Albany International's (AIN) CEO Joe Morone on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Albany International (AIN)

Albany International Corp. (NYSE:AIN)

Q2 2014 Earnings Conference Call

August 5, 2014 9:00 am ET

Executives

John Cozzolino - CFO, Treasurer

Joe Morone - President, CEO

Analysts

Jason Ursaner - CJS Securities

John Franzreb - Sidoti & Company

Steve Levenson - Stifel Nicolaus

J.B. Groh - D.A. Davidson & Company

Operator

Ladies and gentlemen, thank you for standing-by and welcome to the Second Quarter Earnings Call of Albany International. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session; instructions will be given at that time. 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.

John Cozzolino

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 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'll provide some opening remarks. Joe?

Joe Morone

Thanks John. Good morning everyone welcome to our Q2 2014 call. As always, I will 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 will turn to your questions.

Q2 2014 was a strong quarter for the company both businesses performed well and according to expectations. There was only one complicating factor in the quarter which was the charge to correct an overstatement and 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 a 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 appear to be fully recovered from that Q4 slowdown and the Q1 weather related problems. Meanwhile, sales in Europe and Asia remain steady for this 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, CFM announced the total orders for the LEAP engine had grown to over 7500 orders and that it had raised assessment 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 GE 9X engine, which will power Boeings 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 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 a full production early next decade, this should represent $20 million to $25 million per year opportunity for AEC. So overall and across the board in both businesses, this was the 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?

John Cozzolino

Thank you, Joe. I would 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 discussed last quarter and were up 1.3% compared to the same quarter last year.

On to 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 adjustment 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 included $0.04 per share and $0.47 per share charged for restructuring respectively also 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 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. 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 net 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 GE 9X 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 would like to turn it back to Joe for some additional comments before we go to Q&A.

Joe Morone

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 an overall company adjusted EBITDA to outperform the second half of last year.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Jason Ursaner [CJS Securities]. Please go ahead.

Jason Ursaner - CJS Securities

Good morning.

Joe Morone

Good morning, Jason.

Jason Ursaner - CJS Securities

Just first on Machine Clothing, you talked about the sequential improvement, but obviously was down a little bit compared with last year and the commentary is everything between the grade and region seemed pretty solid. Just wondering was there anything particular about last year's figure or anything this year that would have led to a pretty modest top line contraction.

Joe Morone

I think the contraction is more a function of a very strong comp than usually strong comp than anything else when we look at market in the Americas, it's pretty – it's completely in line with what we are – what we have been expecting. So Q2 2013 just had everything going forward the right way, was those one of the quarters. You look sequentially as I think John mentioned. We have seen steady improvement and its right where it should be.

Jason Ursaner - CJS Securities

Was Q2 2013 though was it driven more by the Americas, or you said it a strong…?

John Cozzolino

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 America. And the Americas are performing very well; they just performed very, very well in Q2 of 2013.

Jason Ursaner - CJS Securities

Okay. Was in any particular grade or just an overall sense of the market?

Joe Morone

It is one of those quarters where everything was [humming] (ph).

Jason Ursaner - CJS Securities

Okay. And for China, what do you see there in terms of overall production capacity versus demand growth obviously, ability is a good thing but some point that region needs a resume growth it's going to be part of an offset to keep the overall business holding steady in the long-term. To just…

Joe Morone

Let's take this -- Jason 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's been steady, Asia has been steady, we haven't needed that growth to make our model work.

Meanwhile, over in the other – over in the Western Hemisphere, the way we get stability is growth in South America plus growth in packaging and 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 at North America. And right now, they are doing that.

If Europe were declining, then would 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 you can – the evidence certainly – the evidence around new machines in tissue and packaging grades in Asia, China in particular certainly supports that view.

Jason Ursaner - CJS Securities

Okay. But though – so the fact – because Europe all came out kind of at the same time though that was I guess two years ago, I mean the thought had been even then that it was going to happen over time where Asia and Europe were balancing out. I guess, you are not really looking at it as a need to catch up the – to get the business back to…

Joe Morone

No. I think we are feeling that this level of EBITDAs are baseline.

Jason Ursaner - CJS Securities

Okay.

Joe Morone

And it's been pretty again over the course of the business cycle you 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 the think of this as the base line 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 is enough overcapacity in Europe that growth in Asia will offset Europe. We still think that's the right model.

Jason Ursaner - CJS Securities

Okay. And last question, for the engineering composites, what do you see as the incremental margin right now as you are kind of hovering around what close to breakeven just because I was back in last year's Q4 before you started allocating the R&D. And on an adjusted basis it looks like nearly 100% flow through at the current run rate on revenue. So I'm just wondering how to balance fixed cost and overhead absorption.

John Cozzolino

Right.

Jason Ursaner - CJS Securities

With understanding long-term that it's kind of going to hit those traditional aerospace margins?

Joe Morone

Right. Well, the comparisons are maybe a little more complicated because we have started folding R&D in. But, 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 is 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 process 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 will put EBITDA, just to give the midpoint is 15% that's in 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 the 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 are 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 in – at full production of LEAP, so 2019 at $367 million. We have also publicly disclosed that multiple we use to get to that value was 9.5x EBITDA. So that gives you a basis for what clearly ramp LEAP EBITDA should look like. So again, if you start with where EBITDA is today, we decide R&D where EBITDA is today minus R&D. And you know where it's going to be in 2019, again, you can start modeling what the incremental drop through would be.

Jason Ursaner - CJS Securities

Okay. I appreciate all those details. I will jump back in the queue. Thanks John.

Operator

Your next question comes from the line of John Franzreb [Sidoti & Company]. Please go ahead.

John Franzreb - Sidoti & Company

Good morning guys.

Joe Morone

Hey, John.

John Franzreb - Sidoti & Company

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 like a overhanging for quite some time and maybe just bring us up to speed on your thoughts Joe.

Joe Morone

Yes. The overcapacity is systemic. It's both in the paper industry and in the paper machine clothing industry. And well, 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's still there. And there is still a fair amount of capacity that needs to pick up not on both the customer base and our industry before that that structural overhang is fixed. The way it's been largely in North and South America. That said, so despite the fact that this structural conditions haven't really changed fundamentally, we have seen stability for the last – as I said six quarters.

John Franzreb - Sidoti & Company

Okay.

Joe Morone

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 should be Asia.

John Franzreb - Sidoti & Company

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 is a couple of other coming up for bid at second half of the year.

Joe Morone

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

John Franzreb - Sidoti & Company

Right.

Joe Morone

It was a big one in Asia which we weathered.

John Franzreb - Sidoti & Company

Great.

Joe Morone

There is another one coming up at the end of the year. Again, we are not at the moment we are not raising the price risk flag, we are still in the mode of saying that our – from what we can see today the number one risk both upside and down is macroeconomic.

John Franzreb - Sidoti & Company

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

Joe Morone

Yes.

John Franzreb - Sidoti & Company

Any concerns from the customer base that we may a see reoccurrence of that event or is the chatter that you hear is that we are stable and there is no outline concerns?

Joe Morone

It really is – it's back to what we view as the major risk factor. It really is going to depend on how strong the economy is going into the fourth quarter and 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 for the second half of the year will not be as weak economically as it was last year, but let's see.

John Franzreb - Sidoti & Company

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

Joe Morone

Are you talking about MC?

John Franzreb - Sidoti & Company

I'm talking about company wide on the EBITDA on the second half year-over-year?

Joe Morone

Yes. I think it's the improvement year-over-year should come from all three categories if you back to that adjusted EBITDA table. In Machine Clothing, our margin should be a little better than last year because of the -- primarily because of cost take out. And you see they should be better primarily because of improvement in the Texas operation.

John Franzreb - Sidoti & Company

Right.

Joe Morone

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

John Franzreb - Sidoti & Company

Okay, perfect. Thank you for the color.

Operator

Your next question comes from the line of Steve Levenson [Stifel Nicolaus]. Please go ahead.

Steve Levenson - Stifel Nicolaus

Thanks. Good morning, John and Joe.

Joe Morone

Good morning.

Steve Levenson - Stifel Nicolaus

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

Joe Morone

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

Steve Levenson - Stifel Nicolaus

Okay, great. Thank you. And in the press release, I know you mentioned enhancements on the LEAP that would save 100s of pounds. Incrementally, what do you think that might mean to you and is that something that will require an engine recertification or these non-structural non-operating modifications that they can stream into the engine as production moves forward.

Joe Morone

Steve that's – it's a big question that as you know is driven more than anything by competitive factors. 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 if they – the more they push it out, the more enhancements to 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 that was a – I mean, the orders for CFM were –

Steve Levenson - Stifel Nicolaus

I think they were 2/3rds of all the engine orders at the show.

Joe Morone

And yes, if – and Pratt did not do very well in the market that we are serving, which suggest that at least for the moment some of that competitive pressures is easing a bit, but you know that can turn on the dime. So I think the answer to your question is entirely a function of how the competition – how the competitive dynamics play on.

Steve Levenson - Stifel Nicolaus

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

Joe Morone

Let's 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% what we have now.

Steve Levenson - Stifel Nicolaus

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

Joe Morone

While the potential enhancements that we would put on to LEAP performance upgrades will – they would – what we are working on with Safran is a lot highly differentiated technology, so it would be using our advance technology.

Steve Levenson - Stifel Nicolaus

Got it. Thank you very much.

Operator

(Operator Instructions) Next we will go to the line of J.B. Groh [D.A. Davidson & Company]. Please go ahead.

J.B. Groh - D.A. Davidson & Company

Hey, guys thanks for taking my call.

Joe Morone

Hey, JB.

J.B. Groh - D.A. Davidson & Company

Hey, how are you doing? I was wondering on, you gave some good detail on the 777x and expectations for hopefully increased content on new LEAP, maybe talk about potential structural opportunities with some of these other derivative aircraft coming on. I don't know, ASP 30 is an opportunity, maybe talk about how are coming on the structural side, outside of the Safran relationship.

Joe Morone

Well, on engines, what you saw with the 9X engine is really how our future is likely to play, will either be on Safran engines or on engines on which Safran is a revenue risk sharing partner, as it is on the 9X.

So we will follow that. So as far as I know they are not at least on the fan module going to be an active player on the 330 [NEOs] (ph), so as a result we would be. I think they have 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 short-hand way of figuring out, if we have an opportunity for is, 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 when depends heavily on how aggressive they are with their platform derivatives. I mean we are not seeing – I'm sure you are not seeing any noise right now about our whole new platform which is when the flood gates for real opportunity open up. We are not seeing any noise about that right now until sometime next decade.

So most of the work on the airframe is on derivatives, extension of the A350 or the 787-10 and whether or not we are able to get on those will depend on variety of factors but I think the big factor is going to be, do they have a weight problem, if they do then we have an opportunity. We are certainly working with them on both – on all of the – on the major OEMs and on the Tier-1s airframe applications. And we are optimistic that it's going to be a wave of opportunity after LEAP 2. And there is – it will be interesting to see if we are able to get on any derivatives of the main airframes in a more incremental basis this decade. It remains to be seen.

J.B. Groh - D.A. Davidson & Company

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

Joe Morone

Yes. I mean the 777x is a great example. The Boeing is very deliberately trying to minimize the amount of risk it's taking on that plane. CEO of Boeing keeps referring to no more Moonshots this decade. And you can 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 on to any of these derivatives with new technology. But again, this is all function of a competitive environment.

And as you know, competitive environment can change fast, and more competition is good for opportunity from our point of view.

J.B. Groh - D.A. Davidson & Company

And Joe maybe lastly could you give us maybe an update on your thoughts of the non-aerospace opportunity, and I know you talked about the market in the past any progress there that's reportable?

Joe Morone

We are still in probe mode. And we are – the efforts we have had to develop a side impact being that is as effective as a metallic side impact being, but 20% to 30% lighter. That is – that's proving out. And so we continue to explore with partner in the automotive space potential applications at the high-end of automotive. And we will know a lot more by the end of this year earlier 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 are still in the mode of a probe.

J.B. Groh - D.A. Davidson & Company

That's it. And than lastly, the inventory does not – there is no adjustment made on your adjusted EPS that's just [cost you full] (ph), correct?

John Cozzolino

Yes. That's correct JB. It's not adjusted in that chart.

J.B. Groh - D.A. Davidson & Company

Great. Good. Okay. Thank you.

Joe Morone

Thanks JB.

Operator

And at this time there are no further questions.

Joe Morone

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

Operator

Ladies and gentlemen, a replay of this conference call will be available at the Albany International Web site 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.

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