Albany International Corp (AIN) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second-quarter earnings call of Albany International. At this time participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time.

At the request of Albany International, this conference call on Tuesday, August 4, 2009, will be webcast and recorded. I would now like to turn the conference over to our host, President and Chief Executive Officer, Mr. Joseph Morone. Please go ahead.

Thanks, Ernie. Good morning, everyone, and welcome to our Q2 2009 earnings call. As always, I'll open with some commentary and then turn the call over to our outgoing Executive VP and CFO, Michael Nahl, who will provide some amplifying comments on our balance sheet and cash flow. And then he'll turn the call over for some very brief -- a brief hello from our incoming CFO, Michael Burke; and then we'll go to your questions.

Q2 results were affected by several large non-operational items, most notably the previously announced buyback of convertible debt, which had an unusually large effect on net income. But it was three other developments in the quarter that should have an enduring impact on future operating results.

First, for the first time since Q2 2008, sequential quarter-to-quarter global sales increased, and the end markets in each of our businesses showed signs of having bottomed. Second, the recently announced plant closures and reductions represent the final steps in our three-year restructuring program. And third, for the first time since Q2 2008, sequential quarter-to-quarter adjusted EBITDA also improved, reflecting the growing impact of previously completed restructuring.

Ever since Q3 2008, when it became clear that the economy was sliding into global recession, our near-term objective has been to take the steps necessary to generate strong free cash flow in 2010. Specifically, our objective is to exit 2009, quote, as a fundamentally more profitable business with the capacity for sustained and growing free cash flow in 2010 even if the recession extends beyond 2009. End quote.

The three major Q2 developments -- the stabilizing sales outlook, the approaching completion of the restructuring process, and the improving EBITDA -- all indicate that we are firmly on track toward realizing that objective.

Sales in Q2 were 29% lower than in Q2 2008. But in this economic environment, year-over-year trends are less relevant than sequential quarter-to-quarter trends; and in Q2 sales were roughly flat compared to the previous quarter.

Perhaps of greater significance, in Q2 we finally began to see evidence across all of our businesses that the end markets we serve appear to be bottoming. The only exceptions are Asia, especially China, where the paper industry is well off the bottom, and the newsprint markets in North America and Europe, which continue to erode.

There was one other significant market development in Q2. Average prices of PMC orders in Europe were comparable to those of the previous two quarters, suggesting we may finally be entering a period of price stability in Europe.

Despite these signs of stabilization in our markets, we do still see some short-term downside risk in our sales in PMC in the Americas and Europe. Primarily because of seasonal and inventory effects, orders in Q2 in these PMC markets declined. But there is no question that we see growing evidence of an approaching end to the recessionary effect on sales.

As for the nature of the recovery when sales finally do bottom, the available evidence suggests a V-shaped recovery in PMC in Asia and in AEC and an L-shaped recovery in PMC in the Americas and Europe. The nature of a recovery in Doors, Engineered Fabrics, and PrimaLoft Products is still uncertain.

Q2 also marks the rapidly approaching completion of our three-year restructuring program. The magnitude of the restructuring and associated charges in Q2 was greater than we had originally planned; but as the recession drove sales to even lower levels in Q1 than we had been anticipating, we took additional measures. While there will be more charges in Q3 and perhaps Q4 associated with the steps recently announced, cash charges will decline sharply. The only remaining planned process improvement initiatives that will run through 2010 will be the conversion of our Eurasian and Brazilian operations to SAP and the relocation of equipment related to the recently announced restructuring.

Reflecting the growing impact of previously announced restructuring and process improvement initiatives, Q2 adjusted EBITDA improved by almost $4 million compared to Q1 adjusted EBITDA. We now estimate that lower costs from restructuring and performance improvement initiatives, including the recently announced measures, will lead to an additional improvement in EBITDA of about $3 million per quarter by June 4, 2009, growing to $7 million per quarter by Q2 2010.

So take the $28 million of EBITDA this quarter, add $7 million to get the run rate by Q2 of next year. But of course, these estimates assume all other factors that influence EBITDA -- such as sales, currency, and inflation -- remain constant.

In sum, developments in Q2 suggest we're on trend toward our 2010 objectives. While there remains downside risk for sales in the short term because of seasonal and inventory effects, the signs of stabilization in our end markets, the announcements of the final steps in our three-year restructuring process, and the continued improvement in profitability all point in the same direction. Barring unforeseen further deterioration in our markets, we believe we are well on our way toward exiting 2009 as a fundamentally more profitable company.

Coupled with an end to restructuring charges and 2010 capital expenditure spending at or below depreciation, these higher levels of profitability should assure strong free cash flow in 2010, even if 2010 sales remain 20% below 2008 sales. And with that, I'll turn the call over to Michael Nahl.

Thank you, Joe. Good morning. We refer you to the comment about forward-looking statements which is contained in the press release and note that the same statement applies to our remarks in this conference call.

Joe referred to several large nonoperational effects in the quarter, the largest of which were the debt buyback and the restructuring. In the second quarter, the Company purchased $94 million principal amount of our 2.25% convertible senior notes due in 2026 at a cost of $53.5 million, which had the effect of reducing debt on our balance sheet by $29.2 million and contributed $0.73 to our earnings per share.

Perhaps even more compelling is that the combined effect of the four purchase agreements we entered in the first half of 2009 will result in the repurchase of $151.6 million principal value of our convertible notes at a cost of $88.9 million for a net reduction of $62.7 million in obligations which we would otherwise have been required to pay. And we will have reduced net debt on our books by approximately $45 million. After completing all of these buyback transactions, approximately $28.4 million principal value of the 2.25% convertible senior notes will remain outstanding.

The next largest non-operational effect in the quarter was the restructuring cost of $33.8 million in connection with the layoffs, plant closures, and downsizings. All but about $5 million or $6 million of the restructuring charge required or will require cash payments. Cash payments for restructuring activities were $17 million in the second quarter this year in comparison with $8 million in the first quarter this year and were $5 million in the second quarter of 2008.

We have an accrual of $42.4 million for restructuring costs as of the end of the second quarter. We estimate that there will be approximately $25 million to $30 million in cash payments in the second half of 2009 associated with our accrual for restructuring; and most of the remainder of the $42 million will be paid in the first half of 2010.

The other large cash outflow in the second half of 2009 will be for capital expenditures. Capital expenditures are expected to be approximately $24 million in the second half of 2009, resulting in approximately $50 million capital expenditures for the year, in comparison with $58 million of depreciation and $10 million of amortization this year. For 2010, we expect depreciation and amortization to be close to current year levels and for 2010 capital expenditures to be at or below depreciation.

In the past few years, we've also made contributions to our USA pension fund. That is possible again this year, particularly in light of the decline in value of equities since October 2007. In the coming months the Company will make this the decision about the exact timing and amount. Contributions to the fund over the last few years have ranged from zero to $20 million per year.

Results for the second quarter of 2009 include a charge of $10 million, representing an estimated purchase price adjustment related to the Company's 2008 sale of its discontinued Filtration Technologies business. The purchaser of the business has identified certain potential breaches of the Company's obligations under the original purchase agreement. Although the purchaser has not formally asserted any legal claim, the Company has determined that it is appropriate to record the $10 million charge. The charge reflects the anticipated cost to the Company of a tentative agreement between the Company and the purchaser to return a portion of the original $45 million purchase price in exchange for a release of certain future claims under the related sales agreement.

We remain in very good shape with regard to our credit availability, as our leverage ratio -- as defined in our revolving credit agreement -- declined to 2.40 in the second quarter in comparison to 2.82 in the first quarter. We have additional borrowing capacity of $150 million based upon the current leverage ratio.

Our revolving credit agreement matures in April 2011, and we would expect to renegotiate it in the second half of 2010. The interest rate on borrowings under the agreement have recently been 135 basis points over LIBOR, and that will decline to 110 basis points over LIBOR later this month as a result of our leverage ratio falling below 2.50. Due to changes in market rate credit spreads since we entered into our existing revolving credit agreement, we would anticipate that our interest rates on a new revolving credit facility will increase significantly from current levels.

With the last steps of our three-year restructuring program announced and nearing completion, we remain convinced that even if 2010 sales are 20% below 2008 levels we will be able to generate attractive free cash flow, which we would expect to use to further reduce our debt.

I'm very pleased to be turning over the CFO role this week to a very strong and capable CFO, Michael Burke, who has operating experience as well as excellent international treasury and investment banking experience. I think you'll find him to be a strong partner to Joe and the senior management team and to be very shareholder oriented. Michael, would you like to make any comments before we go to Q&A?

Just very briefly. Firstly, thank you, Michael, for those kind words and your vote of confidence. I'm excited to be joining the Company at this next phase of its strategy and to being a strong contributor to the team as we advance our plans here.

In addition, I very much look forward to meeting all of our important stakeholders over the course of the next several weeks, many of whom are participating on this call today. So at this point, I would just like to turn it back over to the operator to open it up for Q&A. Operator?

(Operator Instructions) Ned Borland, Next Generation Research.

Good morning, Joe, Michael, and Michael. First question is on the composite business. Saw a little bit of a decline there; you talk of a V-shaped recovery. Is the $7.4 million, is that -- does that represent sort of a bottom to you, or what are the -- if you could just color in some of the near-term opportunities that could lift that business here.

Yes, it does represent a bottom. If you think of -- if you go back to Q2 last year, and Eclipse is in there, take Eclipse out and we were at about an $11 million run rate quarterly.

We think of this as a V because we think Q2 was the bottom, and by the second half of next year we should be back to that $11 million run rate.

And we get there without any anything dramatic. It's really incremental improvement from a variety of programs, some which were already in the pipeline. For example, we've been working on a number of composite components for the lift fan on the Joint Strike Fighter, and that's been in the development pipeline for a while.

Some of it are small, new programs that we picked up in order to offset the evaporation of the business jet engine market. For example, we are supplying components, composite components, outer guide vanes for one of the existing Snecma GE engines, the CFM56 engine.

Some of it, of this return back to the $11 million, is continuing or slightly growing development activities associated with other work with Snecma and the SAFRAN Group on the fan blades and other parts of the next-generation single-aisle engine.

So there's a variety of programs that we have been working on that are gradually growing. And it doesn't -- so the V-shaped recovery going into the second half of next year doesn't really represent anything dramatic. The drama or potential drama really begins after we get back to that former run rate, when a number of major programs that we have been working on or pursuing start kicking in.

The landing gear for the 787 is of course the most obvious example. The ramping up of the LEAP-X engine as it moves closer and closer to certification, the ramping up of activity associated with that would be another example. There's a big potential contract we are working on; that's a defense-related contract. If that kicks in, as we are hopeful that it will, that would add a significant boost to sales. There are a number of fuselage applications that would be new business for us that we hope over the next year or two start kicking in.

So V-shaped means incremental improvement on existing activities in the pipeline, getting us back to the former run rate quickly; and then the real interesting story begins when we start seeing the front end of -- the new projects begin to start having an effect.

I'm still hopeful that by our Q3 call we'll be able to give investors a better sense of potential growth rates after we get back to the old $11 million per quarter run rate.

Okay. That's helpful. Then in Asia, a nice sequential pickup there from Q1. Some of that's got to do with the capacity you have in place now and your ability to probably pick off some business from local competitors. But how much of that is the new capacity and how much of that is sort of the health of the Asian paper market?

It's both. It's very clearly both. Each by itself would be having a noticeable effect, but both together are really helping to boost sales.

There's no question that the recovery is well underway. The economic recovery as it affects the paper industry is well underway in China, and that was kicking in at the same time that our new plants, new capacity, was kicking in. So there's a double whammy there, for sure.

Okay. Then the usual seasonality in PMC, generally you see the falloff in the August time frame here as Europe is shutting down for the most part. Would you expect the same amount of seasonality as in past years given the level of economic activity (multiple speakers)?

I think that's a key question that we really don't have the answer to. The primary reason, along with uncertainty about inventory effects, that lead us to still, still be cautious about the short-term outlook in PMC in North American and West Europe -- we're pretty confident it's an L-shaped recovery. We are just not sure yet where that flat part of the L hits. Is it at current levels, or is it one step down from current levels?

And the reason we don't know is because we aren't sure how the seasonal effects play out, given the larger effects of the recession. So it's a really interesting question that we will know the answer to by next call.

We don't know what the seasonal effects will be. We do know that historically Q2 has been the stronger, the high-water mark in PMC, precisely because of the seasonal effects that you've talked about.

How did July trend?

Each of the last -- each of the quarters during the recession followed the same pattern -- a strong first month, then a startlingly weak second month -- and it goes right back to last August -- and then a pretty good third month.

And it looked that way in Q3 last year, it looked that way in Q4, it looked that way in Q1, it looked that way in Q2. And so far in Q3, it's the same trend.

Strong July.

That is what I was implying, yes.

All right. Thank you.

Arnie Ursaner, CJS Securities.

Hi, it's actually Jason calling in for Arnie. So I just want to try and run through the kind of EBITDA view that you are taking.

So if we look at the Q2 run rate, you're trying to say that we could see a sequential benefit by Q4 of about $3 million per quarter, growing to $7 million by next year. And that's just really assuming an L-shaped recovery with no real growth.

Yes, it's assuming sales stay roughly where they are, 20% down. So it assumes that the recovery we see in Asia offsets further decline because of seasonal and inventory effects in North America and West Europe. That is, it assumes another step down to get to the L in North America and West Europe.

If we're wrong about that, if there isn't another step down, or if the step down is more muted, then those numbers might be conservative. But that's what we're planning for. That's what we're preparing for.

Okay.

And please don't ignore the caveat. To get that full effect we need to absorb any effect of inflation and we need to absorb any effect of weakening of the dollar.

And looking at --

(multiple speakers) materially affect our earnings.

Right. And looking at composites, I know you talked about more of a V-shaped recovery there. What is leading you to be more -- have more confidence in that segment?

That's what I was suggesting to Ned in reaction to his question. It's less about the industry and more about where our pipeline is and where the development activities that we're focused on are.

You really need to think of this in two steps. One is getting back to where we were, excluding Eclipse; and then -- and that's really incremental improvements on a variety of fronts, of activities in the pipeline.

And then the second wave is really driven by major new programs that we have been working on or are trying to land. You know the ones that we've talked about before. It's all of the activity with Snecma on the next-generation single-aisle aircraft; the landing brace of 787; and then several other really important applications that we're very close to landing.

This might be a good time to elaborate a little bit on what's going on with Snecma. For investors who have a particular interest here, I'd recommend you go to a website, it's an industry website called AINonline, Aerospace International online, so literally www.AINonline. Just go to their search box and type in LEAP-X, all caps, hyphen between the LEAP and the X.

What you'll do is you will pull up a series of articles about the next-generation single-aisle engine, that is the LEAP-X that Snecma is working on. And there is a lot of material now publicly available about the unique work that we're doing with them. It talks about the fan blades, the 3-D woven fan blades. It talks about the casing for the engine that's 3-D woven. And the combination of those two they now project would take about 1,000 pounds off that engine.

They even start talking about something that we felt we couldn't talk about before, which is that they are now exploring using those 3-D woven composite blades on the low-pressure turbine, or the hot end of the engine, which if it all plays out would represent another 350 pounds per aircraft.

So I recommend you taking a look at those articles, because there's some very interesting insight into the power of this technology we're talking about.

Well, that sounds like very exciting stuff. Thank you very much for taking my questions. We look forward to seeing you in two weeks at our conference.

Mark Connelly, Sterne, Agee.

Joe, I wonder if you could talk a little bit more about global competitive positioning, in the two contexts. First, you talk about price stability in European PMC. Can you give us a little bit of sense of what pricing is doing in the other regions?

And then I wonder if you can talk about the shift that is now relatively complete in terms of local market PMC production. You're in Brazil; you're in Mexico; now you're in China. How does that play into your thinking about your relative cost position, not only through this downturn, but just sort of more generally?

Yes, thanks for the question. It really gets at the heart of our future in PMC. We're feeling very well positioned now that this restructuring is pretty much done. So that in the sense that we have aligned our best, most modern capacity with the markets that are both growing fastest and our lowest cost production sites. So we're feeling like that three-year effort has -- the timing of that three-year effort has worked out really fortuitously.

And just as Asia becomes the driving force in the paper industry, Asia and South America, we're -- our capacity there is really sized for those markets. So it should lead to significant competitive advantage in those markets.

At the same time from what we can tell, at least on the production side, at least in terms of COGS, cost of goods sold, we are probably in the low-cost position in the industry now.

Did that answer the question, Mark?

Yes, it's very helpful. Can you talk a little bit about what's going on globally on price? Is anything going on?

Well, as you well know, the hot spot has always been Europe. We are through the heavy contract negotiation season, which is when the uncertainty and the opportunity for price instability is greatest. While sales in the quarter were affected by lower prices in Europe, prices of orders really do seem to have stabilized now. And there is no major contract negotiations coming up for more than a year, more like 18 months; so we may be entering a period of stability.

Now remember, the underlying core reasons for that instability, they still exist. They haven't changed. It will be interesting to see if they're affected at all by the depth and length of this recession. But for now, the industry structure remains unchanged.

So the primary reason for hoping for stability is the contract season is over. And I hope all our competitors have learned that, given our cost position, we will not give up a strategic position with a strategic customer because competitors are trying to grab it by lowering prices. We just won't.

If we move to Asia, Asia has not been the most profitable PMC market over time. Is your new capacity there going to exacerbate that in the short run?

No. No, because the --

Just trying to figure out how your competitors are responding.

The margins in those, in our plants in Asia, are comparable. Well, when they are fully loaded, even at Asian prices, the margins will be every bit as good as the margins in North America.

Okay, okay.

But when they're fully loaded. You know, before they are fully loaded, the margins aren't as good as they'll get.

Okay. And two questions for Michael.

And remember one thing that's really important for people to understand. The new machines in Asia are world-class machines and they're being run by world-class operators.

The reference machines for the future of the industry are going to be -- are already in Asia. So performance is over time going to be more and more of a factor to our customers in Asia than anything else, and that should have a beneficial effect.

Two questions for Michael. First, as you think about the shift you have made and the machines that you're moving around and still moving around, what is that doing to the impact of currency swings at Albany? How should we be thinking about currency sensitivity with this sort of new relatively finished restructuring?

I think in Joe's remark he mentioned that our sensitivity to currency is something that we are focused on. He has referred to the fact that if the US dollar were to weaken substantially against the principal currencies in which we are producing goods, the fact that we do sell some of our products in US dollars that are manufactured in those other currencies means that that would be detrimental to our bottom line.

I'm pleased to report that Michael Burke has been given a wonderful assignment right from the start here with regard to a thorough analysis of that particular shift you're referring to. He is, with John Cozzolino, working very hard right now at trying to think through whether there should be a change in our philosophy with regard to hedging against those exposures.

Mark, I think you hit the key -- the root, core reason that we're looking at this so hard, precisely because the number of plants in our business has shrunken so dramatically from about 24 to 13 in short order. We really need to have a complete understanding of all of the exposure and what we can do to dampen the exposure.

But for now, first approximation, that rule of thumb still holds. A weaker dollar, while it may help the top line, hurts the bottom.

Just one last question for you, Joe. As you think about composites, when the business was booming you were struggling to keep up with production. Then we saw a little bit of a bust that gave you some breathing room to get back where you need to be.

Now, as you have maybe a clearer appreciation of the pipeline, is it going to be necessary to see some additional investment? Or maybe not necessary, but more opportunistic investment in the composite space.

We've looked hard at this, and each time we do we come to the same conclusion. The pathway to growth in this business is organic growth. We do have capacity to absorb the full ramp-up of the landing brace program for Boeing. At one time last year they were pushing us to ramp up to be able to produce 10 braces from per month, and we were ready for them; but by the time we were there, they were asking for down to one brace per month. As that ramps back up (multiple speakers) we will have the capacity.

We'll have to add capacity as some of these other programs come on stream, like the [VAX] engine. But keep in mind that adding capacity in aerospace, in the aerospace composite business, is far less capital-intensive than adding capacity in our core business. And for the moment, we think we can handle what we see coming pretty much within that $60 million depreciation number that we have out there.

Now if there is a sudden addition of a major new program, we may have to put additional capital in beyond the CapEx run rate of $50 million to $60 million a year, but we're not seeing it right now. It would be a good problem.

Right, exactly. Thank you.

(Operator Instructions) Paul Mammola, Sidoti & Company.

Hi, good morning, everyone. Joe, if you look at the PMC margin in the second quarter, obviously seeing a slight sequential decline despite some sales growth. Could you describe that a little bit more for us? Is some of that price, by any chance?

Yes, some of it is price in Europe, which as I said we think we're going to see a flattening of that effect. But there is so much -- quarter-to-quarter there is so much variation in just product mix that we think if you look year-to-date you'll probably get a better sense of the improvement in margins.

And year-to-date in PMC, margins -- excluding all of the performance improvement costs and so forth -- it goes from about 38.9% last year year-to-date to about 40% this year year-to-date. And our aggregate, overall, our gross margins go from about 35.9% to 36.5%. So we think the trend is in the right direction there. That's point number one.

Point number two, the improvement from Q1 to Q2 in EBITDA was mostly [a ball] because of lower STG&R. That's directly related to moves we made in Q1 that -- for example, an early retirement program in North America -- that played out in quarter two.

We think most of the improvement going forward, that incremental $7 million of EBITDA, all else being equal, that plays out through Q2 of next year, most of that will be at the gross margin effect. It will be a gross margin effect.

Okay. That's very helpful. Then, do you have a sense of what your customer inventories are like? Obviously, with so much capacity coming off-line, that it potentially created a glut of PMC. Is that your perception, and maybe some of that is starting to work down now?

That's the other reason that we are still cautious about the short-term outlook for PMC. It's because the inventory effects are hazy, to say the least. It's pretty hard to sort them through.

There are inventory effects on the finished goods side of our customer. There are inventory effects on the incoming raw materials, that is our products going to our customer. There are inventory effects in our plant. We think they are washing through; but there's a lot of uncertainty here.

I'll just give you a small example. The time between order and expected delivery from our customers has shrunk in half since the recession started. It's gone from about 70 days to 35 days. And just trying to understand what effect that has on sales going out the next few months, coupled with uncertainty about seasonal effects, makes this very hard to sort through exactly what the causal impact of inventory on sales will be in the short term. That's why we say there is still some downside risk.

One of the pieces of data that we look at very carefully is the trends on number of our pieces that are installed, actually installed and running on customers' machines. That trend is starting to upward. Still below, still well below prerecession levels, but it's trending upward.

If it were trending down or if it were flat, that would suggest that the inventory effects will have a while to play out. But if it's trending upward, it's just a matter of time now before it plays out.

Okay. Then on Hangzhou, obviously still some charge for underutilization of capacity there. What is that plant running in terms of utilization? And can you remind us what your grade exposure breakdown is in Asia in terms of tissue, brown and white grades?

Yes. Well, it's a big plant with a lot more room to grow, but the equipment that is operational is now close to being fully utilized. We're going to keep adding more equipment; so in that sense we'll keep adding to capacity to that plant that we're not even halfway, or maybe about halfway, toward the ultimate capacity of that plant. So in that sense, it will remain underutilized.

But of the equipment that we are now depreciating, we're utilizing or close to fully utilizing it, or will be fully utilizing it by late this quarter.

The best way to think about grade exposure -- I don't have a precise breakout in Asia. But the important grades for us, most important grades for us in North America are the Kraft grades and the tissue grades. They represent together about 55%, 60% of our exposure in North America.

In Europe, on the other hand, by far the most important grades are the white paper grades. Asia is Kraft; that's the big grade. White paper is less important. Tissue is still starting to come on.

Okay, perfect. Then Michael, as a final question, after you buy back that last piece of debt -- I think you said in October -- of the convert, what would be left out there of the convert after that?

$28.4 million.

Okay. Perfect. Thanks for your time, guys.

Thank you. Gentlemen, there are no further questions in queue.

Okay. Thank you, Ernie, and thank you all for listening in on the call and we will look forward to seeing you in the weeks and months ahead. Until then, if you have questions, please call as you always do. Thank you.

Thank you. Ladies and gentlemen, a replay of this conference call will be available at the Albany International website beginning at approximately noon Eastern Time today.

That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.