Altra Industrial Motion Corp.
Q4 2014 Earnings Call Transcript

Published: 19 Feb 2015

[Operator:]

Greetings, ladies and gentlemen and welcome to the Altra Industrial Motion Fourth Quarter 2014 Financial Results Conference Call. At this time all participants are in a listen-only mode. A 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, Mr. Andrew Blazier of Sharon Merrill. Thank you, sir. You may begin.

[Andrew A. Blazier:]

Thank you, Jane. 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 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 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 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 Q3 2014 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 Andrew and please turn to slide two. Our progress in executing on our acquisition organic growth strategies as well as implementing profit improvement initiatives contributed to our solid performance in 2014, amid a mixed end market environment and a weakening global economy. We finished 2014 strongly as our fourth quarter performance exceeded our expectations on a number of fronts. Revenues increased 6.3% from the fourth quarter of 2013, to $192 million. Net of acquisitions net sales were a $164.8 million in Q4, 2014. We continue to see gross margin expansion primarily as a result of our strategic pricing initiative. Total pricing added a 120 basis points to our top line for the quarter. Operating income also increased from the prior year quarter. The change we made in our tax structure in the third quarter delivered significant improvement on our tax rate and we increased non-GAAP earnings 10.9% year-over-year to $11.2 million, or $0.42 per share. These were significant achievements in the face of a challenging global economic environment and sluggishness in several of our most significant end markets. As we discussed on previous calls a significant increase in medical claims resulted in higher expenses. In the fourth quarter these medical claims costs continued but to a slightly lesser extent. We made plan design changes effective January 1st that we believe will help to mitigate such higher cost claims in the future. Now please turn to slide three. As I mentioned we saw more prevalent weakness towards the end of the year in several of our significant end markets as well as in international geographies and the global industrial forecast for 2015 suggests the continuation of this trend. I will go through an overview of our end markets now. I will then turn the call to Christian for his financial review. We will follow up after that with our plans to address this new environment. Let’s begin with our distribution channel which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. In the fourth quarter distribution revenues were essentially unchanged year-over-year as sales to the aftermarket were offset by a slight decline among OEMs. In Turf and Garden where we have a significant share of the market sales were basically flat from the fourth quarter 2013. This market is expected to grow in the low to mid-single digits in 2015 on improved housing starts and an expected increase in U.S. disposable income as a result of lower commodities and fuel prices. Weakness we’ve seen in the Ag market deteriorated further in the fourth quarter just as lower commodities have boosted consumer demand they have reduced investments in new commercial agricultural equipment and we expect this trend to continue in 2015. We are working on a few new product programs but these are still not far enough along to offset the market decline. Transportation was up modestly in the quarter, led by stronger automotive sales. We expect this market to be flat to up slightly in 2015 as a result of general economic growth and greater disposable consumer income. The materials handling market was down from the fourth quarter of 2013, primarily on a decline in demand for elevators in the developing world. However we expect this market to flatten out in 2015. Looking at our late cycle markets, we will begin with energy. Not quite three months ago we were talking about the possibility of oil breaking $80 a barrel and what that might mean for demand among oil producers. Since then the price of crude has dropped below $50 a barrel and now it’s hovering just above that mark. This has had a significant effect on demand for our oil and gas related products. Drilling rig counts have already declined small operators are ceasing operations and OEMs are delaying or cancelling orders. We began to feel the impact of these events in the fourth quarter and we now project Altra’s revenue from oil and gas will be down by approximately 25% in 2015. That’s our best estimate currently but our visibility into the second half of the year is not clear, so there is an opportunity for improvement in our forecast should oil prices rebound later in the year. Alternative energy on the other hand performed well during the quarter, driven by demand in the wind market, primarily in Asia. Power generation revenue was essentially unchanged from the fourth quarter 2013. We expect alternative energy will perform well in 2015, particularly in China. In the metals markets, sales were down somewhat from a year ago. However we expect this market to be up slightly in the low single digits in 2015. One caveat in metals, demand for some of our products in this market is tied to pipe used in oil fields and it remains unclear what impact if any reduced drilling will have on steel and when that impact could flow through to our product demand. Mining continued to be weak and was down year-over-year, although flat sequentially. We have seen an increase in the number of proposal requests in this market during the past two quarters and we expect sales to be essentially unchanged in 2015 from 2014. Sales in aerospace and defense were up strongly in the fourth quarter from a year ago as we eliminated the bottlenecks that occurred during the third quarter. We expect 2015 to be largely unchanged from 2014 as our sales in this market stem more from demand in defense than in commercial aerospace. In terms of geography, excluding the effect of recent acquisitions North America was down slightly from a year-ago while sales in Europe and Asia were down more substantially. The outlook for the global economy has softened with deteriorating conditions in Europe and Russia but relative strength in North America. With that I will hand the call over to Christian and close with a discussion of our outlook for 2015 and strategic actions we are implementing to confront the shifting global economic landscape. Christian?

[Christian Storch:]

Thank you Carl and good afternoon everyone. Please turn to slide four. Overall we had a better 2014 than 2013 with record full year non-GAAP earnings per share of a $1.83, an increase of 11.6% over the prior year. Highlights for the quarter are looking at the top line excluding acquisitions foreign exchange had a negative impact of approximately 270 basis points driven by the recent strength in the U.S. dollar, priced [ph] at 120 basis points as we continue to benefit from our strategic pricing initiatives. Volume declined 500 basis points as a result of the slowdown in oil and gas, ag and to some extent in mining. Therefore sales declined to 6.5% year-over-year when the impact of acquisitions is excluded. Geographically, excluding acquisitions, North American revenues declined 1.2% year-over-year. European revenues decreased by 14.8%. Half of this impact is due to foreign exchange rates. The balance was driven by declines in end markets such as elevators and oil and gas. Sales to the Asia Pacific region declined by 16.8% was 13.2% without the impact of foreign exchange. Interest expense was $3 million, up $200,000 from the prior year due to the financing cost related to the Svendborg acquisition. During the quarter the average price of the company's common stock exceeded $26.71 which represents the current per share conversion price of the company's convertible notes. This resulted in additional 300,000 shares being included in the diluted earnings per share calculation causing less than 1% reduction in diluted net income per share. This was largely offset by our repurchase of 162,500 shares in the quarter. We recorded a tax rate of 31.1% during the quarter compared with a tax rate of 34.1% in the fourth quarter of 2013. The foreign subsidiary reorganization we made during the third quarter had a direct impact on our lower tax rate for the fourth quarter. We expect this effect to continue going forward. Please turn to slide five. To enhance the information Altra provides to its investors beginning with the fourth quarter of 2014 we are reporting our results of operations in three segments; clutches and brakes, couplings and gearing and other power transmission components. And I now provide a brief review of each segment’s performance during the quarter. For the fourth quarter of 2014 net sales in clutches and brakes were $101.4 million, an increase of 15.8% from the year ago quarter. The increase was primarily as a result of growth from the Svendborg acquisition which was partially offset by the declines in the agricultural, oil and gas and mining markets. Segment operating income grew by $1.9 million due to the addition of Svendborg, partially offset by the negative end market trends. Svendborg’s profitability profile also enhanced segment performance. Net sales in the coupling segment were $33.3 million, an increase of 13.3% over the year ago quarter. The increase was primarily due to the growth from the Guardian acquisition, gas stove [ph] and machinery and for the oil and gas and power generation markets, and project related to steamer repairs in the metals market. These factors were partially offset by economic weakness in Brazil. Segment reporting income increased $400,000. Segment performance continues to be negatively impacted by the startup cost of our couplings facility in China. Net sales in gearing and power transmission components were $58.3 million compared with $64.7 million in the year ago quarter. It's important to note that this segment has a significant European exposure including exposure to Russia through the power brand. Therefore the decline was primarily the result of unfavorable foreign exchange translation, economic weakness in Europe and headwinds in Russia. Additionally a large one-time transit project in the fourth quarter of 2013 did not repeat in 2014. Segment operating income as a result declined $2 million. Slide six is a reconciliation of our non-GAAP measures. Please turn to slide seven. Our balance sheet remains strong. Book equity was $259 million and our cash balance was $48 million. During the quarter we've repurchased 162,500 shares of Altra stock for a total of $4.8 million under our $50 million stock buyback program that expires at the end of 2016. For the year we've repurchased 554,000 shares totaling $17.6 million. We are actively in the market and will continue to repurchase Altra shares from time-to-time as market conditions warrant. Slide eight reviews our working capital performance. Svendborg was a significant contributor to our improving inventory levels as the business reduced its inventory levels by EUR5 million throughout 2014. Our working capital improvement efforts continue to contribute to the company's strong operating and free cash flow performance. For the year Altra generated free cash flow of $56 million which was 140% of our net income. Capital investments during the quarter totaled $11.6 million and depreciation and amortization was $8 million, inline with our expectations. Please turn to slide nine and our guidance for 2015. In 2015 we faced sizable headwinds from foreign currency translation, weakness in Europe and Russia and challenging dynamics in our oil and gas, agricultural and mining end markets. As a result of these headwinds, Altra is currently forecasting sales in the range of $765 million to $800 million and non-GAAP diluted EPS in the range of $1.65 to $1.85. The company expects its tax rate for the full year to be approximately 30% to 32% before discrete items. We also expect capital expenditures in the range of $24 million to $26 million and depreciation and amortization in the range of $30 million to $32 million. Please turn to slide 10. The midpoint of our guidance range assumes the following. Negative year-over-year impact from foreign exchange of $40 million in revenues and $0.10 on adjusted EPS. We are using January month end spot rates and are comparing that to the average rates in 2014. Major currencies are the euro, the British Pound and the Danish Kroner. The revenue decline of $17 million assuming oil prices continue at current levels which reflects a market decline of approximately 25%. This will have an estimated negative impact on EPS of $0.17 a share. Our guidance assumes weak demand in Ag and mining, continued weakness in parts of Europe and Russia. We're also planning on startup cost in Brazil for Svendborg brake assembly operation of approximately $1.5 million as we continue to invest in our business. These effects are partially offset by the elimination of SAP implementation cost of $2.5 million, when compared to the prior year and the positive contribution of our strategic pricing initiatives. While we are facing a challenging 2015 we’re driving cost management actions throughout the organization. With that I will turn the discussion back to Carl.

[Carl R. Christenson:]

Thank you Christian and please to turn to slide 11. I'd like to add some detail to the challenges we were seeing in the global economy and specific end markets and the actions we were taking to counteract the adverse impact we are experiencing on our financial performance. First and foremost is energy. As both Christian and I have discussed the more than 35% decline in the price of oil since our previous earnings call is impacting both large and small energy companies and that directly translates to reduced demand for our products in the oil and gas market. Second is foreign exchange. While the growing strength in the U.S. dollar is good for domestic consumption it has a negative effect on revenues for companies with an international presence. For Altra that exposure is primarily in Europe owing largely to our Bauer and Svendborg operations. Third, is the agricultural market. The deep decline in commodity prices coupled with the recent significant investments in equipment has left farmers with less cash to invest. This dynamic has precipitated the softening we experienced in the second half of 2014 and we expect this to continue into 2015. And finally Russia, our exposure in Russia is less significant than the effect of the other factors. Still the deterioration of that economy has weighted on our performance and we do not expect that to change in 2015. To offset these challenges to organic growth Altra is focusing on a number of substantive initiatives to reduce expenses. I won't list all of them now but they include facility consolidations, discretionary expense reduction, supplier cost negotiations and other actions to bring SG&A expense inline with expected decline in revenues. We're also looking to rationalize our product offerings which would reduce the number of line items we produce. We're evaluating and prioritizing these potential actions and expect that the results of some of these actions will gradually contribute to our performance as we proceed through 2015. Obviously some of the actions are long-term in nature, will have a permanent impact on our cost structure in 2016 and beyond. In terms of M&A our balance sheet is solid and we continue to pursue strategic acquisitions with the emphasis on strategic in this market. In summary, I want to thank our employees for their diligent work which has produced solid results for Altra. Even in the current environment our consistent execution on our profit improvement initiatives has driven robust cash generation, which enabled Altra to return more than $32 million to shareholders through quarterly dividends and our stock repurchase programs in 2014. Thank you for your continued support of Altra and we'll now open the call to your questions. Operator?

[Operator:]

Thank you ladies and gentlemen we will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Jeff Hammond with KeyBanc. Please proceed with your question.

[Jeffrey Hammond:]

Hey, good afternoon guys.

[Carl R. Christenson:]

Good afternoon. Hey, Jeff.

[Jeffrey Hammond:]

Hey good color on '15. Just couple of follow-ups on the internal initiatives. Can you just kind a quantify how you're thinking about Europe restructuring in '15 and strategic pricing and then also the abatement of some of these one-time healthcare and supply chain costs.

[Carl R. Christenson:]

Yes, we are we're not going to quantify the restructuring yet. But the strategic pricing we still plan to have that contribute 50 basis points and then the healthcare issue we have seen a decline in the fourth quarter compared to the third quarter and we've seen a further decline in January, a rather significant decline. While it's not a trend yet we think that the plan changes we made will have a significant benefit but we again, Jeff we can't quantify that yet in that kind of detail.

[Christian Storch:]

The strategic initiatives that we have previously talked about, like SAP implementation cost strategic pricing and so forth will have a positive impact next year of somewhat being $0.15 to $0.18 a share is what we're forecasting at the midpoint of the range, which will then will be offset by the FX and the oil and gas and the softness or weakness in Russia and the startup cost in Brazil and it kind of reconciles, I think our 2014 performance through the midpoint of our guidance.

[Jeffrey Hammond:]

Okay, but just to be clear the midpoint of the guidance does that include -- does that consider that these one-time healthcare and supply chain cost abate?

[Carl R. Christenson:]

That assumes, the midpoint of the guidance assumes that the healthcare cost are flat year-over-year.

[Jeffrey Hammond:]

Okay, okay and then just good color on the segment data. Can you just kind of go through rationale for breaking it out and then structurally where you think the margins can go on a segment basis and in particularly maybe just focused on the gearing piece within that, given the lower margin rate.

[Carl R. Christenson:]

Yes, so essentially the rationale behind the segmentation is that -- essentially what we make, we make clutches and gearing, clutches and brakes, gearing and couplings. And so we thought that was a logical way to provide more color on our results. If we look at the lowest performing business, which is gearing, Bauer with its European exposure, with its Russia exposure is inside of that and is dragging down the performance of that segment. That's the biggest, I think contributor to the performance levels. And if you look at the couplings group the China startup cost are weighing on that segment’s performance, probably magnitude of about a 150 basis point drag on that segment performance. And then inside of the remaining segment of clutches and brakes, here we got some of the heavy hitters in terms of mining and some of our very profitable pieces. It’s the larger segment by far and that's kind of like we look at the operating income performance of these segments.

[Jeffrey Hammond:]

Okay, thanks guys.

[Carl R. Christenson:]

Good, thanks Jeff.

[Operator:]

Our next question comes from the line of Mark [ph] Duncan with Stephens, Incorporated. Please proceed with you questions.

[Matt Duncan:]

Hey guys, it's Matt.

[Carl R. Christenson:]

Hey Matt.

[Matt Duncan:]

So the first thing Carl just can you maybe walk us through the sales trends and order intake trends that you're seeing in the business. I know you said you saw things start to weaken, especially from the energy patch there. Later as the fourth quarter went on, it might be helpful to give us some idea what the trajectory is looking like, so we can maybe marry that up with what's going on with rig count to try and see how to maybe forecast where the bottom is for you guys. And then how much do you think you might lag that data point by?

[Carl R. Christenson:]

Yes, I don't -- so it's difficult us to break it out because there is such an impact from the foreign exchange also in the incoming orders. So it's -- so some of this is not real detailed science. But we definitely saw a trend even going into this quarter of customers and some of our customers' customers cancelling orders and really shutting down operations in some cases. And that's disturbing to see that happen. That's why we're projecting that there’s going to be a significant decline for the rest of the year. I think, as you said, it did -- the beginning of the fourth quarter actually we didn't see much decline in rig count. We’re still pretty good, probably the end of November is when we really started to see a decline start to occur and starting to hear from our customers that they were thinking about pushing out orders and maybe even cancelling some orders and then into December and January we saw that materialized. We haven't seen it accelerate lately so it seems that it's that it's about at the level where and I don't know that it's going to hold there, but it seems like it's at a relatively flat level. On the good news side the declines, the cancellations and the push outs have been primarily on the original equipment side and the aftermarket piece is still very strong, it's still very good and we just completed an analysis of the incoming orders on that aftermarket piece and there is been very little decline since September-October of last year till now. So there maybe a lag there but I think when what we've read and what we see is that the production still remains out there and that there is still is very good production levels but that the exploratory and new drilling is where the slowdown is occurring.

[Matt Duncan:]

Okay.

[Christian Storch:]

And maybe some additional color from a currency perspective, the average euro rate in the fourth quarter was $1.25. So it's going to get worse from here should the euro remain at a $1.12, $1.13. Last year first quarter the P&L rate was $1.37. So we're going to have -- we have major headwinds in the first and second quarter assuming exchange rates stay where they are currently are in respect to the Euro's and to some extent respect to the British Pound. And the kroners really tied to the euro, so it’s going to run in tandem. And then it’s going to get little bit better in third quarter and fourth quarter, the comparison will be better, but significant FX headwinds in the first and second quarter.

[Matt Duncan:]

Okay that helps. Christian while we are on this topic, just on guidance, in terms of the gross margin, so you guys are still expecting a kind of 50 basis points benefit from strategic pricing but obviously there’s other puts and takes in that gross margin line. How should we think about the gross margin on a year-over-year basis? Can it still be up as the strategic pricing I guess more of a benefit, is there maybe some mix benefit that might help in that line, just help us think through how that’s going to consolidate?

[Christian Storch:]

So we are projecting that we are still see an improvement in our gross profit margins, our chance will be next year is to manage our SG&A. A portion of SG&A is fixed so some of things that Carl talked about as we focused on managing the cost side will be focused on reducing SG&A spend and we’ll probably see an increase in SG&A as percentage of sales despite all these efforts and we would do what [ph] as far as we can to reduce our SG&A spend.

[Matt Duncan:]

So earnings at the midpoint then I guess you must be using still about a 50% basis point increase in gross margin to get to the midpoint then?

[Christian Storch:]

Yes.

[Matt Duncan:]

Okay, that helps.

[Carl R. Christenson:]

With the caveat method the oil and gas if you look at the numbers that Christian gave you is a very profitable segment for us, a very profitable market for us. So if that get worse than we might slip on gross margin. If it doesn’t get as bad then our gross margin may not or make it even better but we got some really good programs that we are working on to try to maintain and improve gross margins.

[Matt Duncan:]

Okay, and the last thing from me just back on the healthcare theme, maybe to pile on what Jeff was asking here, if you were to continue to run at the rate you saw in January how much of a year-over-year benefit would that be from a expense perspective, because it sounds like it’s running lower, the action that you took on January 1, that maybe helping and continue to help but the guidance has got flat healthcare cost. So if we see the benefit continue how helpful would that be?

[Christian Storch:]

The benefit in general was about $100,000. So if you would assume it’s a $100,000 a month will be $1.2 million. But one month doesn’t make a trend, so we are very careful -- can you re-ask that question after the first quarter and we get a trend on in that.

[Matt Duncan:]

Yes, hopefully we will right.

[Carl R. Christenson:]

The third quarter was sequentially better than the -- the fourth quarter was sequentially better than the third quarter. The fourth quarter was better than the third quarter slightly and -- but we don’t want to call it a trend yet.

[Matt Duncan:]

Okay, all right guys, thanks for the color.

[Carl R. Christenson:]

All right, thanks Matt.

[Operator:]

Thank you. [Operator Instructions]. Our next question comes from the line [indiscernible] with Jefferies and Company. Please proceed with your question.

[Bhupinder Borat:]

Hey, good afternoon guys.

[Carl R. Christenson:]

Hi, Bhupinder.

[Bhupinder Borat:]

Question about the geographic, I believe, Christian actually gave the geographic growth rates here for North America, Europe and Asia-Pac. Can you give us more color -- you have mentioned, I believe North America declined modestly, Europe and Asia-Pac declined substantially. Just wanted to get some more color which end market actually were impacted in Europe and Asia-Pac?

[Carl R. Christenson:]

So North America was -- so we have ag was a significant piece of that, oil and gas towards the end of the quarter was a significant piece of that. And in Europe and Asia some of its exchange rate, particularly in Europe and then in Asia it’s mining. So if you look at -- we include Australia in our Asia market and that’s down significantly compared to prior year. So it will be primarily mining and then there was some decline in material handling. I think the construction slowdown in China and the fewer elevators being installed, has had a little bit of an impact there, we put elevators into material handling.

[Bhupinder Borat:]

Okay.

[Christian Storch:]

As Carl said the decline in mining in Australia had the most significant impact on Asia rest of the world. That was the primary driver.

[Bhupinder Borat:]

Okay. And just one more question on, Carl you mentioned about M&A. You stressed the word kind of strategic acquisition. If you can expand on that with where you look at net debt to EBITDA ratio, pretty good balance sheet here and I don’t know what’s the reason behind disclosing three segments now, is that kind of becoming more transparent in terms of like which of those three businesses you want to expand and any color on that? I am trying to link the M&A factor here with the disclosure of like three segments here.

[Carl R. Christenson:]

Yes, there is a no linkage between them, but the M&A focusing on strategic, my emphasis on strategic acquisitions is that we are well positioned to make acquisitions and the -- however the market is pretty tough right now, the pricing is very high and we don’t want to over pay for deals. The only one thing worse than not doing a deal and that’s doing a bad deal. So we just want to make sure that we are disciplined in the transactions that we try to execute on. And then I don’t know Christian if you want to talk about the segmentation at all but they are not linked, Bhupinder.

[Christian Storch:]

No, they are not linked and essentially we want to communicate performance in these three segments; clutches and brakes, couplings and gearing and I think it will help also our investor base to understand where the proper improvement needs to take place essentially which is in gearing related to things we have talked about in the past and it’s across in China and all that as we tackle all these things should help to improve segment performance of those two segments.

[Bhupinder Borat:]

Okay, thanks a lot guys.

[Carl R. Christenson:]

Good, thank you.

[Operator:]

Thank you. Ladies and gentlemen I would now like to turn the call back to Carl Christenson for closing comments.

[Carl R. Christenson:]

Okay. And I would just like to thank everybody for joining us afternoon and we look forward to speaking with some of you at our Annual Meeting in April. Thank you and enjoy your evening.

[Operator:]

Thank you. Ladies and gentlemen this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.