Albany International Corp /De/ Q2 FY2024 Earnings Call

Thank you for joining us. I would like to welcome everyone to Albany International Corp's Second Quarter 2024 Earnings Conference Call. I will now hand it over to JC Chetnani, VP of Investor Relations and Treasurer. Please proceed.

Thank you, Debbie, and good morning, everyone. Welcome to Albany International's Second Quarter 2024 Earnings 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 the notice regarding our forward-looking statements and the use of certain non-GAAP financial measures and their reconciliation to GAAP. For the purposes of this conference call, those same statements apply to our verbal remarks this morning. Today, we will make statements that are forward-looking and 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, please refer to both our earnings release of August 6, 2024, and as well as our SEC filings, including our 10-K. Now I will turn the call over to Gunnar Kleveland, our President and CEO, who will provide opening remarks.

Thank you, JC. Good morning, and welcome, everyone. Thank you for joining our second quarter earnings call. I will provide an overview of our business performance. Rob will later discuss our financial results in detail. Overall, we had another good quarter as our businesses delivered strong results and are responding well to their industry challenges. We continue to deliver strong profitability and have further strengthened our balance sheet. Free cash flow was strong with $64 million generated in the second quarter. Machine Clothing revenues at $194 million grew year-over-year, driven by our Heimbach acquisition, slightly offset by lower organic demand, primarily in Europe and North America. Our global order backlog remains stable. We continue to make progress with the integration of Heimbach. Our performance has improved sequentially quarter-over-quarter with a 220 basis point expansion in Machine Clothing adjusted EBITDA margins, and we took further action on our global footprint with the consolidation of two U.K. facilities. We successfully implemented SAP at Heimbach in the second quarter, which will enable us to further execute on our integration plans for the second half of this year. We commend the team for executing the implementation with no operational disruption, and I thank them for all their hard work. Moving to our Engineered Composites segment, we are pleased to report that during the quarter, we received over $200 million in new orders, bringing our year-to-date orders to over $900 million. This will further drive revenue growth in 2025 and beyond. For the quarter, we delivered 20% year-over-year top line growth as our current programs ramp up. We see growth in our commercial markets, especially in Space and other emerging platforms. Our Defense business is also growing, primarily the CH-53K and JASSM platforms, partially offset by the Joint Strike Fighter program. However, our profitability for the quarter is lower with adjusted EBITDA margins at 16.9%, lower by 130 basis points versus the prior year, driven by inefficiencies related to program ramp-up. We expect margins to improve in the second half due to operational improvements and program mix. Turning to the LEAP program, we've been working closely with Safran to adjust our 2024 production plan in light of the continued situation at Boeing. We now anticipate LEAP revenue to be slightly down this year versus the prior year, with minimal impact to overall profitability. Despite changes to lead production, we're maintaining our full-year AEC guide as all the programs will serve to offset this reduction. Overall, our business is performing well. Our margins in Machine Clothing are improving as we execute our Heimbach integration plans, and substantial new business wins at AEC have improved our backlog. I would also like to welcome Chris Stone as President of AEC. Chris brings strategic capability combined with experience in leading complex operations and supply chain. These skills will be critical to AEC as they continue to execute our growth strategy. And with that, I'll hand it over to Rob to provide more details on the quarter.

Thank you, Gunnar, and good morning, everyone. I will review our second quarter results of 2024 and then provide our outlook for the balance of the year. Consolidated net sales came in at $332 million, up 21.1% from the second quarter of last year. The growth was driven by a combination of Heimbach revenues and organic growth at Engineered Composites. Machine Clothing net sales of $194 million increased 21.6% versus the second quarter of the prior year, driven by Heimbach, partially offset by a $4 million decline in organic sales on a currency-adjusted basis. North America comps were lower year-over-year, primarily due to a strong performance in the second quarter of last year. However, for the first half of the year, North America is stable and it simply reflects quarter-to-quarter variability. AEC net sales of $138 million increased 20.5% from the second quarter of 2023. Our growth was driven by CH-53K, 787, and other commercial and Space programs. We continue to see a ramp-up of our various commercial and Defense programs. Consolidated gross profit was $112 million, up $10 million or 9.4% from the same period last year. Machine Clothing gross margin decreased from 50.8% in the second quarter of 2023 to 45.9% in 2024. The reduction was driven by the inclusion of Heimbach. When you exclude Heimbach, Machine Clothing gross margins increased 90 basis points to 51.7% versus the prior year, reflecting continued excellent execution. We continue to progress on our Heimbach integration plans, and we expect further margin expansion as a result in the coming quarters. AEC gross margin decreased 200 basis points from 19.0% in the second quarter of 2023 to 17%. This includes a $5 million unfavorable change in the estimated profitability of long-term contracts. This is due to inefficiencies related to program ramp-up. For comparison purposes, in the prior year, we recognized an unfavorable $2 million charge. Net R&D expenses increased $2 million in the second quarter versus the prior year, remaining at approximately 4% of revenues. We continue to make strides as we focus on material science capabilities to further differentiate ourselves from our competition. SG&A expenses for the quarter increased by 18.7% nominally, but this was due to Heimbach. As a percentage of revenue, SG&A has decreased from 17.1% to 16.7%, as we continue to further streamline our operations and focus on efficiencies. Corporate expenses increased $7 million; this is primarily due to the Heimbach IT-related costs, acquisition and integration-related expenses, and employee-related compensation. Additionally, we recorded foreign exchange hedging losses of $4 million as part of our global foreign exchange hedging program. These transactions do not qualify for hedge accounting treatment, and as such, we will experience quarterly fluctuations in the normal course of business. The effective tax rate for the quarter was 27.9% versus 42.8% in the prior year and generally in line with our long-term guidance of 30%. The rate for the second quarter of 2024 was lower than the prior year, mainly due to the unfavorable discrete adjustments we took in the prior year period. GAAP net income attributable to the company for the quarter was $25 million compared to $27 million last year. GAAP diluted EPS was $0.79 per share in this quarter versus $0.85 in the same period last year. After adjustments primarily related to the Heimbach acquisition and other restructuring activities, as detailed in our non-GAAP reconciliation, the adjusted diluted EPS was $0.89, unchanged from the same period last year. As a reminder, we also had a $0.10 headwind from foreign exchange hedging this quarter that is not reflected in our adjustments. Consolidated adjusted EBITDA was $63 million for the second quarter versus $65 million in the prior year period. Machine Clothing adjusted EBITDA, including Heimbach, was $62 million, an increase of 5% versus the prior year. Adjusted EBITDA margins were 32.2% versus 37.3% in the prior year, with the decrease driven by the inclusion of Heimbach. AEC adjusted EBITDA was $23 million, a nearly 12% improvement over the prior year. Adjusted EBITDA margins at AEC were 16.9% of sales versus 18.2% in the prior year. During the second quarter, free cash flow was $64 million with positive operating cash flow of $83 million, offset by capital expenditures of approximately $19 million. Our balance sheet remains strong with a cash balance of over $116 million and $430 million of borrowing capacity under our committed credit facility. Net leverage is below 1x. This provides us with significant financial flexibility. Turning to our outlook for the balance of 2024. We are reaffirming our full guidance for the year. I want to provide some context around the segment level guide given the dynamic environment we are in. For Machine Clothing, the low end of the range reflects greater-than-expected softness in our European and Asian markets and delays in the realization of our targeted Heimbach synergies. The high end of the machine clothing guide reflects improving market conditions, in particular, Europe, combined with constructive markets in the Americas and Asia, with Heimbach synergies realized ahead of plan. For AEC, the low end of the range reflects further reductions in LEAP production, lower 787 rates, as well as continued challenges as we ramp up our key programs. The higher end of the range reflects better-than-expected performance on our program ramps, including on our new programs. Now I would like to open the call for questions.

Your first question comes from Peter Arment with Baird.

Could you provide some insights on the organic performance? It seems North America experienced growth in Q1 but a decline in Q2. Is that primarily related to timing? Are you observing any continuity in that trend as we reach the midpoint of Q3?

Peter, the comparison for year-over-year was difficult this year. But if you look at overall North America for the first half, we are up. So we believe that it's a continued strong market in the U.S.

Got it. Can you update me on your progress with footprint consolidation? Have you completed it for the year, or is there still more to do?

No, Peter, we're continuing. We are on plan, and we're continuing the efforts through, frankly, through 2025, but there's more actions coming.

Got it. And then just quickly on AEC. You mentioned that LEAP revenues are going to be slightly down. Can you call out maybe some of the programs that are going to be offsetting or providing you the ability to grow? Is that CH-53K, is it JASSM, anything in particular?

On the military programs, it is definitely a CH-53K and JASSM. But for our guide, some of our new programs that we reported, the $200 million in new orders includes Space, engine components, and that will start later this year and continue through the long term. We are signing some good long-term contracts, and that's helping our backlog in the future. But there are some additions this year as well. So that's how we're holding our guide.

Okay. And just lastly, regarding the 737 rate, when do you expect to be aligned with Boeing's target of 38 a month by the end of the year?

Yes, that's difficult to answer, Peter. I think Boeing will not have any issues meeting any ramp-up. We know we have the capacity. Our focus is working with Safran to ensure that we do not build inventory during this period. Therefore, we have adjusted our rates. Our ability to ramp up afterwards is not a concern for us, and we will keep an eye on Boeing as well as the developments with the LEAP engine and some related supply chain issues. We are collaborating closely with Safran and making adjustments as needed.

Next question comes from the line of Pete Skibitski with Alembic Global.

Gunnar, I want to confirm that I understood you correctly. Did you mention that the year-to-date orders exceed $900 million for AEC, or is that figure referring to the backlog?

Yes, the new orders we have taken this year amount to $900 million. Some of that will transfer to backlog this year, but primarily it will be for 2025 and beyond.

Okay. So that was the order flow, what's the backlog?

It's about $1.2 billion, Pete.

Okay. And that's just for AEC, you guys are talking about?

Yes, that is correct. Yes.

Okay. That's great. That's pretty sizable. It seems like at this point. And then you guys talked in the release about the strength in Space and other emerging markets. I guess that was part of that order flow. Any more details, I know you've been kind of reluctant to talk too much to the new stuff, but are we any closer to being able to talk more about what exactly you're doing in Space and what other new programs you're involved with there? So we can get a sense of kind of the long-term upside.

I believe the positive aspect here is that we continue to receive orders that are not one-time purchases. Instead, they are long-term agreements based on our capability to deliver in both the Space sector and other programs. We are currently unable to disclose the identity of our customers. As these programs develop, I aim to share that information, but we are not there yet.

Okay. Fair enough. Last one for me. The $5 million negative EAC adjustment. Do you feel like you've got a good handle on that program now? It sounds like it was a newer program, and you haven't had a history of significant EAC changes. Aerospace analysts seem surprised because other companies are consistently taking EAC charges quarter after quarter on the same programs. I would like to know if you feel that this particular program is well aligned with what future accounting looks like.

Yes. Pete, this is Rob. I mean, if you look historically, our EAC adjustments have been less than 1% of top line. So to your point, this year to date, we're about $7.5 million, which is a bit higher than clearly than we would like. But we've been working very closely on a number of these programs and feel good about the adjustments that we've made to reflect the state of the programs. And we're certainly very closely monitoring the operations to make sure that they're performing. So at this stage, we feel confident with the adjustments. And these are really good long-term programs that are complicated in their ramp-up. So we're working that very closely.

And I would just add, this is the area where we added the additional content, and we're going to full rate at the same time. So it's a major effort by the team, but we are ramping and we're supporting our customers.

Next question comes from the line of Jordan Lyonnais with Bank of America.

Regarding the AEC guidance, I appreciate the insights you provided earlier. Considering the downside risk, how much attention is being given to the potential impact of an extended strike at Boeing and its implications for follow-on production rates for the LEAP?

Yes, Jordan, that's a very good question. If there were a strike at Boeing, we have already factored some of that into our downside. However, the impact would really depend on the duration of the strike and its specifics, which is challenging to predict. Nevertheless, the downside does account for lower LEAP production, which would indeed occur if there was a strike.

Got it. Okay. And then on the new orders, strong backlog, how do you feel about current head count to meet the ramp across these programs?

Hiring has been challenging over time. Salt Lake is our largest site, where we are hiring the most. We are nearly at the right headcount needed for the current ramp-up. The key now is to retain everyone. Our HR team is performing well; we are successfully bringing people in and they are becoming effective. However, hiring is more difficult in Salt Lake compared to our other sites. I can say that for both MC and AEC, we do not face hiring challenges at any of the other sites.

Next question comes from the line of Jack Ayers with TD Cowen.

So just kind of on the drill down again on sort of the LEAP production forecast. I know you guys are just kind of calling it down year-over-year. I wonder if you can maybe refine that a little bit more? And then, I guess, going into next year, how we think about 2025, just given the assumptions already at CFM about the 40% sequential ramp in LEAP output in H2, if those guys don't hit those targets, kind of what that means for 2025, just any color there would be helpful.

Yes, Jack. I mean, I think for '24, we're looking at approximately $5-or-so million reduction in LEAP revenues and approximately about $1-or-so million of EBITDA impact. The planning, of course, is underway for 2025. We're not in a position to necessarily provide any outlook towards 2025. But as Gunnar referenced, we're very much aligned with the friend who clearly has in close discussions with their customers regarding the LEAP engine. So we have the flexibility to adjust our output either up or down. And to your point, right, there's just a lot of volatility right now around the LEAP supply chain, nothing to do with us. But we're just going to have to navigate.

Okay. That makes sense. And then just a quick one on 787. I know you guys called it up this quarter. Can you size that like basically how big that program is today for you guys?

Yes, it is an important commercial program for us. We haven't discussed the exact size of the program in the past. Year-over-year, our production rate for the 787 has been low for a while. However, it's been a favorable comparison for us, and we are aligning our production with Boeing's run rate as they increase to five per month.

Okay. Great. And then I guess just one high-level question, I guess, for Gunnar here. Kind of coming into this relatively new, I think for the past few quarters, just would love to hear your sort of perspective on the portfolio. You've got a ramping Aero business here, and a kind of unique MC business. So would love to hear your impressions of the MC business and kind of moving forward, how you kind of see the portfolio evolving?

Thank you, Jack. We are currently reviewing our strategy and planning for the next five years, and I feel well-informed on that front. I appreciate being considered new; I think I have another month in that category. I genuinely enjoy the Machine Clothing business, though I believe the name may not fully represent its scope. It's a strong business, and our acquisition of Heimbach presents a good opportunity. As we integrate, this will continue to deliver solid returns and generate significant cash flow, which is highly favorable. The foundation of Machine Clothing lies in material science, and we have the potential to leverage our technology and material science to build on what was started in this area, expanding into Aerospace with 3D-woven parts. There are numerous opportunities ahead, and the growth rate in the Aerospace business looks promising. We need to manage this growth effectively, with an eye towards enhancing our technology. Thus, 3D-woven parts will be a key focus in the coming years.

And we have our last question from Michael Ciarmoli with Truist Securities.

Just to maybe keep beating this LEAP issue. Can you just maybe give us a better sense of, do you have an idea of what kind of inventory is in the channel? And I know you said a couple of times you're aligned with Safran. I mean they were originally planning 20% to 25% growth in LEAP for the beginning of the year, which I guess would have been nearly 2,000 engines, they scale that back to 10% to 15% and now flat. So I mean, are you guys actually producing units now? Or is it an inventory burn down situation? Can you give us any more color of maybe what's in the channel there?

Yes, we are continuing to produce. It is important that we continue to produce and keep our people both engaged and the technology fresh there. We were flat from last year, which means we had started the inventory burn down. As we're coming into the second half, we are further reducing our rates, which will have an impact on inventory going forward. But we're trying to maintain an inventory for the contract with Safran. Where the inventory on beyond that? I don't know.

Okay. And then just thinking about knowing that contract and not as accretive to margins. The second half AEC, and obviously, you had the negative EAC this quarter, but it looks like you got a 21% or so run rate in the second half. What are the big sort of drivers that kind of give you the confidence in that margin level in the second half?

Yes, Michael, this is Rob. There are a few things that give us that confidence. The first is there is going to be a bit of a shift in program mix. A lot of our Space and other programs that we expect to see improved sales in the back half of the year carry higher margins. The operational challenges that led to some of the EACs, we're working to overcome those, and we feel confident that we'll be able to produce more efficiently in the second half. So you have that. And then thirdly, a number of these restructuring activities that you see at AEC are really about getting the cost structure to a much better place at AEC. And that is also going to be a significant contributor in the second half of the year, based on the SG&A reductions that we've made there. So it's really those three items that give us the confidence in the back half of the year margin.

Got it. And then just one more, more broadly on that, not to hone in directly on that negative EAC. But clearly, you're winning more Defense and Space work. And presumably, those programs come with a lot more risk. I mean, as you look at your bidding process, contracting terms, design, analysis, program management, do you feel that everything is robust enough to sort of contemplate and capture any potential overruns or challenges so you kind of don't get into this sort of persistent negative EACs?

Yes, I'll begin and then let Gunnar add his thoughts. Michael, we have a strong bid review process in place. Over the past few years, we've assembled an effective business development team that collaborates closely with program management and supply chain to thoroughly understand the requirements of each program. We have turned down several potential opportunities when the economics didn't make sense and the risks were too high. This quarter, we are seeing a significant increase in large programs even in a challenging labor market, which is the main factor affecting the EACs you're observing. If we exclude a couple of programs, the others have been relatively neutral overall. So, we maintain a positive outlook on our review process and the types of work we are willing to pursue. As Gunnar said, we will continue to prioritize our 3D-woven technology and explore related opportunities. You're correct that in any fixed-price contract, risks associated with supply chain and labor must be factored into pricing. Contractually, we believe we have effectively protected ourselves to the greatest extent possible, and our execution team is performing well.

We have the opportunity to be selective. And so we'll select the programs that make the most sense for us. And I have to emphasize the ability of this team to execute is great. So we're going through a significant ramp, and we're seeing some effects of that. That ramp was the beginning of this year. We're continuing to ramp up through the end of the year. We're adding new programs. Some of the new programs are added at our various facilities, which help us disperse the risk. So in support of Rob fully in that answer.

There are no further questions at this time. Mr. Gunnar Kleveland, I turn the call back over to you.

Thank you. And thank you, everyone, for joining us on the call today. We appreciate your continued interest in Albany International. Thank you, and have a good day.

This concludes today's conference call. You may now disconnect.