Albany International Corp (AIN) 2014 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 4, 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, 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 Form 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 Q3 2014 earnings call. As usual, I will open with a summary of the quarter and then John will review the results in more detail. I will follow with a quick overview of our outlook and then we will go to your questions.

Although adjusted EBITDA improved by 5% compared to a year ago and AEC performed well on all fronts, our performance in Q3 2014 did not meet our expectations, because of soft sales in machine clothing. However, we do not see this soft Q3 as an indication of any sort of structural change in machine clothing and we expect good year-over-year performance in Q4 for both machine clothing and AEC.

For the most part, machine clothing performed as we had expected. Sales and margins reflected normal Q3 seasonality and Europe and Asia were once again stable.

The shortfall came in the Americas. As we have discussed on numerous occasions, we are underexposed to the publication grades in North America. Our long-term model of study cash flow assumes that we will get enough growth in South America and in the packaging and tissue grades in North America to offset what we all realize is an inevitable structural erosion in the North American market for the publication grades.

In Q3, that North American publication market suffered a larger than normal year-over-year decline. Meanwhile, in the growth segments that we count on to offset the declines in the publication market, North American packaging and tissue grew in line with our expectations, but South America did not.

It was hurt by the weakening Brazilian economy and even though our competitive position remained very strong, our sales in South America dropped more than 10% on a year-over-year basis. It was the combination of a decline in one of our key growth markets at the same time that we were hit with a larger than normal decline in one of our shrinking markets that accounted for the Q3 weakness.

Several other Q3 developments in machine clothing bear mention. First, we reached a successful conclusion of contract negotiations with Europe's two largest papermakers. Despite strong price pressures, we were able to hold our position with no significant impact on revenue, thanks to the recognition by our customers of our superior performance and technology.

Second, despite the soft sales, gross margins improved and adjusted EBITDA held steady compared to Q3 2013. And third, orders were strong in the quarter and ahead of orders for the comparable period last year. Shipment activity at the end of the quarter was also strong.

As for AEC, it performed well financially in operations and in R&D. Adjusted EBITDA, which includes rapidly growing R&D spending, improved to breakeven compared to a loss of $1.6 million last year.

The LEAP engine test program is proceeding well. LEAP orders have now climbed to over 7,700 engines, and we continue to make steady progress in preparing for the ramp-up that begins in the second half of 2016.

Our operations in Boerne, Texas, also performed well. And we are encouraged by progress in R&D as we expand our engagement with existing and potential new customers on possible applications for both aircraft engines and airframes.

Also based on positive results from market research, design studies, simulation, and testing, we have decided to accelerate our efforts to break into the high end of the automotive industry and have begun to significantly expand this R&D activity.

That's a quick summary of what we saw for Q3. We will now turn to John, who will review the quarter in a bit more detail.

Thank you, Joe. I would like to refer you to our Q3 financial performance slides. Starting with slide 3, net sales by segment, total year-over-year net sales in Q3 decreased 1.3%, excluding the effect of currency rate changes.

On the same basis, MC net sales declined 2.5%, while AEC net sales increased 8.3%. The decrease in MC sales was mostly due to lower sales in the Americas, as Joe discussed, while the increase in AEC reflects growth in the LEAP and joint strike fighter lift ban programs.

Total Company gross margin percent, as shown on slide 4, increased to 38.2% in Q3 compared to 37.1% in Q3 of last year. MC gross margin improved to 41.9% in the quarter, compared to 41.6% in the same period last year, despite the lower year-over-year sales.

On a year-to-date basis, MC gross margin of 43.1% for the first nine months of 2014 is comparable to the 43.2% gross margin in the same period of 2013. As discussed in the past, MC gross margin is typically lower in Q3 compared to the first half of the year due to seasonal slowdowns.

Moving on to earnings per share on slide 5, we reported net income attributable to the Company in Q3 of $0.37 per share compared to $0.15 per share in the third quarter last year.

Foreign currency revaluation gains and losses resulting primarily from the revaluation of nonfunctional currency in cash balances, accounts receivable, and intercompany loans had a significant impact on the year-over-year comparison, as Q3 EPS includes income of $0.08 per share for reevaluation compared to a loss of $0.06 per share in Q3 2013.

Other EPS effects in one or both periods related to discontinuing operations, restructuring, tax adjustments, and an insurance recovery gain are noted on the slide. Excluding the effect of the adjustments, EPS this quarter would be $0.31 per share compared to $0.24 per share last year.

Slide 6 provides adjusted EBITDA details for Q3 2014 and 2013. Adjusted EBITDA in Q3 2014 increased to $33.5 million compared to $31.9 million in Q3 last year. MC adjusted EBITDA and corporate expenses were essentially flat in the quarter compared to last year, while AEC adjusted EBITDA improved principally due to the improved profitability at our Boerne, Texas, operation.

Year to date, total Company adjusted EBITDA improved to $108.5 million compared to $101.8 million for the first nine months of 2013.

Slide 7 shows our change in total debt and net debt. During Q3, total debt declined marginally to $284 million. Net debt -- total debt less cash -- increased $10 million to $88 million, as cash was negatively impacted by about $7 million due to changes in foreign currency rates as compared to the end of Q2.

Finally, as discussed in the release, certain participants of the US pension plan were notified of a limited time lump sum opportunity. Lump sum payments from pension plan assets are expected to occur before the end of the year. Depending on the number of participants that elect to take the lump sum payment, we expect to record a non-cash settlement charge of about $5 million to $10 million in Q4.

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

Thanks, John. So turning to our outlook, we expect a strong Q4. In machine clothing, the strong Q3 orders, strong shipment activity at the end of the quarter, better margins in Q3 than last year, and a healthier packaging market in North America than last year all suggest that even with a weakened Brazilian market, we expect Q4 MC sales to be comparable to Q4 2013 sales and Q4 MC adjusted EBITDA to outperform Q4 2013 adjusted EBITDA.

We continue to expect full-year machine clothing adjusted EBITDA to be comparable to last year. And we continue to view global economic conditions as our primary risk factor in this business.

Our outlook for AEC is for strong fourth quarter, as our second LEAP plant, located in Commercy, France, begins to come online. We continue to expect full-year AEC sales to be roughly 10% ahead of full-year 2013 sales.

So in sum, even though adjusted EBITDA improved by 5% compared to a year ago and AEC performed well, Q3 fell short of our expectations due to the soft sales in the Americas machine clothing. In Q4, we expect both businesses to outperform Q4 2013 and we continue to expect full-year machine clothing adjusted EBITDA to be comparable to last year and full-year AEC sales to be roughly 10% ahead of full-year 2013 sales.

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

(Operator Instructions) Jason Ursaner.

Just for the MC segment, a lot of the questions I have are pretty similar to the previous couple of quarters. The stability in Europe -- it seems like a very good thing that the region continues to hold its own, just considering some of the other various potential outcomes.

So just two things there. One, how does the overall capacity picture look to you, Joe? And then second, the two major contract negotiations that were successfully completed. What, if anything, does that do to change the outlook for you in Europe?

I think the short answer is while there are changes at the margin, the overcapacity -- the structural overcapacity in our industry in Europe is unchanged. So there's some capacity at the margin going out, but it's got to go out at a pretty rapid rate, given the state of the European economy and the overcapacity in the paper industry. So I would say basically no change.

We've been trying to suggest for the last couple of -- last year, at least, that even though there wasn't any structural improvement, that, for the moment, we felt -- while there's always price pressure because of that structure, that the real short-term risk factor in Europe is macroeconomic and we are still there.

The successful conclusion of those big contract negotiations reinforce that. And we got hit with a lot of price pressure, but we were able to hold our position. And I think the -- for the short term, our outlook in Europe continues to be driven by what's going on with the European economy for the long term. Right now, not much is going on with the European economy.

For the long term, we're still in the same place as we've always been. We need enough growth in the growth markets of Asia to offset what we think is inevitable -- steady, structural decline in the paper industry in Europe. So I would say no change in the stability plus the outcome of these contract negotiations reinforces that.

Okay. The largest producers there, though, they seem to be managing pretty well, just given that there is some of this overcapacity. Is it -- I guess when you look at their performance, is it possible to -- even if some capacity comes out over time, it really isn't going to impact your business from this point very much.

Yes, UPM and Stora are the two big producers that we're talking about -- Stora Enso. And they have been aggressively taking out cost, which I think more than anything helps to account for their improved performance. The fundamentals remain the same.

As with every developed market, the publication grades are -- will inevitably erode. And the companies that have bigger -- that have more assets invested in those publication grades are the ones that are going to have to struggle with matching demand -- market demand to their capacity over time. And that hasn't changed.

Okay. And on the other side, in Asia, the stability there, not such a great thing. What do you need to see growth return there? Is it local demand, is it stronger exports, and how close do you see that market to coming in balance with the capacity that's been put in?

I think the -- it's -- demand and capacity aren't that far off. The issue is we need domestic growth there. And that's why we keep saying that really, this -- the way we have structured this business, we are really set up to follow the business cycle.

And over the course of a normal business cycle, we should outperform on the upside and underperform on the downside. But over the course of the business cycle, we should be flat. And that means those growth sectors in North America and South America are offsetting publication and growth in Asia offsetting declines in Europe.

What's been interesting over the past year is a stage in the business cycle where we should be seeing better than normal growth in the economies. We're seeing very weak growth in Europe and Asia and now South America.

So that's why we keep saying our number one risk factor is macroeconomic. And you tell us when the domestic economy -- domestic G&P in China starts picking up and we will then be able to tell you when our sales will start picking up in Asia.

They are very tightly tied. They're even more tightly tied than they used to be, because order cycles in our business have gotten so short that you really -- and the economic activity -- macroeconomics of a quarter will dictate how well we do in that quarter. There is no more -- we are no longer a leading indicator or a lagging indicator.

Right. And that was actually just my last question -- that the order cycle shortening, just overall visibility for you. It does seem a lot shorter than it used to be. When you're looking at Q4, other than the pickup you saw at the end of the past quarter, is there anything else driving the outlook for a strong conclusion to the year based on what you're seeing in inventory or capacity, just given that it does have some seasonal variance?

Right. In general, we are able to see out 6 to 8 weeks.

Okay.

We are able to look into at least the first half of December now.

Okay. Sounds good. I'll jump back in the queue. Thanks, Joe.

John Franzreb.

Joe, actually I want to start with one of the last things you said in your prepared remarks. Did you actually say the AEC you expect to be up 10% year over year? Was that on a quarterly basis or on a full-year basis?

Full-year basis.

So you are looking at a rather substantial step up in revenue in Q4. What is driving that?

Well -- so yes, your interpretation is correct. And what's driving it is our second plant has now come online and there was a lot of inventory that was building up there and that's going to -- that should -- there was never a guarantee, but that should flow through in Q4. So we will get a bump that will catch us up to what we originally expected for the full year.

Okay. And is that a sustainable kind of a run rate going forward?

No, I think the way to think about it is if you take the full year and average it out, you will get our run rate.

Okay. Okay. All right. And on the pricing of the new contracts, you said there was -- it was an aggressive pricing environment. So on an apples-to-apples basis, should we be thinking of a lower gross margin profile for PMC over the near term?

I don't think so. If -- I think if we're in the range we've been in with -- I think we said 43% year to date, I think that's the range we should stay in. In order to stay in that range, we just need to keep beating inflation year over year. That's the primary task for us.

Okay. All right. You mentioned also a step up in R&D spend to address potential high-end automotive applications. When has that step up commenced and how high do you think R&D will get in the coming year?

I think if you look at the Q3 run rate, that might be a little high going forward through next year. Maybe at about that level.

Okay. And one last question, and John, this one is for you and I'm sure we're going to love it, but I would love for you to actually walk through the impact on the euro -- on the P&L changes, especially since it seemed to have a pronounced impact on the SG&A line in the quarter. That might be helpful if we review that in the public domain.

Yes. So as I said when we were reviewing the slides, we basically had a $0.14 swing when you compared Q3 last year to Q3 this year due to revaluation. So what we're talking about here for our Company -- it's mostly related to our non-US entities and it's mostly related to our euro-based entities.

And those entities have balance sheet items, so I talked about cash and trade accounts receivable and intercompany loans. They have balance sheet items that are non-euro based. So it's the revaluation of those assets and liabilities back to the euro that creates the revaluation.

Now that easiest marker to look at is what happened to the euro versus the dollar compared -- from June 30 to September 30. So remember, we are revaluing at a point in time.

And it basically dropped 80% against the dollar. Now revaluation is going to be the euro against the dollar and other currencies, but that's a significant drop for any currency. But particularly for us, having euro-based entities.

So the close to $4 million of total revaluation gains that we recorded throughout the income statement was basically due to that weakness in the euro as of the end of September. And it's related to the translation of those nonfunctional currency assets and liabilities.

Okay. So as we look forward, for modeling purposes, do we hold the status quo here and hold our breath or what do we do?

I think the one point that I should add is one of the reasons that -- we started calling this number out years ago -- a few years ago, whether it was big or small, because for us, these type of exposures don't really have much of an economic impact on us.

So in our view, we think to get a better understanding of the operations for each quarter -- it's at least good for everyone to see them and we either add them or subtract them when we look at our adjusted EBITDA.

When you model going forward -- I can just tell you what we do when we look at it is really -- it's not very useful to model it. You assume -- you have a euro right now that's under $1.25.

It certainly could go lower, but there's so much speculation as to what direction some these currencies can go in, I don't really see it as a good exercise to try to make a guess, whether it's going to go up or down. So typically for modeling, you just hold -- you just assume revaluation is not going to be part of the results.

Okay.

If it had an economic effect, John, then we would treat this differently. But it's not really having a --

No, I just wanted to get it out there, guys, concerning how much the euro moved and how much impacts everything. But I just wanted -- I wanted John to get some talking.

This is really the primary reason we do adjusted EBITDA is because the swings can be -- every once in a while, they are as big as they were this quarter. And it just --

Right.

It distorts economic reality.

Right, right.

In our opinion.

Okay, guys. Thanks. I'm going to get back into queue and someone else in -- all right.

Steve Levenson.

Can you tell us a little bit about -- a little bit more about the auto applications. And forgive me, does high-end auto mean expensive cars or expensive applications on the kind of cars most of us drive?

Well, I don't know what kind of car you drive, but it's not the kind of car I drive. No, we're talking about the very high performance and -- the Lamborghinis and the McLarens and that sort of thing as an entry point to break into the industry. We -- as I think I've mentioned, we built a composite -- 3D woven composite side impact beam.

And we -- just a very rough one. It wasn't optimized in anyway. We then tested its crashworthiness, if you will, and its weight against an actual metallic side impact beam.

And what we've learned through the testing, through simulation and analysis as well is that the 3D woven composite side impact beam, which hasn't been optimized, absorbs almost as much energy with a lot less weight. So it's almost as crash resistant, even in this very early state, and it's much lighter.

So at the same time, we were engaged with a partner in the automotive industry looking at potential applications and we've concluded it is worth going the next step in a serious way. And the next step is we will now try to make -- we will now make some generic sample parts. And with those generic sample parts, we will approach some of the OEMs at the high end and see if we can get some business.

Now it really is first wave of breaking into this market and we will see over the next couple of years if we can land a contract or two. They wouldn't be huge contracts, but they would be -- they would open the door for us to this industry. That's what we're trying to do.

And presumably, if there was a less expensive material to work with that performed the same, it would open up the market to high-volume vehicles as opposed to the high price vehicles.

Yes, I think the ideal -- if you really want to look at the optimal scenario, it would be that we would wind up with a couple of applications that are really relatively small volume, high end, and are just demonstrating the capability of the technology. And then it becomes a matter -- how fast we penetrate would be entirely a function of how far we can get price down.

Okay, thanks. And in terms of developing those parts, does that help you in any way for the light weighting efforts in airframes or do you use similar sort of parts that can be used in those applications?

That's a really interesting question. And it turns out that the technology development we will be doing, the generic technology work that we're doing to advance our efforts in automotive directly apply to our efforts to advance our capability on the airframes side.

So in that sense, there's upside to this, but is not really that much downside. The R&D will certainly be generically applicable.

Okay, thanks. Next, I was going to ask about ceramics and if you could give us an update on the testing of the tailcone and what other opportunities there might be in ceramics going forward and of course, composites -- carbon fiber-based composites to replace metallic parts and jet engines?

Well, the -- you may have read the Boeing's test and its clean program of those ceramic matrix composite nozzles have gone very well from a performance point of view. They had a flight test that went well.

And so this is a technology that looks -- a technology platform, really, that looks promising. We're well positioned on it and it's one of these cases where we are waiting for the right platform to come along.

You know that Boeing has been somewhat conservative after the 787 on rushing out new technology on to the platform that it is pushing. So as of now, we don't see any evidence that it's going to be on the next major platform, which will be the 777X.

So this is looking like an important technology for next next wave -- sometime next decade, timed with -- the real opportunity will be the next major platform that Boeing decides to launch.

We are seeing some earlier applications on the -- that would be a lot smaller and more esoteric that have more to do with military and space and we can't really get into that. On the engine, as Safran has made clear, they are actively engaged in working on ceramic matrix composites for the low-pressure turbine.

They displayed a low-pressure turbine blade made out of ceramic matrix composites at the Paris Air Show last year. And that's a high risk, high payoff activity that continues as far as we know.

Okay. Anything to do with replacing metal rings in the engine case with ceramics? I know one of your -- one of the companies that you've partnered with has filed a patent covering some of those products.

Well, I'm not familiar with specifically what you're talking about. We are working with Safran on a number of applications -- potential applications for where carbon fiber would replace metallic on future engines, for sure.

Okey-doke. Thanks very much.

JB Groh.

Kind of looking out to 2015 and I know you are not doing any 2015 guidance, but how should we expect the AEC ramp second half weighted there? It's going to ramp up with the lead production?

2015 is -- it's kind of a bridge year, because the ramp -- the entry into the service of the LEAP-1A, the Airbus version, is the second half of 2016. The entry into service of the Boeing -- the B-1B is first half of 2017. So the ramp doesn't begin in earnest until initially the second half of 2016.

So 2015 and early 2016 is all about all of the remaining milestones associated with qualifying everything and getting the yield where it is and doing production runs and locking down any final modifications to design that might pop up. But it's not going to be -- so it's going to be a lot of activity, but it's not going to show up as much of anything on the topline.

Okay, so that will be a 2016 -- early 2016 kind of thing.

I would say middle to second half of 2016 will be when the thing starts. And --

So it's almost current, but the entry into service.

Yes. You -- I think if you take -- we haven't really started talking about next year, but first approximation, if you take the run rate that -- the annual run rate that you see this year after Q4 and assume that that's more or less, give or take, what you'll see next year.

Okay. And then could you talk a little bit -- you mentioned, I think, some of the legacy business in terms of margins, but could you -- is there a way to disaggregate what was LEAP-related and what was your legacy business in AEC?

Would rather not do that. I think the closest we could come to answering that question is there is -- in a rapidly growing business like this, as you know, there is a -- we've been building up a lot of the fixed costs that become the platform -- organizational platform that we grow off.

So incremental revenue from here should be dropping through at a pretty -- at a pretty good clip. Whatever the -- whatever that business is, there's going to be -- margins should grow with incremental revenue.

Okay, that's fair enough. Thanks for the input, guys.

(Operator Instructions) Rick D'Auteuil.

Actually, both Steve and JB answered -- asked my questions, so I'm all set. Thank you.

John Franzreb.

Yes. Just one question on the capital spending plans going forward. Could you just update us on how much you expect to spend this year and what the initial expectations are in 2015?

Well, we are still -- we're not yet coming off our guidance of $60 million to $70 million a year on average. If that changes, it will be because a significant opportunity popped before the spending on LEAP started to wind down in 2018, 2019.

That far out before we start seeing the LEAP wind down is 2018? Okay.

Yes. So I think if the guidance changes, that's basically good news. But as of now, you should count on -- continue to count on $60 million to $70 million on average.

Okay, that's fine. And just on the revenue step function when LEAP starts to roll in in the second half of 2016, what kind of magnitude should we be thinking about on a topline basis?

Well, if you assume $100,000 per shift set and 1,700 engines by 2019, and so $170 million of revenue by 2019 and we are running now at about half our total revenue. So if we go from $45 million or $50 million to $190 million and it's just basically draw a straight line from the back end of 2016 to 2019, you get a pretty good slope.

Okay.

Pretty good estimate.

All right. Thanks, Joe.

And with that, no further questions in queue.

Well, thank you everyone for participating on the call. And as always, we will look forward to seeing you in between now and our next call and talking to you more about what's going on with Company. Thank you and talk to you next time.

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 our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.