Albany International Corp. (AIN) Q4 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Fourth Quarter Earnings Call of Albany International. [Operator Instructions] At the request of Albany International, this conference call on Thursday, February 09, 2012 will be webcast and recorded. I would now like to turn the conference over to our host 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 10-K. Now, I will turn the call over to Joe Morone, our Chief Executive Officer, who’ll provide some opening remarks, before we go to Q&A. Joe?

Thank you, John. Good morning, everyone. Let me add my welcome to all of you. Thank you for joining us. As this has become our custom, I’ll start with a few introductory comments to give all of you a feel for how we think about this quarter and also for how we think about our outlook and then we’ll go to your questions. If you set aside the effects of the sale of the Doors business, Q4 2011 is on the surface, a pretty simple quarter. That seasonal weakness in PMC that we have been expecting was offset by good performance in AEC and PrimaLoft. The overall result is flat, year-over-year performance. So, if you exclude the discontinued operation, currency effects, restructuring and the gain on that building we sold last year, EBITDA in Q4 ‘11 is essentially the same as EBITDA in Q4 ‘10, $32.3 million this year excluding Doors and $32.6 million last year excluding Doors. Now, to properly assess this quarter and what it tells you about our outlook, we think it is important to focus on 5 factors in particular. First, there is the accounting treatment of the Doors transaction. Many of you will recall that the Doors business was centered in Germany, it still is, and a good fraction of the profits are generated there. Without the Doors business, our ability to generate future profit in Germany will be significantly reduced, that is why we recorded in Q4 a large reserve against the deferred tax assets in Germany and that is what creates the loss in overall company net income in Q4. Now, since the sale did not actually close until January, it is a gain from the sale which will be considerably larger than that reserve, will not be recorded until Q1, so we will see the opposite effect next quarter. Q1 net income will be inflated by the gain from the sale. That brings us to issue #2 and in our minds the real story in Q4, which is the seasonality in PMC. If you go back a year Q4 2010 and Q1 2011, the paper industry was at a very different stage in the business cycle than it is today. Up and down the supply chain, the industry was restocking. Our backlogs and delivery times were abnormally high and we were running our plants at high rates right through the quarter. But this year, by Q4 2011 the industry was well past the restocking phase of the business cycle and if anything, parts of the industry were destocking towards the end of the year. We responded accordingly with production slowdowns in December culminating in plant shutdowns at the end of the month. The effect of the slowdown was most pronounced on our gross margins. If you look at October and November, our margins were among the strongest of the year. In December, they were sharply lower and well below the PMC average. We will see a similar set of comparisons in Q1 2012. The slowdown at the end of Q4 means a slow start at the beginning of Q1, whereas the year earlier, the strong finish to the year flowed into an unusually strong January. So, it is unlikely that PMC performance in Q1 2012 will compare favorably to PMC performance in Q1 2011.On the other hand, orders did strengthen this January. We are expecting performance to strengthen as the quarter and year progresses and we continue to expect full year PMC performance in 2012, to be in line with full year PMC performance in 2011. The third important factor this quarter was AEC which along with PrimaLoft performed well. AEC grew 20% year-over-year in Q4 and was EBITDA positive. For 2012, we expect AEC to grow more than 20%, while EBITDA will remain roughly constant with 2011, at little above breakeven, because of those heavy 1x expenses associated with intense hiring, but growth, we will see probably more than 20%. As discussed in the release, we view 2012 as pivotal to the ramp of the LEAP program and we are working closely and effectively with our customer SAFRAN group to execute on that ramp. Fourth, we have now completed the integration of engineered fabrics and paper machine clothing and beginning with Q1 2012 we will present combined results to this now unified business and we continue to expect by mid-2013 about $15 million in incremental EBITDA from the synergies created by this business. Returning to the fifth factor of significance in this release. Now that the sale of Doors has closed, we are finalizing our plan to use the proceeds to aggressively strengthen our balance sheet. In John’s commentary in the release, he lays out significant and considerable detail, how we plan to invest the proceeds to significantly reduce our pension liabilities as well as our long-term debt. Our goal is to have this plan completely implemented by the end of Q2 which means that we should see the full impact on income, cash flow, and the balance sheet beginning in Q3. Now, these 5 factors together the accounting treatment of the Doors transaction, seasonality in PMC, strong performance in AEC and PrimaLoft, the integration of PMC and EF and the plan for investing the proceeds of the sale by mid-year. All of those together lead us to the following outlook: For 2012, excluding the Q1 gain from the sale of Doors and the Q2 charge associated with the pension liability reduction plan. We expect modest improvement in year-over-year performance. EBIDTA from PMC and AEC are likely to be flat in 2012 compared to 2011, so the improvement will come primarily from the impact of our plan to reduce pension liability along with continued growth in PrimaLoft. For 2013, we expect stronger year-over-year improvement in performance driven primarily by the synergies from the merger of PMC and EF, coupled with a full year of reduced pension expenses. And for 2014 and beyond, we expect continued improvements in year-over-year performance, to be driven by AEC as growth in its EBITDA begins to contribute to overall company performance. And for the entire period, 2012, 2013, and 2014 and beyond, we expect continued strong generation of excess cash particularly with the substantially lower requirements for contribution to our pension plans. So that’s how we look at this quarter, 5 factors together laying out the outlook and what we will do now is just turn to your questions. Thank you, operator.

[Operator Instructions] First question today comes from Jason Ursaner from CJS Securities.

In PMC, with the magnitude and speed of the slow down at the end of the year in paper production, you know little bigger and faster than you expected? And was your decline in PMC, did it match production or was there an additional hit from customers reducing inventory?

I think it was pretty much what we expected. I don’t think we -- it’s hard to say. We weren’t particularly surprised that it followed along the patterns we were expecting. We were expecting it to be more of a slowdown in North America and that’s really what occurred. I think the important point here is -- the critical point to sort through is, is it a seasonal slowdown or is it a structural reduction. And if it’s a seasonal slowdown, then take the time off, at the end of December as your customers are doing the same thing. If it’s a structural slowdown, then you have to be a lot more aggressive and you have to start reducing employment and downsizing to match so that permanent capacity is going to match up with permanent demand. So, in our view everything we were seeing structurally was telling us that everything we were seeing with our customers and in the market place were telling us that this is a seasonal slowdown. We are seeing shorter order cycles, customers coming out of the recession. Up and down the supply chain, everybody coming out of recession is much more disciplined about managing inventory, which leads to shorter order cycles. And all of this said to us, there wasn’t any fundamental changing in the market or deviating from our view of this market, which is overtime flat to 1%.

Okay. And I guess because of the temporary slowdown, you know how big an impact it’s selling out of inventory has on margin in the quarter do you think?

The easiest way to think about this is, if you look at the difference between -- you can either take Q3, Q4 or Q4 last year to Q4 this year. And, if you look at the difference in sales, let us go Q4 to Q4, the difference in sales is about, once you take currency into account, it is about $3 million. As we have always said about a $1.5 million of that drops through. The delta in EBITDA was about $4 million, so about one and a half of it is accounted for by the drop in sales and the rest in our mind is accounted for, by the difference in margin and that margin difference is really, a hot December in Q4 2010 versus a weak soft December in 2011. So, the margin effect is on the order of $2.5 million. And really the way to sort this out very simply is, note both Q4 against Q4, that could control the things like currency and restructuring and you get a $4 million delta of EBITDA. Most of it is the difference between running hot and running soft margins and a little bit of it is sales.

And you mentioned that continuing into January, did it also begin to spread to Asia with the lunar new year being early, how big a hole do you think you’re starting Q1 and given the tough comp?

The normal seasonal effect in Q1 is all in January, in Q4 it is in December and there are 2 components of the seasonal effect in January. One is just the soft start because there are fewer shipments coming in to the quarter from December, but the second is the Chinese New Year as China becomes a bigger part of our overall sales mix, that seasonal effect becomes more important and since -- whenever it comes it is going to come in the first quarter, so it came a little earlier this time, but that is a big contributor to the seasonal effect in Q1. By the time we wash through those our expectation is, we’re back to the normal range in PMC, which as we say year-over-year and your flat to 1%.

So, the overall performance for being pretty flat, given the currency headwinds you are going to have to overcome in Q2, Q3, wouldn’t the industry need to show much stronger growth in that 1%, 2% growth in the second half to get you there?

As you know, we always try to control the currency. We do control the currency, we try to make that clear in our releases, because you can’t get through the structural trends and the long-term sales patterns, unless you control [indiscernible], the fluctuations are just wild. So, if you leave that aside, we think what reasserts itself is growth in China, sideways within the Americas coupled with over capacity in Europe, leaving the consumption of paper and demand for paper in Europe will be relatively flat, there is over capacity in the paper industry, there will be a reduction in number of machines that need to be closed. You add all those together and you get in our models flat to 1% in PMC and then you got to ride the seasonal fluctuations to see that.

Okay, and just last question from me, you talk a lot about normalized EBITDA at certain sales levels and then incremental EBITDA. So, if you look at this quarter, as if that was sort of a mid 2013 quarter with Doors out, the utilization issue of PMC out, maybe EF having a little bit better margin given the revenue available there, that you add in some of the synergies from PMC and you should be around $3 to $4 million a quarter. And then, the pre-tax benefit from pension, is the right way to think about a run rate more in that $40 million range still at this level of sales, as you look out a couple of years?

Yes, if we get up to the middle of 2013, I think that’s about right. I think you did the math faster, but I think that’s basically right. If you take roughly $9 million EBITDA factor, $10 million net income effect from the investment of the proceeds of the sale and then on the order of $15 million of synergies, so that’s $25 million and divide that by $4 million, so you are getting - right you are in the ballpark.

And we do have a question from the line of Mark Connelly with CLSA.

Good morning, this is Tom Knott on for Mark. On the PMC, can you just talk a little bit about what you are seeing on the input cost side? I think last quarter you talked a little bit about building inventories of raw materials and just how the cost trended since last quarter and how are they looking in the first quarter of ’12?

It’s been - you can almost predict it by just looking at the paper business cycle, which I know you guys do a lot of. So, when the whole supply chain was restocking, we were very concerned about inflation, all the indicators were tight supply for our raw materials with inflationary pressures driven by oil. And then as the economy softened, as the outlook softened, as the business cycle matured a bit, those pressures started to ease. As we start seeing in 2012, as we get economic recovery on the pace that we are seeing, coupled with slow growth in energy prices, then we will start seeing incremental pressure on inflation. But, it really is not the factor it was a year ago. It was a real concern a year ago, right now it’s not. Don’t forget. On the labor side, while there isn’t much inflationary pressure in North America, there is in our growth markets, in South America and in Asia, we do, we have got real inflationary pressures. That’s our challenge, as to offset that year-over-year, given a business that’s flat to 1%.

Okay. On Engineered Composites, I kind of want to switch over to that, can you add some more color on the additional R&D spending in the quarter and then just kind of the hiring plans you have for 2012? I guess that R&D, should we expect spending to remain a little at these levels? And then on hiring, should you be able to fully staff the business this year or hiring continue kind of steadily as -- into 2013 as orders continue to ramp?

I think the Q4 rate of R&D spending as a percent of sales at EC[ph] is probably a pretty good. That’s fine for now. The hiring - one way of thinking about this is as we ramp, we are building up our infrastructure which is really saying we are building up our fixed costs. And you reach a level of fixed costs, where you then start getting some economies of scale for a certain rate of growth, before you start having to add another layer of fixed cost. So, it’s hard to envision, while they will continue to be after this year pressure or higher, it’s hard to envision that the pressure will be as intense. On the hiring that’s really more of business and engineering infrastructure hiring, Head of Operations for example, Plant Managers, Planners. Then the hiring as the plants come on line, the hiring will be much more people in the plant than it will be essentially the overhead infrastructure.

And, we do have a question from the line of John Franzreb from Sidoti & Company.

Good morning, Joe and John. I guess, I want to start with the demand profile coming out of January. You had structural pull back in demand at the end of December, we had the Chinese New Year and a little bit to the fact that it was strong coming out of January. We had a supply-demand equilibrium at this point, Joe, or is that further down the timeline?

By demand equilibrium in PMC or…

PMC, yes.

Assuming nothing unexpected happens in China and everybody comes back from the New Year holiday and then it’s back to the same China we saw before the holiday with around 7.5%, 8%, then yes, we think we are lined up, if we didn’t think we were lined up, then instead of a [indiscernible] suggesting before then instead of taking temporary shutdown around the holidays, we would have been downsizing or upsizing and we weren’t doing either of those. So, yes, we think we are pretty much in line there.

Now, are your concerns in China - last quarter you mentioned there were some products that had overcapacity, is that were your concern is in China or is there something above and beyond that?

No concerns in China right now. We had another - if you look at the sales pattern in Q4, China did very well again, so there is nothing untoward that we seeing going on. We know with certainty that there is over capacity in the paper industry in Europe. And, we have got quite a bit of visibility into the capacity patterns in North America. Coming out of the recession, the industry did a lot of what it needed to do to position itself for the long haul. So, the wild ride continues to be in China where there is so much growth. So, the only thing that could upset the long term apple card to flat to 1% is if something untoward happens in China. We are not seeing the signs of that.

Fair enough. The AEC, you called out as a driver of revenue growth in 2012, could you elaborate a little bit on that?

Well, I’d say if you take our biggest programs, LEAP will grow substantially in 2012, no surprises there. As our development activities associated with maturing the product and our processes to the point where we can start producing as those intensifies. So that will drive growth. Our second biggest program is the landing brace which slowed significantly for the 787, which flowed significantly in the second half of ’11 and that will start ramping back in ’12. And our production will not be that far off from Boeing’s announced schedule, they are hoping to ramp from about 2 planes per month at the beginning of the year to 5 planes per month by the end of the year and that’s where we will see our production there from the order of 2 ship sets a month, at the beginning of the year down the order of 5, at the end of the month, so you will see growth there. The work we are doing on the Joint Strike Fighter on the LiftFan through the Joint Strike Fighter for Rolls Royce that will ramp during the year to meet the production schedules for the - with the stalwart version of the Joint Strike Fighter. So, we just take those 3 as our biggest program, each of them, if we execute we will show significant growth in ’12 over ’11.

Perfect. In your press release you mentioned several critical product and design test milestones that will be reached this year, what’s the time line for that? And, if you will be willing to share with what those design milestones are in particular, if not, on finding the way?

So I think I would say stay tuned for any - whether it’s CFM or SAFRAN, they go about tests that they are running for the LEAP engine, but we have to produce parts for those tests and those parts need to meet quality standards. So as they freeze the design, we need to freeze our production processes and then make enough parts so that they are able to test the engines. So, that’s what I was alluded to and those are very useful milestones for checking whether you are ramping at the rate that your customer wants you to ramp and we will keep reporting that along the quarter, but there is not going to be any earth shattering or singular moments that will tell you, “Yes, everything is on track” or “No, it’s not,” it will be quarter-by-quarter, we will continue to report progress.

Okay. And your Cap budget seems to be kicking down again from your previous expectations last quarter. Is that a function of anything in particular?

No, I think that was timing, we will see a ramp. We will certainly see a ramp in 2012, we will probably be up about $50 million in 2012 and that will be a combination of ramp up investment in PMC coupled with a ramp in AEC. No surprise there, actually no surprise anywhere, but we will see a gradual increase in our CapEx budgets towards that $70 million mark over the next few years.

[Operator Instructions] And, we do have a question from the line of Rich D'Auteuil from Columbia Management.

On the PMC side, are there any large customer negotiations scheduled for 2012?

There may be one in Europe at the end of 2012. We will be sure to provide clarity on that in Q1, I’ll need to check that. I think there is one in Europe for 2012. Prices have been, I know if that’s what you are really getting at it is, prices have been stable, our prices have been stable - continue to be stable over the past few quarters.

So, the industry dynamics are also stable, in other words, if competitive universe hasn’t seen changed in any material way in the last 12 months?

No, they really haven’t. Say the one significant announcement that you might hear about on Xerium call is that the CEO of Xerium, Stephen Light is stepping down, I think, by the end of the year and so there will be a transition there and that can always create some instability if a new person comes in with new ideas, but that’s really the only notable change in the competitive dynamics of the industry. So, it has been fairly stable.

Okay. On the consolidation of Engineered Fabrics in PMC, I think you have said, it’s going to generate $50 million starting EBITDA starting, is it next year or…

Our goal is to just try to achieve those kinds of synergies by the middle of next year.

Okay. What was the cost of executing the restructuring this to, position it for that? What was the aggregate cost?

Well, all what we really talked about is a couple of small plant moves in North America in Q4 and Q3. And those costs were the primary contributors to the restructuring charges that we had in Q3 and Q4.

Is there more to come? I guess I am a little confused.

Well, what we have said is we are still formulating our plans and in Q1 and Q2, we will provide more clarity on, as those plans get fully formulated, we will provide clarity on what if any additional costs we would have.

We’ve owned you as you know for a long time and if this essentially been a kind of permanent restructuring play. Is there a point when you think the coast will be clear and we will be able to read release and not have to decipher 50 accounting issues or you know I not only mean that, I am just curious if you think there is this always going to be the case or do you think we are going to get to the point where post that consolidation, as your AEC starts to ramp up. You have eliminated one division and there maybe another non-core business in the portfolio. As we put that behind us do you think we will have clean quarters or?

We did have a few. We had, one moment in time.

I think we had a clean quarter.

I doubt you would be asking this question if hadn’t sold the Doors business. I think we would be in a mode that you know we could be a lot more comfortable with. But the Doors transaction created a number of spin off effects and a number of accounting effects. And may be just think about the ones I mentioned so, the evaluation reserve this quarter is purely the function of the Door sale. The big gain we are going to get next quarter is purely the function of the Door sale. The charge will get around the pension plan in Q2 withdrawals of the function of the Doors transactions, because we wouldn’t be making this big move on our balance sheet if we didn’t have the proceeds from the Door sales. So that’s really what is muddy in the waters and will for the next couple of quarters, which is why we tried so overtly to map them out in the release which of course turns the release into a tone. So I hear your pain.

You know a year from now, is there anything on the restructuring front, will that be largely behind us? I guess currency will be a continuing callout but other than currency?

Right, should be it.

Okay. I know you have given us some guidance for this year, but where would you expect the operating cash flow to come out?

Well, if you just go back to the envelope [ph] now, so this isn’t guidance, this is just giving you a way to think about it the way we think about it. Let’s say it 3 years from now and we are running at CapEx is at amortization and depreciation. So, we are heavy into equipping our composite plans for continuing to reinvest in PMC and our CapEx is gone up to about $70 million. Well let’s assume just for the sake of simplicity that EBITDA is roughly where it was in 2011. So that’s about a $160 million of EBITDA. So track $70 million of CapEx and then subtract $15 million for first approximation, $15 million for dividend, $15 million for taxes, $15 million for interest. That leaves you about $45 million of excess cash and so that is about $1.50 per share of excess cash. That’s rough term how we think about it.

So with that 3 years to now or 2011?

I think if you take 2011 EBITDA and assume we are spending at a much CapEx rate, that’s what you get.

Okay. But you’re going to understand depreciation and amortization in 2012.

In 2012, yes.

It will be creeping up and we will creep it up. I think the investments, the CapEx rate in PMC that we see in 2012 is probably barely representative of what we will see in the long term. What will change is the AEC will ramp up, investment will ramp up as we equip those plants.

Okay. Prior to that ramp, so is there anything near term more that can be done on working capital or do you think you’re at a stable level there?

Yes. If there is more, it will be small.

And we do have a follow up question from the line of Jason Ursaner from CJS Securities.

Can you quickly go through what is driving PrimaLoft and what do you think the long term strategy for that business is?

Well it had a great quarter and if you look at the historical pattern in PrimaLoft, Q4 is usually very soft and we used to say up until last year, if we do better than breakeven in Q4, we are very happy. The performance, the growth right now is being driven by very strong performance in Europe in particular in outer wear and if that is an insulation for outer wear, what appears to have happened is that the order and sales cycle in PrimaLoft just seems to have been permanently moved forward by a matter of weeks, 8 weeks or so. Because everybody is ordering sooner, because the capacity can make outer wear for our market. In Asia is very tight so retailers like NORTHFACE are placing their orders sooner in order to make sure they have got enough capacity than they used to. So, the normal cycle would have had some of these sales that showed up at the end of Q4, show up in Q1. But everything has moved forward so Q4 this year was strong but we continue to expect Q1 in 2012 to be strong.

And next year, if this new seasonal pattern holds, then will the warm winter in the US going to have a major impact on inventories.

The way to think about it is vital, so if think retail. Let take L.L. Bean for example. So, there is a warm winter so L.L. Bean has lower sales in Q1. Now, if that then leads them to have lower orders for the following season because they have a lot of inventory remaining then, PrimaLoft sales would get hurt into the back end of 2012. If on the other hand L.L. Bean and its competitors decide to run big sales to move the inventory which is what happened last time when something like this occurred during the recession. Then they are going to have to reorder and re- stock. So a cold winter drive their sales which make makes reorders buy them pretty predictable. A warm winter means they have lower sales and then the question becomes what their retail strategy going to be? Are they going to try to move the inventory hard with big discounts in which case we’ll get orders for the following season as it had been a cold winter. A warm winter can lead to downward pressure on sales and orders for next year.

Okay and where PrimaLoft fits into the overall portfolio of Albany, is there an opportunity with the yarn to really make it into something big longer term or is it still noncore?

Well we really like this business and yarn is a significant part of its future. But on the other hand we have also said our 2 core businesses are PMC and AEC and it will always be a price where it makes more sense for a strategic bi-autographed PrimaLoft than for us to hold it. But we like this business and you look at Q4 performance and you would understand why we like it.

And then just last question. Is there any update on the nozzle [ph] program in AEC and any key milestones on that?

There will be a ground test this year, flight test. I think it is for a 787 currently is what FAA is saying, next year. There is public information on this. If you Google CLEEN Program and FAA, there are public disclosures about this program.

And at this time there are no further questions in queue. Please continue.

Okay. Thank you everyone for participating on this call and John and I will look forward to meeting you and talking to you over the course of the quarter and if we don’t, talk to you next quarter. Thank you.

[Operator Instructions] That does conclude our conference for today. Thank you for your participation and for using the AT&T Executive TeleConference Service. You may now disconnect.