Albany International Corp (AIN) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second-quarter earnings call of Albany International. (Operator Instructions). At the request of Albany International, this conference call on Tuesday, August 5, 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.

And for purposes of this conference call, the same statements also apply to our verbal remarks this morning. And for our 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 our Q2 2014 call. As always, I'll begin with a quick summary of the quarter. John will then go into more detail about the financial results. I will follow with a few words about our outlook, and then we'll turn to your questions.

Q2 2014 was a strong quarter for the Company. Both businesses performed well, and according to expectation. There was only one complicating factor in the quarter, which was the charge to correct an overstatement in the value of machine clothing inventories that originated several years ago when we transitioned to a new ERP system. This charge reduced Q2 machine clothing gross margins by about 1 percentage point, adjusted EBITDA by $1.6 million, and earnings per share by about $0.03.

Turning first to machine clothing, we are seeing stability in every geographic region. Sales in the Americas returned to normal levels in Q2 and appeared to be fully recovered from that Q4 slowdown and the Q1 weather-related problems. Meanwhile, sales in Europe and Asia remained steady for the sixth consecutive quarter. And as John will discuss, gross margins were in the normal range. And most importantly, this business continued its outstanding performance in each of our strategic market segments, and with all of our strategic customers.

AEC also performed well on all fronts: preparation for the LEAP ramp, turnaround in our Texas operation, and expansion and advancement of the R&D portfolio. Two important developments took place just after the close of the quarter. At the Farnborough Airshow, DFM announced that total orders for the LEAP engine had grown to over 7,500 orders, and that it had raised its estimate of the total potential market that LEAP is competing for from 40,000 engines to 45,000 engines.

The other development was the announcement by GE and Safran that AEC, through Albany Safran Composites, will be providing the fan case for the GE9X engine, which will power Boeing's new 777X. According to GE, the 9X will be the largest engine ever developed. So the news that AEC will supply the fan case for it represents an important and high-profile validation of the advantages of our technology. We have not yet finalized contract details, but it is reasonable to assume that at full production early next decade, this should represent a $20 million to $25 million per year opportunity for AEC.

So, overall and across the board in both businesses, this was a good quarter for the Company.

Now, to give you a little more insight into our performance, John will walk you through the slides that accompanied our release. John?

Thank you, Joe. I'd like to refer you to our Q2 financial performance slides. Starting with slide 3, net sales by segment, total year-over-year net sales in Q2 decreased 3%, excluding the effect of currency rate changes. On the same basis, MC net sales declined 3.5%, as Q2 2013 net sales were particularly strong, especially in North America. Compared to the last three quarters, sales in North America have improved; and as Joe mentioned, they are stable in the rest of the world. AEC net sales rebounded from the transitional effects of the change in LEAP invoicing terms, as discussed last quarter, and were up 1.3% compared to the same quarter last year.

On slide 4, total Company gross margin percent decreased to 38.9% in Q2, while MC gross margin decreased to 42.4%. MC gross margin percent was negatively impacted by about 1 percentage point by the inventory adjustments discussed in the release. On a year-to-date basis, MC gross margin of 43.7% for the first half of 2014 is comparable to the 44.0% gross margin in the first half of last year. As noted last quarter, MC gross profit in the first half of the year tends to be higher than the second half, due to seasonally strong production rates. The results during the quarter are consistent with that seasonal pattern.

Turning to earnings per share on slide 5, we reported net income attributable to the Company in Q2 of $0.35 per share compared to a loss of $0.23 per share in the second quarter last year. Second-quarter EPS in 2014 and 2013 include a $0.04 per share and $0.47 per share charge for restructuring, respectively, mostly related to our actions in France. Other EPS effects in one or both periods related to discontinued operations, tax adjustments, currency revaluation, and an insurance recovery gain, are noted on the slide. Excluding the effect of the adjustments, EPS this quarter would be $0.37 per share compared to $0.33 per share last year.

Slide 6 provides adjusted EBITDA details for Q2 2014 and the same quarter last year. The year-over-year adjusted EBITDA in Q2 2014 increased compared to the same period last year. MC adjusted EBITDA was down compared to last year, due to lower sales noted earlier, and the impact of the inventory adjustment. AEC results were better than last year, due to the turnaround results at our Boerne, Texas, operation. Corporate expenses continued to show improvement. Year to date, total Company adjusted EBITDA improved to $75 million compared to $69.9 million for the first six months of 2013.

Lastly, slide 7 shows our change in net debt. During Q2, net debt -- total debt, less cash -- decreased $15.8 million due to strong cash flow during the quarter. Since cash balances were mostly flat compared to the end of Q1, the improvement in that debt was a result of reducing our total debt to about $285 million at the end of the quarter.

Looking forward, our outlook for capital expenditure spending is unchanged, despite the added capital needed for the GE9X program. This year, we expect total CapEx spending to be $60 million to $70 million; and through 2018, to average about $70 million per year.

Now I'd like to turn it back to Joe for some additional comments before we go to Q&A.

Thanks, John. Turning briefly to our outlook, we expect to continue to outperform 2013 in the second half of the year. As John mentioned in his discussion of gross margins, because of those seasonal effects the second half of the year for machine clothing -- and, therefore, for the overall Company -- is usually weaker than the first half. But on a year-over-year basis, we expect machine clothing adjusted EBITDA to outperform the second half of 2013; AEC sales to outperform both the first half of 2014 and the second half of 2013; and overall Company adjusted EBITDA to outperform the second half of last year.

And with that, let's go to your questions. Greg?

(Operator Instructions). Jason Ursaner.

Just first on machine clothing, you talked about the sequential improvement that obviously was down a little bit compared with last year. And the commentary is, everything between the grades and regions seem pretty solid. So just wondering, was there anything particular about last year's figure, or anything this year that would have led to a pretty modest topline contraction?

It was just -- I think it's the contraction is more of a function of a very strong comp, an unusually strong comp, than anything else. We look at the market in the Americas; it's completely in line with what we've been expecting. So Q2 2013 just had everything going for it the right way. It was one of those quarters. If you look sequentially, as I think John mentioned, we've seen steady improvement, and it's right where it should be.

Was Q2 2013, though, was it driven more by the Americas, or you just had a strong --?

Yes, yes. It's remarkable, in the other parts of the world, how stable sales have been over six quarters, so it goes back even before Q2 of last year. So, the delta is primarily the Americas, and the Americas are performing very well. They just performed very, very well in Q2 of 2013.

Okay. And was it any particular grade, or just the overall sense of the market?

It was one of those quarters where everything was humming.

Okay. And for China, what do you see there in terms of overall production capacity versus demand growth? Obviously stability is a good thing, but at some point that region needs to resume growth if it's going to be part of an offset to keep the overall business holding steady in the long-term. (multiple speakers)

Yes, let's take this in steps, from the back forward. The way we think of our business model is Asia needs to grow enough to offset, over the long-term, European decline. So, Europe has been steady; Asia has been steady; we haven't needed that growth to make our model work. Meanwhile, over in the Western Hemisphere, the way we get stability is growth. And South America, plus growth in packaging in tissue, offset the sectoral decline in printing and writing. So both of those need to balance: Asia and Europe and South America, plus packaging and tissue in North America, offsetting decline of printing and writing in North America. And right now, they are doing that.

If Europe were declining, then we'd be under more pressure to see growth in Asia. We don't see any reason to deviate from the expectation that over the long run, as domestic consumption grows in China, we will see more growth in China. And the evidence around new machines in tissue and packaging grades in Asia, China in particular, certainly supports that view.

Okay. Because Europe all came out at the same time, though; and that was, I guess, two years ago. And the thought had been, even then, that it was going to happen over time, where Asia and Europe were balancing out. I guess you're not really looking at it as you need to catch up to get that business back to (multiple speakers).

Now, I think we're -- we're feeling that this level of EBITDA is our baseline.

Okay.

And it's been pretty -- again, over the course of a business cycle, you'll get some up years and some down years. But over the course of the cycle, this has been a pretty steady level of EBITDA. And so think of this as the baseline, and then if Europe is stable and Asia starts to grow a little bit, that's upside. But over the long haul, we think there's enough overcapacity in Europe that growth in Asia will offset Europe. We still think that's the right model.

Okay. And last question for me, the engineered composites, just what do you see as the incremental margin right now as you are hovering around -- well, close to breakeven? Because I looked back at last year's Q4 before you started allocating the R&D, and on an adjusted basis it looked like nearly 100% flow-through at the current run rate on revenue. So I'm just wondering how to balance fixed costs and overhead absorption with understanding long-term that it's going to hit those traditional aerospace margins.

Right. Well, the comparisons are made a little more complicated because we have started folding R&D in. But I think R&D, if you figure is running at about $2.5 million, I think we show that on table 3. But so keep that in mind. Here's the easiest way to think about incremental -- the impact of incremental revenue and how much drops through. We've said that we think that the right way to think about profits in this business, certainly our goal for this business, is to have EBIT margins in the normal range for the aircraft engine industry, which is somewhere between 12% and 18%.

So I would put EBITDA -- so if you figure the midpoint is 15%, that says an EBITDA margin of about 20%; EBIT 15%, EBITDA 20%. That's really where we hope to be, as this business -- as the first wave of growth in this business fully kicks in. So that would be once LEAP hits full production. So, if you are out 2018, 2019, we should be looking at EBIT margins in that range, 12% to 18%. We're certainly not there now, as you can see from our tables, particularly the EBITDA table.

So to get from where we are today to where we want to be, when LEAP is in full production, you clearly have to have an incremental drop-through that's greater than that 12% to 18%. That's one way of looking at it.

The other way of looking at it is we have publicly disclosed that Albany Safran Composites is valued by both parties at full production of LEAP, so 2019, at $367 million. We have also publicly disclosed that the multiple we used to get that value was 9.5 times EBITDA. So that gives you a basis for what fully ramped LEAP EBITDA should look like.

So, again, if you start with where EBITDA is today -- leave aside R&D -- where EBITDA is today minus R&D, and you know where it's going to be in 2019, again, you are going to have to -- you can start modeling what the incremental drop-through would be.

Okay. I appreciate all those details. I'll drop back in the queue. Thanks, Joe.

John Franzreb.

Just going back to the European overcapacity issue, could you just give us a sense of how much more do you think needs to be addressed? It seems to me it's been an overhang for quite some time. Maybe just bring us up to speed on your thoughts, Joe.

The overcapacity is systemic. It's both in the paper industry and in the paper machine clothing industry. And while, as you know, we have taken some capacity out, there is still overcapacity in our industry and in our customers' industry. So the overhang of long-term structural price pressure, structural -- industry structure-based price pressure -- that is still there. And there is still a fair amount of capacity that needs to come out of both the customer base and our industry before that structural overhang is fixed; the way it's been largely in North and South America.

That said, so despite the fact that the structural conditions haven't really changed fundamentally, we have seen stability for the last, as I said, six quarters.

Okay.

One of the reasons that the long-term growth in China is an important question, which one we still feel optimistic about, is because unless and until the structural conditions in Europe are addressed, there will still be downward pressure in Europe. So that needs to be offset by upward pressure somewhere else, which would be Asia.

And against that backdrop, one of the few destabilizing events has always been negotiations of new, large contracts, given the tough competitive landscape. I believe you said previously there's a couple that are coming up for bid at the second half of the year.

John, there was a big one in the first half of the year, which we weathered.

Right.

There was a big one in Asia, which we weathered.

Great.

There's another one coming up at the end of the year. But, again, at the moment, we're not raising the price risk flag. We're still in the mode of saying that our -- from what we can see today, the number-one risk, both upside and down, is macroeconomic.

Okay, perfect. And just last on PMC, the seasonality that you expect in the second half versus the first half -- last year in the fourth quarter we had a little blip in that normal seasonality; it was a little weaker than expected.

Yes.

Any concerns from the customer base that we may see a reoccurrence of that event. Or is the chatter that you hear is that we're stable, and there's no outlying concerns?

It really is -- it's back to what we view as the major risk factor is -- it really is going to depend on how strong the economy is going into the fourth quarter; which, in turn, affects our customers' inventories; and which, in turn, affects whether or not they feel they need to make some adjustments and start slowing down.

So, as a general rule, the stronger the economy is, the more muted the seasonal effect is. And the opposite is also true: the weaker the economy, the more magnified those seasonal effects are. And they hit us pretty hard last year. The evidence to date is that the second half of the year will not be as weak economically as it was last year, but let's see.

Okay. And the expectations on EBITDA margin, the improvement, is it more a function of gross margin benefits from restructuring actions, volume leverage on the SG&A line, or maybe even a lower R&D spend? Can you just walk us through the improvement there?

Are you talking about MC?

I'm talking about Company-wide, on the EBITDA in the second half, year-over-year.

Yes. I think the improvement year-over-year should come from all three categories, if you go back to that adjusted EBITDA table. In machine clothing, our margins should be a little better than last year because of the -- primarily because of the cost take-out. In AEC, they should be better primarily because of improvement in the Texas operation.

Right.

And our corporate expenses are running at a lower level because a variety of cost reduction measures there. So, each of those has the potential to contribute to improved EBITDA year-over-year.

Okay, perfect. Thank you for the color.

Steve Levenson.

Forgive me, I've been jumping back and forth between calls, so I hope I'm not posing a repeat of anything. Can you tell us where the construction or completion of Commercy stands right now, when you expect it to open?

The construction is done. We're finishing off equipping the plant. We haven't started making parts yet, but we're not -- it's coming fast. There should be official opening of the plant probably in October.

Okey-doke, great. Thank you. And in the press release, I know you mentioned enhancements on the LEAP that would save hundreds of pounds. Incrementally, what do you think that might mean to you? And is that something that will require an engine recertification, or are these non-structural, non-operating modifications that they can stream into the engine as production moves forward?

Steve, it's a big question that, as you know, is driven more than anything by competitive factors. The more pressure CFM is feeling from Pratt, the more urgency they are going to feel to make upgrades sooner. The less urgency they are feeling about competition from Pratt, the more they will push that out. And the more they push it out, the more enhancements they will load in there, which could lead to more of a requirement to certify.

So it's a little bit difficult to say right now. You saw what happened at Farnborough. There was a -- the orders for CFM were (multiple speakers)

I think they were -- what? About two-thirds of all the engine orders at the show?

Yes, and Pratt did not do very well in the market that we're serving, which suggests, at least for the moment, some of that competitive pressure is easing a bit. But you know that can turn on a dime. So I think the answer to your question is entirely a function of how the competition -- how the competitive dynamics play out.

Okay, thanks. But incrementally, is it equal in content to what you have now, or less or more?

I'd say it has the potential to be, depending on how aggressive the package is, and when it occurs, it has the potential to be anywhere from 30% to 100% of what we have now.

Got it. Thank you very much. And just last, is that a 3D woven product, or is it more of a traditionally made product?

Well, the potential enhancements that we would put onto LEAP performance upgrades, they would -- what we were working on with Safran is all highly differentiated technology. So we would be using -- they would be using our advanced technology.

Got it. Thank you very much.

(Operator Instructions). J.B. Groh.

I was wondering on -- you've given some good detail on the 777X and expectations for hopefully increased content on new LEAP. Can you maybe talk about potential structural opportunities with some of these other derivative aircraft coming out? I don't know if the A330 is an opportunity. Maybe talk about how you are [going] on the structural side, outside of the Safran relationship.

Well, on engines, what you saw with the 9X engine is really how our future is likely to play. We'll either be on Safran engines, or on engines on which Safran is the revenue risk-sharing partner, as it is on the 9X. So we will follow them. As far as I know, they are not -- at least on the fan module -- going to be an active player on the 330neo; so, as a result, we wouldn't be. I think they've got a small part in it, but it's not any portion of the engine that would be relevant to us.

As you hear about other re-engining opportunities, the shorthand way of figuring out if we have an opportunity for it is watch how hard Safran tries to bid on being a partner on the engine, a risk-sharing partner on the engine. Off the engine, we are working aggressively with the major OEMs for the airframe, and with Tier 1s on the airframe. And I think the question there is -- when, not if. And that when depends heavily on how aggressive they are with their platform derivatives.

We're not seeing -- I'm sure you are not seeing -- any noise right now about a whole new platform, which is when the floodgates of real opportunity open up. We're not seeing any noise about that right now until sometime next decade. So most of the work on the airframe is on derivatives: an extension of the A350 or the 787-10. And whether or not we are able to get on those will depend on a variety of factors. But I think that big factor is going to be, do they have a weight problem? If they do, then we have an opportunity.

We're certainly working with them on both -- on all of the -- on the major OEMs and on the Tier 1s, on airframe applications. And we're optimistic that it's going to be a wave of opportunity after LEAP 2. And it will be interesting to see if we're able to get on any derivatives of the main airframes in a more incremental basis this decade. It remains to be seen.

Okay. So I guess since most of these derivatives, the gains come from the engine area, that's probably where you are going to -- most likely place for you to be?

Yes, the 777X is a great example. Boeing is very deliberately trying to minimize the amount of risk it's taking on that plane. The CEO of Boeing keeps referring to -- no more moonshots this decade.

Yes.

And you could understand why. All the OEMs are now trying to get the return on the investment from the last wave of big change. And so that makes it tougher to break onto any of these derivatives with new technology. But, again, this is all a function of the competitive environment. And as you know, the competitive environment can change fast. And more competition is good for opportunity, from our point of view.

And, Joe, maybe lastly, could you give us maybe an update on your thoughts on the non-aerospace opportunity? I know you've talked about some markets in the past. Any progress there that's reportable?

We're still in probe mode. And we are -- the efforts we've had to develop a side-impact beam that is as effective as a metallic side-impact beam, but 20% to 30% lighter -- that's proving out. And so we continue to explore, with a partner in the automotive space, potential applications at the high end of automotive. And we'll know a lot more by the end of this year or early next year. But I think at this stage, we are making prototype structures, but it's really to take to potential customers to see if we can get them interested. So we're still in the mode of a probe.

Got you. And then lastly, (technical difficulty) that the inventory, there's no adjustment made on your adjusted EPS for that, right? That's just the cost of goods sold, correct?

Yes, that's correct, J.B. It's not adjusted in that chart.

Right, good. Okay, thank you.

And at this time, there are no further questions.

Okay, thank you, everyone. Thanks for participating on the call. And we will, as always, see you in the weeks and months ahead at the various conferences. Thank you.

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