May 5, 2015
Executives
Joseph Morone - President and Chief Executive Officer John Cozzolino - Chief Financial Officer and Treasurer
Analysts
Jason Ursaner - CJS Securities John Franzreb - Sidoti & Company Steve Levenson - Stifel
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the first quarter earnings call for Albany International. [Operator Instructions] At the request of Albany International, this conference call on Tuesday, May 5, 2015, will be a webcast and recorded.
I would now like to turn the conference over to your Chief Financial Officer and Treasurer, Mr. John Cozzolino, for introductory comments.
Please go ahead sir.
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, 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 will provide some opening remarks. Joe?
Joseph Morone
Thanks, John. Good morning, everyone, and welcome to our Q1 2015 call.
As always, I'll start with a quick summary of the quarter, John will then go into more detail, I'll follow with our outlook, and then we'll turn to your questions. This was a good quarter for Albany International compared to Q1 2014, which represents a strong comp.
Sales, excluding currency effects, improved 7% and adjusted improved 10%. Machine Clothing performed very well across the board and AEC continue to make good progress toward the both LEAP ramp and next generation of new products.
As John and I have discussed many times, in the normal business cycle, because of seasonal factors, the first half of the year for Machine Clothing is usually stronger than the second. Sales tend to be good in Q1, peak in Q2, and then weaken in the second half of the year.
Gross margin typically peaks in the first quarter and then drops in the second and third quarters. So we would expect Machine Clothing to perform well in Q1.
But even against this expectation, this was a fine quarter. In comparison to the strong Q1 of last year, sales again excluding currency were up 3.5% and adjusted EBITDA was up 7%.
There were a number of contributing factors, most notably the relatively healthy U.S. economy, improvement in the European economy, strong new product performance in every major product line, a favorable product mix and our continuing efforts to reduce costs.
Q1 was also a good quarter for AEC. Sales were in line with our expectations, LEAP orders continue to grow, we made important strides toward leap production readiness, two legacy programs in Boerne that have long been in development finally entered into production, and we continue to advanced development of new applications for aircraft engines and airframes and our probe into the automotive market.
So this was a very good quarter, highlighted by strong performance in Machine Clothing in just about every respect, and continued progress against the critical checkpoints in AEC. And now, to give you a bit more insight into the quarter is, John.
John Cozzolino
Thank you, Joe. I'd like to refer you to our Q1 financial performance slides.
Starting with Slide 3, net sales by segment. Total net sales in Q1 increased 7%, excluding the effect of currency rate changes.
On the same basis, MC net sales increased 3.5%, as sales were strong in every major reason. AEC net sales increased 42.8% compared to the same period last year.
Most of the increase was related to LEAP production activities, as sales in Q1 2014 were affected by a temporary lag due to start up in inventory effects. As shown on Slide 4, total company gross margin percent increased to 42.3% in Q1 compared to 41.5% in Q1 of last year.
MC gross profit was $75.3 million or 47.5% of sales in the quarter compared to $73.9 million or 45% last year. Despite a negative impact from currency effects, MC gross profit improved due to the higher sales volume, favorable product mix and the impact of cost reduction activities.
In addition to that, gross profit as a percent of net sales at current currency levels is higher than we have seen in the past, as the stronger U.S. dollar had more of an effect on net sales on gross profit.
Turning to Slide 5, earnings per share. We reported net income attributable to the company in Q1 of $0.38 per share compared to $0.33 per share in the first quarter last year.
Foreign currency reevaluation gains once again had a significant impact on current earnings, as Q1 2015 EPS includes income of $0.10 per share for reevaluation compared to income of $0.01 per share in Q1 2014. During Q1 2015, the company recorded a restructuring charge of $0.18 per share, principally related for the company's plan to discontinue MC manufacturing operations in Germany.
Other EPS effects in one or both periods is related to tax adjustments and a gain on in investment sale are noted on the slide. Excluding the effects of the adjustments, EPS this quarter would be $0.45 per share compared to $0.37 per share last year.
Adjusted EBITDA details for Q1 2015 and 2014 are provided on Slide 6. Adjusted EBITDA in Q1 2015 increased to $41.5 million compared to $37.8 million in Q1 last year due to improved operating results in MC.
MC adjusted EBITDA increased to $52 million in Q1 compared to $48.6 million in Q1 last year. AEC adjusted EBITDA was essentially flat in the quarter compared to last year.
Lastly, Slide 7 shows our change in total debt and net debt. Despite improved EBITDA in Q1, net debt, which is our total debt less cash, increased approximately $19 million to $112 million.
As we have experienced in the first quarter of past years, Q1 net debt was negatively impacted by incentive compensation payments. Net debt also increased through higher accounts receivable and inventory, and the negative impact on cash of unfavorable currency rate changes.
Now, I would like to turn it back to Joe for some additional comments, before we go to Q&A.
Joseph Morone
Thanks, John. Turning very briefly to our outlook, in Machine Clothing, same factors that contributed to the good Q1 sales should hold in Q2.
As we mentioned in the release, the one soft spot is China, but otherwise we expect Q2 to follow the normal seasonal pattern, which means that once again excluding currency effects, we expect Q2 Machine Clothing sales and adjusted EBITDA to be roughly comparable to a strong Q2 2014 results. In AEC, our outlook for the year is unchanged.
We continue to expect full year revenue to be 5% to 10% ahead of last year, and preparing for the LEAP ramp continues to be our overwhelming priority. In sum, Q1 2015 was a very good quarter, marked by strong performance in Machine Clothing and good progress in AEC.
Our short-term outlook for Q2 was for comparable performance to Q2 of last year. And given the growth in LEAP orders, the progress toward new applications in AEC and the encouraging new product and technology performance in Machine Clothing, we continue to be optimistic about the long-term outlook for both businesses.
So that's a quick overview. Let's go to your questions.
Operator
[Operator Instructions] Our first question will come from the line of Jason Ursaner of CJS Securities.
Jason Ursaner
The organic growth of almost 4% in Machine Clothing, maybe you can walk through some of the factors that drove that by geography and grade in the quarter? And when you talk about the seasonal peak next quarter, talking about comparable sales, other than the softer environment in China.
I guess, you're basically saying organic trend should stay relatively similar kind of other than currency there? I'm just talking what would be driving organic [multiple speakers].
Joseph Morone
So let's assume currency stays roughly where it is, so just control for that. Everything else equal, you'd expect Q2 sales to be a little bit better than Q1, that tends to be the seasonal trend, but margin drops.
And so that's what we would normally expect. The most important variable right now, as we've talked about before, is macroeconomic.
And so if you see reasonable health in the U.S. economy and some size of the pulse in Europe, those are all reasons to expect the continuation of what we saw in Q1.
It should be softer in China for the reason we described. Brazil is clearly in recession, and Brazil is a very important market for us.
On the other hand, there is enough going on in the rest of South America, enough positive momentum in the rest of South America that we think there is reason to expect that we can offset the softness in Brazil. So we're not seeing right now any significant variable that would lead us to deviate from the normal seasonal expectation.
Jason Ursaner
And anything specific by grade in the quarter or just pretty broad-based strength relative to the past couple of quarters?
Joseph Morone
Well, again, for our model to work, for us to have a good quarter in a normal business cycle, we need the GNP-driven segments, packaging and tissue to be healthy enough to offset the constant steady structural decline in the printing and writing grades, and that's what we saw. There's a lot of action in particular in tissue that was very encouraging.
Jason Ursaner
And margin in that business look to be well ahead of last year. Any kind of balance between the manufacturing absorption, product mix, and maybe this new technology platform that's starting to come in, in terms of how those combined in the margin performance in the quarter?
And when you look forward to Q2 and kind of the balance of the year, what stays in that versus what goes into the dropping off?
Joseph Morone
Well, let me take a whack at it, and then John can dive into clean up the mess I make. So if you look at the slide that John used, I think it was the Slide 2, gross profit margin by quarter.
You can see, and if you were to stretch that out a couple of years, you get a continuation of that same curve. So Q1 to Q1 that tends to be the high point for margin.
So in that sense it was right in line with the seasonal expectation. Now, you're asking why the big jump year-over-year, and let's start with the absolute numbers rather than the margin.
If you start with the gross profit rather than gross profit margin, Machine Clothing gross profit increased by about $1.5 million, and that's in line with the sales increase, excluding currency. So the drop-through was more or less what you'd expect from the increase in sales.
So there is nothing particularly unusual going on in the absolute gross profit. The big change is in the percentage in the margin.
So the percentage of sales, gross profit as a percentage of sales, that's what jumps. And why does it jump?
It jumps because the numerator improved a little bit gross profit, and with the currency effect sales decline. So you get an arithmetic effect of a higher percent of sales just because the denominator didn't move much and the numerator moved.
If currency stays at this current level, then you're going to see quarter-over-quarter a slightly higher or somewhat higher gross margin percent in this business. If currency goes back to where it was a year ago, then at this level of gross profit, our margins will slip back to more or less where they were a year ago maybe a little bit higher.
So don't get blinded by the arithmetic or the arithmetic artifact of the currency. Basically, sales were hurt by currency, but gross profit wasn't.
Jason Ursaner
And for composites, just EBITDA that was a bit below, where I was thinking at this level of sales. Just wondering how you're looking at that number internally and where you see profitability trending before the inflection point?
And then, I guess, maybe just more reiterating the long-term view of profit after the inflection point.
John Cozzolino
Well, the biggest change in profitability is nearly $600,000 increase in R&D. And so that accounts for much of the lower than you'd expect EBITDA for that level of sales.
There was a little bit of erosion in Boerne, but the main thing is the R&D. Our view of the business is unchanged, that as we start seeing topline growth, you should assume that $0.15 on the $1 more or less falls all the way through for every incremental dollar of growth.
Operator
Our next question will come from the line of John Franzreb of Sidoti & Company.
John Franzreb
Just to backtrack to the gross margin question a little bit. I don't think you touched on any benefit from the closing of the Germany facility, or maybe it did not impact the quarter.
If that's the case, when do you expect to receive some of those benefits?
Joseph Morone
Yes, it's correct. It did not impact the quarter.
Those benefits should be all in by the beginning of next year. They'll start flowing in slowly the second half of the year.
And if you go by historical standards, you should expect about $1 million to $1.5 million of positive effect per quarter starting next year. Now, remember that might not all fall through -- that might not all be visible, because some of that winds being offset by inflation and possible price erosion in Europe, but its reasonable to assume a $1 million to $1.5 million higher profit per quarter than we otherwise would have had, had we not taken that action starting next year.
John Franzreb
And you walked into my next question about the pricing environment, especially given the changes in the euro. Can you just walk through what you're seeing out there in the competitive landscape in pricing?
Joseph Morone
Well, the pricing environment, as we've discussed, is really driven by structural overcapacity primarily in Europe and secondarily in Asia. And the first approximation, that's not really influenced by currency, but the biggest influence on price is, really how healthy the economy is.
So if there is a lot of economic activity, it's a strong economic activity, there is more demand for paper. There is more demand for paper, the machines are running harder.
If they're running harder, there is more demand for clothing. There is less pressure from that overcapacity.
So that's the real pressure relief valve on pricing in Europe and Asia's economic growth. Asia is slow, particularly China, so we're not seeing any relief of pricing pressure in Asia.
The problem in Europe remains the same, there's still lot of overcapacity. And even thought there is some economic improvement, it's not enough to really offset that overcapacity.
So let's say, no change in the pricing environment in Europe and Asia.
John Franzreb
And just sticking with the PMC, Joe, can you provide color as to the new technology platform? What you're expectations are, what the reception has been like?
It's kind of a little bit of a black hole right now?
Joseph Morone
Yes. Well, there's only so much -- John, you can appreciate, there's only so much we can say about this, because its proprietary technology and all our friends in the industry are on the call.
But the simplest way to think about this is, think of basically applying composites to the production of clothing. So in some ways, our aerospace business derived from our clothing business, and now we have a feedback loop back.
And what that does is it creates the potential for a way of making these permeable and impermeable belts, that has the potential to provide interesting performance advantages and at lower cost. So the challenge, as you start introducing a whole new platform -- same thing is going on with our aerospace business is you've got to pick off, you have to identify the early applications, where the cost benefit ratios are most beneficial.
And the temptation is to spread yourself thin, like you're spreading peanut butter over a lot of applications and you wind up not getting the impact. So the art in this is to nail the early applications that give you the biggest bang and then spread it from there.
And we're quite encouraged by the performance of this different way of making belts in the early applications that we're looking at. We had a really nice trial this quarter for example, that was very encouraging.
John Franzreb
And then shifting over to EC, the 737 MAX and the neo are falling short in some of those fuel saving targets, the MAX by 4% to 5%, the neo less by 2%. Is that any cause for concern within the supply chain?
Joseph Morone
John, there are few bloggers who have alleged those numbers. And so you've got to take those publications with a grain of salt.
So let me tell you what we're seeing. Number one, on their recent earnings call, the CEO of Safran addressed those rumors, and said he is, quote unquote, a 100% confident that LEAP is going to be on target and on schedule.
Number two, since those rumors were out there Boeing just landed a huge order for another family of MAX's. And number three, all of the pressure on us, and I think its intense is to be prepared to make more parts sooner.
We're not getting any whiff of pullback or a pull down of the future demand for this engine. So I think the right way to think about this, and the way we were thinking about it is in every engine test program, it's never the case.
I don't know of any case, where the engine hits right on its performance targets in the early tests. There are only some adjustments and tweaking to the design after the initial tests.
It's always like that. The results that, as far as we can see, and as far as everything that's being published, the tests for the LEAP engine are well within the normal range of test results that you would get at this stage in an engine development program.
John Franzreb
And I don't know, I may have missed this, but is there any update on your non-aerospace initiatives, or even more so the other potential aerospace programs that you have out there?
Joseph Morone
Our probe into the automotive industry is doing exactly what we hoped it would do. And our relationship with Ricardo is doing exactly what it hoped we would do.
We're having very useful explorations and testing of possible applications. We're having useful and interesting conversations with OEMs.
And we're encouraged. And I think we're going to know in the next year to year-and-a-half, we're going to know whether the cost benefit package from our technology is mature enough that we can get on a real platform at the high-end of the industry by this decade.
A year or year-and-a-half of the kind of interactions we've been having, and we'll know either, yes, it's mature enough now; or no, we need to go back to more fundamental research on low cost materials before we can take another step in two or three years. And I will say this, we had thought going into this that the automotive industry would discount our experience in aerospace, that we'd bring them, show them our experience with bird strikes on a fan blade or fan blade out onto a fan case, that they would say, well, what's that got to do with the car.
But instead, we're finding that really leading edge experience in the aerospace industry is validating through the automotive folks, that they are being hit barraged with all sorts of companies coming to them with new technology ideas and they have no way of validating those new technology ideas. And here we're bringing them a technology that has been validated, so then it comes very quickly down to, is there an application where the cost benefit ratio works.
We know we're lighter. We know we're as strong as metals and a lot stronger than conventional composites.
The question is can we get to an application without so much cost penalty that we get knocked out of the box, and that's what we're proving. So it's very encouraging.
On the engine and the airframe sides, the game is to think of this development process like a funnel. You start with a lot of possibilities, and as the technology matures, the range of possibilities begins to shrink.
So what you'd like to see is steady progress through the various toll gates, as you move from the fat part of the funnel towards this end. And at the same time, as possibilities drop off, you want more possibilities coming into the front of the funnel than our possibilities dropping off.
And we're seeing both of those. We're seeing some nice progress towards the thin part of the funnel with some very interesting applications, and at the same time we're seeing more stuff popping into the pipeline.
So the word remains encouraging progress is the best way we can describe it.
Operator
Our next question will come from the line of Steve Levenson of Stifel.
Steve Levenson
Based on your comment that you're going to have some pressure to make more parts sooner on LEAP, will there be any other capital expenditures required? And if so, are you able to use the strong dollar to take advantage of some accelerated spending in Europe?
Joseph Morone
We'll have a better fix on whether there's more CapEx spend required in the next few quarters. But for now we still think that estimate we gave to all our investors of $70 million a year on average through the decade, for now, it looks like there's enough cushion built into that estimate on average.
Sometimes it will be over it by quite a bit and sometimes it will be under it, but on average through the decade that still looks like a good number. And by later this year, we'll have a more refined estimate of that.
Steve Levenson
You haven't mentioned anything to do with ceramic matrix composites on this call. I just wondered if there was something you might want to mention?
Joseph Morone
I would just take the comment I made to John about progress through the funnel as applying to that as well.
Steve Levenson
And last sort of housekeeping question. Yesterday you had the 8-K announcing the second-quarter charge.
Is that expected all to be cash related to severance or is there a non-cash portion?
John Cozzolino
So, John, that number that we disclosed yesterday in the 8-K was related to severance. And that was cash, so that will be cash, most likely paid out in the second quarter.
And we may have some non-cash charges down the road, as we analyze the equipment and property in Germany. But that is not included in that number that was disclosed in the 8-K.
Operator
Gentlemen of the panel and ladies, if there are any present, there are no questions in queue at this time. End of Q&A
Joseph Morone
Thank you. Thanks everyone for participating on the call and we look forward to seeing you in the months ahead.
And for those of you, who will be at the air show, see you in Paris. Thank you.
Operator
Ladies and gentlemen, a replay of this conference call will be available at 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 services. You may now disconnect.