Altra Industrial Motion Corp.
Q3 2013 Earnings Call Transcript

Published: 24 Oct 2013

[Operator:]

Greetings, and welcome to the Altra Industrial Motion's Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Calusdian, from Sharon Merrill Associates. Thank you, Mr. Calusdian. You may begin.

[David C. Calusdian:]

Thank you, Manny. Good morning. Welcome to the call. With me today is 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 expectation. 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 Holdings, Inc. does not intend to update or alter its forward-looking statements, whether as a result of new information, forward events, 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 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 table of the Q3 2013 financial results press release on Altra's website. I'll now turn the call over to Altra's CEO, Carl Christenson.

[Carl R. Christenson:]

Thank you, David, and please turn to Slide 2. We demonstrated positive momentum in several areas during the third quarter, even amidst economic headwinds that continue to make revenue growth challenging. Revenues were up slightly from the same period a year ago, reversing 2 quarters of year-over-year declines. Gross margin increased 80 basis points year-over-year as we continued to see margin improvement as a result of our strategy initiatives. Our operational excellence program, strategic pricing and underperforming business improvement efforts all contributed to the improved margin. Net income increased 24% despite a challenging top line and a tax rate that was 8 percentage points lower a year-ago. For the past several quarters, we've discussed improvements we've made in Europe and in certain underperforming businesses in the U.S. Our restructuring plan in Europe continues to perform as we expected, delivering margin improvement in line with our expectations for our Bauer business. Although top line results continue to be essentially flat in a sluggish end-market environment, we're very pleased with the margin improvement. Some of our end markets are showing very early signs of improvement, and our increased operating leverage should translate to the bottom line when that improvement materializes. Operating free cash flow remained strong during the quarter at nearly $29.2 million. Through the first 9 months of 2013, operating cash flow was $62.2 million, a 14% increase over the same period in 2012, and we have paid down nearly $60 million on our credit facility. Please turn to Slide 3, and I'll talk about some of our specific end markets. We'll start with our distribution channel, which is predominantly comprised of sales of aftermarket parts and original equipment parts for small OEMs. In the third quarter, distribution sales were still down year-over-year, with the largest declines at specialty distributors and challenging markets like mining. Industrial growth forecasts have been pushed into 2014, and we expect sales to the distribution channel to be essentially flat year-over-year for the remainder of 2013, in large part because of easier comparisons to our results at the end of last year. In Turf & Garden, we did not experience the typical seasonal decline in Q3. Demand was up substantially year-over-year as an extended growing season caused by favorable weather conditions led consumers to make outdoor equipment purchases they had delayed in Q2. As a result, we experienced record Turf & Garden sales in August and September, and we're now up slightly in that market year-to-date. The Ag market continued to perform well in Q3 and was up a bit from last year. Our new product programs are shipping on schedule, and we had some very good project wins. We expect these programs and other new product development efforts will make significant revenue contributions during the remainder of this year and throughout 2014. The transportation market also performed well, driven by continued demand from automotive OEMs. The materials handling market remained bifurcated with our elevator and forklift programs performing very well year-to-date. At the same time, the Crane & Hoist markets are underperforming. Meanwhile, the conveyor systems market continues to be flat. Turning to our late-cycle market, beginning with energy, has improved drilling technology, has increased efficiency and longevity of rigs. The number of rigs in the upstream component of the oil and gas segment have declined somewhat. We expect that trend to continue into next year with the result being lower demand for our products in this segment. On a positive note, demand in offshore drilling is quite good currently. Activity on offshore is increasing and bookings have been strong. In addition, we are seeing some positive indications in frac-ing, where demand was very low due to excess capacity. This continues to be a very good long-term market segment for us. The market for global power generation is still quite strong. In petrochemicals, we're beginning to see early-stage inquiries for new refineries. And in alternative energy, the wind turbine market improved in Q3, and we expect it to remain relatively steady for the near term. The mining and metals market improved from Q2 but is still very weak, as has been the case for several quarters. Demand for aftermarket products remained steady, but we expect the overall market to be down through much of the next year. In aerospace and defense, the timing in many projects has been delayed into at least next year as contractors await the result of the recent federal budget stalemate in Washington. With that, I'll turn the call over to Christian, and then I'll close with a discussion of our strategic initiatives.

[Christian Storch:]

Thank you, Carl, and good morning, everyone. Please turn to Slide 4. Third quarter net sales were $175.4 million, up slightly from $174.5 million in the third quarter of 2012. Foreign exchange rates of 50 basis points and price of 80 basis points had a favorable impact, while volume was down slightly. Sales growth in Europe was 5% and was offset by a 2.6% decline in sales in North America. Rest of the world sales increased 0.5%. The sales increase in Europe was driven by strengthened European currencies. Despite tepid sales growth, we continued to see solid margin expansion. As Carl mentioned, gross margin increased 80 basis points year-over-year to 30.6%. This was the result of pricing improvements in our profit enhancement initiatives at certain underperforming businesses. Non-GAAP operating income increased 40%. Third quarter net income was $10.5 million or $0.39 per diluted share compared with net income of $8.5 million or $0.32 per diluted share in the third quarter of 2012. Non-GAAP net income in Q3 2013 was $10.8 million or $0.40 per diluted share compared with $9.1 million or $0.34 per diluted share a year ago. We reported a tax rate of 33.1% in the quarter, which is within our guidance for the year. This compared with a tax rate of 25% for the third quarter of 2012. The main driver was lower year-over-year interest expense, which has increased U.S. pretax income as a percentage of total pretax income, contributing to the rate increase. Slide 5 is a reconciliation of our non-GAAP measures. Please turn to Slide 6. Our book equity was $258.9 million compared with $232 million at year end. Cash and cash equivalents was $70.3 million at the end of the quarter. During the quarter, we paid down our revolving credit and term loan facilities by more than $15 million, supported by strong generation of free cash flow. Free cash flow was $47.8 million for the first 9 months of the year. Our pension plans will be nearly fully funded by the end of the year due to the voluntary contributions we have been making over the last few years. As a result, we will be moving to a 100% liability matching investment style. Slide 7 reviews our working capital performance. Working capital decreased approximately 1% in the quarter sequentially to $172.9 million. Capital investments during the quarter totaled $4.4 million, and depreciation and amortization was $7 million. Please turn to Slide 8 in our guidance. We expect the fourth quarter to be choppy and revenues to come in modestly below the prior year fourth quarter. As a result, we are revising our previous full year 2013 guidance for revenues in the range of $710 million to $720 million and non-GAAP EPS in the range of $1.58 and $1.64. Our expected tax rate for 2013 should still be approximately 31% to 33% before discrete items. We now expect capital expenditures in the range of $19 million to $21 million, well below our annual depreciation and amortization of $27 million to $29 million. We expect to continue to generate very strong free cash flows in the fourth quarter. With that, I'll turn the discussion back to Carl.

[Carl R. Christenson:]

Thanks, Christian. Let's briefly discuss the various strategic initiatives we're working on, and please turn to Slide 9. We continue to expand Altra's presence in emerging geographies, primarily in South America and in China. Our activities in both regions continued to progress on schedule. We're working to integrate the operational excellence component of our strategy more extensively into our operations. We recently completed a Kaizen in Columbia City, Indiana as part of the consolidation of 3 locations into a new leased facility. We incorporated lean concepts into a plant layout event which will pave the way for a complete consolidation of the 3 facilities by this time next year. We continue to make steady progress with the implementation of SAP. We plan on completing the initial phase of the implementation by the end of the first half of 2014 and will transition our efforts to fully realizing the benefits of the investment we have made over the last several years. We are making solid progress on the new pricing strategy which we initiated in Q3. Thus far, we have seen positive contributions from pricing to gross margin, and we expect additional improvement from pricing in coming quarters. In terms of top line growth opportunities, our product development initiatives are resulting in new program wins. Per our model, these new programs enable us to collaborate with customers on new products, which results in closer alignment with customers and generate additional orders for us in the future. Turning to external growth initiatives. Our balance sheet is very strong, and we are ready to execute on our acquisition strategy. In summary, our end markets continue to be challenging, but we are optimistic about potential improvements in certain markets as we look to next year. Our operational improvements at underperforming businesses, our operation excellence programs and our pricing initiatives are delivering the positive effects that we projected, and we are generating top line growth opportunities as well. With that, we will open it up for your questions.

[Operator:]

[Operator Instructions] Our first question comes from Jeffrey Hammond of KeyBanc Capital Markets.

[Jeffrey D. Hammond:]

Can you just talk about -- distribution, you said, still down year-over-year. Can you just talk about the trend through the quarter? Any signs that, that's turning up with some of the PMI data we've seen?

[Carl R. Christenson:]

I think people expected the distribution channel to improve in the second half of the year, and we haven't seen it improve. And I think the expectation is that it's just going to be relatively flat with very modest growth into next year, Jeff. So it's -- we do not have high expectations for growth in that channel for next year, other than gaining some share, possibly.

[Jeffrey D. Hammond:]

And I jumped on late. I think as I jumped on you were maybe giving some end market color, but what -- can you talk about the markets you're perhaps most optimistic on for reacceleration or inflection as you look into '14?

[Carl R. Christenson:]

Yes. I mean, we haven't given guidance for '14, but just talk about the markets a little bit. I think we've had some good project wins in Turf & Garden and agriculture, and those have been very good markets for us this year and we think that will continue into next year. I think the ones that have been down, energy and mining have been particularly weak, and we think we're starting to see a bottom there, that we've recently gotten requests for proposals for some mining projects and for some energy projects. I think the excess capacity that was in frac-ing is starting to get used up. I think on the drilling side, it's probably still going to be slow. Offshore, we've seen some very good inquiries for offshore. They haven't materialized into orders yet, but the offshore market seems to be improving. So I don't think we see any particular market, Jeff, that's going to just dominate and take off and be very robust, I think it's just going to be kind of a general steady improvement in some of the markets that have been down.

[Jeffrey D. Hammond:]

Okay, and then just final question. I mean, you seem more optimistic about the M&A pipeline. What's changed there? What kind of -- are these more privately negotiated deals? Are they bigger? More on the smaller bolt-on size, maybe just a little more color on what's changing within the M&A landscape.

[Carl R. Christenson:]

I think in order to have a successful M&A, you have to have a willing seller and a willing buyer and it just seems like there's been -- we've had more interest in companies we've contacted in having discussions, so it’s just been a little more activity there. Obviously, we can't discuss any timing or anything. It's -- but it just seems like there is more activity there. And we're ready to do it, so I think the management team is ready, and we've got the bandwidth to do it and we've got the balance sheet to do it. So we're out aggressively trying to make something happen.

[Operator:]

The next question comes from Matt Duncan of Stephens Inc.

[Matt Duncan:]

First question I've got, just on revenues by geography. Can you give us some color on how your -- what your growth rates looked like in the 3 geographies?

[Christian Storch:]

Yes. We said that Europe was up 5%, and that was all currency, essentially. If you look at how this euro has strengthened and the British pound compared to last year's third quarter, that was about 5% on balance. Our North American sales were down 2.6%, and then the rest of the world, which was -- includes Latin America, Asia and other parts of the world, were up 11.5%.

[Matt Duncan:]

Okay, how much of that rest of the world, Christian, was volume versus currency?

[Christian Storch:]

Most of that was volume.

[Matt Duncan:]

Okay. And then within Europe, it sounds like things have probably bottomed there, and I guess there's some early signs that maybe they are trying to get better. Do you think that market will provide you with an opportunity for volume growth out of Europe next year?

[Christian Storch:]

Given the trends in the PMI, particularly in Germany, we're hopeful that we're going to start to see some volume growth there. Some of the end markets remain weak that we participate in, in Europe. One example is the Crane business that our Bauer business participates in, for instance. Mining, we also serve all of that geography, but then I think relative to the other end markets, we will anticipate some growth next year.

[Matt Duncan:]

Okay. And then looking at your gross margin, can you maybe talk a little bit, Christian -- I mean, you were up 80 basis points year-over-year and 60 basis points sequentially. Can you maybe break that down for us in terms of how much of that is the early impact of the strategic pricing initiative versus other things?

[Christian Storch:]

I think when we look at the third quarter, where we had positive price of 80 basis points, and this is a guess that maybe 20 basis points of that might be the pricing initiative and the rest is normal price initiatives that we have. Yes, we started increasing prices August 5 with the first couple or 3 business units that went through the process, so there's some impact, but it's still modest in the third quarter.

[Matt Duncan:]

Has customer retention through that process been what you would expect it to have been?

[Christian Storch:]

Yes, customer retention has been very good, very much in line with our expectations.

[Carl R. Christenson:]

Yes, I think the other thing to consider there, Matt, is that we have cost increases in July. Relative to wages, we have an inordinate percentage of wages go up in that time period in the beginning of the third quarter, so I was really pleased with the operational results to offset that cost increase, as well as have some margin expansion with virtually no volume mix -- with virtually no volume increase. So we're really pleased with it.

[Operator:]

The next question comes from Bhupender Bohra of Jefferies & Company.

[Bhupender Bohra:]

First question, just piggybacking on one of the monthly trend questions which was asked earlier. Just wanted to get a sense of how these sales actually trended in maybe August, September. And how -- over the last 3 weeks, do you see -- what are the trends here?

[Carl R. Christenson:]

Yes, I think one of the really good benefits was that the bad weather situation in the beginning part of the year turned, and in late second quarter, early third quarter, we had very favorable weather conditions. So the Turf & Garden business was very good through the third quarter, and normally we see a seasonal decline there. We didn't see that. With that, we -- that continued pretty much through the quarter into September, and we're now getting into the busy season. So that helped. And I think other than that one particular market that was unusually strong, the balance of the trend through the quarter was relatively flat. We didn't see any -- it didn't decline through the quarter. It didn't really increase significantly through the quarter. It was relatively flat, both on an incoming and a shipments standpoint.

[Christian Storch:]

As we look at our fourth quarter forecasts and projections, we look at the fourth quarter as somewhat being a wildcard with the December holidays and how customers do behave at the end of the year, in terms of their stocking requirements or delaying purchases, so we always look at that fourth quarter with some caution.

[Bhupender Bohra:]

Okay. Just to follow on, on the acquisition related charges which you have year-to-date, now, those actually kept on increasing quarter-by-quarter. Is that an indication that -- you said like M&A was kind of active. Are you seeing some deals which -- I mean, you're getting close to a deal and it's not happening or something like that?

[Christian Storch:]

What I can say is that we have been looking at more deals, and that's a reflection of these higher costs. As to timing or whether or not something will occur, I don’t think we're prepared to comment on that, but as Carl mentioned earlier, we have seen more books, have looked at more deals than we maybe have had in the first -- in the last 3 or 4 calls.

[Bhupender Bohra:]

Now can you give us a sense of like where you're looking, like in Europe or Americas?

[Christian Storch:]

We're looking in both geographies, Europe and North America and...

[Bhupender Bohra:]

Okay. The last question on the Ag and Turf & Garden, just kind of refresh us like what new product introductions you have for 2014? What's going to drive those sales?

[Carl R. Christenson:]

Yes, so we've talked about a couple in the Ag market, one being on a SEDAR application, which is going very well, and we've had good revenues on that in '13 and will continue into '14 and grow in '14. Also, in some irrigation applications, we've had some very good growth and some new products in irrigation applications.

[Operator:]

[Operator Instructions] And the next question is from Mike Halloran of Robert W. Baird.

[Michael Halloran:]

So just wanted to get a sense for the moving pieces within the revenue guidance for the fourth quarter. I know you just mentioned that there's an element of caution that you're going to want to have going into the fourth quarter every year just because of some of the variable buying patterns that happen, but I wouldn't mind you talking about a couple of things here. One, we know we have a couple of more selling days year-over-year and I think 2 or 3 more sequentially in the fourth quarter. There is some seasonality in the fourth quarter to begin with, so maybe you could talk about those and then put those in the context of what distributor inventories look like today, and I guess just trying to angle in why there is a little bit of modest pressure year-over-year to that revenue number.

[Christian Storch:]

So most selling days we have -- we will have 2 more selling days this year compared to last year. Sequentially, we are going to have 62 versus 62. That is flat. I think what makes us cautious is what we have seen in distribution over the last -- well, throughout the year with distribution being weak and what we've seen in some of these very weak markets like mining, like some of the energy markets. Mining is off very, very substantially for us. So then you get the December with very few shipping days, and there's really uncertainty how customers behave in December. It's a real wildcard. And therefore, we want to be cautious about the fourth quarter, and I think there is a reason to be cautious.

[Michael Halloran:]

Okay, and based on the commentary, though, it sounds like maybe there's some caution going into the fourth quarter, but based on the prepared remarks, that you're expecting growth to begin to emerge once you get past the fourth quarter.

[Carl R. Christenson:]

Yes. I think we expect that there'll be -- it's going to be very modest improvement in the economic environment. Also, the customers and distributors that I have talked to are not expecting next year to be a miraculous upturn in the end markets they serve. It's going to be just kind of slow, steady growth. And for us, it's about going out and winning the programs that we're competing for. So I think that's where we're going to be driving at. We're not going to be depending on economic improvement. It's going to be, how do we go win in the marketplace.

[Christian Storch:]

And we don’t have high expectations for revenue growth next year. We have high expectations for ourself to grow our earnings next year.

[Michael Halloran:]

Yes, that's fair. And then a last one from me, just wanted to make sure I understand. You guys have had some nice Ag-related in the Turf & Garden and just the pure Ag-type pieces. The commentary seems a little bit more bullish than many of the other Ag-related people that we track. It seems like it's also more internally driven versus externally driven, but wouldn't mind hearing your differentiated thoughts on the environment itself and then what you're specifically doing in some of those markets.

[Carl R. Christenson:]

No, I think that's right. I think the environment has been very good and that people expect it not to be as good as it has been. And I think we agree with that, but we think it's a very good long-term market for us, so we've applied some resources to go out and win some projects, and that's where we're seeing the growth. So it's all internally driven. We're not expecting to get it from the external environment there, either.

[Christian Storch:]

And some of these new products that we introduced are going to have annual sales volumes of $5 million to $10 million and potentially more a year, so these are very meaningful for us, very meaningful project wins.

[Carl R. Christenson:]

They are great applications for us, where there is challenging environments, it's an engineered product where they're looking for performance at a good cost, and so they're great applications for us.

[Operator:]

Thank you. We have no further questions in queue at this time. I'd like to turn the floor back over to Mr. Christenson for any closing remarks.

[Carl R. Christenson:]

Okay. Thank you for joining us this afternoon, and we look forward to seeing many of you at the Baird Industrial Conference in Chicago on November 5. Thank you.

[Operator:]

Thank you, ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.