Albany International Corp (AIN) 2013 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the second quarter earnings call of Albany International. At this time, all participants are in a listen-only mode. Later, we will conduct and question-and-answer session and instructions will be given at that time. At the request of Albany International, this conference call on Thursday, August 1, 2013, will be webcast and recorded.

I would now like to turn the conference over to our 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?

Thanks, John. Good morning, everyone. As always, I will provide a few introductory remarks that add some color to John's and my commentary in the press release and then we'll turn to your questions. I'll comment on three Of the topics that we addressed in the release -- the year-over-year Q2 performance, which we view as essentially comparable, our outlook for the rest of the year, which is unchanged even though year-to-date, we are ahead of last year, and some thoughts about the long-range outlook for AEC, especially in light of the recently concluded Paris Airshow.

So let's begin with the year-over-year Q2 performance. Adjusted EBITDA declined from a very strong $40 million in Q2 last year to $36 million this year, but when we look at the actual operating results, we see similar year-over-year performance.

Now, probably the best way to view this is to compare tables 5 and 6 in the text of the earnings release. So if you go to those tables --that's tables 5 and 6 on page 4 of the release -- and then start with the Machine Clothing column, you see that year-over-year adjusted EBITDA declined by $1 million or bit less than 2%.

Now, keep in mind that Machine Clothing sales were virtually identical in the two quarters. The difference in adjusted EBITDA is entirely attributable to a slight drop in gross margin from 44.2% in Q2 2012 to 43.8% in Q2 2013. 43.8% is well within our target range and right at the full year gross margin for 2012.

Moving next to the Engineered Composites column, you can see that year-over-year adjusted EBITDA in AEC dropped by about $900,000. Well, $900,000 is the cost of the inventory write-offs associated with the closeout of the legacy program in our Texas operation that I mentioned last year -- last quarter.

And then moving over to the third column, you come to the largest year-over-year delta in adjusted EBITDA, which is Unallocated Expenses. The difference between the two years is just about entirely due to accrual adjustments in both periods for stock-based incentive compensation and other items.

Accrual adjustments increased this year's expense by $400,000, and as I discussed in last year's call, reduced Q2 2012 expense by about $1.5 million. In short, when you look at the repeatable year-over-year performance, Q2 '13 was comparable to Q2 '12.

That brings me to item number two, our outlook for the rest of 2013 and beyond. Turning first to Machine Clothing, year-to-date for the first half of 2013, Machine Clothing adjusted EBITDA is $8 million or roughly 7.5% ahead of first year 2012 adjusted EBITDA.

Meanwhile, orders in Europe and Asia in Q2 were considerably stronger than they've been in several quarters. The benefits of the restructuring in France should begin to flow into earnings in Q4. And in our key segments in the Americas, the market is stable, our customers are healthy and our share is, if anything, growing.

Nonetheless, we are sticking to our outlook of flat full year adjusted EBITDA in Machine Clothing. In other words, despite the encouraging first half and underlying conditions, we expect adjusted EBITDA In the second half of the year to be weaker than it was in the second half of 2012.

As we explained in the release, the primary reason is the shift in treatment of inventory away from consignment that we made a year ago with our largest customer. This had the effect of accelerating about $8 million of revenue in Q3 Of 2012. We will see the reverse effect in the second half of this year, as our customer works off the inventory that we recognized as revenue last year. It is this reverse effect that is holding us back from upgrading our outlook for the year in Machine Clothing.

As for all the Engineered Composites, we see the first half of 2013 with its breakeven EBITDA as the low water mark for profitability. We expect to see steady and significant improvements in EBITDA for the second half of 2013 continuing into next year and basically, through the rest of the decade.

Better profitability in our legacy programs and our Texas operations should contribute to this improvement over the next several quarters, but of course, the primary driver will be the LEAP Program, particularly once LEAP production begins to ramp in the second half of 2015.

That brings me to the third and last topic, which is AEC growth beyond the initial version of LEAP. We continue on plan and schedule toward the LEAP ramp and are progressing well toward the completion of the definitive agreement that will create Albany Safran Composites. At the same time, we continue to pursue the next generation of opportunities beyond the initial LEAP fan module.

There have been several public developments since our last earnings call that have potential implications for AEC's future. For example, at the Paris Airshow, there was considerable publicity about Boeing's plans for its next generation 777, the so-called 777X. Also, at the airshow, Safran displayed a prototype of two potential future engine parts made with our technology -- a ceramic matrix composite low-pressure turbine blade for possible application on future versions of the LEAP engine, and a fan blade for an open-rotor engine, a leading candidate to power the next generation of single-aisle aircraft.

And in the May issue of Boeing's in-house magazine called "Frontiers," which is published on their website, an article describes its ceramic matrix composite engine nozzle and the successful ground tests that were conducted earlier this year.

At this stage in its development, we tend to think about the revenue potential of AEC as a series of S-curves or ways of potential revenue growth. The LEAP fan module represents the first S-curve. The most likely next major wave of opportunity, or S-curve, which should phase in near the end of the decade, just as the first wave is flattening, is the initial upgrade to the LEAP engine.

We are working on a broad array of applications of our technology for future versions of LEAP in both the fan module and in the low-pressure turbine, as the ceramic low-pressure turbine blade that Safran displayed at the air show suggests. That is, we're working on applications for the front of the engine and for the higher temperature back end.

The Boeing 777X represents a possible third S-curve of opportunity starting at the end of the decade. There could be a number of possible applications for our technology on this platform. The engine will have a composite fan module, the wing will be composite and the 777X could well be the first platform for the ceramic engine nozzle.

At this stage in their development, it is too early to know, with any degree of certainty, what content we will be successful in capturing on either of these two platforms, but this growing array of possible applications on each of them does reinforce our confidence in our ability to realize our growth objectives of a $300 million to $500 million business by the end of the decade.

So to summarize, first, Q2 2013 was another solid quarter and roughly comparable to performance in Q2 '12. Second, even though year-to-date in Machine Clothing, we are well ahead of last year and the outlook in Europe and Asia is better than it's been in a while, we are holding to our forecast for flat full year adjusted EBITDA because of the impact on second half revenue of that shift away from consignment that we made and discussed last year.

Meanwhile, profitability in AEC should improve steadily and significantly beginning in the second half of this year. And third, we see a growing array of possible applications for our technology on two important future platforms, the next version of the LEAP engine and the 777X, reinforcing our confidence in our ability to realize our objective of AEC as a $300 million to $500 million business by the end of the decade.

So with that, let's go to your questions. Brad, we can take the first question.

(Operator Instructions) Our first question this morning comes from the line of Jason Ursaner with CJS Securities. Please go ahead.

Good morning.

Good morning, Jay.

I was just wondering first on the Machine Clothing business, Joe, if you could talk about linearity month-to-month and some of the trends in Europe and Asia, whether it was just a strong June or really sort of a month-to-month improvement. I guess I'm just trying to gauge how much of it is conservatism for the consignment to make the shift versus really too early to tell.

Well, I think the trend in -- what we can say with some confidence about Europe and Asia is the sales trend has been flat for several quarters and we had thought that Europe would be L-shaped with a big drop up front, which really anticipates the gradual takeout of capacity over time, and that's exactly what's happened. It dropped more than a year ago and it's just hung down at the same level each quarter for about four or five quarters.

Q2 was the first quarter where we actually saw an increase in orders above that flat level. Now, whether that's because of short-term inventory adjustments or whether that's an early sign of an uptick off the bottom, time will tell, and it's a little too early to say, but what we can say with confidence is it's been flat for quite some time and given the increase in orders, there's no evidence that we're about to see another step down. If anything, there's evidence, in the last four months of the year, once we get through the summer slowdowns in Europe, we might see an uptick.

Asia is a similar story, just not as long. I mean, there was a big drop, more like 10% a year ago, rather than the 20% in Europe, and we think from a macroeconomic point of view, those two are connected. Then it has stayed flat down there at a little more than 10% below previous levels and once again in Q2 for the first time, we saw strengthening of orders. And again, we think that suggests that in the back half of Q3 and in Q4, we should see some strengthening.

Okay. And second question is more on the composites, the S-curve and that $300 million to $500 million of revenue by 2020. I think you had talked about the first sort of threshold on LEAP being closer in the $150 million to $200 million range.

Right, right.

And today, it's, I think, roughly half of the development revenues, so the legacy programs are running in the $40 million-ish run rate.

Right.

So the subsequent improvements, I guess that first part where there's some more confidence on that hitting, how many of those improvements, or how much of that kind of can get you to the bottom end of that $300 million without the nozzle or other airframe applications?

Right. I think that's a really interesting question and if you -- the more certain or the more likely S-curve is the next version of LEAP because history tells us that every new engine program has repeated technology inserts and upgrades every two to three years, depending on competitive conditions, and in this case, the competitive environment is pretty intense. So there's a pretty good likelihood that sometime that the end of the decade, there's going to be an upgraded version of the LEAP engine, just as the way there will be an upgraded version of the gear turbo fan.

We are working a lot of possible applications. The only real uncertainty is when do they get -- do they get folded into the first upgrade or future upgrades? There is so much volume on these single-aisle engines, on the LEAP engine, that it only takes one good part, one significant additional part, to get us from that $150 million to $200 million with LEAP, plus the $40 million of legacy to get us up into the bottom end of the range, bottom end of that $300 million to $500 million objective range. So it only takes one good solid application on the first upgrade to LEAP to get us to the low end.

Now, how you get to the high end is you get more parts onto that first version or a quickly following version, plus we get some content on 777X, plus we get some airframe -- smaller airframe content on a few other platforms. That's the way it would -- that's what brings you up toward the higher end of that objective range.

Okay. And --

You can't understate the importance of the volume associated with -- volume of engines associated with the LEAP Program, so any time you just get one more part, you're talking 1,800 engines, 1,600 to 1,800 engines a year, 1,000 engines to 1,800 engines a year. There's a big revenue impact of additional content.

Okay. I appreciate that. I'll jump back in the queue. Thanks again.

Our next question comes from the line of John Franzreb with Sidoti. Please go ahead.

Good morning, guys.

Hi, John.

Could you just discuss that $8 million in consignment revenues? How does that play out in the second half of the year? Is it all imbedded in one quarter? Is it evenly distributed?

It will spread out over the two quarters. It will probably be more heavily loaded in Q3 than Q4.

And you alluded to the fact that the EBITDA is going to improve noticeably in Composites for the balance of the year. Why is that; what's driving that? And what kind of targets should we be thinking about by year end on Composites?

What's driving it is primarily in the short term -- well, it's the same two variables. It's improving profitability in some of these legacy programs in Texas which has been dragging down our profitability, and continued incremental growth in LEAP, which improves the margins as well. So it's the combination of both of those trends; so it's those two.

I mean, you should certainly -- if you just interpret our comments on Q2, we're saying the right way to think about that run rate is just add back the cost of termination, so that brings EBITDA up to a little over $1 million at this level of sales. And we don't think that's good enough; we think it should be at least double that. So I think if you use this as a baseline and then do some incremental improvement in EBITDA from this quarter, you're heading in the right direction. And then as revenue grows incrementally, that growth in revenue should drop through.

Okay. And Joe, just discuss the seasonality that you're seeing now in PMC. It's been kind of lumpy over the past couple of years. What does the second half kind of look like as far as the revenue trends for the year?

That's a really interesting question, and let me get at it in a couple of ways. Let me first answer the specific question and then go back to the bigger picture. The most important seasonal effect in Machine Clothing occurs at the end of the year, as holiday slowdowns around the world lead to lower production of paper, which leads to lower consumption of paper machine clothing, which leads to lower orders for our products.

The effect of those seasonal slowdowns at the end of the year don't really hit our earnings until Q1, but the effect of that seasonal slowdown is that there's actually less -- we have fewer shipments going out in the back end of Q4 and most of those shipments going out in the back end of Q4, they don't really get recognized as revenue until Q1. So you've got less flow of shipments from one quarter to the new quarter at the end of the year and the beginning of the next year than you do at any other time of the year. So Q1 historically is the low quarter.

The second seasonal effect is the summer slowdowns, particularly in Europe, and it means typically that July and August are soft. Now, how soft that turns out to be depends on how big a run-up we get in September and you never really know until the end of the quarter, but there's definitely a seasonal effect in the summer, particularly in Europe.

These seasonal effects are magnified in the last few years because customers in the Americas and Europe have gotten much more efficient at managing inventory and at squeezing down inventory, and so you get greater fluctuations. They will run down their inventory more as you get slowdowns and then they will ramp up harder, faster and want to restock harder, faster once you start getting an upturn. So these fluctuations get worse.

That said -- all of that said, I think the most important point for investors to keep in mind is don't get distracted by these quarter-to-quarter fluctuations. This is fundamentally -- in our minds, this is fundamentally a flat business, a flat EBITDA business. It's our job to basically keep it flat. And you get fluctuations from quarter-to-quarter, but it's basically a $54 million to $55 million on average per quarter business, a $215 million EBITDA, adjusted EBITDA, to $218 million, $220 million adjusted EBITDA business per year.

And you'll get this volatility; the volatility seems to be getting worse as our customers' supply chain management gets tighter. But it's not worth trying to read too much into these shifts in gross margin or shifts from quarter-to-quarter. It's basically a flat business. And what investors should be -- in our minds -- should be thinking about is are we saying anything about structural changes that would lead us to, or lead you, to think it's no longer a flat business, or it may be slightly better than flat?

For example, if we started saying this macroeconomic weakness in China is actually leading us to have a fundamentally different view about the long-term growth potential of China, that's a structural change that would say, well, maybe this isn't a flat business. We don't think that's the case, by the way. I'm just trying to give you an example.

Or if our -- the paper machine clothing business consolidated, that would be the kind of structural change that might lead you to start wondering if there isn't room for a little bit of growth above that flat $54 million to $56 million per quarter EBITDA. That's how we think about it.

Okay. And against that whole structural environment, can you talk a little bit about the pricing end of it?

The pricing environment In Europe, which is always the high-risk area, is okay right now in the sense that we're past the contract season, contract renegotiation season, and won't really open up that window for another year and a half to a year and three-quarters. And as far as we can tell, the pricing impact of the last contract negotiation season is already built into our revenue, so that's the good news.

The unchanged news though is that the underlying structural conditions, the overcapacity in our industry in Europe, has not changed. We still see pricing behavior that makes us scratch our heads. The underlying structural condition hasn't changed, but we think we're in a more stable period right now.

Brad, I think we lost John. We lost the last questioner's line, so he will probably queue back on. We can go to the next --

My apologies. Our next question then comes from the line of Mark Connelly. Please go ahead.

Hi, Joe.

Hi, Mark.

Just a couple of things -- we know that airplane companies never fall behind schedule with their new planes, but with respect to the 5,300 LEAP orders that you referenced, if we didn't have anything go wrong, how would that play out time-wise?

The easiest way to think about this is the LEAP engine replaces their current -- CFM's current generation of engine, the CFM56 and the CFM56, they're making about 1,500, 1,550 engines per year. And they expect -- CFM expects to have completely displaced CFM with LEAP by 2019. So it gets introduced in 2016, LEAP, and gradually those CFM engines are displaced by LEAP, and by the time you get out to 2019, all of CFM's engines are LEAP engines. So it's a three-year phase-out, except for maybe 100 engines a year, the old type, for just repairs and replacement.

(Inaudible).

So you would see a rapid increase in LEAP engines at least to the current volume of CFM engines, 1.500, 1.550 a year, and then CFM and Boeing and Airbus all expect there will be more increase in demand for those kinds of engines, incremental increase for those engines between now and 2019. So that 1,500 gradually moves up to 1,700 or 1,800 a year.

The other way to look it this is to look at the per-month production of single-aisle aircraft, the 737 and the 8320, and both Boeing and Airbus are now at, or committed to, 42 planes a month, so 84 engines. They need 84 engines a month, each of them. And there's a fair amount of speculation, which they are fueling, that that per-month production of planes is going to increase from 42 to something more than 42 -- 45, 50. And if you do that math, and assume CFM holds its share of 100% of Boeing and half of Airbus, you get back to that 1,600, 1,700, 1,800 engines per year.

Okay. Okay, that helps. And now, with respect to your comments about EBITDA, I wonder if we could try to take that to cash flow a little bit as we think about the impact of the next generation LEAP technology? Can you remind us how the development in investment ramp would look and obviously, it's early, because you don't know which parts we're talking about, but I'm trying to get an order of magnitude impact of the -- layering in the cost of development of the new LEAP project into our existing cash flow.

Right. I think the approach we take back of the -- which you can summarize with some back-of-the-envelope math, goes something like this. Take last year's adjusted EBITDA, which I think was about $145 million, and then subtract out $70 million for cap ex, which is roughly amortization and depreciation. And we've said for the next -on average, between '12 and '16, cap ex will be about $70 million. We think it'll be right about $70 million this year.

So $145 million minus $70 million, and take out $15 million for interest, $15 million for taxes and $15 million for dividends. And that leaves you on the order of $30 million, $35 million left over of basically excess cash, so roughly $1 per share of excess cash after cap ex, interest, dividends and taxes.

The $70 million a year assumes about $45 million a year for AEC and we're right in the middle of a very heavy -- the peak investment this year and especially next year and the year after, peak investment for the LEAP program, two big plants that we're going to fully equip over the next couple of years.

So assuming -- if you just make the assumption that we're going to hold at that high level of investment, it would mean we are equipping two big plants every year. So we think if you go out through the decade at $70 million a year of cap ex, that's a pretty conservative way of thinking about it.

Perfect, that's great. Thank you.

We don't think it will be that high, but --

Okay. Okay. No, but that's very helpful. Thank you.

(Operator Instructions) And we do have a question from the line of Steve Levinson with Stifel. Please go ahead.

Thanks, good morning, Joe and John.

Hey, Steve.

I appreciate your being conservative with what you said about Safran, but in their technology both, I think they had a dozen or so parts, including a number of static parts that were made with 3D woven materials. Could you give us an idea of what it would take for an air-framer to replace a metal part with a 3D woven part, what the price performance differences might be, including things like changes in the maintenance procedures and such?

On the airframe side?

Yes.

Well, we think the -- if you think in terms of the skeletal structure of a wing or an airframe, and you look for load-bearing, impact-bearing components of that structure, those are natural applications for us. And we believe that there are performance advantages relative to conventional composites because we can bear load, and weight advantages compared to metals. So it's going to be component-by-component, a normal economic analysis.

Do the weight advantages of our composites offset any economic disadvantage compared to metals? And sometimes, the magic works and sometimes, it doesn't. We are encouraged by initial progress we're making working with a tier-one supplier on an airframe application on a wing. It's a relatively small, from a revenue point of view, application, but it is a great first demonstration of what we're capable of doing on the airframe.

We do think the airframe becomes a major source of potential application for us. That's one of those S-curves that's out there in time and is highly dependent on, as you know, when a new platform gets introduced. That's why the 777X is an interesting platform. Anybody who's serious about composites is going to try to figure out a way of seeing if they can compete for part of that wing. The next big platform that will create opportunities for airframe applications for composites is probably the next generation single lap. Maybe there's some derivatives of the 8350.

Okay, thanks. I guess single lap is still too far out to even think about right now.

Right.

And you did mention 777X and we spoke to the GE people at the show because they've been talking about fourth-generation composite blade and case for the engine.

Right.

And while, of course, they wouldn't name a supplier -- I guess nobody has been chosen -- they did say it would be 3D woven. So assuming that it might be you, that's an engine that's 132 inches in diameter against 79 for the LEAP, for the big LEAP, I think.

Yes.

Is that still a part that you can make on the equipment that you are installing or would it require an additional investment?

Well, let's back up here. The short, direct answer is if we got to that, it would require additional investment. Those are bigger parts, but we will be at full capacity just meeting the requirements for LEAP, but let me step back from that answer. The GE 9X engine will indeed, from everything that's said, have a composite fan module. We believe that our technology would do well on that application and we know, because of GE's involvement in CFM, that they know about our technology.

Now, whether GE and Safran reach an agreement to use our technology on the fan module of the GE 9X remains to be seen, and as far as I know, those conversations, they have taken place in a very preliminary way. There's no agreement that I know about. GE will have an orientation to see if they can have as much work in-house as possible on that engine.

On the other hand, we're the only supplier capable of doing 3D woven parts. So it's an interesting application; it's a potentially big application. It would require more investment, but my view is anybody who's telling you that there's an agreement here is way ahead of themselves and I don't think we (inaudible) --

Oh, no, nobody said there's an agreement.

Right.

I said you might assume that the suppliers on LEAP might be the same for GE 9X.

Well, nobody has told us yet.

Okay.

I don't think we'll know. I think --

You're talking to the wrong guys -- just a joke.

Right. I don't think that gets clarified until the end of next year. That would be my guess.

Okay, got it, thanks. And last, you talked about the CMC blade for the low-pressure turbine. Would you expect CMCs to be covered in the proposed joint venture agreement with Safran or is that something you expect to retain 100% of?

It would be part of the agreement.

Okay. Thank you very much.

Right, Steve.

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

Okay. Thank you, everyone, for listening in on the call in and thank you for the questions. And as always, John and I look forward to meeting you at the next shows or in between when we're out on the road, or on the call -- on the phone when we talk to each other. So thanks again and talk to everybody soon.

And 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.