Q2 2019 Earnings Call
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[noise]. Good morning May have the name of the conference you're calling to join please.
[noise] the.
The Altra industrial motion earnings call.
<unk> I think you may have the spelling of your first and last name. Please.
Ryan Healy BR y and HP.
Hi.
Thank you and your company please.
Era AI era.
Hi.
Right.
Thank you your call is in progress joining you now.
Specific customers in the heavy duty truck market.
First a Chinese customer converted some of their purchases to an indigenous supplier.
Second another Chinese customer is up nicely year over year, but down from what we expected because of their customer having too much inventory.
And finally, a us customer reduced demand in the quarter to reset their inventory.
We expect demand for the remainder of the year to be similar to Q2 in this market.
Demand in factory automation and specialty machinery was down double digits again in Q2.
Primarily due to the same factors that impacted last quarter tough year over year comps continued slowing in semiconductor markets OEM destocking in robotics and softness in China.
We had been optimistic that demand would improve in the second half of the year, but we now do not expect that to occur until the fourth quarter at the earliest.
Metals declined by by low single digits, due primarily to ongoing slowing in the automotive industry and over overall economic demand.
Our core distribution business was down in Q2, due to upstream oil and gas industrial automation and slowing general industrial activity around the world.
We continue to expect distribution sales to be down for the balance of the year.
Turf and garden was down high single digits in AG was down low double digits due to weather and the effects of the ongoing trade dispute.
We saw mixed results in the energy market, which was up nicely in Q2 compared to the same quarter last year.
Renewables were up double digits for the quarter and sequentially.
This was partially offset by low double digit decline in oil and gas due to less drilling activity because of the high number of drilled but uncompleted wells.
And we continued to experience strong demand in several several key markets. The medical equipment market continues to have strong momentum up low double digits in Q2.
With growth growth driven by strength from surgical power tools surgical robotics.
Diagnostics and oncology equipment.
The mining market was up high single digits supported by strong aftermarket parts activity and moderate capex spending.
In defence performed extremely well up double digits since we saw strong demand across the board.
From a mattress macro perspective, we have started to see signs of the overall industrial environment growing more cautious, which we believe is in part due to continued uncertainty surrounding trade wars and the secondary impact of the tariffs. We do believe that the second quarter was a reset and that demand for the balance of the year will be slightly lower than the Q2 run rate due primarily to the typical seasonal effects, we experienced in the second half.
These are related to seasonal shutdowns and vacations in Q3.
And the holidays in Q4.
Now please turn to slide seven.
We remain focused on executing our strategic priorities to position ultra to deliver on our promise as a premier industrial company.
Cash management remains a top priority and in Q2, our efforts yielded a favorable $47 million of free cash flow.
On a year to date basis, the company has generated $72 million of free cash flow.
We continue to advance our goal of Delevering, the balance sheet paying down $35 million of debt during the quarter. This brings our total debt pay down to $70 million since the close of the ANS merger and keeps us on track to deliver on our goal of paying down a total of $130 million in 2019, and ultimately return to a two to three times net debt to adjusted EBITDA by the end of 2020.
We've also made excellent progress with the strategic integration of the ANS and ultra.
Our sales collaboration program, which continues to deliver.
In fact by the end of the second quarter, our team generated over 600, new leads which is more than 40% of the total program goal keeping us well on track to achieve our 2020 bookings target for this program.
The previously announced closure of a significant northeast facility remains on track to be completed before the end of the year.
Planning is underway to consolidate additional facilities.
We also continue to make meaningful progress with our supply chain optimization efforts to identify both indirect and direct cost savings.
And finally, our two cultures are coming together very well. We believe there is a tremendous value creation opportunity ahead, as we integrate our world class business systems across the company.
We are highly pleased with our progress integrating the business and we are on track to exceed $10 million to $12 million of synergies in 2019, and deliver a total of $52 million of synergies by year four.
While we remain excited about the long term potential of the new growth markets. We have entered in the ongoing strength of several legacy markets. We are taking a more cautious view on the balance of the year.
This is reflected in the revised guidance that Christian will cover after he reviews, our financial results in more detail.
With that I'll turn the call over to Christian.
Thank you Carl and good morning, everyone before I review the details of our second quarter financial results I would like to note that results for the second quarter of 2019.
Including the recently acquired and as businesses unless otherwise noted results for the second quarter of 2018 do not include pro forma ANS results.
As a reminder, we are reporting reserves in two segments, the automation and specialty segment and the power transmission technologies segments.
Representing the legacy Alterra businesses.
Please turn to slide eight.
As Carl noted second quarter sales of $466.5 million were disappointing and came in well below expectations.
Foreign exchange rates had a negative effect of 260 basis points, while price had a positive impact of 145 basis points.
On an unaudited pro forma basis sales grew 1.7% in North America declined 9.3% in Europe and 16.8% in Asia.
And the rest of the world.
Excluding the impact of foreign exchange sales in Europe were down 3% and in China, 13.5%.
Looking at the results sequentially compared to the first quarter revenues for the PTT segment were flat non-GAAP income from operations increased 130 basis points to 14.6%.
And as segment revenues declined $15.8 million and our non-GAAP operating income declined by 230 basis points to 20.2%.
The provision for income taxes in the second quarter of 19 reflects an estimated annual tax rate of 23.9%.
As noted last quarter. This full year tax rate is lower than initially estimated as our tax planning efforts are starting to pay off.
non-GAAP adjusted EBITDA was $95.5 million for the second quarter or 20.5% of net sales.
Please turn to slide nine.
In terms of cash our top priority continues to be paying down debt and to de levering the balance sheet. Following DNS combination.
In the first six months of the year, we have generated $96.1 million of operating cash flow and $72 million of free cash flow, allowing us to pay down a total of $50 million of debt and to pay approximately $22 million in dividends in the first half of 2019.
As expected second quarter frequent fresh.
Second quarter free cash flow was 47 million almost double when compared to the first quarter.
For the balance of the year, we expect to pay down an additional $80 million on our terminal, bringing the total to $150 million since acquiring the ANS businesses.
We exited the quarter with a leverage of 3.9 times net debt to adjusted EBITDA.
Capital investments totaled $24 million year to date with $10 million for the quarter.
Depreciation and amortization totaled $64.3 million.
Year to date and $32.2 million in the second quarter.
Although we don't believe that downturn will.
Be long term or exceptionally deep we have taken steps to accelerate synergies and cost reductions, including head count reductions in all geographies. We now expect to realize in year synergies of $15 million in the year end exit run rate of $26 million.
We expect to record an additional pre tax charge of a seven of about $7 million in 2019.
Now please turn to slide 10 for a review of our outlook for 2019.
Today, we are revising our guidance for full year 2019 to reflect our expectations given the market softness seen in the second quarter.
We now expect annual sales in the range of 1.85 to 1.8 billion. This reflects an organic growth rate on an unaudited pro forma basis of flat to negative 1.8% for the full year.
The midpoint of the range assumes a modest deceleration from our second quarter run rate.
So expect the rate of decline for the ANS business to moderate.
We continue to expect the exchange rate headwinds experienced through the first quarter and first half of 2019 to ease as we move into the third quarter and to subside in the fourth quarter.
As previously indicated following the ANS combination we began to exclude acquisition related amortization net of tax from non-GAAP income and non-GAAP EPS.
We now expect non-GAAP adjusted EBITDA in the range of 385 million to $400 million, we expect net debt to non-GAAP adjusted EBITDA leverage of approximately 3.6 to 3.8 times exiting the year.
And free cash flow of $175 million to $200 million.
We expect net income in the range of 116.8 to 125.8 million and non-GAAP net income in the range of $181.2 million to $191.5 million.
GAAP diluted EPS is now expected in the range of $1.81 to $1.95 in non-GAAP diluted EPS in the range of $2 and 81 to $2.97.
We expect depreciation and amortization in the range of 128 to 135 million in capital expenditures in the range of $50 million to $55 million.
And we expect our normalized tax rate for the full year to be in the range of 23.5% to 25% and with that I would like to turn the discussion back to Carl.
Thank you Christian and please turn to slide 11.
Well, 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 is to deliver on our $52 million synergy target by leveraging sales collaborations advancing our supply chain optimization efforts and continuing to integrate our world class business systems across the combined organization.
Second is to remain focused on cash generation to Expediently de lever to our target range of two to three times net debt to adjusted EBITDA and strengthen the balance sheet.
And third is to deliver on a 425 basis point improvement in the non-GAAP adjusted EBITDA margin by the end of 2022.
We believe we are taking the necessary actions to navigate through the near term market dynamics and keep ultra on track to achieve our long term goals I'm confident we have the right team the right technologies, the right businesses and the right strategy to deliver on the promise of Alterra as a premier global technology leader in our industry.
With that I'd like to turn it back.
To Simon to open the call to your questions.
Thank you at this time, ladies and gentlemen, I'd like to remind everyone that in order to ask a question.
Please press Star then the number one on your telephone keypad.
We'll pause for just a moment to compile the couponing roster.
And your first question comes from the line of Jeff Hammond with Keybanc capital markets. Your line is open.
Hey, good morning, guys.
Good morning, Jeff.
So just wanted to.
Understandable it looks like most of the.
The headwind incremental headwind was and.
Hey, Ns.
Certainly the magnitude was a little bit bigger.
Can you just talk about like where the biggest variances were versus in terms of end markets.
Versus what you were expecting because I know you guys had expected some slowing in the automation piece on or off transport was worse, but just a little more color on kind of where the biggest surprises work. Thanks.
Yes, I think I think it was in the automation.
Area and in high Tech space.
Where we thought that some of the inventory adjustments would be done and we'd be back on a on a little bit better.
Incoming order rate.
And then transportation was the other one that was.
Was that that was in the heavy duty truck market.
A little bit in North America, with some inventory adjustments and then in China.
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Okay.
And then just.
You gave us an update on free cash flow can you just talk about you know.
Your level of confidence that you can kind of hold the line there even if even if the margins.
Or the demand is coming in weaker and how your.
How you're able to do that thanks.
As always.
The free cash flow forecast numbers that I gave you 385.
I'm sorry, other 275 to 200 doesn't assume any improvement in working capital and I think should things get worse, we will definitely see an improvement in working capital as we go for the remainder of the year.
So we do feel comfortable that we will end the year inside of that range.
Okay, just on the I think you're saying two to 50 before and now 175 to 200, which seems like a bigger caught them.
Yes to the EBITDA cod.
I mean, why wouldn't you be able to squeeze a lot more working capital on hold the line on on free cash flow better.
Well, we look.
And we had a big snap back in the first quarter I think working capitals net back by about $40 million.
We look sequentially between Q1 and Q2.
Working capital was flat.
We do think there's opportunity to second half, we made some progress in inventory, but not enough.
I think there is some opportunity to second half to improve for working capital terms.
And that's why I feel confident that we can come inside of that range to 250 million that we said when we initiated guidance that assume that we can make some significant improvements in working capital as I stated at that time.
And that is not unfolding.
Yeah, and I think that ensued market conditions, getting better Jeff and and.
That would have helped the working capital situation too so.
Okay I'll get back in queue.
Okay. Thanks.
Your next question comes from the line of John Franzreb with Sidoti and company. Your line is open.
Yes, just on the transportation side of the business.
How big.
Our customer loss was that on in the quarter on an annualized basis and is that business and ANS strains safran.
Is that business can you repeat the last part of the question. John is that is that part of the Ana segments.
Yes, that's part of the ANS segment and its the.
It's in the Jake brake business.
And it's in the range of around $10 million.
Annually, I mean last year annual annually annually, yes, sorry annually.
Great.
And call on your expectations being pushed back on return of I don't know.
Factory automation sales.
Kind of thinking becoming back sooner now it sounds like if I heard you properly, it's going to be a fourth quarter recovery.
What's changed in the environment out there that's pushed it back so far.
Well I think part of it I think is that the we haven't gotten any trade resolution yet.
And.
And so it's really in China.
And so.
Okay.
If we do get some trade resolution and I think that that could come back sooner and if not then it's going to take a little bit longer.
I think thats the primary.
Okay can you remind me how much China was of second quarter sales.
So the decline in China was around 16% year over year.
China accounting.
So we have Asia.
$60 million for the quarter for.
For Asia, and the rest of the World and China is the biggest piece of that.
Okay.
And one last question you did mention you had you had some price increases where were you able to put in pricing.
So we have.
With a with a variety of businesses, we have throughout the year, we have price increases going through and so these were both from our strategic pricing initiative, where we have very specific discussions going on with Oems and then the general price increases that for those businesses that do it not at the beginning of the year, but during the year. So it wasn't any one particular area it's been across several of our businesses.
And we continue that John I mean Esa.
That's been a really good.
Improvement for us in the last 12 18 months.
In Europe , the price increases do not include yet any.
Impact of.
The strategic pricing process that we are implementing both the.
And ANS.
That project has been kicked off we get the first feedback from the algorithms that numbers are being scrapped so we anticipate.
To see the benefits.
Of that process as in late in the fourth quarter early next year.
Great Great. Thanks, Christian I'll get back into queue guys. Thank you.
Thanks, John .
Your next question comes from the line of Mike Halloran with Baird. Your line is open.
Hey, good morning, guys.
So also on the you gave the 175 to 200 million of free cash assumptions and I believe at some point so that the debt paydown remains unchanged from a thought process.
What what's the exact dollar number you guys are hoping to pay down or at least the range. This year.
So for the year or 130 million, which leaves 80 million for the second half of the year that will bring the total to 150 million since we acquired an asset that we did pay down $20 million in Q4 of last year.
So seasonally our cash flow improves as we go through the year first quarter being the weakest getting better in the second quarter and then typically the fourth quarter is the strongest cash flow quarter.
Looking at the effect forecast projections, we feel very confident that we can deliver the $80 million in debt paydown.
And if I can add you know since since we acquired.
And as we repatriated about $45 million in cash from overseas locations, we have another $25 million in the pipeline.
As of now for the third quarter.
So we'll be able to deliver that $80 million.
So so a few questions on Jake breaks and could you remind me percent of revenue what it is on the overall company off of call. It last year's is somewhere around 10% is that fair.
We don't really disclose that we reported in the segments and we don't break out the individual businesses.
But I think if you look at the transportation segment.
The.
Vast majority of that would be the Jake break piece.
In transportation.
Transportation is 16% around 16%.
Okay, and so so could you help frame the what's happening and Jake breaks relative to what our.
A more challenging class eight truck order environment.
So you had a couple of customers take down their assumptions on on on excess build.
Excess inventory build excuse me.
Let me see the customer losses is separate.
Well, how do you see that cadence thing out over the next 12 18 months in line of where the orders are do you expect accelerated cancellations happening in the pipeline that that impact you why why why are you guys comfortable that the exit rate from two Q.
Is the right exit rate for that business.
Well I think for the rest of the year. It's it's the right rate just based on.
Discussions with customers and public information on what the build rates are in the incoming order rates for the customers I think the bigger question is 2020, where people expect the.
North American class eight truck business to cycle down.
I think when you look at the publicly available numbers here in the.
2025, maybe.
I think the average is probably in the 25% to 30% range for North America I think if you look at.
China, they're expecting a decline in the 10% to 15% range and in Europe , I think it's actually up very low single digits, one or 2%.
So when we look at the global market, where we participate thats kind of the numbers that we're looking at and trying to plan for.
For 2020.
And I think the good news is we should overachieve in China based on the fact that they're implementing more auxiliary breaking technology, rather than just using the foundation breaks so even though the market is going to be 12 down 12%, we do not expect to be down that much.
About half our businesses in North America, which is where the real.
Thats, where we will probably follow the market in that region, but will offset it with some growth in China and then we're also penetrating Europe at a better clip so of Europe's market truly is flat and we and we grow there a little bit.
The decline that we will see we will not being near the the number that you will see in the North American truck market.
Yeah and the other thing is I can add Mike is that.
The laws of this there's one customer.
That is actually with the second quarter is behind us from a year over year perspective that shares comparably lives.
That also helps us too.
In our assumption that we've seen the bottom there or very close to the bottom at Jay Bray for for the remainder of this year and then were off all have to see what happens next year or when the North American truck market will settle down.
That's good color guys. Appreciate it so then.
A couple a couple of more questions here, one just the organic assumptions back half of the year for the two segments seems like it's somewhere down mid single digits for UNEV and then for the legacy business up slightly is that is that a fair way to think about it organically.
And then came in saying cadence in the margins for an asset in the back half of the year could you provide a little help there obviously, we don't have the year over year.
Margin levels to help in the third quarter, we do in the fourth but could you could you frame. How you expect those margins to track relative to what we saw in the second quarter here.
So I would think that on the ANS side. So what happened is that we got really surprised in June June shipments were very weak thats really when.
When it really started to show up.
On.
And then if I can add the good news is I think.
July is not going to be a great month, but the bookings in July .
Have picked up meaningfully.
So having said all of that is that we do and so we were late.
For that reason because we got to answer price in June to take out cost.
All of these businesses and globally. So since then.
Weve, taking actions you all codes have taken action to take cost out.
I mentioned would incur an additional $7 million in restructuring charges.
Payback is about one year on that so were taking about $7 million of additional costs out of the organization that is in motion has started.
We're going to start to see the benefits probably late third quarter, and then into the fourth quarter.
So I would expect that.
Margins in DNS business will be very similar to the second quarter.
Given that we have some additional topline decrease.
From a seasonal standpoint, but that were able to offset that through the cost actions that the business have taken and will take.
So is that just twoq to Threeq, you or is that to Q2, the whole second half the year. That's Q2 to Q3 and if we look from a seasonal standpoint.
Q4 is for the ANS side is going to be from a topline perspective for a review.
Similar to each other the Q3 and Q4.
In some or you get the weak December .
But we also have a weak July .
And I know, we expect the rest of the demands to be fairly similar going through.
The rest of but from a mark but from a margin perspective, probably a little better threeq to Fourq you just because of the.
Yes, it was all raising momentum on that.
Okay.
And then when you said July was a little better from an orders perspective was that for the overall organization or is that just applied to the ANS piece.
So I think.
It applies to both sides, we saw some improvements.
On the Tech and robotics signed.
We also saw.
Improvement very strong bookings, what we used to call the CCB.
Large way can couplings business.
Delivered very strong bookings.
In July so far.
Yes, thats been some good project work, it's been renewable energies.
So its some pretty good activity out there.
Mining.
Medical we've got.
Supporters cab business as we see some nice orders so.
Well, it's a very mixed bag.
Out there and.
But so far July has been.
As we passed as we expected in the.
And the revision of the.
Guidance.
Great. Thank you guys appreciate the color.
All right. Thanks, Mike.
Your next question comes from the line of Jeff Hammond with Keybanc capital at Keybanc capital markets. Your line is open.
Hey, guys.
If I could just go if we could just go back to the PTT margins in a similar way because it seems like.
I think whats a little confusing in the models your margins are way up and PGT and maybe under a little more pressure and ANS and maybe that's a function of.
Corporate reallocation or Greece.
The resegmenting or I don't know the cost saves but.
Yes, it just seems like Thats.
Even on muted sales running a lot higher so how should we think about margins in PTT.
First half or second half versus first half. Thanks.
So couple of things number one.
On the synergy side most of the synergies that we as we had projected accruing on.
The legacy Altrus side, the PTT side, not all but a big chunk for thinking about procurement and other things. We're PGT just had to catch up to.
Awareness was performing so thats one part the other part of it is that.
The CCB business, which always has been the most profitable piece within sight of PTT.
Has delivered nice year over year margin improvements as projected which is partially offset by.
Our turf and Garden AG business, which is a lower margin business compared to CCT.
I think the combination of the two is driving.
Margins up on the PTC.
Uh huh.
So how should they look sequentially <unk> <unk> <unk> <unk>.
Second half versus first half.
So sequentially historically margins in the second half tend to be slightly lower than the first half.
Given the drop in the second quarter I also would expect that margins on the PTT side will be just.
Maybe modestly higher than in the second quarter.
And the reason for that is mainly driven by we're going to see an acceleration in synergies.
And so.
As we go through the second half of the year and on those benefits, mostly accrued to PTC.
Okay, and then can we just talk about distribution like I know you had tough comps in the first half.
But you're saying I think you're going to you're saying you're going to continue to see declines and I see like motion, which is a big distributors out, saying like 6% to 8% growth in the second half and I think most of the other guys are at least calling for low single digit growth. So is it is a heavy destock thats going on or what's the disconnect between what your distributors are saying and what you're kind of guiding to thanks.
Yeah, I think when you look at some of the markets that are served.
Through the distributor and some of the smaller Oems that we serve we think that the smaller Oems are going to be are going to struggle through distribution and that.
Things like our oil and gas business, which has been weak through distribution.
We think thats going to continue.
And also some of our distributors that are specialty distributors like the the high tech distributors in the automation space.
That that's not going to get any better. So it's not just the motions in the ease of the world. It's some of the other distributors that we serve that we work with.
And the and also our distributors in other parts of the world.
So.
So it's a mixed bag.
And Jeff again at the weakness in distribution that we see is of course across all brands Oh within Archrock.
And so.
We think that that is a reflection of.
What's going on in the general industrial economy.
And maybe distributors able to offset that in other parts of the business.
We don't know we have not seen.
A significant.
Inventory.
Not inventory and its not share loss through distributors, either that's because of just broad base every brand.
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Uh huh.
Okay, and then last one.
How are you rethinking like where you think maybe leverage falls out.
Versus getting it down to three by the end of 2020, given given the reset here. Thanks.
So we are now guiding to an exit leverage of 3.6 to 3.8.
Depending on whether we come into high end or the low end of of our guidance range.
The high end that would be just a slight miss two to three and a half that we projected or become just inside of three and a half.
Uh huh.
Well have to see.
[noise] leverage remains very very manageable at that.
<unk> <unk> <unk> <unk> and these are at the end of the day very good cash flow generating businesses. So we feel that as a very confident that we can deliver deliver on the 80 million.
This year and then we'll have to see where EBITDA outcome.
To determine the leverage of 3.6 to 2.8 as possible.
And I think it's important to note that Christian made a statement in his part of the discussion that we don't expect.
Long term debt.
Correct.
I had a couple right.
I think the macros perspective on why that the data is leading us to think that way.
And if you look at interest rates in the discussion about where they think interest rates are going if you look in Europe , where they're talking about cutting interest rates or Q we.
If you look at the employment numbers, you think about 2020 is an election year.
There just aren't that many catalysts that say this should be a deep long.
Downturn now.
I'm not an economist and him and certainly don't have a crystal ball in front of me, but the data doesn't seem to indicate that this is going to be long term. So.
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I think we get comfortable with that.
We should be able to generate.
Cash pay down the debt and and hopefully recover at some point during the economy recovers at some point.
Okay, and then last one.
Kind of cleanup interest expense came in a little bit lower than I thought can you give us an update on what you think.
GAAP and cash interest expenses for the year.
So the.
The cash interest expenses around $10 million lower than the GAAP interest expense.
And so we are projecting that interest expense in the second half.
We will be slightly lower than the first half due to the debt pay down we're anticipating.
A 25 basis points drop.
In liable for so we think about a million and a half lower in the second half.
About a million dollars less in the second half than the first half.
On a GAAP basis.
Okay. Thanks, guys.
All right. Thanks, Jeff.
And there are no further questions at this time Mr. Christenson I turn the call back over to you.
Okay. Thank you Simon and thank you all for joining US today, we look forward to keeping you updated in the next few months and have a good day.
Bye.
Ladies and gentlemen. This concludes today's conference call you may now disconnect.