Albany International Corp (AIN) 2011 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the fourth 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, and instructions will be given at that time. At the request of Albany International, this conference call, on Thursday, February 9, 2012, will be webcast and recorded.

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

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.

Good morning, everyone. Let me add my welcome to all of you. Thank you for joining us. As has become our custom, I'll start with a few introductory comments to give all of you a feel for how we think about this quarter, and also for how we think about our outlook. Then we'll go to your questions.

If you set aside the effects of the sale of the Doors business, Q4 2011 is, on the surface, a pretty simple quarter. That seasonal weakness in PMC that we had been expecting was offset by good performance in AEC and PrimaLoft. The overall result is flat year-over-year performance. So, if you exclude the discontinued operations, currency effects, restructuring, and the gain on that building we sold last year, EBITDA in Q4 '11 is essentially the same as EBITDA in Q4 '10 -- $32.3 million this year, excluding Doors, and $32.6 million last year, excluding Doors.

Now, to properly assess this quarter and what it tells you about our outlook, we think it's important to focus on five factors in particular. First, there's the accounting treatment of the Doors transaction. Many of you will recall that the Doors business was centered in Germany, still is, and a good fraction of its profits are generated there. Without the Doors business, our ability to generate future profit in Germany will be significantly reduced. That's why we recorded in Q4 a large reserve against deferred tax assets in Germany, and that is what creates the loss in overall Company net income in Q4. Since the sale did not actually close until January, the gain from the sale, which will be considerably larger than that reserve, will not be recorded until Q1. So, we'll see the opposite effect next quarter -- Q1 net income will be inflated by the gain from the sale.

That brings us to issue number two, and in our minds, the real story in Q4, which is the seasonality in PMC. If you go back a year, Q4 2010 and Q1 2011, the paper industry was at a very different stage in the business cycle than it is today. Up and down the supply chain, the industry was restocking. Our backlogs and delivery times were abnormally high, and we were running our plants at high rates right through the quarter. But this year, by Q4 2011, the industry was well past the restocking phase of the business cycle, and if anything, parts of the industry were destocking toward the end of the year. We responded accordingly, with production slowdowns in December culminating in plant shutdowns at the end of the month. The effect of this slowdown was most pronounced on our gross margins. If you look at October and November, our margins were among the strongest of the year. In December, they were sharply lower, and well below the PMC average.

We'll see a similar set of comparisons in Q1 2012. A slowdown at the end of Q4 means a slow start at the beginning of Q1, whereas a year earlier, the strong finish to the year flowed into an unusually strong January. So, it's unlikely that PMC performance in Q1 2012 will compare favorably to PMC performance in Q1 2011. On the other hand, orders did strengthen this January. We are expecting performance to strengthen as the quarter and year progresses, and we continue to expect full-year PMC performance in 2012 to be in line with full-year PMC performance in 2011.

The third important factor this quarter was AEC, which, along with PrimaLoft, performed well. AEC grew 20% year-over-year in Q4, and was EBITDA-positive. For 2012, we expect AEC to grow more than 20%, while EBITDA will remain roughly constant with 2011 at a little above break-even because of those heavy one-time expenses associated with intense hiring. But growth we'll see, probably more than 20%. As discussed in the release, we view 2012 as pivotal to the ramp of the LEAP program, and we are working closely and effectively with our customer, the Safran Group, to execute on that ramp.

Fourth, we've now completed the integration of Engineered Fabrics and Paper Machine Clothing, and beginning with Q1 2012, we will present combined results for this now-unified business. And we continue to expect, by mid-2013, about $15 million in incremental EBITDA from the synergies created by this business.

Turning to the fifth factor of significance in this release, now that the sale of Doors has closed, we are finalizing our plan to use the proceeds to aggressively strengthen our balance sheet. In John's commentary in the release, he lays out in considerable detail how we plan to invest the proceeds to significantly reduce our pension liabilities, as well as our long-term debt. Our goal is to have this plan completely implemented by the end of Q2, which means that we should see the full impact on income, cash flow, and the balance sheet beginning in Q3.

Now, these five factors together -- the accounting treatment of the Doors transaction; seasonality in PMC; strong performance in AEC and PrimaLoft; the integration of PMC and EF; and the plan for investing the proceeds of the sale by mid-year, all of those together lead us to the following outlook. For 2012, excluding the Q1 gain from the sale of Doors, and the Q2 charge associated with the pension liability reduction plan, we expect modest improvement in year-over-year performance. EBITDA from PMC and AEC are likely to be flat in 2012 compared to 2011. So, the improvement will come primarily from the impact of our plan to reduce pension liability, along with continued growth in PrimaLoft.

For 2013, we expect stronger year-over-year improvement in performance, driven primarily by the synergies from the merger of PMC and EF, coupled with a full year of reduced pension expanses. And for 2014 and beyond, we expect continued improvements in year-over-year performance to be driven by AEC, as growth in its EBITDA begins to contribute to overall Company performance. For the entire period -- 2012, 2013, and 2014 and beyond, we expect continued strong generation of excess cash, particularly with the substantially lower requirements for contribution to our pension plans. So, that's how we look at this quarter -- five factors together laying out the outlook.

And what we'll do now is turn to your questions. Thank you. Operator?

(Operator Instructions) Jason Ursaner, CJS Securities.

In PMC, was the magnitude and speed of the slowdown at the end of the year in paper production a little bigger and faster than you expected? And was your decline in PMC, did it match production or was there an additional hit from customers reducing inventory?

I think it was pretty much what we expected. It's hard to say. We weren't particularly surprised. It followed along the patterns we were expecting. We were expecting it to be more of a slowdown in North America, and that's really what occurred. I think the important point here is, the critical point to sort through is, is it a seasonal slowdown or is it a structural reduction? If it's a seasonal slowdown, then take the time off at the end of December as your customers are doing the same thing. If it's a structural slowdown, then you have to be a lot more aggressive, and you have to start reducing employment and downsizing to match so that permanent capacity is going to match up with permanent demand.

So, in our view, everything we were seeing structurally was telling us -- everything we were seeing with our customers and in the marketplace were telling us this was a seasonal slowdown. We're seeing shorter order cycles, customers coming out of the recession, up and down the supply chain, everybody coming out of the recession is much more disciplined about managing inventory, which leads to shorter order cycles. All of it said to us, there wasn't anything fundamental changing in the market or deviating from our view of this market, which is, over time, flat to 1%.

Okay. And I guess, because of the temporary slowdown, how big an impact did selling out of inventory have on margin in the quarter, do you think?

The easiest way to think about this is, if you look at the difference between -- you can either take Q3, Q4, or Q4 last year to Q4 this year, and if you look at the difference in sales, let's go Q4 to Q4. The difference in sales is about, once you take currency into account, is about $3 million. As we've always said, about $1.5 million of that drops through. The delta in EBITDA was about $4 million. So, about $1.5 million of it is accounted for by the drop in sales, and the rest, in our minds, is accounted for by the difference in margin. That margin difference is really a hot December in Q4 2010 versus a weak, soft December in Q4 2011. So, the margin effect is on the order of $2.5 million.

Really, the way to sort this out very simply is go Q4 against Q4. Control for things like currency and restructuring, and you get a $4 million delta in EBITDA, most of it is the difference between running hot and running soft margins, and a little bit of it is sales.

Okay. And you mentioned it continuing into January. Did it also begin to spread to Asia with the lunar new year being early? How big a hole do you think you're starting Q1 in, given the tough comp?

The normal seasonal effect in Q1 is all in January, just as in Q4 it's in December. There are two components of the seasonal effect in January. One is just the soft start because there are fewer shipments coming into the quarter from December, but the second is the Chinese new year. As China becomes a bigger part of our overall sales mix, that seasonal effect becomes more important. Whenever it comes, it's going to come in the first quarter, so it came a little earlier this time. That is a big contributor to a seasonal effect in Q1. By the time we wash through those, our expectation is, we're back to the normal range in PMC, which, as we say, year-over-year, figure flat to 1%.

So, the overall performance for being pretty flat, given the currency headwinds you are going to have to overcome in Q2, Q3, wouldn't the industry need to show much stronger growth than that 1%, 2% growth in the second half to get you there?

As you know, we always try to control for currency. We do control for currency. We try to make that clear in our releases, because you can't get to the structural trends and the long-term sales patterns unless you control for that, because the fluctuations are just wild.

So, if you leave that aside, we think what reasserts itself is growth in China, sideways moving into the Americas, coupled with over-capacity in Europe. Even though consumption of paper and demand for paper in Europe will be relatively flat, if there's over-capacity in the paper industry, there will be a reduction in the number of machines that need to be [clothed]. You add all those together and you get, in our models, flat to 1% in PMC. Then you've got a rise of the seasonal fluctuations to see that.

Last question for me. You talk a lot about normalized EBITDA at certain sales levels, and that incremental EBITDA. So, if you look at this quarter as if it were a mid-2013 quarter, with Doors out, the utilization issue of PMC out, maybe EF having a little bit better margin given the revenue level there, you add in some of the synergies from PMC and EF, should be around $3 million to $4 million a quarter, and then the pretax benefit from pension. Is the right way to think about a run rate more in that $40 million range still, at this level of sales as you look out a couple years?

Yes, if you get out to the middle of 2013, I think that's about right. I think you did the math fast, but I think that's basically right. If you take roughly $9 million EBITDA, factor $10 million net income effect from the investment of the proceeds of the sale, and then on the order of $15 million of synergies, so that's $25 million. Divide that by $4 million. Right, you're in the ballpark.

Appreciate the commentary. Thanks a lot, Joe.

Mark Connelly, CLSA.

Good morning, this is Tom Knott on for Mark. On PMC, can you just talk a little bit about what you're seeing on the input cost side? I think last quarter you talked a little bit about building inventories of raw materials, and just how the costs trended since last quarter and how are they looking in the first quarter of 2012?

You can almost predict it by just looking at the paper business cycle, which I know you guys do a lot of. When the whole supply chain was restocking, we were very concerned about inflation. All the indicators were tight supply for our raw materials with inflationary pressures driven by oil. Then as the economy softened, as the outlook softened, as the business cycle matured a bit, those pressures started to ease. As we start seeing in 2012, as we get economic recovery on the pace that we're seeing, coupled with slow growth in energy prices, then we'll start seeing incremental pressure on inflation. But it really is not the factor it was a year ago. It was a real concern a year ago; right now it's not.

Okay, that's helpful.

Don't forget, on the labor side, while there isn't much inflationary pressure in North America, there is in our growth markets. In South America and in Asia, we've got very real inflationary pressures. That's our challenge, is to offset that year-over-year, given a business that's flat to 1%.

Okay. On engineer composites, I want to switch over to that. Can you add some more color on the additional R&D spending in the quarter, and then just the hiring plans you have for 2012? I guess with R&D, should we expect spending to remain at these levels? And then on hiring, should you be able to fully staff the business this year, or will hiring continue steadily into 2013 as orders continue to ramp?

I think the Q4 rate of R&D spending as a percent of sales in AEC is probably a pretty good baseline for now. The hiring -- one way of thinking about this is, as we ramp, we're building up our infrastructure, which is really saying we're building up our fixed-costs. You reach a level of fixed-costs where you then start getting some economies of scale for a certain rate of growth before you start having to add another layer of fixed-costs. So, it's hard to envision, while there will continue to be, after this year, pressure to hire, it's hard to envision that the pressure will be as intense on the hiring that's really more of business and engineering infrastructure hiring. Head of operations, for example, plant managers, planners. Then, the hiring, as the plants come online, the hiring will be much more people in the plant than it will be essentially the overhead infrastructure.

Thanks. That's all from me.

John Franzreb, Sidoti & Company.

I guess I want to start with the demand profile coming out of January. You had a structural pullback in demand in December. We had Chinese new year. You alluded to the fact it was strong coming into January. Are we at a supply/demand equilibrium at this point, Joe, or is that further down the timeline?

Supply/demand equilibrium in PMC?

PMC, yes.

Assuming nothing unexpected happens in China, and everybody comes back from the new year holiday, and it's back to the same China we saw before the holiday with 7.5%, 8% growth, then yes, we think we're lined up. If we didn't think we were lined up, then instead of us -- that's what I was suggesting before that instead of taking temporary shutdown around the holidays, we would have been downsizing or upsizing, and we weren't doing either of those. So, yes, we think we're pretty much in alignment.

Are your concerns in China, last quarter you mentioned there were some products that had over-capacity. Is that what your concern is in China, or is there something that is above and beyond that?

No concern in China right now. If you look at the sales patterns in Q4, China did very well again. So, there's nothing untoward that we see going on. But we know with certainty that there's over-capacity in the paper industry in Europe, and we've got quite a bit of visibility into the capacity patterns in North America. Coming out of the recession, the industry did a lot of what it needed to do to position itself for the long haul.

So, the wild ride continues to be in China, where there's so much growth. The only thing that could upset the long-term apple cart of flat to 1% is if something untoward happened in China. We're not seeing the signs of that.

Fair enough. The AEC you called out as a driver of revenue growth in 2012, could you elaborate a little bit on that?

Well, I'd say if you take our biggest programs -- LEAP will grow substantially in 2012. No surprise there, as our development activities associated with maturing the product and our processes to the point where we can start producing, as those intensify, so that will drive growth.

Our second-biggest program is the landing brace, for the 787, which slowed significantly in the second half of 2011. That will start ramping back in 2012. Our production will not be that far off from Boeing's announced schedule. They're hoping to ramp from about two planes per month at the beginning of the year, to five planes per month by the end of the year. That's what we'll see in our production, from on the order of two ships at the month at the beginning of the year, to on the order of five at the end of the month. So, you'll see growth there.

The work we're doing on the Joint Strike Fighter, on the lift fan for the Joint Strike Fighter for Rolls-Royce, that will ramp during the year to meet the production schedules for the Stovall version of the Joint Strike Fighter. So, if you just take those three as our biggest programs, each of them, if we execute, will show significant growth in 2012 over 2011.

Perfect. In your press release, you mentioned several critical product and design test milestones that will be reached this year. What's the timeline for that? And if you'd be willing to share what those design milestones are in particular? Or if not, I'm fine either way.

I would say stay tuned for any CFM or Safran make about tests that they're running for the LEAP engine, but we have to produce parts for those tests. Those parts need to meet quality standards. So, as they freeze the design, we need to freeze our production processes, and then make enough parts so that they are able to test the engine. So, that's what I was alluding to.

Those are very useful milestones for checking whether you're ramping at the rate that your customer wants you to ramp. We'll keep reporting that along the quarter, but there's not going to be any earth-shattering or singular moments that will tell you -- yes, everything is on track, or no, it's not. It will be quarter-by-quarter, we'll continue to report progress.

Your cap budget seems to be ticking down again from your previous expectations last quarter. Is that a function of anything in particular?

No. I think that was timing. We'll see a ramp. We'll certainly see a ramp in 2012. We'll probably be up [to] about $50 million in 2012. That will be a combination of a ramp-up in investment in PMC, coupled with a ramp in AEC. No surprise there, there's actually no surprise anywhere. But we'll see a gradual increase in our CapEx budgets toward that $70 million mark over the next few years.

Thank you very much, Joe.

(Operator Instructions) Rick D'Auteuil, Columbia Management.

On the PMC side, are there any large customer negotiations scheduled for 2012?

There may be one in Europe at the end of 2012. We'll be sure to provide clarity on that in Q1, but I'll need to check that. I think there is one in Europe in 2012. Prices have been -- I know that's what you're really getting at is, prices have been stable, our prices have been stable, continue to be stable over the past few quarters.

So, the industry dynamics are also stable? In other words, the competitive universe hasn't changed in any material way in the last 12 months?

No, they really haven't. I'd say the one significant announcement that you might hear about on Xerium's call is that the CEO of Xerium, Stephen Light, is stepping down by the end of the year, so there will be a transition there. That can always create some instability if a new person comes in with new ideas. But that's really the only notable change in the competitive dynamics in the industry. So, it's been fairly stable.

Okay. On the consolidation of Engineered Fabrics and PMC, I think you've said it's going to generate $15 million in EBITDA starting, is it next year?

Our goal is to try to achieve those kinds of synergies by the middle of next year.

Okay. What was the cost of executing the restructuring to position it for that? What was the aggregate cost?

Well, all we've really talked about is a couple of small plant moves in North America in Q4 and Q3. Those costs were the primary contributors to the restructuring charges that we had in Q3 and Q4.

So, is there more to come? I guess I'm a little confused.

Well, what we've said is, we're still formulating our plans. And in Q1 and Q2, we'll provide more clarity as those plans get fully formulated; we'll provide clarity on what, if any, additional costs we would have.

We've owned you, as you know, for a long time, and it's essentially been a permanent restructuring play. Is there a point when you think the coast will be clear, and we'll be able to read a release and not have to decipher 50 accounting issues? I don't mean that in a -- I'm just curious if you think -- is this always going to be the case? Or do you think we're going to get to the point where, post this consolidation, as your AEC starts to ramp up, you've eliminated one division, and there's maybe another non-core business in the portfolio -- as we put that behind us, do you think we'll have clean quarters?

We did have a few. (laughter) We had one moment in time I think where we had a clean quarter. I doubt you would be asking this question if we hadn't sold the Doors business. I think we would be in a mode that I think you'd be a lot more comfortable with. But the Doors transaction created a number of spin-off effects, and a number of accounting effects. And if you just think about the ones I mentioned.

So, the valuation reserve this quarter is purely a function of the Doors sale. The big gain we're going to get next quarter is purely a function of the Doors sale. The charge we'll get around the pension plan in Q2 was also a function of the Doors transaction, because we wouldn't be making this big move on our balance sheet if we didn't have the proceeds from the Doors sale. So, that's really what is muddying the waters, and will for the next couple of quarters, which is why we tried so overtly to map them out in the release, which, of course, turns the release into a tome. So, I feel your pain, Rick.

So, a year from now, is there anything that -- on the restructuring front, will that be largely behind us? I guess currency will be a continuing call-out, but other than currency?

Right, should be it.

Okay. I know you've given us some guidance for this year, but where would you expect the operating cash flow to come out?

Well, if you just do back-of-the-envelope math, so this isn't guidance, this is just giving you a way to think about it the way we think about it. Let's say it's three years from now, and we're running at -- Cap Ex is at amortization and depreciation. So, we're heavy into equipping our composite plans. We're continuing to reinvest in PMC, and our CapEx has gone up to about $70 million. Let's assume, just for the sake of simplicity, that EBITDA's roughly where it was in 2011. So, that's about $160 million of EBITDA. Subtract $70 million of CapEx, and then subtract $15 million for -- first approximation, $15 million for dividends, $15 million for taxes, $15 million for interest. That leaves you about $45 million of excess cash. So, that's about $1.50 per share of excess cash. That's, rough terms, how we think about it.

So, was that three years from now, or is that --?

I'm saying if you take 2011 EBITDA, and assume we are spending at a much higher tax rate, that's what you'd get.

Okay. But you're going to underspend depreciation and amortization --?

In 2012.

In 2012. Okay.

It'll be creeping up, and we will creep it up. I think the investments, the CapEx rate in PMC that we'll see in 2012 is probably fairly representative of what we'll see in the long-term. What will change is the AEC will ramp up, investment will ramp up as we equip those plants.

Prior to that ramp, is there anything near-term more that can be done on working capital, or do you think you're at a stable level there?

Getting greedy. If there is more, it'll be small.

Okay. I appreciate the answers.

Jason Ursaner, CJS Securities.

Can you quickly go through what's driving PrimaLoft, and what you think the long-term strategy for that business is?

Well, it had a great quarter, and if you look at the historical pattern in PrimaLoft, Q4 is usually very soft. We used to say, up until last year, if we do better than break-even in Q4, we're very happy. The performance, the growth right now is being driven by very strong performance in Europe, in particular in outerwear, that is an insulation for outerwear. What appears to have happened is that the order cycle, order and sales cycle in PrimaLoft just seems to have been permanently moved forward by a matter of weeks, eight weeks or so. Because everybody is ordering sooner because the capacity to make outerwear, for our market, in Asia is very tight. So, retailers like North Face are placing their orders sooner in order to make sure they've got enough capacity than they used to. So, the normal cycle would have had some of these sales that showed up at the end of Q4, show up in Q1. But everything has moved forward, so Q4 of this year was strong, but we continue to expect Q1 in 2012 to be strong.

Next year, if this new seasonal pattern holds, is the warm winter in the US going to have a major impact on inventory?

The way to think about it is as follows -- think retail. Let's take L.L. Bean, for example. So, there's a warm winter, so L.L. Bean has lower sales in Q1. If that then leads them to have lower orders for the following season because they have a lot of inventory remaining, then PrimaLoft sales would get hurt in the back end of 2012. If on the other hand, L.L. Bean and its competitors decide to run big sales to move the inventory, which is what happened last time something like this occurred during the recession, then they are going to have to reorder and restock.

So, a cold winter drives their sales, which makes reorders by them pretty predictable. A warm winter means they have lower sales, and then the question becomes -- what's their retail strategy going to be? Are they going to try to move the inventory hard with big discounts, in which case we'll get orders for the following season, as if it had been a cold winter. A warm winter can lead to downward pressure on sales and orders for next year.

And where PrimaLoft fits into the overall portfolio of Albany, is there the opportunity with yarn to really make it into something big longer-term, or is it still non-core?

We really like this business, and yarn is a significant part of its future. But on the other hand, we've also said our two core businesses are PMC and AEC. There'll always be a price where it makes more sense for a strategic buyer to grab PrimaLoft than for us to hold it. But, we like this business. You look at Q4 performance, and you can understand why we like it.

Last question, is there any update on the nozzle program at AEC, any key milestones on that?

There'll be a ground test this year. Flight test, I think it's for a 787 currently, is what FAA is saying, FAA and Boeing are saying, next year. There's public information on this if you Google CLEEN program and FAA, there are public disclosures about this program.

Okay. Great. Thanks a lot.

At this time, there are no further questions in queue. Please continue.

Thank you, everyone, for participating on this call. John and I will look forward to meeting you and talking to you over the course of the quarter, and if we don't, talk to you next quarter. Thank you.

Ladies and gentlemen, a replay of this conference 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 the AT&T Executive Teleconference service. You may now disconnect.