Albany International Corp. ($AIN)

So, okay. So let's get started. I'm Chigusa Katoku. I'm multi-industry analyst at JPMorgan. Today, I'm very excited to have with me Willard Station CFO of Albany International. So I think I have a bunch of questions. So we'll just jump right in.

So yes, aerospace is obviously really topical right now. So a lot of my questions are going to be focused on AEC. So maybe just first starting off with the most recent quarter, the fourth quarter. The top line at AEC was really strong at 45% organic growth. Can you kind of unpack this for us between the material pull forward that you commented on, some accounting nuances and then -- and what's like the actual underlying demand trends that you're seeing here?

Sure. Overall, we had a solid Q4 within our AEC business. And the way to think about it, there were 3 primary drivers. First being we had across the portfolio, we just had solid performance across each of our programs across the portfolio. And that was largely driven by LEAP, Beta and then our Boeing one-piece frame. Secondly, I would say we had a quarter finally with no EAC adjustments or cost growth, which impacted our performance that we saw in the prior year. And then third, I would say we have the material pull forward, which was aligned with the ramp-up that we're seeing in our overall business. If you look at our current production rate, we're expecting revenues to be about $120 million per quarter. In Q4, we're at $143 million. And we're not expecting that to repeat as we look into fiscal '26, but we will continue to see some steady improvements in ramp-up throughout the year. But overall, the business performed very well in Q4, and we're really pleased with those results.

Okay. That's great to hear. So if there weren't those nuances like the material pull forward [indiscernible] all, do you -- can you break down how much the organic growth was or not something that you would break out?

Yes. I would say if you want to think about it, I would break it into 1/3. I would say 1/3 of it was just solid performance with the programs. We had 1/3 of it driven by the fact that we didn't have any material EAC growth in the quarter. And then 1/3 was just the accounting treatment with a material pull forward. Surely, we're seeing some organic growth driven by the ramp-up in LEAP and then there are some rate-ups in Beta as well. But I will look at it in 1/3s.

All right. That's super helpful.

Yes.

And then shifting to the first quarter, AEC organic growth is implied around 5% at the high end of guidance. And so compared to the fourth quarter, this kind of deceleration, but what is driving this?

What's driving the growth?

Yes. The first quarter, you gave guidance for the first quarter AEC organic growth, and it's implied around 5%, even at the high end of the guidance. So is this conservatism? Or how do you -- what's driving this deceleration from the fourth quarter?

Yes. I think so -- I think what we provided in Q1 is more reflective of the ramp-up that we're going to see throughout the year. So we're going to start Q1 with a modest growth rate. And again, it's driven by the program ramps. And as those programs ramp up throughout the year, we'll continue to see stronger growth throughout the year. But the pacing item for AEC in Q1 specifically is just we're aligning with the program ramps. And so the growth we provided is in line with the ramps that we expect to see across the programs for Q1. And then again, it's going to ramp up as we perform throughout the remainder of the year.

That's super helpful. So for the full year, do you expect about high single-digit range organic growth for AEC?

Not going to. No, I don't think [indiscernible].

Okay. You're not going to comment. Okay. Okay. That's fine. And then moving on to margins. I think on the conference call, you mentioned 10% margins.

Yes.

Can you clarify what that -- what part of the business that is about?

Yes. So we're referring to AEC. And so if you go back to Q3, our margins are in at about 9.7%. And then in Q4, we came in at 13%. And again, Q4 was driven by some of the performance items I mentioned earlier. As we look across -- we look at our performance for the full year, we're expecting our range to be within that 10% to 13% for our AEC business. Now once we make it through and complete the strategic review of our Salt Lake City site, we will have better quality of earnings for the remaining programs. And obviously, we got to go through a transition period where we work through the fixed costs and the stranded costs. But once we complete that, we're expecting the overall margins for that business to be in the mid- to upper teens for AEC, which is solid performance, very solid performance.

Sounds great. And that's a great segue. So maybe just talk about the progress on the structure assembly business exit. Maybe can you talk about first a reasonable time line here?

We're -- I would just say that it is the top priority for the business. We believe divesting this business is going to drive greater value for Albany and our shareholders as well as drive greater value for that site itself. We have invested in that space quite a bit. It's a well-capitalized site, tons of automation and technology. And I'll tell you, the team there, strong manufacturing, strong operational background, and we continue to deliver to our customers and support the war fighter, which we're very proud of what we've done at that site. And so as we look forward, once we divest the Salt Lake City business, which is, again, a top priority for us, we're then going to start working through those stranded costs, those overhead lingering costs and then focus more on the high-growth areas aligned with our 3D weaving technology where we see very strong economics, and we see very strong market demand. Our strategy is to really focus on that technology that distinguish us from our competitors, where we have strong IP and where we're seeing a lot of demand for it. The margin profile for our programs aligned with that technology is solid and we're going to continue to invest and grow that and make that a focus as we move forward for the business.

Okay. That's great. I have a few follow-ups on that. Firstly, so can you comment -- can we expect maybe by year-end? Is that kind of a reasonable time frame?

I don't -- I mean, like I say, it's a top priority. So we're all focused on it. We have strategics, private equity, we've seen a lot of interest in that space, well-capitalized site, a lot of capability. There's over 11 autoclaves at that site. And so it's a top priority for us. We're going to keep pushing forward. I can't comment to say we'll be done by the end of the year, but we're giving all our efforts to make sure we can transition and divest this space as quickly as we possibly can.

Okay. Sounds good. And then on the stranded cost comment, about how big do you expect that to be? And how many months do you expect to take to drive that down?

That's a good question. We're still working through that. We've hired an accounting firm to help us kind of work through identifying the stranded costs. They're in the final stages of completing their analysis. And then it's just going to be a focus, right? Working through that stranded cost is going to be a key focus for us. We're anxious to share and show the true value of the business once you separate Salt Lake City and really look at what's remaining. It's a strong quality of earnings. We know that. But we have to work through the stranded costs. And so it's a top priority for us. We're not going to do it incrementally. So we're not going to wait until we divest the site and then start tackling the stranded costs. We're going to start tackling as soon as we get through the analysis from the accounting firm and start positioning ourselves to be ahead of the curve instead of behind the curve as we work through the divestiture.

Okay. That sounds good. So this year, margins is probably in the 10% to 13% range even as you kind of...

Absent any additional EAC issues.

Okay. Absent -- and although you maybe start to work down some of the stranded costs beforehand. And then ultimately, maybe it's not right after you divest in 2027, but maybe 2028 onwards, your AEC margins could potentially be in the mid- to high teens range.

Yes. Yes.

Okay. That's helpful. And then just building off of that, can you kind of help us understand the AEC business composition today a little bit better. We know that LEAP is about 35% of AEC sales and then CH-53K is the second largest. Can you remind us of the revenue contribution from CH-53K today?

Yes. I don't think we've shared revenue by program. So that's not something that we've shared. I can say, though, as we work through the divestiture, obviously, LEAP will be a larger portion of the company's revenue as we move forward. And then in addition to that, we're seeing a lot of interest coming in for additional 3D weaving opportunities for the business. So the pipeline is strong in terms of growth and opportunity as we move forward. But we haven't shared any program-related revenue by business. And so we won't share it.

Okay. That's fair. Then maybe can you kind of rank contribution after LEAP and CH-53K, maybe if you can rank the contribution from Boeing one-piece frame, GNX engine, F-35, JASSM or LRASM, AM space, hypersonics, all these businesses, if there's any way you could help us.

So the Boeing one-piece frame will be part of the -- so you think about the site and what we are divesting for the AED site, right? And so you have some of the Beta, large structure Beta work will be part of the divestiture. Boeing one-piece frame will be part of the site and the divestiture there. Obviously, you got the CH-53K and you got a little of the F-35 work. We have Beta and F-35 work at our Boerne, Texas site as well, so it can get a little bit confusing. And so Boeing one-piece frame won't be part of what I would say will be the growth as we move forward. JASSM, LRASM, LSRO, missiles, obviously, will be part of our growth as we move forward along with LEAP. I would say each of those programs are adding tremendous value to our business. LEAP, obviously, with the projected rate up over the next few years, is going to take a bigger -- be a bigger portion of our revenue for the overall business. But any further breakdown we haven't provided with JASSM or LRASM, LRSO and all the other remaining programs. We haven't provided that level of detail.

Yes. That's fair. So after the structures business assembly exit, your portfolio -- your AEC portfolio is going to be close to half LEAP is what I estimate. And then you also mentioned some like missile exposure. So -- and I think -- and maybe I just wanted to dig into this. Is there any way -- maybe you could help us understand your percent exposure to missiles and space too? These are kind of really growthy markets.

I would say space and missiles; they are a meaningful and growing portion of our business. And obviously, we're seeing new business opportunities as we look forward. We haven't provided any percentage breakdowns of what that looks like for us. And so we're not ready to talk it at that level. But we're seeing a tremendous amount of opportunities there. And again, it's just another example of where we're leveraging our 3D weaving technology in growing markets that have great returns. And so we're excited about what we're seeing in that space. We're excited about the role that we're playing today. And we're looking forward to capturing those new businesses opportunities that are on the horizon. And so I think we're well positioned there. The business today, I would say it's steady, but we're seeing a lot of opportunities for growth.

Makes sense. So it's maybe like still low single-digit percent exposure.

You try to get an answer out of me. No, [indiscernible], I'm not sharing.

Yes. Okay. That's fair. And then, yes, so said you touched on the 3D weaving opportunities. Maybe can we get an update on how it stands right now in terms of how big they are? I think LEAP is the biggest. And then when Boeing 777X begins full-scale production, you'll be supplying 2 fan cases for GE9X.

Yes.

And you have EV tool space, hypersonics, et cetera, but if you can give us an update on how big this 3D weaving is today and how big it could get?

I'll say this. It's a healthy pipeline. As you mentioned, with the 777X, the fan case there, we're excited for the opportunity to be a part of that. Obviously, with LEAP, I think year-to-date, we provided over 200,000 or so LEAP fan blades. So you think about that, over 200,000 times, we have replaced titanium with our composite 3D weaving capabilities. It's exciting. And we're seeing additional applications as we move forward. We have interest from all the major engine OEMs. We haven't obviously done any business with them yet, but we have interest coming in from all, I'll say, the major engine OEMs. And we've seen a very healthy pipeline. And if you think about the strategic review and the position we took with our structured business, a lot of that was we see more value, greater value, greater returns, greater growth when we focus on that 3D weaving technology. And the marketplace seems to be responding very well to our technology. We are in a position with leading capabilities. We believe we can drive the price point that we desire in this space. And -- we're just looking forward to the growth opportunities. Looking forward to the growth opportunity.

Yes, it's really exciting. And I visited your 3D weaving facility, and it was very impressive. I feel like for you, more the near-term execution, especially given you've had those AEC adjustments for the past year. So I think -- I think people pretty much agree that the long-term story is very exciting. And so I think it's more about the near-term execution.

Yes, we have to get through the strategic review with the CH-53K program. The good thing, as I mentioned earlier, we stabilized the site. We're delivering today. Our team, strong team, they're producing the [indiscernible] section. They're meeting our commitments on the legacy contract that we have there with sponsons, horizontal HTAP, et cetera. The team is performing well today, and we have very, very strong operators, and it's a well-capitalized site. But when you think about us and our strategy and where we want to focus and grow as a business, it's just not aligned with that focus and growth. And our goal is to unlock the maximum amount of value we can for our shareholders. And so yes, working through that strategic review is going to be a top priority for us. It is the key focus for us. We have -- since we mentioned it in Q3 till today, we have made it a top priority as a business. All the leaders within the business are focused on divesting that site.

Sounds good. So in the third quarter, you recorded a charge for the remainder of the life of CH-53K. It was a pretty meaningful charge, but it was very nice to see in the fourth quarter, you didn't have any EAC adjustments. And I guess my question is, so is that comprehensive, the charge that you took in the third quarter so that we won't see...

Yes. It's -- so with -- it's a firm fixed price development program for those who are not familiar with it. And under the rules, once you get into a loss position, you have to recognize those losses for the duration of the program. And so what we estimated in Q3 was estimating 8 years out what our labor and material impacts would be for that program. And I'll say we did it in a very conservative way. We removed any type of performance improvements that were already baked into the estimates. And we assume that we were going to get hit by the majority of the labor and material cost growth. And so we want to be conservative. We want to ensure that we covered our cost exposure for the next 8 years, and that's the approach that we took. I believe it was the right approach because as you mentioned, we had Q4 and there was no additional EAC issues or growth on that program, which now allows us to really showcase, okay, here's what the rest of the business looks like, right? And so in Q4, we had margins of about 13% for AEC. I believe we're going to finish this year in that 10% to 13% range. And then once we exit out of the strategic review and work through those stranded costs, we'll be mid- to upper teens. And so our goal is to really give our investors an insight of what the remaining business looks like and how -- looks like and how healthy the 3D weaving technology is for us and how well we are performing. And so we conservatively went into that Q3 [ reach ] forward loss. We want to kind of get rid of the noise that was around CH-53K, which really was hindering showcasing just how well the team is performing.

Yes. That sounds great. So maybe we'll shift a little bit. Maybe on the raw material topic, just to touch on this because inflation has been topical recently. Can you talk about your raw material basket and kind of if you're seeing any impacts to margins from this?

We're not seeing -- I'll say this, and it goes back, I hate to keep talking CH-53K. At some point, we're going to stop talking CH-53K. But when you think about our business, CH-53K is the one program where I would say we are locked into a firm fixed price agreement over -- it was a 10-year contract, meaning whereas we saw our cost increase, whether it be material costs, labor costs, we really didn't have any remedies in the contract to adjust and reprice. As we look at the remaining business, we don't have that type of condition. We don't have any long 10-year type fixed price agreements. And so as we continue -- we see cost pressure, inflation, whether it be all whatever, we see any type of those type of cost pressures moving forward, we will have the ability to reprice in our current agreements. And so there could be some near-term increases in cost, but we're not expecting it to be meaningful. But on a long-term basis, contractually, we have the remedies in place where we can go in and reprice and acknowledge that cost growth and make sure that we're passing that cost growth over to the customers and not absorbing it as a company.

Make sense. Is there like a lag, a typical lag that you can talk to it through pass-through point?

We're not seeing any -- today, I would say, right now, we're not seeing any signs of any lags today. There could potentially be some in the future. But right now, we're not seeing anything that will suggest that we will have any type of meaningful EAC impacts to our business.

Okay. That sounds good. And then maybe touching a little bit on your other business, which is actually bigger at 60% of sales. Machine Clothing was off to -- it starts off slow in 2026. And you mentioned that you can make up lost volumes for the remainder of the year. Do you expect this business to grow this year or it's...

I would like for it to grow. I like all our businesses to grow. When you look at Q1, I think you got to keep in mind, we had a significant equipment failure, right? And we discussed it on the call. We had an equipment failure for Machine Clothing in Q1. and that's impacting our performance for Q1. We're expecting to recover that throughout the year. So far today, we have the equipment up and running, and it's performing fine, which is good. So we expect that to recover again for the remainder of the year. I would say, overall, there's kind of mixed demand across the geographies in Machine Clothing. In North America, we have stability through the fourth quarter, but our order intake was pressured during that same period due to the industry consolidations. In Europe, we saw a strong recovery in the fourth quarter and signs of stability coming from a down cycle. It's really what we're seeing in Asia, particularly in China, where you have that overcapacity, and we have a limited view of what's going to take place within China for the remainder of the year. We can say that we saw stability in Q4, which was good. And we're expecting as we think about fiscal '26 and the performance of that business in fiscal '26, we're expecting it to be flat to what we saw in fiscal '25. And that being said, Machine Clothing is a steady, predictable cash flow business, and we're expecting that cash flow to be similar to what we saw in '25 in fiscal '26.

Okay. So MC top line flat versus 2025?

Yes. That's what we're expecting.

That's helpful. And then, yes, you touched on the cash point. So certainly, MC has very good cash conversion.

Yes.

And AEC was bit more a user of cash. But how is that profile now versus MC versus AEC?

I think as we -- AEC is the growth business. MC, as you say, strong cash flow, stable business. We're leading in the marketplace, performing well. Customers love what we do on the Machine Clothing side of the business. AEC is where we see a tremendous amount of growth. We expect the cash conversion to be slightly below 100% as we move forward. And that's largely driven by the fact that we're going to continue to invest in our AEC business. It's a high-growth business with strong economics, and we're going to overweight our investments there. We expect at some point as the programs ramp up and mature and we get to a steady rate that we'll see an improvement in the cash flow for our AEC space, but that's going to take a little time. And we recognize that, that's going to take a little time. But we do believe with the strategic review and the decisions we made with the Salt Lake facility, our AED site specifically, we do believe that's going to allow us to get to the other side a lot faster when it comes to our AEC business and overall performance.

Okay. Great. So right now, is AEC a use of cash? Or is it just...

It's -- yes. Yes, it's historically use of cash. Yes.

Yes. That makes sense. Okay. And then -- so maybe just to talk about the portfolio. So you're trading at a discount to some of the parts. And so as you clean up these cost overrun issues and you're looking ahead, you have a cleaner aero portfolio. So it's not generating cash now, but are there any opportunities? Or do you get any interest for -- like a split up because your aero asset is pretty attractive and MC is also stable cash cow.

I would say, no, I'm not aware of any opportunities for a split up. And quite frankly, we don't believe that, that will maximize value for our shareholders. The way to think about our business is, yes, it's disparate end markets, right? So the end markets are definitely different, but the technology is the same. It's the exact technology. And the technology that's making us successful and position us for growth in our aerospace business that was born in Machine Clothing. Sometimes when I walk through Machine Clothing part of our business and aerospace part of our business where we're doing a 3D weaving, sometimes I just close my eyes. And when I close my eyes, I hear the exact same thing. I hear the exact same thing. You hear the weaving, you hear the looming. It's the exact same thing. And so we're excited about having these 2 businesses together. We believe from a technology standpoint, from a financial standpoint, it makes a lot of sense to keep these 2 businesses together. And we're looking forward to the growth opportunities for both. Machine Clothing, yes, we've had some challenges, I would say, these past couple of years, but we have plans to grow in that business just as well as we're going to grow in our aerospace business. But I don't think from a shareholder value standpoint, we will create greater value separating the 2. The 2 belong together, the technology is the same. And I would say, overall, when you think about us, we find markets, attractive markets with strong returns where we can land and expand our technology, we're going to look for opportunities to land and expand that technology. It doesn't necessarily tie us to one space, which I think is good for us, good for our shareholders and it's good for growth. And so yes, I mean, the 2 are joined. There is a connective tissue between the 2. Many people don't understand it. But if you walk through a Machine Clothing production facility and the AEC production facility and you just close your eyes for a bit, it sounds the exact same. Sounds the exact same.

Yes. It's amazing. Yes, the AEC technology is definitely coming from Machine Clothing. I guess the end market exposure, it's different and the strategic initiatives are probably different too, because one side is growing very quickly and the other side is more stable. And for example, at MC, you guys bought Heimbach a few years ago. But I guess the integration process and the margins that you're getting for it is kind of being masked by the overcapacity issues in China.

Yes.

And just how do you prioritize -- how do you have focused strategic and capital allocation decisions for these 2 businesses because they're pretty different.

Yes. I would say the AEC capital allocation historically has been focused on growth. It has been largely focused on growth, which is what you would see, for instance, with the Salt Lake facility and while I say it's well capitalized with 11 autoclaves, it has been focused on growth, also been focused on growth in Rochester and where we're doing our 3D weaving and expanding that technology. MC business was more or less focused historically on sustainment, right? Maintenance and sustainment, let's just make sure none of the equipment fails, right? Because if it fails, it could be very impactful to the business. As we look forward, we're looking for growth opportunities within MC as well. We're continuing to make advancements with our technology. We're continuing to see additional applications for that technology. And so one thing that we're doing now is we're challenging both segments to grow. For MC, we want top line growth. We're not going to get into '26. I already mentioned that. But for MC, we want to position that group for top line growth. And so we're making investments in this space to achieve it. And then for AEC, it's the quality of the earnings, right? We want to improve the quality of the earnings. Yes, we've demonstrated we can generate top line growth, has to be profitable growth. The economics have to make sense, has to be cash flow -- positive cash flow. And so we're continuing to invest in both. The focus is a little different for each of the segments, but growth is definitely a top priority for the businesses as we move forward.

That's helpful. And maybe just stepping back, so you started -- how many months has it been?

It feels like it's been a few years.

That is [indiscernible]...

I'm 6 months in. 6 months in.

6 months in.

Yes. Still learning. I got a lot to learn.

Yes, there must be. Just like what do you think you could bring to Albany that's different because it has obviously been in a situation for the past year with these cash overrun issues, but to kind of move it in the right direction.

Yes. I will say this. I think, one, I'll say I'm very proud to have the opportunity to be a part of this team. This team was already a strong team well before I got here. Gunnar, our CEO, when he came in, he recognized some of the challenges and some of the strengths and where we have weaknesses, he brought in leaders to kind of advance the business and move the business forward. And that was probably one of the final pieces of that vision for him. We have very, very strong operators within Albany. Many of them have been here for years and for decades and they have set us up to do some tremendous things as we look forward. The leaders that I'll say we have on the leadership team now, I think we all bring a tremendous amount of experience coming from larger companies. So I came from Boeing. We have folks there from Lockheed. Believe it or not, you got Lockheed and Boeing people working together. I never thought that happened. But we're working together. We're teaming together. We're partnering. We're bringing in our expertise. We're aligning that with the folks who have been here before us, and we're making some tremendous improvements. I'm excited about where we're headed. I'm excited -- really excited about the technology and the focus on the technology. We're focusing on the things that really differentiate us in the marketplace, and that's how people should think about us. And as we make that the primary focus, and we're getting attention from OEMs, and all sorts of different opportunities are coming forward. Now it's about how quickly can we execute on those and really show what we can do as a company. But it's been 6 months. It's been a fun 6 months. I have learned a ton. And I'm really excited about the team that we have, the culture that we have in Albany, the technology. It's just a great place. It's a great place. I'm fortunate to be here.

Yes. The runway is definitely exciting. So it just really all comes back to how the CH-53K. This is going to work out. And maybe I just have a quick follow-up on this. So would you -- would a renegotiation of the contract terms with Lockheed be kind of necessary for a sale to either to occur?

Contractually no. Contractually there is...

Would there be interest with the current contract structure with Lockheed from the buyers?

I think so. Yes. I think when you look at -- so one, it's an 8-year program, right? So there's 8 more years left on that contract. Two, it's a well-capitalized site. And so for some strategic buyers, it makes a lot of sense. Try to get 11 autoclaves into a space up and running, it will take a few years to get there, and this has it today. And so would a buyer want to renegotiate the contract with Lockheed, they could. Do I necessarily have to renegotiate the contract to sell it? I don't. I don't. I think we are positioned to divest that regardless of how the contract sits with Lockheed today. It could be part of the buyer strategy, but it's not something that's a requirement for us as we move forward.

That's because regardless of the contract structure of the asset, but the...

I think the facility is very, very attractive facility when you think about the capabilities, the automation that's there. Like I say, we had several strategics who are interested into the space now. And it's a very -- I think it's a very attractive facility. Yes.

Okay. Interesting. And then in theory, let's say you are not able to sell it. Given that you have already recorded these charges in the third quarter, will we not see any charges going forward even if you are -- you still have it?

I hope your theory is completely wrong. We need to -- it's less of -- I'll say this, we believe we did a really nice job estimating the labor and material cost growth over the next 8 years. We believe we did a really nice job estimating that. Could there be some additional exposure or cost growth on that program? Sure. That's with all programs. I can't predict what the future is going to look like 8 years from now. But right now, it looks like our estimate aligns with our production capabilities, and we're feeling confident in where we sit today. But there's always the risk with a fixed price long-term agreement of additional cost growth, especially if you don't have any natural remedies built into the program, which -- into the contract, which we don't today.

Okay. That makes sense. Okay. So I think we are at 12:05.

All right.

And thank you so much for coming.

Thanks for having me. Thanks for having us out.

Thank you.

Okay. Thanks.