Albany International Corp (AIN) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third-quarter earnings call of Albany international. (Operator Instructions). At the request of Albany International, this conference call on Tuesday, November 5, 2013, will be webcast and recorded.

I would now like to turn the conference over to the 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 the associated reconciliation of GAAP.

And for purposes of this conference call, those same statements also apply to our verbal remarks this morning. And for a full discussion, please refer to that earnings release as well as our SEC filings, including our 10-K.

Now I'll turn the call over to Joe Morone, our Chief Executive Officer, who will provide some opening remarks before we go to Q&A. Joe?

Thank you, John. Good morning, everyone. As always, I'll start with some introductory remarks that amplify John's and my commentary in the release, and then we'll get to your questions.

Q3 was a disappointing quarter due to weak sales in machine clothing. In many ways, Q3 was similar to Q1 2012, which was the last time we had a weak quarter. Then, as now, seasonal softness was compounded by unexpected weakness in a key market. The unexpected weakness then was in Europe. This time, it was in Asia.

In the typical annual machine clothing business cycle, there are two seasonal soft spots -- the beginning of the year, when sales are dampened by weak shipments from late December because of holiday slowdowns in late December; and the first two months of Q3, when sales and margins are dampened by summer slowdowns. The severity of these two seasonal soft spots depends on the strength of the overall economy. A stronger economy mitigates the softness; a weaker economy exacerbates it.

In Q3, all of the markets we serve exhibited at least some economic weakness. We do expect a quick rebound in machine clothing, just as we experienced in the months following Q1 2012. Even if Asia remains soft, the absence of a seasonal effect should result in improved performance in Q4, which is consistent with what we are seeing through the first third of the quarter.

There will likely be a slowdown at the end of the year, as our customers drive down their inventory and as we shut down our plans for the holidays. But unless our customers perceive a significant weakening of the economy and pull back even more than we are anticipating, this late-December effect is likely to be reflected more in the typical slow start to the new year than in Q4 results.

And even with a slow start to the year, we expect that the first half of 2014 should be strong; and that for the full year, 2014 machine clothing adjusted EBITDA and cash flow should be roughly comparable to 2012 levels.

Turning to AEC, sales growth continued to be driven by the LEAP program. LEAP now represents half of total AEC sales. EBITDA strengthened, beginning what we expect to be a long-term trend of steady improvement. And, as we discuss in the release, three important recent developments in AEC bear mention.

First, the initial test of the LEAP engine -- the so-called first engine to test -- have been very successful and our composites have performed well. Second, we expect to sign the agreement to create Albany Safran composites very soon, probably later this week. As we discussed in the release, ASC -- that is, Albany Safran Composites -- will be a new division within AEC, owned 90% by Albany and 10% by Safran.

With this agreement, ASC will be the sole source for all applications of our 3D weaving technology within Safran. Initially, ASC will comprise all of the AEC people and equipment dedicated to the LEAP program. Any new parts that we agree to make for Safran, whether on LEAP or on any other Safran platform, will also be housed within ASC. Excluded from ASC, and housed in the other two [visions] of AEC, will be 3D woven parts for applications outside of Safran; and all composite parts, whatever the application, that utilize AEC technology other than 3D weaving.

Safran will pay $28 million for its 10% stake, which puts the initial value of ASC at $280 million. Safran would have the option to purchase the remaining 90% of ASC, but only if Albany were to sell AEC to a competitor of Safran, or if ASC failed to perform and was unable to remedy the failure in a reasonable period of time. The initial value for the remaining 90% of AEC will be set at the current valuation of $280 million, and will grow as the LEAP program grows to full production. After LEAP hits full production, the valuation will be equal to ASC EBITDA times 9.5.

The third major recent development in AEC pertains to new estimates of the size and timing of the market for LEAP. When we launched this program, we had expected that the market would support 1500 engines a year by the end of the decade. That estimate increased last year, to 1600 a year. Now, CFM has publicly stated that it expects demand to grow to 1700 engines per year by late 2018 or early 2019, and possibly to 1800 engines per year by the end of the decade.

Boeing's recent announcement that it plans to increase production of 737s to 47 per month by 2017 is consistent with this larger number. Those same public statements by CFM suggest that the ramp to this larger number of engines will begin late in 2016 rather than in 2015, as I suggested in Q1. The 2016 ramp start gives us a little more time to prepare, which is helpful; but it means that the ramp itself will be even steeper than we had anticipated, especially given the higher annual rate of production.

Essentially, we'll have to ramp from very low rates of production to 30,000 blades per year in a little more than two years. Of course, all of this could change again, but if it does not change, the financial implications are roughly as follows. The spike in LEAP revenue, and therefore AEC revenue, is now expected to begin in the second half of 2016 rather than during 2015. Before the spike -- that is, between now and the second half of 2016 -- LEAP revenue should continue to grow rapidly. Full-year LEAP revenue in 2016 has the potential to be roughly 80% higher than full-year LEAP revenue in 2013.

Once the production ramp begins in 2016, LEAP revenue growth should accelerate sharply. Full-year revenue in 2018 has the potential to be double that of full-year revenue in 2016, with still more growth in 2019 and 2020. Revenue at full production should be at higher levels than we had previously estimated, reflecting the now-larger estimates for the LEAP market.

Because the ramp begins late in 2016 rather than 2015, CapEx will be lower for the next two or three years than we had been anticipating. An annual average of $55 million of CapEx for the total Company -- that's the total Company; LEAP plus other AEC, plus machine clothing -- an annual average of $55 million of CapEx for the total Company, rather than the $70 million annual average that we had previously estimated, is now more likely for 2014 and 2015.

In sum, this was a disappointing quarter because of soft sales in machine clothing. At the same time, we do not believe the weak quarter for machine clothing results in a change in the outlook for this business, near- or long-term. Assuming the economy holds, we expect at least a partial rebound in Q4 followed by a healthy first half of 2014.

As for AEC, it continues to progress well toward that LEAP ramp, which now appears more likely to start in 2016 than in 2015, and to reach higher levels of production and revenue sooner than we had been previously estimating.

Those are my opening comments. Cynthia, if you could turn to our questions, please.

(Operator Instructions). Jason Ursaner, CJS Securities.

Good morning. Excluding the customer contract change from last year, I'd still been expecting sales performance in machine clothing to be closer to flat. You mentioned it came in lower due to the decline in Asia, and that it was across both packaging and publication grids. So, my question is within the context of the long-term positioning for the business. What is still giving you confidence that there will be excess growth in developing markets like China that could offset secular declines, when the business there now is already tracking more GDP-driven?

Well, as we've discussed before, the play we think about the long-term model, and the reason we think this is a flat EBITDA business is -- let's go beyond China. In the Americas, growth in South America, coupled with slow incremental growth in the packaging and tissue grades of North America, should be sufficient to offset declines in the printing and writing grades, particularly given that we are overexposed to tissue and packaging and underexposed to printing and writing.

And then when you go over to Europe and Asia, we see essentially the same formula while, essentially, Asia growth for us to have stability needs to be as fast as the European decline. If Asian growth is faster than European decline, then there's a little bit of upside. But all we need for that model to work is Asian growth to be roughly equal to European decline. And if you look at the dynamics of paper grades, and let's stay with China, they're going to go through the same process.

Printing and writing is probably already overbuilt. But the growth that gets driven by -- the growth in consumption of tissue and packaging grades -- think food containers, for example -- in a growing, long-term economy like China should be more than sufficient to offset the slow demise of the printing and writing grades. So, we're not seeing anything fundamentally changing in any of those markets off the long-term, sectoral trends that we've really built this business around.

Okay. And on the AEC ramp, I understand the push-out doesn't impact the timing of the commercialization. But my understanding was that Safran could have used the balance sheet to minimize the risk of the production ramp as it moves to full production in a relatively short amount of time. So, what's changing there that would make that less attractive to try to eliminate that risk?

I think you're reading this exactly right that, if you look at the sales of the LEAP engine onto the 737 MAX and the neo -- the Airbus A320neo -- they've always said that entry into service for the LEAP -- for the Airbus version would start in second half of 2016. And entry into service of the LEAP for the MAX would be in mid- to third quarter of 2017. That hasn't changed. So from a commercial point of view, the only thing that's changed is they are now preparing for a prospect of selling even more engines than they had been saying before, and getting there fast.

What has changed for the time being, and we'll see if it changes again -- it appeared that they were going to build an inventory of engines in advance of commercial introduction. And now they're backing away from that. You can guess the reasons of once they actually do the math and realize the amount of cash that they would be carrying to hold an inventory of engines, it just -- it was a big number. So I would guess that that's what's driving them back toward a steeper ramp, rather than a smooth ramp in the first couple of years. I think it's cash.

And just last question for me, on the steepness of the ramp, I understand the estimates that are being put out there for the peak of 1700 to 1800 engines. But that is still 20% to 25% higher than current mature production on the CFM56.

Yes.

So, just trying to stay balanced on that, should we be taking those estimates with some reservation? Or do you really think investors could have a pretty high conviction in those targets being achieved in a relatively short, five-year time period?

I think that's a very fair question. You look for calibration between what CFM is saying, what we're seeing from internal projections that we're hearing, and then look at how Boeing and Airbus are behaving. And so I think the announcement last week that Boeing made, that it is going to increase its production of 737s in 2017, to 47 planes per month, is very significant and completely consistent with these new numbers. So if you just do the math, 47 MAXes a month times 2 -- because we're selling 2 per MAX -- times 12, and you get to something like 1200 engines a year by 2018. Because they are going to flip over from the traditional 737 to the MAX very quickly, according to all their public statements. There's also a lot of speculation out there, which they've helped fuel in some public conversations, that they're not done at 47; that they're looking at going higher, as high as 62 per month by the end of the decade. And Airbus has been talking about the same kind of increases. They've been talking publicly about going from their current 42 a month to 44, and their slots are sold out and they're still getting orders.

So, if you look at this -- the best way to gauge the market is to just do the math around how many of these re-engined narrow-bodies Airbus and Boeing are planning to build per month, and you can quickly get to a number for LEAP that way. Assume 100% of the Boeing narrow-bodies and 50% of the Airbus narrow-bodies, and you'll get to a number that's very consistent. Even without COMAC sales, you'll get to a number very consistent with what CFM is talking about.

Okay, great. Appreciate the details. Thanks.

John Franzreb, Sidoti & Company.

Good morning, Joe and John. Joe, it took a while to sign the Safran agreement. Have there been any material changes from that agreement that you initially negotiated in May to the one you expect to sign next week?

No changes. It is taking so long primarily because this agreement creates a new entity, and essentially all of our employees who are currently working on LEAP shift into this new entity. So there's a lot of detail on that side. But, no, it's been grinding and grinding, but there's been no material change at all.

Okay.

We are excited about this agreement.

Okay. And shifting to PMC, you seemed to suggest you expect the first half of 2014 to be a good one. You mentioned the normal seasonality that you'd expect in the beginning of the year. And orders are up in China -- I'm sorry, in Asia. What else gives you confidence that you're going to have positive year-over-year growth in the first half of 2014, given the current environment?

Well, you just go customer by customer; and working with our customers, develop an understanding of what their production expectations are. So, it's really a bottom-up analysis of what our customers are expecting of us, when that leads us to that conclusion. That's point one. Point two, with this shift in contract terms that we keep referring to -- in the Americas now, more than two-thirds of our sales are essentially just in time; and, three or four years ago, only 25% worse. So it's a major shift.

In Europe and Asia, it's almost all just in time. The net result is, with our customer now holding the inventory, we're going to see more volatility because they are going to drive their inventory down at the end of the year. And then once the new cycle begins, they're going to scramble to refill their inventory. There's some real economic weakness. And you get a reinforcing effect. If the economy is ticking up a bit, then not only are they restocking but they're having to restock more because of expectation of more sales on their part.

So you get greater volatility once we shift from essentially us holding consignment in, by far, our largest and most important market, to now everywhere the customer is holding inventory. So you get this slowdown at the end of the year, and then quickly ramping up at the beginning of the year. So, it's a combination of bottoms-up analysis, customer by customer, coupled with an appreciation of the significance of the shortened order cycle of our customers.

And then you layer on top of that, do we see anything fundamental happening in the macro economy? Do we see Europe taking a step down? No; it's been stable. Do we see Asia taking a step down? No; there's a pulse, so there's a chance it could tick up a bit. And do we see the Americas taking a step down? And, again, you look at the same data we are, but we're not seeing any signs of a further slowdown.

So all of those together lead us to the conclusion that we should see a strong first half.

Okay. And in regards to restructuring actions that you've taken, could you just outline the benefits to the core structure that you see playing out in 2014?

I think we've publicly said there's about $10 million of lower costs from the restructuring that we took on in France. And those should start flowing in -- there may have been a little bit in in September -- but they should start flowing in in Q4, and then being fully realized in Q1 and Q2. And that's one of the reasons, despite softness in Asia; despite a big shutdown in International Paper; despite price erosion late last year, early 2013 in Europe, one of the reasons we have confidence that year-over-year EBITDA -- that EBITDA full year, and cash flow full year for machine clothing in 2014, it should be pretty comparable to 2012. We think the annuity is helping.

Okay. Do you have much more room to cut? Or right now is the capacity equilibrium pretty much set for what you expect the market to be going forward?

I think there will always a gradual process of aligning capacity to the way the market shifts. But every time I say this publicly it comes back to haunt me, but we're not seeing any need for a major capacity moves in the near-term.

Okay. Thanks for taking my questions.

Steve Levinson, Stifel.

Thanks. Good morning, everybody. You talked about the terms of the joint venture and how the price ramps up with LEAP production. But are there provisions in there for additional amounts if you win other business on newer versions of CFM or GE, or other engines in which Safran is involved, or other 3D woven parts? Or is it pretty much just tied to LEAP?

Well, by the time LEAP hits full production, the evaluation method would shift to EBITDA times a multiple of 9.5. So that would -- as EBITDA grew beyond, because of new programs, beyond LEAP, it would get reflected in the valuation. Remember, I think we talked about this last time, we don't anticipate major increments in revenue from new programs hitting before 2019, 2020. So that's when the next couple of S-curves are likely to hit. And that's when LEAP is flattening and hitting full production.

It's pretty much covered, therefore?

Exactly.

Okay, thanks. And, second, you're getting in a little slug of cash here, and you don't need as much for capital expenditures. Could you tell us about what the plans are? Is there going to be debt repayment, stock repurchases, dividend increases, acquisitions, or some sort of balance of all those uses?

Well, never say never. But I would say we're not -- we view this as an organic growth play. So we're not -- and the acquisition space, which we always look at, as you well know, this industry has really consolidated. And there isn't -- what's available for acquisition is either way too big or something that doesn't really make much sense. So I think it's probably safe for investors, at least based on what we see today, to take that option off the table.

As for the others, it's a topic that we constantly review with the Board. And we're driven by the combination of making sure our balance sheet is absolutely in the best possible shape to take advantage of growth opportunities in AEC; and then, whatever excess cash remains, it's about maximizing shareholder value.

Great, thank you. And, last question, do you have an update on the ceramic engine tail cone? And what's going on with testing?

No new update. There was a flight test scheduled, I think, next year. I would say the best update I can give you is we're just -- the pipeline of opportunities on the airframe continues to grow. There's a lot of interesting possibility on the airframe side. Basically, everywhere you see, on the skeletal structure of the plane, anywhere you see a joint or a fastener or -- for the skeletal structure that is bearing an out-of-plane load, that's grist for our mill, so we're pretty excited about that.

Okey-doke, thank you very much.

(Operator Instructions). JB Groh, D.A. Davidson and Company.

Good morning, guys. I think you said that LEAP was roughly half of AEC in the quarter. Is that correct?

Yes. Currently, yes.

And could you talk about the non-LEAP stuff for a bit?

Well, JB, the most important non-LEAP programs we have today, as opposed to development projects, would be the work we're doing with Rolls-Royce on the joints. We're making components for the lift fan of the Harrier version, the STOVL version, of the Joint Strike Fighter. And we're also making parts for Rolls-Royce's business jet, the RB725. So if you look at our operation in Texas, which represents one-quarter of our sales -- 40% going to 45%, thereabouts, of those sales are Rolls-Royce related. I think our -- that would be our second-biggest and most important [coster]. And that program should be growing. Both those program should be growing through the decade.

The other large program we have had, which we've talked about before, is the landing brace for the 787. But as discussed, at the end of the year, that program ends, and they go back to metallic braces on the 787. Technically, that program has been working very well and we've our targets. But economically, that program is not working for Messier-Dowty, so they've gone back to metallic braces.

Right. Okay.

So, we will see, as LEAP gross it will become a larger and larger part of AEC over the space of the next few years.

Got you, okay. And then in this new ramp, obviously the total amount is bigger and it's steeper. What are the biggest challenges you think that you're going to have with that steeper ramp? Obviously you had one plan in place for the original ramp, and now you've probably got to re-sharpen the pencil.

Yes, it's going to be more like the kind of ramp you see in the automotive industry, where you have run -- to do some, essentially, full rate test runs periodically before you hit the ramp. Take a module of the plant, even before the plant is fully equipped, but enough of a strip of all of the production equipment, and run it flat out for a week or two weeks or three weeks on two shifts, and just really test where you are. And you have to do that periodically in order to identify any weak spots in your system, any places where you're getting sources of variability and low yield that you weren't anticipating.

Whereas before -- so, you do these test runs all-out. Whereas before, if we were going to build inventory ahead of demand, then you would use that inventory build to identify the weak spots that you could then fix. So it's going to be a very deliberate process that we go through. It will be more like what the automotive industry goes through when it just flips a switch with a ramp.

Okay. And then could you maybe address pricing in the MC world?

Pricing for the -- pricing has been stable around the world. You're new to us; the window for pricing and stability opens lightest when there's a new round of contract negotiations. And we won't see one of those for at least another year, and that will be in Europe. And the sensitivity to pricing is greatest in the markets where the industry, our industry, is least consolidated, and our customers have the most overcapacity. And that would still be Europe; and, to a lesser extent, Asia. In Europe now, we are about 20% exposure, so the exposure to pricing right now is not that great right now.

Okay, good. Thank you, sir.

Thank you, JB.

Thank you. And we have no further questions. Please continue with any closing comments.

Well, thank you all for participating on the call. I know John and I will be seeing many of you over the next few weeks and months. And we'll look forward to answering any questions you have then, when we see you; or before then, if we talk you on the phone. Thank you, and talk to you soon.

Thank you. And, ladies and judgment, 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 call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.