Altra Industrial Motion Corp (AIMC) 2017 Q2 法說會逐字稿

Greetings, and welcome to Altra Industrial Motion Second Quarter 2017 Financial Results. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to turn the conference over to your host, Mr. David Calusdian from Sharon Merrill Associates. You may 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 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 U.S. 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 operating working capital and non-GAAP free cash flow. These metrics exclude certain items discussed in our slide presentation and in our press release under the heading Discussion of Non-GAAP Financial Measures and any other items that management believes should be excluded when reviewing continuing operations.

The reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available in the financial tables of the Q2 2017 financial results press release on Altra's website.

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

Thank you, David, and good morning, everyone. And please turn to Slide 2.

We continued the strong momentum we established in the first quarter with another quarter of record performance in Q2. Our sales, GAAP EPS and non-GAAP EPS were records for the quarter. We reported year-over-year sales growth of 22.3%, and excluding acquisitions, we grew 4%. We are seeing ongoing improvement in certain of our end markets that had been challenged and incoming orders are coming in at a healthy level, although somewhat lower than Q1.

We are now leveraging that healthier demand environment with a lower cost structure as a result of the consolidations, supply chain enhancements and pricing initiatives we implemented during the downturn. As a result, we achieved a 47% increase in GAAP EPS; a 36% increase in non-GAAP EPS; a 40 basis point increase in gross margin; and a 150 basis point increase in operating margin.

As I mentioned on our Q1 conference call, given that we have completed our planned consolidations and that our supply chain and pricing initiatives are firmly ingrained in our corporate culture, we will not be providing incremental status updates on these initiatives.

We're tremendously proud of all that the team accomplished during the industrial downturn to optimize our infrastructure to capitalize on our growth initiatives and the eventual market rebound. We're excited to have begun to see the results of these efforts in the first half of the year.

Before we move on to review -- our review of the end markets, I'd like to provide a brief update on our Stromag acquisition. Please turn to Slide 3. We closed on the transaction at the end of last year and the integration is growing -- is going extremely well. Our anticipated cost synergies for year 1 have already been secured. We completed the move of the fourth and final Stromag manufacturing operation out of the seller's facility on schedule, and to date, we have exceeded our accretion assumptions for Stromag.

Early in Q2, we held a joint cross-selling training session for our sales forces and our cross-selling efforts are proceeding ahead of schedule. In fact, we have already received several orders for products that utilize the combined technology. We're excited about the prospects for Stromag and look forward to updating you on further progress.

With that, let's turn to Slide 4 and review our end markets. When I offer sequential and year-over-year performance comparisons, I will be using pro forma results as if Stromag were part of Altra in both the 2016 and 2017 periods.

We'll begin with distribution, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. Distribution sales were essentially flat year-over-year, and up slightly sequentially. We expect distribution to be up slightly for the year as headwinds are not as severe as last year.

Turf and Garden sales were up slightly year-over-year and we're now about flat for the year-to-date period. We're operating in a relatively stable market right now and we continue to expect this market to be similar to last year. We had record years in both 2016 and 2015.

Following a strong Q1, farm and agriculture had another positive quarter with sales up both year-over-year and sequentially. We are cautiously optimistic for an improved 2017, even though the fundamental market dynamics are still weak. We are fortunate that our large OEM customers in the Ag market are performing well.

Material handling was down year-over-year across most sectors. However, we continue to expect 2017 overall to be similar to last year as the general industrial economy improves.

Turning to energy, energy overall was down from a year ago, as weakness in renewable energy offset strong oil and gas sales. Looking at oil and gas specifically, rig counts are up significantly from the bottom but have leveled off recently. We've experienced 2 consecutive strong quarters and we are still cautiously optimistic that orders will continue to be strong during the balance of the year. We're watching this market closely.

Renewable energy sales were down as a result of timing issues. However, we expect sales for the full year into this market to be similar to last year.

Conventional power generation sales were essentially flat. Conventional power generation projects which have been very strong for the last few years have plateaued.

The metals market continues to be challenging as a result of global overcapacity, particularly in the steel industry. Sales were flat year-over-year. Global pricing and excess inventory continues to weigh on this market. We are hopeful that the U.S. Federal Government's investigation into steel dumping will benefit this market.

Mining sales were up in the quarter both year-over-year and sequentially as maintenance spending continues to improve. We believe a recovery in this market has started, although most of the growth is still being driven by replacement parts orders as mines get more active. We remain hopeful that we'll also start to see an increase in orders for new equipment this year as the outlook for capital spending is positive in this market.

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

Thank you, Carl, and good morning, everyone. Please turn to Slide 5. The second quarter was a very strong quarter for Altra. On the top line, we reported sales of $223.4 million, which was up 22.3% year-over-year. Excluding acquisitions, revenues were up 4%. Price contributed 90 basis points while FX had a negative effect of 150 basis points.

Geographically, excluding the effect of foreign exchange and Stromag, North American revenues were up 6.6%; sales to Asia Pacific and other geographies were up 27.3%; and European revenues were down primarily due to the timing of shipments, 1.6%.

Our gross margin continued to improve and we reported a 40 basis points increase from the second quarter a year ago, as we are seeing the benefits of the facility consolidations.

Non-GAAP operating income was 11.2% of sales for the quarter compared with 10% in the prior year quarter, an improvement of 120 basis points. For the second quarter, GAAP diluted EPS was $0.53 versus $0.36 a year ago, and non-GAAP diluted EPS increased 36% to $0.57 from $0.42 a year ago.

Second quarter 2017 non-GAAP EPS excludes restructuring and consolidation costs and acquisition-related items. In addition to those items, non-GAAP EPS in the year-ago quarter also excluded legal fees associated with the pursuit of an unfair trade remedy.

Please turn to Slide 6 for a discussion of our segment performance. Please note that segment results are not adjusted for onetime items or acquisitions.

For the second quarter of 2017, net sales in Couplings, Clutches and Brakes were $111 million, up 42% when compared with the prior year. Excluding the acquisition of Stromag and the negative impact from foreign currency, revenues grew 9.4%. This segment has Altra's highest exposure to the oil and gas, metals and mining markets. Segment operating income was $12 million or 10.8% of sales, up from 9.7% of sales a year ago.

Net sales in the Electromagnetic Clutches & Brakes segment were $65.3 million, up 14.4% from the second quarter of 2016. Excluding the acquisition of Stromag and the negative impact from foreign currency exchange, sales increased by 4.9%. Segment operating income increased to $8.2 million or 12.6% of segment sales, up from $7.1 million or 12.4% of sales a year ago.

Finally, net sales in the Gearing segment were $49.1 million, essentially flat with the year-ago quarter. Segment operating income increased to $6.6 million or 13.4% of sales compared with $5.9 million or 12% of sales a year ago. This segment is not impacted by the acquisition of Stromag.

Please turn to Slide 7. Our cash balance was $59 million at the end of the quarter, while book equity was $368.8 million. Our balance sheet strength provides us with enough dry powder to execute on bolt-on acquisitions.

In terms of use of cash in 2017, we continued to favor debt pay down over share repurchases. We paid down approximately $19 million of debt during the first half of 2017, and we did not repurchase shares in the second quarter.

Capital investments totaled $7.1 million for the quarter, below depreciation and amortization of $8.8 million. Capital expenditure levels are slightly elevated as we are investing in the upgrade of 3 facilities.

Please turn to Slide 8 and our guidance for 2017. As a result of our strong performance in the second quarter, we are raising our top and bottom line guidance for the full year. We now expect full year 2017 sales in the range of $850 million to $865 million. We further expect GAAP diluted EPS in the range of $1.74 to $1.84 and non-GAAP diluted EPS in the range of $1.95 to $2.05.

We expect our tax rate for the full year to be approximately 29% to 31% before discrete items, and capital expenditures in the range of $25 million to $30 million. Depreciation and amortization, we expect to be in the range of $35 million to $37 million.

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

Thank you, Christian. Let me leave you with 3 key thoughts, and please turn to Slide 9.

First, as our markets continue to strengthen, we expect our bottom line to benefit increasingly from our work during the past few years on consolidation, supply chain, strategic pricing and operational excellence initiatives.

Second, we continue to be excited by the progress of our Stromag acquisition, where we already experienced strong cross-selling activity in the second quarter. We continue to seek further acquisitions but remain highly disciplined in that pursuit.

And finally, our success thus far this year has enabled us to once again raise our guidance for the full year. We look forward to the solid execution of our strategic plan during the second half of the year.

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

(Operator Instructions) Our first question comes from Matt Duncan with Stephens.

So, Carl, first question, on sales and order trends and sort of the trends that you're seeing there, what's that looking like? You referred to a little bit lower -- it sounds like just a lower growth rate in orders in the 2Q than the 1Q, maybe if you could talk about what markets are driving that little bit of slowdown as well?

Yes, I think if you'll recall, Matt, at the end of the year last year when we reported our first quarter results, we felt like the -- that there had been some order holdbacks at the end of last year, and that then we had seen a little bit of fill-in from those orders that were held back in the first quarter. So we had very strong orders and particularly in the industrial distribution channel, which does have some inventory that they can manage one way or the other. So we think that got -- that, that dissipated through the first quarter. And then also in Europe, we had a very strong first quarter. So I think it's more that the first quarter had some unique things going on than something declining in the second quarter. The markets are -- seem across the board in very good shape.

So what kind of growth are you seeing in the order book on a year-over-year basis? How much are orders up right now?

It's in the low to mid-single digits depending on the markets. There's nothing that's extremely strong and -- but it is a nice across the board recovery.

All right. And then on the guidance, what kind of organic growth rate are you guys expecting in the second half of the year?

So I think, Matt, we continue to assume somewhere in the low to mid single-digit growth rates in the second half. Typically, when you look historically, second half is around -- first half of the year is around 50.5% to 51.5%, midpoint about 51% of annual sales. And we think that, that trend will continue, that we are range bound inside of those metrics.

Okay, that helps. And then last thing from me just on Stromag. If you could talk a little bit more about the EPS accretion you've seen so far. And it sounds like you're having some good successes with cross-selling, maybe you could give us some examples there. And what you're now thinking the annual revenue upside may be as a result of the cross-selling activity that you could realize from the deal?

Yes. So there is one example that I'll give you that's -- it was in our Couplings product line, where Stromag makes a -- it's an elastomeric coupling that goes into marine applications, and one of the Altra businesses makes a composite drive shaft. And they combined those 2 technologies for a marine application that was a great effort on both teams to work on the design and combine the technologies. And there's 3 or 4 other applications like that, that we've already gotten orders for. So that's one example.

I don't think these numbers are going to be significant this year. What's encouraging, as Carl said, is that usually we don't see that type of activity in the first year. Usually that's in the second and third year. So we feel very encouraged that we see these activities early on. And relative to accretion, Stromag was accreted by $0.06 in the second quarter, which then makes up a total of $0.11 for the first half, so it's been performing well inside of -- slightly above our expectations.

Our next question comes from John Franzreb with Sidoti & Company.

Could you just walk us through the consolidation process in the Stromag facilities? And how long you expect that to take?

So we completed what we call Phase 2 of our facility consolidations with the closure of our plants in Green Bay in the fourth quarter of last year. Our first phase was back during the big recession, when we closed 6 plants in 2009. And so we call this Phase 2. Phase 2 has been completed. And subsequent to that in the first 2 quarters of this year, we moved 4 operations out of [GTNO] owned facilities into Altra-owned facilities, 1 in China, 1 in Brazil and 2 in North America. That has been completed in the second quarter.

Okay, so is there anything left to move as far as the Stromag acquisition?

No, not at this point in time. I mean, as we go through common product lines and common manufacturing, there will be some further plans put together. But as of this point in time, those 4 were the ones that we wanted to get done right away.

And we are evaluating a Phase 3 at this point. But we do not expect to make any -- to make further movements with a Phase 3 this year.

Got it. Got it. And regarding the Gearing segment, it seems not to be participating as much in the recovery as the other 2 segments. Can you just talk to why that's the case?

So within this segment, we have Bauer. Bauer is growing in local currency. They've had a nice growth in the second quarter. Also, Bauer's operating income performance is improving. They're performing at 9% operating income, up about 100 basis points from the prior year. And revenues were up, in euros, 6%. A significant piece of their business is in Europe and there were still some slight currency headwinds out of Europe in the second quarter, which should disappear hopefully in the third quarter and in the fourth quarter. And so the North American part of that business has an exposure to the bridge and...

Yes, the infrastructure...

Infrastructure projects.

And also mass transit, which we haven't seen recover yet.

Which we haven't seen recover yet.

So hopefully when some infrastructure gets funded, we will see that. There are some good projects that we've been quoting on the infrastructure side and we've also been quoting some mass transit work. But it just hasn't materialized like oil and gas and ag and mining that have come back nicely.

The good news about that segment is that their operating income performance continues to improve as the Bauer performance continues to improve.

Is that infrastructure-related business always been lumpy for you? Or is it unusually lumpy recently?

No it's always been lumpy. They're big, big gearboxes and systems that we build, some of it is bridgework and they're big expensive projects.

Our next question comes from Scott Graham with BMO Capital Markets.

So I wanted to ask about sales because you kind of wrote that a little bit differently in the press release this time than I think you have in the past. So were organic sales, Christian, up 4% or 5.7%?

So they're up 4%. If you take out Stromag, that gives you organic sales are up 4%. And you're right, we reworded that. So the 4% is made up of 3 components, volume, price and FX. And then if you look at these 3 components, FX was up 90 basis points -- sorry, price was up 90 basis points; FX was a negative 150 basis points; and the balance then is volume.

Right. So in other words, when you say your sales were -- ex Stromag were up 4%, that includes the minus 1.5% for FX.

Correct.

Okay. So then as you go through, Carl, the different end markets as you typically do, it was a lot of flat and stable, which is not really agreeing with that type of number. So would you be able maybe, Carl, to call out the 3 -- the couple of end markets here that were the biggest drivers? I'm assuming mining and oil and gas upstream, but what else?

Yes. So Ag, we've seen some really nice business, unexpected improvement in the Ag business. And then oil and gas has been strong and mining also, which was probably stronger than expected.

Right, but I mean in the tune of like -- those businesses had to be up, sort of like, 5% to 10%, right?

Yes, when I say -- when it's also lumpy, and our sales and what's going on in the markets can be lumpy. So if we see a 2% or 3% improvement, I might call it flat, when we're seeing some improvement. And so it depends on the volume that we're -- that we have going into that market too. They can fall on flat versus up significantly or up slightly.

Well, then to that end, which of the markets that you said were flat were really up? Was distribution up?

I'd say probably the one that I'm a little bit more cautious on -- 2 of them would be -- yes, distribution was up sequentially. I think, would be mining was very good for us and Ag was very good for us. So I probably didn't express as much optimism about those markets as we saw in the actual incoming order rates. [I think it was pretty good.]

So if we could just maybe, last question here, is to drill down into distribution, which I contend was up, but that's me, as opposed to flat, which you said. Can you unbundle that a little bit for us maybe because it seemed like the distributor sales this past quarter were all reported and there's some pretty good numbers out there. Is that a timing thing? Did aftermarket slow? Because the small OEM piece should have been up, no?

Yes. I think -- let's see here. Give me a second, Scott. So distribution was up in the low single digits for us, both in sales and in order book. And the one caveat there is we don't know what they do with inventories through -- across the whole distribution channel. So they can see a change in sales that's different than what we see based on how they adjust their inventories. So I was a little bit cautious in expressing what our sales to distribution are and how that reflects what's going on in that channel until we get the numbers on what the inventories have done.

Our next question comes from Bhupender Bohra with Jefferies.

So my question is around pricing question, if you can talk about the 90 bps. Is it still market driven pricing? Or is this the internally what you have been doing over the last 1.5 years now? Is that still the result of that?

Yes. So it's two things. One is the continuation of our strategic pricing initiative, where we continue to see benefits and continue to be able to raise prices really as we explained this in the past very surgically. We've seen some uptick in commodity pricing. And so more and more our businesses are going out and asking for price increases to counter the commodity price increases we have seen.

Okay. So how should we think about pricing in the second half? Because if I hear the commentary from some of the distributors kind of talking about that some of the customers expect price increases in the second half, should we be a little bit more positive on the price increases here? Or how should we think about that?

I would not expect more than the 90 basis points in the second half. If you look back last 2 years, I'm guessing now, but it's somewhere been between 50 and 90 basis points, put this in the 70, 80 basis point range, I would expect that to continue unless we see a significant change in commodity prices. And I would just expect the same over the balance of the year.

And I think net, after cost increases, I agree with Christian because if commodities -- we've seen some commodity cost increases and wage inflation. So we've got to offset that with price increases.

Okay. Got it. My follow-up question on Europe, actually. You mentioned something about timing issue in the quarter. It was pretty strong if I look at the PMIs and the IP numbers in Europe, pretty strong. There was commentaries, talk about domestic economies in Europe much stronger than what they used to be now. So if you can comment and how should we think about the second half for Europe?

We see the same data and we do believe that the European economy is doing very well. Most recent data coming in about Germany and the ifo index, also very positive. People feel good about the outlook. I think we attribute the softness in the second quarter to a very, very strong first quarter. I think the first quarter revenues grew 6.5%, something like that. And that was unusually high, I think, ate up a little bit of the second quarter profitability. So we're at this point not concerned. We've seen 1 or 2 projects where the customer didn't take delivery at the end of the quarter and so that gets moved into the third quarter. That hurt us in Europe. But overall, we continue to be upbeat on volume.

Okay. And lastly, if I may include one more here on your EBIT margin target of 15%. Do you still think you need that distribution of 350 bps from the cost side and 200 bps from the top line? The mix, how you get to your 15%?

So we think that the benefit of the facility consolidations is in the current run rate. We still need more pricing for another 2 years, this pricing benefit. And we do need additional procurement savings. We've done well in all 3 aspects so far. And then potentially, a Phase 3 of facility consolidations that we're currently reviewing.

And we do still need the end market recovery to continue.

So again, 13% is what we think we can get to without end market recovery and then the remaining 200 basis points have to come from end market recovery.

(Operator Instructions) Our next question comes from Jeff Hammond with KeyBanc.

So oil and gas, it sounds like the trend is favorable but you're seeing rig count level out. Any indications that some of the improvement or strength is abating or is that just a comment, maybe, at a sequential level, we shouldn't expect more increase?

Yes, I think when we look at the rig count is up significantly from the bottom and the price of oil has stabilized and maybe it's ticked up a little bit. The rig count continues to go up a couple rigs a week but it's definitely plateaued. There's a lot of activity out there and so we don't expect it to decline from this point. We expect it to remain stable, at a much better level than it was a year ago.

Yes. And then just on capital allocation, anything really showing up in the pipeline? How would you characterize valuations? And just kind of management capacity as it seems like you've gotten through most of the Stromag integration.

Yes, I'll start and then I'll let Christian jump in. But I think we feel good about the balance sheet. I think our net-debt-to-EBITDA leverage ratio is just over 2x, 2.2x. And so we feel good about where we are. There's been -- it's been relatively slow for the last few years but it does feel like it's getting a little bit better out there from an activity level. And we're going to keep working it really hard. I think from a bandwidth standpoint, we could certainly handle a good sized bolt-on at this point. And the Stromag acquisition, the fortunate thing there was, that team thinks like us, they are part of the company instantaneously. So it was a really good integration. And so there's not a tremendous amount of activity from the senior management team still to make that happen. I don't know if you want to add anything, Christian?

No. And we're very pleased with the equation so far, as I mentioned, $0.11 a share for the first half. And I think we're going to have a lot of fun with that business.

Yes, the only thing I'd add, Jeff, is that we will be disciplined. I mean, I think the acquisitions we've made so far have all worked well. I think the Bauer one took longer to get moving than we did, but that was more the environment we were operating in. So we're going to make sure that we buy companies that fit well with what we have today.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd like to turn the call back to Carl Christenson for closing comments.

All right. Thank you, Rob, and thank you, everyone, for joining us this morning.

This concludes today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.