Albany International Corp (AIN) 2010 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the first-quarter earnings call of Albany International. 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.

At the request of Albany International, this conference call on Thursday, May 6, 2010, will be webcast and recorded.

I would now like to turn the conference over to Senior Vice President and Chief Financial Officer, Michael Burke, for introductory comments. Please go ahead.

Thank you, Operator, and good morning, everyone. Before starting the call with some opening remarks by Joe, just a couple of brief housekeeping items. The first thing is please refer to our detailed press release that we issued last night regarding our quarterly financial results, and with particular reference to the Safe Harbor notice that's contained in the text of the release about forward-looking statements, the use of certain non-GAAP financial measures and associated reconciliation to GAAP. And for purposes of this conference call, those same statements also apply to our verbal remarks that we're going to have this morning. For a full discussion, please refer to today's earnings release, as well as our SEC filings, including our 10-K.

And then finally as a reminder and for those new participants listening to our earnings call, following Joe's brief opening remarks, we'll go straight to the question-and-answer portion of the call. And so with that background, I'll now turn the call over to Joe Morone, our Chief Executive Officer of the Company. Joe?

Thanks, Michael. Good morning, everyone. That seasonal effect that we talked about in Q4 hit us hard in January. In fact, January was the weakest sales month in memory, and that had the effect of dragging down our overall sales in the quarter, back to Q1 2009 levels. But apart from January, the trends in the quarter were good. Sales improved sharply as the quarter progressed. Orders were strong, both relative to Q1 2009 order levels and relative to Q1 2010 sales levels. And profitability was strong. Again, that's several quarters in a row that we've seen strong profitability, which certainly gives us confidence that the profitability levels we're seeing are sustainable.

Let me just try to give you a little bit of clarification on how we're measuring profitability. As we're coming out of recession, and as we're pretty much completed with the three-year restructuring program, we've made the deliberate shift back to more traditional measures of profitability. So we are comparing profitability from year over year, so Q1 to Q1, and our measure of profitability is now EBITDA adjusted only for two items—GAAP-based restructuring and any extraordinary gains or losses in non-operating income from things like sales of buildings or, as was the case in Q1 2009, gain from the buyback of our bonds.

So on that basis, EBITDA only adjusted for GAAP-based restructuring, EBITDA in Q1 2010 was $29 million compared to $16.5 million in Q1 2009. Now, that $29 million EBITDA in Q1 2010 does include about $5 million of costs that are the lingering effect from the restructuring program. Idle capacity, equipment relocation, SAP. If we were to go back to the measure of profitability that we've used for the past three years, EBITDA adjusted for all of the costs associated with restructuring and performance improvement, then that $29 million in Q1 2010 becomes $34 million. And that $16.5 million in Q1 2009 becomes $25 million. So $34 million versus $29 million. Against relatively flat sales.

So however you slice it, $29 million versus $16.5 million in adjusted EBITDA or $34 million versus $25 million, the old measure of adjusted EBITDA, it's a strong profitability, particularly in the context of flat sales.

Now, the one question that Q1 2010 doesn't answer for us because of that January effect is what's the new post-recession normal for sales? We think Q2 should give us a pretty good indication of that, both the sales trends and the order trends. The sales trends in Q2 are not affected by any negative seasonal effects the way sales are in Q1, and orders by Q2 should be free of any of the inflationary effects that might have affected orders in Q1 because of inventory restocking after recession at the beginning of the year by our customers.

So Q2 should give us a pretty good indication of the, at least for the short term, post-recession normal in sales.

So overall, Q1 was an encouraging quarter, and we all think Q2 should give us a much better feel for the post-recession short-term revenue outlook. So with that commentary, let's turn to your questions.

(Operator instructions.) And first the line of Jason Ursaner with CJS Securities. Please go ahead.

Good morning, Joe and Michael.

Good morning.

Good morning, Jason.

So first I just wanted to make sure I'm clear on atypical expenses if I'm looking at it from an apples-to-apples comparison. There's $3.7 million that would have been adjusted in cogs for this year versus $5.1 million for last year or $7 million for last year?

Jason, it's Dave Pawlick. Last year, the number was $7 million. That also included some under-utilized capacity in the Asia plant.

You mentioned in the press release that order trends in Asia have increased 64%. I would assume the under-utilized capacity there, since we didn't mention it, is getting better?

Yes. Last year, we were very much in startup mode in that plant, and we're out of startup mode.

And you talked about a weak January. You mentioned sales improving sharply as the quarter progressed. Was this a week-to-week trend, month-to-month, and have you continued to see this into April and into May?

We primarily—we do track week to week, but think in terms of months. Month by month, the sales progression improved strongly as the quarter progressed. And we haven't really gotten into talking about Q2 results until after the quarter, and we'll leave it at that. But the trends are all, as I said, Jason, the trends both on the order side and on the sales side were encouraging.

And is it by all the geographies? I know Asia was showing stronger growth.

The trends including the January trend were remarkably consistent across businesses and across geographies with the possible exception of China, which was just strong. It was a remarkably consistent effect across the board in everything, sales trends, order trends, profitability trends.

Good. And then just in engineered composites, we'd seen a better operating income. This quarter, it dropped back to that $2 million loss. I thought we had changed the accounting for research and development, so is this really seeing a ramp in expenses that need to be incurred? Kind of a front-end buildup?

This has nothing to do with R&D. This is really the effect of slower sales at the beginning of the quarter at the same time that we're ramping up our costs in anticipation of a sharp increase in output and sales.

Okay, good.

There's nothing unexpected there or surprising.

Good. I'll jump back in the queue. Thanks, guys.

Next, we go to Ned Borland with Next Generation Research. Please go ahead.

Hi. Good morning, guys.

Hi, Ned.

I did not see in the release any mention of competitive pricing pressures or anything surrounding certain negotiations with customers. Are we to assume that demand now is strong enough that this becomes much less of an issue, or did something develop?

The contract negotiations that we've alluded to before are ongoing, and the customer schedule is to get them done this quarter. So there's nothing to report. The order—the best way to look at the competitive pressures is to look at the trend of prices on orders. Whether you look at prices for sales or prices for orders, they were pretty stable across all geographies, which is encouraging. Now that said, I have to give our disclaimer that we always give. The underlying structural conditions, particularly in Europe, there's over-capacity in the paper industry, there's over-capacity at least from an equipment point of view in the PMC industry. That hasn't changed. But we're seeing, in the near term, stability.

Okay. And then with regard to restocking versus demand recovery, it sounds like you saw a fair amount of restocking in the first quarter. How long does the restocking process generally last by your customers?

Well, usually—well, you know, it's—we're not really sure what we're seeing, and that's why we want to wait for Q2 to get a better fix on the trends. Ordinarily, orders are strongest in Q1, but we've controlled for that by comparing Q1 to Q1. The reason we're a little hesitant to take the absolute level of orders from Q1 to the bank is we're coming off this incredible recession, and it could well be—it's more likely than not that there was a certain amount of restocking of inventory going on during Q1. It's hard to imagine that it wasn't. We just don't have any basis for quantifying how much that was.

Okay. Well, maybe going at it a different direction here. On your EBITDA margin, given the level of cost reduction that you've pulled off here, what's a reasonable range for—excluding restructuring, what's a reasonable range for EBITDA margin on a more normalized or pre-recession level of sales?

It's going to be—if you take it at existing level of sales, it's in the 16 to 17 range, EBITDA margin. If you got back to pre-recession level of sales, it's going to be—I haven't done the math, but it's going to be 19, 20.

Right.

Okay. Thanks.

(Operator instructions.) And we'll go to Paul Mammola with Sidoti & Company. Please go ahead.

Hi. Good morning, everyone.

Good morning, Paul.

You guys obviously usually don't report orders, so for historical context, do you by any chance know when the last time was orders were up 23% or so year over year?

It's unusual. We haven't seen that kind of comp or the kinds of order-to-sales ratio that we saw in Q1 in memory. But again, we're coming off unusual circumstances, so you just have to be careful about how literally to take those results. In Q1 2009, we were heading into recession, and we had falling orders the following quarters. And the trend is exactly the opposite now. We're coming out of recession.

So it's clearly an encouraging trend, but you don't want to go overboard here. And we're not going overboard, and we really think we have to wait for another quarter, this quarter, where to the extent that there were abnormal inflationary effects on our order levels post-recession, because of post-recession inventory restocking, that should have pretty much washed through by Q2. So we'll have a much better indicator of where we are. It's encouraging but how encouraging remains—would be a little cautious about taking that—

Using that trend--

It's an encouraging directional trend. Don't take it for more than that at this point.

Okay, understood. And if you could go to Europe and kind of give us a sense of what's happening order-rate wise there, and also comment on, if you have it, what specifically you've taken the production footprint down to? I think Sweden or Switzerland was down 60% and Germany down 25%, but I don't have the number as a whole. So just those couple of things to get a sense of what's going on there.

Paul, I'm not sure where you got those two numbers from, but our manufacturing footprint in Europe is now in PMC a large plant in Sweden, which from a production point of view is our largest plant in the world and also is one of our two primary centers for global R&D, a second plant in France where we do forming production primarily, and a small plant in Germany where we make press fabrics, and one plant in England where we make belts for the entire world. There were before recession three other plants in Europe, which we have since shut down. So we basically have the capacity in terms of numbers of plants in Europe.

Okay. And then finally, in aerospace as it pertains to the competing Pratt & Whitney engine compared to the LEAP-X, was that always there or is that competing engine kind of coming out of nowhere all of a sudden? And is there any update as to what you guys have seen in terms of that landscape lately?

The Pratt & Whitney engine is the geared turbo fan, and it's always been there. It's been there in development by Pratt for at least the last three or four years and probably longer. But to set the scene for you, the two dominant single-aisle aircraft, not including a new entry by the Chinese, is the Boeing 737, the Airbus 8320 and the related family, 8319 for example. Pratt and the GE-Snecma JV have shared the Airbus market, and the GE-Snecma JV have had 100% of the Boeing market. That's the startup point. So the LEAP-X is intended to replace the engine that basically covers half of the Airbus, and today covers 100% of Boeing. The decisions we're all waiting for are first is Airbus going to decide to re-engine? And if so, is it going to continue with the 50-50 arrangement between Pratt and GE-Snecma? And second, will Boeing follow suit? And if it follows suit and decides to re-engine, will it continue with 100% to the GE-Snecma JV, or will it let a second contender in? The three contenders are the GE-Snecma JV, Pratt and Rolls. Pratt and Rolls have been working together on a JV themselves, but they haven't come up with a common engine, so it will either be—so it's more likely that it's either Pratt or Rolls, but not a combined engine. They each have their own contenders. The Pratt contender, geared turbo fan, is not new news. It's about as new news as LEAP-X is.

Okay. That's helpful. I think you guys have talked about 1,000 units per year opportunity. I was curious if it's 1,000 units 737 or 1,000 units 737 and 8320 combined?

The 1,000 unit number is our estimate based on market data of what the size of the current market is for the CFM engine; that is, the engine produced by the GE-Snecma JV. So that's roughly their current rate of production, and those engines go on the Boeing 737 and on the Airbus 8320 in the manner I described before. So that's the current annual production rate of CFM engines, and those are the engines that are intended to be replaced by LEAP-X.

Okay, perfect. And then just to clarify, the LEAP-X has really no impact on the projected, say, revenue double and EBITDA break-even over the next eight to ten quarters?

LEAP-X production does not. LEAP-X development does. That is, our revenue in our composites business is partially production revenue and partially revenue from development funding. And the development funding for the LEAP-X is increasing as we get closer to production.

Okay. Thanks for your time.

You're welcome.

And we do have a follow-up from Jason Ursaner. Please go ahead.

Hi there. Just a couple follow-ups. You mentioned orders versus sales before. Can you talk about how long the process takes for orders to flow through to revenue?

It varies with markets and with business. In Europe and Asia, it is a relatively quick process, and it usually washes through in a quarter or two. But not more than that. In North America, where there are different kinds of inventory practices, it can take substantially longer than that. It can take two to three quarters. In both instances—we're talking about PMC. And in both instances, the way we think about orders is they really are a directional indicator, but you can't get—it is a complex, multi-variant regression problem to try to predict sales precisely in PMC, and orders are one of the variables, but not the only variable. There's still a wide range of variability beyond orders when you're trying to go from orders to sales. So what we always say is treat it as a directional indictor. If orders were going down, that would be a directional indicator that sales are heading down. If orders are going up a little bit or are relatively stable, then the directional indicator is sales will be stable. And if orders are going up, that's a directional indicator that's hopeful.

Great. And now that the restructuring is complete, you mentioned disproportionately larger improvements in EBITDA. Can you try and walk us through how incremental margins for the various business lines might look?

Well, you can almost get that at the gross level by looking at the data in the release. But we think—and also by looking at the operating income margins that are suggested in the release. You're getting pretty good indications. Now, as we said, there's still that $4 million, $5 million in lingering restructuring effect, and by the end of Q3, they should be gone. So the results you're seeing, the operating income by division that you're seeing in the release, will be a pretty good indication of what the sustainable operating margins are.

But in terms of the incremental flow-through?

[I've kind of said] if you look at Table 2 and Table 3 in the release. You've got operating income, and we've tried to show how you would have to adjust operating income by unit in order to correct for GAAP-based restructuring. And then you know that we had these additional charges, and they're almost all associated with PMC. Not all, but almost all. So you can get a pretty good sense of the run rate that we're expecting for operating income margins from that data.

I guess trying to look at it another way, you mentioned closing three of the facilities in Europe. If you had a $20 million increase in orders, would you have to create capacity? How much headcount might you have to add? What type of expenses would need to come back besides (inaudible—multiple speakers)--

We're still in the mode of expecting high fixed-cost leverage. That is, there might be some increase in variable labor, but incremental sales should lead to disproportionately higher incremental EBITDA.

Okay. And then just a quick one on AEC. The press release mentioned several key programs. Are any of these programs that we haven't previously talked about?

The sharp ramp-up that we're anticipating comes from the familiar programs. From the landing brace ramping up, from LEAP-X development ramping up, from the joint strike fighter ramping up and from another program that we've mentioned, which is the outer guide [lanes] for the existing CFM engine. That's ramping up as well. And that's the short-term growth is really being driven by those familiar programs.

Okay. And then just for the LEAP-X, you mentioned there's 1,000-unit estimate based on the market, and you've given before a lower bound for revenue content of about 100,000. Can you try and I guess go through a little bit of detail on the LEAP-X as it continues to develop and where it got I guess selected, as COMAC has already selected it, versus the future developments that are still ongoing with that?

So there are three pieces of the puzzle. COMAC, the new Chinese entrant into the single-aisle aircraft model was announced in December and that's what launched this whole flurry of interest in LEAP-X because they picked LEAP-X, so that meant the LEAP-X program definitively had to be launched. Which means a scramble now between now and 2015 to finalize designs, get certification, ramp up production, get up the learning curve. So that's Piece Number 1.

Now, Piece Number 2, which should be announced one way or the other this quarter, or at the very latest at the Farnborough Air Show in England in mid July, so before our next earnings call, that piece is Airbus' decision on whether it will re-engine and who it will pick for the re-engining if it does re-engine.

And then the third piece of the puzzle, as we've talked about before, is Boeing. It's really hard to imagine Boeing not deciding to re-engine if Airbus does. So then the question will be if Airbus does decide to re-engine, Boeing is expected to follow suit later in the year, and then we'll have the same question again, will they pick one engine or two? I don't know if I'm answering your question because I'm repeating what I know you already know to be the case.

I guess I'm trying to ask it about the revenue content, and there's contingent—I guess you would be (inaudible—multiple speakers).

So it would be the two-- the revenue content. How many engines is the CFM joint venture going to be making? How many LEAP-X engines will they make? And the answer to that question depends on these re-engining decisions.

But does the revenue content potentially change?

Then the second question is how much revenue content will we have per engine? And we can't give you a better or different estimate from what we gave you last quarter, which is substantially in excess of $100,000 per engine, because we haven't completed our negotiations yet.

Right. Okay. Thank you for the details, and that's all I've got. Thanks a lot, Joe.

Okay. Thanks, Jason.

And we do have a follow-up from Ned Borland. Please go ahead.

Yes, just a quick one on what's going on in China. We've heard that there's some paper companies out there that are making projections that they'll essentially quadruple papermaking capacity—some select companies are saying this—by 2015. How are you—in your discussions with customers over there, how are you assessing what's actually going on with capacity over there?

Well, it's a hot market, for sure. But I hadn't heard the quadruple number. That would be—that's new news for us. It would be great news, but we haven't heard it. The best number I can give you is worldwide, the best estimates we've seen worldwide, new machine construction will grow at about 3% per year, worldwide. Now, if you ask where is that new machine construction taking place, most of it is taking place in China and Asia. So it's a highly concentrated rate of growth, but in the aggregate worldwide, it represents about 3% of machines.

Okay, but that nets out closures, does it not?

No, that's just new machine build.

That's just new machine build, okay.

New machine activity. You look at current new machine activity, it will continue at its current pace, plus 3% per year. That's got nothing to do with paper production worldwide. Paper production worldwide, all the projections we see, traditional industry sources say in the order of 1% to 2% per year worldwide, with declines in North America, in Europe in the printing grades, and stability in the packaging grades and GNP growth in the tissue grades in North America and Europe. And in growth in Asia and South America. No news—we haven't seen any new news on that front. All the evidence we see is consistent with the picture we've been painting.

Okay. And then competitively, has there been any new entrants into the Asian market or the Chinese market?

Not that we have seen, no.

Okay. Thank you.

And we do have a follow-up from Paul Mammola. Please go ahead.

Hey, sorry to jump back in. But on the tax rate, obviously it cost a few cents in the quarter. I guess what's pushing that up, and what do you expect for the year?

Right. Well, Paul—it's Michael. What we have talked about in the release looking forward is the current rate of 34.5, and there are a couple of things to remember. One is that we emphasize that the changes to the effective rate for GAAP book purposes, it really does not have, in our view, is it going to have a material effect on a cash basis, on the rate going forward. So you need to consider that when you're thinking through your assumptions. This year, for 2010. And then as we've said, we're continuing to focus on specific objectives that we have, planning outcomes that we think under those actions as we work through them will have a beneficial effect on the overall effective rate, as we think out beyond 2010. There were three specific items that we mentioned in the release. One in particular is probably the largest of the effects. It has to do with the temporary loss of an ability to use a tax shelter, if you will, relative to losses that we're incurring. So as we work through our appeals processes, as we work through those tax initiatives and we're confident as we think beyond, that that rate will come down after 2010.

Okay. Thanks again.

We have no further questions in queue. I'll turn it back to the presenters for any closing comments.

Thank you all for your questions, and we'll—as I mentioned, Q2 is going to be an interesting quarter, and a revealing quarter, and we look forward to talking to you at the end of Q2, and if not in between. Thanks, and have a good day.

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.