Albany International Corp. (AIN) Earnings Call Transcript & Summary

Good morning, everybody, and thank you very much for joining us to listen to Albany International. This morning, we have CEO, Bill Higgins; and CFO, Stephen Nolan. Before I hand over the call to Bill and Stephen, just want to let everyone know that you can submit questions through the Veracast system. Or if that's not working for you, please feel free to e-mail me or my team, any of the questions, and I'll be sure to make sure that your questions are asked. So without further ado, go ahead, Bill.

Thank you, Caitlin. We're glad to be participating in the conference today, and it's such an important time for all of us. So I'd like to start by making a few comments about Albany International and where we stand today. We have 2 business segments serving different markets that are bound together by our engineered materials technology. And our legacy business is our Machine Clothing segment. Last year, it generated roughly 60% of our revenue and delivered adjusted EBITDA margins in excess of 35% and generate significant cash flow. This business produces Paper Machine Clothing, the belts and felts used to make all grades of paper from tissue to packaging to writing papers. Albany is the leader in this space with 30% market share. We have strong customer relationships around the globe and continue to introduce new material technologies and new products that help our customers run their processes more efficiently. In the near term, our order book in this segment remains robust, and all our MC plants are open and operating around the world to support this demand. We are watching these markets. However, as we anticipate orders may fluctuate in the second half of the year as supply catches up with demand and as the paper industry is impacted by the slowdown in global GDP. Our second business segment, Albany Engineered Composites serves aerospace, above commercial and military. And this segment generated about 40% of the company's revenue in 2019 with adjusted EBITDA margins of 21%. About half of our annual sales in this segment are generated by our proprietary 3-D weaving process, and we believe this represents the next generation of composite technology. 3-D woven composites are more durable than traditional composites and lighter than metallic structures. And currently, our 3-D composites are used in engine applications and most notably Safran's LEAP engine program. Our goal is to advance this technology and expand its use across the airframe and to other applications. In this segment, more than 1/3 of our sales are to military customers, which remain strong and are expected to continue to grow. From an overall company perspective, we enter the current environment in a position of strength. We have a solid balance sheet with nearly $425 million in available liquidity at the end of Q1, and we've taken steps to cut costs, reduce CapEx and discretionary spending. In summary, while we have limited visibility at this time, we are focused on what we can control. Our plants have adopted a host of new operating procedures, so we can run them as safely as possible. We're doing a great job for our customers, and we expect to generate significant free cash flow this year. Thank you. And Caitlin, I'll hand it back to you.

Thank you very much, Bill. So I'll kick it off here with some questions. Before I let -- I turn to any questions that the attendees might have. And as a reminder, you can submit them through the system or you can e-mail me or anyone on my team, if you'd like to ask a question. So you know that we are nearly halfway through the second quarter, can you provide some color on how the pandemic has been affecting demand across your businesses, particularly at MC segment? And how do you see those demand dynamics potentially changing in the longer term?

Yes, I'll start, Caitlin, and then Stephen can add some detail. In the MC segment, as I noted in my comments, and as we noted in our earnings release on the 30th, the MC business has held up very well. In fact, our bookings there have been a little stronger than we expected as we came into this year. We reported that we expect Q2 to be sequentially a little bit better than Q1. We've seen demand, as you know, as everybody knows, demand for tissue and packaging and paper products, where there's been a shift to at-home consumption, and the paper company has been running to fill that demand. But we're somewhat cautious. We're watching the latter part of the year and into next year to see how that plays out. There are some products we think might have legs such as tissue in this sort of COVID-19 environment, but we're watching cautiously. But so far, so good. We're very pleased with how the business has been operating very effectively. And as we announced, record gross margins in the first quarter. So that's been a plus for us so far this year. We talked quite a bit about our aerospace business, commercial aerospace, everyone knows the story there. It's been hit very hard on the aftermarket, which we have very little business in aftermarket, we -- about half of our business with a Safran program and in our AEC business. We have 3 plants that are furloughed right now, and we're waiting for production to start back up as we plan the rest of the year for that and going forward. And then as I mentioned in our remarks, about 1/3 of our business is military, and we're excited about that. We're on some great growth programs with the CH-53K, the Sikorsky helicopter, the Joint Strike Fighter with Lockheed Martin and the JASSM missile program. So we're in good shape there. Stephen, I don't know if you want to add anything in the mix there.

Yes. The one thing I'll just add, Caitlin, what's very interesting about our -- the order flow in our Machine Clothing business is, as we've discussed before, we are a bit of a lagging indicator, in that, when demand rises or falls for a particular grade of paper, it could be a quarter or 2 quarters before that actually hits our revenue and potentially even longer depending on the position on the machine we're talking about. And therefore, certainly, at the end of Q1, and even today, we're not yet seeing a huge impact in the order flow, driven by COVID-19 specifically. We certainly saw some impact to our revenue in Q1 just because of our facilities being down in China, although it was around the margins because we got those back up and running fairly quickly. But the order flow -- the spike we're seeing now, whether it's in nonwoven products, so for masks or gowns on medical side or for the tissue and towel, as Bill was talking about, where there's been this surge certainly in the at-home market. The impact of that, we're barely starting to see now in our order flow. What we've seen to date was just more a result of what happened pre-COVID from a production perspective, it's really only starting to impact us right now. And Bill is right, what we expect to see is continued strong orders, certainly for tissue and towel, products, particularly for the at-home market, packaging, certainly in the near-term appears robust, although there is a long-term concern, Bill referenced about, overall economic activity. Publication grades, we do expect to continue to decline. As we mentioned on the call, year-over-year, if we look at the trailing 12 months order book, we were down significantly in the 15% range year-over-year, looking at trailing 12 months orders for publication grade. And that was -- the bulk of that is pre-COVID. I would expect to see a continuation, if not acceleration of that trend in the publication grades as we go forward. But as we discussed, publication grades, in the most recent quarter was only 19% of our revenue in Machine Clothing. It's an important part of our business. We're in no way walking away from it. But declines in that business are not -- it's not sufficiently larger clients in that business significantly impact our top line.

Okay. That's very helpful. And then Bill, you just touched on defense briefly. So if I could go into that a bit more. The DoD is currently accelerating progress payments for its supply base and just last week, your largest customer, Lockheed Martin, reported that the company had achieved its goal of delivering, I think, over $450 million in accelerated payments from the DoD to its supply chain. So can you talk about if you've seen this trend impact your business at all? If you've been a beneficiary? And if so, how should we think about that impact on your cash flow?

We've been looking into it, and it could possibly benefit us, but I wouldn't say at a material level today yet. Our programs are in good shape there. We've been ramping them up. We haven't experienced any -- how would I say, supply chain issues or payment issues. So things seem to be working well there. So we're happy to see that activity. And as I said, we're excited about the defense military work that we do, and we'd like to continue growing that business. Stephen, I don't know if you want to add to that.

Yes, we are not a major beneficiary of the $450 million, at least not so far. If you look at our programs with Lockheed, on F-35 and JASSM both, we have very regular deliveries of components on that. And so we're getting paid on a regular basis. The one with a longer-term nature to it was probably CH-53K with Sikorsky within Lockheed, where these are very large components with a very protracted delivery schedule. And that's one area we're looking at it, but it has not materially impacted us yet.

Okay. And then just to sort of drill down a little bit more in the defense segment. I think investors are interested to know how you're thinking about the growth of this segment for your business over the long term. And I know you intend to increase your exposure in defense. But how do you view that exposure changing? If you can just give any high-level -- from a high-level viewpoint, how do you see it changing over the next few years?

Yes. I think we're going to work pretty hard to continue to develop our composite technology and applications into defense. What I like about our position today is that we're on relatively few programs, but we're on very good ones. And we've added part numbers over the last year or so to build up more business with those programs, and we'll continue to do that as we can as well. So I think we're in good shape. We're on solid programs going forward. And then the technology will take to other applications. We've announced on the commercial side, we're on the Wing of Tomorrow with the Airbus group to develop the next technology used in next-generation aircraft wing. And while on the commercial side, that goes out further. We're going to continue to work on the military defense side as well to bring our technologies to the next generation of applications.

Okay. That's very helpful. And then maybe switching gears, how should we think about cash flow in 2020, especially given that AEC in 2019 became cash flow positive, but we obviously know that you're currently not delivering for the LEAP. So how should we think about moving pieces and cash in 2020 and beyond?

Yes. So you're certainly correct, Caitlin, as we had highlighted in our fourth quarter earnings call, 2019 was the first full year where AEC was cash flow positive at a free cash flow line. And we were very pleased with that and certainly had expressed in our fourth quarter, our intention to repeat that feat here in 2020. It's clearly being put under some pressure right now with both the LEAP factories being shut down, all 3 of them, with Boeing announcing 787 volumes dropping down to the 10 rate. All of those put pressure on that business. The target of AEC, as Bill mentioned, is defense and that will still be a strong cash flow business. But certainly, on LEAP, even though we're recognizing revenue right now, as I mentioned on our Q1 earnings call, LEAP is an interesting contract, where revenue and cash flow, cash collections are in very different cycles. We recognize revenue as we incur cost as is required under the relevant accounting standards, given the features of our contract -- the termination liability features of our contract with Safran, we're required to recognize revenue as we go and -- as we incur costs. And we're continuing to incur costs even today with our fixed cost at the facilities, whether it be depreciation or the like. And so we will see some revenue, but no cash collections until we start delivering. And as we mentioned, the plants will be down for Q2 and in some cases, well into Q3. So Q2 and Q3, looking just at AEC, are going to be very poor from a cash flow conversion perspective. In that, if we look at our profit line and free cash flow compared to that, it is going to be poor. There's no doubt in these couple of quarters. We certainly hope to see a significant improvement in the tail end of the third quarter and into the fourth quarter. Now, Machine Clothing is still generating a lot of cash. So as a company, we still expect this to be another year with good free cash flow, overall, as a company. Not as strong as we delivered last year, given how strong Machine Clothing was last year for cash flow conversion and the fact that AEC is positive, but we do expect another strong positive free cash flow year.

Okay. And then going a little bit back on to a point you just made, Bill, about future capabilities that -- and applications you're looking at applying your weaving technologies to, are there any ones that you're really excited about today that you would like to discuss? Any other -- you mentioned the Wing of Tomorrow, but are there any other sections of the engine that you might be able to apply your technologies to? And just, is there anything you can share with us on that front?

I would say, both on the commercial and on the military side, we're working on programs that we're pretty excited about, but I can't yet talk about. So we're just going to have to hold off in announcing what they are. But if you think about how we've announced our effort on the Wing of Tomorrow or the fiber placement on the Joint Strike Fighter, we're continuing to develop technology that we can bring and take the whole science and technology of composites and composite components to the next level, and we think the 3-D woven composites is the way to do that. But unfortunately, I don't have programs I can name publicly today.

Fair enough. And I'm maybe also just thinking more from a high-level perspective, not necessarily a specific program, but types of technologies such as a different section in the engine? Or could you have hypersonics exposure in the future? Just trying to think about where your technology could go, not in terms of the specific program, but in terms of a type of technology?

Yes. My answer to that would be yes to all of the above. We're working on multiple end markets and applications. So not just engines, but as we've talked about the Wing of Tomorrow, and then on a military program, other applications as well. Yes, we're pretty excited about -- we're going to continue to invest very carefully, but we're going to continue to invest to develop the technology. One of the things we were so excited about last fall, as the LEAP program was ramping up, we were on our long-term goals of developing the process capability, the technology, the yield, the material improvements and the cost of the material production, we were in great shape. So the volume really helped us develop the technology so that we can take it to other applications. So we made some great strides last year that we can work off as things slow down on the commercial side and keep working them for the long term.

Okay, great. That's very helpful. And then I think lastly for me, do you -- is there anything that you feel is misunderstood about your business that you could -- you would like the investment community to understand a bit better? And if so, could you kind of go into that a little bit more?

Yes. Let me try that, and Stephen can add some of his thoughts. When I look at the business, and when I joined the Board of Albany, I was incredibly impressed not only with the long-term goal to developing a whole new generation of materials and moving from the paper industry end market into aerospace as a company, as in a huge strategic step but most of the focus in the last few years has been on the aerospace, when our -- Machine Clothing business is just a phenomenal business. And when you think about our presence globally, our structure, how we've rebuilt the footprint. As we went through the last downturn in 2007, 2008 and the decline in writing grades of paper and publication, the team has done a great job of building on a global footprint with a strong technology business. And we know our customers process from end-to-end. So we're not only supplying the belts they make paper on, but we're also in the facilities with our customers monitoring their processes, advising them and developing new materials and new belts for sort of the applications. And most of the belts in our Machine Clothing business are custom made. So it's a made-to-order business. It's a really strong business from end-to-end. We have great documentation going back decades to track how materials perform and then to develop the next generation of materials. And so it's been a tremendously successful business, in what hasn't been perceived as the greatest of end markets, but a really strong business, and it shows in the profitability and the cash flow generation that we've been able to achieve, and we're proud of that business. And I just think it's one that's a little less appreciated maybe by general investors. Stephen, I don't know if you -- anything you want to add.

Yes. I'd just add one thing to what you said, Bill, and it's sticking with MC. It's about the end markets. There is -- I think some people have perspective that this is a -- there's a long-term secular decline in our -- in the end markets. We don't view it that way. Certainly, as you look at tissue and towel globally with a growing middle class, as you look at packaging, particularly with the rise of e-commerce, but also just growing GDP in the developing nations. There is a long-term secular growth trend outside of publication grades. Publication grades have now shrunk to the level where they're no longer large enough to drag that market down. It's also a sustainable product, which I think is very important as we think about the substitution options for this, many of them are not sustainable products. And I don't see a huge threat on the horizon for most of the pulp and paper market. So we see a long-term positive growth trend in that. Obviously, this year is a bit of a messy year for that, and we'll see how this turns out. But I do, sometimes in conversations with investors, get the sense that people think, well, that's a -- that is a declining market overall. And we don't see it that way at all. We continue to invest in that market. We continue to invest both to maintain our market share, but also to maintain our premium pricing in that market because we offer a premium product with value-added services, as Bill indicated.

Okay. That's very helpful. And then I have one more question that came in from my team. But before I get to that, I just want to remind the audience members that if you do have a question, please submit that question, either through the Veracast site or you can e-mail that question to anybody on my team. And then the question that I got from a team member is about your China exposure. If you could touch on that a little bit for MC? And then just from a high-level perspective, do you see any implications to your supply chain there from what has transpired with the pandemic and sort of your latest thoughts on that market?

We have -- I'll start here. We have 2 facilities in China, very well run. And I think if you step back and look at our global footprint, we've put -- I guess, we've consolidated our global footprint so that we serve our customers basically within region. We have continuity plans and flexibility to move production around the world. But we do a very good job of serving our critical customers in the regions where they are. So our China plants, while they export a little bit, primarily are serving the local markets in China and have done a great job of that. So as -- regarding the supply chain, as Stephen mentioned, the plants went down for a little bit in Q1 and came back up and are running now, running very well. So -- we'll see how -- I assume implicit in the question is, how will either bringing supply chains back home to the United States? Or the pressure on globalization, how that will play out if there's more of a national approach to manufacturing. I think in the event that we do go in that direction, we have major facilities in the United States, in Canada, in Brazil, in Europe, across Europe and Sweden. So as I said, we're serving our customers in their end markets. So I think we're in pretty good shape that way. Stephen, I don't know if you want to add any color to that.

Yes. I'd say, from a financial perspective, our exposure in China. So as Bill mentioned, a lot of what is produced in China is consumed in China. There's a little bit exported to other parts of Asia, small amount to Europe, but there's a similar amount of product that is imported from our plant in Korea or a little bit from Europe into China. So the exports almost equal the imports for our business. So our revenue and our produced volume in China are almost the exact same, and it's about $1 million a week. It's roughly $50 million a year we generate in China, whether you're thinking about revenue we generate in China or whether you're thinking about revenue we produce in China, irrespective of the market, it's about the same number in that $50 million range. So a small percentage of the overall company. And as Bill mentioned, we do not export any product from China to North America. It's really within the Asian region and a small amount to Europe.

Okay. Thank you. Bill, Stephen, thank you very much for your time. I appreciate it a lot. And if anybody has any follow-up questions for either Bill or Stephen, please let me know.

Thank you, Caitlin.

Thank you, Caitlin. Thank you, everybody. Have a good day.