Barnes Group Inc.
Q4 2017 Earnings Call Transcript

Published: 16 Feb 2018

[Operator:]

Good morning. My name is Carol and I will be your operator today. At this time, I'd like to welcome everyone to the Barnes Group Inc. Fourth Quarter and Full-Year 2017 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. At this time, I would like to turn the call over to Bill Pitts, Director, Investor Relations.

[Bill Pitts:]

Thank you, Carol. Good morning and thank you for joining us for our fourth quarter and full-year 2017 earnings call. With me are Barnes Group's President and CEO, Patrick Dempsey; and Senior Vice President of Finance and Chief Financial Officer, Chris Stephens. If you have not received a copy of our earnings press release, you can find it on the Investor Relations section of our corporate website at bginc.com. During our call, we will be referring to the earnings release supplement slides, which are also posted on our website. Included in our slides for this quarter is information related to the impact of U.S. Tax Reform which Chris will cover shortly. Our discussion today includes certain non-GAAP financial measures, which provide additional information we believe is helpful to investors. These measures have been reconciled to the related GAAP measures in accordance with SEC regulations. You will find a reconciliation table on our website as part of our press release and in the Form 8-K submitted to the SEC. Certain statements we make on today's call, both during the opening remarks, and during the question-and-answer session, may be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. Please consider the risks and uncertainties that are mentioned in today's call and are described in our periodic filings with the Securities and Exchange Commission. These filings are available through the Investor Relations section of our corporate website at bginc.com. We will now open today's call in our usual fashion with remarks from Patrick, followed by a review of our fourth quarter and full-year results and our 2018 outlook from Chris. After that, we will open up the call for questions. Patrick?

[Patrick Dempsey:]

Thanks, Bill, and good morning, everyone. Barnes Group delivered a very good 2017 with impressive revenue and adjusted earnings growth. Backlog increased to over $1 billion during the year on strong order intake, as our businesses both industrial and aerospace are well-positioned within generally favorable end markets. We also made substantial progress on our transformational journey to position Barnes Group as a leading global provider of highly engineered products and industrial technologies, as well as further advancing the Barnes Enterprise System with additional investments in innovation and talent management. The effectiveness of our global growth strategy and our solid execution of this strategy provided for a total return of nearly 35% to our shareholders, surpassing the broader indices of the S&P 600 and the Russell 2000. In addition, we celebrated a number of milestones during the year, a few of which I'll discuss shortly. But before doing so, let's touch upon a few highlights from our fourth quarter and full-year results. Please note my discussion this morning will focus on adjusted operating income and adjusted earnings. Similar to many other companies, the impact of the new U.S. tax reform has had a meaningful impact on our fourth quarter results which Chris will address later in the call. In the fourth quarter, net sales increased 15% with organic sales up 10%, a notable accomplishment given the strength of last year's fourth quarter. Both industrial and aerospace contributed to the results. Adjusted operating income declined approximately 1% primarily as a result of ongoing challenges within Associated Spring and adjusted operating margin declined 230 basis points. Adjusted EPS was $0.71, an improvement of 6% over last year's fourth quarter. For the full-year, given our favorable end markets, total sales increased 17%, while organic sales increased 11%. Organic orders were up 13% a very solid result and backlog increased 17%. Adjusted operating margins declined 120 basis points, but as you will hear our 2018 expectation is to reverse that decline as current operational challenges abate. Adjusted earnings per share were up nearly 14%. For our segments, beginning with Industrial and focusing on the fourth quarter. Sales growth was 18% with strong organic growth of 11%. As has been the case all year, end markets served by both our Molding Solutions and Nitrogen Gas Products businesses have been very strong. In fact both SPUs achieved double-digit organic growth, sales growth. Engineered components likewise demonstrated solid organic growth, up 7% in the quarter, as general industrial, heavy-duty truck, and construction markets led the way. Adjusted operating margin was down 370 basis points from last year primarily due to the two factors called out last quarter

[Chris Stephens:]

Thank you, Patrick, and good morning everyone. Let me begin with highlights of our fourth quarter results on Slide 5 of our supplement. I'll also speak briefly to our full-year results, and then end with our initial outlook for 2018. For the fourth quarter, sales were $373 million, up 15% from the prior year period driven by organic sales growth of 10%, FX benefited sales by approximately 4%, while acquisitions provided 1%. For the fourth quarter, we reported a net loss after the impact of U.S. tax reform of $59.2 million or $1.10 per share. On an adjusted basis, net income was $0.71 per share, up 6% from $0.67 last year. Adjusted net income per share in the quarter excludes a $1.79 charge related to tax law changes and $0.02 per share of restructuring actions within our Industrial segment. For the full-year, sales were $1.4 billion, up 17% from the prior year. Organic sales were strong up 11%, while acquisitions provided 5%, and favorable FX contributed 1%. Net income including the impact of tax reform was $59.4 million or $1.09 per share compared to $2.48 per share a year ago. On an adjusted basis, net income was $2.88 per share, up 14% from $2.53 last year. Please keep in mind that in the second quarter of 2017, we recorded a discrete tax benefit via consolidation of several Swiss legal entities which provided approximately $0.12 of EPS benefit. Now onto segment performance starting with Industrial -- beginning with Industrial, so fourth quarter sales were $254 million, up 18% from the prior year period. Organic sales increased 11% with growth across all three business units, FX increased sales by 6%, while acquisition revenue added 1%. Fourth quarter operating profit of $26.9 million, down 11% from the prior year period as continuing higher costs incurred on certain programs within Associated Spring and incentive compensation at select SPUs, were only partially offset by the profit benefit of increased sales and the absence of $1.8 million in for bullish short-term purchase accounting adjustments taken last year. In the quarter, there were $1.4 million in restructuring charges related to previously announced plant consolidations. So excluding this adjusted operating profit was $28.3 million down 12% from a year ago, and as Patrick noted, adjusted operating margin was 11.1% down 370 basis points. For the year, sales were $974 million, up 18% from last year. Organic sales were up 10%; while acquisitions contributed 7%; a favorable FX added 1%. Full-year operating profit of $127.1 million was down 2% from the prior year. On an adjusted basis, operating profit decreased 3% to $129.4 million versus a year ago with adjusted operating margins of 13.3% which was down 290 basis points. Moving on Aerospace, fourth quarter sales were $119 million, up 9% from the same period last year, operating profit was $22.7 million for the fourth quarter, up 7% reflecting the profit impact from higher sales volumes and productivity benefits, partially offset by scheduled price deflation. Excluding a contract termination award of $1.4 million in the fourth quarter of last year, adjusted operating profit was up 15% from a year ago, while operating margin was 19.1% which was up 90 basis points. For the year, Aerospace sales were $463 million, up 14% from last year and operating profit was $83.2 million, up 33% versus a year ago. And on an adjusted basis, operating profit was up 30%, while operating margin increased 220 basis points to 18%. Aerospace total backlog ended 2017 at a record $723 million, up 14% compared to a year ago and up 1% sequentially from the third quarter of 2017. For OEM only, backlog was $714 million and we expect to ship approximately 50% of that backlog over the next 12 months. Some other items for the full-year to note, interest expense increased $2.7 million to $14.6 million primarily as a result of higher average effective interest rate versus a year ago. Other income decreased $2.3 million largely due to the absence of $1.4 million of interest income related to the contract termination arbitration award last year. The company's 2017 effective tax rate was 69.6% compared to 25.7% last year. The increase is predominately due to the mandatory deemed repatriation required per the Tax Cuts and Jobs Act enacted in December 2017. Our effective tax rate would have been 20.2% in 2017, if you excluded the impact of U.S. tax reform. On Slide 6 of our supplement, we highlight some key impacts of U.S. tax reform for 2017 and 2018. In the fourth quarter, we recorded a provisional one-time tax charge of $96.7 million reflecting the impact of certain sections of U.S. tax reform such as transition taxes on cumulative foreign earnings payable over eight years, and a charge related from applying the new 21% U.S. corporate tax rate on our deferred tax asset positions. Please note however the U.S. Treasury's continue to issue guidance regarding the enacted legislation and as a result adjustments may need to be made in 2018 as additional guidance is issued, but as of now we estimate our 2018 effective tax rate to be between 25% and 26% inclusive of a two point improvement from U.S. tax reform which provides an $0.08 EPS benefit. With respect to share count, our fourth quarter average shares outstanding were 53.9 million shares. During the fourth quarter, we were an active buyer in repurchasing 270,000 shares at an average cost of $64.76 per share. For the full-year, we repurchased 677,000 shares at an average cost of $60.24, and at year-end 3.8 million shares remain available for repurchase under existing board authorizations. Full-year 2017 cash provided by operating activities was $204 million versus $218 million last year. Included in those results are discretionary pension plan contributions of $10 million in 2017 and $15 million in 2016. Full-year free cash flow which we define as operating cash flow less capital expenditures was $145 million compared to $170 million last year. And this year's capital expenditures were $59 million which was up $11 million from $48 million in 2016. With respect to the balance sheet, our debt to EBITDA ratio was 1.7 times at quarter end. Under our existing debt covenants, additional borrowings of approximately $486 million of senior debt would be allowed, while $429 million remained available on our credit facility at quarter end. Turning to our initial 2018 outlook on Slide 7 of our supplement, on top of a strong 2017 sales we expect 2018 total revenue growth of 4% to 6%, with organic sales growth of 3% to 5%. FX is expected to benefit revenues of 1%. Operating margin is forecasted to be in the range of 15.5% to 16.5%. EPS is expected to be in the range of $2.98 to $3.13, up 3% to 9% from 2017s adjusted diluted earnings per share of $2.88. We see our EPS weighted to the second half of the year with a roughly 47% to 53% split first half to second half. Also we envision the first quarter of 2018 to be a few cents below the strong first quarter of 2017. With respect to the new revenue recognition standard we do not expect it to have a material impact. And a few other items for 2018 outlook, interest expense is anticipated to be between $14 million and $14.5 million. Our CapEx expectation is $60 million to $65 million, which is roughly 20% higher than our average capital expenditures over the past three years. Average diluted shares are forecasted to be between 53.5 million and 54 million shares. And cash conversion is expected to be greater than a 100%. So, in summary, a good 2017 performance has set us up well entering into 2018. We anticipate solid revenue growth even with difficult comparisons and improved financial performance. Our well-positioned balance sheet and reliable cash generation allows us further investment in organic growth and strategic acquisitions which promotes our long-term objective of delivering increased shareholder value. Operator, we'll now open the call for questions.

[Operator:]

Thank you. [Operator Instructions]. Our first question today comes from Pete Skibitski from Drexel Hamilton. Please go ahead.

[Pete Skibitski:]

Yes. So the guidance was pretty good but let me ask you about the $50,000 content on the LEAP-1B just kind of how you're thinking about that, are you disappointed that it's lower than the 1A content, are you surprised, should we be disappointed or are you kind of viewing this as a starting point maybe and kind of upward from there? Just engineering your thoughts on that topic.

[Patrick Dempsey:]

Yes, so Pete from our perspective we're extremely pleased with the content on the Boeing 737 MAX and particularly because it's a, as you know, it's going to be a high volume program. The content we've always indicated that whilst we continue to work the program, the content wasn't going to be a one-on-one -- one-to-one read across from the A320neo. And the reason being because as the OEs position these two aircrafts enter into service of roughly the same time. There was a very deliberate strategy around creating multiple sources for the components. And so, with that, the content that we have we're very pleased with, but we also believe that there are ongoing negotiations in play that will allow for additional opportunities not only in terms of the engine, but also the airframe itself as it pertains to the 737 MAX.

[Pete Skibitski:]

Okay, that's interesting. Let me ask you as a follow-up, your Singapore expansion. Actually, I think GE is expanding in Singapore as well; is that mainly for the 320neo work or anything else can you give us a little more detail on Singapore?

[Patrick Dempsey:]

So we've seen considerable strength, as you know, across all of aerospace, both on the OE side as well as on the aftermarket. So our current -- the announcement that we made recently is with respect to the OE side of the house which is continued expansion not only within our U.S. locations, but also in our Singapore location to support the LEAP program. We also continue to look at the aftermarket and the opportunities that are there and expect that we'll continue to expand on a global footprint basis to support worldwide demand as it pertains to the aftermarket as well. And the aftermarket primarily been driven by our RSPs, CRP programs, as well as other programs within the MRO services.

[Pete Skibitski:]

Got it. Okay. Just my last one then I guess, Associated Spring did you -- is the facility in question is that now closed? And do you have pretty good line of sight of the improvement there by the third quarter?

[Patrick Dempsey:]

We have -- we basically been working these new programs that I had mentioned in terms of moving them throughout the year now and great progress made in Q4. And as I indicated, we expect that through the first half, we'll have it behind us. The facility that you referenced that we're consolidating is still operational today with a view to it closing in the early months of 2018. And, but more importantly, we've been working extremely close with the customers for necessary approvals and the authorizations to move the work to our other existing facilities.

[Operator:]

Our next question comes from Edward Marshall from Sidoti & Company. Please go ahead.

[Edward Marshall:]

So I just wanted to follow-up on Pete's first question on the OEM content, I'm curious on the 737 next-generation the CFM-56, what -- what's the content that you have on that aircraft OEM?

[Patrick Dempsey:]

On the 737 next-generation as in the predecessor to the MAX.

[Edward Marshall:]

That's correct.

[Patrick Dempsey:]

Very, very, very little, piece in -- so far as that our focus historically has always been on the wide-body aircraft as opposed to the narrow-body. Our content on the narrow-body historically has been in the aftermarket as opposed to the OE side.

[Edward Marshall:]

Okay. So it's not you don’t have a comparable number to that 50,000?

[Patrick Dempsey:]

No.

[Edward Marshall:]

Got it. And then on the Industrial side, you talked about, you said there were a few things that would benefit you to bring you back to the mid-teens Industrial margins that you saw before. I know there was margin compression into the quarter this year, could you kind of talk about what those -- what those items might have been, I understand just the benefits of restructuring in Switzerland, maybe you can walk through your outlook for 2018?

[Patrick Dempsey:]

Sure. So we talked about over the course of last year, we announced two consolidations one which you just mentioned which was within FOBOHA which was the facility in Switzerland being consolidated into our other locations. And the one I just mentioned a little earlier which was the facility in Associated Spring. Both of those we cited it contributing a benefit of savings into 2018 of approximately $5 million in savings. On the movement back to the mid-teens in 2018, a big driver of that will be Industrial, and in particular, the improvements that we expect to see coming out of Engineered Components, in particular, Associated Spring, and so the heavier costs that we incurred in 2017 we do not see repeating in 2018. And then also of course our continued emphasis on productivity across the entire portfolio of businesses.

[Edward Marshall:]

Great. When was the Associated Spring restructuring completed?

[Patrick Dempsey:]

It's going -- right now, we're highlighting that we expect it to be totally complete within the first half of 2018.

[Chris Stephens:]

Yes. So when we announced the two consolidations, the one within Molding Solutions within our FOBOHA operation has been completed at year-end. And as Patrick mentioned, the Associated Spring one will be completed here in the beginning part of the year.

[Edward Marshall:]

So I guess that it parses back to your guide first half versus second half split. So I assume that the first half Industrial margins are going to be probably comparable to the second half of 2017 and then you'll see a big pickup in the second half; is that the way you're thinking about it?

[Chris Stephens:]

It's a good way to look at it exactly. That's why we're looking at kind of the EPS guidance for the full-year kind of, our outlook is more than 47

[Edward Marshall:]

Got it. And the final question, just curious got to ask GE impact any payment terms changes, discussions, or maybe in-sourcing, or actually further outsourcing that you might be seeing as the result of some of the issues that you have?

[Chris Stephens:]

Yes. And I would just comment maybe on the payment terms; clearly it's a constant discussion with them in terms of those payment terms. There are occasions that we will provide for, and negotiate with our customer, specifically GE that offer longer payment terms, but that comes with an overall negotiation of business in general. So as we continue to win with GE, we have to contribute and that's one way we're able to help make this economically better for Barnes Group in the long run as we work on new programs thinking about price and thinking about volume longer-term.

[Operator:]

Our next question comes from Josh Chan from Baird. Please go ahead.

[Josh Chan:]

Hi, good morning. So just baseline some of the numbers for the Industrial business, so how much do you think the Associated Spring issue kind of cost you over the course of 2017 is this $10 million close to ballpark and I guess how much of that goes away next year or in 2018?

[Patrick Dempsey:]

So I would say it's just slightly north of the $10 million, and we expect the majority of it to go away going into 2018. So as we move forward and all work has been moved to the designated locations and we work to bring that transferred work up to speed, as well as we've continued to evaluate the Associated Spring portfolio as to different aspects of that business as to what is meeting our expectations and some work that may not be. As we work through that, we expect a significant improvement as we go sequentially through the year, but with a view today predominant portion of additional costs behind us through the first six months.

[Josh Chan:]

Okay. So that's good. So I guess -- so this -- most of this 10 plus million goes away and then on top of that, you get the $5 million savings from the consolidations am I thinking about that, right?

[Patrick Dempsey:]

Yes, it's correct.

[Chris Stephens:]

Exactly, yes exactly.

[Josh Chan:]

Okay. And switching gears if I could to the Aero business, very strong OEM backlog so I guess if you ship 50% of that you might get kind of a double-digit type of OEM growth, so is the high-single-digit forecast kind of designed to allow for some timing shift potentially or is there some other offsets that we should think about?

[Patrick Dempsey:]

No, I think we've indicated in terms of guidance high-single-digits and I think that we're very confident in that number, it's primarily driven by the ramp within the LEAP program on the A320, but also now as you're heard we're also contributing to the 737 MAX. We're also looking at some slight increase in 2018 as it pertains to the A350 as the Dash 1000 comes online. So overall, there are movements nonetheless, we are seeing some slippage on other programs to the right. And so as we look at the full-year, if they pull back in, we should have a very strong year, but with everything we have right now we're looking at high-single-digits.

[Josh Chan:]

Okay, great. And last one for me I guess in terms of M&A kind of how active is the pipeline has anything changed since the tax reform late last year, just what are you looking basically?

[Patrick Dempsey:]

So from our standpoint the M&A continues to be something that we're working very diligently. I never mentioned it before relative to Q4 but part contributor to compression of margins was a deal that we walked away from in the fourth quarter. So we're continuing to be active as it pertains to M&A and we're excited about opportunities that we're exploring not only within the space that we've already entered into through Molding Solutions but other end markets and other technologies that we're also research and exploring at the moment in the context of M&A, so overall, a lot of effort going in our behalf.

[Josh Chan:]

Okay. And that’s great to hear. And thanks guys for your time.

[Patrick Dempsey:]

Thank you.

[Chris Stephens:]

Thank you, Josh.

[Operator:]

Our next question comes from Michael Ciarmoli from SunTrust. Please go ahead.

[Les Sulewski:]

Good morning guys. This is actually Les in for Michael.

[Patrick Dempsey:]

Good morning, Les.

[Chris Stephens:]

Good morning, Les.

[Les Sulewski:]

Actually just to go back to that previous question from Josh on the M&A front, you mentioned a deal you walked away from the pressure to margin, I guess first can you talk about what was that Industrial or Aero deal related? And any other pressure on margin specifically in Industrial other than Associated Spring?

[Patrick Dempsey:]

Well, we -- the deal was in Industrial and it was an opportunity that we looked very hard at and spent, a lot of resources in terms of doing our evaluation. However, we remained very disciplined to our criteria on all M&A. And so, in this particular instance we just couldn't get to the point we wanted to. In terms of other areas of margin compression, I did highlight as throughout the year within the other SPUs, particularly NGP as an example, as that business has ramped to what are now as record high levels of production and demand. With that comes some inefficiencies and so we have seen some compression there with respect to expediting of materials or shipping of products from Europe to China or to Asia which because that's where we're seeing increased demand. So a number of areas but nothing significant the largest is the commentary already as it pertain to Associated Spring.

[Les Sulewski:]

Got it. Thank you for that additional color. On the Aero aftermarket side, you're lapping some really strong quarters; is there any risk to your guidance on the growth rates there, specifically in MRO and Spares?

[Patrick Dempsey:]

So as you look at our aftermarket, it's driven primarily by our participation in terms of our revenue sharing programs as well as our component repair programs. Both of those are driven by the CFM-56 engine as well as the CF6, one being a narrow-body aircraft engine and the other being wide-body. What we saw throughout 2017 was strength on both programs. Surprising maybe on the CF6 because it's an older engine and it's coming to the back half of its product lifecycle. But with continued demand and air traffic right now had been very robust with air traffic just recently captured at 7.5% for 2017 in terms of RPKs. We've just seen high utilization rates that have driven the engines into the shops. So as we move into 2018, we expect that strength to continue. And of course because the CFM which is the bulk of our revenues that particular engine is coming into its sweet spot in terms of requiring maintenance for a number of years to come.

[Les Sulewski:]

That's great, thank you. I guess last one from me is on the CapEx, I believe that the number bumps up a little bit in 2018, is this kind of a one-off event or is that more of a normalized rate running looking forward?

[Chris Stephens:]

Yes, and I would say, this is Chris. I would say we're going to continue to fuel internal growth opportunities and we do see the CapEx requirement come across both industrial and aerospace, so in the near-term $60 million to $65 million full-year coming off the year at $58 million, $59 million. We will continue to feed our businesses as those opportunities present themselves for profitable growth. We, as we internally say, we are not going to start capital, we're going to make appropriate investments in our business to grow globally.

[Operator:]

Our next question comes from Christopher Glynn from Oppenheimer. Please go ahead.

[Patrick Dempsey:]

Good morning, Chris.

[Christopher Glynn:]

Thanks. Good morning guys.

[Chris Stephens:]

Good morning, Chris.

[Christopher Glynn:]

So you had a nice sequential pop in the aerospace margins, I think last quarter you talked about adverse mix within OEM. Just wondering if you could flush through that dynamic if that inter-OEM mix kind of renormalized or it was really just the growth of the aftermarket that caused the sequential improvement?

[Patrick Dempsey:]

I would say the primary driver was aftermarket, Chris, in that we saw extremely strong performance out of both spare parts and our component repair programs which is refurbishment of existing parts that are coming into the shops for overhaul. The OEM side continued to make a very nice progress in particular on the ramping programs with the teams just doing an outstanding job there in meeting the customers' requirements. And so as we move into 2018, both aftermarket and OE, we see continued strength into both segments of the aerospace side of our business.

[Christopher Glynn:]

Okay. So you don't anticipate mix within OEM being particularly noisy next year or this year?

[Patrick Dempsey:]

No not that I would draw attention to, we always have mix issues within the aerospace business and what we have sometimes is a movement in and out of any particular quarter depending on how a program is progressing. So again if the program's on track then it's a little bit more predictable but whenever there is any type of issues in the supply chain or in the design aspects of any program there is movement and that movement can be equated to mix in one sense depending on what we were planning to ship, but overall we're very confident going into the year.

[Christopher Glynn:]

Okay. And you touched on interesting point of high level with Associated Spring a few questions back, but if you look at 2017 margins came off above three points on 10% organic. Just wondering about the view towards revisiting some attrition within Associated Spring or the question whether Associated Spring as a whole fits within the Barnes portfolio here.

[Patrick Dempsey:]

So as we've end -- as we proceeded on our new vision and strategy one thing that I constantly make reference to is that we set a bar for all of the businesses in terms of expectations and it's not to say that one set of expectations is different for any given business and what we're looking at is saying that we expect high performance out of each of them. In the case of Associated Spring we see the opportunity for them to continue to improve as we migrate into 2018. We're also looking always as particular product lines or particular programs within our Industrial business, in this case Associated Spring, as to whether it meets those hurdle rates and as a result we've been very deliberate to exit certain work if we don’t believe that it’s in our best interest over the long-term. And so if I raise it up then to the overall portfolio, I think that from a strategic standpoint we're migrating the business to a more highly differentiated group of businesses, and within Associated Spring they have to work through that same process as to how to differentiate themselves in the market space or -- we’re continually evaluating product lines businesses and the entire portfolio from a strategic standpoint on a ongoing basis and we’ll continue to do so.

[Operator:]

We have no further question in queue. I'll turn the call back to Mr. Bill Pitts for closing remarks.

[Bill Pitts:]

Thank you, Carol. We would like to thank all of you for joining us this morning and look forward to speaking with you next in April with our first quarter 2018 earnings call. Carol, we will now conclude today's call.

[Operator:]

Thank you. This does indeed conclude today's conference and you may now disconnect.