Altra Industrial Motion Corp.
Q1 2015 Earnings Call Transcript

Published: 1 May 2015

[Operator:]

Greetings and welcome to the Altra Industrial Motion First Quarter 2015 Financial Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Andrew Blazier with Sharon Merrill Associates. Thank you, Mr. Blazier. You may now begin.

[Andrew Blazier:]

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'll 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, 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 free cash flow, and non-GAAP operating working capital. 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 Q1 2015 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 Andrew and please turn to Slide 2. On today’s call I will go through an overview of our performance during the quarter and the major driver of that performance and then provide an update on the actions we are taking to address these conditions. I will also provide my usual review of our end market. And then Christian will go over the financial results and I will close with the summary of the quarter. Our first quarter performance reflects the global economic environment and end market sluggishness that we projected at the beginning of this year. We said on our Q4 call the 2015 would post significant challenges for us and that is indeed the case thus far. We continue to face unfavorable conditions in our oil and gas, the agriculture and mining end markets as well as headwinds from foreign currency translation. Oil and gas is performed about as we had expected well above Ag and mining or down more than we had anticipated. In addition, Christian will discuss how the dollar strengthen in the quarter compared with the $1.12 rate we discuss to month ago and how this negatively impacted the top line. On our last call we also slighted the deteriorating conditions in Europe and Russia in our guidance. But these have been less of here than we expected. Primarily as a result of these conditions revenues decline 7.9% from the first quarter of 2014 to $193.4 million. Net of acquisitions net sales were $191 million. Gross margin was positively impacted by our strategic pricing initiative which added above 50 basis points year-over-year. However operating income decline from the prior year quarter primarily because of the decrease in sales and the impact of foreign exchange. In turn non-GAAP earnings decline 15% year-over-year to a $11.1 million and $0.42 per share. While we continue to face end market and currency headwinds, we are taking a actions to reduce costs and align our operations according to current levels of demand. We are also working with our suppliers to ensure we are realizing price reductions commensurate with commodity cost reductions and we are managing labor costs through reduced working hours. In addition, we have completed the previously announced actions to reduce costs through headcount reductions primarily at the Bauer and Svendborg operations. This month we will complete the announced facility consolidation at Bauer in Germany which over the last few years has resulted in combining six facilities into one complex and one office building. In total, restructuring costs were $1.8 million during the first quarter. As I mentioned last quarter, we are undertaking actions including discretionary cost reduction to reduce SG&A expense. We are also looking to implement additional initiatives to help us achieve our long-term operating margin objective. Please turn to Slide 3 for a review of our end markets. Let’s begin with distribution channel which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. In the first quarter distribution revenues were down slightly on declines primarily related to distributors with exposure to oil and gas, mining and steel. In Turf and Garden where we have a significant share of the market sales were up against the strong first quarter a year ago. This market performed very well in our seasonally strongest quarter as manufacturers gear up for the spring selling season. Turf and garden is expected to do well this year on improved housing starts and increased housing disposable income in the US. The first quarter demonstrated this strength. As I mentioned at the start of the call, Ag underperformed against our already reduced expectations as demand in this market deteriorated considerably in the first quarter. We began is several new Ag projects last year but demand for these programs have been significantly reduced. Transportation was unchanged this quarter as increased sales in marine and rail were offset by lower sales on the automotive programs we participate in. Overall, we continue to expect transportation to be up slightly in 2015. The materials handling market was down from a year ago. Sales for conveyors, forklifts and elevators declined primarily as a result of the growing strength of the US dollar. Crane and hoist demand was up modestly. Turning to the energy market, energy overall was not down as much as we expected. Our projection at the start of the year was that Altra's revenues from oil and gas will be down 25% in 2015. Oil and gas performed better than that this quarter but continued to weigh significantly on our performance. Alternative energy was up modestly, driven by demand in the wind market in Europe and Asia. We still expect alternative energy will perform well in 2015, particularly in China. Power generation revenue was down from the first quarter of 2014. In metals, sales are down from a year ago, as we said last quarter some demand for our products in this market is tied to pipes used in oilfields and it appears continued sluggishness in oil and gas has had an indirect negative effect on the demand for steel. Mining continued to be weak and was down both year-over-year and sequentially. We have seen an increase in the number of proposal requests in this market during the past several quarters, but this has not translated into an increase in orders. Sales in aerospace and defense were up strongly in the first quarter following a solid fourth quarter. Overall, we still expect this market to be largely unchanged in 2015. In terms of geography, excluding the effect of recent acquisitions and foreign exchange, North America and Europe were down from a year ago, sales in Asia were up slightly. The outlook for the global economy has improved slightly, although we remain cautious on both Europe and Russia and the outlook for the U.S. has softened recently. With that, I will hand the call over to Christian and then close with a brief discussion of our other initiatives. Christian?

[Christian Storch:]

Thank you, Carl, and good morning, everyone. Please turn to Slide four. As Carl said and as we expected, our performance during the quarter reflects the challenges from the global economy in some of our largest end markets. For the first quarter of 2015, non- GAAP EPS was $0.42 versus $0.48 per share a year ago. I would note that the higher medical costs we discussed in this previous quarters receded during the first quarter, although it is unclear whether medical costs will continue to follow that downward trajectory in coming quarters. Looking at the top line, foreign exchange rates had a negative impact of approximately 560 basis point driven by continued strength in the U.S. dollar while price added 60 basis points. Volume declined 410 basis points as a result of the slowdowns in oil and gas, AG and mining. Net of acquisitions, sales declined 9.1% year-over-year. Geographically excluding acquisitions and the effect of foreign exchange, North American revenues declined 4.6% year-over-year while European revenues decreased 2.9%. Sales to Asia Pacific and all other geographies increased 1.6%. Restructuring charges for the quarter total $1.8 million and we should start to see the benefits of the resulting lower headcount later in the year. However these reductions had been effected into our guidance. We expect to pursue our cost reduction activities as we progress through the year. Interest expense was $3 million essentially unchanged from the prior year. We recorded a tax rate of 30.6% during the quarter compared with the tax rate of 29.4% in the first quarter of 2014. Please turn to Slide 5 for discussion of our segment performance. For the first quarter of 2015 net sales in clutches and brakes were $101.6 million compared with $113 million in the year ago quarter. The decrease was primarily the result of declines in the agriculture oil and gas in mining markets. Segment operating income was $11.7 million versus $12.9 million a year ago. Net sales in gearing and power transmission component segment were $61.5 million compared with $67.3 million in the first quarter of 2014. The decline was primarily of the result of unfavorable foreign exchange translation, as a result of the segment operating income decline $100,000. Net sales in the coupling segment were $31.9 million, an increase of 2.9% from the year ago quarter. The increase was primarily the result of growth from the Guardian acquisition, which was partially offset by economic weakness and foreign exchange. Segment operating income decline 600,000 largely as a result of margin pressure from the strengthening of the British pound versus the Euro. Slide 6, is a reconciliation of our non-GAAP measures. Please turn to Slide 7. During the quarter the average price of the common - the company’s common stock approximated the conversion price of the company’s convertible notes and therefore the boards were not dilutive for the quarter. During the quarter we repurchase 170,000 of Altra stock for total of $4.6 million under our $50 million stock buyback program that expires at the end of 2016. Since the program’s inception last year we have purchase approximately $22 million, or 716,000 shares another program. You will continue to repurchase Altra shares from time-to-time as market conditions warrant. Slide 8, reviews our working capital performance, our working capital improvement efforts contributed to the company’s operating free cash flow for the quarter Altra generated free cash flow of $5 million. Please keep in mind that our free cash is typically higher in the second half of the year. Capital investments during the quarter totaled $7.7 million as we are completing the construction project at Bauer in Germany. Depreciation and amortization was $7.5 million in line with our expectations. Please turn to Slide 9 and our guidance for 2015. Altra is currently forecasting sales in the range of $760 million to $780 million and non-GAAP diluted EPS in the range of $1.60 to $1.75. This guidance includes the expected savings from the restructuring actions taken in the first quarter. The guidance now reflects a stronger dollar and larger than expected weakness in the end markets discussed today. The Company continues to expect its tax rate for the full year to be approximately 30% to 32% before discrete tax items. Altra also expects capital expenditures in the range of $24 million to $26 million and depreciation and amortization in the range of $30 million to $32 million. With that, I will turn the discussion back to Carl.

[Carl Christenson:]

Thank you, Christian. And please turn to Slide 10. We continue to make progress on our strategic initiatives during the quarter. As I said, strategic pricing added about 50 basis points to gross margin while the Bauer consolidation is on schedule and should be completed this month. As Christian mentioned, we continued to return capital to shareholders buying back $4.6 million of Altra shares during the quarter under our stock repurchase program. In terms of M&A our balance sheet is solid and the market for potential acquisitions is relatively open. Although as I mentioned last quarter, valuations are fairly steep so we are being selective as we look at potential deals. Overall the year is shaping up largely as we expected. Some markets are performing below our expectations while others are exceeding our initial projections. We believe we are being aggressive with our approach to profitability and we believe this is an appropriate time to right size our operations. We look forward to providing additional insight on our progress when we speak again on our second quarter call. Thanks for your continued support of Altra. We will now open up the call for your questions. Rob.

[Operator:]

Thank you. [Operator Instructions] Thank you. First question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please proceed with your questions.

[James Pickerel:]

Hey guys, this is James Pickerel filling in for Jeff.

[Carl Christenson:]

Good morning, James.

[James Pickerel:]

Good morning. So can you just provide additional color around the restructuring actions you took in the quarter and maybe just what you expected to the remainder of the year? And within that, maybe the expected cost and time frame of the savings you can generate?

[Carl Christenson:]

Yes, we reduced our headcount globally by about 120 heads which is slightly below 3% of our global headcount. A lot of the action related to Europe headcount reductions at Bauer and at Svendborg. And then the remainder was also in North America as well as in other parts of Europe. That was the main goal of the restructuring so far is to reduce headcount. We anticipate further headcount reductions as we go through the year and we will update you on future calls relative to those activities.

[James Pickerel:]

Okay. And then just on FX, obviously the environment from a translational top line perspective is challenging, can you just maybe speak to the transactional side are there inherent benefits given your position in Europe? Any color there would be helpful.

[Carl Christenson:]

In most cases we sell in the jurisdiction that we manufacture. We have some challenges in the UK where we sell to European customers in Euros and as those - as those currencies have changed there is some margin pressure on a couple of our businesses in the UK. Other than that, we don't have a lot of transactional exposure. The Canadian dollar and the weakness in the Canadian dollar I think has hurt us slightly as some of our competitors are importing from Canada and that has had a slightly negative impact but nothing significant.

[James Pickerel:]

Got it. I will get back in queue. Thanks.

[Carl Christenson:]

Thank you.

[Operator:]

And our next question comes from the line of Ryan O'Donnell with Robert W. Baird. Please proceed with your questions.

[Ryan O'Donnell:]

Good morning, guys. Thanks for taking my questions.

[Carl Christenson:]

Good morning.

[Ryan O'Donnell:]

Can you guys just kind of walk through the progression month by month through the quarter and within that maybe the key end markets, AG, mining, oil and gas, how they trended?

[Carl Christenson:]

Yes. Through the quarter the incoming order rate picked up. So we saw a little bit of acceleration. Not significantly, but it was noticeable. Oil and gas, the - what we expected to see was that the large OEs it we service would want to push out orders and cancel orders as you know as the price cratered at the end of the last year, beginning of this year. And we didn't see that. They actually, the backlog stayed about what it was. We saw some push-outs, but not as many as we expected. So through the quarter we had, you know, the backlog to work off of and the shipments into the oil and gas industry were better than we had anticipated. However, the incoming order rate was not. I mean it was what we expected down in that 25% range that we stated and so we expect the second half of the year as we work through the backlog will be worse than the first half of the year in oil and gas. Those are probably the two noticeable trends that would have happened in the quarter. Other than that, I think things were reasonably close to what we anticipated and reasonably stable.

[Ryan O'Donnell:]

Okay. That makes sense. And then you guys mentioned stabilization in Europe and Russia kind of relative to your expectations. Maybe just what you are seeing in those markets and how they will kind of play out through the year as you see it today?

[Carl Christenson:]

Well, I think it’s just the weakness in the euro has given that economy a little bit of a boost there so it started to improve a little bit and certainly stabilize. And then Russia we have seen that demand stabilize also I think as things have settled down a little bit there. It gets hot and cold, but certainly the demand for some of the products we sell there has stabilized at a much lower level than it was two years ago, three years ago, so - but it is not continuing to deteriorate.

[Ryan O'Donnell:]

Okay, thanks a lot guys.

[Operator:]

Our next question comes from the line of Matt Duncan with Stephens. Please proceed with your question.

[Unidentified Analyst:]

Hi, good morning, guys. This is Will on the call for Matt.

[Carl Christenson:]

Welcome.

[Unidentified Analyst:]

Hey, just as a follow on to the previous question with the quarterly trends I'm kind of wondering how April shaped up. Did you see a slight pickup from the March levels or how are you seeing things now currently?

[Christian Storch:]

It’s not significant change. I think that the levels are about what we saw in March. So certainly not enough of a difference to call a big upturn. And we don't expect that for the year. We are just anticipating that this is going to be a year to focus internally and not expect demand to drive our results.

[Unidentified Analyst:]

Okay. That helps. And I'm curious on the research and development line these expenses jumped about $1 million in the quarter from where they’ve been trending recently. Wondering if that was something one time in nature or if we should expect it to stay around the $4.8 million range throughout the year.

[Christian Storch:]

You should expect that to stay around the $4 million range. It is impacted by the comparability due to the Svendborg activity. We brought the Svendborg reporting in line with the rest of the Altra organization. On a true apples-to-apples basis, I think there was only a slight increase in R&D expenses. So assuming $4 million what you are seeing I think for the right balance of the year is the right thing.

[Unidentified Analyst:]

Okay great thanks guys.

[Carl Christenson:]

Okay.

[Operator:]

Thank you. Our next question comes from the line of John Franzreb of Sidoti & Company. Please go ahead with your questions.

[John Franzreb:]

Good morning, guys.

[Carl Christenson:]

Good morning.

[John Franzreb:]

Could you just provide an update on the healthcare costs? From what I recall the January number is down roughly $100,000. What’s the current run rate as far as down year-over-year?

[Christian Storch:]

So in the first quarter we were down $200,000 from the prior year we just around a 5% decrease. We did get hit in the second and third quarter of last year, the first quarter last year was actually a fairly normal quarter for us. So the big impact was in the second and third quarter. So we are hoping that this trend continues but we can't be sure. We did see a reduction in the number of large claims but we a high deductible healthcare plan so in the early part of the year people are still leading through their deductibles before we get, you know, fully hit. So it as little bit too early to make predictions.

[John Franzreb:]

Okay, thanks for the color. From I recall in the last quarter you kind of mentioned as part of your restructuring actions the possibility of reducing the number of product offerings. Is that something you are still doing? I didn't quite hear that in today's dialogue?

[Carl Christenson:]

I mean we are always looking at that as we try to reduce the number of end items. I think we wouldn't reduce the product offering necessarily but reduce the number of end items and certainly the number of components we manufacture so that activity is constantly going on yes.

[John Franzreb:]

Okay. And then moving to some of the top line. Can you just talk about your distributor customer base what their inventory looks like? Any color there would be helpful.

[Carl Christenson:]

Yes, I think it’s relatively stable it might a tweaked up a little bit. So but I think it’s relatively stable and some of our larger distributors have increase the inventory on some of our items a little bit. But not enough to have driven demand and made a huge change in our top line.

[John Franzreb:]

All right, one last question give the tougher environments are you getting push backs on your pricing strategy?

[Christian Storch:]

Well, I think in the quarter we had about 60 basis points. I think last quarter we had about 80 basis points. So it is becoming a little more challenging but we are still seeing very positive results.

[John Franzreb:]

Okay, thank you for taking my questions, guys.

[Christian Storch:]

All right, thanks, John.

[Operator:]

Thank you. [Operator Instructions] Our next question is coming from the line of Scott Graham with Jefferies. Please proceed with your questions.

[Scott Graham:]

Hey, good morning, guys.

[Carl Christenson:]

Good morning.

[Scott Graham:]

The question - couple of questions that I have relate to the restructuring. Someone asked the question earlier and I was kind of hoping that you would be able to answer, Christian, on the savings that you expect from the headcount reductions? And also if you wouldn't mind adding to that what the savings you expect will be derived from the Bauer consolidation? Maybe those two things in two separate buckets.

[Christian Storch:]

So, Bauer this last step where we are exiting the last two buildings will save about half a million dollars a year. Overall since we started this program and moved from six to now finally two facilities it is about $1.3 million savings. This last phase is about half million dollars incremental to last year. The restructuring itself relative to the headcount reduction, that savings is about in total if you include on an annualized basis around $3 million.

[Scott Graham:]

Got it.

[Christian Storch:]

Now that will not all be available next quarter. In Europe you have termination periods so you will still have for a couple or three months you will have a continued payroll for some of these individuals. But I think starting the second half we should start to see more and more of that benefit rolling in. We are also, as Carl mentioned, very aggressively negotiating with our suppliers. So far we have addressed about $90 million of our spend and with some nice favorable outcomes and we hope that these savings will help to offset the mix changes as oil and gas and mining are very profitable sections of our business [indiscernible] for example is less profitable so we have a mix change that is impacting our performance. That we can use that to offset that impact or mitigate that impact.

[Scott Graham:]

Okay, thank you. Last two questions are is there any way to if we were to look at pricing in total and strip out the 50 basis points from strategic pricing, was pricing stable or has it begun to decline for you elsewhere?

[Christian Storch:]

I think if you strip out the strategic pricing, pricing is stable. We’ve had price increases. We have gone out with price increases on certain products, but the general price increases they are harder to get right now in this environment.

[Scott Graham:]

Understood. Well, it looks to me like the midpoint of your guidance suggests only a slight decline in our earnings per share for the year, so I would consider that a victory in this environment. So thanks for taking the time.

[Carl Christenson:]

Thank you.

[Christian Storch:]

Thank you.

[Andrew Blazier:]

Thanks Scott.

[Operator:]

Our next question is a follow-up from the line of John Franzreb with Sidoti. Please proceed with your question.

[John Franzreb:]

Yes, just one question about the margins in the coupling segment. Is that business still being hurt by startup costs in China or is there a mix issue going on there?

[Carl Christenson:]

Two things. Still being hurt by startup costs in China, yes they are about flat compared to last year, so no change year-over-year there, but it is still a drag on the business. And them the second the biggest issue was that we have a couplings business in the UK which is selling the last portion of its products in euros and with the strengthening of the British pound against the euro they have come under margin pressure because a lot of their competitors are euro-based. And that has affected the performance of that.

[John Franzreb:]

So when do those issues go away there?

[Carl Christenson:]

I think the China issues are probably going to be with us for most of this year. And then the margin issues hard to predict how the British pound and euro will behave over the next - over the balance of the year.

[Christian Storch:]

Yes, what we are doing there John as we are going to manufacture some of the components, not in the UK where we get - where we will have a better cost base. And that is going to take awhile to transition those. But that will happen over the next six to five months.

[John Franzreb:]

Carl, will you have redundancy costs associated with running multiple lines that kind of mask some things and we will see a pop when that transition is finished?

[Carl Christenson:]

No, we should not see - I hate to say no, you won't, but we don't expect to see a redundancy cost there with multiple line or redundant capital expenditures. We shouldn’t see that.

[John Franzreb:]

Okay great thanks for the color guys.

[Christian Storch:]

Thank you.

[Carl Christenson:]

Thanks John.

[Operator:]

Our next question is a follow-up from the line of Scott Graham with Jefferies. Please go ahead with your question.

[Scott Graham:]

Hi, I just add one other what is your assumption that’s a contemplate in the guidance for FX for the year?

[Christian Storch:]

We are using a $1.9 for the Euro. So we are using the end of the first quarter spot rate, it was about a $1.9. Our first quarter we had $1.12 that ran through the P&L. So the headwinds in particular in the first month of the second quarter is going to be some headwind compare to the first quarter. If the currency stays where it is right now on $11.12 there should be some slight upside compared to the guidance for the remaining two months.

[Scott Graham:]

Right, so on forgive me for asking you to do the full math here, Christian, but is the rest of year guidance contemplate in the same level of I am sorry a little bit more on the negative FX then what we saw in the first quarter.

[Christian Storch:]

Yes.

[Scott Graham:]

Right, okay very good. Thanks.

[Carl Christenson:]

When you look at the bottom end of the guidance we took the bottom end down and 90% of that is FX.

[Scott Graham:]

Understood. Thank you.

[Operator:]

Thank you. At this time, I will turn the floor back to Mr. Carl Christenson for closing comments.

[Carl Christenson:]

Right. Thank you, Rob and thank you to everyone for joining us this morning. We look forward to speaking with you with many of you at the KeyBanc Industrial conference in Boston on May 28. Thank you and have a great weekend.

[Operator:]

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