Altra Industrial Motion Corp (AIMC) 2015 Q3 法說會逐字稿

Greetings, and welcome to the Altra Industrial Motion third-quarter 2015 financial results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. David Calusdian, with Sharon Merrill Associates. Thank you, Mr. Calusdian. You may now begin.

Thank you, Rob. Good morning, everyone, and 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 the 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 the 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 Industrial Motion Corp. 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, non-GAAP gross margin, 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. These reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available on the financial tables of the Q3 2015 financial results press release, and in the Appendix to the third-quarter conference call slide presentation, both of which are on Altra's website.

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

Thank you, David. Please turn to slide 2. On today's call, I will go through a brief overview of our performance during the quarter and the major drivers of that performance, and then I'll provide my usual review of our end markets, and then Christian will go over the financial results, and I'll be back to wrap things up.

Altra again delivered strong results during the third quarter on excellent execution of our cost reduction and restructuring initiatives, combined with raw material cost reductions as a result of lower commodity prices. You will recall that we began to implement profit improvement initiatives at the beginning of 2015. These initiatives had a positive impact in the third quarter, as we weathered continued weakness in several of our key end markets.

We increased our non-GAAP gross profit by 80 basis points year-over-year despite a nearly 10% decline in revenues from the third quarter of 2014. Foreign exchange accounted for 5.7 points of the 9.6% decline, while net of foreign exchange, sales were down 3.9%. Non-GAAP net income was $11.3 million or $0.43 per diluted share compared with $12.2 million or $0.45 last year.

Cash flow from operations was very strong, and free cash flow for the quarter was $28 million, part of which we used to repurchase more than $6 million of Altra stock. We also amended and extended our credit facility during the quarter, which provides us with increased liquidity, additional flexibility, and better pricing. Christian will provide details in a moment.

Now, please turn to slide 3. We realigned our operating segments during the quarter. This changed better lines of businesses across the end markets we serve, which we expect will improve cross-selling and help with facility consolidations.

Now please turn to slide 4. While the global outlook remains mixed, we expect the softness in our agriculture, oil and gas, mining and metals end markets to continue for some time, as many OEMs in these sectors are beginning to implement restructuring and cost reduction programs. In addition, we've started to see weakness in some sectors that previously had not been affected. In the industrial distribution channel, which is predominately made up of sales of aftermarket parts and original equipment parts for small OEMs, revenues were down significantly year-over-year, primarily due to continued erosion and demand for OEMs in our oil and gas and metals markets.

Turf and garden continue to be our leading market. Sales were up sharply from a year ago on a strong domestic housing market and favorable weather conditions. We continue to expect this market to do well, based on solid housing demand forecasts. Agriculture was still quite weak during the quarter and down significantly year-over-year. Low commodity prices and the strong dollar continued to negatively affect US exports. In addition, two strong organic programs we introduced last year are running at lower levels.

Transportation was essentially flat from a year ago and is off slightly year-to-date. Automotive sales continued to be soft as a result of timing issues at a major automotive manufacturer. Marine sales were down slightly, while increased revenues from rail partly offset the decline. In materials handling, sales continued to worsen as expected, and were down substantially from a year ago. Demand in forklifts was essentially unchanged, while elevators were down, primarily on currency translation. Demand for conveyors was weak, due to decline in the export market.

Turning to energy, energy overall was down significantly from a year ago and off modestly on a sequential basis. Year-to-date, oil and gas has performed about as we expected at the start of the year. Alternative energy, led by wind, was up slightly both year-over-year and sequentially. Meanwhile, power generation revenue was down modestly from a year ago.

Demand in the metals market weakened during the quarter and was off substantially from the third quarter a year ago. Slower growth in China, and consequently increased steel exports from China, continued to weigh on this market.

Mining continued to be weak and was down year-over-year. Sales increased slightly from the second quarter, but we view this as an anomaly in the context of the overall downward trend in this market.

Finally, sales in aerospace and defense declined modestly during the quarter compared with the third quarter a year ago. We still expect this market to be essentially flat for the full-year.

In terms of geography, excluding the effect of foreign exchange, North America and Europe were both down from a year ago, while sales in Asia and our other geographies were up nicely. The outlook for the global economy remains mixed, and we still -- we are still cautious on Europe. Meanwhile, the domestic US outlook appears to have softened and the outlook for China remains uncertain.

Now I'll turn the call over to Christian, then close with a discussion of our strategic initiatives and a brief summary. Christian?

Thank you, Carl, and good morning, everyone. Please turn to slide 5. Altra delivered a good quarter despite the topline decline of nearly 10% year-over-year. We delivered expansion of our gross profit margin on a non-GAAP basis and operating income margin, as well as strong free cash flow.

The topline results continue to be negatively impacted by foreign exchange rate headwinds in a very challenging industrial economy around the globe. The 80 basis points increase in the non-GAAP gross profit margin that Carl discussed excludes a $2.1 million warranty expense as a result of a quality issue related to a defective component. That expense resulted in an increase in cost of goods sold. However, we are pursuing multiple avenues to recover these expenses, although there can be no assurance that these efforts will be successful.

Looking at the topline, foreign exchange rates had a negative impact of approximately 570 basis points, driven by continued strength of the US dollar, while price added 80 basis points despite a challenging pricing environment. Volume declined 470 basis points; and net of foreign exchange, sales declined 3.9% year-over-year.

Geographically, excluding the effect of foreign exchange, North American revenues declined 7%, while European revenues were down 3% year-over-year. Sales to Asia-Pacific and other geographies increased 13%. Interest expense was essentially unchanged from the prior year at $2.9 million.

We recorded a tax rate of 21.7% during the quarter. As you can see in the non-GAAP table we provide in our earnings release, we recorded a $900,000 tax benefit related to the foreign tax reorganization we completed during the third quarter last year. Excluding discrete items, we recorded a tax rate of 29.6% during the quarter.

Please turn to slide 6 for a discussion of our segment performance. Beginning with the third quarter, we realigned our three business segments as part of our business simplification efforts. Going forward, our three segments are -- couplings, clutches, and brakes, or CCB; electromagnetic clutches and brakes, or ECB; and gearing, which includes bearings. This new structure is better aligned across Altra's end markets, and will better facilitate the Company's strategic initiatives for growth, procurement, and facility consolidation.

For the third quarter of 2015, the net sales in CCB segment were $85.8 million compared with $100.4 million in the year-ago quarter. The decrease was primarily the result of declines in the agriculture, oil and gas, and mining markets. Segment operating income was $8.9 million versus $13.1 million a year ago.

Net sales in the ECB segment were $50.4 million compared with $49.8 million in the third quarter of last year. This segment performed well as a result of continued strength in turf and garden and elevator sales, as well as low exposure to the oil and gas, and mining end markets. Segment operating income increased $700,000 as a result of the aforementioned items.

Finally, net sales in the gearing segment were $48.8 million compared with $54 million in the year-ago quarter, primarily due to weakness in North American distribution and FX headwinds. As a result, segment operating income declined $400,000.

During the quarter, the average price of the Company's common stock did not exceed the current per-share conversion price of the Company's convertible notes. As a result, the notes were not dilutive to earnings.

Please turn to slide 7. Yesterday, we amended and extended our revolving credit facility, which provides us with increased liquidity and better pricing as we continue to manage all cost areas efficiently for the benefit of our shareholders. We extended the term of the facility by two years to the fourth quarter of 2020, reduced the interest rate by an eighth at our current leverage profile, and increased borrowing capacity under the revolver to $350 million. We also eliminated the associated term loan.

Our balance sheet remains strong. Book equity was almost $250 million, and our cash balance was $49.6 million. Net debt declined by nearly $22 million over the last 12 months.

Please turn to slide 8. The restructuring and cost reduction initiatives we implemented earlier this year contributed to the Company's robust operating and free cash flow performance for the quarter.

For the quarter, Altra generated an impressive free cash flow of $28 million and had a cash conversion rate of 275%. Year-to-date, we generated $44 million of free cash flow, roughly two-thirds of that during the third quarter alone. During the quarter, we repurchased 250,000 shares of Altra stock for a total of $6 million, under our $50 million stock buyback program that expires at the end of 2016.

Since the program's inception last year, we have purchased approximately $31.9 million or 1,090,000 shares. We are active in the market and we continue to repurchase Altra shares from time to time as market conditions warrant. Capital investments during the quarter totaled $5.7 million, and depreciation and amortization was $7.5 million.

Please turn to slide 9 and our full-year guidance for 2015. As we look ahead, we see increased challenges for our industrial businesses. While the FX headwinds are likely to decline, we expect our North American distribution business to weaken, and also expect weaker business investments and CapEx spending in a number of our end markets.

We therefore adjust our forecast and now expect sales in the range of $745 million to $755 million. The Company is also narrowing its non-GAAP diluted EPS guidance to the range of $1.60 to $1.68 for 2015. We now expect the tax rate for the full-year to be approximately 29% to 31% before discrete items. Altra also expects capital expenditures in the range of $24 million to $26 million, and depreciation and amortization in the range of $30 million to $31 million.

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

Thank you, Christian. And please turn to slide 10 for some closing thoughts.

Global economic and market weakness that began last year has continued through the first nine months of 2015. In response, as these conditions persist, we are managing the business to the level of end market demand we are seeing. At the beginning of the year, we announced significant European restructuring and cost reduction initiatives, and those efforts have provided a substantial boost to profit margin despite the overall decline in our sales.

These initiatives include the Bauer profit improvement plan, which really has taken hold as the year has progressed. As a result, Bauer has gained significant traction at the bottom line. In addition, we continue to see nice results from our strategic pricing initiative. However, the pricing environment is extremely challenging, and we expect the contributions from normal annual price increases to be lower.

We continue to make progress on our business simplification plan, which we've designed to make substantial progress towards our goal of a 15% operating margin by the end of 2018. The first three facility consolidations under the plan are well underway, and we expect them to be substantially completed during the first quarter of next year. We plan to initiate a fourth consolidation during the first quarter as well.

We have also started several initiatives related to our supply chain improvement program we announced as part of the plan. It is still very early in that effort, and we expect to provide additional updates when we speak again next year.

We are excited about the bottom line improvement we have achieved this year and we look forward to additional opportunities we have to improve margins under the business simplification plan as we move into 2016. We are executing extremely well in a very challenging end market and global economic environment.

Thanks for your continued support of Altra, and we'll now open the call to your questions. Rob?

(Operator Instructions) Matt Duncan, Stephens.

So I was hoping you could maybe give us a little insight, Carl, into what the order trends are looking like right now. You mentioned that you've got some end markets that are getting softer that you previously had not seen weakening. So what markets are those? And what is the order book looking like?

Yes, I think it's similar to some of the other industrial companies that have been talking publicly. And that through the quarter, through the third quarter, it's softened some. And the good news is that we'll lap some of the bad news at the beginning of 2016. But we did see softening -- some of it seasonal for us -- in the third quarter. But I think the surprise was probably the industrial distribution business kind of weakening a little bit through the quarter.

Okay. Christian, on the gross margin, the adjusted gross margin was obviously very strong this quarter at 31.6%. Is that a number we can use going forward? Or was there something that you benefited from this quarter that maybe you would caution us not to model it quite that high?

I would caution you particularly regarding the fourth quarter to not model it that high. What helped us was material cost reductions. We expect those to continue. We've been working very hard with our suppliers to get benefits of commodity price declines, but we also had some businesses that performed very, very well.

Our aerospace business saw some meaningful margin expansion during the quarter. Our wind business had very good margin expansion. And one of our oil and gas business saw some margin expansion despite a topline decline, as we saw a shift from OEM to spare part. And spare parts are a significantly higher margin, so we benefited from that mix change.

Those -- performance of those businesses I wouldn't expect that they would continue at that same rate. The material cost, we should see continued health. And then the other thing we're not sure is on the pricing whether we continue to get 80 basis points a quarter, as we get into a more and more challenging pricing environment.

Okay. So it's something more similar to the gross margin level that you reported on an actual basis probably about where we ought to be then?

Yes. That plus a little maybe, yes.

Okay, that helps. Then last thing for me just if you could talk about cash priorities, given that you are seeing some additional weakness in your end markets. I assume M&A is probably a little bit difficult right now, but how are you thinking about using cash between M&A, stock repurchases, and debt paydown?

Yes, that's right, Matt. I think a couple of things are impacting the M&A world. But primarily with these big end markets being down and things trending lower, if you are a good company with good margins and don't have to sell, well, why would you sell when things are looking worse? I would wait until things got better.

So we don't expect to have a really robust pipeline right now. Obviously, there will be some private equity firms that may want to exit a business who are -- something is happening that I wouldn't completely rule it out, but it certainly is challenging.

So our priority -- number one priority is to invest in the business. We are going through the consolidations. And as we go through and review the equipment that we are moving, and what we are going to put into the expanded facilities, we may do some upgrades there. Certainly, we do still have some new projects that we are working on. So, tooling and new product development would be a high priority for us. And then returning cash to our shareholders so that they can reinvest it, that's our -- that would be our other priority.

Okay. Thanks, guys. Appreciate the insight, and good job in a tough environment.

Thank you, Matt.

Jeff Hammond, KeyBanc Capital Markets.

So, you talked about softening industrial distribution. What are they telling you about inventory levels and what they are doing in terms of de-stocking if that's occurring, and how long it continues?

Yes, so, for us, Jeff, I think we've done a -- I think, a very good job with lean. And so our on-time delivery performance and lead-times are in pretty good shape. And over the years, since 2009 when they went through a big de-stocking, they haven't built a lot of inventory back on our products.

So, what we are hearing is that they -- there may be some modest declines in inventory, and we also get numbers from some of our larger distributors on the sellthrough of our product and their stocking levels. And it doesn't look like there's been a significant de-stocking on our products. I think there may -- that may not be true across their whole product range, and I think that there probably are some places where they will be trimming some inventories possibly. But I think in our components, we are okay.

Okay. And then with respect --

I was just going to add onto that. There are lots of cases, though, where we aren't seeing demand for aftermarket parts because they are cannibalizing equipment out in the fields. In the oil and gas fields and in the mining industry, they are doing a lot of cannibalization. So, that's one place we are probably seeing a little bit of -- I guess you could call it inventory, but some depletion of components, as they are taking rigs and equipment off-line and using those parts -- those pieces of equipment for parts.

Okay. And then just back to price cost. Can you give us a sense of how much the margin improvement was? You know, was it lower material costs? And then as you think about price into next year, is it just getting difficult from the standpoint of a normal course of business price increase? Or are some of the strategic pricing initiatives also getting more difficult?

Yes. So we've completed the strategic parts initiatives at several of our businesses. And so we are going into round two there. So that will be probably a little lower value as we get into the second step from the first step.

And then some of the businesses we did first had higher opportunities, I guess, related to strategic pricing. So it's getting more difficult but we are also getting better at it. So we still expect to get the 50 basis points a year. We overachieved probably at the beginning, but I believe we'll still get that 50 basis points on strategic pricing.

I think when we look at the normal price increases, annual price increases, that is getting harder. Our OEMs are certainly pushing back in relation to commodity costs are down. But you know there still is an opportunity, and this is a very rational industry. So, I think that there is some opportunity, but it will be less than it has been in prior years on the normal price increase side.

And then just as a follow-up on that, on the cost side, how much of your margin improvement would you attribute to the lower material costs?

About 30 basis points.

Okay. Thanks, guys.

Thanks, Jeff.

John Franzreb, Sidoti & Company.

Can you just walk us through the decision to rebalance the segments again?

Yes. So we had a realignment of our management team, where we now -- previously, we had five division presidents. We'll use that number two and three. And as we were realigning the management team, we realigned the responsibilities of these three presidents. The SEC reporting requirements are such that your segment essentially follows your management structure, which caused them to realign the external reporting segments.

The realignment was driven by better aligning our end markets to these three divisions. The oil and gas, the mining exposure is mainly in the PCB business now. The others have some exposure but the biggest piece is now concentrated in that division.

The other intention was to get the majority of the consolidations inside of these platforms. In other words, if I consolidate -- shut down a plant and I consolidate into another, in the majority of the cases will be inside of one division, which will make the execution much smoother going forward.

That's actually perfect. So that dovetails into my next question. So the restructuring actions you announced last quarter, it sounds like now they are going to be mostly concentrated in CCB. Two things. Is that true? And secondly, are you still on target for that $50 million in savings by 2018? Can you kind of timeline us where you stand on that?

That is true. It's mainly in CCB, although there will be some activity in ECB and in gearing, but on a smaller scale compared to CCB. And we are on track. The first three that we announced, these are smaller ones, will be completed in the first quarter. All these moves will be completed in the first quarter. And we, as Carl mentioned in his prepared remarks, we have made a decision relative to a fourth consolidation, which we will announce internally in the first quarter.

Okay. And one last question. The healthcare costs that were weighing on the profit profile last year, can you bring us up to speed where we are in 2015? How much of a headwind or tailwind that was in the quarter and year-to-date?

Year-to-date about $400,000 savings; $200,000 of that in the third quarter. That's about 4% reduction. But keep in mind that healthcare costs are trending up year-over-year about 8%. So, on a constant dollar basis, so to speak, we are down 12%.

Okay. Thank you for taking my questions. I'll get back in the queue.

Thanks, John.

(Operator Instructions) Bhupender Bohra, Jefferies.

Just a question for Christian. On the pricing, I believe you said like 80 basis points. How much of that is strategic pricing in the quarter?

It's hard for us to tell. I would say that the majority -- vast majority of that is strategic pricing, because right now it is very, very difficult to get what we consider to be normal price increases.

Okay. Okay. Yes, because I think Carl was talking about it's difficult to get normal pricing. So going forward, I think this 80 bps, which is applied to -- I don't know how much is -- that's applied over what percentage of total revenue right now? I think it started with like one-third initially and where we are right now?

So, that 80 basis points relates to the entire sales of $183 million in the quarter. But typically, as we stated in the past, once we -- when we do an analysis at a business unit, typically, we see opportunities for somewhere between 200 and 400 basis points on 60% of the revenues of that business unit.

Okay. And can you give us some updates on Bauer, like where that business is now in terms of margin? You know, I've heard like on other conference calls talking about Europe being stable. As you said, Europe was down, I believe, down 3%, but kind of more stable than actually a year or two years back. So just give us some perspective on that.

Well, in a very good third quarter, the best quarter since we owned that business, which we bought in May of 2011, the operating income came in at 9.5%. Now that is not sustainable. The fourth quarter is going to be lower, given the holidays in December where the business shuts down for almost two weeks.

But year-to-date, they are about 700 basis points, 7% operating income, which is up 200 basis points from the prior year. So, we are very encouraged about the positive trends that are coming out of Bauer. We'll see some modest topline growth at Bauer. That has helped. But the majority of the improvement is coming from cost reductions, the restructuring that the business did early in the year, as well as other cost reduction efforts.

Okay, you said modest topline growth. So are there any end markets where they sell -- do you see some positive end markets like how that topline is growing? Like where are they getting growth from?

Yes, it's really across the board, Bhupender, and some initiatives that they've been working on for quite a while. So, it isn't any one specific end market. It's pretty broad-based.

Okay. And is export to China like Asia a part of that business? Are they -- do they depend or do they do any exports?

Yes -- oh, yes. And we actually have an assembly operation for Bauer in China and that business is actually off this year. There's -- some of that is tied to construction in China and that's off. Some of it is tied to steel. That's off. So some of the end markets in China that they serve are weak.

Because geographically Russia is flat for Bauer; China is down, as Carl mentioned. So we've seen some growth in Europe and some growth in North America for Bauer. And in Europe, we've seen some improvement in countries like Spain and Portugal. We've seen some in Germany as well as in North America.

Okay, got it. Thank you very much.

Thank you. Bhupender.

Jeff Hammond, KeyBanc Capital Markets.

Just a quick follow-up on the restructuring and realignment. Can you just maybe talk about, as you look into 2016, what kind of incremental cost savings you've been able to quantify from the actions you've already taken, or what you think that number is?

Yes, I'll give my opinion first. So, we believe it's going to be relatively small in 2016, Jeff, as we get these facilities moved into the new facility. You have to go through a learning curve and get the productivity back to where it was before you moved it from the other location. So we might see a little benefit in the back half of 2016, but I think it's going to be 2017 before we really see the -- those benefits start to flow through.

The first three, we are targeting cost reductions of $1.6 million. That -- we'll complete these consolidations in the first quarter, but then the receiving end needs to come up to the same productivity levels as the sending end. And that may take a couple or three quarters. We don't know. But past experience shows us they are not going to be producing at the same productivity level out of the gate.

But once we are back at those productivity levels, we're estimating about $1.6 million out of the first three, which are small. The fourth one, which we are going to announce internally in the fourth quarter, is larger. Those benefits we probably won't see until 2016 -- 2017.

All right. Okay and then --

I'll just add that in the most recent review we did, the -- what we had for initial plans and what's been confirmed as we're going through more details, it has confirmed our assumptions on the savings. So we are very confident that we'll be able to achieve those savings.

Okay. And then just from a topline perspective looking into 2016, I think you mentioned some of those commodity-driven markets start -- just starting to be challenged or continuing to be challenged. So just kind of as you peek into 2016, I mean, what's the prospects that you start to see as you see some organic growth?

Yes. We aren't ready to give guidance for 2016 yet, but we do think those markets are going to continue to be challenged. Some of our large customers are just announcing restructuring plans. The rig counts, if you look at -- well, the data we look at says that rig counts are going to continue to decline into mid-2016. And so we think some of those markets are going to continue to be extremely challenged. So our focus is, internally, how do we get these consolidations done as fast as possible, so when things do recover, we are ready to go?

Okay. Thanks, guys.

All right. Thanks, Jeff.

John Franzreb, Sidoti & Company.

Yes, I guess my first question is with distribution being what you are most surprised about, at least in the near-term, should we be rethinking the margin profile with that business being off, call it, surprisingly so? Or do you think it will stabilize and from this point going forward?

I don't think so, John. I think there is some upside in the aftermarket parts of the business. We've got -- as people run out of machines to cannibalize in some of our big end markets, we'll get some more aftermarket parts. One of the reasons that the rest of the world was up for us was a big aftermarket parts order we got for Chile. And so, I don't think we'll see a significant impact on the margin profile of the business. And I think, overall, the aftermarket parts will help offset some of that.

Okay, that's comforting. And in your slide presentation, you mentioned that the SAP is going to have a next phase in the second half of 2016. What is that next phase? And is there any incremental costs associated with it?

There's going to be some incremental costs associated with it, but they're not going to -- they are going to be significantly below what we've done in the past. What is left to do is -- we acquired Svendborg, for instance. At some point, we need to convert Svendborg over to SAP. We've got three more locations in North America that we need to convert. And we want to bring the Bauer SAP instance and the Altra SAP instance, which is a smaller project.

So significantly lower run rate than what we had in the past. In the past, we said $1 million a quarter. I think these will be small enough that we probably might not even call them out.

Okay. Thank you very much, guys.

Thanks, John.

Thank you. Mr. Christensen, there are no further questions at this time. Would you like to make any closing remarks?

Yes, thank you, Rob. And thanks to everyone for joining us this morning. We look forward to speaking with many of you at the Stephens Conference in New York on November 10 and/or the Baird Conference in Chicago on November 11. I hope you have a wonderful weekend. Thanks for joining us.

This concludes today's teleconference. Thank you for your participation. You may now disconnect your lines at this time.