Albany International Corp. (NYSE:AIN) Q2 2019 Earnings Conference Call July 31, 2019 9:00 AM ET

Company Participants

Stephen Nolan - CFO and Treasurer
Olivier Jarrault - CEO

Conference Call Participants

Peter Arment - Robert W. Baird
Christian Herbosa - Noble Capital Markets

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter Earnings Call of Albany International. [Operator instructions] At the request of Albany International, this conference call on Wednesday, July 31, 2019, will be webcast and recorded.

I'd like to now turn the conference over to Chief Financial Officer and Treasurer Stephen Nolan for introductory comments. Please go ahead.

Stephen Nolan

Thank you very much 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 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 to GAAP. For the purpose of this conference call, those same statements also apply to our verbal remarks this morning. For a full discussion, including a reconciliation of non-GAAP measures we may use on this call to their most comparable GAAP measures, please refer to both the earnings release as well as our SEC filings, including our 10-K.

Now I will turn the call over to Olivier Jarrault, our Chief Executive Officer, who will provide some opening remarks. Olivier?

Olivier Jarrault

Thank you, Stephen. Well, good morning and welcome, everyone and thank you for joining our second quarter earnings call. Once again, I’m pleased to report that Albany International delivered strong results in Q2 2019. Once again, we delivered strong growth.

Total company net sales increased 7% or 9%, excluding the impact of currency translation effects. We also continued to deliver strong profitability. Compared to Q2 2018, operating income grew by almost 29% and adjusted EBITDA by almost 18%. This quarter did benefit from a favorable net change in the estimated profitability of certain long-term contracts in our AEC segment.

This net change reflects improvements in labor productivity, pricing and operational efficiencies, in some cases, well ahead of expectations. Even excluding the impact of this favorable net change, we are currently on a solid path to deliver on our profitability expectations for AEC. Once again, as I have stated before, I want to credit those profitability improvements to the dedication of our people to our company and to generating shareholder value by working relentlessly to drive productivity gains.

Turning now to the current state of our business. In Engineered Composites, we continued the streak of strong quarterly growth with 27% growth in net sales over the same quarter last year or 28% when excluding currency translation effects, another remarkable achievement. We continued to be on track to meet the full rate production demands of our key programs, including LEAP, Boeing 787, F-35 and CH-53K.

In terms of current period profitability, AEC delivered 24% adjusted EBITDA margin for the quarter, well ahead of our expectations. We delivered strong labor productivity and operational efficiency gains achieved through our relentless focus on operational excellence, which helped drive both the favorable net change in the estimated profitability of long-term contracts and also additional profitability improvements.

We continue to expect to deliver between 18% and 20% adjusted EBITDA margins for the full-year of 2020. We continue to monitor very closely the ongoing situation with the Boeing 737 MAX program to which we are a key supplier through our joint venture with Safran on the LEAP engine. We have previously indicated that the LEAP program represents about half of AEC's net sales. This continues to be the case. It represented a little under 50% of AEC's Q2 net sales.

As I'm sure you're aware, we are the exclusive supplier for the life of the program of components, fan cases, fan blades and spacers for both the LEAP-1A variant used on the Airbus A320neo family and the LEAP-1B variant used on the 737 MAX. Based on the latest communications with our customer, Safran, we’ve implemented certain reductions to our production plans for LEAP components for the second half of the year, which will impact AEC's second half results.

However, as we have indicated before, the somewhat unique structure of that program which is being operated under a cost-plus fee arrangements mitigates the financial impact to AEC of any production changes.

As a result, as will be clear from Stephen's remarks, this revised outlook should not at this time, impact our ability to deliver our previously issued guidance for the year. However, it does limit our ability to deliver upside to this guidance range, particularly with respect to net sales. We strongly value our relationship with Safran and are proud of our participation on the Airbus A320neo and Boeing 737 MAX programs. Overall, we remain very pleased with AEC's progress and its ability to meet the program needs of our customers and to deliver strong returns on capital to our shareholders.

Turning to Machine Clothing. For full-year 2019, we previously indicated that we expected revenue to be relatively flat for the full-year when compared to full-year 2018. For Q2 2019, on a currency-neutral basis, we delivered net sales about 2% below a very strong Q2 2018. However, year-to-date, on the same basis, net sales are up slightly relative to the prior year.

We continue to expect revenue to be relatively flat for the full-year when compared to full-year 2018, with board and packaging, tissue and towel and pulp grade PMC sales increases, more or less offsetting declines in publication grade PMC sales. We are very pleased with our profitability in the quarter. Even with the lower volume and resulting lower fixed cost leverage this year, we delivered gross margins of 51.8% compared to 48.9% last year.

We continue to face challenges in this market primarily due to pricing pressure and rising input costs, whether those be labor or raw materials. We rely principally on continuous improvement manufacturing initiatives, superior customer service and technology leadership to continue to drive profitability in this business.

With that, I'd like to turn the mic over to Stephen who will provide more details on the quarter and our guidance for the full-year. Stephen?

Stephen Nolan

Thank you, Olivier. I will talk first about the results for the quarter and then about the outlook for the balance of the year. For the second quarter, total company net sales were $273.9 million, an increase of 7.3% over the $255.4 million delivered in the same quarter last year. Adjusting for currency translation effects, the growth in net sales was 8.8%.

On the same basis, excluding currency translation effects and in part due to the very strong Q2 in 2018, MC net sales declined by 2.4% driven primarily by a decline in publication PMC grades, partially offset by a modest net increase across all other grades.

AEC net sales grew at 28.2% primarily driven by growth in the LEAP, F-35 and Boeing 787 programs. Second quarter gross profit for the company was $105.2 million, an increase of 14.8% over the comparable period last year. The overall gross margin increased by 250 basis points from 35.9% to 38.4% of net sales.

Within the MC segment, gross margin improved from 48.9% to 51.8% of net sales due to improved labor productivity and reduced depreciation expense, partially offset by lower net sales driving reduced fixed cost leverage.

Within AEC, the gross margin improved from 13.5% to 20.9% of net sales driven by a favorable net change in the estimated profitability of long-term contracts, higher net sales driving increased fixed cost leverage and improved productivity.

Second quarter selling, technical, general and research expenses increased from $46.9 million in the prior year quarter to $50.1 million in the current quarter, but decreased as a percentage of net sales from 18.4% to 18.3%. The increase in the amount of expense was driven primarily by the revaluation of nonfunctional currency assets and liabilities, which resulted in gains of $2.4 million in Q2 2018 and losses of $400,000 in Q2 of 2019.

Total operating income for the company was $54.2 million, an increase of 28.6% from $42.2 million in the prior year. MC operating income decreased by $800,000, principally as a result of the increase in STG&R noted above, while AEC operating income grew by 333% to $17.7 million driven by higher gross profit and lower STG&R.

The income tax rate for the quarter was 29.6% compared to 18.9% in the same period last year. The tax rate in Q2 '19 includes charges of $600,000 for income tax adjustments, while Q2 '18 included $4.1 million of reductions to income tax expense that resulted from tax adjustments, principally the reduction of tax valuation allowances in Europe.

Net income attributable to the company for the quarter was $34.1 million, an increase of 13.9% from $29.9 million last year. The increase was driven by improved operating income, which was partially offset by the favorable tax adjustments in 2018.

Earnings per share was $1.05 compared to $0.93 last year. After adjusting for restructuring expenses and the impact of foreign currency revaluation gains and losses, adjusted earnings per share was $1.09 this quarter compared to $0.94 in the comparable period last year.

Adjusted EBITDA grew 17.9% from last year to $72.4 million for the current year quarter. MC adjusted EBITDA was $56.4 million or 36.4% of net sales this year, down 2.7% from $58 million or 35.8% of net sales in the prior year quarter.

AEC adjusted EBITDA grew from $15.1 million or 16.2% of net sales last year to $28.6 million or 24% of net sales this quarter. As Olivier mentioned in his remarks, AEC results this quarter benefited from a favorable net change in the estimated profitability of long-term contracts.

We review the estimated profitability of all long-term contracts every quarter. And while we frequently report net changes, sometimes positive and sometimes negative in estimated long-term contract profitability, the $5 million favorable adjustment this quarter was unusually large.

Several of our contracts on which we've been executing successfully for several years achieved cost or revenue objectives during the quarter that caused us to increase the gross profit rate at which we're recognizing profit on those programs. Those increased rates affect not only the profitability of those contracts in the current and future periods, but require that we record in the current quarter the effect of those higher rates on revenue recorded on those long-term contracts in prior periods.

Therefore, while the improvements result from strong operational improvements both in this and earlier quarters and while we will recognize profit on the affected contracts of rate higher than we had done previously, the overall profit recognized in this quarter on those contracts is not reflective of the ongoing level of profit.

Turning to our debt position. Total debt, which consists of amounts reported in our balance sheet as long-term debt or current maturities of long-term debt, decreased by $9 million to a balance of $482 million at the end of Q2, and cash increased by about $28 million during the quarter, resulting in a reduction in net debt of about $37 million.

Our working capital initiatives resulted in a significant improvement in cash flow as second quarter cash provided by operating activities increased from $36 million in 2018 to $59 million in 2019.

For the first six months of the year, cash provided by operating activities increased from $17 million last year to $83 million in 2019. Payments for all capital expenditures in Q2 fiscal '19 were about $15 million, reflecting continued investments in equipment to support multiple ramp-ups in AEC.

Looking forward to the full-year, we continue to expect MC revenue to be relatively flat on a currency-neutral basis compared to fiscal '18 and to generate between $195 million and $205 million of adjusted EBITDA. And we expect AEC to generate 20% to 25% of revenue growth with improved EBITDA margins in fiscal '18.

Assuming no significant changes in global economic conditions, we still believe that our segment guidance holds even after incorporating the changes to our LEAP production schedule Olivier described earlier. At the company level, our guidance also remains largely unchanged.

For the full-year of fiscal '19, we continue to expect at the company level revenue of between $1.05 billion and $1.08 billion; adjusted EBITDA, after incorporating both prior segment guidance and corporate expenses, of between $225 million and $240 million; effective income tax rate, including tax adjustments, of 27% to 29%; depreciation and amortization of between $70 million and $75 million; GAAP earnings per share of between $3.04 and $3.34; and adjusted earnings per share of between $3.05 and $3.35. We now expect capital expenditures for the full-year to be in the range of $80 million to $90 million.

With that, I will pass the call back to Olivier for further comments.

Olivier Jarrault

Thank you, Stephen. As indicated by Stephen's remarks, we continue to feel very good about the year, and we’re confident in our ability to deliver our corporate and segment guidance. MC is performing well in a challenging environment with market and input cost pressures, but is more than holding its own.

AEC is achieving productivity gains, meeting its obligations to its customers and delivering on its profitability targets. We remain on track to hit our 2020 objectives for that segment. Overall, I feel very good about the business and our ability to hit our expectations.

With that, let's go to the line for any questions. Operator?

Question-and-Answer Session

Operator

[Operator instructions] Our first question comes from the line of Peter Arment with Baird. Your line is open.

Peter Arment

Yes, thank you. Good morning, Olivier and Stephen. First, I guess, Stephen, thank you for clarifying the favorable adjustment. So if we were to back that out, you still had a very strong AEC margin performance, almost 11%. Can you -- Olivier, maybe just highlight some of the operational metrics that you are seeing at AEC, the improvements that you are seeing?

Olivier Jarrault

Yes. Sure. Good morning, Peter and thank you for being with us this morning. Yes, a very strong quarter, as Stephen was saying, even excluding the $5 million favorable impact driven, I would say, across the board, across all the aerospace manufacturing footprint by a very strong year-over-year process productivity metrics, driven through technology initiatives, metal engineering, scrap reduction that we're seeing that across the entire system, the very strong manufacturing productivity gains also year-over-year driven by our continuous improvement, lean manufacturing deployment. All that, if you will, driving a very nice improvement in terms of labor utilization, labor efficiency, therefore labor productivity. But also, as I mentioned very often in the past, the key metrics for me and for all of us being the increased operational equipment effectiveness, if you will, of our key assets, building our looms, our auto clears and so on, right? So that's really what I'm seeing a very -- and we're all very happy about it. Still a lot more opportunities to -- again, and to improve on it, but that's the major metrics we are following and we are happy to see improvement. Okay?

Peter Arment

Yes. And just as a follow-up, if I could. Just how this all rolls up to your annual guidance. I appreciate that you're -- there's a lot of moving parts when you look about the second half and changes with the LEAP. But I guess, wondering what keeps the lower end of the EPS range still intact, why that would move up just given the performance and how well you guys are executing. Thanks again.

Stephen Nolan

Yes. So a couple of items there. And we would certainly hopefully beat the lower end of our range, but we did not change our range this quarter. There's enough uncertainty that we will look at that again three months now at the end of our third quarter call. But certainly, as we look forward right now, there are really two areas of challenge in the back half of the year. The first half, Olivier mentioned in his remarks with respect to AEC with the reduced volumes that we’re now planning for production of components for the LEAP program, and that certainly put some pressure on AEC in the back half of the year. And secondly, we’re seeing overall in the MC market, it still is a challenging market out there. We’ve overperformed in the first half of the year, but there's enough uncertainty if you look at the broader paper and packaging market. There are some challenges in that market. And while there's a bit of a lag in terms of how those challenges in the end use market, how they ripple back into the PMC market, there's enough uncertainty there that we decided to keep the range intact for this quarter. But we will certainly hopefully be in a position three months from now to raise the lower end of the guidance, but it's premature to do so at this stage.

Peter Arment

Appreciate that. Thanks, Stephen.

Operator

Thank you. And our next question comes from the line of Christian Herbosa with Noble Capital Markets. Your line is open.

Christian Herbosa

Hi. Thanks for taking my call and congrats on a great quarter. I just have one question for you. So can you say what percentage of revenue in the AEC segment can be attributed to the LEAP program?

Olivier Jarrault

Yes. Good morning, Christian and thank you for being with us. Yes, listen, as we’ve already indicated in the past, I mean, the content of ourselves to Safran for LEAP-1A, 1B, roughly about 50% of our total AEC revenues. We saw that again confirmed in the second quarter.

Stephen Nolan

But it's important to note that, as Olivier said, that is for both 1A and 1B. 1A, obviously, which powers the Airbus A320neo family, the 1B that powers the MAX. So the part -- the portion of AEC's revenue, which is related to the MAX program, we've never broken out 1A and 1B within that. But you think of -- you wouldn't be too far off if you thought of close to half of our LEAP revenue is being associated with the MAX program.

Christian Herbosa

Okay, thanks. And so you expect that percentage to maintain going forward?

Stephen Nolan

So in the back half of the year, it's a little uncertain at this stage. I think that percentage will obviously change a little from the front half of the year given the reductions we are expecting and given the continued growth we expect in the other programs in AEC. But generally, as we look forward, that’s roughly the right number over the next certainly 12 to 18 months.

Christian Herbosa

Okay, great. Thanks for the color and thanks for taking my call.

Stephen Nolan

Thank you, Christian.

Operator

At this time, there are no further questions. [Operator instructions] And at this time, we’ve no one queued up for questions.

Olivier Jarrault

Well, again, thank you all for joining us on the call. We appreciate your time today and your continued interest in Albany International. I'd like to conclude today's call by recognizing the entire Albany team for another very strong quarter of performance. 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 service. You may now disconnect.