Albany International Corporation

Ladies and gentlemen, thank you for standing by. And welcome to the second quarter earnings call of Albany International. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. At the request of Albany International, this conference call on Wednesday, July 31, 2019, will be webcast and recorded. I would like to now turn the conference over to Chief Financial Officer and Treasurer Stephen Nolan for introductory comments. Please go ahead.

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 Giraud, our Chief Executive Officer, who will provide some opening remarks. Olivier?

Thank you, Stephen. Well, good morning and welcome, everyone, and thank you for joining our second quarter earnings call. Once again, I am 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 continue 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 continue to be on track to meet the full rate production demands of our key programs, including LIP, 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 LIP 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 A320 NEO family and the LEAP 1B variant used on the 737 packs. Based on the latest communications with our customer Saffron, we have 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 arrangement, 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 A320 NEO 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. 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 pub-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 would like to turn the mic over to Stephen, who will provide more details on the quarter and our guidance for the full year. Stephen? 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 decline in publication PMC grades, partially offset by a modest net increase across all other grades. AEC net sales grew significantly 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 non-functional 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 SDG&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 2019 includes charges of $600,000 for income tax adjustments, while Q2 2018 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 favourable 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 contract at a 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 2019 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 the currency neutral basis compared to fiscal 18 and to generate between 195 and 205 million of adjusted EBITDA. We expect AEC to generate 20 to 25% of revenue growth with improved EBITDA margins from 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 lead 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 and 1.08 billion, Adjusted EBITDA after incorporating both prior segment guidance and corporate expenses of between 225 and 240 million. Effective income tax rate, including tax adjustments of 27 to 29%. Depreciation and amortization of between 70 and 75 million. Gap earnings per share of between 304 and $3.34. and adjusted earnings per share of between 305 and 335. We now expect capital expenditures for the full year to be in the range of $80 to $90 million. With that, I will pass the call back to Olivier for further comments.

Thank you, Stephen. As indicated by Stephen's remarks, we continue to feel very good about the year. and we are 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?

The phone lines are now open for questions. If you would like to ask a question, please press star, then 1. If you are using a speakerphone, please pick up the handset before asking a question. Once again, if you would like to ask a question, please press star then 1 now. 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're seeing at AEC, the improvements that you're seeing?

Yeah, 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 across the board, across all the aerospace manufacturing footprint by a very strong year-over-year process productivity matrix. driven through technology initiatives, method engineering, scrap reduction, that we're seeing that across the entire system. Very strong manufacturing productivity, again, so you're driven by our continuous improvement, lean manufacturing deployments. 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, a key matrix for me and for all of us being the increased demand operational equipment effectiveness, if you will, of our TSS, meaning our looms, our autoclaves, and so on, right? So that's really what I'm seeing, 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're following, and we're happy to see improvement.

Okay? Yeah. Just as a follow-up, if I could... just how this all rolls up to your annual guidance. I appreciate that there's a lot of moving parts when you look at 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 wouldn't move up just given the performance and how well you guys are executing. Thanks again.

Yeah, so a couple of items there. 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 from 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 are now planning for production of components for the LEAP program. That certainly puts some pressure on AEC in the back half of the year. And secondly, we are seeing overall in the MC market, it still is a challenging market out there. We have 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, you know, while there is 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'll 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.

Appreciate that. Thanks, Stephen.

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

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 AAC segment can be attributed to the LEAP program?

Yeah, good morning, Christian, and thank you for being with us. Yeah, listen, as we have always indicated in the past, I mean, the – the content of our sales to Saffron for LEAP 1A, 1B, roughly, you know, about 50% of our total AEC revenues. We saw that, again, confirmed in the second quarter.

But it's important to note that, as Olivier said, that is for both 1A and 1B. 1A, obviously, which powers the A plus A320 NEO 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 wouldn't be too far off if you thought of close to half of our LEAP revenue as being associated with the MAX program.

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

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're expecting and given the continued growth we expect in the other programs in AUC. But generally, as we look forward, that's roughly the right number, you know, over the next certainly 12 to 18 months.

Okay, great. Thanks for the call, Aaron. Thanks for taking my call. Thank you, Christian.

At this time, there are no further questions but if you wish to ask a question, please press star then 1. And at this time, we have no one queued up for questions.

Well, again, thank you all for joining us on the call. Appreciate your time today and your continued interest in Albany International. I would like to conclude today's call by recognizing the entire Albany team for another very strong quarter of performance. Thank you.

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.