AIMC (2019 - Q3)

Thank you for standing by. And welcome everyone to the Altra Industrial Motion Q3 2019 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your moderator today, Mrs. Ryan Flaim. Thank you. Please go ahead. Ryan Fla

gfollow 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 3. 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 Industrial Motion does not intend to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.On today's call, management will refer to non-GAAP diluted earnings per share, non-GAAP income from operations, non-GAAP net income, non-GAAP adjusted EBITDA, non-GAAP organic sales, non-GAAP operating working capital, non-GAAP net debt 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 continuous operations. The reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available in the financial tables of the Q3 2019 financial results press release on Altra's website.Please turn to Slide 4. With me today are Chief Executive Officer, Carl Christenson; and Chief Financial Officer, Christian Storch.I'll now turn the call over to Carl.

Thank you, Ryan, and good morning, everyone. And please to turn to Slide 5. Our third quarter performance was highlighted by our ability to deliver excellent free cash flow and working capital improvement, as well as strong earnings per share despite macro-economic pressure on the top line.We continue to experience mixed business conditions with weakness in several markets while other end markets remain strong. Q3 sales grew 94% year-over-year to $442.9 million, reflecting the addition of A&S segment. On a pro forma basis, organic sales declined 3.6% due to softer than expected demand from some end markets. Most notably, the heavy duty truck market in North America, as well as reduced demand in key geographies such as Germany and China as a result of the trade dispute with China.At the same time, we are encouraged by our operating margin performance. Despite a sequential revenue decline of 500 basis points, Q3 operating margin was only down 40 basis points as the benefits of our cost actions and synergies helped mitigate the impact of the top line decline. As we navigate through the current macro headwinds, we are focused on cost containment while working to ensure that we protect the long-term growth opportunities for our business.Excluding the effects of foreign exchange, net sales for the PTTE segment were down 2.3% while net sales for the A&S segment on a pro forma basis decreased 5.9%. This quarter compared with the same quarter of last year. The declined were due to a difficult comparison with the third quarter a year ago along with continued weakness in the factory and automation and specialty machinery and transportation markets. The A&S segment comparison is based on management's estimate of unaudited A&S financial results from the same quarter of 2018.Net income was $25.7 million, or $0.40 per diluted share compared with $12.3 million, or $0.42 per diluted share the year ago quarter. And non-GAAP EPS was $0.69 per share compared to $0.71 last year. As a result of our cost reduction and synergy initiatives, margins were up year-over-year but were down slightly on a sequential basis. This includes a gross profit margin of 35.4% and non-GAAP operating income margin of 16.5%.Non-GAAP adjusted EBITDA was $89.0 million with an adjusted EBITDA margin of 20.1%. Please turn to Slide 6 to review our end markets. Starting first with a closer look at the more notable market headwinds faced in the quarter. Sales into the transportation market were again down low double digits as a result of the significant and continued decline in the heavy duty or Class 8 truck market, as well as slowing in the automotive market. The heavy duty truck market has dropped with the slowing economy since the end of last year.We expect our sales into the global Class 8 truck market to be down approximately 20% or $40 million in 2020, when compared with 2019. Historically, the typical down cycle for heavy duty trucks has been about a year and a half to two years, followed by a three to four year up cycle. We will manage costs during the decline and we’ll be well positioned for the upturn.I'd like to note that despite the cyclical market factors pressuring transportation in the near term; our Class 8 truck business is developing exciting new technology to provide safer braking systems, as well as systems that improve fuel efficiency and lower emissions. These technological advances will provide good long-term growth potential.In addition, our Classic A truck businesses had a very significant win in China, as demand for one of their customers natural gas engines is ramping up at a much faster rate and greater extent than expected. Demand in factory automation and specialty machinery was down double digits again in Q3 as we continue to face the same factors that impacted last quarter. Tough year-over-year comps, continued weakness in the end markets, destocking and softness in China.It appears that demand has stabilized albeit at a relatively low level, this market should be one of the first to emerge from the downturn. Despite the current market dynamics, this is a market with great long-term secular growth opportunities.Metals declined by double digits due primarily to ongoing slowing in the automotive industry and fewer capital projects. However, the aftermarket demand continues to be stable.Our core distribution business was down again in Q3 with declines across the board. Some of this was inventory reduction, which we are optimistic will bottom out in the coming quarters. We continue to expect distribution sales to be down balance of the year as the general industrial economy has continued to soften.Turf and Garden was down high single digits due to weather in the spring and the resulting inventory hangover at our customers and the big box retail outlets. Ag was down mid-single digits due to weather and the effects of the ongoing trade dispute with China.On the positive side, we also continue to experience strong demand in several key markets. We expect the medical market to continue to be a growth engine for us and a bright spot as we look out to next year with expected growth in the mid-single digits.We reported strong results in the energy market, which was up high single digits overall in Q3 compared to the same quarter last year. Within the energy market renewables were up double digits for the quarter and oil and gas was up slightly quarter-over-quarter.The mining market was up low single digits quarter-over-quarter as a result of strong aftermarket parts activity, but was down double digits sequentially, as we had experienced a very strong Q2 in this market. And aerospace and defense performed well up double digit year-over-year again, as we saw strong demand across the board.From a macro perspective, we have continued to see the overall industrial environment, operating more cautiously, which we believe is in part due to uncertainty surrounding the trade war and the secondary impact of tariff. In our opinion the global industrial economy is in the midst of a cyclical downturn, which we continue to believe will be relatively short lived and not especially deep.As a result of the uncertainty visibility into when the market will turn remains limited. We also anticipate the customers may delay receipt of shipments at the end of the year to manage working capital in a weak environment.Please turn to Slide 7. As we navigate through the current macro headwinds, we continue to focus on executing on our strategic priorities to position Altra to deliver on our promise as a premier industrial company. Cash management remains a top priority. And in Q3, our efforts yielded a record $71.5 million of free cash flow.On a year-to-date basis, the company has generated $143.5 million of free cash flow. We continue to advance our goal of delevering a balance sheet. We paid down $40 million of debt during the quarter. This brings our total debt pay down to $110 million since the close of the A&S merger and keeps us on track to deliver on our goal of paying down a total of $130 million in 2019.It has been -- it has now been a year since we completed the transformative merger with A&S and we remain as excited as ever by the opportunities we have with this powerful combination. During that time, we have made excellent progress with the strategic integration of A&S and Altra. We're accelerating the combination of business processes to become a truly integrated company and we are well on our way to having a world class business system across the entire organization.We also remain extremely pleased with our progress in capturing synergies and will remain on track to deliver $15 million of synergies in 2019. This is above our target of $10 million to $12 million and keeps us well on our way to deliver a total of $52 million of synergies by year four. While remain excited about the long-term potential of the new growth markets we have entered. The ongoing strength of several legacy markets, the power of our technology portfolio and the depth of our talent. We continue to take a cautious view on the balance of the year and expectations going into 2020.This is reflected in our revised guidance for 2019 and the preliminary 2020 outlook that Christian will cover after he reviews our financial results in more detail.With that, I'll turn the call over to Christian. Christian?

Thank you, Carl and good morning, everyone. Before I review the details of our third quarter financial results, I would like to note that unless otherwise noted, results for the third quarter 2018 do not include pro forma A&S results.Please turn to Slide 8. In the third quarter, sales were affected by the macro factors as Carl mentioned. We delivered solid operational results for the quarter. Highlights of our performance are third quarter free cash flow of $71 million. Free cash flow was $143.5 million year-to-date. Operating working capital declined $25 million when compared to the end of the second quarter, contributing to the free cash flow generation in the quarter. Looking at the top-line foreign exchange rates had a negative effect of 175 basis points while price had a strong positive impact of 155 basis points. The sequential revenue decline is partially seasonally driven, but we also experienced a significant deceleration our Class 8 truck business.On an unaudited pro forma basis, sales declined 2.6% in North America, and declined 10.6% in Europe and 4.4% in Asia and the rest of the world. Excluding the impact of foreign exchange, sales in Europe were down approximately 5.7% and 3.1% in China. The provision for income tax on third quarter of 2019 reflects an estimated annual tax rate of 21.3%. Quarterly earnings per share will positively impact by around $0.03 per share, due to a lower Q3 tax rate. Non-GAAP adjusted EBITDA was $89 million for the third quarter or 20.1% of net sales.Please turn to Slide 9. In terms of cash, our priority continues to be paying down debt and delevering the balance sheet following the A&S combination. As planned, we pay down $40 million of debt in the third quarter. And for the fourth quarter, we expect to pay down an additional $40 million on our term loan, bringing the total to $150 million since acquiring the A&S segment.We exited the quarter with leverage of 3.8x net debt to adjusted EBITDA on a trailing 12- month's basis. A number of our investors might not appreciate the fact that for financial covenant purposes under our credit agreement, the unsecured senior notes are excluded from that leverage calculation. Consequently, under that calculation leverage is at 2.7x. The covenant is scheduled to step down to 5x at the end of 2019 and 4.7x at the end of 2020.Capital investments totalled $36.9 million year-to-date with nearly $13 million for the quarter as we continue to reduce capital expenditures this year from previously plan levels.Depreciation and amortization totalled 96.4 million year-to-date, and $32.1 million in the third quarter. When we began to see the beginnings of the downturn earlier this year, we initiated steps to accelerate synergies and cost reductions, including headcount reductions in all geographies. We now expect to realize in new synergies, including cost of our actions of $15 million and a year and exit run rate of $26 million. We expect to add additional pre-tax charges of approximately $3 million to our restructuring efforts in 2019.Now, please turn to Slide 10 for review of our outlook for 2019. Today, we are revising our guidance for full year 2019 to reflect our expectations given ongoing market softness. We're not expecting sales in the range of $1.827 billion to $1.837 billion. This reflects an organic growth rate on an unaudited pro forma basis of negative 2.3% for the full year.The midpoint of the range assumes a modest deceleration from Q3 run rate as we expect the decline of our Class 8 truck business to continue. We continue to expect change rate headwinds into the fourth quarter.As previously indicated, following the A&S combination, we began to exclude acquisition related amortization net of tax from non-GAAP net income and non-GAAP EPS. We now expect non-GAAP adjusted EBITDA in the range of $375 million to $381 million and we expect net debt to non-GAAP adjusted EBITDA leverage of approximately 3.8x exiting the year. And we also expect free cash flow of $185 million to $200 million. GAAP diluted EPS is now expected in the range of $1.71 to $1.81 and non-GAAP diluted EPS in the range of $2.77 and $2.83. We expect depreciation and amortization in the range of $128 million to $130 million, and capital expenditures in the range of $50 million to $55 million.On our normal tax rate, normalized tax rate is expected to be in the range of 23.5% to 24.5% for the full year and approximately 21.3% including discrete items. Looking ahead at 2020, we expect that market demand will continue to be challenging in several of our key markets and as a result, we expect 2020 sales in the range of 2% to 4% below 2019, with more significant year-over-year decline in the first half of the year. While we believe that approximately 40% of our portfolio will see low single digit growth in 2020, we expect that our class 8 Truck business will be a 220 basis points headwind to our top line. For the rest of the business, we expect low single digit year-over-year revenue declines.With that, I would turn the discussion back to Carl.

Thank you, Christian. Please turn to Slide 11. We take actions to manage through the near-term headwinds, we continue to execute on our strategic priorities that will position Altra to deliver on our promise as a premier industrial company. The first is to deliver on our $52 million synergy target by leveraging sales collaborations, advancing our supply chain optimization efforts and continuing to integrate world class business systems across the combined organization. Second is to remain focused on cash generation to expediently delever to our target range of 2x to 3x net debt to adjusted EBITDA and strengthen the balance sheet. And third is to deliver a 425 basis point improvement in the non-GAAP adjusted EBITDA margin.As I emphasized earlier, despite the macro headwinds that have created some near-term challenges, we are extremely excited about the prospects for Altra. This a great company with great products and extremely talented team. Cash flow from the businesses remains very strong. Our focus on working capital improvements is paying off and there's a significant opportunity ahead as we continue to realize the benefits of cross-pollinating our best-in-class business processes across the organization. We look forward to keeping you updated as we forge ahead.With that I'll turn the turn the call back over to Cheryl to open up the call your questions.

[Operator Instructions]Our first question comes from Michael Halloran with Baird. Your line is open

Hey, good morning guys. So first on the free cash maybe we can get some updated thoughts when we think free cash went up this year and then also maybe give some preliminary ideas on what kind of cash generation, you’re thinking about for 2020?

So for this year, I would imply $185 million to $200 million of free cash flow. We assume we can deliver additional working capital reductions in the fourth quarter and if that goes through as planned, we have a very good chance to reach the high end of that range. We’ll finalize our guidance and we bought back when we released fourth quarter earnings. We thought at this point, it might be helpful just to give some top line guidance, and that will go down through the P&L, but I don’t think we’re prepared yet to give more detail on the guidance as we think so.

I understand. Let me reframe that a little bit then for next year, maybe you can just talk about the ability to maintain cash generation in a declining revenue environment. So using that $185 million to $200 million kind of as a base and a decline in revenue, is there the capability of being able to hold that revenue cash flow range or maybe just talk about puts and takes in that context?

Puts and takes will be what decline in revenues there will be decline in operating income and net income associated with that but on the flip side; we will be able to reduce working capital levels further. In an addition, we’re going to keep our capital expenditures probably in a similar range maybe slightly lower than this year to maintain healthy free cash flow levels.

Appreciate it and then just to make sure I understand the thought process here. I think in the prepared remarks, the midpoint of the guidance is assumed some deceleration 3Q to 4Q largely because of the Class 8 Truck side, could you talk a little bit about what you’re seeing in the core trends through the quarter outside of Class 8 Truck? Was there deceleration through the quarter? Is there any embedded deceleration in the thoughts from the third quarter level into the fourth quarter? And then maybe a same process with that down 2% to 4% that you’ve implied for next year? Is there deceleration from the current run rate that’s assumed into next year?

Yes, Mike the third quarter is always difficult to look at trends through the quarter because of the things has happened in the -- around the world, Europe has some areas and almost shut-down in August and, so it’s tough to look. But kind of on an ad-hoc basis, I’d say that the trend through the quarter was pretty stable.There were some markets that continued to decline, but others that we saw maybe level-off and maybe going to improve a little bit. So I’d say on balance it was fairly leveled. And then going into the fourth quarter, Christian do you want to?

Yes, going into the fourth quarter we continue to expect a deceleration in Class 8 Truck, but what we’re mostly concerned about is performance in December. We anticipate that a number of our customers would have plant shut-downs in December will extended, plant shut-downs around the holidays that we expect customers to delay shipments into January to manage their working capital at year end and so therefore December becomes a very unpredictable month for us. And that’s why we assumed some modest deceleration eventually from the third quarter going into the fourth quarter. But we just thought it was worst to pointing out that risk in December, yes.

That makes a lot of sense. And then the run rate for 2020 then is just kind of using an adjusted fourth quarter the right proxy excluding the Class 8 Truck then?

Yes, I think with the fourth quarter run rate in Class 8 Truck we are, we are approaching in a very close to next year’s run rate.

Yes, and seasonally we usually see a pick up, the first half is usually better than the second half. So we look at Q3, Q4 and then jump into the new year particularly people do things to manage the balance sheet, you might see a little improvement in Q1, Q2.

Yes. So the first half comparison will be challenging next year. When we look at the portfolio and as I said in my remarks, there's a 40% of the portfolio will see growth next year. That would include medical business with Portescap. We think that even on the Kollmorgen side, we are very close maybe we are at the bottom there. And so other than Class 8 Trucks, we’ll see some modest revenue declines year-over-year in some sections of a portfolio whether it's oil and gas and some of the other end markets.But we thought we provide that top line guidance initially to kind of signal. Next year it's not going to be a disaster, continue to be a challenging year for the industrial world. But the world is not coming to an end.

No. That's super helpful. And then my last one, I think you said the exit rate is $26 million synergies for next year, you're implying kind of $11 million of incremental synergies going into next year. What's the thought process for new synergies that you're going to be working on for next year? And how much do you think that could help at this point for 2020 on top of the $11 million?

Yes, so we think we're going to add $8 million to the exit run rate by next year of which half of that call it $4 million should be realized in year that would get us from the 15, of the 11 plus four around $15 million in year's synergies next year.

Thank you. Our next question comes from John Franzreb from Sidoti & Company. Your line is open.

Yes. Christian just on the fourth quarter and cost comment on the delay of shipments. Are there certain businesses that are more susceptible in your portfolio to those delays and others?

I think from a geographic standpoint Germany is susceptible. There's a great tradition to close factories between Christmas and New Year. And we think that those shutdowns might take place prior to the Christmas holidays. And that would then mean which businesses are impacted as partially CCB is partially our gearing business could affect the Kollmorgen business as well. So it's more geographic than I think customer specific.

And I think it's almost across the board, John, it's just whoever's trying to manage their balance sheet andIncentives. So --.

Okay, thanks, Carl. And other than the Class 8 side of the truck side of the business, in the first half of next year what businesses face the toughest comps on a year-over-year basis?

I think CCB businesses, they've got some.

Yes. So if we look at PTT side, with CCB particular we’ll have some tough comps. Whether that's --we had a very strong wind business in the first half of the year, for instance, within CCB. I think also when we look at our ECB business that will have challenging comps. It's essentially ECB -- CCB even our Thompson business will have some challenging comps.

Okay, great. Thanks. And one last question on the price increases. Where have they been most effective within the portfolio?

So we starting the price increases have not yet seen the benefit of strategic pricing. We didn’t expect strategic pricing to make a contribution and as we start the first quarter. We have made some great progress there with two of the A&S businesses and they're very close to implementing strategic price increases. And so these are still price increases that are at a much higher level than normal because of the tariffs and the tariffs have impacted businesses like Kollmorgen and have impacted CCB business. I think those are the two main areas where we have seen the impacts of tariffs but others as well.

Again, I think all of our businesses have worked hard this year on. So, it’s been a really good effort by all businesses to try to make sure that we cover any input cost increases as well the tariffs and it's been generally very well done.

Thank you. Our next question comes from Jeffrey Hammond from Keybanc Capital Markets. Your line is open.

Hey, good morning guys. So, it sounds like most of the weakness today has been kind of China and Germany or your broader Europe. Can you just talk about what you're seeing trend wise in North America and where you are seeing maybe things starting to weaken?

So, I think the metals business is probably one that was doing pretty well that's weakened a little bit. I mean, obviously, the class 8 trucks are the number one but we've talked about that I think plenty. So, I think metals as the -- there was duties put on metals coming in and the exchange rate had the opposite effect. So, I think the -- and then the automotive industry turning down a little bit has had an impact on that industry. The Ag business was doing well and turf and garden but with the weather and the spring and then the trade dispute that markets weaken and that's weaken globally I think not just in North America.Vertical or our lifting business which would include fork trucks, cranes and hoist, we've seen that weakened probably a little bit, and then the distribution business has weakened somewhat, which is kind of the general industrial activity out there an indication that that's slow down.

Okay, and then and distribution is the view that inventory should be pretty lean by the end of the year or what are your distributors telling you?

I think our distributors are telling us that they believe that our inventories are in good shape. Our factory performance has been really good and so they're turning our inventory, a really good clip. But also, that performance has enabled them to take a little bit more out. So, it hasn't been tremendous reductions in inventory, but is -- but they have taken a little bit more out. But I would like to think that going into the beginning of next year, get the inventories lined up on our products and restart the year fresh.

Okay, and then just finally on the on the truck piece, can you just kind of unpack that down 20% what you see North America versus some of the other parts of the world? Thanks.

Sure. Yes. So, for 2020 our assumptions are that the NAFTA truck market will decline 32% and this is for us. China will be down 3% for us, Europe will be down 18%. The rest of the world which was mainly Japan and Korea will be flat. With NAFTA being 45% of Class 8 truck exposure for us, China 20%, Europe around 16%, rest of the world around 19%. That averages to around 18% to 20%. We are hoping to potentially outperform that in China, we saw we think in the fourth quarter we see some substantial sequential growth in China.As Carl mentioned, the natural gas engine that we're supporting for one of our customers is really taking off much better than the customer and we had expected. So, we anticipate sequential growth potentially as much as 60% in China, and if that will continue, we might outperform what I just gave you for China.

And that will be on that particular model not for the whole geographic region.

Okay, and then if I could sneak one more in. I think you mentioned renewables or the win business having a tough comp. Are you seeing any degree of slowing there or is that just a function of tough comps that you made a comment?

Well, I think it's just the ---not having the visibility, the first part of last year was much stronger than our customers had anticipated or had told us was going to happen. And we were able to perform but consequently they're as big as those machines are and as long as they take the ability to think they have a little bit more predictability than they do, but so we're just being cautious beginning of last year was very good. This whole year been super and so it kind of continues.

Yes. Fourth quarter of '17 is very, very weak. And then we had a very strong first quarter and second quarter as customers caught up to their orders like before as in the fourth quarter.

Yes. So there's no indication, Jeff that it's going to be down. I mean we don't see any paying customers coming over to secure portion things out, still very robust.

Thank you very much. And that concludes the questions in the queue. I'll now turn the call back to Carl Christenson.

Okay. I want to thank you all for joining us today. And we look forward to meeting with many of you in the months ahead as we go on the road to discuss the Altra story. On that note, we'll be at the Baird Conference on November 5th in Chicago and hope to see many of you there. Have a great day. Thank you.

Thank you. This concludes today's conference call. And thank you for participating. You may now disconnect.