Albany International Corp (AIN) 2014 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the first quarter earnings call of Albany International. (Operator Instructions). At the request of Albany International this conference call on Tuesday, May 6, 2014, 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.

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, Joe.

Thanks, John. Good morning, everyone, welcome to Albany's Q1 2014 call. Before we begin I wanted to let everyone know we have decided to modify our format a bit but for these earnings calls. I will begin, as usual, with some general introductory comments but then I will turn the call back over to John, who will review the results of the quarter in a bit more detail. During his comments John will be referring to the slides that are attached to our webcast page. And for those of you on our distribution list, the slides were attached to the e-mail containing the earnings release that we sent to you yesterday evening. So, let me begin with an overview and then we will go to John.

Q1 2014 can be easily summarized, machine clothing rebounded as expected and AEC continued to make progress on all fronts. The overall result was a 12% improvement in EBITDA, 12% both on a year-over-year basis and on a sequential basis. The only complication in the quarter was a delay in LEAP sales due to a shift in invoicing terms. John will talk a bit more about this, but the important point is we are on track in LEAP and we expect a strong full-year performance for AEC. So, in Q1 2014 both businesses performed well and in line with our expectations.

If we go one step deeper in machine clothing sales and orders in Europe and Asia were once again stable, that is 5 quarters in a row of essentially steady sales and orders. And the Americas, as expected rebounded from the soft Q4 right along with the containerboard market. Gross margins for machine clothing also rebounded sharply as John will describe in more detail.

More generally, the highlight of the quarter for machine clothing was excellent performance with all of our key customers in each of our key product segments and in every region of the world. Likewise, AEC made good progress on all fronts. On the LEAP program our parts are performing well in engine tests and both plants are advancing toward the ramp-up on schedule.

Commercially, the LEAP engine has now won over 6000 orders and we are still more than 2 years away from entry into service. In R&D we're making good headway across the board on engine applications both for LEAP and beyond LEAP and both for the fan module and for higher temperature parts, on airframe applications and also in our preliminary exploration of the possibilities in the automotive industry.

So, overall, for Q1 2014 good performance in both businesses resulting in strong EBITDA. Now, let me turn the call over to John who will review these results in a bit more detail, John.

Starting with slide three, Net Sales by Segment, total net sales in Q1 decreased 3.8% compared to last year. AEC net sales were down about $3 million or 15.7% due to a temporary lag in sales of LEAP test parts. Our shift to larger scale production of these parts, along with the related change in customer invoicing terms that took effect at the beginning of the year, resulted in a buildup of inventory and an estimated lag of approximately $5 million in sales.

On to slide four, total company gross margin percent increased to 41.5% in Q1. While MC gross margin increased to 45%. The higher gross margin at MC was primarily due to seasonally strong production rates along with lower-costs from the European restructuring. This is consistent with our normal seasonal pattern. As you can see on the chart, gross margin was strong during the first half of 2013 and somewhat declined during the second half.

Looking at Earnings Per Share on slide five, we reported net income attributable to the company in Q1 of $0.33 per share compared to $0.37 per share in the first quarter last year.

First quarter EPS in 2013 included a $0.06 per share gain from the sale of a foreign manufacturing facility. Other EPS affects in both periods related to restructuring, tax adjustments, and currency revaluation are noted on the slide. Excluding the effect of the building gain and those items, EPS this quarter would be $0.37 per share compared to $0.32 per share last year.

Slide six provides adjusted EBITDA details for Q1 2014 in the same quarter last year. As noted in the earnings release, starting this quarter we have included all research and incentive compensation expenses directly attributable to that MC the AEC business segments. Prior-year information has been recast to conform to this change. MC adjusted EBITDA is essentially flat compared to last year, while AEC and corporate expenses showed improvement.

Lastly, slide seven shows our change in net debt. During Q1 net debt increased $12.2 million due to incentive compensation payments that typically occur in the first quarter along with cash outflows for restructuring payments. Compared to the balance at the end of Q1, we expect net debt to decline throughout the year. Now, I would like to turn it back to Joe for some additional comments before we go to Q&A.

Thanks, John. Turning briefly to our outlook, it is basically unchanged. In machine clothing we expect Q2 to be comparable to Q1. Beyond Q2, as John indicated, because of seasonal factors the second half of the year in machine clothing tends to be weaker than the first half. Exactly how much weaker depends on the severity of those seasonal affects, which in turn depends on the health of the macroeconomy.

More generally, we continue to view the macroeconomy as the primary short-term risk factor, both upside and down, for machine clothing. As for AEC, we expect the next three quarters to be substantially stronger than Q1 and we still expect full-year revenue in AEC to be roughly 10% ahead of 2013.

So overall, this was a good quarter with good performance in both businesses, and barring any macroeconomic disruptions, we are on track for a strong full-year performance that is consistent with both our near and long-term expectations for both businesses.

With that, let's go to your questions. Operator.

Thank you. (Operator Instructions). First on the line, Jason Ursaner with CJS Securities, please go ahead.

Good morning.

Hey, Jay.

First for the AEC segment, what was the magnitude of the shift from development to production?

Well, the -- go ahead, Cozz.

Jason, as we said when we reviewed the net sales slide, the impact of that shift in the terms we're at about $5 million in sales. So had we been under the previous terms we would have had $5 million more in sales during the quarter.

Got it. And what do you think incremental either margin or flow-through is on that $5 million of sales? And then, also it has been a pretty predictable revenue stream at $20 million-ish a quarter, is it likely to have more volatility quarter-to-quarter going forward between now and the inflection point as you need to match production levels?

No, it shouldn't be. Particularly if you look year-over-year it should be pretty steady. We may get some fluctuations quarter-to-quarter for precisely the reason you just described, the ebbs and flows, but if you go year-over-year it will be a pretty steady incremental increase until we hit the inflection.

Okay. And for the machine clothing segment, I understand that the commentary on the rebound in North America containerboard from Q4, but overall sales were still a little bit lower than I had been expecting, was containerboard and tissue in North America, was it up year-to-year or just from Q4?

Sequentially. If you look at the actual production statistics for containerboard I think Q1 might be 1% ahead of Q1 last year. But most of the major producers emphasized that they were hit hard by the bad winter. International Paper, for example, said their income would have been about $60 million higher were it not for the bad weather affect.

Rather than try to take any of that into account all we were trying to say is it hit a seasonal low at the end of last year which was magnified by a general economic weakness and it came back off those lows, the low of the low was November, and the overall market came back well off those lows into a more normal range in Q1. And with it, so did our overall sales.

We didn't think that this was at all out of the ordinary sales quarter for a Q1 in machine clothing. We tend to think in terms of ranges, mid-160s to mid-170s is a normal quarterly range for this business. Gross margins we have talked before, 42.5% to 44% will be the normal quarterly average. EBITDA, $44 million to $48 million, $49 million to $50 million that will be the normal quarterly average. If we do our jobs right over time that is roughly where the business will be. There will be fluctuations because of macro factors but until something structural changes that is more or less what the business is and what we saw this quarter was actually between normal and pretty good for machine clothing in Q1.

Got it. And did you see a month-to-month build at all? I guess I'm just trying to balance what you just said with Q2 being comparable to Q1, Q2 has always seemed to be a stronger seasonal quarter, I'm just wondering if it is revenue or EBITDA.

I think you are barking up the right trees. In Q2 we will tend to have stronger sales than Q1 just because each month tends to be normal. In Q1 there are weak shipments coming in from December so that tends to pull back sales a bit. And then February tends to be a short month and there is always the Chinese New Year holiday. So all of that tends to dampen Q1 a little bit from a topline point of view. On the other hand, our plants are typically running hard through the month and so you get good margin. Second quarter, there are no topline seasonal affects, so it typically from a topline is our best sales quarter, not always, but typically. But the margin tends not to be quite as good as Q1 if for no other reason than raises kick in on April 1 and so you get a -- across the world we get a margin hit from labor inflation.

Got it. Okay, and in Asia, you mentioned stability for a little over a year there, some of the long term thesis had been predicated on growth in China offsetting a lot of other smaller headwinds, just longer-term how are you looking at the fundamentals in that region? And is the overbuild, in capacity, is it specific to printing and writing there? Or are you seeing stability or maybe a lack of growth across all of the different paper grades?

We still think that long-term this is a critical market and a growth market and you have to be there in a strong way to grow with that market. But, we're not seeing anything in the short-term to make us excited. Everything you read in the business press about general lack of energy, let's put it that way, in China is consistent with what we are seeing. We're not seeing any short-term catalysts.

As far as overcapacity, there looks like there is a small amount of overcapacity in all of the grades in China right now. So, short-term no reason to expect any kind of a strong rebound. Long-term, every way you look at it this is still an important growth market.

Okay. I appreciate all the commentary. I have a few more but I will jump back in the queue.

Next we will go to John Franzreb with Sidoti & Company. Please go ahead.

Good morning, guys.

Good morning, John.

Joe, could you just talk a little bit about the gross margin improvement in PMC? How much do you attribute to the rebound in volumes versus how much do you attribute to the European restructuring actions you took a year ago?

Well almost -- if we look at the slide that John went through, slide four, and just take a look at the trends last year in the first half and you can see it is hovering around 44% in Q1 and Q2 and then drops down. It drops down, I think John mentioned this, it drops down because in Q3 and Q4 you have these seasonal affects that tend to reduce plant utilization. Whereas the plants tend to be running pretty full in the first half of the year, barring some economic abnormality. So we will always see, we always expect to see and we were indicating that we were expecting to see a rebound in margins in the first half of the year. The fact that it bounced that high certainly has above our normal range of 42.5% to 44% is an indication of the impact of the French restructuring -- the European restructuring.

Okay. And then sticking to PMC --

Just one --

Sure, go ahead.

Long-term you shouldn't deviate from that average, over the full year, an average gross margin of between 42.5% and 43.5% in that range, that is typically where the full year average will turn out.

Okay. And in PMC can you talk a little bit about the pricing environment, are there any major contracts that are coming up? What is the competitive landscape now?

Structurally, if we go back to the root causes here, structurally the overcapacity in our industry and in the paper industry that we serve is most acute in Europe still. And so the greatest risk of price instability remains in Europe. None of the underlying structural factors have changed so we continue to emphasize with investors that is really the primary risk factor for the investment in Albany.

On the other hand, while there are a couple of important contract negotiations coming up later in the year we are not -- in Europe, we are not raising the price instability flag right now. We are feeling, we've tried to emphasize we think the primary risk factor in the short term, short-term equals 2014, is macroeconomic. We think that has a bigger effect on how strong or weak the seasonal affect in the second half of the year is than anything can comes along [in pricing power].

Okay. And switching over to AEC could you talk about traction you are making in non-LEAP related programs, potential awards, timeline and update on that R&D spend?

First of all, remember that beyond the initial wave of parts per LEAP, the fan blades and fan cases, because, I think we have talked about this on other calls, the volume of LEAP, the LEAP program is so large relative to other programs in aerospace that any additional parts that we get on LEAP as LEAP evolves and as every engine program has an evolution, that is the single biggest impact on future revenue that you can have, is additional parts on a super high volume program. So I assume when you say beyond LEAP you mean beyond the initial wave of LEAP parts?

Correct.

Okay. We continue to be encouraged by the progress we're making on the following fronts; additional LEAP parts both in the fan module, the front of the engine, and in the back of the engine on possible longer-term high-temperature applications. We continue to feel bullish about working on the next wave of engine beyond LEAP, the replacement engine, whether that is the open rotor or ultrahigh bypass contained engine. Either way it is going to need blades and it is going to need either containment or protective fuselage that has real strength if it is open rotor.

We continue to be optimistic about the progress we're making on airframe applications. We continue to work near daily and into our monthly with extensive interactions with customers exploring those applications. And we're still moving ahead with our probe, and I think that is the right way to think about it, a probe, into the automotive industry to see if there might be an early application or two at the very high end of that market. So we are pushing ahead on all of those frontiers. On LEAP, both low-temperature and high, next generations after LEAP, airframe, across multiple OEMs, automotive, a probe into the very high end of that industry.

And if you were going to set a reasonable timeline when you could probably announce some sort of award on any of those fronts where would you put that?

Well, you know, we are constrained by what we can and can't say by our -- constrained by our customers to what we can and can't say. I think that over the next 2 years, given the competitive pressures in the engine business that CFM, the Safran, GE partnership is going to have to start talking about what their plan is to evolve LEAP, just as Pratt will have to do so on the gear turbofan. And as those competitive pressures lead them to announce plans to improve their engines, that will be the context in which we will be able to talk about what and which, if any, new parts we will be having on that evolution program. I think it is, next 2 years is a pretty reasonable bet.

Okay. Great, thanks for taking my questions.

Next we will go to Steve Levenson with Stifel. Please go ahead.

Thanks. Good morning, Joe and John.

Hey, Steve.

You have been talking a little bit about high-temperature applications, could you give us an update, please, on the CMC nozzle in the test program? Will that be flying soon?

I think the short answer is it will be flying in a test program under the CLEEN program of the FAA. But we're not seeing any indications from Boeing that that is going to be, that those nozzles are going to be included in any commercial platform this decade.

Not this decade?

Yeah, we're not hearing anything about 77X, we're not hearing anything about 787-10, so the vibe we're getting is that this is more of a next, next. This is a promising technology for the next wave of platforms which is out next decade. More generally, we do think this whole domain of high temperature applications for composites is really important to us and we are actively working on it.

We have seen, for example, it is small but a derivative application of that nozzle work on hypersonic applications for defense. And as you saw, I think you saw at the air show, the Paris air show, Steve, Safran has talked about a composite low pressure turbine blade which we are working with them on. So this is an important area, the nozzle is feeling more like it is still going to be in development through the decade. I think the more significant early application is going to be driven by the LEAP evolution.

Got it. Thank you. And in terms of LEAP, I know there is no ramp-up expected until sometime next year when they start getting ready to produce engines in quantity, but can you give us an idea how many units it takes to have, sort of, a basic operating margin you look for? And is there, just for forward modeling purposes, have you figured what incremental operating margins are per, I don't know if you want to say 10 or 20 or 50 engines worth of parts?

Yes, we have a pretty good sense of incremental margin contribution [width], as volume grows it is pretty much 1-to-1, there is a margin contribution, a steady margin contribution with each engine basically. So we will --

And what is your measurable impact? That is good to know, thanks. Can you quantify it at all or do you want to keep that confidential for now?

Well, if you take the average EBIT margin in the engine business, if GE is at 18% EBIT margin and Rolls is at 12% thereabouts, so if you take the average and assume that for every incremental dollar of revenue as we grow LEAP that average EBIT drops down. That is probably a reasonable way to think about it, EBIT and EBITDA will grow with revenue for that first application, pretty steadily.

Got it. Thank you very much.

Our next question is from J.B. Groh with D.A. Davidson. Please go ahead.

Hi, guys, I am pretty much almost covered here, but a lot of these paper guys had this weather impact, is it your contention that none of that really trickled down to you in Q1?

It trickled down in a very big way, but on the other hand we had some other stuff going in our favor so it hurt us, other stuff helped us. Our attitude is the quarter was what the quarter was, which was a pretty normal, pretty good first quarter for machine clothing.

So maybe a little higher volatility but at the end of the day within the realm of expectations?

Yes.

Is there any way to quantify weather?

Well, International Paper did, they said that their earnings were $60 million lower than they otherwise would have been. So you have to go into their numbers and see in percentage terms what that means, but that is a pretty big effect for them.

Right.

I guess about a 10% effect.

Okay, so maybe similar for you guys?

Well, no but we had some other stuff going in our favor. So I don't think we should, we didn't mention it in any significant way and I think you should just assume this was a pretty normal, this was a good Q1.

Okay. And then, John, can you remind me of the CapEx plan for the balance of the year?

Yes, our forecast for the spend for the year is $65 million to $75 million. I think we were about $14 million through the first quarter.

Okay and so that assumes this ramp and LEAP goes forward as planned, no variance from that? Thank you, that is all I have.

Thanks, J.B.

(Operator Instructions). We will go back to Jason Ursaner, please go ahead.

Thanks for taking the follow-up. The overcapacity in China, do you think producers are viewing that capacity as needing to be absorbed by domestic consumption or was it built assuming a stronger export market? Just because you also mentioned some of the structural problems in Europe.

Well, rather than trying to get into what their intent was, I think in reality is, whatever their intent was, the effect is that once Europe slowed down significantly the export market dried up, and once the export market for Chinese paper makers started to weaken that is when the overcapacity was exposed.

So all indications are Europe is doing a little bit better, but a little bit better is 1% GNP without the underlying structural problems in Europe, particularly in the paper industry are still there. So I think the way you posed the question is the right way to think about this. The overcapacity, which is not a big overcapacity in Asia, we're talking 2% to 3%, like that, that sort, not European-style overcapacity which is 12% to 15%. I think the right way to think about it is domestic growth should catch up to that overcapacity more than return to the [booming] export days.

Okay. And you mentioned just the macroenvironment as really being the primary risk factor for the short-term, how much more limited is your visibility now than it has been historically because of the trend towards make to ship instead of consignment?

It is much less visible. A large chunk of our orders in a quarter actually turn into sales that quarter, so orders become far less useful a predictor than they did in the past. Moreover, when parts were sitting in consignment they had a, what we call a sunset date that after a certain period of time if they hadn't been installed they would be recognized as revenue. And so there was always a predictable element that way too, that you are always able to estimate when the pieces in consignment would eventually be turned into recognized revenue. Whereas now, sales are often -- sales in a quarter are often triggered by orders in that quarter. There often, if there's anything unexpected happening on the customer side they have a problem with a machine, or they have a surge in demand, we will get orders dropping in in the quarter on an emergency basis.

So there is far less visibility. On the other hand, that is on the one hand, on the other hand there's no mystery about what drives this industry. Just look at GNP trends and if GNP is strengthening you have a pretty good bet that containerboard consumption and tissue consumption is going to grow with GNP or slightly less than GNP. And so paper mills will be running at higher capacity and therefore they will be consuming more of our clothing.

So, even though our visibility is shorter because of shorter lead times on orders, the economic using GNP trends as an indicator of what our outlook is, is a pretty reliable way to go.

That is why we say if you tell us what the GNP is going to be for US and Europe and China in the second half of the year, we will tell you whether we're going to have a very limited, muted, seasonal effect or a very strong seasonal effect. By the end of Q2 last year we were feeling that the economy was slowing down and so we were concerned about the second half of the year, particularly the end of the year. And sure enough, they were weak for paper consumption and they were weak in our key market, containerboard. If we see the growing economic consensus is right and we are seeing 3.5% growth or 4% GNP growth then we're going to have a stronger second half than a weaker second half.

Okay. And on the positive side of that GNP growth where do you think your market position is in terms of capability to be a trusted supplier on short notice? Because a lot of times you talk about being a strategic partner, do you think that your business is aligned with those strategic customers, you know, stronger than ever because of kind of a trend towards make to ship but limited visibility?

Well, they're all connected, you can't -- the short answer is yes and I tried to elude to that in my summary comments about the highlight of the quarter was really a very strong performance with our key customers in each region of the world. But you can't get away with shortening your supply chain and your order chain, typically, unless you narrow your supplier base and develop tight relations with that supplier base. Yes, I think it does work hand in glove.

Okay. And just last question for me, on the nozzle program, you mentioned no indications about inclusion on aircraft programs, but there used to be some optimism on a retrofit opportunity, is there any structural impediment that would preclude a retrofit on the nozzle?

No, but I think if and when that market hits you think from 30,000 feet it feels like there would be a retrofit market. But the first step is the way these things evolve is technology needs to mature enough and the OEM, say, Boeing, needs to feel enough pressure, either competitive pressure or fuel efficiency pressure that they're going to take the leap on the new technology. And that typically will happen with a new platform. Next-generation single-aisle, that is for example, I am just speculating here. But say next-generation single-aisle. Now at that point, once the technology starts getting down the learning curve then they will look for other ways of using the technology to create incremental advancements on existing platforms.

Okay. But for instance on the LEAP, the size relative to the old plane, there really wasn't a retrofit option, it sounds like that, on the nozzle that at least isn't the case. It could be a retrofit if it is desired by the industry.

It could be but I think we are in speculation on speculation. I think the best, the safest way to think about the nozzle is it is a very interesting high temperature part of the high temperature portfolio of applications that we are exploring and that is one of the longer term ones that unless something changes unexpected, isn't going to kick in until next decade sometime. That is like the next, next S-curve.

Got it.

Candidate for the next, next S-curve.

Got it. Okay, all sounds great. Appreciate the commentary, thanks.

Thank you.

And we have no further questions in queue.

Thank you everyone for participating on the call and for your questions. And as always, John and I will look forward to meeting many of you at upcoming investor conferences. Thank you and have a good day.

Ladies and gentlemen, a replay of this conference call will be available at the Albany International website beginning at approximately 12 PM Eastern Time today. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.