Albany International Corp (AIN) 2012 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. (Operator instructions.)

At the request of Albany International, this conference call on Thursday, May 3, 2012, will be webcast and recorded.

I would now like to turn the conference over to CFO and Treasurer, John Cozzolino, for introductory comments. 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 will turn the call over to Joe Morone, our CEO, who will provide some opening remarks before we go to Q&A. Joe?

Thanks, John. Good morning, everyone.

Well, Q1 2012 was obviously a very disappointing quarter for us as sales in machine clothing, particularly in Europe, were much softer than we had anticipated. And so, what I'd like to do at the beginning of this call, before we get to your Q&A, is discuss what happened in machine clothing in Q1, why we didn't see this coming, and what it means for our outlook.

As we discussed last quarter, we had been expecting a slow seasonal start to the year, and that did indeed occur. In fact, the seasonality was a little more extreme than we were anticipating. But we were also expecting the slow start to be followed by a gradual ramp-up in sales as the quarter progressed. And given the strong order trends right from the start of the quarter and increasing activities in our plants and strong shipments in the back end of the quarter, we kept expecting that ramp-up in sales right through the end of March. But it never materialized. Revenue remained -- stayed soft through the entire quarter.

Now, there were a number of positives in Q1. Let me run through them quickly, and then I'll come back to the weak Q1 sales in machine clothing. So first, just a minute on the positives in Q1. As I mentioned, orders in machine clothing, except for Europe, were strong through the quarter. Our plants were busy in March, and shipments flowing into Q2 from the end of the quarter, and which will be recognized in Q2, were very high, unusually so.

Considering the soft sales, our margins in machine clothing were good. We made good progress on our efforts to strengthen the balance sheet, with large reductions in net debt and pension liability. Net debt declined by $70 million. By the end of this month, our total pension obligation will have been reduced by over $200 million, and the unfunded portion of our remaining pension obligation will have declined to about $30 million.

Yesterday we announced that we've entered into an agreement to sell PrimaLoft for $38 million, which will further strengthen the balance sheet. And as I discussed in some detail in the release, our composites business had a very encouraging quarter, 35% year-over-year growth, operating income break-even, improving productivity, excellent progress toward the LEAP ramp, excellent progress in building up our R&D pipeline, and the potential for annual EBITDA to grow to about $20 million in 2016, which is, of course, the starting point for that LEAP ramp and the inflection point for sales and profitability.

So there were a number of bright spots, but obviously the story in Q1 is the soft sales in machine clothing. So before we go to your questions, I'd like to give you a sense of how we're thinking about the top line in machine clothing and what that Q1 performance means for the rest of the year.

The average revenue per quarter in machine clothing for quarters two through four of last year was $184 million. So going into this year, we thought that this $184 million average was a reasonable benchmark for quarterly sales in machine clothing. Now, we knew we were going to have to deal with seasonal effects, especially in Q1, but excluding seasonal effects, we thought the $184 million average seemed like a good quarterly benchmark.

Well, as we now know, machine clothing sales in Q1 2012 were only $164 million, so $20 million below that quarterly benchmark. We think more than half of the missing $20 million is a matter of seasonality and timing, and should bounce back right away in Q2 and for the rest of the year and beyond. So more than half of the $20 million bounces right back.

But there's another portion of the $20 million, roughly $5 million to $7 million, that's related to weakness in Europe, and that $5 million to $7 million per quarter is probably not going to bounce back. Given the weak and deteriorating European economy, combined with the structural over-capacity in the European paper and paper machine clothing industries, we think that $5 million to $7 million per quarter is probably gone permanently, not just for the rest of this year, but permanently. In other words, that benchmark of $184 million per quarter of machine clothing revenue is more like $178 million per quarter.

Now, we've been talking about over-capacity in Europe for some time, and we had taken it into account in our long-term model of flat to 1% growth in machine clothing. But we've been expecting our sales in Europe to decline gradually over several years rather than all in one quarter. In hindsight, one of the lessons we learned in late 2008 seems to apply directly to our European sales in Q1 2012.

At the front end of a serious recession, which is what appears to be what Europe is heading into, when you're dealing with over-capacity, as we are in the European paper industry, sales dropout in big chunks rather than gradually, and they don't come back. We think that's what just happened to machine clothing sales in Europe in Q1. It hit all at once, and it hit late, and so a quarter that was already being dragged down by an unusually strong seasonal effect was made quite a bit worse by what is probably a more permanent structural effect.

So what does this mean for the rest of the year? $178 million run rate in machine clothing, rather than $184 million, puts us even with Q2 2011 but behind Q3 and Q4, which were at $188 million and $183 million respectively. However, profitability in machine clothing has and should continue to improve as we keep reducing costs and improving productivity. At $178 million run rate, adjusted EBITDA in machine clothing for the rest of this year should be comparable to adjusted EBITDA in machine clothing for Q2 through Q4 of 2011.

So assuming global economic conditions did not deteriorate significantly through the course of the year, our revised target for machine clothing for the rest of the year, that is for Q2 through Q4, is for flat year-over-year adjusted EBITDA, lower sales, but for Q2 through Q4, flat adjusted EBITDA. Now, when you consider the entire company and add the improving performance in AEC and the positive impact of the pension liability reduction, total company adjusted EBITDA for Q2 through Q4 of 2012 should be slightly better than total adjusted EBITDA for Q2 through Q4 of 2011.

As you know, there's a lot more material in the release about Albany engineered composites and the pension liability reduction, but I hope I've given you enough here to give you a clear understanding of how we're viewing Q1 and the outlook for machine clothing.

So I'll stop here, and let's go to your questions. Operator, [Greg]?

(Operator instructions.) Mark Connelly from CLSA.

Couple of things, Joe. Can you talk about PMC regionally outside of Europe and the US? We haven't really heard you talk much about Latin America lately, nor that much about China. And we tend to think of China as a region where your margins are struggling to get up to the level of other regions. Obviously if the other regions come down, it's easier, but just curious if you could give us a bit of a sense what's going on elsewhere.

Okay. Let's start with China, then go to Latin America. China had a very good Q1, and assuming nothing usual happens in the economy in China -- don't know where that came from.

I didn't think my question was that hard.

No, it wasn't. We think China stays strong and keeps growing. And there'll be bounces as the growth rate modulates in China, but we feel positive about China on the top line. Margins in China are actually comparable to a little bit better than margins in Europe. So even though prices are lower, costs are low enough that we don't see any diminution in margin. If anything, we see an improvement in margin as sales from China and Asia replace sales from Europe.

South America has been relatively flat, but orders are very strong and margins are very good. North America is solid. So the weakness we're seeing, if you leave aside the timing and seasonal effects, it really is concentrated in West Europe.

Okay. Okay. And then, just a quick question. With respect to PrimaLoft, can you give us a sense of how certain that sale is? Are there a lot of conditions attached to it, or is it just too early to know for sure?

[Cozz], you want to--?

--Yes, Mark. There really are not a lot of conditions to it. There are typical conditions to closing. But if everything goes as expected, we would expect to close on that transaction by the end of the quarter. So there's a very high probability of closing that transaction.

Okay. And then, just one final question, maybe the harder one. When we see companies making contributions to pension plans, we know that the pension accounting can get just incredibly complex. Can you just give us a sense of how you thought about these contributions in terms of the return on doing this versus doing something else with that capital?

Yes, Mark. Our two primary alternatives were paying down our revolving credit agreement or putting a large amount of proceeds into our pension obligations. The pretax return on paying down the debt at current rates is around 2.5%. And when we look at the pension plan and really taking two key things into consideration, which is the interest charge on the unfunded liability, which is essentially a form of debt, as well as the administrative costs of these plans, we were looking at around a 5% return on the pension plans. So there was a significant economic benefit to putting the money into the plans.

Now, beyond the cash outflows that you've talked about in these next two quarters, is there anything meaningful beyond those two?

There still is pension plans out there. We haven't settled all the liabilities. The obligations, or the total obligations that are out there that Joe talked about go down $200 million, which is a pretty big number. So we're not looking at a lot of cash requirements into those plans, going forward, probably less than $3 million or $4 million per year--.

--Compared to--.

--Compared to close to $18 million to $20 million per year now of required contributions before we started the strategy. So it's a significant reduction and exposure.

Okay. And Sweden, then, is effectively done, and the status of Canada?

Canada, we are in process of fully funding and purchasing annuities for a portion of that plan, about half of that plan.

Half the plan, okay.

And for the US, we have actually, after the end of Q1, towards the end of April, we actually purchased annuities for two-thirds of that population of that plan.

Okay. So we're not -- we are presumably not going to see a lot of additional charges and items related to this after the next quarter. Is that right?

Correct. Q2 we will see the large $100 million-plus charge that will come through in settling those liabilities. And then, after that, we shouldn't have anything, assuming we get the Canadian plan done this quarter as expected.

Okay. And just one last question on composites, and I apologize for asking so many. But we know how lumpy it is for new project approvals to come through, and you've always been good about giving us updates where you can. Is 2012 likely to be a light year for those kind of announcements? I think of 2011 as a pretty heavy year.

Yes. 2011 was the big year for announcing big new programs. What's happening in 2012, in addition to the progress toward the ramp-up of LEAP, is the number of projects that we're building up in our R&D pipeline is growing. They have an impact, positive potential impact on revenue in the second half of the decade, after 2016. We're not able to talk about them yet until our customers talk about them.

It's possible -- that is a fair possibility that, by the time of the Farnborough Air Show, some of our customers will be talking openly, or more openly, about some of the things we're working on. And if they are, then we'll be able to disclose more. But that will be pipeline -- projects in the pipeline that have revenue potential after 2016.

Okay, that's super. Thank you.

Thanks, Mark.

John Franzreb from Sidoti & Company.

Morning, John.

Morning, guys. Firstly, in the press release, you provided some EBITDA guidance on the engineered composite segment, based on what your expectations were by 2016. I'm just wondering if you want to provide a little bit more color on what your thought process is, [maybe] providing it at this point, or any incremental data that made you comfortable with providing that number at this point?

Well, we had been saying that we weren't expecting any improvement in EBITDA in AEC this year because of -- particularly because of one-time charges, and that a year ago we had offered Q2 2012 as a target of hitting $60 million run rate and break-even operating income, and then we backed away from that. We got to that level that we had backed away from earlier in Q1, and so we thought it was significant development and enough of a development that we ought to explain what the implications of hitting that revenue run rate and operating income break-even sooner rather than later. It basically leads us to the conclusion that we're going to see more profitability from this business sooner, and that's why we laid it out.

Great. Great.

As I lay out in the earnings release, there's still the potential for lumpiness here, and we will get some of these charges associated with moving -- new moving costs associated with [providers]. But we think that underlying run rate of about $5 million of EBITDA and $60 million of revenue, that's a good baseline, sustainable.

Good. With regards to Europe, you kind of spent some time earlier about -- we'll call it deteriorating market conditions. I wonder if you could address the competitive landscape against that backdrop, what are you seeing out there. And I guess, as a subset of that, are there any material new contracts that are coming out to bid in the coming year?

Well, there, I believe, is an important contract at the back end of the year with Stora Enso. I'm not quite positive. I'm pretty sure.

But look, we know there's over-capacity in the paper industry. We know there's over-capacity in paper machine clothing. And so we'd expect the competitive environment, the pricing environment, to get worse as the sales environment gets worse. That's one of the reasons we're saying that $5 million to $7 million of revenue, we're assuming that's gone permanently. We're building into that the presumption of declining revenue from both declining volume and growing price pressure there.

There isn't any reason to be optimistic right now about what's going on in Europe, and it's a combination of what looks to us like a bad macroeconomic environment coupled with over-capacity that didn't get taken out in the last recession the way it did get taken out in North America.

Joe, how do you think that resolves itself?

I think the only way it resolves itself, and if I can quote the CEO of UPM, the number one paper maker in Europe, the only way it resolves itself is through consolidation of capacity. And he keeps pounding the drum for the only way the European paper industry gets healthy is if it consolidates, if it shuts down capacity. And he's done his part, he keeps saying. He's waiting for everybody else to do their part.

It's very instructive to compare how International Paper is feeling about itself, having gone through great pain in 2008 and 2009, and how the European paper makers are feeling about themselves, having delayed taking the pain. It feels like it's coming home to roost now.

Okay, and one last question. As you divest operations and you soon generate relatively strong -- or call it healthy cash flows from machine clothing, will there be a point in this process that you'll move away from balance sheet improvement and potentially move into a more acquisitive stance, maybe just kind of broaden the product line again or re-adjust the product line offerings?

Well, so far, what we've -- where we would do the acquisition, and it's pretty clear, we're a two-business company -- where we would do the acquisition is on the composite side. But on the paper machine clothing side, we have such high share that any acquisition, we're going to wind up paying for the acquisition, paying for the consolidation costs associated with the acquisition, and then probably losing share to competitors because our combined share will be so high, our customers will inevitably move some share over. So it doesn't make sense. When you add on top of that flat to 1% growth, you just don't get the return.

So the acquisition activity is almost certainly, if there is any, going to be on the composite side. What we're seeing so far, and we revisit this question repeatedly, is the organic growth opportunities are so significant that -- and they far outweigh anything that we're seeing in attractiveness on the acquisition front. So a strengthening balance sheet, if it's going to get reinvested into composites, will be for -- the way it looks right now, it's more likely to go to organic -- funding organic growth than funding acquisition. Of course, that's always subject to change, but that's how it looks to us today.

I guess just on the -- one last question. Will your R&D spend be going up materially to fund those investments over the next couple years?

Well, it has been going up, and I don't think it will have a material effect on the story, no.

Okay, thank you very much. I'll get back into queue.

Thank you.

(Operator instructions.) Jason Ursaner from CJS Securities.

Good morning.

Morning, [Jay].

Joe, I just want to try and reconcile the scenario that played out in the quarter with what you'd previously talked about with a relatively flat outlook. If Europe hadn't sort of dropped out in one quarter, is there anything that changed about your outlook, given the growth you're seeing in China, the growth in South America? Would it still have been that sort of gradual covering of it if it hadn't come out in the quarter?

Correct. We would be talking about -- the only thing we'd be talking about is timing effects, that we had these strong shipments at the end of the quarter that won't get recognized till next quarter. We had expected them to get recognized in Q1, and we'd be mostly talking about that. There wouldn't be anything structural.

North America looks [just] the way we're expecting. South America does. Asia does. There's obviously ups and downs with the GNP in this industry, but the structural change here is Europe. And it's not -- five years from now, it'll look -- three years from now, Europe will look like what we thought it would look like. It just all came out in one quarter. That's how it's looking to us, right now.

Got it. Assuming that the seasonal and timing effects, taking that out as sort of a Q1 blip, if we just concentrate on Europe, the permanent part, I guess you'd been talking about over-capacity for a long time, and no one really seemed to care because demand had been pretty flat. As demand softened, and now you see these shut-downs, assuming that they are permanent capacity reductions, is production matching demand at the current level, or is there still an over-capacity issue?

Well, we have been -- I think we've mentioned, and we've been thinking that over-capacity in Europe in paper is about 15%, and $5 million to $6 million per quarter is about 15%. Now, there'll still be those sectoral trends with printing and writing declining every year offset somewhat, but we think this chunk is a pretty good reflection of what the over-capacity was.

Okay. And, I mean, can you talk any more about share in the region, how your customers may be different than what some of the other customers are doing, and the grades that you're most tied to in the region still?

Well, I don't want to talk too much about share, but our thinking is very clear. There will be winners and losers in any industry consolidation, and our strategy for the past five years is to try to align ourselves with the companies and the machines that are the long-term survivors in the industry. So the highest speed, most modern machines in Europe, they're not going to go away. The ones that will get shuttered in the consolidation will be the less efficient machines.

So we've been working very deliberately to strengthen our position on the machines that are going to survive. And that's where we're able to differentiate ourselves on product and service, and that's where there's less likely to be a commoditization of commodity-like pricing of paper machine clothing.

Okay. And on the cost side, you mentioned pretty solid margins still in the machine clothing segment. Were you still selling out of inventory at all as you came out of the shutdown from December, or had the shutdown really matched -- gotten your inventory to where it needed to be for utilization in the quarter?

Jason, this is John. A lot of the sales now, and a growing percent we would call make and ship, so they're manufactured and shipped and recognized during the quarter. So there was certainly a large piece of that. There is still inventory -- there's still inventory that was also sold during the quarter that was made in a previous quarter. And I think the indication to us, though, with the margins holding firm, even with that level of decline in sales to us is indicative of just the continuation of the improved cost structure that we have in that business.

Okay. And on composites, you got asked a little bit about R&D, and you mentioned the strong pipeline for after 2016. Is there anything you could add about -- will there be different capital requirements sort of on the out-programs later in the decade where you don't have the process as set as you do already on some of the LEAP-X and some of the other shorter-term ones? And then, is there also anything you could add on the programs in terms of where it is? Is it still -- is it coming from the private sector or public sector? You mentioned Farnborough. Is it still aerospace, or are these other applications?

Yes. We've been pretty consistent about saying that our expectation is total CapEx for the Company for the next five years, which includes the ramp for LEAP, the new plants for LEAP, will be at or slightly below, on average, amortization and depreciation. So that has not changed, and that's -- as we get closer to the LEAP, those numbers are still holding firm.

So now, if we're on a new program, or if there are enhancements to existing program that require more productive capacity, that would lead to both an increase in capital spending and an increase in revenue and income. The capital spending does not lag the revenue and income by that much. We start loading up -- start equipping the plant, production starts pretty shortly thereafter.

So yes, there is the potential for a requirement for more capital spending as some of these new programs, and enhancements to programs, turn into new revenue potential. We don't see anything immediately. Our estimate for capital spending for the next four to five years, we're not adjusting at this point. If we did, it would mean that we'd be adjusting our revenue and income potential upward.

Okay. Okay, appreciate all the commentary. Thanks.

Rick D'Auteuil from Columbia Management.

Good morning, Rick.

Good morning. Just a couple of -- so on the composites, just following through on that, the little more bullish tone, can you get into the granularity on what the upgrade to your thoughts are, both on the $60 million and $5 million in EBITDA sooner rather than later? What specifically contributed there?

Revenue is hitting sooner. Productivity is improving. And the current run rate -- what was interesting about Q1 is you saw the run rate without these one-time charges that we think we're going to get, so it was a unique snapshot, and that's why we thought it was worth talking about it. So at this run rate, we've been loading up on fixed costs as we're essentially creating an additional layer of organizational infrastructure, because we know this big ramp in revenue is coming.

So if this is the run rate at this level of revenue, this run rate of EBITDA, that profitability should improve, so that EBITDA should grow faster substantially than sales growth from here on, because the amount of investment we're making in fixed cost is going to decline as a percentage of every incremental piece of revenue.

So this is a good snapshot of what our profit potential is at this level of sales, and as sales nearly double over the next four years, we'd expect EBITDA to quadruple. Always remember that, in this kind of a young business, there'll be some volatility with those one-timers every once in a while. But yes, that run rate is -- we're pulling it in, it's coming sooner than we thought, (inaudible).

And is it -- is this New Hampshire business, or where was your acquisition? Was it Texas?

Yes. Well, the productivity in Texas is definitely improving, and the revenue especially in Rochester is definitely increasing. So you take the combination of both of those, and again, at some point a slowing down in the increase in fixed cost, and that puts us in a better place sooner than we were anticipating.

And then--.

--But always with that caveat, Rick, that it'll be choppy for a few quarters, (inaudible) choppy.

On the revenue side?

No, more on the cost side because of one-timers.

Okay, that's my sort of -- my second question. The reference to charges on the composite side?

Well, here's what we know and here's what we don't know. What we know is we are recruiting people from all over the country, and they are senior engineers, managers of quality, heads of operations, and virtually all of their houses are under water. And so, in order to recruit them, we put together relocation packages, and the relocation packages will include help with their houses. That's the only way we can recruit them. So, after they sell their houses, we'll help them with the real estate charges, or the closing costs, or something like that.

And so, we know those are coming, and we think it's somewhere between $1.5 million and $2 million. It's not quite as high as we thought it was going to be because we've been more successful recruiting locally than we thought we'd be. But there is a known $1.5 million to $2 million of relocation costs that are still to come. Even though some of the people are already here, they haven't sold their house yet, so we don't know exactly what that support for them will be.

The unknown one-timer that's more of a generalized caveat, any time you're in a business -- an aerospace business with a lot of program development, sometimes those programs get canceled, or you're not successful in developing the program, and then you've got to write off that program investment. We had about $2 million of write-offs, or $1.5 to $2 million of program write-offs at the last recession when investments in R&D we were making in developing parts for jets for business -- engines for business jets. Those business jets and those engine programs got canceled, so we had to write off that program investment. That's always lingering out there, and right now we don't see anything on the horizon, but it's always there, at least until we're large enough that those write-offs then are in the noise, and you don't see them.

Okay. Thank you.

Thanks, Rick.

John Franzreb from Sidoti & Company.

Actually, Rick picked off a lot of my follow-ups. The $1.5 million to $2 million, that's a total gross number? That's not on a quarterly basis, just to clarify real quickly?

Yes. Yes. I think, if you assume $1.5 million a quarter for the next three to four quarters, that's a pretty good assumption.

Perfect. And when are you going to break ground on the new facility, Joe?

The ground is broken.

It is? Okay. How far along are we in the process, then?

I think by this time next year, the building will be complete and we will start equipping the building.

All right, that's all I got. Thank you.

Okay. Thanks, John.

And at this time, there are no further questions.

Okay. Thank you, everyone, and we'll do our best to be in touch with you during the quarter. And if not, we'll talk to you next quarter. Thank you for participating in this call.

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 for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.