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Albany International Corp. (NYSE:AIN)

Q1 2010 Earnings Call

May 6, 2010 9:00 am ET

Executives

Michael Burke – Senior Vice President and Chief Financial Officer

David Pawlick – VP and Controller

Joseph G. Morone – Chief Executive Officer and President

Analysts

Jason Ursaner – CJS Securities

Ned Borland – Next Generation Research

Paul Mammola – Sidoti & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the first quarter earnings call of Albany International. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. At the request of Albany International, this conference call on Thursday, May 6, 2010 will be webcast and recorded.

I would now like to turn the conference over to Senior Vice President and Chief Financial Officer, Michael Burke, for introductory comments.

Michael Burke

Thank you, operator, and good morning everyone. Before starting the call with some opening remarks by Joe, just a couple of brief housekeeping items. First thing is please refer to our detailed press release that we issued last night regarding our quarterly financial results and with particular reference to the Safe Harbor notice that’s contained in the text of the release about forward-looking statements. 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 that we’re going to have this morning.

For a full discussion, please refer to today’s earnings release as well as our SEC filings, including our 10-K. Finally, as a reminder and for those new participants listening to our earnings call, following Joe’s brief opening remarks, we’ll go straight to the question-and-answer portion of the call. So with that background, I will now turn the call over to Joe Morone, our Chief Executive Officer of the company.

Joseph G. Morone

Thanks, Michael. Good morning, everyone. That seasonal affect that we talked about in Q4 hit us hard in January. In fact, January was the weakest sales month in memory and that had the effect of dragging down our overall sales in the quarter back to Q1 2009 levels. But apart from January, the trends in the quarter were good. Sales improved sharply as the quarter progressed and orders were strong, both relative to Q1 2009 order levels and relative to Q1 2010 sales levels.

Profitability was strong, again, up several quarters in a row. We’re seeing strong profitability, which certainly gives us confidence that the profitability levels we’re seeing are sustainable. Let me just try to give you a little bit of clarification on how we’re measuring profitability. As we are coming out of recession and as we are pretty much completed with the three-year restructuring program, we have made the deliberate shift back to more traditional measures of profitability.

So we are comparing profitability from year-over-year, so quarter 1 to quarter 1, and our measure of profitability is now EBITDA adjusted only for two items, GAAP-based restructuring and any extraordinary gains or losses in non-operating income from things like sales of buildings or, as was the case in Q1 2009, gain from the buy-back of our bonds. So on that basis, EBITDA only adjusted for GAAP-based restructuring. EBITDA in Q1 2010 was $29 million compared to $16.5 million in Q1 2009.

Now that $29 million EBITDA in Q1 2010 does include about $5 million of costs that are the lingering effect from the restructuring program, idle capacity, equipment relocation, SAP. If we were to go back to the measure of profitability that we’ve used for the past three years, EBITDA adjusted for all of the costs associated with restructuring the performance improvement, then that $29 million in Q1 2010 becomes $34 million, and that $16.5 million in Q1 2009 becomes $25 million, so $34 million versus $29 million against relatively flat sales. So however you slice it, $29 million versus $16.5 million in adjusted EBITDA or $34 million versus $25 million, the old measure of adjusted EBITDA, it’s a strong profitability particularly in the context of flat sales.

Now the one question that Q1 2010 doesn’t answer for us because of that January affect is what’s the new post-recession normal for sales? We think Q2 should give us a pretty good indication of both the sales trends and the order trends. The sales trends in Q2 are not affected by any negative seasonal effects the way the sales are in Q1, and orders by Q2 should be free of any of the inflationary effects that might have affected orders in Q1 because of inventory restocking after the recession at the beginning of the year by our customers. So Q2 should give us a pretty good indication of, at least for the short term, post-recession normal sales. So overall, Q1 was an encouraging quarter and we all think Q2 should give us a much better feel for the post-recession short-term revenue outlook.

With that commentary, let’s turn to your questions.

Question-and-Answer Session

Operator

(Operator instructions) First on the line is Jason Ursaner – CJS Securities.

Jason Ursaner – CJS Securities

First, I just wanted to make sure I’m clear on atypical expenses. If I’m looking at it from an apples to apples comparison, there’s $3.7 million that would have been adjusted in COGS for this year versus $5.1 million for last year or $7 million for last year?

David Pawlick

Jason, it’s Dave Pawlick. Last year, the number was $7 million. That also includes some under-utilized capacity in the Asia plant.

Jason Ursaner – CJS Securities

You mentioned in the press release that order trends in Asia have increased 64%. I would assume the under-utilized capacity there since we didn’t mention it is getting better?

David Pawlick

Yeah, last year we were very much in startup mode in that plant and we’re out of startup mode.

Jason Ursaner – CJS Securities

You talked about a weak January and mentioned sales improving sharply as the quarter progressed. Was this a week-to-week trend, month-to-month? Have you continued to see this into April and into May?

David Pawlick

We do track week-to-week, but think in terms of months. The month-by-month sales progression improved strongly as the quarter progressed. We haven’t really gotten into talking about Q2 results until after the quarter and we’ll leave it at that. But as I said, Jason, the trends both on the order side and on the sales side were encouraging.

Jason Ursaner – CJS Securities

And is it by all the geographies? I know Asia was showing stronger growth.

David Pawlick

The trends, including the January trend, were remarkably consistent across businesses and across geographies with the possible exception of China, which was just strong. It was a remarkably consistent effect across the board in everything, sales trends, order trends, profitability trends.

Jason Ursaner – CJS Securities

Good. And just in engineered composites, we’d seen a better operating income. This quarter it dropped back to that $2 million loss. I thought we had changed the accounting for research and development, so is this really seeing a ramp in expenses that need to be incurred, kind of a front-end buildup?

David Pawlick

This has nothing to do with R&D. This is really the effect of slower sales at the beginning of the quarter. At the same time, they were ramping up our costs in anticipation of a sharp increase in output and sales. There is nothing unexpected there or surprising.

Operator

Next we go to Ned Borland – Next Generation Research.

Ned Borland – Next Generation Research

Good morning, guys. I did not see in the release any mention of competitive pricing pressures or anything surrounding certain negotiations with customers. Are we to assume that demand is now strong enough that this becomes much less of an issue, or did something develop?

David Pawlick

The contract negotiations that we’ve alluded to before are ongoing, and customers’ schedule is to get them done this quarter. So there is nothing to report. The best way to look at the competitive pressures is to look at the trend of prices on orders. Whether you look at prices for sales or prices for orders, they were pretty stable across all geographies, which is encouraging. That said, I have to give our disclaimer that we always give. The underlying structural conditions, particularly in Europe, there is overcapacity in the paper industry, there is overcapacity, at least from an equipment point of view, in the P&C industry. That hasn’t changed. But we’re seeing, in the near terms, stability.

Ned Borland – Next Generation Research

Okay. And then with regard to restocking versus sort of demand recovery, it sounds like you saw a fair amount of restocking in the first quarter. How long does the restocking process generally last by your customers?

David Pawlick

Well, we’re not really sure what we’re seeing and that’s why we want to wait for Q2 to get a better fix on the trends. Ordinarily, orders are strongest in Q1. But we’ve [controlled] for that by comparing Q1 to Q1. The reason we are a little hesitant to take the absolute level of orders from Q1 to the bank is we’re coming off this incredible recession and it could well be, more likely than not, that there was a certain amount of restocking of inventory going on during Q1. It’s hard to imagine that it wasn’t. We just don’t have any basis for quantifying how much that was.

Ned Borland – Next Generation Research

Okay. Well, maybe going at it from a different direction here. On your EBITDA margin, given the level of cross-reduction that you’ve pulled off here, what’s a reasonable range for excluding restructuring, what’s a reasonable range for EBITDA margin on a more normalized or pre-recession level of sales?

David Pawlick

If you take it at existing levels of sales, it’s in the $16 million to $17 million range EBITDA margin. If you got back to pre-recession level of sales, I haven’t done the math, but it’s going to be $19 million or $20 million.

Operator

(Operator instructions) We’ll go to Paul Mammola – Sidoti & Company.

Paul Mammola – Sidoti & Company

You guys obviously usually don’t report orders, so for historical context, do you by any chance know when the last time was that orders were up 23% or so year-over-year?

David Pawlick

It’s unusual. We haven’t seen that kind of comp or the kind of order-to-sales ratio that we saw in Q1 in memory. But again, we’re coming off unusual circumstances so you just have to be careful about how literally to take those results. In Q1 2009, we were heading into recession and we had falling orders the following quarters. The trend is exactly the opposite now. We’re coming out of recession, so it’s clearly an encouraging trend. But you don’t want to go overboard here, and we’re not going overboard.

We really think we have to wait for another quarter, this quarter, to the extent that there were abnormal inflationary effects on our order levels because of post-recession inventory restocking. That should have pretty much washed through by Q2, so we’ll have a much better indicator of where we are. It’s encouraging, but how encouraging, we’d be a little cautious about taking that… It’s an encouraging directional trend. Don’t take it for more than that at this point.

Paul Mammola – Sidoti & Company

Okay, understood. If you could go to Europe and kind of give us a sense of what’s happening order-rate wise there and also comment on, if you have it, what specifically you have taken the production footprint down to. I think Sweden or Switzerland was down 60%, Germany down 25%, but I don’t have a number as a whole. So just those couple things to get a sense of what’s going on there.

David Pawlick

Paul, I’m not sure where you got those two numbers from. Our manufacturing footprint in Europe is now in [PMC]. A large plant in Sweden, which from a production point of view is our largest plant in the world and also is one of our two primary centers for global R&D, a second plant in France where we do forming production primarily, and a small plant in Germany where we make press fabrics, and our one plant in England where we make [inaudible] for the entire world. There were, before recession, three other plants in Europe which we have since shut down. So we basically halved the capacity in terms of numbers of plants in Europe.

Paul Mammola – Sidoti & Company

Okay. Finally, in aerospace, as it pertains to the competing Pratt & Whitney engine compared to the LEAP-X, was that always there or is that competing engine kind of coming out of nowhere all of a sudden? Is there any update as to what you guys have seen in terms of that landscape lately?

David Pawlick

The Pratt & Whitney engine is the gear turbo fan and it’s always been there. It’s been there in development by Craft for at least the last three or four years and probably longer. But to set the scene for you, the two dominant single-aisle aircrafts, not including the new entry by the Chinese, is the Boeing 737, the Airbus 8320 and the related family, 8319 for example. Pratt and the GE Snecma JV have shared the Airbus market, and the GE Snecma JV have had 100% of the Boeing market. That’s the starting point. So the LEAP-X is intended to replace the engine that basically covers half of the Airbus and today covers 100% of both.

The decisions we’re all waiting for are, first, is Airbus going to decide to re-engine, and if so, is it going to continue with the 50/50 arrangement between Pratt and GE Snecma? Second, will Boeing follow suit? If it follows suit and decides to re-engine, will it continue with 100% to the GE Snecma JV or will it let a second contender in? The three contenders are GE Snecma JV, Pratt and Rolls. Pratt and Rolls have been working together in a JV themselves but they haven’t come up with a common engine, so it’s more likely that it’s either Pratt or Rolls, but not a combined engine. They each have their own contenders. Pratt contender gear turbo fan is not new news. It’s about as new news as LEAP-X is.

Paul Mammola – Sidoti & Company

Okay. That’s helpful. I think you guys have talked about 1,000 units per year opportunity. I was curious if 1,000 units 737 or 1,000 units 737 and 8320 combined?

David Pawlick

The 1,000 unit number is our estimate based on market data of what the size of the current market is for the CFM engine, that is the engine produced by the GE Snecma JV. So that’s roughly their current rate of production. Those engines go on the Boeing 737 and on the Airbus 320 in the manner I described before. So that’s the current annual production rate of CFM engines. Those are the engines that are intended to be replaced by LEAP-X.

Paul Mammola – Sidoti & Company

Okay, perfect. And then just to clarify, the LEAP-X has really no impact on the projected, say revenue double and EBITDA break even over the next 8 to 10 quarters?

David Pawlick

LEAP-X production does not. LEAP-X development does. That is, revenue in our composites business is partially production revenue and partially revenue from development funding. The development funding for the LEAP-X is increasing as we get closer to production.

Operator

We do have a follow-up from Jason Ursaner – CJS Securities.

Jason Ursaner – CJS Securities

Just a couple of follow-ups. You mentioned orders versus sales before. Can you talk about how long the process takes for orders to flow through to revenue?

David Pawlick

It varies with market and with business. In Europe and Asia, it is a relatively quick process and it usually washes through in a quarter or two, but not more than that. In North America where there are different kinds of inventory practices, it can take substantially longer than that. It can take two to three quarters. We’re talking about PMC, and in both instances, the way we think about orders is they really are a directional indicator.

It is a complex multi-variant regression problem to try to predict sales precisely in PMC. Orders are one of the variables, but not the only variable. There is still a wide range of variability beyond orders when you’re trying to go from orders to sales. What we always say is treat it as a directional indicator. If orders were going down, that would be a directional indicator that sales are heading down. If orders are going up a little bit or are relatively stable, then the directional indicator is sales will be stable and if orders are going up, that’s a directional indicator that is hopeful.

Jason Ursaner – CJS Securities

Great. And now that restructuring is complete, you mentioned disproportionally larger improvements in EBITDA. Can you try and walk us through how incremental margins for the various business lines might look?

David Pawlick

Well, you can almost get that at the gross level by looking at the data in the release and also by looking at the operating income margins that are suggested in the release. You’re getting pretty good indications. There’s still that $4 million, $5 million of lingering restructuring effect and, by the end of Q3, they should be gone. So the operating income by division that you are seeing in the release will be a pretty good indication of what the sustainable operating margins are.

Jason Ursaner – CJS Securities

But in terms of the incremental flow-through?

David Pawlick

What I’m trying to say, if you look at Table 2 and Table 3 in the release, is that operating income and we’ve tried to show how you would have to adjust operating income by unit in order to correct for GAAP-based restructuring. And then you know we have these additional charges and they’re almost all associated with PMC. Not all, but almost all. So you can get a pretty good sense of the run rate that we’re expecting for operating income margins from that data.

Jason Ursaner – CJS Securities

I guess maybe trying to look at it in another way. You mentioned closing three of the facilities in Europe. If you had a $20 million increase in orders, would you have to create capacity? How much head count might you have to add? What type of expenses would need to come back?

David Pawlick

We’re still in the mode of expecting a high fixed cost leverage. There might be some increase in variable labor but incremental sales should lead to disproportionally higher incremental EBITDA.

Jason Ursaner – CJS Securities

Okay. And just a quick one on [AEC]. The press release mentioned several key programs. Are any of these programs that we haven’t previously talked about?

David Pawlick

No. The sharp ramp-up that we’re anticipating comes from the familiar programs, from the landing brace ramping up, from LEAP-X development ramping up, from the joint strike fighter ramping up and from another program that we’ve mentioned which is the outer guide vanes for the existing CFM engine that’s ramping up as well. The short-term growth is really being driven by those familiar programs.

Jason Ursaner – CJS Securities

Okay. Just for the LEAP-X that you mentioned that’s a 1,000 unit estimate based on the market and you’ve given before a lower [bound] for revenue content and about $100,000, can you try and go through a little bit of detail on the LEAP-X as it continues to develop and where it got selected as Commack has already selected it versus the future developments that are still ongoing with that?

David Pawlick

Well, there are three pieces of the puzzle. Commack, the new Chinese entrance into the single-aisle aircraft model, was announced in December and that’s what launched this whole flurry of interest in LEAP-X because they picked LEAP-X so that meant the LEAP-X program definitively had to be launched, which means a scramble now between now and 2015 to finalize designs, get certification, ramp up production, get up the learning curve.

So that’s piece number 1. Now, piece number 2 which should be announced one way or the other this quarter or at the very latest at the Farnborough Air Show in England in mid-July so before our next earnings call, that piece is Airbus’ decision on whether it will re-engine and who it will pick for the re-engining if it does re-engine.

The third piece of the puzzle as we’ve talked about before is Boeing. It’s really hard to imagine Boeing not deciding to re-engine if Airbus does. So then the question would be if Airbus does decide to re-engine, Boeing is expected to follow suit later in the year and then we’ll have the same question again. Will they pick one engine or two? I don’t know if I’m answering your question because I’m repeating what I know you already know to be the case.

Jason Ursaner – CJS Securities

Well, I guess I’m trying to ask about the revenue content.

David Pawlick

The revenue content, how many engines is the CFM joint venture going to be making? How many LEAP-X engines will they make? And the answer to that question depends on these re-engining decisions. And the second question is how much revenue content will we have per engine? We can’t give you a better or different estimate from what we gave you last quarter, which is substantially in excess of $100,000 per engine, because we haven’t completed our negotiations yet.

Operator

We do have a follow-up from Ned Borland – Next Generation Research.

Ned Borland – Next Generation Research

Just a quick one on what’s going on in China. We’ve heard there’s some paper companies out there that are making projections that will essentially quadruple paper-making capacity, some select companies are saying this, by 2015. In your discussions with customers over there, how are you assessing what’s actually going on with capacity over there?

David Pawlick

Well, it’s a hot market for sure, but I hadn’t heard the quadruple number. That’s new news for us, which is great news, but we haven’t heard it. The best number I can give you is worldwide, the best estimates we have seen worldwide new machine construction will grow at about 3% per year. Now, if you ask where is this new machine construction taking place, most of it is taking place in China and Asia. So it’s a highly concentrated rate of growth, but in the aggregate worldwide, it represents about 3% of machines.

Ned Borland – Next Generation Research

Okay, but that nets out closures, does it not?

David Pawlick

No, that’s just new machine building. If you look at current new machine activity, it’ll continue at its current pace plus 3% per year. That’s got nothing to do with paper production worldwide. In paper production worldwide and all the projections we see, traditional industry sources say on the order of 1% to 2% per year worldwide with declines in North America and Europe in the printing grades and stability in the packaging grades and G&P growth and the tissue grades in North America and Europe and in growth in Asia and South America. We haven’t seen any new news on that front. All the evidence we see is consistent with the picture we’ve been painting.

Ned Borland – Next Generation Research

Okay. And then competitively, has there been a new entrance into the Asian market, the Chinese market?

David Pawlick

Not that we have seen, no.

Operator

We do have a follow-up from Paul Mammola – Sidoti & Company.

Paul Mammola – Sidoti & Company

Hey, sorry to jump back in. On the tax rate, obviously it costs a few cents in the quarter. What’s pushing that up and what do you expect for the year?

Michael Burke

What we talked about on the release looking forward is the current rate at 34.5%, and there are a couple of things to remember. One is that we emphasize that the changes to the effective rate for GAAP purposes, it really does not have in our view, is it going to have a material effect on a cash basis on the rate going forward? So you need to consider that when you’re thinking through your assumptions this year for 2010.

And as we’ve said, we’re continuing to focus on specific objectives that we have, planning outcomes that we think under those actions, as we work through them, will have a beneficial effect on the overall effective rate if we think beyond 2010. There were three specific items that we mentioned in the release. One in particular is probably the largest of the effect. It has to do with the temporary loss of an ability to use a tax shelter if you will relative to losses that we are incurring. So as we work through our appeals processes and as we work through those tax initiatives, we’re confident as we think beyond that that rate will come down after 2010.

Operator

We have no further questions in queue. I’ll turn it back to presenters for any closing comments.

Michael Burke

Thank you all for your questions. As I mentioned, Q2 is going to be an interesting quarter and a revealing quarter and we look forward to talking to you at the end of Q2, if not in between. Thanks. Have a good day.

Operator

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.

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Source: Albany International Corp. Q1 2010 Earnings Call Transcript

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