Albany International Corp. — Q2 2017 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. Albany operates through Machine Clothing (MC), its established paper-industry business, and Albany Engineered Composites (AEC), which serves aerospace and defense markets. The 2016 acquisition of Harris Corporation’s composite aerostructures business affects comparability, particularly for the six-month period.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $215.6 million | $203.2 million | $414.8 million | $375.5 million |
| Gross profit | $63.1 million | $78.3 million | $139.0 million | $150.8 million |
| Gross margin | 29.2% | 38.5% | 33.5% | 40.2% |
| Operating income | $9.2 million | $17.9 million | $31.3 million | $40.1 million |
| Operating margin | 4.3% | 8.8% | 7.5% | 10.7% |
| Net income attributable to Albany | $12.0 million | $23.9 million | $12.0 million | $23.9 million |
| Diluted EPS | $0.03 | $0.32 | $0.37 | $0.74 |
| Adjusted EBITDA | $30.6 million | $46.6 million | $74.1 million | $87.9 million |
Q2 net sales increased 6.1%, while six-month sales increased 10.5%. MC sales declined 1.6% in both periods. AEC sales increased 27.2% in Q2 and 54.3% year to date, principally from LEAP program growth and, for the six-month comparison, the inclusion of a full period of the acquired Salt Lake City business.
MC remained profitable, with Q2 operating income of $38.4 million versus $35.4 million and six-month operating income of $76.7 million versus $72.5 million. AEC reported operating losses of $17.8 million in Q2 and $22.9 million for the six months, compared with losses of $5.8 million and $9.6 million, respectively, in the prior-year periods.
Cash flow, debt and liquidity
- Cash provided by operating activities was $3.8 million for the first six months, down from $24.0 million in 2016, primarily because of higher AEC receivables and inventories.
- Capital expenditures were $46.4 million, compared with $28.1 million in 2016, primarily reflecting the ramp-up of AEC programs.
- Cash and equivalents were $138.8 million at June 30, 2017, down from $181.7 million at December 31, 2016. Approximately $127.9 million was held outside the United States.
- Total debt was $496.0 million and net debt was $357.2 million at June 30, compared with year-end net debt of $303.2 million.
- The $550 million revolving credit facility had $430.0 million drawn, with approximately $120 million of additional borrowing capacity subject to applicable conditions. A $50 million private-placement note matured October 25, 2017.
- Leverage was 2.55x and interest coverage was 9.41x at June 30, versus covenants of no more than 3.50x leverage and at least 3.00x interest coverage. The company reported compliance with all debt covenants.
- Quarterly dividends were $0.17 per share; $10.9 million was paid during the first six months. No share repurchases occurred in Q2.
Material changes and unusual items
- AEC recorded a $15.8 million cost-of-goods-sold charge in Q2 for downward revisions to estimated profitability of two fixed-price contracts: $10.2 million for the Rolls-Royce BR 725 program and $5.6 million for Airbus A380 components. The revisions reflected lower expected demand and, for the A380 contract, program inefficiencies.
- The charge included a $4.0 million inventory write-off and an $11.8 million reserve for future contract losses. Total future contract-loss reserves were $11.8 million at June 30, 2017, versus $0.1 million at December 31, 2016.
- Q2 foreign-currency revaluation produced a $1.9 million loss, compared with a $1.6 million gain in Q2 2016. Six-month foreign-currency revaluation losses were $2.0 million, versus a $2.0 million gain in 2016.
- Restructuring expense declined to $2.0 million in Q2 and $4.7 million year to date, compared with $6.6 million and $7.3 million, respectively. AEC restructuring principally involved Salt Lake City personnel reductions; MC costs principally related to France.
- Management estimates annual savings of approximately $4 million to $5 million from AEC restructuring beginning in Q3 2017, principally in selling, technical, general and research expenses.
- The Q2 effective tax rate was 59.1%, compared with 37.6% in 2016, partly because of uncertain-tax-position and prior-period tax adjustments. The six-month effective rate was 40.6%, versus 35.9%.
Outlook, commentary and risks
No specific consolidated revenue or earnings guidance is provided in the filing. Management expects MC earnings to remain broadly stable over time but faces paper-industry overcapacity, pricing pressure and declining publication-grade demand. Growth expectations for AEC depend substantially on aerospace production schedules, including LEAP, GE9X, F-35, Boeing 787 and other programs.
Management states that AEC fixed-price contract estimates can materially affect revenue and gross profit in the period of revision. The filing also identifies risks from aerospace demand reductions, program delays, technical difficulties or cancellations, failure to achieve profitable AEC growth, macroeconomic conditions, foreign-exchange movements, customer concentration and working-capital requirements.
The company expects sufficient capital resources for the foreseeable future based on cash and credit facilities, but cash generation weakened materially and borrowings increased. Approximately $62.6 million of foreign earnings had been targeted for future repatriation, with a related deferred tax liability of $4.5 million.
Albany was defending 3,737 asbestos claims at June 30, 2017. The company believes available insurance and indemnification should prevent a material adverse effect, but it cannot meaningfully estimate the potential loss range. Approximately $140 million of insurance coverage was reported as remaining for current and future claims.
Disclosure controls and procedures were reported as not effective because of previously identified material weaknesses involving controls at the Japan subsidiary and certain foreign locations, as well as management review of potential loss-contract reserves. Remediation was in progress, with management expecting remediation by the end of 2017, subject to testing. Internal controls at the Salt Lake City operations were implemented during Q2.
Facts investors should verify
- Whether AEC’s BR 725 and A380 contract reserves are sufficient and whether additional demand or profitability revisions are required.
- Progress toward the projected $4 million to $5 million of annual AEC restructuring savings.
- AEC cash generation, working-capital needs and capital spending as LEAP and other aerospace programs ramp.
- Refinancing or repayment of the $50 million private-placement note and the company’s borrowing capacity under its revolving facility.
- Remediation and testing of the material weaknesses in internal control over financial reporting.
- Exposure to paper-industry declines, aerospace program delays or cancellations, foreign exchange and asbestos litigation.
- The quantified impact of adopting the new revenue-recognition standard on AEC long-term contracts; the filing states that the full effect and cumulative adjustment could not yet be determined.