AIMC (2021 - Q2)

Good day, and thank you for standing by, and welcome to the Altra Industrial Motion Q2 2021 Earnings Call . Please be advised that today's conference is being recorded . I would now like to hand the conference over to your speaker today, Mr. David Calusdian. Please go ahead. David Ca

Thank you. Good morning, everyone, and welcome to the call. To help you follow management's discussion on this call, they will be referencing slides that are posted to the altramotion.com Web site 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 US Securities and Exchange Commission. Except as required by applicable law, Altra Industrial Motion Corp. does not intend to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

Thank you, David, and thank you for joining us today to review our Q2 2021 results. And please turn to Slide 5. Our business is firing on nearly all cylinders as we capitalize on demand strength across the vast majority of our end markets. We delivered Q2 revenue of $488 million and earnings per share of $0.62 on a GAAP basis and $0.89 on a non-GAAP basis, results that not only exceeded the year ago quarter but also outperformed Q2 2019 pre-COVID levels. I would like to start today's call highlighting five themes that have continued to play out for Altra through 2021. First, the combination of our high quality portfolio of diverse brands and businesses with our team's ability to remain nimble, manage the supply chain and reliably deliver products to our customers has continued to be a powerful differentiator for Altra. In addition to supporting our strong top line results, this combination positions us to benefit from several secular tailwinds in markets like electronics assembly equipment, general factory automation, medical and robotics in the near term and mid and later cycle markets, such as mining, metals, ag and heavy machinery. Second, our incoming order rate remains extremely strong. In fact, our backlog grew significantly to a new all-time high for Altra and our book-to-bill ratio in Q2 was 117%. This positions our company very well for the coming quarters, gives us confidence to again raise our 2021 guidance and further validates our belief that there is a long runway ahead for both Altra and the general industrial market in 2022 and beyond.

Thank you, Carl, and good morning, everyone. Our second quarter results were highlighted by Altra's resilient and balanced portfolio, strong top line and cash flow performance and solid progress delevering the balance sheet. Operationally, it was a very challenging quarter, given input cost inflation, strained logistics and supply chain channels in a very tight labor market. Turning now to a review of our top line performance in the second quarter. Sales were up 21.9% compared with the prior year period. Organic sales grew 17.2% with price contributing 130 basis points. In addition, several businesses imposed surcharges. Foreign exchange rates had a positive effect of 470 basis points. Excluding the effects of foreign exchange, net sales for the PTT segment were up 16.1%. Booking momentum has remained strong across most end markets, including Turf and Garden, ag, factory automation and material handling. Excluding the impact of foreign exchange, net sales for the A&S segment were up 18% compared with the same quarter last year. This segment once again saw strong broad based growth, including transportation, factory automation, medical equipment, construction and farm and ag markets.

Thank you, Christian, and please turn to Slide 11. We remain extremely pleased with our performance so far this year. We believe we are at the beginning of a broad based market recovery, and Altra is in an excellent position to capitalize on several secular tailwinds as we move through the year and into 2022. Our focus remains on executing against our strategic priorities to optimize our opportunities as a premier industrial company. This includes leveraging our efficient cash generative business model in the Altra Business System to maximize cost and sales synergies, delever the balance sheet further and expand our margins. Now that we have reached our target leverage range, we expect to accelerate our focus on driving top line growth, both organically and inorganically. However, we do intend to remain disciplined. Finally, we continue to make great strides advancing our ESG efforts, including making headway with our recently formed Diversity, Equity and Inclusion Committee and completing an ESG materiality assessment. We are very confident in our ability to deliver on our new 2021 guidance and maximize value for our shareholders as the industrial world economic recovery accelerates in 2022 and beyond. I want to thank the Altra team for their continued commitment and resilience that has enabled us to deliver exceptional results, provide the best possible customer service and advance our strategic priorities. With that, we'll now open up the call for questions.

Your first question is from Jeff Hammond from KeyBanc Capital Markets.

So just thinking about sequential momentum between the two segments into the second half, if you look at orders, backlog and seasonality, it looks like A&S was kind of flattish 1Q to 2Q, and PT had the big step up. But just how do you think about the sequential dynamic?

So I think in the second half, we expect that the PTT on the top line will outperform A&S side modestly. One of the reasons is that the third quarter will be the low point for our Class 8 truck business in the year as China sales will drop significantly sequentially and then recover strongly in the fourth quarter. Turf and Garden, that seasonality typically causes some sequential decline for the PTT side but we see strength in other markets like oil and gas and mining that we think will help to offset that. When we look at A&S, on the A&S side, I think the strength is broad based on that side of the business, whether it's factory automation, whether it's the medical side, really good momentum going into the third and fourth quarter, so into the second half.

And then just to be clear on the supply chain dynamics. So it sounds like 2Q is kind of the biggest challenge and then 3Q is kind of a transitory quarter, and 4Q you fully catch up. Is that the right way to think about it? And just within that, anything getting particularly better or worse within some of the supply chain challenges?

I think the supply chain challenges have been pretty stable. I mean it is with the old whack-a-mole game where something pops up. But we've been able to work around the chip shortages that we've had and it's taken some engineering work to do so, but we've been able to work around that. And that's probably been the worst issue. So I'd say that's fairly stable. And hopefully, it's going to get better in some areas. I think it's going to be a little bit for the chip supply to really get better. But some of the other items, I'm hopeful will start to get better.

And then just to sneak one more in. Corporate expense, I think last year was kind of zero and maybe zero to $1 million a quarter, and it seems like it stepped up a bit. And I'm just trying to understand what's going on there and how to think about corporate expense going forward?

So there's a big swing in medical cost. We provide, so to speak, a guaranteed cost program to the OpCos. And any overruns or underruns, we absorb at the corporate level. So last year with significant health care cost savings, the benefit showed up at the corporate level and not at the OpCo level. This year, you'll therefore have a big swing as medical expenses have return to more normal levels. You have a huge year-over-year swing here in the second quarter and that's 90% of what has driven that year over year change.

Your next question is from Bryan Blair from Oppenheimer.

PTT margin was very encouraging in the quarter, in my view, maybe the biggest highlights for the quarter. Given continued top line growth in the back half, catch up on price cost as you outlined, and I suspect some incremental cost actions or drop through from cost actions. Is Q2 type margin sustainable through the second half of the year?

So I think when we look at the margin in the second half year, at the gross profit level, I think they are sustainable. At the operating income level, we'll probably see a modest decline here in the third quarter and in the fourth quarter, mainly related to some of the costs that are coming back and the seasonality of the business. I think from a mix standpoint, I think gross profit margins, we can hold those here in the second half.

And going back to price cost, you noted price cost compression in the second quarter, that's perfectly understandable narrowing through Q3, projected to be favorable in the fourth quarter. Can you parse out price contribution to the second quarter and expected back half realization on price?

So the way I can answer that is when we look at how much price are we short, so to speak, we're missing about 120 basis points of price. And so that's what we're trying to recover here starting in late in the second quarter and then into Q3. So if you think about 120 basis points over $490 million in revenues, that's the dollar amount of price we're missing to be made…

What we got in the second quarter was around 130…

We got 130 already, but we need another 120…

And then there's a surcharge fee too that we don't include in that 130, Bryan. So the surcharge…

Around 50 basis points probably for surcharges. There's no margin on that. But we got about 50 basis points in addition to the 130 basis points of price in form of surcharges in the second quarter.

And then, Carl, you offered kind of the typical walk through of core market trends and just anticipated second half dynamics. I'm not asking for anything to be quantified here. I know that 2022 guidance, we have some time to wait for that. But could you provide a high level perspective, similar walk through on the puts and takes as we look to 2022?

Thanks for that, because it's -- I'm really encouraged by 2022 for several reasons. One is the amount of backlog we are building, and some of that obviously is we've extended lead times, and so you get more orders because the lead time is longer. Some of it, people are trying to get in the queue because they're afraid of what might happen if they're not in the queue. And I don't have a really good handle on how much of that is related to those two things. But the underlying demand is just really, really strong. I mean if you look at a book-to-bill ratio of 117%, I can't remember many times in my lifetime that we've seen that. And then when you look at the inventory positions, one of our general managers, one of our OpCo presidents at the staff meeting last week showed a picture of the local Home Depot when they had one teeny-weeny garden tractor out in front of the store and not inside. So it was kind of unbelievable that the inventory positions on garden tractors just aren't there. Look at automobiles, they aren't there. And so there's some -- I think, some very, very significant pent-up demand, you could just go get inventories back in place. And it's going to take a while. If you look at the supply chain constraints, we could be shipping significantly more if we had labor and we had materials, we could be shipping significantly more. So I think this is going to -- we've got a really good prospects for 2022. And then barring any outside things that happened to cause things to slow down, I think beyond '22 looks really good too from our projections, our internal projections. And I'm excited too, Bryan, that in March of next year, we're planning to have an Investor Day where we can talk about the long term prospects for the company and our portfolio management activities that we've been working on. So I'm really looking forward to the next couple of years.

Your next question is from Joel Tiss from BMO.

So the backlog, can you give us the number of what the backlog is today versus what it was in the same quarter in 2019? And also, is that -- it sounds like it's a little bit of a combination of demand is strong, but also your inability to get stuff out the door because of the supply chain challenges. So maybe just shed a little light on that.

While we don't disclose the backlog number, I can tell you it's up 35% from where we were a year ago. That's a big number for us. And our shipments are really constrained at this point. We would love to ship more because we get the backlog, we get the bookings, but supply chain in a tight labor market just are the constraints that we're dealing with right now.

We're not having any significant customer issues. We haven't shut down any customers' lines. Some of it is the backlog build is also our customers' ability to produce because of the supply chain, et cetera. So we don't have any major customer issues. It's hand to mouth but we're in pretty good shape.

And can we dig a little more into acquisitions? Are you waiting to get that $100 million paid down by the end of the year, or you're kind of looking -- you're feeling pretty good probably at 2.8 times and visibility to get it down under 2.5%? And just where are we, like you think before the end of the year that you feel more comfortable if the right thing came along? And maybe just one or two little highlights of areas that look really attractive to you.

Yes, I think we are definitely out there looking and checking some tires, and I'm really excited about our balance sheet position and the projections of where the balance sheet is going to be at the end of the year. The discouraging thing is that when you look at what even small bolt-ons are going for in the marketplace, it's just some of it doesn't make any sense to me from a return perspective. So we're going to remain disciplined. And if the right thing comes along that's strategically critical for us, I think we'd be willing to participate. But at some of the pricing levels, it's just a little lofty right now, a little crazy. But we'll continue to look and hopefully, we can find something that makes sense and we can get the right return metrics on it.

Your next question is from Scott Graham from Rosenblatt.

I wanted to maybe ask first, Carl. You had some statements around transportation, suggesting the softening certainly relating to China. I'm just wondering that the US market is pretty good. Europe looks like it's improving as well. And has China become like a much -- I'm sure it's become a larger portion, but I mean, maybe you can kind of size what each of those markets look like today off of China's strength so far this year? And then maybe I would understand that statement a little bit more if you could help us with that.

I'll start, and then Christian can go in with some of the numbers. So the North American market is very, very strong and I think the constraint there is our customers' ability to get everything they need to produce the engines they need. So that one that is definitely constrained by supply chain issues. Not with us, I think we've got most of our supply chain issues resolved and it is hand to mouth a little bit. But with some of our customers, they're constrained. But North America is doing very, very well. And then Europe is also doing very well. We've seen a nice pickup in Europe. I think when you look at the size of the markets, the North American market is probably about a third of what China is now. They make about 1 million trucks in China a year on average. I mean, I think $1.5 million, somewhere in that range last year but it was a huge year last year. So it's just the size of the North American market is not anywhere near what it is in China to be able to offset any declines there. Now the good news for us is that in China, the prevalence of engine breaking has been very low until the new standards have been put in place. So we expect over the next years that the percentage of new engines and new trucks will have engine breaks on them for supplemental braking for safety reasons and environmental reasons. Christian, I don't know if you want to add anything on the numbers.

As I said, in terms of -- for us, China is about 35% of revenues and so is the North American market. So China has become very, very important to us. And the nice thing about it is that cyclicality in both markets is different and they, to some extent, offset each other, was currently seeing significant declines in China as their additional program has expired, and we see, on the other hand, very strong growth here in North America that's offsetting that decline.

I just maybe wanted to go back to the second quarter and maybe even carrying that into July here. Could you maybe talk a little bit about by segment, the progressions of sales and orders? I'm assuming that they were sequentially better, because the year-over-year comparison of that's kind of hard to litmus test that. But I'm just wondering the incoming rate of orders maybe in dollars sequentially in each segment, how is that faring into July? And are you seeing any restocking benefits? Did you see any, for example, in the second quarter?

So I think what we saw was a second quarter for the PTT segment, the incoming order rate picked up significantly and has been really strong and stable through the second quarter. The A&S business, the incoming order rates have been at a very good level and have been stable and strong through the quarter. I think we should probably see a little bit of a decline as people have now gotten their orders in based on the new lead times and the inventory positions that they want to build and so forth. So my expectation is that we'll see it drop off a little bit but we haven't really seen a noticeable drop yet. But my expectation is we will see a drop as their planning gets put in place.

And on the restocking, did you benefit at all in the second quarter?

I don't think we benefit…

In your distribution channel, in particular?

I don't think we did because of the capacity constraints. And the distributors -- our distributors have told us that they are not increasing their orders to build inventories on our products. There are some products that they are trying to build a little inventory on. But on our products, they're not trying to build inventory significantly. The OEMs and some of the channel partners, I think the OEMs are trying to get some things back in place. But the distributors are only increasing inventories based on higher business levels. Does that make sense, Scott?

Your next question is from Mike Halloran from Baird.

I just want to clarify a few things here. So if I'm thinking about puts and takes on the margin profile in the back half of this year, it was 130 basis points of price realization but you need 120 bps more, that should lessen 3Q and then flatten out year-over-year, maybe even be a slight tailwind by the time you hit the fourth quarter. And so one, is that the thought process? And then secondarily, on the surcharges, could you just provide what those are specifically attached to? Is it transportation, oil and gas, some sort of other commodity?

So all the surcharges are copper related and therefore, they are tied to motors and electromagnetic brakes. So think about Turf and Garden, ag, in particular. That's probably where it's very heavy and then some automotive application, brake applications, some other end markets, probably. And then when I look at price, several of our businesses are going out with second round of price increases here in July and in some cases, in August. Now it will take a while until we see that price flow through you count backlog is at the oil price that needs to turn. And so I don't think we'll see the benefit really pop up until Q4. And therefore, we do expect that gross profit margins in the fourth quarter will be stronger actually than here in the third quarter.

And then the other two kind of layering points, and you answered Jeff's question then on the corporate expense line. Certainly understand the variance on the health care costs. How should I think about that line item on a full year basis as we're sitting here? And what does that go forward look like after we get that kind of year-over-year normalization figuring out?

On a full year basis, corporate expenses should be trending around $10 million to $11 million.

And that's the right run rate moving forward, you think beyond?

Yes.

And then last one, as we think about the second half of the year, same kind of cost question. How much is left from a normalization perspective on what you drew down last year for COVID on the cost line and what you think is coming back? Any way you can conceptualize that for us in terms of dollar numbers or percentage, whatever makes sense?

We think that when we look at Q3, Q4 combined, there's about a little over $20 million left that will come back. Second quarter was about $13 million that came back. Third quarter is about the same, and then it starts to drop into the fourth quarter.

And then off the cost side, more broadly, maybe just an update on how the revenue synergy side of the A&S acquisition is going, and any kind of updates on that piece?

It's going pretty well. And we think we're currently working on around 125 opportunities out there and the value in the funnel is probably about $20 million. So obviously, we won't get all of that, that's opportunities that are out there. But my hope is that we'll see very meaningful numbers in next year, certainly in 2022.

And what are those tied to, Carl, what types of applications are we thinking about?

We just landed a nice one that was in printing and paper market in Italy. There was another one that there's a kind of a humorous one, but it's for dog food and it's processing and packaging. It's a whole line that just starts from raw material and a big bag of dog food comes out. So it's a big automated line but that was a nice cross-selling win for us. And it's across a whole variety of markets.

Your next question is from John Franzreb from Sidoti.

Christian, I thought I heard you say that the transportation business would -- third quarter will be the weak given a rebound in the fourth. Could you just talk to me as to why? And is that backlog extends into 2022 for transportation?

So the backlog does extend into 2022 in terms of -- usually, these are not firm orders. These are more forecasts, but we have long term agreements in place that go into 2022 as well. The main driver of that sequential drop in Q3 being the low point in transportation is China. China's program expired at the end of June, early July. And so there was a lot of prebuy and inventory as well. And as they work through that the publicly available forecasted build numbers for China would suggest a very strong rebound in the fourth quarter.

It's going to drop in the third quarter to kind of chew up some of the inventories and then rebound in the fourth quarter.

Fourth quarter, we're projecting in China to actually be slightly better than the second quarter, a sequential drop in Q3 went compared to Q2.

And I don't know if we touched on this and I missed it, on some of the lagging markets. What are you hearing around metals and mining, oil and gas, anything hearing positive and negatively about those markets going forward?

So in metals and mining, they're very positive news. And we actually got a really nice order for some ball mill projects that we hadn't seen since probably 2012. I think it has been a long time since there's been any investment in those. We had a really nice order. And so there's some investment just starting to ramp up. Now some of the project work is longer lead times, so we probably won't see the revenues until 2022, but we're starting to get orders. Oil and gas is still lagging. We've seen a little bit of an uptick there. But I think, in general, the oil and gas guys are sitting on their wallets until probably fourth quarter, first quarter next year.

Mining is very strong. We own a business down in Texas. Their orders are up 53% year-over-year, all led by mining. I think then second to that would be general industrial and then up. But in last place, will be oil and gas.

And steel is doing, we're seeing some nice activity in the steel mills, too, as you'd expect with what's going on in those markets.

There are no further questions at this time. I'll the CEO, Carl Christenson.

Okay. Thank you. And thank you again for joining us today. We look forward to engaging with many of you in the months ahead, and thank you for your time.

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