Altra Industrial Motion Corp (AIMC) 2017 Q3 法說會逐字稿

Greetings and welcome to the Altra Industrial Motion third-quarter 2017 financial results conference call. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Blazier, Sharon Merrill Associates. Thank you, sir, you may begin.

Thank you, Christine. Good morning, everyone, and welcome to the call. With me today are our 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 operating working capital, non-GAAP gross profit, non-GAAP gross profit 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.

The reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available in the financial tables of the Q3 2017 financial results press release on Altra's website. I'll now turn the call over to Altra's CEO, Carl Christenson.

Thank you, Andrew, and good morning, everyone. Please turn to slide 2. We reported another excellent quarter with a 24% increase in overall sales and a 3.8% increase in sales net of acquisitions as the industrial economy continues to improve. The fact that this was the fourth consecutive quarter of year-over-year organic sales growth gives us confidence that the upturn in certain end markets that had been challenged has truly taken hold.

I will go over each of our end markets in just a moment, but we are encouraged by the continuing positive trends we're seeing in late stage end markets like oil and gas and mining. The success of our margin improvement initiatives enabled us to leverage this volume growth into a significant year-over-year improvement on our bottom line.

We also benefited from foreign exchange. We achieved a 130% increase in GAAP EPS, a 37% increase in non-GAAP EPS, a 90 basis point increase in gross margin, a 390 basis point increase in operating margin, and a 130 basis point increase in non-GAAP operating margin. We are proud of the work our team accomplished on several key margin improvement initiatives during the past few years to enable us to leverage the upturn in the industrial markets.

With that let's turn to slide 3 and review our end markets. When I offer sequential and year-over-year performance comparisons I will be using pro forma results as if our Stromag acquisition, which we closed at the end of 2016, were part of Altra in both the 2016 and 2017 periods. We will begin with distribution, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs.

Distribution sales were up slightly year-over-year as a result of the general improvement in the general economy. Turf and garden sales were essentially flat with last year and we continue to be on pace to be flat with 2016 overall, which was a record year. We recently attended an industry association tradeshow and customers are feeling optimistic about next year as a result of strength in the housing market.

Farm and agriculture continues to be strong with another quarter of year-over-year improvement driven primarily by commodity price increases. Based on the positive sentiment we are hearing from customers, we are cautiously optimistic that this momentum will continue.

Material handling started out slow in 2017 but has been improving as we progressed through the year. Sales were up double digits in the quarter driven by strength in elevators as well as forklifts. This was partially offset by weakness in cranes and hoists which are dependent on the still sluggish metals market. We expect 2018 to be a better year with improvement from the metals and oil and gas markets.

Turning to energy, oil and gas was up year-over-year and we've now reported three consecutive strong quarters. Renewables were up slightly year-over-year, although we expect next year to be similar to 2017. The sentiment on wind is turning slightly negative with increasing pricing pressure in parts of the world like Europe and India. We expect demand in North America and China to be strong next year.

Conventional power generation sales were down significantly for the quarter as customers put some projects on hold. We expect this to improve as a high level of project work is in the queue.

The metals market had been challenging for some time -- reported sales increases both year-over-year and sequentially. Industry plant utilization has grown from 68% to 72%, climbing incrementally closer to what is considered a healthy rate of 80%. General economic strength is boosting this market while the slowing automotive market has been a drag on growth. Duties on steel imported from China should also have a positive impact on this market.

Mining sales continue to be strong with sales up double-digits in the quarter. With another quarter of sequential improvement, we believe the recovery in this market is real. Most of the growth is still being driven by replacement parts orders as mining, particularly copper, improves.

With that overview I will 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. As you can see on slide 4, and as Carl discussed at the top of the call, we reported a very good quarter with strong overall organic growth and excellent leverage on the bottom line. Our 3.8% growth excluding acquisitions accrued at a 95 basis point contribution from price and a positive FX effect of 150 basis points.

Geographically, excluding the effects of foreign exchange and Stromag, North American revenues were down 2.6%; sales to Asia-Pacific and other geographies were up 29.5%; and European revenues were up 2.7%. Our strong third-quarter 2017 non-GAAP EPS excludes restructuring and consolidation cost and acquisition-related items. In addition to those items, non-GAAP EPS in the prior year quarter also excluded legal fees associated with pursuit of an unfair trade remedy.

Please turn to slide 5 for a discussion of our segment performance. Please note that segment results are not adjusted for one-time items or acquisition. For the third quarter of 2017 net sales in our couplings, clutches and brake segment were $110.1 million, up 42.2% compared with the prior year. Excluding the acquisitions of Stromag and the effect of foreign currency revenues grew 3.8%.

This segment has autosized exposure to the oil and gas, metals and mining market. Segment operating income was strong and came in at $12.7 million, or 11.5% of sales, up 300 basis points from 8.5% of sales a year ago. This performance shows how important these markets are for this segment. Net sales in the electromagnetic clutches and brake segment were $58.3 million, up 15% from the third quarter of 2016.

Excluding the acquisition of Stromag and the impact from foreign exchange, sales increased by 1.9%. Segment operating income was $6.1 million or 10.5% of segment sales, down from $6.6 million or 13% of sales a year ago.

Finally, net sales in the gearing segment were $48.4 million, up 3% from the prior year quarter. Segment operating income was essentially flat at $5.7 million or 11.8% of sales compared with $5.7 million or 12.1% of sales a year ago. This segment is not impacted by the acquisition of Stromag.

Please turn to slide 6. Our cash balance was $53.2 million at the end of the quarter while book equity was $383.6 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 pay the debt pay down of our share repurchases. We paid down approximately $32 million (inaudible) of debt during the first nine months of 2017 and we did not repurchase shares in the third quarter.

Operating cash flow performance in the quarter was disappointing due to the increase in operating working capital. We believe that operating working capital is elevated by approximately $13 million.

Capital investments totaled $8.9 million for the quarter. This was offset with proceeds of $3.2 million for the sale of a property. Depreciation and amortization was $9.3 million. Capital expenditure levels in the quarter are elevated as we are investing in the upgrade of three facilities.

Please turn to slide 7 and our guidance for 2017. As a result of our strong performance in the third quarter we are raising our top- and bottom-line guidance for the full year. We now expecting full-year 2017 sales in the range of $860 million to $870 million and we fully expect GAAP diluted EPS in the range of $1.76 to $1.82 and non-GAAP diluted EPS in the range of $2 to $2.06.

We expect our tax rate for the full year to be approximately 29% to 31% before discrete items and capital expenditures to be approximately $30 million. We expect depreciation and amortization 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 three key thoughts and please turn to slide 8. First, the improvement in the industrial economy is encouraging and we are now capitalizing on the positive momentum to drive organic growth initiatives. Our sales and engineering teams are targeting specific strategic end markets with focused activities that are already generating new opportunities. We look forward to reporting our progress to you in the quarters ahead.

Second, 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. At the same time, as the economy improves we will need to work hard to manage the supply chain as commodity costs go up and be disciplined with pricing to offset both the commodity cost increases and wage increases.

Third, we continue to be excited by the progress of our Stromag acquisition. Our synergies are on track and our cross-selling initiative is performing better than our expectations. We will continue to seek additional strategic 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. Thank you for your continued support of Altra and we will now open the call to questions.

(Operator Instructions). Matt Duncan, Stephens.

Nice job again this quarter. So first question just on sales and order trends through the quarter and so far into October. What's that looking like, Carl?

So, they are pretty good. It's still lumpy, but the industrial reduction numbers are strong, the ISM numbers are strong. And the bookings reflect what's going on in industrial production and the ISM numbers. The great thing is it's not in any one particular geography; it seems to be a fairly solid industrial economy around the world.

Okay. As you look at year-over-year bookings, if Stromag had been part of the business last year, is the order book growing faster than revenue currently is?

Yes, we have a little bit positive. In the third quarter we had positive book to bill ratios and so that was good news. And so the backlog has been building.

Okay. What about the specifically in the oil and gas market? With rig count starting to slide just a little bit here, are you sensing any change at all there or outlooks still seem pretty good?

Yes, no, we haven't. And I think for us, once there's a little momentum things tend to continue and it would lag the rig count somewhat. But we don't expect there to be a significant decline because rig counts have flattened out.

Okay. On Stromag you mentioned that the cross-selling is going better than you had expected it to. How much is that contributing to revenue at this point? And can you maybe update us on what your thoughts are on how much it can ultimately add once you have had time to let that really take hold?

We will reserve the long-term impact for a later date, but I would say that it's probably twice what we thought it would be. And we'll probably have opportunities that we haven't closed, but opportunities in the several million dollar range.

And it's probably -- I'm trying to add them up in my mind, but probably between $4 million and $8 million for the opportunities that are on the list. Some of them have a very high percentage of closing and some of them medium percentage. And we've probably booked more than $1.5 million.

Okay, good. And then last thing for me just on gross margin. Obviously 90 basis points of year-over-year improvement this quarter is outstanding. And you mentioned a little bit of you're going to have to start watching out for cost inflation. What is your thought around what gross margin ought to do from here?

And I know it is early, but just sort of looking out into 2018, can you stay on this path of maybe 30 to 50 basis points a year of gross margin expansion through strategic pricing and other stuff?

Matt, this is Christian. Yes, we are very proud about the margins in the quarter, particularly when we look at it sequentially compared with the second quarter. Gross profit margins were flat despite the fact that revenues seasonally are down about $9 million. And as we look ahead to next year without giving guidance, we reserve that to when we release fourth-quarter results in February.

We expect our margins to continue to expand based on strategic pricing, based on additional facility consolidations as well as our procurement efforts. So, we are planning on further gross profit margin expansion and we're planning on reducing our SG&A as a percentage of sales next year.

Okay great. Thanks, guys.

And Matt, I will just add that on the margins that we also see that of the end markets that we look at, that the vast majority of them look like they're going to improve -- continue to improve slightly. It's not rapid growth but it's certainly good growth, and so that's certainly going to help on the margin side too. We will get a little leverage there.

Sure. All right, thanks, guys.

John Franzreb, Sidoti.

Carl, I just want to start with some of your prepared remarks. You mentioned that you had some power generation orders deferred in the quarter, but they seem somewhat firm anyway. Can you just expand upon that, how much of an impact was that?

Yes, I mean that's not a huge part of our business, but it's significant and it is profitable. And I think that we have more projects probably now than we've had in a long time in the pipeline, but they just delayed them. And I think the industry literature that I read says that there's still great opportunity in places like India and China for gas power generation. So I'm optimistic about the market long-term. It is just I think it's hit a pause here for people pushing projects out for this year.

Is this a one or two quarter pause or is it beyond that?

No, I think, at least the companies that we've talked to, I think they are going to pick up back right after the first of the year.

Okay. And I think we touched a little bit on this last quarter, but can you just walk me through the electromagnetic clutches and brakes? Revenue up year-over-year but op income down and op margin down. Can you just walk me through the dynamics of what's driving that?

So, our electric clutch brake, there's a couple key end markets. One of them is turf and garden, which this year has -- was more front end loaded in the beginning of the year. So we were up significantly through the first half of the year in North America and then in the third quarter in North America it was down a little bit. Globally it was about flat. But that's certainly had an impact for us there. And then I'm going to let Christian talk about (multiple speakers).

I think one of the impacts that we've had [impact on] this quarter is a tough comparison, particularly in regards to our servo motor business, which is European-based. That business had an extremely strong quarter last year. It's based in the UK; also had some favorable currency trends, really some tailwinds last year in terms of currency against the euro and that comparison was just not repeatable this year.

That had a meaningful impact on the bottom line for that segment. And then I think we also have seen on the turf and garden side, as Carl mentioned, some weakness in this quarter as the season developed differently from last year, particularly here in the US. We don't think this is a reason -- we are not concerned about this segment at all. This is a temporary (inaudible) issue.

Yes, and if you go back three or four years and look at the numbers from that segment, they are significantly more profitable than they were a few years ago. We've had some great activity in that business to improve the margins and that's continuing. So, I'm not concerned about it at all.

Okay, great. Thank you very much for taking my questions.

Scott Graham, BMO Capital Markets.

So, I have some questions around the margins; maybe just gross margin first. It seems to me as if you are going to end the year up about 70-ish basis points in gross margin, which is actually less than pricing. So, if supply chain initiatives impact the gross margin as they typically do, and those are proceeding reasonably well for you, what's on the other side of the [equal] sign here? Is mix on the negative side for you? Can you square that for us?

No, I think on the negative side is the commodity cost inflation. That's one of the items. So, while we have positive results in line with our expectations from the supply chain initiative, I think commodity price inflation has been a little bit higher than we had expected. And that offsets either supply chain improvements or the price increase that you get.

I guess then -- that answer doesn't surprise me. But I guess then your strategic pricing is away from the whole commodities inflation thing -- would suggest to me that -- because you are re-pricing items within your portfolio. So why wouldn't we look to increase prices further with the commodity inflation backdrop?

Well, I think you will see that down the road, but there's a time lag where in some cases it requires us -- we've got to give 90 day notice for price increases and some of these contractual obligations we just can't immediately react. So there's typically a time lag of three months and in some cases six months.

So you have increase prices beyond strategic pricing?

Oh, yes.

Okay.

When you look at some of our distribution businesses, they are going out with price increases January 1. I think it's around 3% price increases. So, we are actively managing that.

Okay, great. Are there any other businesses that you are going out with pricing?

Oh, yes.

Yeah, all of them pretty much.

Great, great.

What we try to do is take an offset what we see for -- everybody wants a raise every year too. So, we have to offset the wage increases and the commodity increases with our general price increases and we are trying to use a strategic pricing to expand the margin a little bit.

So, that's -- but we go after price increases all the time. I think in my dialogue I mentioned that, with the increase in commodity costs and wages, we are going to have to be -- we are going to have [to out with] price increases.

And Scott, we have communicated that our goal is to increase operating income margins by 100 basis points and I think we have overachieved on that goal.

That's right.

I'm with you. Okay, so that dovetails into the part two here and that is your incremental margin this year has been bouncing around the mid-teens. It looks like it's going to be lower than that in the fourth quarter off your guidance, presumably again because of the commodities inflation.

I guess this is a number that I think we've talked about being mid-20s kind of thing. What do you envision as your incremental margin? And is that a number that will work for 2018?

So, I think we were actually very happy with the incremental margins. And the way we look at incremental margins is you need to take out the year-over-year improvement in revenues Stromag. Stromag was accretive year to date $0.15 a share and that is what you are going to assign to those sales.

And then you look at the remaining incremental sales and you look at the remaining operating income and you calculate the leverage. And I think when we do that math we are looking at around 30%.

Wow, really? That different? Okay. And that's in the number --?

Significantly different. Given the size of Stromag, it has a meaningful impact and so you need to do the math I think this way. Just take out Stromag, assign the $0.15 a share, convert that into operating income and then you've got a better view of the real incremental margins on the base business.

That's excellent -- and I certainly agree with that math. Okay. And if I may, one last question. The organic growth in the second quarter was quite good and then it slowed this quarter. It kind of looks in and around the same level for fourth quarter based on your guidance. Admittedly a tougher comp in the fourth quarter, but in the third quarter it was kind of about the same comp. So, sequentially what slowed in the third quarter relative to the second quarter?

Yes, I will start and then let Christian go. But third quarter historically has seasonality in it for us. So our turf and garden business is very seasonal and in Europe there's more vacations in the summertime than there are in the first and second quarter, so the third quarter in Europe is slower.

And typically we say that 51% to 52% of our top-line comes from the first half and then 48%, 49% in the second half. And then in the fourth quarter we also have more holidays. In the US you have Thanksgiving and Christmas, which we don't see the same number of holidays in the first half of the year.

And then the other factor is what do people do with their balance sheets in the fourth quarter and do they hold back on shipments or do they accelerate shipments and also cash flow? Some of our customers try to manage what's going on with cash flow in their balance sheets.

So, we see -- sometimes they will say don't ship with this until after the first of the year or we want you to pull that in and ship it to us before the end of the year. So, there's a lot going on in the second half of the year that we don't see in the first half.

And if I can add, as Carl mentioned, typically 51% of the revenue in the first half and 49% in the second half. If you look at our guidance at the midpoint of the guidance, that would suggest actually that it's more 50.5% in the first half. So slightly better than historically, which in my mind speaks to some modest strength in the second half.

So you're suggesting that -- obviously holidays fall the same days each year, but it's because of that vagary that things could be a little bit more volatile as a result. Because seasonality is seasonality, right? On a year-over-year basis things are the same, right? Except if how they fall differently by current Easter for example. I'm asking -- you had 6% organic in the second quarter, seasonality factors are always in those numbers. I'm just wondering why it dropped down to 2 in the third quarter.

As I said, we actually believe there is strength relative to the first half in the second quarter if we do the math. And Carl mentioned the positive book to bill ratio, so we don't see any issues with our second half results.

Okay, thanks, guys. I appreciate your time.

(Operator Instructions). Jeff Hammond, KeyBanc.

I got on a little bit late. Did you give the FX revenue contribution?

Yeah, we did. FX contributed 150 basis points and then price was 95 basis points. That leaves for volume about 135 basis points for a total of 3.8% growth excluding the Stromag acquisition.

Okay. And I think you went through the geographies. Can you just hit those real quick again?

Yes, sure. North America was down 2.6%; Asia was strong, 29.5%; and Europe was strong, up 2.7% and that excludes foreign currency impacts.

Okay, and so what's going on in North America where it is down -- I mean I think you said distribution slightly up? It seems like the distributors are reporting mid-single-digit growth. So what's been the drag in North America?

So there's a couple things. One is the wind business, we think it's more timing and it's not -- that long-term this is not an impact. But wind was down and that was offset by wind in China. So, if you look at the total wind business it was about flat, but it was down in US and up in China.

Our Kilian business, we don't have a significant amount of sales in auto, but we do have an auto business and it's a very limited number of programs that we are on. And one of the programs is going away and that will be fully offset in 2019. But in the changeover from one program to another that impacted us in the third quarter.

And then turf and garden in North America was down some, offset by some new programs in the rest of the world. But that was down a little bit and that was -- it's flat year-over-year but it was much more front end loaded this year in North America. So still optimistic there, but those are the three big things, Jeff.

So, North America distribution seems at least relatively stable or growing at a decent clip?

Yes, North America distribution, and we've built some backlog in that. They service some OEMs for us too. And it looks like the OEM business through our distributors is picking up a little bit.

Okay great. And then can you just address -- what are you seeing in the pipeline? A lot of companies are citing expensive valuations. But just it seems like you've done a great job with Stromag, balance sheet is in pretty good shape, hopefully delever. What's the appetite and the pipeline? Thanks.

Yes, I think the pipeline is better than it has been for the last couple years, but the multiples are extremely high. So, we are going to be very disciplined and we are going to make sure that we buy the right companies and that we don't overpay for them.

So, while the environment seems to be getting better as the economy picks up and people are probably a little more willing to sell on an upward curve rather than a downward curve, the prices certainly haven't changed at all.

And if I can add, we expected actually a pickup in activity in the first quarter of next year, but it started earlier. I think people, as they approach year-end and they get a good forecast for what earnings are going to look like for this year, they initiated these processes earlier than we anticipated. So, activity is good, as Carl says, but multiples in our space, we've seen transactions at 12, 13, 14 times and that is very high.

Thanks, guys.

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, Christine. And I want to thank you all for joining us today and we look forward to speaking with you next quarter. And I expect we'll see many of you at the upcoming fall conferences. Have a great weekend. Thank you.

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.