Albany International Corp (AIN) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter earnings call of Albany International. At this time, all participants are in a listen-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, November 4, 2010 will be webcast and recorded.

I would now like to turn the conference over to Vice President and Acting Chief Financial Officer, John Cozzolino, for introductory remarks. Please go ahead.

Thank you, operator, and good morning, everyone. As a reminder for those listening on the call, please refer to our detailed press release issued last night regarding our quarterly financial results with particular reference to the Safe Harbor notice contained in the text of the release about our forward-looking statements and the use of certain non-GAAP financial measures and associated reconciliation of GAAP. And for purposes of this conference call, those same statements also apply to our verbal remarks this morning. And for a full discussion, please refer to that earnings release as well as our SEC filings, including our 10-K.

Now, I'll turn the call over to Joe Morone, our Chief Executive Officer, who will provide some opening remarks before we go to Q&A. Joe?

Good morning, everyone. Thanks, John. Welcome to Albany International's Q3 2010 earnings call. Q3 was another good quarter for the company. If you take out the effects in currency, the $6.7 million of revaluation gain in Q2 and the $7.6 million of revaluation loss in Q3, you get basically comparable quarters, the same EBITDA in Q3 as in Q2 on roughly the same sales despite summer seasonal effects.

Q3 was particularly strong for PMC, gross margins hit 44%, operating income margin 25%, sales were steady from Q2 to Q3 despite the summer, orders were strong and backlogs grew and actually hit their high for the year. And perhaps most importantly pricing continued to be stable. We successfully concluded another important contract negotiation and there are no other major contracts pending for two years. The net effect of all that is we are feeling better about the short-term outlook for price stability than we have at any time since basically Q2 of 2006.

Turning to Albany Engineered Composites, we're still on track to double sales from Q3 '09 levels by the end of 2011 or early 2012. We're making excellent progress on new product development that Q3 press release on the ceramic matrix composites substrate for the Boeing engine nozzle was just one example. And we continue to prepare for the LEAP-X program as our recent announcement of the site selection for a new plant that New Hampshire suggests.

On the profitability front, the losses in AEC continued in Q3 but we made good progress in turning the [Burnie] operation around and we're working closely with our customers to finish that effort, and our advanced composites operation in Rochester continues to perform well. And we are still expecting Albany Engineered Composites to be EBITDA positive in 2011, operating income positive in 2012 and cash flow positive by the middle of the decade.

As for our other three businesses, as expected, the top line in Doors is clearly improving with the economy. Sales and order backlogs are well ahead of Q3 '09 and we expect Doors to hit its usual seasonal high point in Q4. Engineered Fabrics was hit very hard by the summer slowdowns with a remarkably weak August, but here too we're expecting a normal seasonal rebound in Q4. And PrimaLoft continues to perform exceptionally well, although it hits it seasonal low in Q4.

So overall, if you control for the impact of currency revaluation, this was another strong quarter despite the seasonal effects. And what we see, based on Q3 tech trends and historical seasonal patterns, we see an outlook for Q4 and beyond that's encouraging across the board.

So that's a quick summary. Why don't we turn right away to your questions? Operator?

(Operator Instructions). We'll go to the line of Jason Ursaner at CJS Securities. Please go ahead.

Good morning, Joe.

Morning, Jason.

So EBITDA or adjusted EBITDA, I just want to make sure that I'm understanding it right. After all the adjustments, based on your commentary and John's commentary, it sounds as if excluding all the effects of currency if we looked at it on a steady state rate EBITDA is essentially in line with Q2.

Yes.

So my question is if EBITDA is holding steady on flat revenue -- but flat revenue for the quarter is a pretty strong performance when I incorporate Q3 seasonality.

Yes.

I think the question is with another quarter to evaluate sort of new normal across your various operations, is a 50% incremental EBITDA margin on revenue growth from here a target we should still be kind of holding you accountable to?

Yes, we think so. Yes.

And then I guess from there, is the seasonal effect of Q3 -- do you think that that's masking accelerating trends or was there really just no seasonal effect this year?

Jason, you can't get around summer shutdowns or slowdowns in Europe. They might be shorter if inventory levels are low or delivery times are high, but there still are slowdowns in the summer in Europe. So I think it's -- I think the reasonable interpretation is activity is masking the effect.

Okay. And can you talk a little bit more about the ratio of orders to sales as it strengthened? Just because I know that this has been a trend that you had actually called out in Q1, which you don't normally kind of separate out. Just if you can give any more detail on that.

Well, we think the backlog is probably a better indicator than the order to sales ratio because the order patterns among our customers are changing. The lead time between order and expected delivery is shrinking dramatically. So orders that might ordinarily have come in in Q2 are coming in in Q3, so better to look at the backlog. And if you look at the backlog, particularly in PMC, it's high for this time of year. Usually the backlog is highest at the beginning of the year and gradually declines and we hit our annual high in Q3.

So in PMC in particular, revenue actually increased sequentially. But as I look towards Q4 with no contract renewals, pricing firm, I guess if you could speak a little bit to customer inventory levels, but how should we be thinking about growth going forward and maybe into 2011? And with revenue growth, are there any structural impediments to continue operating improvement? Are we still getting leverage out of the China facility or is this really played out already in terms of --

[Technical Difficulty from 7 min 57 sec through 8 min 40 sec]

-- so the effects you've been seeing on revenue dropping through the EBITDA should continue from what we can see.

But I guess I'm asking with 40% gross margins in the business at PMC with a 25% operating margin, at what point do we really max out? Have you set any long-term targets there?

Yes. If revenue remains at this level, we've maxed. So if you -- what you see is the run rate of the profitability of the business.

Okay. And then just looking at AEC, without any specific programs can you talk a little bit more about what's giving you confidence for the longer term in terms of sales projections and longer term margin projections and just some of the development projects or whatever is going on in that's really giving you the confidence longer term, besides just maybe what we've seen publicly.

Right. For both short-term growth and long-term, as we've discussed before, our two biggest programs -- well, two of the important programs are the LEAP-X engine and the landing brace. And those are driving -- those are contributing significantly to the short-term growth, in particular LEAP-X would contribute significantly to the long-term growth. If you go out a few years, there's about -- leaving aside LEAP-X and brace, there's about six families of product applications that we're working on and that are in various stages of development. But all of them have the potential to develop into multiple applications.

Now we've mentioned the ceramic matrix composite substrate for the engine nozzle. That is part of a broader family of a broader technology platform that has fairly widespread applications beyond just the nozzle. So there's one family of applications that we've disclosed. We've mentioned that if and when one of the airframe manufacturers takes on a whole -- the development of a whole new airframe, which will have significant composite applications, we'll see a wide array of applications for our technology on the airframe, on applications like airframe [frames] and [beams], joints.

So there's two examples of application families that we see driving long-term growth. And we have at the moment, leaving aside LEAP-X and brace, as I said we have about six of those families that we're working on and they keep expanding. I would say if I were giving this answer a quarter or two ago I would have probably said four additional families.

Concentrating a little bit more on the potential for a new single isle aircraft. If we were talking about an entry into service before 2020, can you talk a little bit about the next generation engine landscape and would [R-Bac] still be the contender in considerate. Just how does that plan to it and would there be potentially other developments for a new aircraft if it got pushed back a little bit.

In the engines in the thrust class associated with single aisle aircraft, whether it's a re-engined existing A320, 737 or it's a whole new single aisle aircraft that would replace 737 or A320. If we're talking this decade, the contending engines are the LEAP-X and the geared turbo fan by Pratt-Whitney. Those are the contenders. It's not until you get out until the second half of next decade that a new contender possibly emerges, and that's the unducted fan.

Now, what's interesting is that if you go to a whole new generation of engine, you need a completely different aircraft design. So an aircraft design for the unducted fan would be completely different from an aircraft design to take on more conventionally configured engines, like the geared turbo fan and the LEAP-X. Anything built this decade, any new aircraft built this decade is going to have to be configured to take on the engines that we see in front of us, LEAP-X and geared turbo fan.

Okay. So a new aircraft really, I mean in terms of your view, it just pushes out the inflection point but really wouldn't make you any issues on whether the LEAP-X really would be --

No.

Okay.

On the contrary, it does several things simultaneously, we think. Now, we're in speculation mode here, but several things simultaneously. Number 1, it brings forward the window of opportunities for new applications on the airframe, which as I just mentioned is an important family of potential applications for us. Number 2, it dramatically extends the life of LEAP-X because if they're building the new airframe this decade it's going to have to use the LEAP-X and gear turbo fan and then those engines -- those planes will be configured to use those engines for the life of the plane, which is like 30 years. And number 3, since it pushes back the introduction of those engines, there's more opportunity for us to get more content on it.

So if you look at this from a pure timing of revenue point of view, re-engining works better for us because the revenue comes sooner. If you look at this from a net present value of future cash flows point of view, a whole new aircraft some times this decade is clearly superior, even though you have to wait a little longer.

Okay. And just last question real quick on Engineered Fabrics. Obviously, the quarter was disappointing but you mentioned suggesting a normal seasonal rebound in Q4. Is the rebound coming from some of the end markets in housing or is it really being driven by the non-woven section. Just any other --

Non-woven, particularly in Europe, partially in Asia, working very closely with the equipment manufacturers for non-woven equipment. That's where the rebound is being driven by.

Okay. So have you seen a pickup in maybe September, October that would really make you more confident that this is kind of a temporary drop in that segment?

Well, we want to resist the temptation to comment on October, Jason.

Okay.

But we know with certainty is August was a miserable month and was really clobbered by the seasonal effects. And we know those seasonal effects aren't there and we see what the demand picture and order picture is like in Europe in a small way Asia.

Okay, great. Thanks. I'll jump into queue, Joe.

Thank you. And next we'll go to the line of Mark Connelly at CLSA. Please go ahead.

Morning, Mark.

Mr. Connelly, your line is open. If you have the mute button on, please take it off.

Can you hear me better?

That's good.

Sorry about that. So when we look at the PMC business and the shift from you normal pattern, clearly there's been a lot of changes structurally in the paper business and a return to better operating levels in the last couple of quarters. So when you think about your backlog, are your customers telling you that they're confident in this sort of extended cycle thesis that they're going to be able to maintain the levels that they've been running recently? Just trying to get a sense of the feedback you were getting from paper companies versus what we're hearing.

I think, Mark, the way we're thinking about it, which is integrating across what we're seeing and hearing from our customers and what we're seeing and hearing across geographies, is we're still relying on the broader structural sectoral trends to understand what's going on in this business more than the shorter term cyclical pattern.

So if you look at our sales patterns, we're seeing growth in Asia and South America offsetting decline in Europe. North America is kind of flat. But then when you get underneath that if you look by grade, you see exactly what you'd expect to see, like the packaging grades are showing incremental growth and the [pre-NIN writing] grades are still under pressure.

So while there -- some of the short cycle patterns might be obscuring things a bit, we still use the sectoral trends, both geographic and by grade, as a pretty reliable guidepost to understanding what's going on.

Okay. So when you look across geographies right now -- you spent the last couple of years getting your cost position stronger in Europe. You've always been strong in Latin America. Can you give us a sense of where you think you stand in terms of where you can be in those geographies? And then also can you talk about PMC margins in China, which historically haven't been as good as elsewhere?

The second answer is easy. We're very happy with the margins in Asia. That is if you take the pricing in Asia and cost of goods sold manufactured there, our margins are -- I mean our Asian operations are helping to drive the kind of margins that we're -- in the aggregate that we're seeing in PMC.

Okay. And in terms of your cost position in other parts of the world, is there more work that you need to do? I mean there's always work you want to do, but is there more work that you need to do? A couple years ago you needed to make changes in Europe.

No, I think at this point the work we need to do is to keep offsetting inflation with productivity improvements. But the structural changes, unless there is going to be another major recession that leads to another step down in production levels in our customer base, we think the kinds of changes that we have to manage our way through over the next few years are much more continuous productivity improvement so we don't allow inflation to erode the gains that we make.

Okay, and just two more quick questions. Your SAP spending program now has outlasted two CFOs and I'm just curious where you are in that implementation.

Just for the record, our first CFO was in place for 28 years and SAP started late in his cycle.

But we still blame him.

We have one major step, which is on schedule, which is go live in Eurasia, and that is scheduled for the beginning of Q2. And after that, we're in maintenance and steady improvement. Most of the project will be over, once we get through that go live.

In Q2?

Yes.

Okay. And then very last question. It's taken you roughly 50 years to get PrimaLoft to where it is, if my math is correct. I'm trying to get a sense of what meaningful growth opportunity you see in that market. I mean should we just be looking at this as maybe get a couple of percent a year out of it, or is there more that you can do with that business?

Yes, I don't think it's 50 years. Probably close --

Wasn't it 1962? I may be wrong. Let's call it more than 40.

This still has a lot of growth in it and it's two forms of growth. One is penetration of the basic insulating product into new applications, particularly in outerwear. And the second, which is -- and new geographies, for example, it's growing very fast in Europe right now.

And the second wave of growth is a whole new product family in which we essentially integrate PrimaLoft into yarn, which allows us to -- allows our customers to make water resistant insulating socks, sweaters, outerwear, which has the potential to essentially double the size of the business. I mean it's that big a product category. So we think there's plenty of growth left in this business.

Okay, very helpful. Thanks, Joe.

Thanks, Mark.

Thank you. And next we'll go to the line of Ned Borland at Hudson Securities. Please go ahead.

Morning, Ned.

Good morning. Just quickly a follow-up question on Mark's question about Asia. Are you guys maxed out in your capacity in Asia or do you still have a little more running room?

In one of our plants we still have more running room.

Okay. And then I guess we haven't really talked about market share in a while and there's been a couple of negotiations. One of them, I guess, was just completed. Everybody seems to be kind of locked in place for a while. I mean where does your market share stand versus where it was, say, back in '06 before all the disruption happened?

Pretty much in the same place. But we don't spend much time thinking about market share. We're focused on -- we're happy with the customers we have and the geographic mix we have and we're really focusing on serving them effectively and eating inflation year-over-year. There's not much -- we don't spend much time focusing on share internally.

Okay. Thanks. That's all I have.

Thank you.

Thank you. And next we'll go to the line of Paul Mammola with Sidoti & Company. Please go ahead.

Hi. Good morning, everyone.

Hey, Paul.

If I can take you back to China as well, I think [Heimbeck] established an operation in [Sujo] over the past 12 months. Has that had any impact on your volume or pricing in the region?

No.

Okay. That's good to hear. And as we look at 4Q, I think some of the operating costs that you warned about over the past couple months certainly came in this quarter. Do you think $67 million and $68 million is a fair run rate for STG&R for 4Q and maybe early 2011?

Well, if you go carefully through everything we described in the release, I think you'll get a very good -- page 2 of the release if you do all that math you get a pretty good sense of the run rate and percent of sales. But you certainly need to -- the wild card in everything is this quarter, last quarter and maybe even Q4 will be the sharp swings in currency and the revaluation effects. And that shows up in two places, one of which is STG&R. So you really need to take that into account. And by the way, those revaluation effects are mostly non-cash effects. So it's really important to try to control for them.

And you gave some information as to what those revaluation effects are, but does that stem from the fact that they're non-functional currency assets, I would assume, are in Asia. Is that right to assume?

No, it's in every geography. I'll just give you a simple example. In Mexico where we make -- which is our plant for making dryer fabrics for all of North and South America, the costs are in pesos, the sales are in dollars. And so if there's any significant change in the relative values of those two currencies, we're going to have a revaluation effect.

And it's principally on the receivables and payables, right?

And also into company loans.

So I got to assume that maybe there's a mark month-to-month or quarter-to-quarter that you kind of have to flow through as you go, right?

Yes. And ordinarily if currency markets are in their normal range, they'll be -- if you go back and look at prior releases, you'll see $500,000, $600,000 maybe $700,000 effect one way or the other. But it's basically in the noise and so we've never called it out. But now you're talking about an order of magnitude larger effect. Last quarter Q2 was positive this quarter it's negative. If the euro stays where it is, there's going to be another big effect. So, it's an unusual period of volatility and it's only then that you see this kind of mark-to-market largely non-cash effect on earnings.

Okay, thanks for your help there. And then finally, is anything new with the comprehensive review you have for the month-end close process I think was put in place in 2Q?

No, there's nothing new. We're feeling fine about that. It's certainly something we pay a lot of attention to. But, no, that's fine.

Okay. Thanks for your time, Joe.

Thank you.

Thank you. (Operator Instructions). And we have a follow-up from the line of Jason Ursaner at CJS Securities. Please go ahead.

Hi, Joe. You talked a lot about outpacing inflation in Asia, and I'm assuming this is in terms of wage inflation, finding and keeping good people in the region. It's a bit of a strange question, but do you have any caution on the longer term potential currency inflation in the region?

Well, it's not just -- first of all, let's just take your overall question, we're not just concerned about inflation in Asia. If you take -- we're actually more concerned about inflation in the no growth markets that we serve. So if you take North America and PMC no growth or slow growth, if inflation is growing faster than the top line we'll very rapidly get margin erosion unless we're able to offset inflation with productivity gains. That's really what our focus is on.

Okay. In terms of the relative value of certain currencies, I mean have you taken any steps to try and mitigate long-term potential [blocks] funds out there in terms of no currencies could revaluate.

John's going to elaborate on this, but essentially we try to hedge against the impact of translation effects, which are real cash effects. But we do not hedge again or take any steps to protect against these non-cash effects because it would be using cash to protect against a non-cash effect, which we think does not serve anybody's interest, least of all our shareholders. John?

Jason, specifically related to the RMB, to the extent that we make and sell in China and invoice our sales in RMB that actually acts as a hedge against the cost. So the more we grow there and the more we have sales against those costs that actually acts as kind of a natural hedge against the consolidated results from China as we convert them into dollars.

Okay, great. Thanks a lot.

Thank you.

Thank you. And there are no further questions in queue. I will turn it back to our host for closing remarks.

Thank you all for joining us this morning and John and I look forward to meeting many of you in conferences coming up over the next few months. And if we don't talk to you -- see you then, see you at our next earnings call. Thank you.

Thank you. And, ladies and gentlemen, a replay of this conference call will be available at 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.