segment, the clutches and brakes, here we've got some of the heavy-hitters in terms of mining and some of our very profitable pieces. It's a larger segment by far. And that is how we look at the operating income performance of these segments.

Okay, thanks, guys.

Thank you.

Thanks, Jeff.

Our next question comes from the line of Mark Duncan with Stephens Inc. Please proceed with your question.

Hey, guys, it's Matt.

Hey, Matt.

The first thing, Carl, can you maybe walk us through the sales trends and order intake trends that you're seeing in the business? I know you said you saw things start to weaken, especially from the energy patch there, later as the fourth quarter went on. It might be helpful to give us some idea what the trajectory is looking like so we can marry that up with what is going on with rig count to try and see how to forecast where the bottom is for you guys. How much do you think you might lag that data point by?

It's difficult to break it out because there's such an impact from the foreign exchange, also, in the incoming orders. So some of this is not real detailed science, but we definitely saw a trend, even going into this quarter, of customers, and some of our customers' customers, cancelling orders, and really shutting down operations in some cases, and that's disturbing to see that happen. That's why we're projecting that it's going to be a significant decline for the rest of the year.

I think, as you said, the beginning of the fourth quarter, actually, we didn't see much decline and rig counts were still pretty good. Probably the end of November is when we really started to see a decline start to occur and started to hear from our customers that they were thinking about pushing out orders and maybe even cancelling some orders. And then into December and January, we saw that materialize. We haven't seen it accelerate, lately, so it seems that it's about at the level where -- I don't know that it's going to hold there, but it seems like it's at a relatively flat level.

On the good news side, the declines, the cancellations and the push-outs have been primarily on the original equipment side, and the aftermarket piece is still very strong. It's still very good, and we just completed an analysis of the incoming orders on that aftermarket piece, and there's been very little decline since September, October of last year till now. There may be a lag there, but I think what we read and what we see is that the production still remains out there and that there still is very good production levels, but that the exploratory and new drilling is where the slowdown's occurring.

Okay.

Maybe some additional color from a currency perspective. The average euro rate in the fourth quarter was $1.25. So, it's going to get worse from here, should the Euro remain at $1.12, $1.13.

Last year, first quarter, the P&L rate was $1.37, so we have major headwinds in the first and second quarter, assuming exchange rates stay where they currently are, in respect to the euros, and to some extent, in respect to the British pounds. And the krone is really tied to the euro, so it's going to run in tandem.

Okay.

And then, it's going to get a little bit better in third quarter, and then fourth quarter, the comparison will be better, but significant FX headwinds in the first and second quarter.

Okay, that helps. Christian, while we're on this topic, on guidance, in terms of gross margin -- so you guys are still expecting a 50 basis-point benefit from strategic pricing, but obviously there's other puts and takes in that gross margin line.

How should we think about the gross margin on a year-over-year basis? Can it still be up? Is this strategic pricing more of a benefit? Is there some mixed benefits that might help in that line? Help us think through how that's going to consolidate.

We're projecting that we still see an improvement in our gross profit margins. Where our challenge will be next year is to manage our SG&A. A portion of SG&A is fixed, so some of the things that Carl talked about, as we focus on managing the cost side, will be focused on reducing SG&A spend, and we'll probably see an increase in SG&A as a percentage of sales, despite all these efforts. But, we will work as hard as we can to reduce our SG&A expense.

So earnings at the midpoint, then, I guess you must be using still about a 50% basis point increase in gross margin?

Yes.

To get to the midpoint, then?

Yes.

Okay. That helps.

Let me throw in the caveat, Matt, that the oil and gas is -- if you look at the numbers that Christian gave you -- is a very profitable segment for us or very profitable market for us. So if that gets worse, then we might slip on gross margin. If it doesn't get as bad, then our gross margin may get even better, but we have got some really good programs that we're working on to try to maintain and improve those margins.

Okay, and the last thing for me, back on the health care theme, to pile on what Jeff was asking here. If you were to continue to run at the rate you saw in January, how much of a year-over-year benefit would that be from an expense perspective? Because it sounds like it's running lower. The action that you took on January 1, that may be helping and continue to help, but the guidance has got flat health care costs. If we see the benefit continue, how helpful would that be?

The benefit in January was about $100,000, so if you would assume it's $100,000 a month, it would be $1.2 million.

Okay.

But you know, one month doesn't make a trend.

Of course, of course.

We are very careful.

Can you re-ask that question after the first quarter and see if we have a trend going or not?

Yes, hopefully we will, right?

The fourth quarter was sequentially better than the third quarter. The fourth quarter was better than the third quarter, slightly.

Right.

But we don't want to call it a trend yet.

Okay. All right, guys. Thanks for the color.

Thanks, Matt.

Thank you.

(Operator Instructions)

Our next question come from the line of Bhupender Bohra with Jefferies & Company.

Hey, good afternoon, guys.

Hey, Bhupender.

A question about the geographic -- I believe Christian actually gave the geographic growth rates, here, for North America, Europe, and Asia-Pac. Can you give us more color? You mentioned, I believe, North America declined modestly, Europe and Asia-Pac declined substantially. I wanted to get some more color which end markets actually were impacted in Europe and Asia-Pac?

So in North America it was -- we have ag, was a significant piece of that, oil and gas towards the end of the quarter was a significant piece of that. And in Europe and Asia, some of it is exchange rate, particularly in Europe.

Then, in Asia, it's mining. So if you look at -- we include Australia in our Asia market and that is down significantly compared to prior year. So, it would be primarily mining.

And then there was some decline in our material handling, I think the construction slowdown in China and the fewer elevators being installed has had a little bit of an impact there. We put elevators into material handling.

Okay.

As Carl said, the decline in mining in Australia had the most significant impact on Asia, rest of the world. That was the primary driver.

Okay. And one more question on the -- Carl, you mentioned about M&A. You stressed the word, strategic acquisition. If you can expand on that with where you look at net debt to EBITDA ratio, a pretty good balance sheet here.

And I don't know, what's the reason behind disclosing three segments now? Is that becoming more transparent in terms of which of those three businesses you want to expand, and any color on that? I'm just trying to link the M&A factor, here, with the disclosure of three segments here.

There's really no linkage between them, but the M&A focusing on strategic, my emphasis on strategic acquisitions is really we are well-positioned to make acquisitions, however, the market is pretty tough right now. The pricing is very high, and we don't want to overpay for deals.

There's only one thing worse than not doing a deal and that's doing a bad deal. We want to make sure that we are disciplined in the transactions that we try to execute on. And I don't know, Christian, if you want to talk about the segmentation at all, but they're not linked, Bhupender.

No, they're not linked. Essentially, we want to communicate performance in these three segments: clutches and brakes, couplings, and gearing. I think it will help, also, our investor base to understand where the profit improvement needs to take place, essentially, which is in gearing related to things we've talked about in the past. And it's our start-up costs in China, and all that, as we tackle all these things, should help to improve segment performance of those two segments.

Thanks a lot, guys.

Okay, thank you.

Thank you. Ladies and gentlemen, I would now like to turn the call back to Carl Christenson for closing comments.

Okay, I would like to thank everybody for joining us this afternoon. We look forward to speaking with some of you at our annual meeting in April. Thank you, and enjoy your evening.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.