Albany International Corp (AIN) 2012 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the fourth-quarter earnings call of Albany International.

At this time, all lines 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 7, 2013 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 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. 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 is 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.

Thanks John. Good morning, everyone, and let me add my welcome to John's. As always, I'll open with a few comments on what we see as key features of yesterday's release, and then we will go to your questions.

As we discussed in the release, Q4 2012 was another strong quarter for both of our businesses. Adjusted EBITDA, that is EBITDA excluding currency revaluation and GAAP restructuring, was 27% ahead of Q4 2011 on slightly lower sales.

Machine Clothing continued its outstanding performance with full year -- full year share of market holding and growing for each of our major customers in every major region of the world. AEC continued its rapid growth and continued to progress towards (inaudible). And we reduced net debt by another $20 million, bringing total net debt down to $129 million compared to $256 million a year ago.

Our outlook for 2013 should come as no surprise -- flat year-over-year adjusted EBITDA in Machine Clothing and continued rapid growth in AEC, both driven by more or less the same internal performance and external market trends that we saw in Q4.

Now, there are three particular aspects of our outlook that I would like to just take a minute to discuss in a bit more detail before turning to your questions. First, in Machine Clothing, we saw signs in Q4 that the decline in European sales may finally be moderating. While sales in Q4 '12 were still nearly 15% lower than sales in Q4 '11 in Europe, they were slightly higher than they had been in the preceding two quarters, that is in Quarter 2 and Quarter 3 of '12. This is the first sequential quarter increase in sales in Europe since Q3 of 2011, so in over a year, five quarters.

Orders followed a similar pattern. To be sure, the European paper and PMC industry still suffer from overcapacity and the European economy, as all of you know, is far from healthy. But our recent sales and order trends suggest that the sharp declines of the past year may finally be giving way to the more gradual and predictable erosion of sales that is driven by the longer-term trends in paper demand for newsprint, printing, and writing grades. And as we've discussed on numerous occasions, for the long haul, we look for gradual erosion in sales in Europe, offset by growth in Asia, and for stability in the Americas with growth in South America and in packaging and tissue offsetting declines in newsprint and printing and writing.

A second point about our outlook, this one having to do with Albany Engineered Composites. Based on current schedules which are of course subject to change for a variety of reasons, we now expect AEC sales of our components for the LEAP engine to pull forward by about a year. We had previously stated that we view total AEC sales, that is including LEAP total sales, as having the potential to grow to $120 million by 2016 from the 2012 level of about $65 million. So, we are near doubling from the end of '12 to '16. Well, that 2016 now seems more likely for that $120 million level of sales.

Likewise, we had previously stated that we expected a steep ramp in LEAP sales and therefore total AEC sales from 2016 to 2019. That ramp now looks more likely between 2015 and 2018. So to summarize that, this apparent pull forward of about a year means that our -- we now view AEC total sales potential to hit about $120 million by 2015, and that sharp ramp to occur starting in '15 and going through to '18. This leads to a third point about our outlook.

This apparent pull forward of our schedule for production of parts for the LEAP engine will be accompanied by a pull forward of our schedule for the associated capital expenditures. We had expected peak spending to occur between 2014 and 2017. We now think the peak will occur between 2013 and 2016. Now, to put that in context for you, in 2012, total capital spending for the Company was $37 million -- total for the Company, so both AEC and Machine Clothing. We anticipate a sharp increase in spending in 2013 due to this acceleration of our investment in AEC, along with the construction of the new R&D facility in Machine Clothing that I mentioned in my comments in the release.

We have stated on numerous occasions that we expect capital spending for the full Company between 2012 and 2016 to average roughly $70 million a year. Our view on this has not changed.

In sum, Q4 2012 was a strong quarter for Albany International. And our outlook for 2013 is for a continuation of the trends that contributed to the Q4 results. In Machine Clothing, those trends are strong competitive performance, promising new products and technology, effective absorption of inflation, and adjustment of capacity to long-term market trends, and healthy markets in the Americas and Asia coupled with a stabilizing market in Europe. And for AEC in 2013, the trends are for continued rapid growth, continued progress towards critical LEAP milestones, continued advances in the new product development pipeline.

So with that, those comments, let's go to your questions. Brad, can we have the first question?

(Operator Instructions). Jason Ursaner, CJS Securities.

Good morning, really nice quarter. Just for the MC segment, demand came in very solid, basically stable, ahead of the seasonal slowdown. And I see the market commentary in the press release, but I want to get a better understanding for how the customer inventories switch last quarter might've been impacted the quarter on a sequential basis. And then also any additional comment on the North America market, how it started off the year, and how healthy you see that market now after years of consolidation.

So let's take Q4 first. If we go -- if we go region by region -- first of all, it's always dangerous in this business to look at trends sequentially, even though we did that with Europe. In general, you have to -- it's much safer to go year-over-year because of these seasonal effects.

That said, with that caution aside, if you look at the sequential trends geographically Q3 to Q4, controlling for that one-time bump because of the contract change in North America we talked last quarter, the Americas were basically flat, both North and South America. Asia was basically flat. And Europe had a bounce back up a little bit. So when you actually look -- try to account for the difference in sales sequentially, it's mostly an improvement in Europe.

On inventory, we have seen really since the recession in 2009 a continuing trend towards customers becoming tighter and managing their inventory more and more tightly. And so more and more -- being more and more aggressive about running down their inventory at the end of the year. And we didn't see anything particularly new in that trend in Q4 other than a reminder that everybody manages their inventory more tightly and so that does introduce an element of volatility, both down and up.

We did see the expected slowdown at the end of the year, particularly in the Americas, but actually we saw it everywhere.

As for the beginning of Q1, no real surprises. Q1 does have a strong seasonal effect, which is really the consequence of the slowdown at the end of the previous year. But we are not seeing anything that deviates from the Q4 trends that we described in the release. North America looks solid. Asia looks like it's starting to come out of its funk. And Europe, let's just say the slope of the decline is moderating. So, I think that covered all of your questions.

Yes. And staying with Europe, the decline obviously moderating, you talked about overcapacity though. How far above consumption do you still think production is, assuming it comes out gradually, which is how much do you think actually does need to come out?

I think a good number is 15% to 20%. Compare to if you took a snapshot at the beginning of 2012, I'd say there's about a 20% gap. That gap has closed some just because UPM acquired Myllykoski and did some consolidation there, and now UPM has announced more closures and Stora is announcing closures and some of the other paper makers are announcing closures as well. So the gap is closing.

From our advantage, what we have seen before, and I think I've mentioned this before, when you get these periods of economic turmoil, our drop in sales happens much faster and tends to approximate the amount of overcapacity, so we seem to get the drop in sales at the beginning of the process even before the paper makers have announced which mills are actually going to shut down. And we think that's what occurred. We hope and think that's what occurred for us in Europe this time. So we had a 15% drop year-over-year in sales. That mimics -- that pretty much approximates what the amount of overcapacity was.

Got it. And just last question for me, can you talk a little bit about the priorities for cash, given that the balance sheet is in much better shape now? And the amount of cash that you're holding overseas, if it can't go to funding AEC or reducing debt, what does the longer-term strategy for that cash?

So, as we noted, a lot of our cash is held overseas, and the first [hardwood floor] we will be investing in composite in Europe over the next few years. After that, we have a pretty detailed repatriation plan that we work through each year that allows us to get a certain amount of that money back (technical difficulty) year to pay down debt, which is what our plan has been. So for right now and the near future, those are basically the primary uses for that money. There's also a certain level of just operating cash that we need throughout the world that we will be maintaining in the different sites.

Clearly, our first priority for use of cash is to position ourselves to take full advantage of the growth potential in AEC while continuing to do whatever we need to do to maintain our leadership in Machine Clothing. And that's a little different from what our priority was a year or two years ago where we felt strengthening the balance sheet was a priority that we were balancing with the strategic needs. We are feeling very comfortable about the balance sheet now, and so the timing we think lines up very well because the opportunities on the AEC side, and as you see this quarter even on the (inaudible) side are pretty compelling. So that's our unambiguous top priorities, is maintain a strong balance sheet and position ourselves to take every advantage of the opportunities that come along. We think there will be more.

Sounds good. Appreciate the commentary guys, thanks.

John Franzreb, Sidoti & Co.

Good morning. I hope you're prepared for the storm headed your way.

My first question is actually regarding the gross margin profile in Machine Clothing. It's been running above your stated historic norms of 42% to 44% for a couple of quarters now. Could you talk a little bit about the sustainability of that gross margin profile and what are the puts and takes that will make you drop back even below that historic range?

I think if you -- you are right. We had been saying that we thought the margin of 42% to 43% was a reasonable estimate, and now that three quarters in a row we are up at the -- what we used to think of as the high end of the range, so we're in the 44% range. There are a couple of reasons for that that we think are sustainable.

The first is that we have made a series of smaller restructuring moves over the past couple of years. And that has gradually washed in. And you'll notice if you go back and look at our earnings releases for the past six or seven quarters, it's been (technical difficulty) restructuring each quarter, and those were a series of smaller moves primarily involved with the integration of Engineered Fabrics and Machine Clothing. That has led to a permanent increase -- led to this increase in gross margin.

Secondly, and ironically, as Europe shrinks as a percent of the total, the gross margin, because of the customer and grade and geographic mix, tends to improve a little bit. So those are the reasons for the increase.

Now, the second half of your question is how sustainable it is. And here are the variables, two of which are sort of under our control, one of which is the risk factor in this business. Inflation, if this is basically a flat slight growth business, inflation is always going to be growing faster than the business. So our number one management challenge, along with maintaining our competitive position, is to absorb inflation year-over-year. If we succeed, that augurs well for holding the gross margin. If we fail, then we start to erode gross margin.

The second is a continuous incremental adjustment of capacity to the geographic end market trends of the sort you've seen over the last few quarters. To the extent we are able to continue to do that, we will hold the margin.

And then the third and the single biggest risk to the whole (technical difficulty) proposition is of course the risk price, the price erosion. That risk is, as we've talked many times, greatest in Europe and we are relatively -- the exposure is relatively small now. And we feel like we are in -- we've taken steps to try to protect against further erosion. So that's roughly the gross margin picture.

Now, you mentioned the pricing environment in Europe. You touched on the capacity take-out. How much do you think -- are you attributing maybe the stabilization that you're seeing in the sales profile in Europe almost entirely to the capacity take-out, or does the macro picture stabilizing in Europe play any part of the stabilized sales environment that you're seeing in Europe?

We think the rumors of stabilization at the macro environment are grossly exaggerated. We don't think we're out of the woods on that. So this is more -- the dynamics we are seeing have more to do with -- we absorb a big drop in sales. And we think that, as I mentioned to Jason, we think that big drop in sales approximates and reflects the overcapacity in the paper industry that will still (technical difficulty) in Europe. That will still continue to be smoothed out over the next few quarters and years. But it's -- in some ways, we've taken a hit in advance.

What's the biggest challenge for you operationally by the moving up of the timeline on LEAP production by a year?

It's -- your question answers itself.

But you have to answer it.

As I think we've talked about before, we are -- the LEAP engine, this engine by the joint venture between GM and Safran, replaces the CFM 56 engine. And CFM, the joint venture, makes roughly 1500 engines a year, the CFM 56, about 1500 engines a year. It has taken that joint venture 30 years to gradually ramp up to the point of 1500 engines.

Now, the LEAP engine, which will completely replace or very nearly completely replace the CFM 56, will need to ramp not in 30 years, but in three years from basically 0 to 1600 engines. That never occurred -- that kind of a ramp has never occurred in the aircraft engine industry. So it is a very challenging proposition to do it that quickly.

Now, add on top of that that this is a new -- the parts we are making are new technologies. So that's the challenge. The challenge was going to be rough starting in 2016, and now we're starting 2015 and it makes the challenge even rougher. And it's all about a continuous process of trying to, on the one hand, mature and industrialize -- if I can use that word -- industrialize our manufacturing process while at the same time our customer is finalizing their design, so there's a constant iteration between their efforts to optimize their design and our efforts to optimize and line up our manufacturing process. And all that needs to be done in a manner that leads to robust high-yield manufacturing by 2015, 2016.

One of the reasons, very logical reasons, that it appears that our customer wants us to start producing sooner is precisely to try to smooth out that ramp a bit. They'll still start their deliveries. They are still planning to start their deliveries in late 2016, 2017, 2018, 2019. But what they are trying to do is give us more time to start making parts, working out any bugs in the manufacturing process in advance of their -- the time when they have to start delivering. So this is, from our advantage, it looks to us like very intelligent risk mitigation to smooth out the curve.

Great, thank you very much. I'm going to get back into queue.

(Operator Instructions). Mark Connelly, CLSA.

Two questions. Is the new $15 million research facility going to mean that total R&D spend goes up as well? I believe that the guidance for R&D has been relatively flat in PMC. And are you going to relocate your existing R&D assets to that new facility?

We have a -- the answer to both questions I think is no, that is we expect R&D in Machine Clothing to hold -- the R&D spending. We have a strong R&D group in Wisconsin. We have a plant that used to do production in Menasha and then we have a plant that still does production in [Kakahna] and they are about 20 miles apart. So in our minds it's essentially one core group of R&D people working together. And the center of gravity for that work has shifted or is shifting to the Kakahna plant. But no, there won't be a movement of R&D assets.

Okay. And just one more question. The change in the LEAP ramp up, now that that's ramping earlier, does that raise the probability that other projects start to move earlier?

No, because --

I'm just curious. Go ahead.

Our customer is not delivering engines sooner.

Right.

It looks like we'll be making parts for them sooner, so I think the way to think about this is between 2014 and 2015 -- I'd say between 2013 and 2015 -- they are going to have to -- our customers are going to have to make some decisions about several new parts that we are developing with them right now. And they are going to have to -- so in that period, there are going to have to be some announcements about plans to add new contents that would lead to potentially new plants. And those announcements typically will come three to five years before the first revenue starts to flow.

So, the way to think about the revenue growth in this business is if we are at a little more than $60 million in 2012, it now looks like, driven by the LEAP ramp $120 million in '15. We've said the LEAP ramp at peak, LEAP by itself is about $160 million at peak. That peak now looks like 2018. Add in another $40 million for the rest of AEC, so you can see a projection from $60 million in '12 to $120, million in '15 to $180 million to $200 million in '18.

We've also said we expect -- we think this business has the potential to be in the $300 million $500 million range by '20. That next wave above the LEAP peak are these new parts that we're working on -- the engine nozzle, enhancements to LEAP, derivatives from LEAP that we are currently working on with customers. And in the next two or three years, there are going to be some customer decisions made about go or no go, and those decisions will dictate growth beyond the 2018 peak to that next level up. Did that answer your question?

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

Most of my question was already answered in that last response. But just for clarification, the two- to three-year time period for announcements on potentially further increased content -- is any of that likely to come in the next 12 months, or is it they really want you to focus on the task at hand before they look at increased content?

I'm not sure. I think you have to -- I think the window 2013 to 2015 is -- I think we should hold to that. And it's not so much concentrating on the task at hand; it's more how -- it's more about their planning. If you look at the history of engine programs, every two or three years there will be a technology improvement program or a next generation engine. And I think it's fairly predictable to expect that if this engine enters into service late '16 -- so let's say 2017 it enters into service, history would suggest that, by no later than 2020, there should be, at a minimum, a technology upgrade. And then by no later, let's say two years after that, there's a new version of the engine. That's what history tells us. So those are pretty -- those are fairly likely. And each enhancement, each two- or three-year enhancement, creates an opportunity for us for additional content. We are working with our customer partially with our own funds, partially with customer funding, on numerous enhancements.

Okay. What -- you may have said this earlier. I joined a little late. But what is the current content you're publicly talking about on the LEAP exit?

Haven't changed that. We are still saying $100,000 per engine. And that's the fan blade, the fan case, some associated parts. But that has not yet -- so that's LEAP 1. All of this ramp so far is about LEAP 1, about the fan module for LEAP 1.

When I talk about the R&D pipeline or the product development pipeline, those are new components that we hope the customer will decide to include in technology improvement programs and then eventually LEAP 2. So the technology development is underway. They are certainly doing their planning. We have not yet negotiated a pricing agreement on those parts, and they have not yet announced the technology improvement program and what's going to be involved in it.

So just so I understand, the last quarter in composites was $20 million. Was that lumpy positive? And you may again -- I'm sorry if you've addressed this already.

When you say lumpy positive --

So is that the new run rate or it would be prior to the ramp in '15, or is that -- was there some special projects in there where we shouldn't expect that level to continue short-term?

I think that's not a bad way of thinking about the run rate for the next year or so, maybe a little more than the next year. But underneath that, there is a fair amount of churning going on. But the growth -- I think it's fair to say that the growth that we will see in revenue from 2012 through 2017, 2018 will be almost entirely driven, or will be -- yes, it will be driven by LEAP.

And you know the parameters of LEAP. It will go from zero to roughly 1600 engines, until you hear otherwise, about $100,000 per chipset. And we mentioned in this release that LEAP represents about 45% of the Q4 run rate. So, it's basically going from roughly $30 million, $35 million, I figure $30 million in Q4 to something like $160 million in 2018, something like that. And that will be the dominant source of revenue growth in AEC. Some programs will fade, like the brace program. Others will grow like to JSF program. But that will all get washed out by the growth in LEAP.

Okay, but that $160 million relates just to LEAP --

LEAP.

-- or is that -- so there should be another $40 million on top of that for composite.

Correct.

Okay.

And that's not including any new components that might get announced to be in that window, '13 to '15 or '13 to '16.

Okay, appreciate it. Thanks.

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

Okay everyone, thank you for participating on the call. And as always, I'm sure we'll be having conversations with many of you between now and the next call. And if not, talk to you in a quarter. Those of you on the East Coast, I hope you do well in the storm. Thanks. Bye.

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.