Albany International Corp. — 2016 Q3 Form 10-Q
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2016. Albany operates through Machine Clothing (MC), its established paper-industry business and primary cash generator, and Albany Engineered Composites (AEC), which serves aerospace and defense markets. On April 8, 2016, the company acquired Harris Corporation’s composite aerostructures business for $187.0 million in cash plus assumed liabilities; the business was renamed Albany Aerostructures Composites LLC (AAC) and included in AEC.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $191.3 million | $178.8 million | $566.8 million | $532.4 million |
| Gross profit | $72.4 million | $75.7 million | $223.2 million | $207.0 million |
| Gross margin | 37.9% | 42.4% | 39.4% | 38.9% |
| Operating income | $24.8 million | $25.8 million | $64.9 million | $49.0 million |
| Net income attributable to company | $13.1 million | $9.7 million | $36.9 million | $19.7 million |
| Diluted EPS | $0.41 | $0.30 | $1.15 | $0.62 |
| Operating cash flow | $29.2 million | $41.9 million | $51.8 million | $59.2 million |
Q3 operating margin was 13.0%, compared with 14.5% in the prior-year quarter. Nine-month operating margin improved to 11.5% from 9.2%. Q3 net margin attributable to the company was approximately 6.8%, versus 5.4% in 2015.
- Q3 MC sales declined 7.3% to $143.2 million; AEC sales increased 97.9% to $48.0 million.
- Nine-month MC sales declined 5.6% to $437.4 million; AEC sales increased 87.9% to $129.3 million.
- Q3 MC operating income was $40.0 million versus $42.0 million; AEC reported an operating loss of $4.5 million versus $4.2 million.
- Nine-month MC operating income increased to $112.6 million from $111.0 million; AEC’s operating loss narrowed to $14.1 million from $26.6 million.
- Cash and cash equivalents were $196.2 million at September 30, 2016, including $160.2 million held by non-U.S. subsidiaries.
- Total debt was $491.8 million and net debt was $295.6 million, compared with $265.7 million and $80.6 million, respectively, at December 31, 2015.
- Capital expenditures were approximately $53.8 million for the first nine months. Management estimated full-year capital expenditures of $75 million to $80 million.
- The quarterly dividend was $0.17 per share; nine-month dividends were $0.51 per share.
Material changes versus the prior comparable period
- Consolidated growth was driven by AAC and continued growth in the LEAP aerospace program, partly offset by weakness in MC, particularly publication grades in Europe and Asia.
- AEC gross profit improved to $15.3 million for the first nine months from a $9.9 million loss, primarily reflecting the absence of the $14.0 million BR 725 contract charge recorded in 2015, AAC contributions, and higher LEAP sales.
- MC’s nine-month gross margin improved to 47.7% from 47.0% despite lower sales, while Q3 MC margin declined to 47.5% from 48.4% because of lower volume.
- Restructuring expense declined to $7.7 million for the first nine months from $13.9 million. 2016 actions included the proposed discontinuation of R&D activities at the Sélestat, France facility, equipment relocation in Germany, and AEC program consolidation in Boerne, Texas.
- Income tax expense was $7.5 million in Q3 versus $12.2 million in 2015. The effective tax rate was 35.8% versus 55.8%, primarily because the 2015 quarter included significant discrete tax audit and uncertain-tax-position charges.
- Operating cash flow declined despite higher earnings because of increased accounts receivable, inventories, and other assets, principally in AEC.
- Debt increased substantially to fund the acquisition. The company entered a new $550 million unsecured five-year revolving credit facility and had $425 million drawn at quarter-end.
Guidance, outlook, commentary, risks and unusual items
- No specific revenue or earnings guidance was provided. Management expects MC earnings potential to remain broadly flat over time amid paper-industry overcapacity, pricing pressure, and changing paper-grade demand.
- Management views AEC as a significant growth opportunity, including LEAP fan blades and cases, GE9X, Joint Strike Fighter, Boeing, and other aerospace programs. AAC contributed $20.4 million of Q3 sales and reported a $1.5 million operating loss.
- AEC must execute production-readiness milestones and ramp three LEAP facilities, including the Queretaro, Mexico facility targeted to come online in 2017. Failure to meet schedules or production targets could materially affect sales and profitability.
- AEC’s long-term contracts require estimates of future costs and margins. A customer dispute over pricing for the Rolls-Royce BR 725 program could materially affect future results if the customer’s position prevails.
- Acquisition accounting remains provisional. The company recorded $59.4 million of acquired amortizable intangible assets and $67.0 million of goodwill, subject to further valuation adjustments. Third-quarter results included cumulative measurement-period adjustments that reduced pretax income by $1.5 million.
- The company paid $5.2 million to terminate prior interest-rate swaps and entered hedges fixing the LIBOR component on $300 million of debt at 1.245% through March 2021, plus the applicable credit spread.
- Leverage was 2.38 to 1.00 on a pro forma basis, versus a 3.50-to-1.00 covenant maximum; interest coverage was 12.93 to 1.00. The company reported compliance with all debt covenants and approximately $125 million of additional borrowing capacity.
- Albany was defending 3,753 asbestos claims and Brandon Drying Fabrics was defending 7,707 claims. Management could not estimate a meaningful range of potential loss but did not expect material liability beyond available insurance coverage.
- The company identified global paper-market weakness, aerospace execution, acquisition integration, foreign-exchange movements, contract profitability estimates, liquidity, and interest-rate exposure as important risks.
Most important facts for investors to verify
- Whether AEC and AAC can achieve projected production ramps, margins, and cash generation, particularly under the LEAP program.
- The final purchase-price allocation for AAC, including goodwill, intangible values, useful lives, and any subsequent measurement-period adjustments.
- Debt repayment capacity, refinancing requirements for the $50 million private placement due October 2017, covenant headroom, and exposure to floating interest rates.
- Working-capital needs and the amount of cash held offshore that may be subject to additional U.S. tax if repatriated.
- Potential financial effects of the BR 725 pricing dispute and other long-term-contract estimate changes.
- Ongoing asbestos claims, insurance limits, indemnification arrangements, and any change in management’s assessment of ultimate liability.
- Full-year capital spending, restructuring cash payments, and whether MC demand and margins stabilize as management expects.