Albany International Corp. (NYSE:AIN) Q2 2023 Results Conference Call July 27, 2023 9:00 AM ET

Company Participants

John Hobbs - Director of Investor Relations

Bill Higgins - President and Chief Executive Officer

Rob Starr - Chief Financial Officer and Treasurer

Conference Call Participants

Gautam Khanna - TD Cowen

Michael Ciarmoli - Truist Securities

Jan-Frans Engelbrecht - Baird

Operator

Good day, and thank you for standing by. Welcome to the Albany International Corporate Earnings Conference Call [Operator Instructions]. Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, John Hobbs, Director of Investor Relations. Please go ahead.

John Hobbs

Thank you, Jacinda, and good morning everyone. Welcome to Albany International’s second quarter 2023 conference call. As a reminder for those listening on the call, please refer to our press release issued last night detailing our quarterly financial results. Contained in the text of the release is a notice regarding our forward-looking statements and the use of certain non-GAAP financial measures and their associated reconciliation to GAAP. For the purposes of this conference call, those same statements apply to our verbal remarks this morning. Today, we'll make statements that are forward-looking that contain a number of risks and uncertainties, which could cause actual results to differ from those expressed or implied. For a full discussion of these risks and uncertainties, including a reconciliation of non-GAAP measures we may use in this call to their most comparable GAAP measures, please refer to our earnings release of July 26, 2023 as well as our SEC filings, including our 10-Q and 10-K. Now I'll turn the call over to Bill Higgins, President and Chief Executive Officer, who will provide opening remarks. Bill?

Bill Higgins

Thanks, John. Good morning and welcome everyone. Thank you for joining our second quarter earnings call. We're pleased to report another strong quarter of results with revenues of $274 million, up nearly 5% compared to the same period last year and solid execution across our operations. GAAP EPS of $0.86 was down from last year to $1.25 impacted by non-operational items that Rob will cover. Adjusted EPS was $0.90 and adjusted EBITDA was nearly $65 million in the quarter. As a result, we finished the first half of the year in good shape and we're raising our guidance for the full year. The Machine Clothing segment continues to deliver healthy results with revenue growth of 5.6% on a constant currency basis, gross margins in excess of 50% and adjusted EBITDA margins exceeding 37%. Our Machine Clothing team has done an outstanding job navigating the challenges posed by macroeconomic headwinds in Europe and China, inflation and the effects of the war in Ukraine. Since the end of 2022, trends in Machine Clothing's revenues, operating profit and adjusted EBITDA have all been positive and now exceed our prepandemic performance. These impressive results are testament to the effectiveness of Machine Clothing's disciplined operating model, the consumable nature of our products and our well earned reputation as a supplier of mission critical paper machine clothing products with exceptional reliability and value to our customers.

Last month, we announced our agreement to acquire the Heimbach Group, a manufacturer of machine clothing based in Germany. Heimbach is a great fit and creates opportunities to provide our customers with even more value. Geographically, Heimbach is strong in Central Europe, which compliments our Northern European presence. The addition of Heimbach’s Asian operations will augment our presence in faster grow Asia as well. Heimbach and Albany each have long proud legacies in machine clothing and we look forward to working with the Heimbach team and leveraging the best of both companies to add value for our customers and shareholders. We expect the transaction to be accretive in both earnings and cash flow in our second year of ownership. And we have good news this morning, we just heard from the regulatory authorities that we've been approved to proceed with the closure of the deal, and we're going to move towards closing. So as we've said before, we expect closing to be in the second half of the year and we’re pretty excited on the news we received this morning.

The Engineered Composites segment achieved top line growth of approximately $5 million in the second quarter, up nearly 5% compared to Q2 of 2022. Growth in the quarter was driven by higher revenues from commercial programs and from some smaller programs that we've brought on over the past 12 months. Our aerospace team continues to ramp up the CH-53K production line and is doing a great job managing supply chain delays and supporting our customers. Adjusted EBITDA in this segment was about $21 million, relatively flat with the second quarter of last year. AEC continues to do a great job for customers and on-time delivery, quality and customer satisfaction, and its strong operational performances, it's notable in an industry that's still hampered by supply chain delays and other challenges. It gives our customers confidence in our ability to take on new business either through more content on existing platforms or new programs. Our aerospace team did a great job at the Paris Air Show and our business development teams, our engineering teams had a full slate of meetings to discuss new opportunities for growth. In many ways, it built on the momentum we achieved last year at Farnborough. We continue to build our reputation as the premier partner of choice in composites manufacturing. Finally, I can report that our Board of Directors is working diligently on my succession, the CEO search process is well underway. I'm committed to a smooth transition, working with the Board and the management team to continue executing our strategy and doing a great job for customers and shareholders, and we'll let you know as soon as we have an announcement to make. So with that, I'll hand the call over to Rob.

Rob Starr

Thank you, Bill, and good morning, everyone. My first full quarter with Albany has been tremendous. I visited a number of our locations in both the US and Europe and I'm impressed with the very visible operational excellence across both businesses. The culture and our people are very inspiring and I'm grateful for the opportunity to be on the team. We had another great quarter and continued to execute on our growth strategies, including the recently announced Heimbach acquisition. As Bill mentioned earlier, Heimbach is an excellent fit for us and creates real opportunities for significant value creation for our shareholders over time. Pro forma for the Heimbach transaction, our financial leverage will remain very modest, with net leverage slightly above 1 times EBITDA as we plan to fund the transaction with available overseas cash. We will continue to have considerable room under the financial covenants in our revolving credit facility to invest in organic and inorganic opportunities.

I will now turn to our second quarter results and then provide our updated outlook for the year. For the second quarter, total company net sales were $274 million, an increase of 4.9% compared to the prior year period. On a constant currency basis, net sales increased 4.8% year-over-year. In Machine Clothing, also adjusting for currency translation effects, net sales grew 5.6% compared to the same period in 2022 with higher sales across all paper machine clothing product lines, somewhat offset by contraction in engineered fabrics as nonwoven demand has returned to its lower pre-pandemic levels. Engineered Composite net sales after adjusting for currency translation effects, grew by 3.8% compared to the second quarter of 2022, driven by growth over a number of programs, including some recent wins. This growth more than offset the temporary decline in CH-53K as we transition from nonrecurring development efforts last year to recurring production in 2023. The ASC LEAP program generated revenue during the second quarter of about $45 million, approximately $5 million higher than the same period last year. While our first half LEAP revenues were above the prior year, that is mostly timing and we expect our full year LEAP revenues to be generally flat when compared to 2022. Second quarter gross profit for the company was $103 million, an increase of about 2% from the comparable period last year. The overall gross margin declined 100 basis points to 37.5% of net sales. This was caused primarily by higher input costs and lower absorption in Machine Clothing combined with program mix impacts and a $1.9 million unfavorable change in the estimated profitability of long term contracts within the AEC.

Second quarter selling, technical, general and research expenses increased from $50 million in the prior year quarter to $57 million in the current quarter. There were a number of factors driving the year-over-year increase. We saw a negative FX impact of approximately $2.5 million at Machine Clothing. We also incurred higher corporate expenses related to executive transitions, professional services related to business development activities, as well as expenses related to the Heimbach acquisition. We also had increased IT spend to support our growth and to enhance security. Other income and expense in the quarter netted to income of $4.5 million compared to $7 million of income in the same period last year due to lower foreign exchange revaluation gains. The effective income tax rate of 42.8% this quarter was unusually high due to discrete tax items, driven by withholding taxes resulting from international tax planning as well as a provision for international tax audits. As we look at the back half of the year, we expect the tax rate to normalize to our historical levels between 28% and 30%. For long range forecasting purposes, we believe that these same effective tax rates apply for our current operations, absent unusual tax items.

Net income attributable to the company for the quarter was $27 million compared to $39 million last year. GAAP earnings per share was $0.86 in this quarter compared to $1.25 in the same period last year. After adjusting for the impact of foreign currency revaluation gains and losses, restructuring expenses, acquisition and integration expenses, adjusted earnings per share was $0.90 this quarter, down from the $1.06 reported in the second quarter of 2022. Adjusted EBITDA of $65 million declined approximately $1 million from the $66 million reported in the second quarter of 2022. Machine Clothing adjusted EBITDA was $59 million or 37.3% of net sales, up from $58 million or 38.2% of net sales in the prior year quarter. AEC adjusted EBITDA was $21 million or 18.2% of net sales, approximately flat with last year. During the quarter, the company generated $12.4 million of free cash flow, defined as net cash provided by operating activities, less capital expenditures, which for the quarter totaled $18.7 million. During the quarter, we experienced some working capital investment that we expect to unwind in the second half, leading to improved cash flow performance in the second half of the year.

I would like now to turn to the outlook for the full year. Overall, we are pleased with our first half performance and are raising our guide for the full year. Machine Clothing delivered another exceptional quarter. Overall business conditions were similar to those we experienced in the first quarter. On a constant currency basis, we experienced demand growth in all paper machine clothing product lines, and as we noted last quarter, a return to lower pre-pandemic levels in our Engineered Fabrics business. Given typical vacation and winter holiday impacts in the second half of the year, combined with softer markets this year in Europe and Asia, we expect revenue in the second half of 2023 to be modestly lower than the first half. Taking into account our strong first half, we are increasing Machine Clothing's revenue guide by $20 million on the low end and $10 million on the high end to a range of $610 million to $620 million for the year. As we've mentioned for the past couple of quarters, inflationary pressures are easing and for some raw materials, we are even seeing price reductions. However, in general, raw material prices remain above pre-pandemic levels. Despite the easing price pressure, it will take a few quarters to see this flow through our results as we work through the raw materials acquired in prior periods. We continue our efforts to offset the inflationary impact through ongoing continuous improvement efforts and input cost management. Logistics have largely normalized with both better pricing and better availability. We expect Machine Clothing's adjusted EBITDA margins to be in line with our long term expectations of mid 30% for the full year. As a result for 2023, we are narrowing our guidance for Machine Clothing pulling up the bottom end of the EBITDA guide by $5 million. We now expect Machine Clothing adjusted EBITDA to be between $210 million to $225 million.

Turning to Engineered Composites. Our outlook for the year improved with some recent new business wins. We are still expecting full year revenues for our two largest programs, LEAP and CH-53K to be relatively stable this year compared to 2022. For CH-53K, we are largely complete with our tooling and NRE work on the app transition. So revenues on that program will grow as the production ramps towards full rate over the next few years. Taking into account the performance so far this year, we are raising the revenue guidance by $10 million. We now expect AEC revenue to be between $430 million and $450 million. Our AEC full year adjusted EBITDA guidance of $82 million to $92 million is up $2 million and implies margin expansion in the second half of the year as we see improved program mix and continued strong operational excellence in the second half. At the total company level, we are updating our 2023 full guidance as follows: Revenue between $1.04 billion and $1.07 billion, p $30 million on the low end and $20 million on the high end from prior guidance; adjusted EBITDA between $232 million and $257 million, up $7 million on the low end of the range and $2 million on the high end; an effective income tax rate of 32% to 33%, implying effective tax rate of approximately 28% to 30% in the second half of the year; depreciation and amortization between $72 million and $74 million; capital expenditures in the range of $85 million to $95 million, this is $5 million lower than our previous guidance as we expect some investment to move into next year; GAAP earnings per share between $3.07 and $3.67; adjusted earnings per share between $3.15 and $3.75, up $0.05 on the low end and $0.15 per share on the high end.

With that, let's open the call for questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now conduct the question-and-answer session [Operator Instructions]. Our first question is from Gautam Khanna of TD Cowen.

Gautam Khanna

I was curious if you could update us on your expectations for the LEAP program this year, and perhaps if you have any early view into next year and also on the CH-53K? I know both were relatively flat this year. But what's your visibility on a reacceleration into next year, if any?

Bill Higgins

We're pretty excited about -- there's some just good news out there on the 737 production rates going forward, longer term, A320 narrow-body is the place to be, as we all know. How that manifests itself, we'll have to wait and see in the next year. As we reported, we overachieved a little bit in the first half of the year versus our LEAP plan for the year, which kind of is a testament to our ability to ramp up real quick. Operations are running really well and inventories are moving through. So we're encouraged as we look at next year, but we don't really have any updates at this point to anything different for this year. We're still maintaining kind of a flattish level this year, although we're on a better run rate than that right now. And then we expect to see growth next year but don't have any numbers on it yet. That's on the LEAP program. On the CH-53K, as I think Rob mentioned, we've gone from the tooling and development stage into the production stages where we've got one line up and running and very successful. We've shipped product to Sikorsky on the CH-53K and continue to, and we're bringing the second production line online, which is an automated production line this -- in the next couple of months. So we expect to be in production and shipping off that second line in the second half of this year, so things are going really well there. And again, good news on the CH-53K demand longer term as well. So excited about that.

Gautam Khanna

And then just if you could also update us on your view on 787 and F-35. 787 look -- Boeing says they're at four a month on the way to five on the way to 10. I didn't know if you guys are finally starting to see demand pick up with the Boeing subcontract manufacturers that you ship to and likewise in the F-35, if you have an update?

Bill Higgins

On the 787, we're pretty much synced with the Boeing demand. We are running the production line. As you know, last year, we had stopped the line and prior to that, we had run at a really low level, so the line is up and running. We were -- how would I say it, cautious in how we started up the line to make sure that demand was coming and it looks like it's pretty good so far. So we're in sync with that four going to five rate level as we go from this year into next year, and we'll continue to ramp up from there. So that looks pretty good so far, so we haven't heard any changes to the production demand there. The F-35, also good news out there about longer term demand, so we're waiting to see. I don't have anything to report today on the demand for it, but we're excited as we look at next year and beyond.

Operator

Our next question comes from Michael Ciarmoli of Truist Securities.

Michael Ciarmoli

Maybe just to stick with Gautam's line of questioning on some of the platforms. Obviously, it's still early with the Pratt & Whitney disclosure. And I know there's been some chatter out there if airlines or deliveries from Airbus get held up could there be a shift to more LEAP platforms. I mean, how are you guys -- too early or how are you guys thinking about that in the trajectory of LEAP production here?

Bill Higgins

I think we're watching it with interest and full disclosure. My first job was at Pratt & Whitney in the Turbine Engine Group, so I'm watching it with a lot of interest. Longer term, it's just a great program to be on the LEAP program and we look forward to increasing our share and being really competitive. So we're just going to watch it and see how it goes.

Michael Ciarmoli

And then I don't want to be kind of flipping here with this question, but the Heimbach deal looks like a solid acquisition. But from a strategic standpoint, how did that come about, the decision to acquire them? Rob, I'm assuming you were too new to be intimately involved. Bill, you're on the way out. Was this from maybe Daniel at the Machine Clothing side, was the Board -- I mean I'm just trying to figure out strategically who really pulled the trigger on this thing?

Bill Higgins

It was a real strong team effort. Board, Daniel and his team, myself, we're all very highly engaged and worked it for a long period of time, I will say. So we're very excited about it. As I said, Heimbach has a long tradition, it's got a great brand in the industry and we're excited about working together with that. So it was a collaborative approach, a lot of work, but we're really excited to get moving forward here.

Rob Starr

And Mike, I'll just add. I came in, obviously, late into the picture. But giving an independent view of it coming in, it's a phenomenal deployment of capital for the company. When you look at the opportunities to create value and to really build out the Machine Clothing business, which, as we all know, generates a ton of cash and has given us the strategic flexibility to pursue a lot of growth across the company.

Michael Ciarmoli

No, I totally agree. I mean it sounds like a great path to earnings and EBITDA accretion for sure. Just the last one for me and I'll get out of the way here. I guess, just looking at the guidance, what has to happen for second half earnings to be down 26% versus first half to get to the low end of the range? I mean, I know you talked about Machine Clothing and normal European seasonality and other pressures. But I mean, it just seems like it would be a real struggle to get down there. And I mean you even had a pretty big tax headwind here in this current quarter. So can you maybe give us some of the mechanics on the ranges out there for the guidance?

Bill Higgins

Let me start and I'll hand it over to Rob. It's a fair question. We look at -- we do a bottoms-up, we look at all our programs we're on, we go through platform by platform in AEC, we look at the marketplace in Machine Clothing. And as you know, the Machine Clothing business, we have bookings that go out a period of time, but they don't go out a long distance. So we look at the market, we look at what the paper companies are doing, the machine, and there's a lot of machine downtime right now where they're doing maintenance. And quite often, we sell when they do maintenance, even if they take extended downtime because perhaps the demand is slower right now. So publication is down in Europe, in particular, quite a bit down. There's more closures coming there, so we're just watching it. So yes, it would take a lot to get down to the lower end of that range but we look at the perturbations of what could happen. And without having bookings that go all the way through the end of the year, at least not significant quantities, we're just trying to put bookends around it. So it's not likely we're going to go to that end of the range, but that's kind of how we teed it up.

Rob Starr

And Michael, I mean, I think it's really just a real caution that we have around the macros in Europe and some parts of Asia, including China. So we wanted to just ensure that the range, as Bill said, kind of captured that possibility. We don't think it's a high probability if we're going to wind up at the low end, of course but we just wanted to bookend it. And I think you raised a fair point that, a lot would have to happen negatively for us to get there.

Operator

Our next question comes from Jan-Frans Engelbrecht of Baird.

Jan-Frans Engelbrecht

Good morning, Bill, Rob and John, I'm on for Peter this morning. So just a quick question on how we should think about Machine Clothing and the margins since it seems like the acquisition probably closed a little earlier than expectations. So if you look at the first year, first half of the year the 35.8% EBITDA margins in Machine Clothing and the guide at the midpoint implies about 35.4%. So that's -- I assume that excludes obviously the Heimbach acquisition. But can you just talk about how we should think about the second half of the year for MC from a margin perspective?

Rob Starr

Yes, JF, I mean there's nothing in our guide that has anything with Heimbach. I mean, Heimbach is not included in any aspect in our -- and I think what we're looking at is, to your point, with the second half of the year tends to be a little bit softer, right, and we have slightly lower sales, which does also impact absorption at Machine Clothing. So that also has a bit of an impact on what we would expect in the second half of the year. And if you were to look very -- I mean, there's a slight level of seasonality that we typically experience in Machine Clothing first half to second half. So that is really what's impacting the margin.

Bill Higgins

There's also some costs that we incurred higher from the inflation that we've experienced where we had material costs we brought in that we've got to work through the system. It'll take a few more months to work through that into the fourth quarter, probably before those higher cost materials flow through the P&L.

Jan-Frans Engelbrecht

And then if I could just have a quick follow-up. And I understand 2026 is far off but if I just looked at the Investor Day targets for LEAP, 787 and CH-53K, are you sort of still comfortable with those targets? If you just look at 787, I think we're doing, let's say, about $5 million this year and that the previous target was at $40 million for 2026 for annual revenues. If you can just talk through those three programs, I guess…

Rob Starr

I think certainly kind of looking at 787, we're at a low point right now, clearly, with the production. But if Boeing's forecast is correct and they ramp up to those production levels then I think we would feel pretty comfortable with our longer term outlook for 787. And in terms of CH-53K, I mean, we definitely feel comfortable with that. And certainly, if you were to look at our backlog numbers that we reported in the Q, a lot of growth relating to CH-53K. We've done very well in getting contracts there. And then on F-35 or LEAP, we feel comfortable with where those productions are based on everything we're seeing.

Operator

Our next question comes from Ron Epstein of Bank of America.

Unidentified Analyst

This is Jordan on for Ron. So actually on the 2026 targets too, with defense spending and all the restocking and also the European spending, are you guys thinking about those targets, especially for missiles improving long term? And then also to anything else that you guys are seeing down the pipe that you think would be really interesting for hypersonics?

Bill Higgins

We didn't talk about technology on this call, we usually do. I get pretty excited when you get into hypersonics discussions. But yes, we are excited about that longer term and we are making some investments there. But again, it's a little bit longer term. Regarding the 2026 targets that we've talked about in the past, and if you go back to last year, our investor conference, where we said we're going to double the AEC business over that time frame. We're still on track to doing that. The mix has changed a little bit. We've won some business to cover for some of the areas that were, maybe have been a little bit shorter than we thought, for instance, the 787 didn't ramp back up quite as quickly as we thought. But we've been -- the team has done a great job winning a new business and multiple of applications. So that adds up to it. So we're pretty confident we get to those 2026 levels, if not beyond.

Operator

Thank you. I'm showing no further questions at this time. I would now like to turn the conference back to Bill Higgins for closing remarks.

Bill Higgins

Great. Thank you. Thank you, everyone, for joining us on the call today. We appreciate your continued interest in Albany International. And of course, if you have any questions, feel free to reach out to John Hobbs, our Director of Investor Relations. So thank you, and have a great day.

Operator

This concludes today's conference. Thank you for participating. You may now disconnect.