Albany International Corp (AIN) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter earnings call of Albany International. (Operator Instructions).

At the request of Albany International, this conference call on Thursday, August 2, 2012, 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, 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 Chief Executive Officer, who will provide some opening remarks before we go to Q&A. Joe?

Thank you, John. Good morning everyone. Let me add my welcome to John and as always, I'll make a few opening comments and then we'll go right to your questions.

Q2 was an excellent quarter despite the economic uncertainties with adjusted EBITDA growing to $40 million compared to $31 million a year ago and $26 million last quarter.

In Machine Clothing, our sales came in pretty much as expected. We had suggested in Q1 that we thought we would see a bounce back in Q2 revenues except in Europe and that's precisely what happened. America's held firm, Asia held firm and West Europe weakened a little bit more dropping below the already weak Q1 levels.

Our margins in Machine Clothing were very strong despite the serious overcapacity issues in Europe. [What narrowly] gross margins in Machine Clothing range from 42% to 44%. Because of strong plant utilization in the Americas and favorable product mix. we came in at the high end of that range.

AEC also performed as expected. Sales and EBITDA grew sharply compared to last year and were consistent with Q1 2012 performance. The LEAP program ramp continue to progress very well and on the commercial front, total orders in hand for the LEAP engine norm numbered nearly 4000. At the recent Farnborough Air Show, at which Albany received a good deal of media attention, CFM disclosed that it expects our production to hit 32,000 fan blades per year by 2019, at 18 blades per engine that translates to nearly 1800 ship sets per year, rather than the 1500 we have been assuming.

At the same time, the pipeline of new product possibilities continues to strengthen the potential for additional content on LEAP both on initial and future versions continues to grow, and the potential for new products outside of LEAP also continues to grow. To take one prominent example, Boeing has scheduled for this quarter a new ground test for the advanced engine nozzle that they are developing. The nozzle uses our ceramic matrix composite substructures.

The other highlight of the quarter was the completion of the sale of PrimaLoft and of our debt and pension liability reduction efforts. To summarize the impact, our net debt at the end of 2012 (sic--2011 per later comment) was about $260 million. Today, it is about a $180 million. Our total unfunded pension liability at the end of 2012 was $100 million. Today, it is about $30 million. So net debt from $260 million to $180 million, unfunded pension liability from $100 million to $30 million, that's between end of 2011 and end of Q2. So in sum, our balance sheet is now in great shape.

As for our outlook, obviously, it hinges on the help of the economy, especially the European economy. Our expectation, given everything we see today, is that adjusted EBITDA for the overall company for the second half of the year should be roughly comparable to adjusted EBITDA for the second half of 2011.

Now, this outlook is based on the following assumptions. First and most importantly, it assumes that the economies in the Americas and Asia hold firm. Second, it assumes some further deterioration in the European economy and paper industry. Third, it assumes the gross profit margin for Machine Clothing, which as I mentioned reached the high end of our normal range in Q2, will regress toward the mean. And one final assumption. You'll see in the discussion of SPG and our in the earnings release that there was a $1.5 million favorable impact in Q2 from normal adjustments to incentive compensation and other accruals.

Our outlook assumes the absence of such favorable impacts in the second half of the year. But the key assumptions, Asia and the Americas hold, Europe continues to deteriorate. So in sum, what we see is very good performance in both businesses in Q2 except for Europe, with an outlook for similar performance in the second half of the year again, except for Europe.

So let's -- let me stop with that and turn to your questions. Operator?

(Operator Instructions). And our first question comes from the line of John Franzreb from Sidoti & Company. Please go ahead.

Good morning, John.

Good morning, John.

Don't you just hate when they put out [delayed] forecasts that are higher than yours?

(Laughter.) Go ahead.

I guess, I want to stop right there. Could you talk a little bit about your scheduling and what kind of may be, high water marks we should look for in the year ahead for you as far as production ramps? What kind of targets you are looking for as far on the hiring front? Things of that nature that maybe through the balance of this year and into early next year that we should be visibly identifying to measure your progress.

John, I think that the dominant variable to monitor is the macroeconomic variables more than any internal announcements we'd be making. So, first and foremost, keep your eye on Europe and I'll tell you where to keep your eye on. Europe historically, every year as it comes out of the summer shutdowns, there is a typically, in our industry a big surge in orders and sales in September. If not September, then October. We are watching very carefully to see if we get a normal surge this September or October or whether because of the economy there, that surge is seriously muted. That will have a big impact on the second half of the year and also we are thinking about what 2013 looks like.

There are several important contracts in paper Machine Clothing in Europe that will be negotiated in that same timeframes, September, October, November. So we'll be watching those really carefully. But again, in many ways there, they'll be heavily influenced by the economic outlook as well. So to us, it's those macroeconomic variables that are really -- for us and everybody else, I'm sure -- that are really the big swinger in our outlook and they'll dictate whether we are being too conservative or too optimistic in our outlook.

Okay, I'm sorry. My real question is actually directed towards -- development. That's what's I was kind of looking for what kind of near term production or development targets are, where are you in that timeline is really what I was looking for? Let's put that aside, John, and stick with what you are talking about right now.

All right.

So given that outlook is that why your gross margin expectation has been dropped from being the above 44% threshold to that lower -- that mid-range -- is that the primary driver there?

No, we are just assuming a normal -- we are just assuming regression towards, I mean, normal variability that is -- what we are -- there is always, for a variety of reasons, there will be some fluctuation within the normal range in gross margin, and we just think it's statistically improbable that you'll always stay at the high end of that range. If we stay at the high end of that range, that means our range has changed and we are not prepared to say that yet.

Okay. So the current volumes don't support that kind of a mix or margin profile?

Let's try to do a number this way. Let's assume we had the identical sales profile. And so, start with the $40.5 million of adjusted EBITDA we had this quarter, take out $1.5 million of those normal incentive compensation accruals.

That's right. Right.

So now you're at $39.0 million, $38.5 million. It's statistically -- we think it's more likely that gross margins will fall back to the normal range of 43%, 42.5%, 43%. So that would take the $38.5 million, $39.0 million of adjusted EBITDA down another $2 million or so. So now you're in the $36 million range. And that's still above the average for the second half of last year, but then we're putting in an assumption that there is further deterioration in the European paper industry because of deterioration in the European economy. And that accounts for another $1 million to $2 million of EBITDA.

Okay.

So that's how we do the math.

Yes. I got you. And last one -- one last question, just then let somebody get in. How much more rebalancing of the pension remains based on your current cash position? How much more is left to be done?

John, we're looking now at about -- as Joe mentioned, we're looking at an under-funded position of about $30 million.

All right.

So there are parts of our US plan, of our Canadian plan that still remain and are ongoing. We don't have plans really to look at that in the near future. We also have a couple plans outside the US that also carry some of that liability. So I think right now for the stage that we've talked about, we're pretty much done. We'll keep looking for opportunities in the future, but that would be over the next few years that we'll continue to monitor it. So I would say based on the plan that we've outlined, we're done.

Okay. Great. That's very helpful. Thank you very much.

We'll come back to your lead question, John, once you get back in queue.

And our next question comes from the line of Jason Ursaner with CJS Securities. Please go ahead.

Good morning.

Good morning, Jason.

Congratulations on a very strong quarter, completion of the various sales, pension stuff. It should be a lot simpler going through these releases going forward hopefully.

Let us hope. We think so too.

Just first on machine clothing, I want to I guess try and dig a little deeper on the gross margin there. Are you saying it's more mix in new products and holding your cost where it could be sustainable but conservatively you're assuming its regression, or did it have more to do with the extra sales that kind of slid out of the weak Q1 due to timing or it was more just utilization benefit that you're fairly sure you don't see that every quarter?

Well, the gross margin is made up of so many moving parts and sales volume, sales mix, geographic mix, plant utilization, seasonality. And so we think it's an exercise in false precision to put a number on it. You really want to look at what's a reasonable range. And we think it would be -- if we hit 43.5%, 44.0% for a couple more quarters, then you could say, all right, our range for all the productivity moves that we've been trying to make, our range is higher than it had been. But one quarter in a row is not sufficient to say that the range has changed. So it looks to us like if the range is 42% to 44%, we came in at 44%. A reasonable forecast would be to assume regression toward the mean. That's all that's going on. It is nothing more complicated than that.

Okay. But it's -- okay. And in terms of the outlook there --

Yes.

Within the industry, what are the general expectations in terms of consumption trends around the world? Has production been matching that outlook, I guess especially in Europe? And then, would your orders be matching current production, or are you seeing any variances in terms of customer inventory levels?

The consumption and production patterns around the world have been remarkably consistent with the outlook that we tried to lay out in Q1 and that we saw again -- and that we saw in Q2, which is American consumption, production, and our sales and orders held firm. And Asia, a little -- there are occasional blips of warnings signs, but on balance, it appears to be holding firm. It's -- so the story is Europe.

And when you look at all the variables you just mentioned, paper industry, production trends and what the major paper makers are saying about their outlook, paper consumption, trends, and the overall paper machine industry order patterns, and our sales and order patterns, we -- and then you add on top of that the macroeconomic outlook that we see from the bottom-up. We think that industry has not and therefore our sales in Europe have not yet hit bottom. We don't -- we can't find a counter -- a piece of counter-evidence to suggest that it has hit bottom.

I guess is it more because there is an expectation consumption is going to continue declining or that [the current] consumption, there's still this overcapacity a little bit?

Right. If you just step back and think about what drives the overall climate for the paper industry and therefore paper machine clothing, it's a GNP-driven industry. So all of the modeling that's done about forecasting, paper industry, consumption and production, is first approximation driven by projections about GNP. And it is a -- you just take it step-by-step. The GNP moves, that is made up of consumption, and consumption in retail markets and industrial markets, and paper production is driven by consumption of printing and writing, tissue, packaging. All of that is driven by how strong the economy is. So, it really is a GNP-driven industry.

Okay.

And in AEC, on the --

And so if you believe the economy in the Americas is going sideways, the economy in Asia is slowing down, but still has some growth in it. And the economy in Europe is going to continue to slide, and that's what gets to the outlook that -- that's what gets to our outlook.

Got it. But it's not a gap in overcapacity, so -- where there is a clear gap relative to what a current consumption is? I think that was more the question.

Yes, we talked about -- the reason that we felt that the big 15% drop in European sales in Q1 would not come back and that the smaller drop in Q2 will not come back is because, I think we talked about this, it mirrors the magnitude of the structural overcapacity in the European paper industry. And that is for the European paper industry to get healthy, that's what needs to -- one way or another, that kind of capacity needs to be taken out. And if you listen to the CEOs of the major paper makers in Europe, they are saying precisely that, that it is their -- when they think about their planning, when they look at the paper industry in Europe, they say that point one, two and three is we've got to take capacity out.

Okay.

So that's the only place that there was a mismatch between capacity and consumption and that's why we see -- we project PMC revenue going down more than the economic declines because of that overcapacity factor. We don't see that as much in the Americas, because we're over-exposed to the segments of the paper industry that are growing and under-exposed to the segments that are shrinking. The segments that are shrinking like newsprint do have overcapacity. That answering --?

Yes. No, the -- I've --

Okay.

That definitely covered it. In AEC, on the nozzle program --

Yes.

What do you think the long-term, what do you think the long term opportunity is in terms of your content and do you still see any potential retrofit opportunity on that program or it's going to be for new engines?

This is a very important ground test that Boeing is running in Q3 that we've referred on the release and there is a flight test scheduled for next year, I think Q3, but really the ground test is the critical test and assuming it succeeds and another reason they do the test is because it may not, but assuming it succeeds, what the heart of the opportunity here is nozzles for engines that run hot. And the larger engines, particularly the more advanced versions of large engines are the ones where they have the highest temperature issues. So the first most obvious initial application or platform for these nozzles would be new engines for large planes. So if you are thinking new version of the 777, upgrades on the 787, that's the natural market.

Now, could it spread to in the long run, now we are out at the end of the decade early next decade, is it theoretical is it conceivable that the same nozzles would apply to single aisle? Well, the new generation of single aisles will be running hotter. So it's possible.

And is there also theoretically possible that there would be a retrofit market eventually? Yes, I mean the whole point here is that these nozzles' current version need to get replaced three or four times in the life of the engine, for larger engines that run hot.

So it's a very interesting potential application, but like all of the interesting potential applications, they really speak to the growth potential of AEC beyond the -- after the introduction of LEAP. It won't materially affect revenues before the introduction of LEAP.

Okay and long-term the opportunity I mean it's comparable to LEAP, half LEAP? You used the baseball references before. If LEAP is the home run, where does the nozzle fit in?

The benchmark, the LEAP benchmark is itself changing. So a year ago, when we were thinking LEAP was 1500 engines at a $100,000 per ship set, then this long-term this opportunity is somewhere between, potentially somewhere between a third to half -- a third to 40% of the LEAP. But the LEAP opportunity is growing. So, now, maybe this looks a little smaller compared to LEAP.

So this is a double and LEAP is a grand slam?

Well, one of the variables here that is hard for people to understand is how the volume on a single aisle aircraft is so large compared to other aircrafts. That it -- yes if you can get a major position on the single aisle aircraft, that's a big opportunity, and that's what we have with LEAP. So everything pales by comparison to that just because of volume.

And just, I guess a last question for John. What do think the full rate benefit to be on SCGNR from -- on the pension contribution side? Is the $1 million per quarter sort of where we should expect it to final out or that should grow given the timing of when you did some of these initiatives?

Yes, we had about $900,000 of benefits that we reported there. It's probably $200,000 or $300,000 more just based on the timing of when we finished that per quarter. So it's probably little over $1 million per quarter on SCGNR, and to get to the full benefit that we talked about, the $7 million to $8 million, this remaining benefit is in our manufacturing cost and that's related to our non-US plans and that's another $0.5 million per quarter. And some of that came through in Q2 maybe about half of it or probably little less than that. But we'll have the full benefit in Q3.

Okay, I appreciate all the details guys. Thanks.

(Operator Instructions). And next we have Mark Connelly from CLSA. Your line is open.

Good morning. This is Kurt Schoen filling in for Mark.

Kurt, how are you?

Good. Just following up on the engine nozzle, if that test -- the ground test does fail, is that going to kill the whole opportunity for the nozzle?

No, it usually means we got to go back and do more research and make some adjustments. So I would say no, it doesn't kill it. We got to go back and do more work.

Okay.

It's rarely are these things black and white. If it passes all the tests, that's black and white. But if they get more vibration than they thought or doesn't -- runs noisier than they thought, then you go back and do some design modification.

But do you think they are committed to composites longer term?

We know that, I mean, Boeing has talked a lot about the appeal of a lighter, quieter, more high temperature resistant nozzle, and so, they find this, yes this is not -- This would have a big impact for them if it will succeed. So I would -- I think it's fair to say that if there is encouraging results from the test, they'll move forward to -- But if the tests aren't fully successful, they'll keep working at this.

Okay, and then going to PMC, I know you said that the bottom really isn't in yet.

In Europe.

In Europe yes, so you don't see that in yet. In terms of market share shift, have you been seeing anything there, and if there is any market share shift in Europe, do you think other markets will be pressured as a result either positively or negatively for you guys?

If you look at market share is a tricky issue. If you look at the aggregate market share for us, around the world, we have not seen any shifts. But we don't -- that's not -- a very important variable for us. What we look at is, our share on the most important paper makers and the most important grades -- that is the growth grades -- in each region of the world and the market share shifts that we see there are positive and encouraging.

I think a version of your question is, if Europe has not hit bottom and there is overcapacity in paper machine clothing industry in Europe, are we going to see a share pressures due to price? And yes, we think the conditions for a price erosion in Europe as we've been saying now for a few quarters are heightened because of the decline in the demand in Europe coupled with several contract negotiations coming up. We've tried to build that into our model.

Okay, and then in Asia, your assumptions, your baseline assumption is that Asia remains firm. If it does decrease where do you see that downside? How much downside is there?

We tend to lose sight of, when we say Asia is softening, we are talking about, if China goes from 9% growth to 6% growth. We view that as a significant economic crisis. Right now, we are not seeing -- or we haven't been thinking about a big downside in Asia. I mean we are really -- the question in our minds is what's the rate of growth going to be? The number of new machines going in tends to ebb and flow and right now it's in an ebb, and the number of new machines starting up does have an impact on our PMC orders and sales.

So, for us, the question in Asia is more, is it stable or are we going to see growth? That's the uncertainty. In Europe, the uncertainty is where's the bottom? And then the Americas, the primary uncertainty is will the economy continue to run sideways? And if the answer is yes, then what we've been performing should be what we get. If we start seeing a pickup in economic activity, that will be good, and if we see a contagion effect from Europe and GNP really starts to drop, then we have some downside.

Right now, we think we have adequately taken into account the downside in Europe. But as I was describing, that's the real uncertainty -- that's the real risk factor that we see. And as I tried to describe to an earlier question, September and October will tell us an awful lot about the outlook over the next few quarters in Europe because there's a seasonal -- there's a very well defined seasonal pattern in orders in particular, but also sales in PMC and in paper in Europe, which as you go, everything slows down in July, and then it comes back hard sometimes in August, usually in September, but it could even be delayed till October.

And in our minds, the size of the bounce-back will tell us a lot about the depth of the, call it, the paper recession in Europe. There will be -- there'll likely be some bounce-back, but is it a muted bounce-back, which says the weakness is we still haven't hit bottom, or is it a sharp bounce-back, the way we ordinarily see that says we did hit bottom in -- at the end of Q2 and in July. And you just don't know until you go through it. We'll know -- we should have a pretty clear picture of it in our Q3 call.

All right. I appreciate the color. Thank you very much.

Thank you. And our next question comes from Mr. John Franzreb with Sidoti & Company. Please go ahead.

Yes, Joe, just a follow-up on that last point that you just made, could there be a scenario that plays out where the -- your European customers reset delivery times or is there a fundamental reason why they have to get the orders out the door quickly in September?

Well, there's the holiday season and they're coming back and starting back up. And so I don't think it's -- I don't think it would be a reset in delivery times. I think the -- you know, I --

Can you elongate it anyway or something?

Well, no, I think the elongation or truncating that's going on is really -- affects us in their treatment of inventory. So, if they are seeing -- if they are pessimistic about the economy, they will run down their clothing inventory before putting in new orders. And so you might see delays, but they are going to need -- there is a -- the seasonal pattern is what it is because of the need for paper production toward the back end of the year for their customers. So that's why the scale of the bounce tells us an awful lot about what paper makers are seeing in the demand from their end-users.

Just a curious thought I just want to throw out there. And then, back to my question from before, just if you could update us on what kind of capital outlays you have coming up on as far as ramping up production, where you are in the process of hiring as far as LEAP is concerned, and anything -- any other color along those lines you could provide, that would be great.

Okay. We had been saying that between 2012 and 2017, we'd expect total CapEx for the company to be on average at or slightly below $70 million, which is the total for amortization and depreciation. That's looking more like, for 2012, 2013, 2014, 2015, we'll be closer to averaging $55 million. And then, 2016, 2017, which is where the surge in CapEx will be as there's a surge in production in LEAP, it will go to $70 million, $75 million.

Okay.

Now, the -- there is a chance that out there in 2016, 2017, the $75 million goes higher, but that's because some of these new product possibilities have kicked in, we've got new contracts and we have to build more capacity. So, it's possible that out at the very end of the investment horizon, 2017, 2018, 2019, we see more capital expenditure than $70 million a year, and that would be because we're seeing another wave of revenue potential on top of the LEAP potential. That was what I talked about.

Okay. Any significant capital outlays in the near-term that we should be eyeballing?

No.

Okay.

No, not beyond what we've already talked about.

Okay, okay. That's fine. Thank you very much.

Thank you. And we have no more questions in queue.

All right. Well, thank you, everyone, for participating on the call and we'll be seeing many of you at several investor conferences coming up in August and early September. And if I don't talk to you or John doesn't talk to you before then, we'll talk to you at the end of Q3. Thank you.

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