Albany International Corp (AIN) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second-quarter earnings call of Albany International. (Operator Instructions) 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.

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 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?

Thanks, John. Good morning, everyone. Welcome to our Q2 2016 earnings call. As usual, I will 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 continued to generate strong profitability and AEC strong sales growth. And both businesses remain firmly on track toward 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 and tighter inventory controls in the packaging grades in the US, 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 papermakers 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 cost, 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 -- that's $54 million versus $29 million -- $54 million for the quarter, and adjusted EBITDA was $5.7 million or roughly 10% of sales.

It's important to note that $7 million of that $54 million in 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 was a good quarter was with significant growth in aggregate sales and income, stable sales and strong profitability in machine clothing, and strong growth and improving profitability in AEC.

Now let's turn to John for more detail.

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% 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 due to 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 in Q2 of last year. The Q2 2015 loss included a charge of $0.28 per share for the BR725 program.

Q2 2016 EPS was reduced by $0.08 per share 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 revaluation are noted on the slide. EPS, excluding all the adjustments shown in the table, was $0.48 per share in Q2 2016 compared to $0.01 in Q2 2015.

Slides 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 at closing as well as related acquisition and financing costs. Total debt also includes about $24 million related to a 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 fixed the LIBOR portion of $300 million of debt through March 2021 at 1.245%, which, including our current spread at 1.5%, results in an effective rate of 2.745%.

Now I'd like to turn it back to Joe for some additional comments before we go to Q&A.

Thanks, John. Turning to our outlook quickly, for machine clothing, given the strength of its performance in the first half of the year, which John just summarized, and assuming a relatively stable currency in the macroeconomic environment, we now expect the full-year adjusted EBITDA to be at the upper end of our $180 million to $195 million range.

Barring 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 of 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 the 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 businesses remain firmly on track for their near- and long-term goals.

And with that, let's go to some questions. David?

(Operator Instructions) John Franzreb, Sidoti & Co.

I'd 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.

Well, if capacity utilization is primarily, as you would imagine, a 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 full through the whole quarter, pretty much from the 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 issue. 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.

I guess I mean with the weakness coming in packaging, Joe, I guess it makes me wonder if you had better than expected volume in tissue, which would suggest that maybe you're running at max capacity in tissue. I was wondering if that might be the case, and how capacity constrained are you in PMC overall?

It wasn't -- it's not -- the sales were stable. So it's interesting; if you look over the past four quarters, and you look by region, you look by grade, sales are remarkably stable. They may fluctuate a little bit from quarter to quarter, but fundamentally we've been shipping roughly the same amount of product pretty much everywhere and by grade over the past four quarters.

So, no, it's 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 GNP-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 of two variables: there's equipment capacity, and then there's 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 overtime 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.

And 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 order. And so the ability to respond to short-term fluctuations really becomes a key dimension of our ability to maintain profitability. 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. Because when those unexpected surges come, they can become a real opportunity if you haven't pulled back too much on capacity. It's a tricky process.

Do you think packaging demand is becoming more seasonal than in years past?

I really think you have to think in terms of GNP sensitivity. And just think -- a box being shipped through retail, electronic retail and bricks-and-mortar. And around the world, as economic activity picks up, box shipments pick up. As box shipments pick up, packaging production increases, and vice versa.

So it is -- when you go over to the publication grade, there's economic sensitivity, but much more important is the structural decline. When you're in packaging and tissue, it's much more GNP-sensitive business.

Okay, switching over to EC. You'd voiced concerns about, call it, 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 that's -- there is no concerns. And would you expect EC to be EBITDA -- would you expect the EBITDA to improve in EC in the second half of the year relative to the first half?

If you start with the ramps, and the monster is, 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 knows that has -- 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 it was coming. And up and down the supply chain, I think everyone has been preparing for this moment. That doesn't make it easy. 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 are on it. But it's crunch time right now.

And the EBITDA expectations for this segment?

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 -- the nonrecurring development tooling, $7 million of development tooling and associated EBITDA, take that out of it, the gross margin 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 efficiencies that come with volume.

EBITDA is trickier, because we're below gross margin you take into account [SG&A] because we are incurring a fair amount of integration costs in the second half of the year as we are implementing ERP systems into the acquisition, and as we're working through trying to consolidate -- trying to marry capabilities from the two groups. So we'll call out as best we can the impact of integration costs on the second-half EBITDA. But so ex that, excluding that, yes, we think -- excluding that and excluding the development tooling, we think Q2 is a pretty representative quarter.

Actually, I'll get back into queue and let somebody else ask some questions. Thanks, Joe.

Thank you, John.

(Operator Instructions) Anthony Young, Macquarie.

Just a question on thinking about the difference between -- or not the differences, but what we're seeing with 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?

So, Anthony, it's an interesting question that really CFM and Safran 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 that 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 their projections that get us from 100 engines in 2016 and 500 in 2017, ramping to over 2,000 engines 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 if you just run those numbers, multiply by 12 and two engines per plane, and you'll get to about 2,000, 2,100, 2,200 engines per year. So that's what they're assuming.

So the question you're asking is: as Pratt struggles to ramp for the neo, is there an opportunity for CFM to grab more share 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 strongest supplier; they have to look at the capability of the weakest link in 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 2,100, 2,200 engines a year with the steepest ramp-up that the commercial industry has ever seen.

So that's 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 overcommit, then you wind up running the risk of disappointing your customers, which created the opportunity in the first place was the reliability of the CFM delivery.

So very tricky, and I don't have a clear answer, but it certainly one watching carefully. In any case -- the safest comment I can make is in any case, it's yet another factor that suggests that for us and for suppliers like us, all of the market pressure right now is for more, sooner. There's just no -- even with these very low oil prices, there's no whiff of pressure in the other direction.

Okay, okay. And then just on the $7 million in revenue that you received for tooling --.

Yes.

Was that mostly in the Harris business, or was that in the legacy AEC business?

There was some for GE9X, which is the legacy AEC business. But the bulk of it was for our aerostructures group in Salt Lake, yes.

Okay.

And the reason we call that out is because if, you know, you were trying to understand, what's the run rate for this combined business right now? We had said, if you think -- we had said last quarter, if you think about a full-year pro forma run rate -- you know, 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 says, oh, we are over that run rate. And so we thought it was important to understand that there is some -- you know, there are some of these -- and it happens every once in a while. You get these nonrecurring 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.

Okay. And maybe just on the $7 million -- there's no margin associated with that, then, right?

There is. Last quarter we mentioned 9X tooling, which did not have and does not have margin associated with it. But as is often the case, 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. And if you basically take that $7 million and apply the average EBITDA margin for the quarter, you get a pretty good idea of --.

Okay. And then last one, just on the balance sheet. You guys have taken on some debt to do the acquisition. I mean, is your first priority here debt paydown? Or are you comfortable with the current level? I mean, obviously, you're comfortable with it, but do you want to see it lower? Or do you see this as something that is sustainable?

Yes and yes. We think it's sustainable, but we would like to see it come down. You know we're pretty conservative about these things.

But it's not -- we think it's unlikely to come down, as I mentioned before, in 2016 and 2017, because these will be peak capital expenditure years for LEAP and for several of the ramps in Salt Lake. So we won't see the kind of free cash that allows us to drive down the debt until 2018. Cozz, anything you want to add?

No, I agree.

Okay. Thanks for the questions, guys.

John Franzreb, Sidoti and Co.

Regarding the integration process, you mentioned, Joe, that ERP systems are being put in place. Could you talk about what else remains to be done and the timeline for completing it all?

Yes. I think the way to think about this is three simultaneous sets 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 the 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. We're basically taking the ERP and related systems from legacy -- all of the engineering 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 -- let's just leave it in that time frame.

And then the third wave of activity that's going on simultaneously, and that's picking up steam as we go. So that first wave, that was the bulk of activity right at the outset; the second wave, the systems, begins at the outset and is now really at its peak and will continue that way for the next couple of quarters. And then the third wave, which is really just picking up steam, is to marry up the capabilities of the two groups.

And we've said from day one that Salt Lake has significant capabilities relative to ours in business development, contract management, program management, and that the Albany legacy side had significant capabilities relative to Salt Lake on R&D and operations management. So we're trying to take the best of both and create an integrated organization and set of capabilities. And that is just picking up steam now.

So on track, no surprises. We're feeling -- it's -- the lack of surprises is surprising. There really haven't been any surprises. What Salt Lake said about themselves through the process and what we have found is -- are entirely consistent. What we've 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 working with our new colleagues in 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's plenty of upside beyond that.

So just on the integration process, excluding the ramp, how much margin benefit do you expect to realize once this process is completed?

I think we haven't -- I would say 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.

Okay. And maybe some -- call it some housekeeping items here. How about the easier one. What would you expect the G&A to be for the full year now?

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 almost a full quarter, just about a full quarter, that's a pretty good number.

Now, we still may have some adjustments to that in the second half. But if you look at $18 million per quarter rest of the year, that's probably a pretty good estimate.

Okay. And what about the tax rate? It seems to be bouncing around a lot lately.

Well, last quarter we were just under 40% to now we're a little under 39%. So we've been pretty consistent. I think we noted last quarter that we would be in the high 30%s. So what you're seeing now is -- probably is what we're expecting rest of the year.

I'm sorry. John, I thought there were moves that were going in place to lower the tax rate. Maybe I misinterpreted that last quarter?

No, we didn't state that. For this year, and based on what we're doing with repatriation and other things, our expectation around tax rate is the high 30%s.

Okay. Thank you. That's all I've got.

Oh wait, actually, I take that back. One more question. Could you just update us on new programs that you're working on that are non-aerospace?

That are non-aerospace?

Correct.

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 around 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-well drilling frac plugs. And there's no change in the status of that. That's not really a development program. Those are parts that we sell, but obviously it's -- those sales have been hurt badly by what's happened to the oil and gas industry.

But as I think I've said before, we've always viewed down-well drilling as one of the most interesting areas to explore beyond automotive and beyond aerospace. So we'll -- over the next couple of years, we'll be looking at that one very closely to understand it better, understand the long-term implications of it.

Okay. Anything in PMC?

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 still holds, 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, you know, there's a market between -- they're 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. It will be -- the engine will be of a size that falls into the CFM agreement between GE and Safran.

So CFM, which is in some ways the incumbent for planes close to that size for Boeing, is going to be competing hard, I would guess, with Pratt and Rolls-Royce for that 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 one carefully over the next couple of years to see, first, does Boeing pull the trigger; and then, secondly, does CFM win the competition for the engine?

Got it. And PMC?

On PMC, we're -- I don't want to overstate this. We are continuing to be encouraged by what we see in testing and initial trials of our new technology platform. And we are continuing to see that the first wave of applications, which are in fact being used by customers or soon to be used by customers, will be in the tissue and towel -- tissue and paper towel segment of the industry. But we're seeing applications for the technology for some applications in other markets as well.

Okay. I guess I'll just leave it at that, then. Thanks, Joe.

Thanks, John.

At this time, there's no further questions in queue.

Okay, thank you, David. Thank you, everyone, for participating on the call. And John and Anthony, thank you for your questions.

Cozz and I will look forward to talking with investors over the next couple of months. And we'll be on the road a bit. And if we don't talk to you then, we'll talk to you on our next call. Thank you and have a good day.

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.