Altra Industrial Motion Corp.
Q1 2017 Earnings Call Transcript

Published: 28 Apr 2017

[Operator:]

Greetings and welcome to the Altra Industrial Motion First Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. An interactive question-and-answer session will follow formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host Mr. David Calusdian. Thank you. You may begin.

[David Calusdian:]

Thank you, Matt. 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 and Presentations in the Investor Relations section. Please turn to Slide 1. During the call, management will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are inherently uncertain and investors must recognize that events could differ significantly from management's expectations. Please refer to the risks, uncertainties and other factors described in the company's quarterly reports on Form 10-Q and 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 intent to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. On today's call, management may refer to non-GAAP diluted earnings per share, non-GAAP income from operations, non-GAAP net income, non-GAAP gross margin, non-GAAP operating working capital, non-GAAP EBITDA 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 on the financial tables of the Q4 2016 financial results press release on Altra's website. I'll now turn the call over to Altra's CEO, Carl Christenson.

[Carl Christenson:]

Thank you, David, and good morning everyone. Please turn to Slide 2. We began 2017 with a strong first quarter. We had record sales and record recurring EPS. As I mentioned during our last call, incoming orders in the fourth quarter of 2016 were disappointing. However, incoming orders picked up nicely at the beginning of the year and have remained at a healthy level. Shipments lagged slightly, but we had a strong March as we gained momentum through the quarter. Our sales performance met our expectations as we reported 19% overall growth when you include the Stromag acquisition and a negative effect of foreign currency translation. Without the impact of Stromag, volume was up 70 basis points and price contributed 90 basis points. These were partially offset by a 150 basis point headwind from foreign exchange. On the bottom line, we drove a 6% increase in GAAP EPS and a 39% increase in recurring EPS, which was better than we had expected. Over the past two years while several of our key end markets were particularly soft, we were able to make substantial progress on the strategic initiatives we launched to improve our cost structure. We've been saying for some time that the results of our three strategic initiatives, consolidation, supply chain enhancements and pricing would result in very strong operating leverage once our markets began to rebound and we started to see that in our Q1 results. Our market still has a way to go, but we are highly confident that what we have achieved during the past two years will have a significant positive effect on our profitability moving forward. The consolidation effort we outlined at the end of 2014 is nearing completion. At that time, we said that we plan to close 8 to 10 facilities with a total annual savings of approximately $7 million. We have now consolidated eight facilities including two in the first quarter. We anticipate closing one additional facility this year and we will have exceeded our annual savings goal of $7 million. We are also in the process of selling two properties. In addition, we will have eliminated approximately 280,000 square feet of space without reducing any manufacturing capabilities or capacity. Our teams have done a tremendous job in getting this all done in a relatively short period of time. Having completed these consolidations during the industrial downturn, we have a much-improved infrastructure to capitalize on growth initiatives as our markets rebound. Along with our consolidations, our pricing improvement strategy and supply chain initiative will have a positive effect on our results going forward. As I mentioned during Q1 -- as I mentioned during Q1, price had a 90-basis points effect on sales and we've been able to increase price on a net basis in the range of 70 to 90 basis points each quarter since the beginning of 2016. We're also making excellent progress towards achieving our goal of developing a world-class supply chain management organization and we see significant potential to drive profits in this area over the next few years. Our pricing and supply chain initiatives are becoming an integrated part of our operational culture. As such, we will not be providing regular quarterly updates on the progress of these efforts going forward, but know that they will be making a significant difference in our ongoing performance. Before I move on to our review of the markets, I would like to comment on our Stromag acquisition, which we closed at the beginning of the first quarter. Please turn to Slide 3. Stromag is 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 highly complementary suite of products. In these early days, the acquisition has everything that it would be. The integration is going very well and our expected accretion from Stromag for the year is on track. As I mentioned on our last call, our cultures are a strong match and the teams are working very well together. Just last week we held a joint cross-selling training session for the sales force and this week we have tremendous interest at the Hanover Massa, which is the largest trade fair for our industry in the world. Individual sales personnel from both organizations are excited to be able to broaden their product offerings. In addition to the cross-selling, Stromag also provides us with the opportunity to expand our geographic presence in Europe and Asia, particularly in India. A significant part of the integration process is the move of portions of Stromag manufacturing, which have been co-located in four of it's former owner’s facilities to our own. Since the close of the acquisition on December 30, we have already completed the move of Stromag manufacturing in China, Brazil and one location in the U.S. to our facilities and we expect to have the final location in the U.S. moved by the end of June. I'd like to emphasize that despite the potential for distraction with the three facility moves in just over three months, Stromag's performance in Q1 was strong. We had also mentioned that we saw an excellent opportunity to leverage cost synergies through the application of our operational excellence and procurement programs. The synergies we had expected to secure in year one has already been secured. We're obviously very excited about the potential for Stromag and look forward to their contributions in the quarters and years ahead. With that, let's turn to Slide 4 and review our end markets. We'll begin with distribution, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. Distribution was up in the low single digits year-over-year and up in the low double-digit 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 down in the single digits year-over-year and what we see as a relatively stable market. We continue to expect this market to be similar to 2016 as we come off two record years. Farm and Ag sales were very strong in the quarter both year-over-year and sequentially. That said, the fundamental market dynamics are not robust and it continues to be affected by low commodity prices and relatively young fleet. However, the prevailing sentiment on the market is less negative than it has been in some time. While materials handling got off to a slow start for the year with revenue down slightly from a year ago, we expect 2017 overall to be similar to last year. Now turning to energy, energy overall was down slightly from a year ago. Looking at oil and gas specifically, we're growing more confident that we reached the bottom and expect this market to continue to improve, especially in the aftermarket as rig count improvements. We're encouraged by what we have seen in the past few quarters and are cautiously optimistic that orders will strengthen during the year. After a good performance in Q4, conventional power generation was down in Q1. We expect this was a timing issue and believe that the market has stabilized and that 2017 will be flat with 2016. Sales into the renewable energy market were down in the low single-digits including a negative currency effect. We expect 2017 to be flat to slightly up from the strong market performance in 2016. The metals market appears to be recovering although because of long lead times, our actual sales were down in the quarter. We expect to see sales improve for the balance of the year. Mining sales were down sequentially, but up again year-over-year and we're seeing some increased activity in the market and growth is primarily being driven by replacement parts business. We're hopeful that orders for components for new equipment will also improve later in the year. With that, I'll turn the call over to Christian to review the numbers before returning for a summary and your questions.

[Christian Storch:]

Thank you, Carl and good morning, everyone. Please turn to Slide 5. We're off to a good start in 2017 with a strong first-quarter performance. Our gross profit margin continued to improve by 40 basis points, when compared to the prior year's first quarter. Excluding the inventory step-up related to the Stromag acquisition our profit margin was 31.8%, an improvement of 150 basis points. Non-GAAP operating income was 10.6% of sales for the quarter compared with 9.1% in the prior year quarter and improvement of 150 basis points. For the first quarter of 2017, GAAP diluted EPS was $0.36 versus $0.34 a year ago, non-GAAP diluted EPS increased to $0.53 from $0.38 a year, the $0.53 had a $0.03 benefit from lower than expected healthcare cost. We expect that this healthcare cost trend will not continue for the balance of the year. Q1 2017 non-GAAP EPS excludes restructuring and consolidation cost, loss on extinguishment of debt, inventory step-up and acquisition-related expenses. Geographically, excluding the effect of foreign exchange in Stromag North American revenues were flat. European revenues were up 6.5% and sales to Asia Pacific and other geographies were up 3.8%. Please turn to Slide 6 for a discussion of our segment performance. Please note that segment results are not adjusted for one-time items. For the first quarter of 2017, net sales in our couplings, clutches and brakes segment were $106.2 million up 40.5% when compared with the prior year. Organic sales growth excluding acquisition of Stromag and the negative impact from currency exchange, sales were up 3.8%. This segment has Altra's highest exposure to the oil and gas, metals and mining markets. Segment operating income was $8.3 million up $2.1 million from $6.3 million a year ago. Net sales in electromagnetic clutches and brakes segment was $63.9 million up 11.5% from the quarter of 2016. Organic sales growth excluding the acquisition of Stromag and the negative impact from foreign exchange was 3%. This segment is benefiting from Altra's facility consolidation and procurement efforts. As a result, segment operating income as a percentage of sales improved to 11.9%. Finally, the net sales in the gearing segment were $47 million compared with $48.9 million in the year ago quarter. Segment operating income decreased 5.2% to $5.5 million and $5.8 million a year ago. Segment operating income is now 11.7% of sales compared with 11.9% a year ago. This segment is not impacted by the acquisition of Stromag. Please turn to Slide 7. Our balance sheet remains strong. Our cash balance was $52.9 million compared with $69.1 million at the end of the year. The decrease was partially due to the paid down of $8 million of revolving debt and the final payoff of the convertible debt of $1 million. Book equity was $347.4 million compared with $283.3 million at year-end. The increase was due to net income and the conversion of the convertible notes, partially offset by the dividends. Our balance sheet strength provide us with enough dry powder to execute on bolt-on acquisitions. In terms of use of cash for 2017, we will continue to favor debt pay down over share repurchases. We did not repurchase shares in the first quarter. Due to the conversion of the convertible notes, average diluted share count increased to 20.9 million. We expect the average diluted share count to increase to approximately 29.3 million by the end of this year. Capital investments totaled $7.3 million for the quarter, below depreciation and amortization of $8.8 million. Please turn to Slide 8 and our guidance for 2017. As a result of the company's strong first-quarter results, Altra is raising its 2017 full year guidance. The company now expects earnings to be in the range of $1.70 to $1.80 per share, up from prior guidance of $1.64 to $1.74 per share. Altra now expects non-GAAP EPS to be in the range of a $1.83 to $1.93 per share. Sales are expected to be in the rate of range of $840 million to $855 million for the full year 2017. The company expect an effective tax rate of approximately 29% to 31% and we continue to expect expenditures in the range of $25 million to $30 million. Depreciation and amortization is now expected to be in the range of $35 million to $37 million down from $38 to $42 million. With that, I will turn the discussion back to Carl.

[Carl Christenson:]

Thank you, Christian and please turn to Slide 9. The first quarter 2017 represented an important turning point for Altra. Our facility consolidation effort is largely complete and our supply chain and pricing improvement initiatives are now ingrained in Altra's operational culture. Because of the very hard work that the team accomplished in a relatively short period of time, we now have the opportunity to capitalize on what appears to be the beginnings of an upturn in certain key end markets. We don't expect that sales to these end markets will ramp up dramatically, but it appears that we are finally coming off the bottom. We also expect to have significantly better operational leverage with our improved cost structure. The Stromag acquisition is very exciting and we're encouraged by its performance thus far and the speed and efficiency of the integration process. Going forward we'll continue to focus on long-term growth both organically and through M&A. We have a strong balance sheet and we're in a good position to act on potential bolt-on acquisition opportunities. Thank you for your continued support of Altra and we'll now open up the call to your questions. Operator?

[Operator:]

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator instructions] Our first question comes from Scott Graham from BMO Capital Markets. Please go ahead.

[Scott Graham:]

Hi. Good morning

[Carl Christenson:]

Good morning, Scott.

[Scott Graham:]

So, I wanted to ask a little bit about the guidance and what you're thinking I heard you go through in the nice detail you went through about what you expect going forward with the end markets of course and really kind of the only thing I heard was that first quarter benefited from healthcare whereas you don't see that recurring. So, I am wondering we had a really terrific operating leverage in the first quarter. It doesn't sound like you're expecting the same level of operating leverage in the next three quarters. Can you talk about that a little bit?

[Christian Storch:]

Yes, so typically the first half of the year is stronger than the second half and right now we assume that that pattern will also be true this year. Revenues typically in the first half are around 51% of annual sales and profitability in the first half of the year might be 53%, 54% typically in the first half of the year. So, if you make that assumption that this pattern will continue this year, I think you get inside of the range for topline and EPS guidance. We do think that as we go through the year, we'll continue to see the strong improvement in gross profit margins and operating income margins, but we also feel that that is reflected in the guidance.

[Scott Graham:]

Fair enough, Christian. The first quarter, when we ex out, let's call them acquisition related expenses, both let's say operationally and purchase accounting wise was Stromag accretive to earnings?

[Christian Storch:]

Stromag added around $0.05 in the quarter.

[Scott Graham:]

Excluding those items or including those items?

[Christian Storch:]

Excluding those items.

[Scott Graham:]

Got you. And last question is what level of sales growth, it's sort of like dovetails off of the first question, but what level of sales growth do you guys think you need organically to get better operating leverage on the SG&A? It was good, but as sales progress, what sort of like the magic number there, is it 3% or 4%, where do you see that as really being a driver to lower SG&A on a percent of sales basis?

[Christian Storch:]

Yes, somewhere between 3% and 5% Graham. We have very strong performance in Europe and it depends on where that growth is. If it's in our oil and gas and our mining business these are extremely profitable pieces of our business. So, if they deliver 3%, 4%, 5% growth we'll see tremendous leverage for those businesses.

[Scott Graham:]

Got you. Thank you.

[Operator:]

Our next question comes from Matt Duncan from Stephens. Please go ahead.

[Matt Duncan:]

Hey, good morning, guys. Good job this quarter.

[Carl Christenson:]

Thank you, Matt.

[Matt Duncan:]

So, Carl, first question you alluded to this in your prepared comments, but the order trend it sounds like it improved through the quarter, end of March and maybe stayed strong. If I look at what you did with your revenue guidance, you didn't take the midpoint up by as much as you beat revenues by in the quarter, which doesn't seem to necessarily marry up with that good order trend. So, is this just a little bit of conservatism maybe we're still a little gun shy trying to make sure that this this recovery is going to stick, is that sort of how I should read that?

[Carl Christenson:]

Yes, so it's still choppy out there and what we saw was the fourth quarter incoming order rates were awful. I think we weren't alone in that but the incoming order rate was not very good in the fourth quarter and right after the first of the year, it ticked up a little bit and it's been in a level since then. So, we haven't seen a tremendous acceleration through the quarter in incoming orders. We do think that the inventory in the channels in some of these later cycle end markets are in line and so we're now starting to see demand reflect what's actually going on out in those markets, but it is still choppy. So, we don't see a lot of benefit in saying that things are going to get a whole lot better through the year. And there are also a few end markets -- there is also a few end markets that people are concerned about.

[Matt Duncan:]

That was kind of where I was going next, what markets are you seeing the strong order book from and where are you seeing softness still?

[Carl Christenson:]

Yes, so I think the oil and gas we're starting to see some really good particularly replacement parts business and the rig count continues to go up. So that looks, we're very optimistic there. Mining we've seen some -- again some very good replacement parts business and we had some good proposals on some new build equipment. So that's very encouraging and it is an indication that the inventories out there are starting to get in better shape and I think the ones on the downside that I would have concern about would be auto. We don't have a big auto business, but certainly the sentiment around autos is not what it was a couple years ago. And then I think in some of the renewable we know it's going to start to taper off a little bit and we won't get the same growth that we've had there. So, there is a few markets that we're concerned about and it is still choppy. When you look at the incoming order rate, even in some of the strong markets, it will be good one week and then soften up another week.

[Matt Duncan:]

Okay. And then last question and I'll hop back in the queue here. The difference in the guidance in terms of a reported earnings and an adjusted earnings, there was a $0.17 gap between those two numbers this quarter, but the full year guide there's only a $0.13 gap. So, I am trying to figure out what I'm missing there. How is that going to reverse and get lower as the year goes on?

[Christian Storch:]

It's not going to reverse. So, we're going to check that and make sure that all numbers are right. We'll get back to you on that. We expect that we had about $0.02 or $0.03 for the rest of the year, in terms of restructuring, acquisition cost maybe a $0.01 and then that should be it.

[Matt Duncan:]

Okay. Christian because as I look at the guide it's a $1.72 $1.80 on diluted earnings and a $1.83 to $1.93 on adjusted earnings. So that's only $0.13 and you're already at $0.17 so…

[Christian Storch:]

Yes, we'll check that.

[Matt Duncan:]

Okay. Thanks.

[Operator:]

Our next question comes from Jeff Hammond from KeyBanc Capital Markets. Please go ahead.

[Jeff Hammond:]

Hey guys. Sorry if I missed this, but you mentioned that healthcare dynamic, did you quantify that and just can you give a little more color there?

[Christian Storch:]

$0.02 a share, was the majority of the $0.03 that I mentioned was healthcare that was stop-loss related where we got refunds from insurance for cases where we had the stop-loss and that is an event that doesn't occur every quarter and we cannot expect that to continue.

[Jeff Hammond:]

Okay. So, the guidance change really seem to reflect that and the lower tax and then a little bit better sales or start to the year?

[Christian Storch:]

Yes.

[Jeff Hammond:]

Okay. Can you give us a sense of like you're still pointing to this low single-digit growth rate, can you just give us give us a sense if you look at the orders in total for 1Q what kind of growth rates are you seeing all in and what's the book-to-bill look like?

[Christian Storch:]

The book-to-bill is pretty solid. We don't -- we don't give the you numbers Jeff on orders primarily because some of them are not contractual requirements. They're scheduled orders from big OEMs but I just don't feel comfortable quoting numbers based on something that's not a contractual requirement. But I think that the incoming, just I think the incoming order rate is reflective of what we've put out in the guidance. We're not seeing bookings that wildly exceed with the guidance that we put out there. They're solid and they're good and it supports the guidance, but not wildly in excess of the guidance.

[Jeff Hammond:]

Okay. And then great color on Stromag, it sounds like you guys are off to an early start, maybe just qualitatively any negative surprises early on or what conversely is really are you feeling better about early days?

[Carl Christenson:]

I think the cultural fit -- we think alike the two businesses do and then an acquisition in my mind, that's one of the biggest risk is that, it's just a different culture and it's a really good fit. The other thing that's really encouraging is the enthusiasm of the sales teams and they are very excited to be part of the Altra organization and have the additional products and the opportunity to take those into the customers and that's a great fit. And then also just digging in on the supply chain issues and where we can work together to save some money there. The two teams are getting right together and digging in and working really hard on it. So, it's just really encouraging that at the outset people just started working together.

[Jeff Hammond:]

And then just finally, is it fair to say like if we characterize things versus two three months ago that oil and gas clearly feels better and maybe you feel a little bit better about distribution and most of the rest is unchanged?

[Carl Christenson:]

Yeah, I think that's fair. I think mining I feel better about too and I feel much better about the inventory positions in some of those markets and I think I am probably a little more optimistic that steel is going to be is -- going to get better in the year.

[Jeff Hammond:]

Okay. Thanks guys.

[Carl Christenson:]

Thanks Jeff.

[Operator:]

[Operator instructions] And our next question comes from Bhupender Bohra from Jefferies. Please go ahead.

[Bhupender Bohra:]

Hey. Good morning, guys.

[Carl Christenson:]

Good morning.

[Bhupender Bohra:]

So first question on the -- let's talk about the end markets here, on the oil and gas, I just want to understand something, we're seeing the rig count kind of improve here, could you talk about your exposure? Are you on the completion side or your products actually go on the production side, which lags the rig count number. So, if you are on the completion, I think you should be benefiting right now and I think Christian you talked about like you haven't seen that kind of activity, but even where it is right now.

[Carl Christenson:]

Yes, we're kind of heavily weighted towards the upstream operations and probably 75% of our revenues are upstream and it's across a wide variety of equipment. So, we're on the drilling rigs. We're on mud pumps. We're on fracking equipment. We're on gas transportation, gas compressors. So, it's a huge huge variety of equipment upstream and we are seeing the benefit is the rig count goes up, it does translate fairly quickly into orders and business for us. So, it's a pretty quick turnaround.

[Bhupender Bohra:]

Okay. Okay. Got it and on the renewables now, that business has been pretty nice for you over the last few years talking about some choppiness here, could you talk -- I think China was a big contribution over the last may be year or two, just talk about like how that business or the end markets from a global perspective where you see the growth and where you see the headwinds?

[Carl Christenson:]

No, I think we think that primarily wind is where we are, but that's a really solid market. We just don't think it's going to grow like it has over the last few years and it's global for us. We're in China, we're in India, we're in Brazil, we're in Europe and in North America. So, it's really a global business for us and I think I would characterize as what we expect is that it's going to be flat to maybe slightly up for the year and some of the downturn was impacted by exchange rate from the euro, and our European business, but from a unit standpoint, it's still very, very good.

[Bhupender Bohra:]

Okay. And lastly, just last question on price increases, I think this strategic pricing, I think most of that is done, but you're still seeing the benefits of that pretty nicely over the last several quarters now. Could you talk from a geographical perspective, I don't know if that makes sense, but whether you're seeing more of that price increase come from the European geography or from the North American customers, if you can give us some color on that thanks.

[Carl Christenson:]

I think we're seeing it globally. So, we've gone through our businesses with the training and implementing the models that we've created and gone through the entire business one time. So, it is across the globe and it never ends. We continue to work the models that we've created and do the analytical work to continue strategic pricing on and what we've seen is it's now become part of the culture. We're just embedded in the businesses, but it will continue forever so a lot of different end items and a lot of different customers. So, to analyze where the pricing is each end item and each customer is something we have to do always.

[Bhupender Bohra:]

Okay. So, the 90 Bps which you mentioned I don't know if you look at it on a geographic basis or region wise or you look at it like on a global basis, I think that's what you're saying.

[Carl Christenson:]

Yes.

[Bhupender Bohra:]

Okay. Okay. And…

[Carl Christenson:]

If you look at it on a global basis and that's becoming more difficult to separate the strategic pricing initiative from normal price increases. So, it becoming one process. So, it will get difficult to split it out as it become more integrated into the businesses.

[Bhupender Bohra:]

Okay. And if I can include one more here on Bauer, now we haven't talked about that business since 2011 acquisition here. where the demand level or the rates, order rates have been over the last few quarters now maybe in 1Q can talk about. And just give us a sense of like where the sales peak for the business and where they're right now, thanks?

[Carl Christenson:]

Bauer had a sales quarter of 3% in the first quarter. They're starting to approach a 10% EBIT or 15% EBITDA for that business. So, they're getting very close to all the target numbers we expect by the end of the year they will be ahead of our target numbers. The big contributor this year to the performance improvement will be the fact that we're starting to insource the manufacturing of your those that will be a large savings for that business once that is up and running in full-scale, there should be that target.

[Bhupender Bohra:]

Okay. Thank you.

[Operator:]

Thank you. This does conclude the question-and-answer session. I would like to turn the floor back over to Mr. Christenson for any closing comments.

[Carl Christenson:]

Okay. And I would just like to thank everybody for participating and we look forward to talking to you at the end of the end of the second quarter. Thank you. Good bye.

[Operator:]

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