Aug 2, 2016
Executives
John Cozzolino - Chief Financial Officer and Treasurer Joe Morone - Chief Executive Officer
Analysts
John Franzreb - Sidoti & Co. Anthony Young - Macquarie
Operator
Ladies and gentlemen, thank you for standing by. 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 and instructions will be given at that time.
At the request of Albany International, this conference call on Tuesday, August 2, 2016, will be webcast and recorded. I’d 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, 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?
Joe Morone
Thanks, John. Good morning, everyone.
Welcome to our Q2 2016 earnings call. As usual, I’ll start with a summary of the quarter, John will follow with more details, I’ll review our outlook and we’ll close with Q&A.
Q2 2016 was another good quarter for Albany International. Including our new composites division, sales grew by 18% compared to Q2 2015, adjusted EBITDA grew to $46 million, both businesses again performed well as Machine Clothing continue to generate strong profitability and AEC’s strong growth.
And both businesses remained firmly on track towards their near and long term objectives. For Machine Clothing in Q2, sales were essentially flat compared to Q2 2015 in the aggregate in each major region and in each major grade.
We had expected Q2 sales to be a bit stronger than Q2 2015 but the expected uptick was held back by slowdowns in tighter inventory controls in the packaging grades in the U.S., Brazil and China. Nonetheless driven by new product technology and strong field services, Machine Clothing continues to perform well in each major region, particularly with leading paper makers and particularly in the growth grades, which once again accounted for 75% of sales.
Ordinarily, we would expect Machine Clothing profitability to decline in Q2 because of annual salary inflation. But Q2 profitability held at Q1 levels due to unusually strong capacity utilization, coupled with the lower materials costs, restructuring actions, and productivity improvements discussed in previous quarters.
As a result, even though Q2 sales were flat compared to Q2 2015, adjusted EBITDA improved by 11%. AEC’s Q2 results include an essentially full quarter of performance of our newly acquired aerostructures division, which had a significant, positive impact on performance.
Without the acquisition, sales for AEC would have been $29 million compared to $22 million in Q2 2015, the growth driven by LEAP. With the acquisition, sales were $54 million for the quarter and adjusted EBITDA was $5.7 million or roughly 10% of sales.
It is important to note that $7 million of that $54 million of Q2 sales were associated with customer reimbursements for development tooling. Of the remaining $47 million in sales, LEAP accounted for about 33%, airframe components for JSF about 16%, and the next largest programs Fuselage Frames for the Boeing 787, bodies for Lockheed missiles, components for the JSF LiftFan, and waste tanks for Boeing aircraft each accounted for roughly 5%.
Meanwhile at the recent Farnborough Air Show, another 400 orders for the LEAP engine were announced, bringing total orders to over 11,100 engines, and reinforcing once again that at least in the narrowbody market, there are no signs of weakening demand. For suppliers to LEAP like Albany, the pressure from the market continues to be for more volume sooner.
Also at the Air Show, there was a dramatic in-flight demonstration of the capabilities of the JSF LiftFan which of course includes AEC composite components. And, in multiple forums before and during the air show, Boeing made clear that it is seriously exploring a new middle-of-market aircraft for possible entry into service mid-next decade.
We continue to be encouraged by new business development activity on multiple fronts, but the primary focus right now in AEC is on execution, and in particular, on the integration of the new division, enhancement of its operational capabilities, and the successful ramp-up of our key growth programs. Integration is on track, and during Q2, we made good progress on the ramp-ups for LEAP, the 787 Fuselage Frames, and the JSF.
So this is a good quarter with significant growth in sales and income, stable sales and strong profitability in Machine Clothing and strong growth in improving profitability in AEC. Now, let’s turn to John for more detail.
John Cozzolino
Thank you, Joe. I’d like to refer you to our Q2 financial performance slides.
Starting with slide 3, net sales by segment, total company net sales in Q2 increased about 18%. Currency effects compared to Q2 2015 were minimal.
MC net sales were down approximately 1% in the quarter, while AEC net sales increased by almost $33 million, as the new acquisition added almost $26 million to second quarter sales. Moving to Slide 4, total company gross margin was 38.5% in Q2, compared to 31.7% in Q2 of last year.
Gross margin in Q2 was somewhat lower than the past few quarters as the business mix changed through the impact of the aerostructures acquisition. MC gross profit margin stayed strong and improved to 47.6% of sales in Q2, compared to 45.2% in Q2 2015.
AEC gross profit was $7.7 million in Q2 2016 with about $5 million coming from the acquired business. AEC gross profit in Q2 2015 included the $14 million BR725 charge.
Turning to Slide 5, earnings per share, we reported net income attributable to the company in Q2 of $0.32 per share, compared to a loss of $0.07 per share on Q2 of last year. The Q2 loss included a charge of $0.28 per share for the BR725 program.
Q2 2016 EPS was reduced by $0.08 for acquisition expenses. Restructuring expenses reduced Q2 2016 EPS by $0.13 per share and Q2 2015 EPS by $0.02 per share.
Restructuring expenses this quarter were mostly related to MC activities in France and Germany, as well as AEC’s consolidation of legacy programs into the facility in Boerne, Texas. Other EPS effects, in one or both periods related to tax adjustments and foreign currency evaluation are noted on the slide.
EPS excluding all the adjustments shown in the table was $0.48 per share on Q2 2016, compared to $0.01 in Q2 2015. Slide 6 and 7 show net income and adjusted EBITDA by segment for the quarter and year-to-date.
Adjusted EBITDA in Q2 2016 was $46.6 million, compared to $18.8 million in Q2 last year. MC adjusted EBITDA was strong in Q2 at $50 million, compared to $45.1 million in Q2 last year.
On a year-to-date basis, as shown on Slide 7 MC adjusted EBITDA was $99 million in 2016, compared to $97.1 million last year. AEC adjusted EBITDA improved to $5.7 million in the quarter, compared to a loss of $15.8 million in Q2 last year, which included the $14 million BR725 charge.
The acquired business added $4.6 million to adjusted EBITDA in the quarter. Lastly, Slide 8 shows our total debt and net debt.
With the completion of the acquisition, total debt increased to $486 million and net debt increased to $310 million. The company utilized the new $550 million credit facility to fund the $187 million due are closing, as well as -related acquisition and financing costs.
Total debt also includes about $24 million related to our capital lease on a manufacturing plant that was assumed as part of the acquisition. Finally, in May, the company entered into new interest rate swap transactions that fix the LIBOR portion of $300 million of debt through March 2021 at 1.245%, which including our current spread off 1.5% results in an effective rate of 2.745%.
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 to our outlook quickly.
For Machine Clothing, given the strength of its performance in the first half of the year with John just summarized and assuming a relatively stable currency in macroeconomic environment, we now expect full year adjusted EBITDA to be at the upper end of our $180 million to $195 million range. Borrowing any additional significant slowdowns in the paper industry, sales for the remainder of the year should remain roughly stable.
But because of normal seasonal effects during the summer and at year end, we expect capacity utilization and margins to come off their first half peaks and therefore we expect second half EBITDA to lag somewhat behind the first half of the year. As for our outlook for AEC, while sales tend to fluctuate significantly in this business from quarter-to-quarter, we expect average quarterly sales of close to $50 million in the second half of the year with gross profit margins roughly comparable to Q2.
We do expect $1 million to $2 million of integration costs associated with the acquisition in the second half of the year. The risk to our outlook for AEC continues to be execution-based.
Successful completion of the integration of our new division, enhancement of its operational capabilities and a ramp up of our key growth programs will drive near-term performance in AEC. In sum, Q2 2016 was another good quarter for Albany International, highlighted by strong profitability in Machine Clothing and accelerating growth in AEC.
And both the businesses remain firmly on track for their near and long-term goals. And with that, let’s go to some questions.
David?
Operator
[Operator Instructions] And we do have a question comes on the line comes from the line of John Franzreb with Sidoti & Co. Please go ahead.
John Franzreb
Good morning guys
John Cozzolino
Good morning John
John Franzreb
I would like to start with the Machine Clothing business, you mentioned in your commentary that revenue was lower than expected for the quarter, but capacity utilization was better-than-expected, can you kind of reconcile those two comments it would seem to be at odds?
John Cozzolino
Well if capacity utilization is primarily as you would imagine in the process of carefully matching up capacity to demand and given that 40% to sometimes 50% of our orders actually are dropped in during the quarter, that turns out to be a tricky process that has to be constantly managed and sometimes we are more successful at it than others. In this case, the team was able to respond very quickly to the fluctuations we were seeing in the quarter.
At the same time because of that because they were able to match demand effectively, the plants were flowed through the whole quarter pretty much from start to finish. And when you get into the other quarters there’s always some kind of seasonal effect that makes maximum capacity utilization difficult.
So for example in Q3, same number of people, same number of plants, but we have vacations. So you have an inherent inefficiency there.
In Q4, same number of people, same number of plants, same amount of equipment, but you always have a slowdown at the end of the year. And in Q1, typically orders are light going into the year so again you have a capacity utilization issued.
In Q2 there are no seasonal effects. So, also in Q1 we have the Chinese New Year, which has another negative effect on utilization.
Q2 you're just running flat out across the board and there’s no inherent seasonal inefficiency.
John Franzreb
Well I guess with the weakness coming in packaging Joe, I mean it makes you wonder if you had better-than-expected volume in tissue, which would suggest that may be you are running at max capacity in tissue. I was wondering if that might be the case and how capacity constrained are you in PMC overall?
Joe Morone
It wasn’t, it is not - the sales were stable. So, it is interesting if you look over the past four quarters and you look by region and you look by grade, sales are remarkably stable.
You know they may fluctuate a little bit from quarter to quarter, but fundamentally we’ve been shipping roughly the same amount of products, pretty much everywhere and by grades over the past four quarters. So, no, it is not really swings from one to the other, from one grade to the other what we’re talking about is, we thought there would be a little more demand in packaging, which is very G&P sensitive and it was held back by sluggishness in those key markets.
Are we capacity limited? We’re matching, you know when you think capacity you have to think two variables, there is equipment capacity and then there is people capacity.
And so we have the ability to surge from an equipment point of view. To surge from a people point of view we need to see the demand surge coming and higher up.
You can go over time in the short term to meet a surge, but if you believe the surge is going to be permanent then you’ve got to hire a bit more, a few more people. So, one of the real capabilities in this business that we think as time passes, particularly since the recession of 2009, we’ve learned the demand cycle is much shorter and so the ability to respond to short-term fluctuations really becomes a key dimension of our ability to maintain profitability and so you're always trying to balance what you see as you believe are short-term fluctuations in demand with maintaining capacity in-line with short term without tying your hands for unexpected surges.
It is when those unexpected surges come the can become a real opportunity if you haven't pulled back to much on capacity. It is a tricky process.
John Franzreb
So do you think packaging demand is becoming more seasonal than in years past?
Joe Morone
I really think you have to think in terms of GNP sensitivity. So, it is a thing of box being shipped through retail, electronic retail and bricks and mortar and as around the world as economic activity picks up box shipments pickup as block shipments pickup packaging production increases and vice versa.
So it is, when you go over to the publication grade there economic sensitivity, but much more important is the structural decline. When you are in packaging and tissue, it’s much more GNP sensitive business.
John Franzreb
Okay. Switching over to EC, you used to voice concerns about the slope of the ramp and that’s the biggest pressure to suppliers, could you talk a little bit more about your concerns there or maybe there is no concerns and would you expect EC to be EBITDA - or do you expect EBITDA to improve any EC in the second half of the year relative to the first half?
Joe Morone
If you start with the ramps, the monsters of course leap, but there are significant ramps in our aerostructures business too as you know, but the leap monster has been, it’s like a cliff that everyone is driving to. Everyone in the supply chain knows they have to scale and it’s been coming closer and closer and now it’s flat in front of us.
It’s in no way a surprise, we all saw what was coming and up and down the supply chain, I think everyone has been preparing for this moment. That doesn't make it easy, it is, I think everyone is under intense pressure to ramp with high quality and on-time delivery and I’ll just speak for ourselves as you know, we've been talking about this for the last three years on every call, we’re on it, but it’s crunch time right now.
John Franzreb
And the EBITDA expectations for this segment?
Joe Morone
If you break EBITDA, if you start at the gross margin level, we think the gross margin that we saw in Q2, if you take out those non-recurring development tooling, 7 million of development tooling and associated EBITDA, take that out of it, the gross margins should be relatively steady and then as we see volumes increase, gross margin will increase, but we also think gross margin percentage will increase with volumes and the efficiencies that come with volume. EBITDA is trickier because we’re below gross margin, you take into account SG&A because we’re incurring a fair amount of integration costs in the second half of the year as we are implementing ERP systems into the acquisition as we’re working through, trying to marry capabilities from the two groups.
So we will call out as best we can. The impact of integration costs on the second half EBITDA, but so ex that, excluding that I think excluding that and excluding the development tooling we think Q2 is a pretty representative quarter.
John Franzreb
Actually, I will get back into queue and let somebody else ask some questions. Thanks Joe.
Joe Morone
Thank you, John.
Operator
[Operator Instructions] And next we will go to the line of Anthony Young with Macquarie. Please go ahead.
Anthony Young
All right. Good morning Joe and John.
Joe Morone
Good morning, Anthony
Anthony Young
Just a question on thinking about the difference between, or not the differences, but what we’re seeing with the Pratt & Whitney and CFM, we had another Indian airline this morning announce that they were seeing some delays with respect to their A320 neos because of the Pratt & Whitney engine. I mean, how much ability is there for CFM and for you guys to be able to respond to possible customer inquiries for their LEAP engines?
You guys have that chart that you supply that sort of shows the uptick in your revenue with respect to LEAP engines. What sort of market share did you guys have priced into that with respect to the A320 neo?
Joe Morone
So Anthony it’s an interesting question that really CFM and Saffron and GE are better qualified to answer, but let me give you an answer from the perspective of the supplier. So without having inside information about how they are thinking about the question, which is clearly a question on everybody's mind.
My impression, our impression of the business case that CFM has used for LEAP and the basis for the projections that get us from hundred engines and 2016 and 500 in 2017 ramping to over 2000 engines a year by 2020. The assumptions that that is based on, which we can all calculate is that they will get 50% of the neo market and obviously 100% of the Boeing market and that Boeing will be making 57 - manufacturing 57 MAXs per month in 2020 and Airbus 60 to 62 neos.
So those are the core assumptions and you just run those numbers, multiply by 12 and two engines per plain and you will get to about 2000, 2100, 2200 engines per year. So that’s what they are assuming.
So, now the question you are asking is as perhaps struggles to ramp for the neo, is there an opportunity for CFM to grab more shares and more volume and the answer is entirely a function of the capability of the supply chain and it’s not the capability of the stronger supplier, they have the look at the capability of the weakest link of their entire supply chain and determine whether that supplier, whoever that is, I have no idea, whoever that is whether they have the capacity to ramp beyond the 2100, 2200 engines a year with the steepest ramp up the commercial industry has ever seen. So that is the question that has to be the calculus that’s going through their minds when they determine whether or not to respond to customer demand.
It’s a really tricky one because if you on the one hand, it’s a rare opportunity to grab share and once you grab it that has cash flow impacts for years to come. On the other hand, if you over commit, then you wind up running the risk of disappointing your customers, which created the opportunity in the first place with the reliability of the CFM delivery.
So, very tricky and I don't have a clear answer, but it’s certainly one watching clear fully carefully.
Anthony Young
Okay.
Joe Morone
In any case the safest comment I can make is, in any case, if you had another factor that suggested that for us and for suppliers like us, all of the market pressure right now is for more sooner it is just no - even with these very low oil prices there is no width of pressure on the other direction.
Anthony Young
Okay. And then just on the $7 million in revenue that you received for tooling.
Joe Morone
Yes.
Anthony Young
Was that mostly in the Harris business or was that in the Legacy AEC business?
Joe Morone
There was some for GE 9x which is the Legacy AEC business but the bulk of it was for aerostructures group in Salt Lake, yes.
Anthony Young
Okay.
John Cozzolino
And the reason we call that out is because you’re trying to understand what’s the run rate for this combined business right now. We had said if you think last quarter, if you think about a full year pro forma run rate if we had Salt Lake for the full year with us, then the annual run rate would be close to about $200 million, and so $54 million in sales were over that run rate.
And so we thought it was important to understand that there are some of these and it happens every once in a while, you get these non-recurring reimbursements which help to boost revenue. But we think a better way of thinking of the recurring revenue run rate at this stage in the development of the business is a little under $50 million, and that’s representative of what we should see for the rest of the year which is consistent with the notion of about $200 million pro forma full year revenue.
Anthony Young
Okay. And maybe just on the $7 million, there is no margin associated with that then right?
John Cozzolino
There is. Last quarter we mentioned 9x tool in which did not have and does not have margin associated with it but as is often the case the development tooling varies contract-by-contract but much of the development tooling, much of that $7 million this year this quarter did have margin associated with it.
If you basically take that $7 million and apply the average EBITDA margin for the quarter, you get a pretty good idea of.
Anthony Young
Okay. And then last one just on the balance sheet and you guys have taken on some debt doing acquisition, is your first priority here debt pay down or are you comfortable with the current level, obviously you’re comfortable with it, but I mean do you want to see it lower or do you see this is something that is sustainable?
Joe Morone
Yes and yes. We think it’s sustainable but we would like to see it come down.
We are really concerned about these things. We think it’s unlikely to come down as I think we mentioned before in ‘16 and ‘17, because these will be peak capital expenditure years for LEAP and for several of the reps in Salt Lake.
So we won’t see the free cash that allows us to drive down that until ’18.
Anthony Young
Okay. Thanks for the question guys.
Joe Morone
Thank you, An.
Operator
And we do have a question from the line of John Franzreb with Sidoti and Co. Please go ahead.
John Franzreb
Hi guys. Regarding the integration process, you mentioned Joe that ERP systems have been put in place.
Could you talk about what else remains to be done and the timeline for completing it all?
Joe Morone
Yes. I think the way to think about this is three simultaneous set of activities and the first which began even before the close is to just make sure the operations continue to run.
So it’s payroll benefits, email, ability to consolidate financial results, so really basic infrastructure needs. That’s pretty much done.
The second wave of integration activity is really the integration of our systems and it’s everything from ERP systems to shop floor systems to product lifecycle management systems to procurement and supply chain systems. And that is well underway, it’s a heavy classic ERP implementation process with basically taking the ERP and related systems from the Albany Legacy, Albany Engineered Composites Legacy businesses and integrating those into Salt Lake.
That will be done either should be done sometime between November and the end of Q1 probably more likely – just leave it in that timeframe. And then the third way of activity that’s going on simultaneously and that’s picking up steam as we go, it’s the first way that was a bulk of activity right at the outset, the second way of systems begins with the outset and it is now really at its peak and will continue that way for the next couple of quarters.
And then the third way which is really just picking up steam is to marry-up capabilities of the two groups and we’ve said from Day One that Salt Lake has significant capabilities related to ours in business development, contract management, program management and that the Albany Legacy side significant capabilities relative to Salt Lake on R&D and operations management. So we are trying to take the best of both and create an integrated organization that sort of capabilities and that is just picking up steam here.
John Cozzolino
So on track, no surprises, we are feeling – it’s the lack of surprises are surprising. There really haven’t been any surprises.
What Salt Lake said about themselves through the process and what we found are entirely consistent with described to investors that we thought we were seeing when we bought this business is exactly what we are still thinking as we are now looking with our new colleagues at Salt Lake. And if all we do not all we do, if we successfully manage this integration process and the associated ramp ups, this is everything we said it would be and there is plenty of upside beyond that.
John Franzreb
So just on the integration process excluding the ramp, how much margin benefit do you expect to utilize once this process is completed.
Joe Morone
I think we haven’t – I would say that if you start with what we said when we announced the transaction that we thought the margins for the combined business would ramp up to 18% to 20% by the end of the decade. We have not come off that number.
I think our degree of confidence and ability to achieve that number if we successfully integrate on all three levels, our degree of confidence is growing.
John Franzreb
Okay. And maybe some closing housekeeping items here.
How about the easier one, what would expect the [indiscernible] to be for the full year now?
John Cozzolino
So john, we had about $18 million in the second quarter and that includes the depreciation and amortization related to the acquisition. And because it was also a full quarter, just about a full quarter, that’s a pretty good number and we still may have some adjustment in the second half.
But if you look at $18 million per quarter rest of the year, it’s probably pretty good estimate.
John Franzreb
Okay. And what about the tax rate?
It seems to be [indiscernible]?
John Cozzolino
Well, last quarter, we were just under 40% and now we’re a longer 39%, so we’ve been pretty consistent. I think we noted last quarter that we’d be in the high 30s.
So what you’re seeing now is what we’re expecting in the rest of the year.
John Franzreb
I’m sorry. John, I thought there were moves that are going in place above the tax rate and maybe I missed that first quarter?
John Cozzolino
We didn’t state that. For this year based on what we’re doing with repatriation and other things, our expectation around the tax rate is the high 30s.
John Franzreb
Okay, right. Thank you.
That’s all I’ve got. Actually, I’ve got one more question.
Could you just update us on new programs that you’re working on that are non-aerospace?
Joe Morone
That are non-aerospace.
John Franzreb
Correct.
Joe Morone
We are continuing to push ahead with our automotive R&D. We continue to work closely with a major OEM in the UK on really crash resistant structures all round bumper concepts and so far so good.
The other major activity right now non-aero is still the parts that Salt Lake makes for down-hole drill frac plugs and there is no change in the status of that. That’s not really a development program, those are parts that we sell but obviously those sales have been hurt badly by what’s happened to the oil and gas industry, but I think I said before we’ve always view down-hole drilling as one of the most interesting areas to explore beyond automotive and beyond aerospace.
So over the next couple of years, we will be looking at that one very closely to understand it better.
John Cozzolino
Understand the long term application better.
John Franzreb
Okay. Anything in PMC?
Joe Morone
Let me just say that before I get to PMC, on the aero side the one to watch – everything we’ve talked about before on engines, on airframe, commercial and defense down-holes but the wildcard to watch now is how Boeing decides to proceed if it decides to proceed on the middle of market aircraft. And in order to hit mid next decade, they need to make a decision really by next year, so they need to make a presentation to their board sometime next year on whether or not to go with the middle of market aircraft.
Given that the aerospace industry has pretty much swung to execution on new platforms, this is the one big new potential platform that’s out there. So everybody is going to be swirling around and looking for opportunity.
If they proceed, there is a market between – they are saying between 2,500 and 5,000 planes which means 5,000 to 10,000 engines. There will be a big competition among the three major engine manufacturers.
The engine will be at a size that falls into CFM agreement between GE and Safran. So CFM which is in some way to the incumbent for planes close to that size for bone is going to be competing hard I would guess with prouder for this business.
If they get that business that’s a big opportunity for us. Those are big engines with potentially a lot of content.
So you want to watch that carefully over the next couple of years to see first is Boeing pulled the trigger and then secondly with the CFM winning the competition for the engine.
John Franzreb
Got it. On TMC?
Joe Morone
On TMC, we are – I want to over state this, we are continuing to be encouraged by what we see in testing and initial trials of our new technology platform, and we’re continuing to see that the first way of applications which are in fact being used by customers will soon to be used by customers will be in the tissue and paper towel segment of the industry. But we are seeing applications for the technology for some applications in other markets as well.
John Franzreb
Okay. I guess I’ll just leave at with that.
Thanks, John.
John Cozzolino
Thanks, John.
Operator
And at this time, there is no further questions in queue.
Joe Morone
Thank you, David. Thank you everyone for participating on the call and John and Antony thank you for your questions, and I will look forward to talking about investors over the next couple of months and beyond the road of it and we don’t talk to you then, we will talk to you on our next call.
Thank you and 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.