CEO Letter to Shareholders
In my letter to you last year, I wrote that Albany was firmly on track toward its cash-and-grow objectives for both 2017 and beyond. I am happy to report a year later that we are still on track, and if anything, somewhat ahead of our prior expectations. MC and AEC exceeded their performance targets for 2017, and their long-term outlooks now appear to be a bit brighter than the already bright expectations that we had for them last year.
Machine Clothing had another good year in 2017. Sales excluding changes in currency rates, gross margin, operating income and Adjusted EBITDA were all virtually identical to the strong levels of 2016. The market trends of 2016 persisted through 2017. A 7% decline in publication grades sales was offset by stable or incrementally growing sales in other grades. Publication grade sales declined to approximately 23% of total sales compared to 25% in 2016. Prices were stable, although pricing pressure remained intense, particularly in Asia. New product performance was strong across the board, and we are greatly encouraged by advances in the new technology platform across multiple segments and product lines. For the full year, gross margin held at 47.5%, and Adjusted EBITDA held at the high end of our expected range of $180 million to $195 million.
We expect full-year 2018 to be comparable to full-year 2017, and thus for MC to again perform in the upper half of our normal range for Adjusted EBITDA. While growing inflationary pressures and a weakening U.S. dollar could lead to some regression away from the very high end of the range, a strong order backlog, healthy economic conditions around the world, and continued strong product performance should lead to another good year for MC in 2018.
But of greater significance than this outlook for continued stability in the short term is what MC’s 2017 performance suggests about its longer-term prospects. Since 2007, MC has faced three sources of downward pressure on margins: declining sales volume due to the collapse of the publication grades; pricing pressure stemming in large measure from the declining volume coupled with new entrants in China; and cost inflation. Of these three, the declining volumes have had the most powerful impact. Since 2007, the total market for machine clothing (and Albany’s sales in that market) declined roughly 30%. Against the backdrop of this decade-long decline in sales volumes, we view the stability of MC sales over the past two years as an indicator of an important structural change. Although publication grade sales are likely to continue to erode at a 5% to 10% annual rate and to cause periodic volatility when large numbers of publication machines are shut down in a short period of time, the publication grades have become a small enough part of MC’s sales mix that, under normal economic conditions, incremental growth in the other grades should usually be sufficient to offset those declines.
MC will still have to deal with pricing pressure and inflation. But as the last two years have demonstrated, without also having to fight the volume effect, we have been able to offset the pricing and inflationary pressures through a combination of investment in technology and continuous productivity improvement. As a result, we think it may now be appropriate to think of MC for the long term as a stable business with some potential for small increases in sales volume during strong economic conditions, rather than as a gradually deteriorating business fighting a market in structural decline.
AEC also had a good year in 2017. Sales grew by 38%, driven by growth in the LEAP, Boeing 787 fuselage frames, F-35 airframe and CH-53K programs. LEAP accounted for 43% of full-year sales; the next largest programs, Boeing 787 fuselage frames and F-35 airframe, each accounted for approximately 10%. All of AEC’s ramping programs made good progress on quality and deliveries, and the first of our two new plants in Querétaro, Mexico produced and shipped its initial LEAP fan blades late in Q4. We continue to see upward pressure on demand for the LEAP program, as Boeing and Airbus explore the possibility of additional increases in monthly production of the 737 MAX and A320neo, while demand on all of AEC’s other ramping programs is either stable or facing incremental upward pressure. We expect the trend of rapid growth to continue in 2018, with a 20% to 30% increase in sales, driven once again by the LEAP, 787 fuselage frames and F-35 programs.
Despite the strong sales growth in 2017, operating income declined compared to 2016, due to the $16 million second quarter charge associated with the BR725 and A380 programs. Aside from these charges, AEC continued to make steady, incremental progress during 2017 toward our target of 18% to 20% Adjusted EBITDA as a percent of sales by 2020. Future AEC profit margins will be affected by the change in revenue recognition standards that went into effect on January 1 of this year. But holding revenue recognition standards constant, the trend toward incrementally improving profit margins should continue through 2018 and 2019, as the rate of hiring, training and new equipment installation begins to slow and operating efficiencies advance.
In new business development, we continued to make progress on multiple fronts during 2017, and as a result, we revised our estimate for 2020 revenue potential upward from $450 million to $500 million to $475 million to $550 million. Looking beyond 2020, we see organic growth potential on four fronts: entirely new platforms, both commercial and defense, such as the potential Boeing 797 program; new contract wins on existing platforms, primarily commercial airframes and engines; additional demand on programs on which we are already well established, such as LEAP and CH-53K; and diversification outside aerospace.
There is also potential to pursue inorganic growth opportunities in the years beyond 2020. As AEC executes the ramp-ups on its existing contracts, it should generate significantly more Adjusted EBITDA, while simultaneously reducing capital expenditures. This increase in AEC cash flow, coupled with stable MC cash flow, should make the potential for inorganic growth once again a realistic prospect for the Company by early next decade. This of course assumes good execution across all of our programs and ramp-ups. One of the inescapable realities of this business is that the most direct pathway to growth beyond 2020 is good execution to 2020. The better AEC performs in the short-term, the greater the long-term opportunities for growth, both organic and inorganic.
So 2017 was a good year for Albany, not just in comparison to 2016 and to the expectations we had for 2017, but also for what 2017 performance suggests about the potential for future stability in MC and continued growth in AEC to 2020 and beyond.
This is my thirteenth and last annual letter. By the time you read this, I will have retired and Olivier Jarrault will have begun his tenure as Albany International’s new President and CEO. I close this letter and my tenure at Albany with two strong sentiments – optimism about the future of our company, our new CEO, and where he’ll lead Albany International; and gratitude to my 4400 colleagues around the world and across both businesses. The progress we’ve made over these past 12 years is above all a testament to their commitment to the Company, our customers, and especially, to you our shareholders.
With warm regards,
Joseph G. Morone
President & Chief Executive Officer
(retired March 1, 2018)