Albany International Corp (AIN) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International third-quarter 2007 earnings conference call. At the request of Albany International, this conference will be webcast and recorded. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to our host, Dr. Joseph Morone. Please go ahead.

Thank you. Good morning, everyone, and welcome to Albany International's third-quarter earnings call for 2007. As always, I'll give some opening comments, and then Michael Nahl, our Executive Vice President and CFO, will make some amplifying comments. Then, of course, we'll turn to your questions.

For the past several quarters, our earnings releases and calls have focused on our efforts to return to Q2 2006 profit levels by Q4 2007, excluding any costs associated with restructuring and performance improvement initiatives.

We have described those efforts as comprising three distinct sets of activities -- the gradual recovery of PMC revenues, fueled by growth in volume; global restructuring; and accelerating growth of our emerging businesses. In each of our most recent calls, we have emphasized that all three sets of activities are necessary to restore and grow profitability, and that we have been making good and sustainable progress in all three. We've also reminded investors that even with this progress, the underlying risk of further price instability in PMC remains real.

In Q3 2007, that good and sustainable progress continued on all three fronts. The restructuring, in particular, hit peak levels of scope and intensity this quarter and reach virtually every corner of the Company, from the consolidation of PMC manufacturing capacity in North America and Western Europe to the expansion of PMC manufacturing capacity in Latin America and Asia; to the startup of the shared services center in Europe; startup of a greenfield manufacturing facility in Engineered Fabrics; consolidation of manufacturing operations in European Doors; integration of an important acquisition in North American Doors and continuing migration of our enterprise business systems to SAP; the rollout of an entirely new global procurement system; and the elimination of another layer of management at corporate headquarters.

The net result is that by the end of the third quarter, we had put in place all of the measures necessary to achieve our short-term objectives of returning to Q2 2006 profit levels by Q4 2007. Actual Q4 results will, of course, depend at least to some extent on short-term market fluctuations. But assuming no disruptions in the PMC market, we are optimistic about hitting our targets. Internally, we have already moved on to the next phase in our cash and growth strategy, which is all about maximizing free cash flow from PMC while maximizing profitable growth in emerging businesses.

The clearest measure of progress this quarter, and of why we are turning our attention now to phase two of cash and grow, is financial performance at the operating unit level; that is, segment net sales and segment operating income before the costs associated with restructuring and performance improvement initiatives.

In the PMC segment, Q3 2007 net sales improved by 8.5% compared to Q3 2006 and hit a record high for third-quarter revenues for this segment. Sales of Paper Machine Clothing by the Americas corridor grew 4% despite a sharp downturn in the Canadian market. Sales by the European corridor grew 8% despite lower prices, and sales by operations in the Asian corridor grew 23%. All of the growth was driven by increases in volume.

The strong PMC top line is particularly noteworthy, given the heavy restructuring in Q3. We were able to push ahead in the marketplace, while at the same time avoiding the kinds of disruptions to customer supply chain that so often accompany restructuring.

We saw similar improvement in PMC segment operating income in Q3. As shown on tables two and three in the release, when the costs associated with the restructuring and performance improvement initiatives are excluded, operating income from PMC increased by 12.5% in Q3 2007 compared to Q3 2006. We expect to see additional improvement in PMC operating income as the savings from the most recently announced plant shutdowns begin to take effect in the second quarter of 2008, and as we continue to transform our business into the most efficient global configuration possible.

In past releases, we have not offered the level of detail shown in tables two and three. We thought it helpful to do so now, in order to provide investors with a sense of the magnitude of the restructuring that we're undergoing and of the very clear signs of the resulting improvement in operational performance that are beginning to emerge.

Turning to Albany Door Systems, in our last earnings release, I expressed my disappointment in the income performance of this business, but also confidence that we were taking the steps necessary to improve profitability in Q3 and to deliver good performance in Q4 2007. Net sales in Q3 were 27% ahead of what was a strong Q3 for Doors in 2006 and were up sharply in all geographic regions and in both product and aftermarket. More importantly, profitability began to improve and was substantially better than Q2 2007. We expect an acceleration of both top and bottom-line performance in Q4 2007 and into 2008.

In Applied Technologies, sales grew by 29% compared to Q3 2006, and operating income excluding the effect of performance improvement initiatives increased 13.9%. The one disappointment in this segment was the $1.3 million -- about $0.03 per share -- operating loss by Albany Engineered Composites. Yet even here, there were important signs of progress, particularly as we turn our attention beyond our short-term Q4 targets. Last quarter, when we reported that AEC lost $1.8 million, we explain that the loss stemmed from delays in shipment requests from key customers, a not uncommon phenomenon in the aerospace industry.

This quarter, exactly the reverse occurred. Customer requests for shipments surged. Sales were 46% ahead of Q3 2006 and 34% ahead of Q2 2007. This spike in customer requests for shipments is also a rather common phenomenon in aerospace, and especially when it is associated with the introduction of a new product, it leads to a classic pattern. As suppliers rush to meet the surge in customer shipment schedules, the normal production learning curve is compressed, which results in costly temporary inefficiencies. This effect at our Boerne, Texas plant was compounded by a 25% increase in Composites business engineering and project management staff, as we continued to add technical talent in order to keep apace of increasing new business development contracts and opportunities.

This pattern is likely to continue for the next two quarters. We expect additional surges in customer requests for shipments. To keep up with the growth in new business opportunities with new and existing customers, we expect to continue to invest in additional engineering talent and capacity.

For the past year, I've told our investors that I expected AEC to be accretive during 2007. It is now clear that it will not be. We expect losses to diminish over the next two quarters, and for the results to then become increasingly profitable over the balance of 2008 and beyond.

In Q3 2007 and again this quarter, Q4, faced with more rapid growth than even we had been anticipating, we could have opted to maximize the Composites business short-term operating income, particularly given all the emphasis on returning to Q2 2006 profitability by Q4 of this year. But doing so would have required us to delay shipments to our customers, which would have undermined our emerging reputation, and to delay hiring new technical talent, which would have forced us to forego a number of promising new business opportunities.

So we opted to place maximizing intermediate and long-term profit growth ahead of Q3 and Q4 earnings in Albany Engineered Composites. Everything we are learning about this business, everything our customers tell us about the distinctiveness of our technology, leads us to the conclusion that this business is an extraordinary growth opportunity that, if managed wisely in the very near term, will generate attractive returns on investment for a long time to come.

So Q3 was an important quarter for Albany International, marked by a combination of an unprecedented intensity and scope of restructuring, continuing progress in each of our three PMC markets and powerful growth in our most important emerging businesses. We believe we have taken all the steps necessary to realize our short-term objective of restoring profit levels of Q2 2006 by Q4 of this year, and are now turning our attention to the next chapter in the cash and grow story.

Thank you, and I'll turn the call over now to Michael Nahl.

Thanks, Joe. First, a reminder that the comment about forward-looking statements that appears in our financial release last night applies to the contents of today's call as well.

In our earnings release, we described our results in considerable detail, and Joe described a range of initiatives we have been working on to maximize cash flow from the PMC business and to profitably grow our Applied Technologies and Door Systems businesses. Combined, those efforts are interrelated, and are designed to maximize the present value of our future cash flow per share when discounted at our cost of capital.

As shareholders, we are encouraged by the progress that we're making on all fronts. Each of the major changes in the balance sheet over the past couple of years has been designed to support shareholder value creation, which is the ultimate objective of our cash and grow strategy.

In 2005, the Company's capital expenditures totaled $43.3 million, $39.8 million of which was for Paper Machine Clothing. We increased capital expenditures to $84 million in 2006, and expect around $160 million this year and $110 million next year.

Of the total of over $350 million capital expenditures estimated for the three-year period ending 2008, $284 million is for our PMC segment, $64 million for Applied Technologies and $3 million for Door Systems. The predominant emphasis on Paper Machine Clothing during this period has been to assure that we can protect and enhance our cash generation from our core business, where we enjoy what we believe are important sustainable competitive advantages.

We have invested much of that capital in the low-cost, fastest-growing markets of Asia and Latin America. At the same time, we are reducing our costs and increasing our efficiency, while simultaneously investing in research and development for the next generations of Paper Machine Clothing solutions for our customers. When we have completed our current capital expenditure program for our Paper Machine Clothing business in 2008, our total Company depreciation will rise from about $58 million this year to approximately $66 million in 2008 and $70 million in 2009, and amortization will rise from approximately $5 million this year to $7.5 million in 2008 and $10 million in 2009.

While the higher depreciation may put some short-term pressure on earnings during the first year or so of startups, if PMC prices do not decline from current levels, the free cash flow profile will begin rising substantially before the end of 2008. Free cash flow for the total Company has the potential to become very substantial in 2009 and beyond.

The cash part of our cash and grow story is pretty clearly on track. We have also been making good progress in our parallel strategy for profitable growth from our Applied Technologies and Door Systems business. With the sales growth we have reported for Applied Technologies and Door Systems this quarter, we believe we are beginning to see validation for the growth part of our strategic vision.

Since Joe covered the growth businesses pretty thoroughly, I'll just add a couple of details. The first has to do with inventories and accounts receivable. In comparison to levels at the end of the third quarter of 2006, inventories for our total Company increased $25.6 million and accounts receivables increased $29.9 million. Changes in currency translation rates caused over half of the increase for both. Substantially all of the remaining increase is attributable to growth in Applied Technologies and Door Systems. It's unlikely that we would have been able to report the sales increases we did for our emerging businesses without some increases in working capital. Sales in our emerging businesses increased about 28% -- 27% for Door Systems and 29% for Applied Technologies. The percentage increase for inventory and accounts receivable for the combined emerging businesses was approximately 15% for accounts receivable and 11% for inventories.

I'd also like to amplify a point Joe made about our Engineered Composites business. Our conviction that this business will build substantial value for our shareholders continues to grow. While there is important work underway with our strategic partners on programs we cannot yet disclose, we can tell you a little more about the reference Joe made in our last conference call about our having a product on the Boeing 787 Dreamliner.

Albany has been working closely and exclusively with Messier-Dowty since the second quarter of 2005 to develop and build the composite braces for the main landing gear structure for the 787. Messier-Dowty is the sole supplier of main landing gear for the 787. The 787 will be the first aircraft ever to employ the use of advanced composites in a landing gear application.

Each of the composite braces we've developed with Messier-Dowty is approximately 1 meter in length and up to approximately 100 millimeter thick. Eight braces are used on each aircraft; that is, four per main landing gear. This is a truly revolutionary development for aerospace composites. The use of advanced composites in landing gear braces replaces more traditional and much heavier steel designs and offers a performance advantage over titanium.

While the announced delay in deliveries of the Dreamliner has reduced our very short-term sales for Engineered Composites business, the opportunity for substantial sales beginning at some point in 2008 and for a multiyear period are very encouraging. The landing gear opportunity is another important validation that our Engineered Composites business enjoys some very real, sustainable competitive advantages.

Some of you have asked us what you should focus on in the quarters ahead to see if we remain on track with our cash and grow strategy. First, you should watch the revenue lines of each of our segments. For PMC, even a flat revenue line going forward would result in improving operating income as our costs decrease. In our emerging businesses, watch the growth rate in sales. In general, we expect sales to lead earnings from those businesses.

Second, for our total Company, watch to see what happens to selling, technical, general and administrative expenses as a percentage of net sales over the next three years. We believe that these costs will decline significantly and will contribute importantly to the increase in free cash flow which we anticipate will begin in the second half of next year.

Third, watch to see what happens to EBITDA beginning late in 2008. Keep in mind that depreciation will jump up sharply when the new PMC investments come online, so EBITDA will be a key metric going forward.

Finally, the ultimate proof of our cash and grow strategy will be the actual free cash flow we generate, and which we believe could become very substantial beginning in 2009.

That completes our comments. We will be happy to take any questions now.

(OPERATOR INSTRUCTIONS). Mark Connelly, Credit Suisse.

Can you talk about European PMC? You're obviously picking up some nice volume there, and that means somebody else is losing. We know what happened the last time somebody else was losing.

I wonder if you could talk about a couple of things. First, how much is currency helping your European results? How much of the volume pickup is related to the contracts that you talked about last year? Is it your sense that we're getting closer to consolidation or closer to another one of the earnings mishaps that we had a year ago?

Let me just handle the currency part of that.

Sure, and then leave the hard part for him.

Of course. We (multiple speakers) this out pretty carefully here. As you recall, we showed on the table on page two of the press release that for total Paper Machine Clothing, the growth was 8.5%, but without the currency effects, it would have been 5%. You can use that general ratio, inasmuch as Europe accounts for roughly 30% of the volume associated with Paper Machine Clothing.

I wish I could give you definitive answers to your questions, because I do think your questions -- they really get to the heart of all of the strategic issues in European PMC. But so far, we still have -- nothing has really changed. We still have the same uncertainties out there in Europe.

I think you're interpreting the top-line progress the way we are interpreting it. Clearly, our competitive position in the marketplace is strengthening, and that is based on direct work with our customers and their recognition of the value, the increasing benefit we're delivering.

But fundamentally, your question is about are we likely to see a price-based reaction by our competitors to our progress in the market. Obviously, we hope not. We hope that our competitors realize that -- and have learned over the past year that they are not going to grab business from us that we really care about by slashing prices; it's just not going to work. At some point, that will become abundantly clear to them, and at that point I think we're more likely to see stability going forward.

The contracts that you've talked about in the past -- is that a growing trend in Europe, or is that sort of a one-shot deal?

The contracts in Europe occur a lot more frequently than they do in North America. Contracts in North America tend to be three to five years. Contracts in Europe tend to be 18 months. There will be another round of important contracts in Europe in the second half of 2008.

I'll just put it this way. The top-line progress suggests we are doing a better job in Europe of trying to understand our customers, trying to work closely with them, trying to anticipate their needs and give them significantly improved benefits. So we will go into those negotiations, this next round of negotiations, with a pretty close understanding of where our customers are coming from [and vice versa].

A question on PMC in the Americas. The up 4% number, despite Canada, is obviously good news. Is that pretty much all coming from Latin America? Just curious how the US is shaking out.

The US is shaking out well. It's not just from Latin America, although Latin America helps. Same kind of answer as in Europe. It's about the top-line progress reflects strong interactions with customers.

If we can switch gears a little bit -- and I'm not sure how related these two questions are. But you talk about SAP costs, and I wonder if you can -- and for most investors, when we hear SAP, we want to hide under our desks, because we know how those implementations have gone for many companies. Can you talk about how far along you are in the SAP process from a cost perspective and from, hopefully, a success perspective, and whether that is central to the global procurement effort that you're talking about, and what we should expect to see out of global procurement?

Then separately, or maybe together, this is the time of year when we often hear from you about raw material negotiations. I wonder if you could give us an expectation on what raw material costs are going to do for you year over year.

Three separate issues -- SAP, procurement and raw material. I just want you to know that as soon as you mentioned the word SAP, everybody here left the room.

The SAP project is progressing on track. It is every bit the monster that it is in every organization, but we have gone into this with eyes wide open. We had given some estimates in Q1 2007, in that call, of the cost of SAP in 2007. 2008 will be the peak year for the project, so the cost will be a little bit higher than it was in 2007.

It is consuming a lot of our energy internally. But, as I said, we're going into this with our eyes wide open, and our hope is, our intention is that that really becomes a critical piece of a restructured organization that is really much more globally unified than it ever was before. So we've talked about before, PMC, we used to have 12, 13 profit centers. We now have three global businesses in PMC, and there will be one common IT backbone, both software and hardware, for that business, once we're through with this project.

So it's a bear. We knew it was going to be a bear. But we're managing the costs; we're managing the schedule. There have been some scope changes, but those are all for the good and improved and increasing the prospects of what we think is going to be a successful implementation.

That's not to say that it isn't painful; it's very painful. But we're managing. One of the -- which I mentioned in my comments -- one of the things I'm most happy about the Q3 performance is there is a lot of restructuring going on, and it has not affected what our customers have seen. That has been an overt objective of ours, is that all the internal restructuring has to be invisible to our customers. So far, it has.

Procurement -- same kind of answer. We didn't have a global procurement system in the way we were structured before, with so many scattered small profit centers. We now have put in place a global procurement team. It's a talented team.

So we are expecting to see significant savings as that team starts managing our supply chain. We are optimistic about the impact, but we're not going to get wildly exuberant yet. We want to see the effects of their negotiations drop to the bottom line before we claim victory. So at this point, we're holding to our estimate that we had given before of $1 a share improvement in cost by the end of 2008, and that includes some of the benefit from procurement.

Raw materials -- as you know, you're seeing the same thing we're seeing, a spike in raw materials. In our mind, the one big difference between an equally steep spike in late 2005 and the one today -- we have a global procurement system. So the first real test of this new team is how well they manage this spike with our raw material suppliers. It's obviously going to have some effect. We think we will manage that effect a lot better than we did last time around.

Ned Borland, Next Generation.

Could you give me a breakdown of the percentage of sales in PMC by corridor? Is that available?

That's what's in my commentary. That's the 4%, 8% and 23%.

Well, not really the growth, but the percentage of sales as a geographic breakdown.

Okay, two ways of looking at it. If you look at it from the point of view of the business units, so percent of production, it's 50% Americas, 40% Europe, 10% Asia. That's aligned with the numbers I gave you in my commentary. If, on the other hand, you look at it as a breakdown in markets, so where our products are sold, it's roughly 50% Americas, 30% Europe, 20% Asia.

Then on the CapEx, it looks like you've got about $70 million being spent this fourth quarter here. Is most of that going to be China, or is that --?

Most of it is the Asian expansion hitting a peak.

And that levels off a little bit going into 2008, as you ramp this thing up in mid 2008?

It's going to be approximately 70% of the CapEx in the fourth quarter will be attributable to to the China investment.

And then our CapEx estimate for 2008 -- have we --?

(multiple speakers). We just discussed that in my commentary, with regard to the proportion of it going to the emerging businesses and PMC going forward. So you've now got that in the public domain.

Arnie Ursaner.

The first question I have is on Albany Door Systems, did you break out the contribution from the acquisition you made of R-Bac as a percent? Can you give us some feel for what percent of the growth was accounted for by R-Bac?

Yes. If we take the sales rate of R-Bac of the prior three months going into the merger and we subtract that number out of our combined results in the third quarter, that 27% growth rate for the Door business would have been 19%. If you exclude currency effects, the 19% growth rate would have been 11.4%.

The reason I say that way is that, in fact, we don't have R-Bac sales and Albany sales anymore. We immediately integrated them. We did some things to push one another's products and so forth.

So going forward, there's no way to say that a certain percentage is R-Bac and a certain percentage is Albany. But clearly, I think that's the most useful way to look at the immediate impact.

Going forward, the best way to gauge that will be, let's look at growth in North America, let's look at growth in Europe, and that will give you an indicator of what the combined effect is. The R-Bac effect is limited to North America.

Trying to follow up on Mark's question earlier on the SAP, I know you are trying to help us. But is my math in the zip code that it's about $1.5 million hit per quarter for SAP?

In the year -- in 2008, which will be a peak year, I think it's closer to $2.5 million per quarter. (multiple speakers) going to do by -- this year in Q1, we tried to gave as precise estimates on what the cost of that big restructuring effects and performance improvements effects would be for the year. We'll do that again in Q1 of 2008, but what you should be thinking about going forward in 2008 is there will be two big items in the performance improvement bucket. One will be SAP, and figure the run rate in Q4 is roughly the run rate we'll see -- roughly, maybe a little bit more -- the run rate we'll see next year. The other is the China startup, and figure the run rate on the startup costs that we're seeing in Q4, which is around $1 million, is what we will see per quarter next year, until this thing is fully scaled up.

The only other item in there that we haven't seen yet is the depreciation effect of the new plant in China as we start up. That will hurt earnings.

Staying on the Composite business for a little bit, you obviously gave us some tremendous detail on landing gear braces. But based on some websites, are you prepared or willing to comment yet on or whether you're involved in engine rotors on the 787?

We are not involved in engine rotors on the 787. As I did hint in my comments, we are working on a number of very important programs on other aircraft going forward, but we're not in a position where we can disclose them at this time.

We understand that giving our investors more visibility in the Composites business is important. That's one of the reasons we commented so much. Our thinking right now is that we do intend to pull it out as a separate segment starting in 2008, still working through with that. But we understand the motivation behind your question, and we're limited by contractual obligations as to what we can say and what we can't say. But the more we can say (technical difficulty).

In prior discussions, you have publicly disclosed or discussed 25% growth compounded over five years for the business. Based on the situations you're looking at today, two questions. One, are you as comfortable with that previous view as you have been in the past? Two, do you have enough capacity to meet the goal?

That number is now appearing to be quite low at 25%. That undershoots what is looking likely and what is actually happening, clearly.

We are adding capacity rapidly, and I think we will continue to add capacity. It's just the capacity isn't nearly as capital-intensive as it is in our core business. So additions to the capacity, the big expense are adding buildings. Then once we've got the building up, which is not inherently an expensive investment, once the buildings are up, the actual manufacturing equipment is much less capital-intensive than in our core business.

Another strategic question for you. About a year or a year and a half ago, I think you spoke at length about you have always been a market leader; it's why you gotten premium pricing in PMC. You talked about, hopefully, some technology or product innovations that would enable you to further gain share. Can you freshen up some of the things you might be doing in the marketplace and how it is impacting your ability to win business? In other words, are you gaining higher premiums, similar premiums -- how you have enhanced your technology portfolio in PMC?

I think we mentioned this on the last -- I think I mentioned this on the last earnings call, that our strategy is to manage the premium. When it gets too large, it starts hurting us in the market. But all of the evidence to date says we will continue to be able to maintain the premium, and the only way we get that premium is by offering a continuing stream of better products, better service, (inaudible) combinations, and we're going to keep doing that.

We haven't really disclosed -- other than a very exciting product in the family of dryer products called Aeropulse, we have not really disclosed the products that we're really excited about in our pipeline. I think I'd rather not, at this point. Suffice it to say that what I said last time about us being enthusiastic about the pipeline, those products are closer to the market than they were last time we talked, and this is one of those unusual cases that, the closer it gets to the market, the more excited we get, rather than the other way around.

(OPERATOR INSTRUCTIONS). Dr. Joseph Morone, there are no additional questions at this time. Please continue.

Well, I think we're done if there are no additional questions. Thank you all for participating on the call, and see you next quarter. Thank you.

Ladies and gentlemen, this conference will be available for replay at Albany International website. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.