Altra Industrial Motion Corp (AIMC) 2016 Q4 法說會逐字稿

Greetings and welcome to the Altra Industrial Motion fourth-quarter 2016 financial results. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to Andrew Blazier of Sharon Merrill. Please go ahead, Andrew.

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 this call, they will be referencing slides that are posted to the altramotion.com website 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 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 include 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 in the financial tables of the Q4 financial results press release on Altra's website.

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

Thank you, Andrew, and good morning, everyone. Please turn to slide 2.

Our fourth-quarter performance was right in line with our expectations as economic conditions in many of our end markets continue to be challenging. Revenue was $172.6 million, down 60 basis points from a year ago. Volume was up 50 basis points, and price contributed 90 basis points. But those gains were more than offset by a 200 basis point headwind from foreign exchange.

Compared to prior year, sales in October were very sluggish but rebounded in November and December. Thus far, in the early weeks of Q1, we are seeing a positive trend. This gives rise to the possibility that some of our end markets are starting to improve.

In the last days of the fourth quarter, we closed on the acquisition of Stromag, a Germany-based maker of hydraulic clutches, electromagnetic clutches and brakes, limit switches, and flexible couplings. Stromag has a very strong brand and excellent technology base and a highly complementary suite of products. We expect to cross-sell these products using our own sales force, and the Stromag salesforce will be able to sell Altra products.

Stromag also provides us with the opportunity to expand our geographic presence in Europe and in India.

In addition, we see excellent opportunity to leverage cost synergies through the application of our operational excellence and procurement programs.

The integration of Stromag is proceeding very well. I recently spent some time with the team in Germany, and I'm even more confident that this is a really superb cultural fit. Stromag has a great team of people, excellent prospects in the pipeline, and outstanding opportunities to fill out the product portfolios. We have already secured the synergies that we had expected to achieve in the first year.

Please see slide 3 for the transaction overview. We are confident that the acquisition will be accretive to EPS in 2017. We continue to expect synergies in the range of EUR5 million to EUR7 million within three to four years. Please see slide 4 for a brief overview of Stromag, including products, markets, and geographies.

As you look at the profile of this Company, I believe you will see the industrial logic of this acquisition. Please turn to slide 5.

In addition to driving growth through acquisition with the completion of the Stromag deal this quarter, we continue to make good progress on the key elements of our profit improvement strategy. Let's start with our consolidation efforts.

During the fourth quarter, we completed the one plant closure that we had anticipated. This brings our total to seven consolidated facilities by the end of 2016.

We also closed a facility earlier this quarter. The combined estimated savings from these eight facilities is $5.7 million, and we have eliminated 278,000 square feet of space without reducing any manufacturing capabilities or capacity. We continue to evaluate additional facilities for consolidation.

We also made great strides with our pricing improvement strategy this year. In the fourth quarter, we increased price by 90 basis points, and we were able to increase price on a net basis in a range of 70 to 90 basis points each quarter in 2016.

Keep in mind that we accomplished this in a very challenging economic environment where we get tremendous pushback for many of our customers to pass on cost reductions. We believe we have more runway with this strategy and expect further incremental improvements in 2017.

Our goal of developing a world-class supply chain management organization is also proceeding well. We have the organizational structure in place now and have analyzed our spend. As a result of the efforts to date, we realized annualized savings of more than $3.5 million in 2016. We see significant potential in this area over the next few years.

We're making great progress regarding operational excellence and changing the culture throughout Altra to one of continuous improvement in all aspects of the business. The advances we've made in on-time delivery performance and lead-time reduction are fortifying our customer relationships. We are extremely confident that when our out-of-favor rnd markets improve, we will be able to respond and we will see tremendous operating leverage.

With that, let's turn to slide 6 and review our end markets.

We will begin with distribution, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. Distribution was down in the single digits year over year but up a bit sequentially. We expect to see a slight headwind in 2017 but not as severe as the one we saw in 2016.

In Turf and Garden, we reported another strong year in 2016 with sales up slightly year over year in the fourth quarter. We expect 2017 to be similar to 2016. Farm and agricultural sales were up year over year for Q4, but down sequentially and for the full year. We anticipate this market will be weak in 2017 as it continues to be affected by low commodity prices and a relatively young fleet.

Materials handling was down slightly year over year as a result of weak elevator and forklift sales due to market conditions in Europe and Asia. This was nearly offset by strong sales of conveyors. With the acquisition of Stromag, we will be adding to our market share in cranes and hoists beginning in Q1.

Turning to energy, energy overall was up slightly from a year ago. Looking at oil and gas last quarter, we mentioned that order rates were stronger and we had hoped that we had possibly hit the bottom of the market. In Q4, shipments were still down significantly year over year but up sequentially. Looking at 2017, we could see incremental improvements in this market and would expect spare parts sales to be stronger.

Conventional power generation performed better than expected and was up on a year-over-year basis. One quarter does not make a trend, but we are cautiously optimistic that the market has stabilized and that 2017 will be flat with 2016.

Sales into renewable energy market were up in the low single digits in Q4. We expect 2017 to be flat to slightly down from the strong performance in 2016 as production tax credit benefits start to decline. The metals market remains weak, and we expect that overcapacity in China and global pricing will continue to affect this market in 2017.

Mining sales were down significantly year over year, and based on order rates, we believe that we have hit the trough for this market, although we expect sales to remain at this tepid level for the foreseeable future.

With that overview, I will turn the call over to Christian to review the numbers before returning for a summary in your questions.

Thank you, Carl, and good morning, everyone. Please turn to slide 7.

It was an eventful quarter with the acquisition of Stromag and related financing and the redemption of our convertible notes. Operationally, the quarter was encouraging. A weak October was followed by a good November and December. At the end, sales, excluding the impact of foreign exchange, increased slightly year over year.

Our gross profit margin continued to improve as we recorded a 70 basis point increase compared to the prior year fourth quarter. Non-GAAP operating income came in at 9.9% of sales for the quarter, slightly down by the 10.2% in the prior year quarter. For the fourth quarter of 2016, GAAP diluted EPS was $0.06 versus $0.23 a year ago. Non-GAAP diluted EPS increased to $0.41 and $0.36 a year ago. The year-over-year increase in non-GAAP EPS was mainly due to a very low tax rate for the quarter.

The low tax rate was driven by a drop in proportional share of US earnings, which had the highest tax rate versus total global earnings and the accumulated catch-up related to that effect. Most of the restructuring consolidation charges, the TB Wood's impairment, and the deferred loss related to the convertible notes was incurred in the US driving US earnings down.

Fourth-quarter 2016 non-GAAP EPS excludes $6.6 million for a non-cash impairment charge related to intangibles at TB Wood's. $3.3 million in restructuring expenses, $1.2 million in acquisition-related expenses, and $1.9 million for charges related to the conversion of our 2.75 convertible senior notes due 2031.

The business of TB Wood's has been negatively impacted by a significant exposure to the depressed oil and gas markets. Looking closer at the top line, volume increased 50 basis points, while our strategic pricing initiative added 90 basis points. However, foreign exchange rates had a negative impact of approximately 200 basis points driven by the continued strength of the US dollar. Net of foreign exchange, sales were up 1.5% year over year.

Geographically, excluding the effect of foreign exchange, North American revenues were flat year over year, European revenues were up 2%, and sales in Asia-Pacific and other geographies were up 7%.

We report an income tax benefit of $1.1 million during the quarter versus income tax expense of $4.4 million for a tax rate of 42% a year ago. Please turn to slide 8 for a discussion of our segment performance. Please note that segment results are not adjusted for one-time items.

For the fourth-quarter 2016, net sales in couplings, clutches, and brakes were $74.2 million, down 3.8% when compared with the prior year. This segment has Altra's higher exposure to oil and gas, metals, and mining markets. Segment operating income was $7.1 million down from $9.1 million a year ago.

Net sales in the electromagnetic clutches and brake segment were $52.8 million, down from $53.4 million in the fourth quarter of 2015. This segment is benefiting from Altra's facility consolidations and procurement efforts. As a result, segment operating income increased 18% to $6.3 million or 11.9% of segment sales.

Finally, net sales in the gearing segment were $47 million compared with $44.7 million in the year ago quarter.

Segment operating income increased 28% to $5.4 million or $4.1 million -- from $4.1 million a year ago. Segment operating income is now 11% of sales compared with 9% a year ago. Please turn to slide 9.

Our balance sheet remains strong. Equity was $283.3 million, and our cash balance was $69.1 million. Please turn to slide 10.

Carl mentioned during the quarter we closed on the acquisition of Stromag. The acquisition cost comprised the assumption of debt totaling EUR14 million and a cash consideration of approximately EUR184 million. To finance the transaction, a majority of the purchase price was borrowed in US dollars and converted to euros through cross currency interest rate swaps. These are a combination of fixed or floating -- and floating for floating rate components.

This structure allows us to match the cash flow currencies of the target for the denomination of the underlying debt. It also allows us to reduce our effective interest rate for the next three years. We expect our effective interest rates to be less than 1% in 2017 for this portion of our debt.

At the same time, we strengthened our balance sheet by issuing a notice to redeem our 2.75% convertible senior notes. As of the end of the year, notes were the principal amount of approximately $39.3 million had been converted into $1.5 million of Altra shares. In January 2017, the remaining principal was converted to common stock with the exception of $900,000 that was redeemed for cash. The conversion will have the effect of increasing our share count by approximately 3.2 million shares to a total of $29.2 million. The net result of the borrowings for Stromag and taking out the convertible notes is that we now have a pro forma leverage ratio of 2.7 times that provides us with enough dry powder to act on bolt-on acquisition opportunities.

In terms of use of cash in 2017, we will favor debt paydown over share repurchases. We did not repurchase any shares in the fourth quarter.

Capital investments totaled $3.2 million for the quarter, well below our depreciation and amortization for the quarter of $7.3 million. Please turn to slide 11 in our guidance for 2017.

We believe that we have hit the trough in certain of our more challenged markets. However, we do not expect an immediate or significant improvement in those markets in the near-term and there remain much uncertainty in the global economy given the change in the US administration, upcoming national elections in many of our key geographies, and Brexit.

In addition, we expect to face meaningful revenue and EPS headwinds relating to foreign exchange. With that said, for full-year 2017, we expect sales in the range of $835 million to $855 million. We further expect GAAP diluted EPS in the range of $1.64 to $1.74 and non-GAAP diluted EPS in the range of $1.75 to $1.85. We expect the tax rate for the full year to be approximately 30% to 32% before discrete items, and we also expect capital expenditures in the range of $25 million to $30 million and depreciation and amortization in the range of $38 million to $42 million.

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

Thank you, Christian. We are cautiously optimistic as we head further into 2017. The positive trends we saw in several of our most challenged end markets give us hope that we finally hit the bottom in these areas. At the same time, as Christian mentioned, we're not expecting growth out of these markets this year. So while we don't see market dynamics getting worse, we don't see them getting much better either.

In this environment, we will continue to control what we can control and execute on our consolidation, supply chain, and operational excellence initiatives. We're very excited about the Stromag acquisition and extremely focused on integrating the business and achieving the synergies.

We will also focus on long-term growth both organically and through M&A. With the cross currency interest rate swaps and the takeout of our convertible senior notes, we have a strong balance sheet and we are in good position to act on potential bolt-on acquisition opportunities.

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

(Operator Instructions) Scott Graham, BMO Capital Markets.

Good morning, guys. It was a nice quarter.

So I have three questions for you. Could you give us about the ZIP Code you expect, interest expense, where do you think that falls in 2017 roughly?

Right now we're assuming around $7 million in interest expense.

Okay. That's P&L, not just cash, right? That's just P&L.

That's P&L, yes. And so the convertible take (multiple speakers) out about $7 million, and then the related financing to Stromag will add about $2 million, $2.5 million. So we think we're going to end up with about -- we are forecasting about $7 million.

Yes, okay. Carl, you said near the top of the call that you were starting to see signs this quarter of not just a bottoming but just maybe an improvement. Could you elaborate on which end markets? Were you talking about orders? Are you actually talking about deliveries? Short cycle, long cycle? Can you give us an idea of what you're talking about?

Yes, I was talking about the incoming order rate. Because, if you recall, the incoming order rate for the fourth quarter was really low. I think that was really cash management by our customers and distributor partners.

So what we're seeing when I look at the first eight weeks, the incoming order rate is about even with what it was last year, which is a significant improvement over what the fourth-quarter incoming order rate was. So it's really nice to see that.

I think if you look at the trends through the year for last year when you saw the sales and shipments declining each quarter in the year and so now to have the incoming order rate back out where it was at the beginning of the year last year feels pretty good.

Okay. And would you be able to share that fourth-quarter order rate, and by extension, should we expect 1Q to be a little bit weaker than even 1Q of last year?

So we don't talk about the actual order number just because some of it is scheduled orders by customers that can change if not firm contractual commitments. And so we are -- I am reluctant to talk about the actual number.

But to give you an idea, the incoming order rate was probably down in the order of 10% sequentially from the third quarter, which is a significant number.

January shipments were not that bad. So I think some of the orders coming in will turn pretty quickly. So we shouldn't see a complete disaster in the first quarter, but we will -- it may be a little bit softer than first quarter last year. And then as we convert those orders into sales, going further in the year, it could get better.

Got you. And last question. On the facility closures and some of your supply chain stuff that is completed, the completed as of fourth quarter -- Christian, this is kind of for you -- as of the end of the fourth quarter, what you have completed -- sorry to repeat myself -- what is the impact on 2017 cost savings wise of those initiatives?

The incremental benefit for 2017 will be $2.6 million.

And if you were to estimate where that run rate would be based on at the end of this year knowing that you are doing more, about where do you think that would be by the end of the year? You follow me?

Yes. So, so far, we have -- with these actions, we estimate that they translate into about $5.7 million in total savings. We are evaluating additional facility consolidations. So I don't think there is much that will happen for the next three quarters in terms of additional savings, and then we should start to see some additional benefits maybe in the fourth quarter.

Yes, I think if you recall, Scott, when we first talked about the facility consolidation plan, we had these first facility consolidations that we could do and could squeeze into existing operations. And because of lean, we freed up some substantial space in some existing operations.

The next ones that we are looking at require two things. One is getting the business that we're going to move ready to move, and then two, we need to do some additional work in the receiving facilities. So we said we thought there would be a lag in the 2017 timeframe and maybe into early 2018, and then we would see the rest of it come at the end once we get everything prepared.

Understood. Thank you.

Jeff Hammond, KeyBanc Capital Markets.

So just to bridge the sales guidance, it seems like -- maybe just walk through what you have in there for Stromag, how much you think the FX headwind is, and it seems like I am backing into flattish core growth and maybe just talk around the ranges.

So what we get in there is, when we look at 2016 and we convert 2016 top line and earnings at current exchange rates for the pound and for the euro, we lose about $7 million at the top line and about $0.08 a share. So we are starting with that headwind into the new year, so that's been factored in. And then for the base business, we assume a growth rate of flat to 2%. And then you add Stromag and that gets you to our guidance.

And what is the outlook in general for Stromag?

So, in terms of top-line development, we think Stromag will be in line with the rest of Altra in that flat to 2% up.

Okay. And then is there any -- you have your own unique seasonality as a core business where the front half is better. How does Stromag flow seasonally as we model it quarter to quarter?

They are fairly even. They don't have the same seasonality that we have, so their first half and second half is pretty much 50-50.

So, Carl, maybe just back to the first eight weeks and things feeling better, can you talk about any particular markets or geographies that you see as inflecting and, just because it is such an important piece, what you are seeing from the distributor channel?

Yes, sure. So it's not euphoric. It just feels better because it was so bad in the fourth quarter. So -- but it is -- it's nice to be back to year-over-year comparisons on the order rate that is flat rather than continuing to be down. So that does feel good.

And the nice thing, Jeff, is that when we look at the projections for -- we track 12, 13 end markets and we have third-party economists that project where they think they are going to go, but we do our own projections. And when I looked at the beginning of 2016, the majority of them were red, and there was only a couple of them that were green. When I look at those same 12, 13 end markets going into 2017, the majority of them are green, and there is only a couple of them that are red. So there's definitely some positive attitudes out there.

Now they are not significant improvements in any one of those end markets. They are all low single-digit improvements, but up. And anecdotally, some of the order rates -- what we're starting to see is some orders for oil and gas. As you know, the oil price has been fairly stable, and I think what we're starting to see is some inventory get consumed out of the channel. There are still some places where it's not. Our build to drive business is one that has a significant portion of oil and gas business, and we think there's still a lot of -- maybe not a lot now. There's still inventory in the channel that has to get consumed before those order rates pick up, but we have seen it on some of the drilling rig components that we build. Those order rates have picked up. We have even seen some in mining, even though we expect mining not to improve significantly. So there has been some also just anecdotal data and information from our customers that things are getting better.

In the distribution channel, we don't expect it to be as bad as it was last year, the same kind of decline as last year, and what we see in the order rates so far is, at the big, national, multi-branched chains, the order rate has improved. Again, I think there was some cash management at the end of the quarter last year or during the fourth quarter of last year, and so they have improved. We are still seeing some of the specialty smaller distributors are still weak, and that's probably because there's still some inventory there.

Thanks for the color, guys.

Matt Duncan, Stephens.

Carl, maybe building on that commentary about distributors, I guess I am a little surprised that we will be talking about potential down sales from that group this year. You mentioned that the larger, more national guys are maybe doing a little bit better. I know in the fourth quarter we saw growth return in the month of December. For a lot of those guys, can you maybe remind us how much of your distribution revenues go through the larger guys versus the more specialty guys?

Got to be about half goes through the larger national chains. And I don't think it's going to be down significantly, and I think what I said was overall distribution could be down slightly from the prior year. I think the guys -- the bigger guys might have managed the inventories better, and so we might see a slight improvement at the larger chains.

Okay. So you feel like for the big guys, inventories are, it sounds like, kind of about where they need to be versus for the small guys maybe they are still a little too much on the shelves.

Yes, I think so. That would be our feel, and what we see for stability in those chains that we do get feedback on and what the inventory levels are, it seems to be fairly stable.

Okay. That helps. Looking at that oil and gas customer base, there was a little bit of commentary there about order trends. Are you seeing order trend growth there, and I would assume there is some potential for decent growth out of that customer base this year?

Yes, I mean the price of oil and gas is the determining factor, but it appears that, as the rate counts go up, that we are seeing some new rig builds. We've gotten some orders for some components for new rigs, and we have -- it does appear that some of the inventory has been consumed in some components. So we are starting to see some orders for replacement parts also.

Okay. Great.

And there's still some pockets where there is inventory, and so I don't want to give the impression that we are off to the races here in oil and gas. But it does -- we're starting to get some stability.

Okay. That helps. And then, Christian, just a couple of numbers things for you real quick. On Stromag, you went through some details on guidance earlier in response to other questions. If I'm doing my math right, it sounds like roughly $135 million is your Stromag assumption. Is that about right?

That's about right.

And then in terms of EPS accretion that you are assuming in this guidance, how much accretion -- if you want to give us a range, that's fine -- but how much earnings accretion are you expecting gets baked into your guide for the year?

For Stromag, we are thinking about $0.15 plus or minus.

Okay. And then lastly on that, just the timing of how the synergies flow through, how much of that $0.15 is from picking up some of the synergy benefit this year and then how much is still in the future?

We think that we're going to do EUR1 million to EUR1.5 million in year one. We feel that we have secured EUR1 million already, and we're working on that additional EUR500,000 in year one. And then I think in total, we quoted EUR500,000 to EUR700,000, so I don't have a timeline yet for you for the rest of that.

Probably the rest is going to flow through, got it.

All right. I appreciate it, guys. Thank you.

(Operator Instructions) Bhupender Bohra, Jefferies.

On the first question on oil and gas, could you give us the revenue base how we will start like 2017? This business was down about 30%, 35% or something for the year in 2016.

Yes, so compared to 2016 -- yes, so it looks like it's probably going to be about flat with last year.

Okay. And from a first-half to second-half perspective, I think, Carl, you did say that we should not expect improvement and growth like significantly, but what is first-half, second-half expectations you have built in?

Yes, we don't expect to see significant improvements, and I think for the last three years, a lot of people predicted that the second half was going to be a whole lot better than the first half, and we haven't seen it materialize yet. So I'm still waiting to see that second-half boost that we have been promised every three years -- for the last three years.

Okay. And the other question was on the slower start to earnings for 2017. I think you did say that -- would it be difficult to grow your earnings year over year in the first quarter? I think you did say that you're going to start slowly and then pick up some pace in the second half or the back half of the year. Are we talking about flat to slightly down earnings EPS growth like in the first quarter this year?

That is primarily due to the comparables. So things got worse through the year last year, and so we're going to start off being relatively flat. And then -- and we do have a little bit of second half being worst than the first half just from seasonality. But if you look at the shipments last year compared to this year, the first quarter was -- and the first half was significantly better than the second half.

So I think in Q1 we did $180.5 million. In Q2, we did $182.7 million. Q3 was $173.1 million, and Q4 was $172.6 million. So we are -- going from that downward trend, now we're going to turn that around and get better.

So from a comparable standpoint, we should see it get better in the second half.

Okay. Got it. That's all I have. Thank you.

Thank you. At this time, I will turn the call back to Carl Christenson for closing remarks.

Okay. Thank you, operator, and thank you to everyone for joining us on this call.

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