Albany International Corp (AIN) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the third quarter earnings call for Albany International. At this time, all participants are on 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, November 3, 2011, will be webcast and recorded.

I would now like to turn the conference over to Chief Financial Officer and Treasurer, John Cozzolino, for introductory comments. Please go ahead.

Thank you, operator. 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 note as contained in the text of the release about our forward-looking statements, and the use of certain non-GAAP financial measures and associated reconciliation with 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 will turn the call over to Joe Morone, our Chief Executive Officer, who will provide some opening remarks before we go to Q&A. Joe?

Thanks, John. Good morning, everyone. Welcome to Albany International's Q3 2011 earnings call. This was an important quarter for us, and a very good one, too. We see four major highlights. I'll run through them quickly, and then we'll turn to your questions.

The first highlight, of course, is the strong financial performance. From our vantage, Q3 2011 is pretty simple to understand. Excluding currency, sales were up $12 million compared to Q3 2010, about half of that brought through to EBITDA.

As you can see in Table 1 of the release, all of our businesses had good top line performance. If there's any one factor that stands out on the top line, it's probably the strong sales growth in PMC in China. Sales in China grew 32% year over year and now account for about 11% of global PMC sales, up from 9% a year ago.

We think this is a good quarter to use as a benchmark to assess future quarters. For this level and mix of sales, $43 million in EBITDA, and excluding reval and GAAP restructuring, $43 million is a good benchmark. So $250 million in sales with this mix gets $43 million in EBITDA. That should give you pretty good calibration.

That said, you have to keep in mind that starting in Q4, total revenue and EBITDA for the Company will exclude Albany Door Systems, which we will start reporting as a discontinued operation.

Turning to the second of our four highlights, during Q3 we initiated the merger of Engineered Fabrics and Paper Machine Clothing, a process that should be completed by year end. We see the opportunity for substantial synergies here, both top line and bottom, and we think it will enhance our ability to realize the growth potential in EF while improving overall Company profitability.

Now, to give you an order of magnitude sense of the synergies, our target here -- now, this is the target -- our target is to realize by mid-2013 $15 million in incremental annual EBITDA from the combined entity. So what that means is once you take Doors out of the mix, that's a target of about a 10% improvement in overall Company EBITDA by mid-2013 from these synergies.

We'll report Engineered Fabrics separately next quarter, but then after that, once the integration is complete, we'll report one set of results for this new segment.

The third highlight, announced last week, is that we have reached an agreement to sell Albany Door Systems to Assa Abloy for $130 million. This contract is subject to anti-trust review. We expect the transaction to close in quarter 1.

As for the proceeds from the transaction, we will focus on -- no surprise to any of you, I don't think -- on strengthening our balance sheet, which in turn will, for the long run, put us in the position to take full advantage of what we see as an opportunity-rich space in composites.

Now, we'll be able to give you a more precise view of exactly how we plan to strengthen the balance sheet in our Q4 earnings call, but to give you a general sense of how we are thinking about it, we see two potential pathways here. The first and obvious approach is to pay down our revolver. But in addition to that approach, we're looking at a second, less obvious, approach, which has to do with our pension liabilities. We're exploring whether it is both technically feasible and economically attractive to accelerate the funding of and possibly retire some of our pension liabilities. There's the potential here -- if it all works out, there's the potential here for both a significant long-term cash benefit and an income benefit.

To put the potential income benefit in context, our total annual expense for pensions is $14 million. So we're analyzing this carefully, and we hope to provide a clear sense in our next earnings call of whether we have an economically attractive option here, and if so, how large it might be.

And finally, the combination of the integration of Paper Machine Clothing and EF and the pending sale of Doors clarifies our corporate structure and strategy. Once the Doors transaction closes, Albany International will comprise two core businesses -- PMC and AEC plus PrimaLoft.

The two core businesses complement each other, and in more ways than just that interesting combination of long-term cash generation and long-term growth. PMC and AEC draw off the same core textiles and materials processing capabilities. For example, the plant manager of our first LEAP plant spent the first decade-plus of her career in PMC. The manager of our second LEAP plant, which will be in France, will almost certainly be recruited from PMC in Europe.

The materials R&D group that we've established in our corporate R&D supports both businesses. The equipment development group in Selestat, France, supports both businesses. Our internal fiber supplier in Homer, New York, supports both businesses. So one feeds off the other, and the combination of the two, the combination of PMC and AEC, is stronger technologically than each is standing alone. So this dual core, PMC and AEC, makes good strategic sense for the long haul. Add a small cash-generating growth business like PrimaLoft into the mix, and then add in what will be a strong balance sheet and the prospect for steady generation of excess cash, and we think what emerges from all this is a very interesting investment proposition.

So in sum, good results in Q3, an internal merger that creates promising synergies, a pending sale and use of proceeds to strengthen the balance sheet, and greater clarity in our corporate structure. That's Q3 2011.

With that, let's turn to your questions.

Thank you. (Operator Instructions) The first question is from the line of Jason Ursaner, CJS Securities. Please go ahead.

Good morning, Joe.

Good morning.

Congratulations on a good quarter. Just the first question, looking at PMC, the growth ex currency, that 3% growth, you had been talking a lot more about moderating sort of to that 0% to 1% growth that's in line with production. Did you see a pickup in production around the world? Is it following production, or is some of that growth more inventory?

We don't think it's inventory. We think the inventory restocking cycle is over. And in fact, as a side point, that'll be a big part of the story going forward when we think about comps. But, no, I think this is more performance, particularly in China. North America -- actually, everybody performed well. North America and Europe were a little bit up year over year against markets that are, I think, basically flat. And the Asian performance was very strong, particularly China.

Okay. I mean, is there any grade in particular where you're seeing the growth within China? And is there -- I guess on the down side, is there potential that you're taking any from Q4?

We're not -- we don't think is about taking anything from Q4, Jason, and the grade story is exactly what you'd expect given long-term trends. There is softness in the printing grades around the world, and is even some -- there are even signs of overcapacity in the printing grades in China. Kraft and tissue are the bulwarks around the world.

And then just in your prepared remarks, you mentioned the second plant for LEAP-X in France, I think you were mentioning. Could you just talk about, I guess, the general timeline for how LEAP -- how AEC is going to work with the new plant in Rochester?

There's no new news on the timeline. It is -- we're still seeing an inflection point in 2015. And to meet -- all along, the plan has been to meet the full demand. We would need the first plant here in New Hampshire, and then as that ramps up, we would start a second plant. Given the customer base, that one will be in France. So there's no new news there beyond the pressure to accelerate and ramp as quickly as possible. That doesn't -- for example, there's no change in our expectation of the required investment in order to fully capitalize the LEAP opportunity.

Got it. And in terms of the operating income in that segment, I mean, is it really just the hiring that's going on with the LEAP-X, or is it also --

Well, it's a little bit the cost of recruiting and relocating in an economy where whoever you try to recruit, their house -- odds are, their house is underwater. It's astounding. The one-time expense associated with recruiting can be as high -- is about as high as $100,000. So if we're heavily in recruitment mode, which we are, there are big -- there are millions of dollars of one-time expenses associated with recruiting and relocation.

So can you, I guess, just on the Boerne, Texas, facility, then -- I mean, is there -- are you making progress on that if that's not really what's holding back?

That is not what's -- I mean, that is the status quo. We've made progress on seven of the ten programs there. The other three, we're working very closely with our customers to get to stable production and profitability. But the real -- the reason we said we think the move from breakeven -- EBITDA breakeven to operating income breakeven is going to be delayed a few quarters is really two factors. The first is the one-time expenses associated with heavy hiring. And that heavy hiring, I'm talking about engineers, heads of operations, supply chain people, planning people, quality people in the dozens that we're recruiting in preparation for the ramp. And we could probably have withstood that if, at the same time, the brace program didn't continue to be stretched out. And so the combination of those makes it -- it makes it a lot tougher to get to operating income breakeven by Q2. It's going to take a few quarters longer.

No, I understand. I appreciate the commentary, and I'll let some other people ask questions. Thanks.

Okay, thank you.

Thank you. The next question is from the line of Mark Connelly, CLSA. Please go ahead.

Morning, Mark.

Morning. I've got a couple of questions. First, maybe we could start with the financial side. I was off a little bit on my working capital, but also on deferred taxes, so I'm wondering if you could help us think about those other cash items as they're going to roll out over the next couple of quarters. And also, you've talked about -- in the last couple of quarters, you talked about building raw material inventories. Didn't talk about that so much this time. I'm curious to whether anything has changed in your raw materials strategy there, too.

I'll take the second question.

Yes, Mark, first on the cash flow, you're looking at cash flow from operations. That line I think you're looking at, which has the deferred taxes and the long-term liabilities, that line would also have in it the $9 million of pension contributions that we made that perhaps you didn't have when you did your model.

Right.

That's probably one of the bigger areas that would be the miss there. I think from the standpoint of the inventory question, we -- the early part of the year, we had been building some inventory. As we had indicated in our last release, we were going to really be focusing on doing better on that in the second half. And actually it was a big focus for PMC, particularly in the raw material area, of controlling the inventories and working to bring those down. And so we'll keep doing that into the fourth quarter, but we hope that we'll get continued good performance in that area.

I think the other --

It's sort of a slow reversal of that trend, then.

Yes.

Yes.

Okay. Okay. Okay, sorry, I didn't mean to interrupt.

No, the last thing I was going to say, I think from a working capital standpoint, one of the largest areas that brought down the cash from operations was the increase in accounts receivable, and that really wasn't a deterioration of the performance. The days sales only went up a day. It was really more related to the timing and the strength of the sales really towards the end of the quarter. So we'll again be looking for pretty good improvement in that in the fourth quarter.

I wanted to make sure there wasn't anything else we were missing. John, as long as I've got you, can you tell us what the return on invested capital impact of the door business is going to be? Are you going to see your overall return on capital go down as a result of selling that just on a one-time basis? I mean, that's been a business that's earned its cost of capital most of the time.

Yes, you're correct. I mean, it's earned its cost of capital. I mean, I think in -- I don't think it's going to have a real material effect on the total Company return just because of the size of the return we get from PMC. It could make it drop a little bit, but I'm not expecting a very big change from that divestiture.

Okay, fair enough. A couple of questions, Joe, on PMC. You've talked about new products lately. Can you give us a sense of how that product performance is coming in the market and whether it's helping you sustain margins better in this market? And secondly, we see -- this is me talking. I see more consolidation coming in the European paper sector. I think we're going to see quite a bit more, so I'm curious of two things. Are you already seeing signs of that? And secondly, how important is newsprint exposure to your mix in Europe? Because I think that's where we're going to see the most change.

I think our overall approach here for the last few years has been to emphasize strategic partnerships with key papermakers in each region over maximizing aggregate shares. So we're much more focused on our performance or our share, if you will, with the likes of International Paper and Georgia-Pacific and UPM and Stora and Nine Dragons and APP than we are aggregate share.

And so we measure our performance against how we are doing with those key strategic partners. And part of the way -- part of the motivation behind the focus on those strategic partners is who are -- who did we think would be the consolidators in each region of the world and who did we expect to be the consolidatees. We've tried very hard to build long-term partnerships with the consolidators. UPM (inaudible) is a great example. IP's latest move is a great example.

And so the way our new product performance plays out is you wind up seeing it from a performance metric in two ways -- a stable or growing share with key customers, key strategic customers in each region of the world, and stable price.

Okay, that helps some.

Did that help?

Yes. No, that's what we want to hear. The bigger players are going to be the ones that survive, it appears to me, and the smaller players are in some pretty serious trouble, I think.

Yes, and it's -- I know you've always had a pretty grim view of the structure of the North American paper industry, but it's starting to feel for the first time like that industry has done a fair amount of consolidating in most of the grades and is looking pretty healthy. And now it's a matter of can Europe pull off the same trick.

Which leads me to my last question, which is are you earning more money on a margin basis in US PMC than you are in Europe consistently at this point?

Yes.

Okay. Perfect. Thank you.

(Operator Instructions) The next question is from the line of [TR Domitzky], Sidoti & Company. Please go ahead.

Hi, guys. Congratulations --

Thank you.

--on the great quarter and the reorganization changes you guys are planning. I missed the beginning of the call. Can you talk a little bit about the business case for the merger of PMC and Engineered Fabrics? Any color on plant consolidations or any other synergies would be great.

Well, it's still early, but there are synergies all over the place, and we think it is -- we've been looking at this carefully for quite a while. We think in many ways we're better able to achieve the growth potential in segments like nonwovens, and at the same time, do it in a more efficient fashion by merging the two groups.

We tried over an extended period of time to leave them separate on the argument that a separate Engineered Fabrics would be able to focus on growth, whereas PMC is a slow growth business, so they have a different set of objectives. And what we've learned increasingly, particularly as we try to expand Engineered Fabrics, is from a technology point of view, a product point of view and a manufacturing point of view, the intersections and combinations of synergies between the two groups are just too complex and we're much better off merging the two groups administratively, manufacturing, technically, and preserving the independent product management and sales effort so that we're going after separate markets with separate product management groups, but taking full advantage of the manufacturing and technical synergies and administrative synergies.

Great. Great. In the release, you mentioned, I think, CapEx for 2011 to be about $30 million, a little different than the $40 million or $50 million we had heard earlier, and obviously different than the $66 million in D&A. Can you just talk about the differences and just as far as CapEx expectations for any of the businesses, PMC, Composites, and the other ones?

Well, I think our long-term expectations are unchanged, that we expect CapEx over the next five years, six years to move towards the total of amortization and depreciation, and then it'll -- over that five- or six-year period, on average, it will be at that level of $65 million, $70 million. Sometimes it'll be below, the way it is now, and sometimes it'll be above, when we're in peak capitalization mode in Composites. But over time, our expectation hasn't changed. We expect to be able to fully capitalize AEC, continue to do what we need to do to maintain technology leadership in PMC, continue to do what we need to do to grow PrimaLoft while spending on average at amortization and depreciation.

So that hasn't really changed. What's changed in the short term is we're still living through the consequences of all the restructuring we did in Paper Machine Clothing over the past four years. And what happened is we went from 12 -- over a four-year period, 12 profit centers in 2006, to 4 in 2007, to 3 in 2008, to 2 in 2009, to 1 global business in 2010. Each time you make one of those moves, you realize there's more efficiency and synergy to be gained. And I think now we're at the point where we'll start seeing capital spending at PMC start to rise some, and overall spending gradually move towards that $65 million to $70 million mark over several years.

Yes, and then just -- but the short term was that $30 million number for like this year? Is that related to the landing brace ramp down in Composites or how -- ?

There's no one factor other than each of the businesses, particularly PMC, being incredibly diligent about making efficient use of their capital, and they've done a great job of it. They're knocking the cover off the ball in terms of performance and new product introduction, and they're being really vigilant about return on invested capital.

Great. That kind of leads into the next one, just on PMC. Can you talk a little bit about the cost containment that you guys alluded to in the release and sort of where that's coming from? And then also anything on new product acceptance or performance with the strategic accounts, why it's so strong?

Not really any new news on either of those fronts. I mean, cost containment for us -- I mean, this is a wonderful business that, unfortunately, is serving a market that is growing 1% or 2%. So inflation is always going to be more than that, so it has become a way of life that year after year, we've got to find ways of offsetting inflation. And the clearest measure of whether we're successful at cost containment -- it's 1,000 individual small items. The clearest measure of whether we're successful at cost containment and offsetting inflation is happening in the margins. Are they stable or not?

And likewise, as I was suggesting to Mark before, the clearest measure -- we talk a lot about new products. In the end, it comes down to are you preserving your margin and are you preserving your position with critical customers and critical grades. And in a competitive industry like PMC with strong competitors, you can't do that unless you're introducing new products on a regular basis, good new products.

Yes, and then can you just kind of -- why, I guess, was performance so strong with those strategic accounts, or what had changed?

It's not changed, TR, as much as it is continuing firm performance. And so you develop a relationship with a key customer in a key region on a key grade and then you have to perform. And the performance can take the form of product, it can take the form of service, it can take the form of a combination of both. And if you don't perform, your product doesn't do what the papermaker wants or the service isn't what they're looking for, then you wind up losing share with that customer. It really is in the trenches day to day.

Great. And then just lastly, I guess can you just touch a little bit on the pressure on the single-aisle aircraft industry -- Boeing, Airbus, CFM -- and how that affects you guys, and anything in regards to business issues, whether it's hiring or capital spending or any of that stuff?

Well, starting with the Paris Air Show in -- when was that, August -- June of 2011, through Boeing's announcement that they were going to re-engine, everybody in the aircraft industry was surprised by how strong the demand turned out to be for the re-engined single aisle. We may have talked about this before, but going into the Paris Air Show, the expectation was Airbus would get about 500 orders for the year for the Neo, and they came out with more than 1,000. And Boeing has also been reporting very strong demand for their re-engined 737, the Max.

And both companies in response to demand have been very public about increasing their production capability of their single-aisle aircraft in order to meet demand. And what they're not saying publicly but what they really mean is if they don't increase their production, that demand will go elsewhere. It will go to Comac, it will go to Bombardier, and so that's not just lost sales, it's lost share.

So they have been -- so the airlines have been putting pressure on them to increase their capacity to deliver re-engined single aisles, which -- and they in turn are saying, well, we're capable of ramping, but only if our supply chain is ramping. Re-engined aircraft are primary changes on the engine, so when they're saying supply chain, they're really saying their engine manufacturers. So they're putting a lot of pressure, in our case, on CFM to ramp and demonstrate that they can ramp. Well, CFM looks -- says, well, we can ramp, but it's a matter of our supply chain. They look down their supply chain and they see -- while they see a number of suppliers, they see one particularly critical supplier, and that's us.

So you basically go from the airlines to Boeing and Airbus, CFM, to us, and they're all looking at Rochester, New York, and in our ability to ramp -- Rochester, New Hampshire. So it's good news, bad news. It's a lot of -- it's mostly good news but it's putting a lot of pressure on us to execute, which we are ramping up to do and are prepared to do.

Great. Thank you. That does it for me.

Thanks, TR.

Thank you. At this time, we have no additional questions in queue.

Okay, thank you, everyone, for participating on the call. We'll be seeing many of you at investor meetings over the next few months, and we looking forward to talking to you then and answering any questions you have. And if we don't see you, we'll talk to you again after -- on our Q4 earnings call. 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 your conference call today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.