Altra Industrial Motion Corp (AIMC) 2016 Q2 法說會逐字稿

Greetings and welcome to the Altra Industrial Motion's second-quarter 2016 financial results conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Calusdian of Sharon Merrill. Thank you, sir. You may begin.

Thank you, Christine. 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 discussion on this call, they will be referencing slides that are posted to the altramotion.com webcast under Events & 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 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 were 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 Q2 2016 financial results press release on Altra's website.

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

Thank you, David. Please turn to slide 2. Our second-quarter results are in line with our expectations, and we continue to have confidence in our guidance for the full year of 2016. We are executing well on our actions to enhance Altra's long-term operating performance (inaudible) as a soft economic environment persists in many of our end markets.

In fact, the results of our efforts are already having a positive effect on our P&L. Our consolidation, supply chain, and operational excellence initiatives drove a 140-basis-point improvement in gross profit margin from the second quarter of last year to 31.9%. This came even as sales declined 7%.

We continue to generate strong cash flow, which enabled us to repurchase $2.2 million of Altra's shares and repay over $23 million of debt. While we were quite pleased with our operational execution, the downside of the quarter is that we are not seeing the beginnings of the turnaround that we had hoped for in some of our most challenged end markets.

In the near term, we don't see any catalysts that will change the industrial economy. Our team is doing a great job in controlling what we can control and making Altra a stronger company. Longer-term, we expect to see the very strong operating leverage when these out of favor end markets return.

With that as an overview, please turn to slide 3 and I will get into more detail about the conditions in our end markets.

We will begin our market discussion with distribution, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. Distribution was flat year over year, and we do not expect to see any significant improvement in this channel in the second half of the year.

In turf and garden, after a strong start to the year, we began to see some softening as the selling season ended earlier than last year, due to weather conditions. We expect the remainder of the year to mirror our performance in 2015.

In the agriculture market, low commodity prices and fewer incentives continue to result in soft ag equipment purchases. Sales were down year over year as well as sequentially.

Transportation, which tends to be lumpy as a result of order timing, was down year over year and sequentially. Rail and marine were weak with automotive up compared to a year ago. Materials handling was down a single digits year over year with continued strength in forklifts, offset by weak conveyor sales. The strength in the US dollar and the weak mining market continued to impact conveyor sales. Elevator sales were flat, and sales were up sequentially with strength in all three segments of the material handling market.

Turning to energy, energy was -- energy overall was down from a year ago, reflecting a significantly weaker oil and gas market. Power generation was down as well, although we expect this market to be relatively flat in the second half. Renewables continue to be very strong across-the-board geographically with increased sales in Europe, North America and China. As we have said previously, we are capitalizing on the demand in this area with aggressive new product development efforts out of our Svendborg wind business.

Sequentially, energy was up driven by increased power generation and renewable sales with a single digit decrease in oil and gas.

The metals market continues to be weak with a significant drop from the year ago quarter as overcapacity in China and global pricing continued to affect this market. US tariffs on Chinese steel were approved in May, but we do not expect this to affect our sales positively until next year. We continue to expect demand for aftermarket parts to remain relatively stable.

Mining sales continued to be challenged with double-digit declines both year over year and sequentially. We do not expect a near-term improvement in this market due to the economic slowdown in China and the emphasis on reducing coal consumption.

Finally, aerospace and defense was up for the quarter, primarily as a result of order timing. Overall, commercial sales are strong with weakness continuing on the defense side of the business.

And now I will turn the call over to Christian and then close with a discussion of our strategic initiatives. Christian?

Thank you, Carl, and good morning, everyone. Please turn to slide 4.

As Carl mentioned, at the outset, we are performing well operationally in a very difficult economic environment as evidenced by our 140 basis points improvement in gross margin against a 7% sales decline. Our operational excellence and consolidation initiatives are proving to be very effective, and we are looking forward to further operating improvements as a result.

For the second quarter of 2016, GAAP diluted EPS was $0.36 a share versus $0.37 a year ago, and non-GAAP diluted EPS was $0.42 a share versus $0.43 a year ago.

Looking at the top line, foreign exchange rates had a negative impact of approximately 100 basis points, driven by continued strength in the US dollar. Volume declined 6.8%, while our strategic pricing initiative added 70 basis points.

Net of foreign exchange, sales declined 6% year over year. Geographically, excluding the effect of foreign exchange, Northern American revenues declined 12% year over year, driven mainly by very weak oil and gas, metals and mining markets. European revenues were up 5%, mainly driven by the wind energy markets. Sales to Asia-Pacific and other geographies were down 5%.

During the quarter, the average price of the Company's common stock did exceed the current per share conversion price of our convertible notes. As a result, the notes were dilutive to earnings by approximately $0.05.

We reported a tax rate of 30.6% during the quarter, which was down from 31.2% a year ago.

Please turn to slide 5 for a discussion of segment performance. Please note that segment results are not adjusted for one-time items.

For the second-quarter 2016, net sales in couplings, clutches and brakes were $78.2 million, down 13% when compared with $90.4 million in the year ago quarter. (inaudible) Altra's highest exposure to oil and gas, metals and mining. Segment operating income was $7.6 million, down from $10.8 million a year ago.

Net sales in our electromagnetic clutches and break segment were $57.1 million, down slightly from the prior year. This segment is benefiting from Altra's facility consolidation and procurement efforts. As a result, segment operating income increased 14% to $7.1 million or 12.4% of segment sales.

Finally, net sales in the gearing segment were $49.1 million, compared with $49.6 million in the year ago quarter. Segment operating income was down slightly to $5.9 million from $6.1 million a year ago, despite continuing operating improvements at our ball business.

Please turn to slide 6. Our balance sheet remains strong. Book equity was $250 million, and our cash balance was $34.3 million. Cash flow has been good this year. As the result of our strong cash flow, we have been able to pay down $29 million in debt since the beginning of the year.

During the quarter, we repurchased more than 80,000 shares of Altra stock for a total of $2.2 million and our 50 million stock buyback program that expires at the end of 2016.

Since the program's inception, we have repurchased approximately $39.3 million of our 1.4 million shares. Capital investments totaled $5.2 million for the quarter, well below our depreciation and amortization for the quarter of $7.5 million.

Before I turn to guidance, I would like to make a quick note about Brexit, and that is -- since that is on everybody's mind. Last year, our sales for UK-based entities were approximately $60 million. Based on the significant uncertainty around the timing in terms of the Brexit, it is much too early to speculate how those sales and our profit will be affected.

Please turn to slide 7 and our guidance for 2016. We continue to expect sales in the range of $700 million to $720 million, and we expect GAAP diluted EPS in the range of $1.20 to $1.30, and non-GAAP diluted EPS in the range of $1.40 to $1.50. We expect the tax rate for the full year to be approximately 29% to 31%, and we also expect capital expenditures to be in the range of $20 million to $24 million and depreciation and amortization in the range of $30 million to $32 million.

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

Thank you, Christian. Now please turn to slide 8. I would like to provide you with an update on our business simplification plan. The first component of our plan is the facility consolidation initiative, and on our last call, we discussed five consolidations that have already been completed. We are working on completing one closure in Q3 and one in Q4. With those completed, we will have consolidated seven facilities and taken out 265,000 square feet of manufacturing space without losing any capacity. These seven closures represent about $5 million of annualized savings out of the total $7 million we expect from our consolidation plan. We will be evaluating three or four additional closures next year and, as we have mentioned previously, these future closures will require that we expand a receiving facility.

A second key to the business simplification plan is our development of a world-class procurement organization. The foundation of this initiative is the use of our new SAP system to be able to analyze data throughout the supply chain.

We continue to make progress on this initiative during the quarter and have realized year-to-date savings of $3.5 million. As Christian mentioned earlier, our European restructuring and cost reduction efforts are coming along very well, and the results are quite evident in our P&L. Bauer's operating margin improvement to 8% has been a tangible example of the success of this effort.

As I mentioned, we had been hopeful to see the beginning of a recovery in the back half of this year. Based on what we are hearing from customers and from other companies in the general industrial economy, we do not expect this to be the case. At the same time, given that we are past the anniversary of when several of our end markets begin to weaken, our year-over-year comparison should be easier as we go forward.

When our most out-of-favor markets do return, we have proved our significant potential for margin appreciation as a result of our aggressive performance improvement actions. Our team has been executing well, and we expect further operational success in the back half of the year.

Thank you for your continued support of Altra, and we will now open up the call to your questions.

(Operator Instructions) Matt Duncan, Stephens.

Carl, can you just start by talking about just general business trends you are seeing, sort of sequential sales and order trends in the business through the quarter into July?

Yes. It has been -- it continues to be very choppy, and there is lot of uncertainty out there. But it does seem to be relatively flat. So we didn't see any particular market have a significant improving trend through the quarter or any particular market having a declining trend through the quarter. It is just kind of flat. That is why we continue to be focused internally and get these activities done while we can.

So I guess just to summarize, it feels like maybe like we are stabilizing a little bit at a bottom here. It is just hard to tell when we will finally see the improvement kick in.

Yes. I am not going to call the bottom, but for the last couple of months, it seems to be fairly stable.

Okay. All right. That's helpful. And then, on the gross margin side, 140 basis point improvement there is obviously very impressive in the face of a 7% sales decline. So can you break down some of the components about what drove that and maybe give us a little help on how we should be forecasting that line going forward? Can you keep getting that kind of year-over-year improvement? Can you maintain kind of this 32% gross margin level? Just help us sort of think through what is going on there.

I think, for the balance of the year, it is not reasonable to expect that we can maintain this level for a couple of reasons. I think this was (technical difficulty) helped to drive this margin probably to a peak level. So I wouldn't know I would not expect that margin -- ultimately, that is our goal to get to the 32% for a full year, but I would not expect that to continue in the second half of the year.

So, Christian (multiple speakers) then around 31%. Is that the way to think about it?

Somewhere in there, yes. 31% -- slightly above 31%.

Okay.

And, Matt, we have -- in Europe there is a lot of vacations in the third quarter. There is holidays in the fourth quarter. The turf and gardens business, which drops off for us in the third quarter. So there is lots of typical seasonality things that happen.

Absolutely. Okay. And then, last thing for me, just on M&A, your leverage is down back close to two turns again. You guys are doing a good job paying down some debt and generating good cash flow here. So are you starting to think a little bit more about M&A, or is the facility consolidation kind of got the organization a little too busy to think about larger acquisitions at this point? Just give us an update on what you are seeing and what you are thinking there.

No, I don't think we have ever lost our desire to continue to make acquisitions. I think the environment wasn't conducive over the last couple of years. And I think -- I expect that to improve, and we have seen a little more activity. So I would hope that over the next year or so that we will be successful. We keep looking.

Scott Graham, BMO Capital Markets.

Nice quarter. Just wanted to maybe get under the SG&A number a little bit. That was a pretty big jump on a percent of sales basis. I know that the sales obviously up just sort of a tad sequentially, but I guess I was not expecting that type of a jump on the SG&A. Could you give us a little bit more what's behind that?

Yes. So, a couple of things behind that. Number one, so far we have protected a number of our functional areas despite the sales decline. So, for instance, our sales force remains -- the headcount remains the same. Our engineering and some other functional areas that we have protected because we need these guys when things improve. And so, therefore, we don't see the same headcount reduction that we have seen, for instance, on the shop floor, and we can't manage it the same way as we can manage our shop floor.

The second piece of that is that we continue to see increased healthcare costs. I think we are not unique at this point. We see that across the US entities that healthcare costs are just skyrocketing. Year to date, our healthcare costs are about $1.2 million above the prior year. So that is another factor that has negatively impacted us.

The biggest part is that we have protected a number of these functional areas that we feel are critical when things rebound for us and take advantage of a rebound.

Understood. Hey, and I do want to maybe go back to, Carl, your comment on gross margin. I think you said at the end that you are expecting like a 31%-plus, but you also mentioned 32%. Was that sort of the original goal coming into the year, or what did I misunderstand there?

So the 32% is our long-term goal. I think with facility consolidations, the procurement efforts and our overall goal to get 15% operating income margin would suggest that we need to operate at around a 32% gross profit margin. And the 31% -- a little over 31% was for the full year.

That's great. Thank you. Last question is this. One of the big initiatives that the Company announced, I guess, about a year and a half back was the entering of new markets broadening out your addressable markets. Is there any way to quantify any of the benefits of that strategy in dollars and also hopefully maybe even subjectively some of the things that you are doing that you didn't do a year ago kind of thing?

I think, Scott, that what we -- right now, we are working on that (technical difficulty).

So, as of this point, though, there has really been no benefit from that strategy?

No, the service business we have got some nice benefit from it. And then, there is a new product that a customer has given us orders for, but I am not prepared to talk about what the customer is or what the product is until we start to ship and deliver it. But we definitely have some successes.

Jeff Hammond, KeyBanc Capital Markets.

So, just going back to the guidance, it just seems like if you go to the low end of the revenue range and you put in 30%, 40% decrementals, you are still at the high end of your range. So I am just trying to understand, given kind of the better start to the year, I understand you are not seeing maybe the snapback you are looking for, but why the conservatism, given the first six months?

A couple of things, I think, in the guidance. There is uncertainty around the mix to the extent that second-half mining, oil and gas, which are more of our profitable pieces, how do they behave relative to the rest of the portfolio? There is uncertainty around healthcare costs in the second half. Typically our healthcare costs in the second half are higher than in the first half. Is their strength going to continue? Is it going to accelerate? That has influenced that range.

There is uncertainty relative to extended -- potentially extended shutdowns by our customers, particularly in Europe, but also to some extent in North America. We hear some rumbling that that might be the case. And then, overall, in the industrial economy, it really remains weak, and we don't see any fundamentals that they have changed. So that overall uncertainty is driving the range in EPS.

What markets are you specifically hearing about extended shutdowns?

I think, Jeff, it is more in the general industrial of what people will do for routine maintenance shutdowns during the summertime.

In Europe, we hear it from some customers that have export activity into China. They are in various end markets.

Okay. And then, distribution, it seems like most of the distributors are still seeing same-store sales declines, and you guys are kind of running flat. Are you guys seeing some restock? Are you outperforming there? What is driving maybe a little bit better results?

Well, I think we have seen year-over-year declines, but sequentially it has flattened out. So I think it depends on the time period you are looking at and the comparisons. And I think that we are, at least in our opinion, we are performing quite well for the distributors and earning some orders because of that.

Yes. I was just looking at the comment on 3 where you said sales were flat year on year and up sequentially.

Yes. And I think it is just that we are outperforming it.

Yes. We do not see restocking activity in a meaningful way. So, therefore, if you think distributors are down a 3%, 4%, in that range and maybe in our space and maybe even a little bit more than that, we don't see restocking, which means we must be outperforming.

Okay. And then, finally, just on the renewable energy side, what is your visibility for that strength to persist through second half and into 2017?

So the PTC has been approved, so we think that was a really good thing. And it is actually a little bit longer term than it normally has been. The wildcard would probably be China, and that has been a really good market for us in the renewable energy side. And so if that continues, 2017 should be another good year. That has been the one market that has really outperformed for us.

John Franzreb, Sidoti.

I guess this might dovetail into the last question. In the couplings operating margin in the quarter, it was up sequentially rather nicely. Is that the renewables, or is that PowerGen? What is driving that sequential margin improvement? Because that has your most exposure to the oil and gas market.

So, what we see there is, to some extent we see the benefits of this early consolidation, which the majority of which take place in that segment. The plant in China, the Changzhou plant, is inside of that, and that was really -- the benefit really started to hit the P&L in the second quarter as we still had some costs in the first quarter as we were closing that facility. It was about $1.2 million on a full-year basis, but that is a big benefit for that segment. And I think some of the favorable items that we saw -- lower warranty expenses, for instance, benefited that segment proportionally more than the other segments.

Okay. Great. And in your current status, you suggest that the pricing initiative is still favorable. I would imagine it would be kind of hard to realize the 50 bps a year that you are kind of looking for in this kind of environment. Can you just talk about how much you did realize in the quarter and why you are confident that you would be able to hit those targets certainly in the near term?

We realized 70 basis points in the quarter. We think most of that -- maybe all of it is strategic pricing versus general price increases. General price increases essentially don't exist with some exceptions. So these are still activities that are very surgical. Customer by customer, SKU by SKU. There are areas where we don't get any price increases. Sectors like mining and oil and gas is impossible in general, but there are still areas where we can get pricing in a very surgical way. And there continues -- and we continue to be very structured in the way we go about this. It is very analytical and very structured. We have a guy here at the corporate office that is fully dedicated to this effort. He works with the business units, and he keeps on pushing our business units to do the analysis, to crunch the data and to go out and raise prices surgically. So we think that 50 basis points is still good.

Okay. Great. One last question. Could you just talk a little bit about raw material costs and your expectations, how they impact the gross margin line in the coming quarters?

There was a windfall in the first half of the year. As we went through the first half of the year, we saw selective increases. Copper, for instance, is very choppy. It is up and down, but we saw year over year. We see, for instance, pig iron is set back at prior-year levels. It increased as we went through the first half. Scrap steel is up. It increased as we went through the year so far, but it is at prior-year levels. So the windfall might turn a little bit on us in the second half of the year.

And, John, a lot of what we buy is not raw material. We buy components that have been machined or processed somehow. So there is usually a lag between when, and then we always fight back and say, we can't accept the price increase from our suppliers. So it is a little early to tell what impact that is going to have so far.

But there is a risk there might be a headwind in the second half.

Okay. Fair enough. Thanks, guys.

Mike Halloran, Robert W. Baird.

Maybe just give us some thoughts on how inventory levels look like to your channels right now. Are you seeing pretty good pull-through relative to core demand, or is any backup in any of the core channels?

No, we don't see anything where inventories are out of line significantly. There's always going to be some adjustments, but we don't see anything where there is a gross misalignment between -- on inventories.

Particularly, distribution remains flattish, lean, in our view. We ship much more direct to our distribution customers than we used to in prior, so they continue to maintain lean inventory levels regarding the whole broad range.

Makes sense. And then maybe just a little more thoughts on what you are seeing in China specifically. I think, Carl, you alluded to some worsening trends over there. What did you see through the quarter? What are your thoughts as you work through the year?

We serve some very specific end markets there, and each end market is a little bit different. I think for the rest of the year, I would expect it to be relatively flat. We have seen some strength in the renewable energy business. We don't see anything there that says that that is going to get worse, and some of the other markets, we see really no change there.

So I think obviously, some of it will depend on what happens overall in China, and there's just rumblings that things might get worse there. But we don't expect it at this point.

(Operator Instructions) Bhupinder Bowah, Jefferies.

Just a question on the cost savings here from the consolidation. I believe in the previous call, you mentioned about the expectations as you exit 2016 was $3.5 million to about like $4 million, and now you are saying like about $5 million. So I think that is progressing a little bit better than expected, and could you give us the number for the second quarter?

So what we said was the $4 million. By the end of the calendar year, $5 million of savings will have been realized with the exception that the productivity typically at the receiving end will not be in the early days of next year where it was at the ascending end. So that is where the delta comes between the $4 million and the $5 million.

The $4 million is, I think, what you are going to see next year. The $5 million is what you are going to see once the receiving end is up to full productivity, which will probably happen as we go through the second quarter -- by the end of the second quarter of next year. The full $5 million should be in place.

And those are annualized numbers.

Those are annualized numbers.

Right. Okay. And just on Bauer, actually, that was -- it seems like with your comments on Brexit, anything on Bauer like the margin improvement has been pretty tremendous over the last few quarters here up to 8%. Any negative impact from Brexit? How does that impact your Bauer business over the long-term?

Should not impact the Bauer business. Bauer has some sales into the UK, but it is not a substantial number. Other markets are much more important: China, Russia, Germany and other European markets. It has potential impact on our UK businesses. So far the currency changes for the drop in the British pound against both the euro and the US dollar, it has been a wash. Our UK businesses are a net euro exporter, which means they sell more in euros than they import in euros. At the same time, they are a net importer in US dollars, and if you do the math, it is a wash.

So while some of the input costs are going up, some of the sales, once they convert them into British pounds, they get more pounds for it, and you compare those two, it is a wash. So the only negative thing that we have so far is translating the UK earnings into US dollars, and that is about a $0.02 a share impact at current exchange rate levels on a full-year basis. So about $0.01 for the remainder of the year.

Okay. Got it. Thank you. And lastly, there was some questions on the distribution business and how we have seen the North America general industrial end market kind of soften. We heard like some of the large distributors talking June was -- we saw some extended shutdowns here in June, and some of them are even pointing towards those extended shutdowns have moved on to like July and maybe some improvement in August, actually. Is that your thinking? That is what you're hearing on your customers or that is what you're feeling?

No, I don't. We think that we don't expect things to get any better. I think there is more optimism out there in some of the published information than what we are seeing. Now, we don't have a tremendous amount of visibility in our order book, but I am not that optimistic. We are not going to plan for it.

Okay. No. My question was to get around how July has started, basically, because some of these guys have been talking that July is along the lines of June, which was -- we saw some extended shutdowns. So just wanted to (multiple speakers).

Okay. I'm sorry. I misunderstood. Yes. So I think if you look at our guidance, what we are expecting is things to be relatively flat, and our order book hasn't reflected that we are going to see a downturn, and it hasn't reflected that we are going to see it get any better. So we are expecting it to be relatively flat and have kind of similar seasonality to what we had in other years.

Now, we are -- we do read those same comments, and if those extended shutdowns do occur and it does impact the order book, then we will adjust accordingly.

We have no further questions at this time. Mr. Christenson, I would now like to turn the floor back over to you for closing comments.

Okay. Thank you, operator, and thanks for everyone to joining us this morning.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.