Altra Industrial Motion Corp (NASDAQ:AIMC)
Q4 2015 Earnings Conference Call
February 17, 2016, 10:00 ET
David Calusdian - VP
Carl Christenson - CEO
Christian Storch - CFO
Matt Duncan - Stephens
John Franzreb - Sidoti and Company
Jeff Hammond - KeyBanc Capital Markets
Bhupender Bohra - Jefferies and Company
Welcome to the Altra Industrial Motion Corporation's Fourth Quarter 2015 Financial Results. [Operator Instructions]. It is now my pleasure to introduce your host, from David Calusdian. Thank you Mr. Calusdian, you may begin.
Thank you. Good morning, everyone and welcome to the call. With me today our Chief Executive Officer, Carl Christensen; and Chief Financial Officer, Christian Storch. To help you follow management discussion on this call, there will be referencing slides that are posted to the AltraMotion.com website, under Events and Presentations in the Investor Relations section. Turn to slide one.
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 an 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 10Q and annual report on Form 10K 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 intent to alter or update its future-looking statements, whether as a result 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 gross margin 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 management believes should be excluded when reviewing continuing operations. The reconciliation of Altra's non-GAAP measures to the comparable GAAP measures are available on the financial tables of the Q4 2015 financial results press release on Altra's website. I will now turn the call over to Altra's CEO, Carl Christenson.
Thank you, David. Please turn to slide two. On today's call I will go through brief overview of our performance during the quarter and the major driver to that performance and then I will provide our usual review to the end markets and then Christian will go over the financial results and I will be back to wrap up. The highlight of the quarter was most certainly our operating performance. We grew gross margins by 80 basis points to 31.2% on a nearly 10% decrease in sales in a very difficult macro environment. The margin improvement was the result of lower raw material costs, outstanding control of other input costs and our pricing initiative.
We delivered our three-year pricing objective in just over two years and we still have some additional runway to drive price. We also increased adjusted operating income by 70 basis points. I am proud of the way our divisions have quickly and effectively managed the cost side of the equation. As a result of our operational performance, we generated strong free cash flow of $18.8 million in the quarter and paid down $5.2 million in debt and returned $10.8 million to shareholders through the dividend and stock repurchase plan in Q4.
For the year, we generated free cash flow of $63.2 million and a very strong operating cash flow of $86.1 million. This enabled us to return $32.2 million to the shareholders in 2015. So in terms of operating performance, we had a very good quarter and year. The top line, however, continues to have its challenges. Please turn to slide three as we discuss the conditions in our end markets. We will begin with distribution which is predominantly made up of sales of aftermarket parts and original equipment parts for small O&Ms.
Distribution was down double digits both year-over-year and sequentially which is a reflection of the industrial economy; especially in key markets such as oil and gas, mining, metals and metals. While there may have been some moderate destocking at the end of the year, we do not expect distribution to rebound in the near term. In addition, we do not anticipate further destocking at this point. Turf and garden which continues to be our leading market, turned in its second consecutive record year.
We were up for the quarter both sequentially and year-over-year on a strong domestic housing market and favorable weather conditions. The industry is expecting modest growth in 2016 and we're on track to have a similar year to the one we had in 2015. We have talked in the past about consolidation of our turf and garden manufacturing into our Columbia City plant. The investments we made in Columbia City have paid significant dividends as we supported customer demand while enhancing margins and substantially lowering inventory.
Turning to agriculture, this market was still very weak with a double-digit decline in year-over-year sales. Low commodity prices, less incentives and the strong dollar continued to negatively affect U.S. exports. We expect continued softness in 2016 -- transportation was off by single digits in the quarter, as a result of a difficult year-over-year comparison in the marine sector where we had some especially large projects in Q4 of 2014. Automotive was essentially flat and we expect this trend to continue in 2016. We had a very good quarter in materials handling with sales up double digits due primarily to strong elevator demand.
Forklifts were also up in the quarter, while conveyor and hoists were down. We see no catalyst that will significantly improve this market from here. Turning to energy, energy overall was down significantly from a year ago and on a sequential basis, driven by weak oil and gas sector. We expect the oil and gas segment to continue to erode as drilling continues to decline.
Conventional power generation was also down in the quarter. Conversely, the renewable side was quite strong on a constant currency basis, led by wind. Our Svendborg wind business continues to outperform. Construction of wind breaks in Brazil began on schedule in the quarter. We're excited about some terrific opportunities on the horizon for Svendborg wind that will improve our leading market position. Given the production tax credit extension, the U.S. market should be strong. We also expect the South and Central American markets to be strong.
The relative strength of the renewables market and our new product development efforts give us reason for optimism about 2016 in this market. Demand in the metal market, in the metals market, weakened further during the quarter and sales were counsel over 10% year-over-year. Chinese capacity in relative lower steel prices throughout the world continue to weigh on this market. Mining continued to be down double digits for the year, but was up on a sequential basis for the second consecutive quarter. Although I will not be calling the bottom of this market.
Softness in China and the emphasis on coal reduction is significantly affecting the mining industry and the outlook could be worse for 2016. Finally, sales in aerospace and defense declined modestly for the quarter, but were up sequentially as a result of a few large commercial aerospace drones. We expect that our aerospace and defense business to be strong in 2016 with demand coming from the commercial aerospace side and the defense business continuing to be under pressure. Now I will turn the call over to Christian and then close with a discussion our strategic initiatives. Christian?
Thank you, Carl and good morning everyone. Please turn to slide four. Our fourth quarter results reflect the continued softening in the global industrial economy in some of our largest end markets, as well as deteriorating sentiment within our distribution channel. For the fourth quarter 2015, non-GAAP diluted EPS was $0.36, versus $0.42 a year ago. Looking at the top line, foreign exchange rates had a negative impact of approximately 390 basis points, driven by continued strength in the U.S. dollar. Volume declined 660 basis points while our strategic pricing initiative added 80 basis points.
Metal foreign exchange sales declined 5.7% year-over-year. Geographically, excluding the effects of foreign exchange, North American revenues declined 13.6% year-over-year, while European revenues were up 7.1% and sales to Asia-Pacific and other geographies were up 7.3%. During the quarter, the average price of the Company's common stock did not exceed the current fair share conversion price of the convertible notes. As a result, the notes were not diluted to earnings.
We reported a tax rate of 42% during the quarter. In the fourth quarter, we recorded a charge of $1.4 million related to the closure of our couplings facility in China which are not tax deductible. Excluding these charges and other discrete items recoded during the quarter, the rate would have been 30%. The full year rate, without discrete items, was 28.4%.
As we announced in our last call, early in the quarter we amended our credit facility which resulted in a two-year extension of the term, the elimination of the existing term loans, more favorable pricing and an increase in total borrowing capacity under the new $350 million revolver. Please turn to slide five for discussion of our segment performance. Please note that segment results are not adjusted for one-time items.
As a reminder beginning with the third quarter, we realigned our three segments as part of our business simplification efforts. The new structure is better aligned [indiscernible] Altra's end markets and better facilitate the Company's strategic initiatives for growth procurement and facility consolidation. For the fourth quarter of 2015, net sales in our couplings, clutches and brake segment was $77.1 million compared with $97.5 million in the year fourth quarter. The decrease was primarily the result of declines in the oil and gas, metals and mining markets. This segment has Altra's highest exposure to these end markets. Segment operating again was $9.1 million versus $14.2 million a year ago. Net sales in the electromagnetic clutches and brake segment were $54.3 million compared with $49 million in the fourth quarter of 2014.
Despite the weak agricultural market, this segment performed well as a result of continued strength in the turf and garden and elevator sales, as well as low exposure to the oil and gas and mining end markets. Segment operating income increased 40% to $5.3 million as a result of volume leverage. Finally, net sales in the gearing segment were $44.7 million compared with $47.2 million in the year-ago quarter. Segment operating income was essentially flat at $4.1 million as a result of our operating margin improvement initiatives primarily at Bauer. Please turn to slide six.
Our balance sheet remains strong. Book equity was $243 million and our cash balance was $50.3 million. Please turn to slide seven. During the quarter, we repurchased about 115,000 shares of Altra stock for a total of $3 million, under our $50 million stock buy-back program that expires at the end of 2016. Since the program's inception, we have repurchased approximately $34.9 million or about 1.2 million shares. We continue to be active in the market. We will continue to repurchase Altra shares from time-to-time as market conditions warrant.
Capital investments total $3.7 million for the quarter and $23 million for the full year. Well below our annual depreciation amortization of $31 million. Please turn to slide eight in our guidance for 2016. We expect a continued weakness in the global industry economy will put pressure on our sales in 2016. As a result, we remain focused on our operating execution. We expect sales in the range of $700 to $720 million and we fully expect non-GAAP diluted EPS in the range of $1.40 to $1.50 for 2016. We expect our tax rate for the full year to be approximately 29% to 31% before discreet items and we expect capital expenditures in the range of $20 to $24 million and depreciation and amortization in the range of $30 to $32 million. With that, I will turn the discussion back to Carl.
Thank you, Christian. Please turn to slide nine. At the beginning of the call, I noted the tangible result that we're seeing from our profit improvement initiatives. I would like to provide you with more detail on a number of areas that we're working on. Let us start with the business simplification plan which has proceeded very smoothly and we're running ahead of schedule. On our last call we mentioned that we had planned to close three facilities by the end of the first quarter and to announce another one during the quarter.
As we speak, we have already consolidated three facilities ahead of schedule in South Africa, France and China; and will have ceased manufacturing at a facility in Illinois by the end of Q1. By early Q2, we will have closed a small facility in Wisconsin and by the end of Q2 we will have closed an additional factory in Illinois. By the time this plan is fully implemented within three years, all of our consolidations will result in an annualized savings of about $7 million, with these first six representing about $3 million of that.
We expect to consolidate a total of 8 to 12 facilities. It is very important to note that we will not be reducing capacity as a result of our consolidation efforts. Thus far we have eliminated approximately 130,000 square feet of floor space without losing any capacity. For some of our future consolidations, we will need to expand the footprint of the receiving facilities before moving the operation. Turning to our supply chain initiative, we continue to make good progress in developing a world class organization. 55% of our cost to goods sold is purchased components and materials, so we have significant opportunity to take advantage of economies of scale and optimize our supply chain to better leverage our global spend.
We have held our first training programs. We have identified targets and we're now executing on the plan. As we execute this plan, we will benefit from the investment we made in our global I.T. system. We still expect to achieve our three-year savings goal. We have already discussed our strategic pricing initiative which has been a great success. We do expect that it will be more challenging in 2016 than 2015 in this area, but we still have good opportunities going forward to drive price.
Last year we announced significant European restructuring and cost reduction efforts and our work in this area has provided a substantial boost to margins, despite the decline in sales. These initiatives include our Bauer profit improvement plan which gained real traction as the year progressed. For the full year, Bauer margins increased 150 basis points and we expect further improvement in 2016. We're also making very good progress with our operational excellence initiatives and we're effecting real cultural change across the organization. If you are interested in seeing some of the good work that the team has done, we would be proud to have you take a tour of one of our facilities.
Before we wrap up and go to questions, I would like to offer a quick update on our efforts to stop foreign dumping the certain belt and drive components. Last year on behalf of the domestic industry, we petitioned the U.S. government to investigate trade violations related to imports of certain iron mechanical transfer drive system components from China and Canada. The government agreed there is a reasonable indication that dumping has occurred and the U.S. industry has been materially injured and they will be proceeding with a final-phase investigation. If the investigation is successful, we're hopeful that duties will be imposed on these imports by the late this year or early next year.
Looking forward, we will continue to aggressively execute on our initiatives to improve margins even as we face challenges in many of our end markets. When these markets do rebound, we will have a significantly better ability to leverage sales growth into greater profitability. Thanks for your continued support of Altra. We will now open the call to your questions. Operator?
[Operator Instructions]. Our first question comes from the line of Matt Duncan with Stephens. Please proceed with your question.
First question I have got is if you could talk a little bit about the sales trends that you saw both through the quarter and so far in January and February and what does the order trend look like as well.
Yes, so we saw during the fourth quarter that it was weak and it continued to deteriorate through the quarter or through the end of December. So when we look at the first quarter for this year, at the end of the year we were very concerned because of that trailing off of the incoming order rate. We now think that was some year-end, you know, adjustments by some of our customers and distributors and we saw the orders pick up right after the first of the year. Some of that is going to be blanket orders from large customers, but some of it is a pickup of orders just as we think this did some adjustments for the end of the year.
We're concerned about the first quarter because, you know, we cannot convert necessarily all those orders into shipments in the quarter. So when we look at the year, we think the first quarter might be a little bit weaker but then pick up in the second quarter as though incoming orders which have picked up and stayed for the first six weeks have been significantly better than the fourth quarter.
And is that, Carl, specifically in the distribution channel or are you seeing that other places? I know some of your larger distribution peers have seen a little better sales trend at January and February so I would assume that that’s part of it, but where are you seeing the orders get a little better?
No, there are some O&M customers that we think, you know, had not placed orders at the end of the year but then did at the beginning of the year. But it is definitely the distribution channel would be the predominant factor there.
And then on the gross margin side, you know, if you back out the supplier warranty provision, you have been 31.8% I believe in the third quarter, 31.6% in the fourth quarter. Is that a level that you guys can hold going forward? Is there something that sort of is unsustainably benefiting that or is that really where you are at now, given all of the hard work you guys have done on the strategic pricing side and obviously with some cost controls as well?
We think that the 31% would hold, virtually all the way up to 31.8%, but somewhere in the 31% range is what we should be expecting going forward.
The one caveat, Matt with the one caveat that if sales deteriorated significantly, obviously we would see some operating leverage and we would take action but we might not see it, you know, immediately.
Okay. Sure. And the last thing for me just to make sure I understood your earlier comment about the shape of the year correctly. It sounds like what you are saying the way order trends trailed off in the fourth quarter we should expect the first quarter to probably be a weak start, but given what you are seeing in the order book so is far, it should pick up notably -- noticeably in the second quarter from there?
Yes, I think if we -- if the order trend in the fourth quarter continued through, you know, we would have expected to see it in the order of a 10% decline in the first quarter year-over-year comparison. So the orders picked up a little bit. We do not give quarterly guidance. But we would expect to see that the first quarter will be weaker.
Our next question comes from the line of John Franzreb with Sidoti and Company. Please proceed with your question.
I guess I actually want to talk a little bit about the revenue e decline and the product mix you are expecting for the year ahead. It sounds to me that you are saying oil and gas is going to be continue to be weaker than 2015, but are there any other end markets that you are notably concerned about that would be weaker in 2016 versus 2015?
Yes, we think mining is going to get weaker. I think there has been some very bad news out of that. The steel industry has been successful in getting some duties; I do not think they have been enough to really change what is going on there, so we would expect to see some decline there also. Agriculture is going to be, you know, a question mark.
In addition, you know, distribution I think we're concerned about given what we have seen, you know, the large players announcing their earnings announcements and their outlooks for 2016 look weaker to us than 2015.
Regarding the distribution, it kind of sounded like a second ago you saying that it looks like stabilization that bounced back in the first couple weeks compared to how it ended last year. But you are saying you think that is only a temporary phenomenon?
No, I think the order has trended down and then they came back in January, but their projections for the year are down significantly. And if you go back three, six months, you know, their outlooks have gotten worse.
Okay. Switching gears here, no pun intended, sorry -- supply chain management, could you talk a little bit about your decision to accelerate the process, where you stand in the process, how much is done, remaining to be done and the timeline for that?
Yes, we think this year we can -- we expect about $2.5 million of cost savings out of that project. Training has happened and is continuing to occur. We have set cost reduction goals for each business unit for the next three years. We have crunched data to identify where these opportunities are; by spend category, by geographic region, by supplier. We identified opportunities to leverage spend across business units and/or business segments. The data crunching part is pretty much done. The training of the procurement people is halfway done and we're now in execution mode relative to specific cost reduction targets in each of the business units so we're in execution mode relative to those.
Meeting with vendors, that means negotiating price. That means looking for alternative sourcing. That means getting engineering departments involved to create engineering changes that would lead to cost reductions. All of the above is in motion with very specific goals and targets for each business group.
And would you say the change-over is 25% done, you know, could you kind of quantify that?
So in terms of the project, the project will last through the end of this year. The savings, you know, are savings that we plan to get 2016, 2017 and 2018 for a total of $78 million.
Okay. One last question, just on material costs and the benefits to the gross margin, how much do you have baked into that 31% you kind of referenced a few minutes ago going forward on that gross margin?
We have baked in that, you know, that we continue to see commodity prices at current levels whether that is iron ore, whether that is steel or oil and gas related, oil products, base products and relative to our purchases in Asia.
Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please proceed with your question.
So I kind of had 2016 a little bit modeled were sales were going to be down a little bit more and margins less. It looks like your decrementals in your guidance are kind of 30% to 40% and that seems that it would be maybe a normal decremental, but if we add in restructuring with strategic pricing and sourcing, it just seems like the decrementals would be a lot less. Maybe just speak to that dynamic.
Our decrementals when you look at the end markets that are down, so oil and gas, mining, agriculture; they are all very profitable markets. And then with the recent, you know, reduction of what we're seeing in distribution, that is also a very profitable end market for us. So we have got the decrementals on the gross profit side probably higher than you might. And then we're making up for it with all the initiatives that we're working on to improve the profitability.
So beyond the strategic pricing, what do you think restructuring and sourcing is? Year-over-year?
So about $5 million between the facility consolidations and the procurement industry. That is $2.5 million we think we can realize in 2016 based on the six facility consolidations that are either done or on their way. And then another $2.5 million approximately over the procurement initiatives. So we assume roughly 35% decremental margins at the EBIT line offset by about $5 million in savings for these two initiatives.
And then we have got other things like wage increases.
We used the price offset inflationary pressure on wages.
And then do you have a sense of how much, you know, destock was, you know, revenue headwind in 2015 that if that should abate, that does not repeat?
No, we do not. I mean we get some data from some distributors but we do not have, you know, a combined direct information from all of our distributors and customers that would tell us exactly what was destocking and how much was decline in market. We make some internal assumptions, but I am not prepared that I am confident enough in them to put them out publicly.
Okay. On slide five you have the segment data and I noticed electric clutches and brakes kind of bucked the trend and grew, you know, versus kind of the couplings clutches and brakes business in a kind of severely hit. Is there anything, I mean anything jump out to you there as far as, you know, structural shift in the industry or anything that is driving that ECB segment, you know, to stand out?
Two of the big areas were elevators and then our turf and garden business. And that is a combination of what is going on in those markets; but also those are two areas that we have really emphasized our operational excellence activities and they are farther along than some of the other businesses, some of the consolidation work that we did is leading to better performance.
So we think that some of the strategic initiatives we're working on are leading to share gain also. Share does not move easy in this industry but, you know, we think that we're starting to see some good activity there. So they have done a great job and that business is, you know, probably does not have the same effort going on in consolidations that we have in, you know, right now that we have going on in the couple of the other businesses.
And I can add that we saw significant growth in our elevator business as Carl said. The turf and garden business we clearly continue to gain share and then our Servo Motor brake business also based in Europe did well. Those three together, you know, accounted for the growth in that segment.
We have had some nice new products on the Servo Motor brake side that is been very successful.
[Operator Instructions]. Our next question comes from the line of Bhupender Bohra with Jefferies. Please proceed with your question.
I had a question on the guidance. Can you just talk about what is actually built at the lower end of the EPS and the higher end? Speaking from the perspective of margin progression through the quarters? Thanks.
So as Carl mentioned, we expect a weak first quarter given the weak bookings rates that we had, but then we saw significant pickups in incomes orders in the first six weeks of the year which would suggest that our second quarter should be fairly reasonable, if that booking trend continues. So sequentially we expect to start off weak, but then see some improvement starting in the second quarter. As it relates to high end and low end of the guidance, it is essentially volume driven. So it depends on how bad things are going to get in oil and gas, metals and mining; and to a large extent how distribution will behave.
Distribution is a significant piece of our business, 30%, 35% of our sales go through that channel. If I look at some of the guidance that we have seen from the big boys in that industry down 8% year-over-year, I think is what some of these guys are guiding to, is also very profitable piece of our business, so the mix between distribution O&M will also play a role in the high end versus low end.
Okay. And I think a question for Carl, I think you said in your commentary earlier that you expect no further destocking to occur. What makes you, you know, more comfortable now? I remember, like, in October there was some indication that destocking would go into, like, the second quarter of this year. Has anything changed since then or you are seeing better than expected 2016 orders now and that has changed your mind on that?
It is really related to the order trends where we saw orders drop off in the fourth quarter decline and then they kind of bounced back in January and have held in February. So I just think it is really my comment is based on those order trends.
Our next question comes from the line of John Franzreb with Sidoti and Company. Please proceed with your question.
Yes, just on your pricing initiatives, where are you seeing the biggest pushback? On the biggest pushback is the O&Ms that are in these distressed markets, so oil and gas, mining O&Ms, they have got a lot of issues. So that is where the biggest pushback is coming from.
Okay. And just regarding I guess we can put periods, whole medical costs issue from two years ago and into 2015. Can you kind of summarize, you know, what the final impact was in 2015? And I am assuming it is gone completely in 2016.
We saw essentially flat year-over-year medical expenses so if you assume a 8% inflation rate in medical expenses, the large claim issue is not completely behind us, but has improved. I think the severity of the claims, when we look at the severity of the claims that has declined; the frequency is still something that will continue to improve next year.
Okay. And medical costs are rising for you in 2016, another 8% clip?
Yes, so I think that is a fair assumption, cost of inflation currently runs around that, in that neighborhood, 8%.
There are no further questions at this time. I would like to turn the floor back over to Carl Christenson for closing comments.
Okay. And thank you Operator and thank you to everyone for joining us this morning.
This concludes today's teleconference. You may disconnect your lives at this time and thank you for your participation.
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