Albany International Corporation

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International fourth quarter 2021 earnings call. At this time, your telephone lines are in a listen-only mode. Later, there will be an opportunity for questions and answers with instructions given at that time. If you should require assistance at any time during the conference call, please press star, then zero, and an AT&T specialist will assist you offline. As a reminder, your call today is being recorded. I'll now turn the conference call over to your host, Director of Investor Relations, John Hobbs. Go ahead, please.

Thank you, Alan. And good morning, everyone. Welcome to Albany International's fourth quarter 2021 conference call. As a reminder for those listening today, 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, these same statements apply to our verbal remarks this morning. Today, we will make statements that are forward-looking, that contain a number of risks and uncertainties, among which are the potential effects of the COVID-19 pandemic on our operations, the markets we serve, and our financial results. For a full discussion, including a reconciliation of non-GAAP measures we may use on this call to their most comparable GAAP measures, please refer to both our earnings release of February 15th, 2022, as well as our SEC filings, including our upcoming 10-K. Now I'll turn the call over to Bill Higgins, President and Chief Executive Officer, who will provide opening remarks. Bill.

Good morning and welcome everyone. Thank you for joining our fourth quarter earnings call. We're pleased to report another strong quarter capping a great year in 2021. Our employees performed remarkably well throughout the year. We continue to do a great job for customers, won new business, brought new products to market, and navigated successfully through supply chain and COVID challenges. We generated record free cash flow of more than $160 million in 2021. our highest cash flow in the history of the company, on sales of $929 million with over 40% gross margins, 27% adjusted EBITDA margins, and world-class operational performance in delivery quality and safety. At the segment level, machine clothing's operational performance and financial results continue to be exceptional. With better-than-expected customer demand at year-end, machine clothing was able to deliver fourth-quarter sales growth of nearly 10% over prior year's fourth quarter and do it with great flow through to the bottom line at 52% gross margins and 38% e-theta margins. Engineer composites also performed well in the quarter with solid program execution across the board. Commercial aviation recover is underway and its initial stage is in 2022. The recovery will be seen as a mixed shift as our elite production volumes ramp back up to support narrowbody aircraft demand. Beyond 2022, as the recovery progresses, we're excited as growth is expected to continue for our LEED and CA53K programs and the anticipated wide-body demand recovery begins. We also expect new business wins will layer on top of that to provide a solid foundation for longer-term growth beyond 2023. As we ended last year, demand in our end markets was healthy, yet still recovering in a few areas. Machine clothing demand was better than expected, and appears robust entering 2022. Packaging, pulp, and engineered fabrics have all been strong, especially packaging in the Americas and Europe. Even publication enjoyed slight growth in 2021, perhaps a short-term rebound, as we expect publication will revert to the longer-term downward trend as digital media continues to replace printing and writing paper. While machine clothing demand is expected to remain healthy in 2022, We're somewhat cautious as some customers may have built up on-hand inventory of machine clothing belts to mitigate the risk of supply chain and logistics disruptions. The outlook for engineer composites demand is improving as commercial aerospace gradually recovers from the pandemic. Domestic airline travel is leading the way while international travel is still slow to come back. Consequently, narrow-body demand has already picked up, and we're ramping our lead production to meet the needs for the Airbus A320neo and Boeing 737 MAX aircraft. We do not expect a recovery in wide-body production, and specifically for our Boeing 787 composite frames manufacturing in 2022. It'll take longer. On the defense side, we have great programs, Joint Strike Fighter CH-53K, JASM missile that have longevity, In the short term, we do see some temporary headwinds on the Joint Strike Fighter as inventories have been overbuilt. Longer term, however, as production plateaus and more aircraft enter service, we expect this to remain a healthy and attractive program for us. Now, let me make a few comments about our strategy. Our first strategic priority is to invest in R&D and product development for organic growth. As planned, we increased R&D investment by 10% in 2021. We added talent to our design, engineering, and customer pursuit teams. We continue to collaborate with key customers to design the next generation of advanced materials and bring new products to market. Our strategy is to position Albany as the technology leader and partner of choice in our segments and markets. This means we must be good at both advanced materials development and operational performance to win new business and to expand our market share with existing customers. Our machine clothing business has successfully used this strategy to establish a leadership position second to none in its industry. We've earned a long-standing reputation for producing products of exceptional quality and durability for our customers. We spend more on R&D than our nearest competitors, and we work intimately with customers to design solutions that address their biggest technical challenges. This results in a pipeline of new product introductions that our customers value. Furthermore, we support our customers with a technical sales team assuring customers they get the best paper quality and production efficiencies that our products can deliver. About a decade ago, machine clothing management recognized the secular shift in the paper industry and redirected investment to emphasize serving customers in the growth areas of the business. That strategy continues to pay off. Today, sales to tissue and packaging producers account for the majority of our revenue, while sales to producers of printing and writing grades of paper, the grades in secular decline, contributed only 17% of our sales, down significantly from over 30% 10 years ago. Machine clothing's focus on improving its global footprint, product technology, operations, and continuous improvement has paid off. As I previously mentioned, machine clothing delivered record-adjusted EBITDA margins of more than 38% in 2021. That's nearly a 10 percentage point expansion over the past decade, reinforcing our strategy of providing the most advanced material solutions with great operational execution. In engineering composites, we're earlier in the journey. We're executing a consistent strategy to bring the next generation of advanced materials to market, and we're earning a reputation for operational excellence and great customer service. It builds on the application of 3D woven composites we developed by collaborating with Saffron on leaf fan blades and cases. The durability and performance of 3D woven composites exceeds those of any other fan blade materials, titanium or 2D composite blades. And the production rates we achieved have demonstrated the commercial feasibility of high-volume production of 3D woven composite components. We're using the LEAP experience as a springboard to build a complement of composite design engineering and manufacturing capability and propagate the use of 3D woven structures across the aircraft. The strategy takes advantage of long-term secular trends driven by climate change and energy efficiency that demand lighter and stronger materials that raise the bar for fuel efficiency and contribute to a more sustainable future. Our strategy is to be at the center of this shift to lighter composite aircraft. We believe it will include a range of composite materials and applications, the right material and manufacturing process for the job. Over the last 18 months or so, we've announced new business wins, partnerships, and technology collaborations that advance the strategy to become the leader, the leading supplier of advanced composite technologies and solutions. We've been awarded more content on existing aircraft, including Boeing 787 composite frames, Lockheed Martin Joint Strike Fighter composite components, now over 200 part numbers, and on Sikorsky's CH-53K helicopter. Winning this additional share reflects the strength of our operational performance, on-time delivery quality and service, and how important it is to our customers. In 2021, we extended our technical collaboration with Safran for 25 years with the goal of developing the next generation of 3D-woven composite products for the revolutionary RISE engine to power the next generation Narabar aircraft. We're also working on the GE9X with Safran to develop a composite fan case for wide-body aircraft. In addition to engines, we're working on 3D woven composite applications for wings as a partner with Airbus on the Wing of Tomorrow program. And in 2021, we also formed a technology collaboration with Spirit Aerosystems to develop 3D woven carbon-carbon composite materials for high-temperature use on hypersonic vehicles. Another application, we're excited about the unparalleled benefits of 3D woven composites. And today, we're pleased to announce that Sikorsky has awarded Albany the CH53K Aft Transition Manufacturing Program. This program award reflects trust and confidence in our ability. It solidifies our strategic relationship with Sikorsky on a durable program critical to defense capabilities with a value over $300 million. It also positions Albany as a major player in composite rotorcraft structures. We already manufacture the CH-53K sponsons and vertical tail. And with the aft transition section, we essentially will manufacture the back half of the helicopter. This win adds to the foundation we're building for long-term organic growth. Effective capital allocation remains a top priority and continues to be focused on driving long-term organic growth. It starts with research and development. And while these expenditures live on our income statement, we consider them an essential investment in our future success. Our capital expenditure program focuses not only on maintaining our current capabilities, but advancing our production efficiency and growing our capacity and capabilities as our business base grows. Share repurchases supplement our regular dividend as a flexible method of capital return. Finally, targeted discipline acquisitions will continue to be a key element of our long-term growth strategy, at the right price, of course. Historically, acquisitions have played an important role by enabling us to build on our technology leadership and global market positions in line with our strategic priorities. As a company, we ended the year 2021 in great shape, a strong pre-cash flow generation, a robust balance sheet, a relentless focus on operational excellence, and leading technologies in both of our segments. We continue to invest in R&D to position Albany for long-term organic growth. We believe long-term secular trends are favorable. Machine clothing continues to advance its technology leadership position globally in an industry that is becoming more attractive as a sustainable resource as paper replaces plastic. Engineer Composites continues to win new business as the emerging partner of choice for the next generation of advanced, lightweight composite material applications on aircraft that will deliver on the promise of more sustainable aviation. So with that, I'll hand it over to Steven.

Thank you, Bill. Good morning to everyone. I will talk first about the results for the quarter and then about our initial outlook for our business in the coming year. For the fourth quarter, total company net sales were 239.9 million, an increase of 5.7% compared to the 226.9 million delivered in the same quarter last year. Adjusting for currency translation effects, principally the decline in the Euro relative to the US dollar, net sales increased by 6.4% year over year in the quarter. In machine clothing, also adjusting for currency translation effects, net sales were up 9.4% year over year, driven by growth in all grades of product. Engineered composites net sales, again after adjusting for currency transformation effects, grew by 1.3% with growth on LEAP and other commercial programs, offset by declines on the F35 and 787 platforms. During the quarter, the LEAP program generated revenue of just under $27 million, compared to a little under $25 million in the same quarter last year. LEAP revenue was also up modestly sequentially as we had delivered revenue of around 25 million in each of the first three quarters of 2021. We finished the fourth quarter with about 115 LEAP-1B engine shipsets in contract assets, largely completing the destocking of LEAP-1B finished goods on our balance sheet. We now expect our production of LEAP-1B units to be more or less in line with our deliveries. Although we should point out that there is still considerable uncertainty related to Boeing's demand, and our planned production rate is still subject to revisions. Also, from time to time, we do expect to see some periods of finished goods inventory stocking and destocking in our customer supply chains for both LEAP 1A and LEAP 1B components. so there will not always be full alignment between aircraft production levels and our production of the respective engine components. Fourth quarter gross profit for the company was 96.1 million, an increase of 5.2% from the comparable period last year. The overall gross margin declined by 30 basis points from 40.3 to 40.0% of net sales. Within the MC segment, gross margin improved from 50.9 to 52.3% of net sales, driven by a one-time benefit from government refunds in certain international jurisdictions where we operate, and improved absorption due to higher production volumes, partially offset by higher raw material and logistics costs. Within AEC, the gross margin declined from 21.7% to 16.9% of net sales, caused primarily by mixed effects due to a decline in revenues on our fixed-price programs while other lower-margin programs grew, and the absence of reserve changes that improves the prior-year gross margin, partially offset by a slightly more favorable net change in the profitability of long-term contracts. Four quarters selling technical, general, and research expenses declined from $54.8 million in the prior year quarter to $53.2 million in the current quarter and declined as a percentage of net sales from 24.1% to 22.2%. You may recall that in Q4 2020, these expenses were higher than normal as the company made a special bonus payment to all non-executive employees. Total operating income for the company was $41.7 million, up from $35.0 million in the prior year quarter. Machine clothing operating income increased by $12.5 million, driven by higher gross profit and lower STG&R expense, while AEC operating income fell by $5.6 million, caused by lower gross profit and higher STG&R expense. Other income and expense in the quarter netted to income of $1.2 million compared to income of $500,000 in the same period last year. The improvement this quarter was primarily driven by a more beneficial foreign currency revaluation effect in this quarter. Income tax rate for this quarter was 27.3% compared to 13.5% in the prior year quarter. The rate this quarter is a little lower than our normal expectations. driven by discrete items, while the abnormally low rate in the fourth quarter of 2020 was due to a significant true-up of earlier quarter's provisions recognized in that quarter. Net income attributable to the company for the quarter was $28.6 million, slightly higher than $27.5 million last year, as the significantly higher operating income was largely offset by the significantly higher tax rate. Earnings per share was 89 cents in both this quarter and the same period last year. After adjusting for the impact of foreign currency revaluation gains and losses, restructuring expenses, and expenses associated with the SIRCOMP acquisition and integration, adjusted earnings per share was 86 cents this quarter compared to 89 cents last year. Adjusted EBITDA increased 5.7% to $60.6 million for the most recent quarter compared to the same period last year. Machine clothing adjusted EBITDA was $59.7 million, or 38.1% of net sales this year, up from $50.9 million, or 35.3% of net sales in the prior year quarter. AEC adjusted EBITDA was $16.1 million, or 19.3% of net sales, down from last year's 21.3 million, or 25.7% of net sales. During the quarter, the company generated free cash flow, defined as net cash provided by operating activities, less capital expenditures, of over 47 million, and for the year generated free cash flow of almost 164 million. The very strong free cash flow this year was driven by both strong operating performance in both segments and by the drawdown of our finished goods inventory on the LEAP program. As we have previously discussed, we recognize revenues and profits on the LEAP program as components are manufactured, at which point they are recorded in contract assets. As we subsequently shift those components, We then invoice and collect cash with no associated revenue or profit. This year, on the LEAP program overall, cash collections were considerably higher than revenue, reversing the pattern we had seen in 2019 and 2020. During the fourth quarter, we returned about $30 million of our free cash flow to investors, comprised of roughly $6.5 million in regular dividends and over $24 million in share repurchases. we repurchased about 285,000 shares during the fourth quarter at an average price of $85.42. Repurchases are continuing. In Q1 so far, we have repurchased a little over 200,000 additional shares. We will provide a full update on Q1 repurchase activity during our next earnings call. For the full year 2021, we returned almost $50 million to shareholders. 24 million in share repurchases, and almost 26 million in dividends. Thanks to our strong free cash flow, our net leverage ratio is now about 0.25. This leverage ratio provides a significant headroom to both continue to return cash to shareholders and, as Bill referenced, explore acquisition opportunities. As we execute our capital deployment strategy, we would be comfortable with leverage ratios on the sustained basis in the 2.5 range, although, as we've done in the past, we could from time to time consider assuming a higher leverage ratio, provided we see a path to returning to our normal comfort range. I would now like to turn towards the coming year and provide our initial financial guidance for 2022, which is expected to be another strong year for both segments. We expect to deliver another year of excellent performance in the machine clothing segment. Fundamental demand for paper products is strong, our order books are healthy, and the segment's culture of continuous improvement continues to deliver results year in and year out. We are in a solid position as we enter 2022. As we began the fourth quarter of 2021, we saw some risks to top-line performance in the segment. At that time, we had been seeing growing inventory at several of our customers of both our products and our customers' finished goods, which raised the risk of an inventory destocking cycle, which would obviously impact our revenue. This risk did not materialize in the fourth quarter, resulting in strong orders and revenues for the segment above our expectations. However, these inventory levels have not reversed course, and in some cases have grown, as we enter 2022. Therefore, the risk of the stocking cycle remains. We do not know when that risk will manifest itself in terms of impacts to our revenue. However, we have accounted for some impact from it in our 2022 outlook. Our revenue guidance for the segment also takes into account the significant weakening of the euro that is taking place over the past several months. We generated over $100 million of our 2021 segment sales in euros. We now expect an exchange rate that is 7% to 8% lower on average in 2022 compared to 2021. This creates roughly $10 million of headwind to 2022 revenues in our outlook. Finally, as Bill indicated, we do expect that the rebound we have seen in publication rates will be short-lived. and we expect that portion of the market to return to secular decline over the next 12 to 24 months. Combining all of these factors with the typical variability in overall demand for machine clothing and other engineered fabric products results in initial net sales guidance for the segment of 590 to 610 million. From a profitability perspective, machine clothing had an exceptional year in 2021. delivering almost 237 million of adjusted EBITDA, equivalent to a record 38.2% of net sales. During the fourth quarter, we began to see the impact on the segment of higher input costs, including raw material, labor, and logistics, hitting the P&L. However, these were more than offset by some non-recurring benefits, by higher fixed cost absorption, and by a continued low level of travel due to the global prevalence of the Omicron variant. In 2022, we expect to be able to offset a modest amount of input cost inflation through pricing to our customers, and to be able to offset a more significant portion of it through continuous improvement. Overall, inflation is continuing globally, and therefore we do not know the final impacts on our profitability. but our current outlook assumes about $6 million of net impact through the bottom line in 2022 compared to 2021. I discussed earlier that over 100 million of the segment's 2021 sales were denominated euros. We do, of course, offer significant expenses in euros. On the net basis, we expect the weaker euro relative to the U.S. dollar will impact our bottom line by about $5 million. We will also see a profit hit from the modestly lower revenues in 2022 compared to 2021. On a currency-neutral basis, the midpoint of our guidance range for 2022 is about $10 million lower than we generated in 2021. As you are no doubt aware, while our gross margins are typically slightly north of 50%, we do have significant fixed costs in our cost of goods sold, resulting in deprimental margins well north of 50%. Therefore, this $10 million reduction in volume is expected to result in a high single-digit million reduction in profitability. Finally this year, we are likely to see the long-expected return to our normal level of travel. While we have expected the return to normalcy to occur before now, it has been repeatedly delayed as the incidence of COVID variants has continued to constrain our ability to travel. We now hope that those travel restrictions are largely behind us and we expect machine clothing travel and R&D will rise by close to $5 million in 2022 compared to 2021. Notwithstanding those concerns, we expect the machine clothing segment to deliver another excellent year of performance and are providing initial adjusted EBITDA guidance for the segment of 205 to 225 million, consistent with or slightly above the EBITDA margins delivered in 2018 and 2019. Turning to engineered composites, the long-term future is very bright. With the successful pursuit of the CH53K app transition program and the ongoing recovery in the global aerospace market, AEC is now on track to deliver revenue in 2023, on par with that delivered in 2019, before the impact of the 737 MAX grounding the COVID pandemic, which would be a terrific milestone for the segment. That would put AEC revenue in the ballpark of $450 million for 2023, which would be up over 40% from the $310 million delivered in 2021. The app transition program is expected to be a very significant program for AEC for many years to come. However, the revenue impact in 2022 is expected to be insignificant. In general, on most of its programs, AEC recognizes revenue as it incurs costs. While this will also be true for the app transition program, once AEC begins recurring production, we do not expect it to be the case for the non-recurring phase in 2022. Instead, We anticipate that the work performed on the non-recurring phase of the program in 2022, expected to represent the equivalent of over $30 million of revenue, will be recorded as inventory and will be recognized as amortized revenue over the subsequent years of recurring production. On the ASC LEAP program, we do expect to see a significant rebound in volumes from the LEAP 1B portion of the program, as we get the inventory destocking phase behind us and begin to produce components for that engine variant more in line with Boeing's demand. We also expect the LEAP-1A volume to remain robust as Airbus continues its meaningful ramp up in production volumes. I will note that revenue does not scale linearly on the lease program with volume due to the recovery of our fixed costs from our customer irrespective of the actual volume. As volumes declined in 2020 and 2021, this effect mitigated the impact of the reduced volumes on our revenue. Now, as we return to growth, it will somewhat mute the impact of that volume gain on our revenue line. We do not expect any recovery on the 787 program in 2022. In fact, volumes are likely to be down from the already low levels we saw in 2021, although the impact on the AEC as a result of any further reduction in the program will be modest, given we finished 2021 with less than $10 million in total program revenue for the year. On the F-35 program, this time last year, we told you that finished goods inventory destocking at our customers and reduced depot consumption of spare parts would drive lower revenues on that program. Due to the timing of customer orders and deliveries, those impacts were stretched out and only partially impacted our 2021 F-35 program revenues. which finished down only modestly from 2020. However, that previously expected dip in demand has not gone away and has instead shifted into 2022 when we expect F35 revenues to be down close to 15 million from 2021. Overall, for the engineered composite segment, we are providing initial guidance for net sales of 330 to 350 million. Turning to the engineered composite segment profitability, we finished 2021 largely in line with expectations with full year adjusted EBITDA of 68.4 million or 22% of net sales. As we look forward to 2022, we will continue to see negative mixed effects on our gross margins. The growth on the LEAF program is expected to exceed the total growth of the segment, implying a net reduction of revenue on the higher margin fixed price programs that make up the remainder of our segment revenue. This will lead to a meaningful decline in our full year average gross margin. Beyond the mix effects, we are seeing some impact from cost growth. First, similar to the MC segment, we are seeing inflation impacting all of our input costs. While we are contraction insulated from cost increases on many of our raw materials, That is not true of all the materials we consume, nor is it typically true of labor and logistics. As a result, we'll see inflation-driven increases in both cost of goods sold and SG&A. Second, we expect a return to normal travel. And third, we continue to invest in both R&D and sales and marketing, predominantly to support near-term identified pursuits. While these investments will depress near-term profitability, we believe that the long-term benefits more than justify the expense. Overall, we are providing initial 2022 guidance for engineered composites adjusted EBITDA of $65 to $75 million. At the total company level, we are providing initial 2022 guidance as follows. Revenue of between $920 and $960 million. effective income tax rate of 29 to 31%, depreciation and amortization roughly flat with this year at 75 million, capital expenditures in the range of 75 to 85 million, gap and adjusted earnings per share of between $2.80 and $3.30, and adjusted EBITDA of between 215 and 245 million. I would like to add a few clarifying explanations for some of the company-level guidance items. First, our tax rate guidance is a little higher than where we finished last year. Most of this increase is driven by expected higher withholding taxes as we return cash from certain overseas jurisdictions and the fact that we cannot forecast discrete items, which ended up being positive in 2021. A significant portion of the increase in capital expenditures is in support of the CH53K after transition program. Third, given the uncertainties around when and how many additional shares we might repurchase in the balance of the year, we have not assumed any such activity in our EPS guidance. So our EPS guidance is based on the latest share count of about 31.9 million shares, which includes the impact of only repurchase activity already completed in the first quarter. And fourth, the company-wide adjusted EBITDA implies a higher level of corporate spending compared to guidance in prior years. While some of that expected expense growth is wage inflation due to current labor market conditions, a significant portion of the increase is driven by higher cybersecurity investments. While we do not provide explicit cash flow guidance, we expect free cash flow to be no more than 100 million in 2022 due to the rise in capital expenditures and the significant investment in new programs, most notably the CH53K AF transition program. Returning to the present, we are very pleased with how the company performed in 2021 overall. We are also excited about the long-term positioning of both segments, and look forward to delivering another strong year of performance in 2022. With that, I would like to open the call for questions. Alan?

Thank you, ladies and gentlemen. If you do have any questions, please press 1 then 0 on your touchtone phone. You'll hear an indication you've been placed into queue, and you may remove yourself from that queue by repeating the 1 then 0 command. If you are using a speaker phone, we ask you to please pick up your handset and to make certain that your phone is unmuted before pressing any buttons. Again, for questions, press 1, then 0 at this time. Our first question will come from the line of Steve Tusa with J.P. Morgan. Go ahead, please.

Hi, good morning.

Good morning.

Can you just talk about... what you expect from a, you know, kind of a volume basis for, you know, the 787-related business and the LEAPs just from a unit perspective?

Yeah, maybe just a little bit, Steve, right up front. You know, from where we sit, we're running at very low levels, and we're going to continue to run at a low level. our customers work with us to keep the line running at a rate where we can actually run it. So we're running it about as low as we can to not lose the technical capability that we have in the manufacturing process.

Yeah, we're running at a very low single-digit rate in terms of units per month. We do anticipate that there may be periods during the year where we have to pause production completely, although as Bill has mentioned, We are doing everything we can to level load the plant. So I'm not sure the average is that meaningful if I try and forecast, you know, what's going to happen in the back half of the year. But I would just say very low single digits right now. On LEAP, you know, our customer doesn't like us talking about, you know, revenue dollars and units. So we typically don't disclose the actual number of units we are producing. But, look, generally, you know, what we're seeing from Boeing, which is a rate in that, let's say, 31 per month, and what we're seeing from Airbus, which is more in the 50 rate per month, recognizing that, you know, 60% to 65% of those are equipped with leaps in the balance with Gears HerpaFound. That's roughly the demand level we are expecting that is driving the production volume we expect.

And then anything on the working capital side, you know, on the engine business that you guys – you know, see out there for this year? Anything moving around on that front? You mentioned capital, you know, CapEx, but maybe just talk about working capital.

Yeah, no, look, as we mentioned, we're close to our normal, you know, inventory levels on both LEAP 1A and LEAP 1B. You know, it goes up and down a little bit quarter to quarter. But there's not a lot of additional, you know, contract asset value to unwind in that program this year. We're more or less, you know, where we expect to finish 2022. The big working capital change in 2022 is, quite frankly, is going to be on the CH53KF transition program. As I mentioned, we will be putting, you know, in inventory the equivalent of over $30 million of revenue based on the anticipated, you know, revenue recognition approach on that contract based on the contract structure. So that will be the biggest growth of working capital this year on the AEC side.

Okay, great.

Thanks a lot. Thanks, Steve. Our next question will come from Gautam Khanna with Colin. Go ahead, please.

Hey, guys. Thanks. I was wondering, on the 737 MAX assumption, you mentioned you're sort of aligned with the customer, but at what point do you have to put more inventory back into the system and sort of get ahead of it? I'm just curious how you guys think your shipments will track with – You know, when you look at Safran's forecast, we've talked about 2,000 total lead deliveries in 23, 1,500-ish this year. At what point do you guys run ahead of that, if at all, just given the need to get inventory back into the channel?

Yeah, look, right now we're close to our, you know, desired level of inventory. We're within spitting distance of it. we do not anticipate a need to build significant additional inventory. That could come in future years if both Boeing and Airbus continue to ramp up, but that's not in our current forecast for 2020.

Yeah, I would say we're sort of more at a normal level of inventory and stock, just as a buffer, and we'll always carry some inventory as a buffer in the channel. We don't see anything changing dramatically over this year.

Okay, and just to be clear on the guidance, at AUC you're not assuming any cum catch-ups, is that right? Favorable profit adjustments.

Yeah, you know, I understood the reference, Colin. No, we're not anticipating any significant, you know, there's a normal level of cost savings that would be built through all of our planning assumptions, but in terms of the outsized you know, out of period profit increases, no, there are no material ones assumed in 2022.

Okay. And then the last one for me, just on F-35, you know, at one point you guys thought it'd be a $20 million headwind, or 20, maybe it was a 20 shift headwind, I can't remember, but what is the impact this year, and then what do you, if you could quantify the dollar value, and then what do you think What happens in 23? Do we recover all of that?

So in 2021, we were down slightly from 2020. I think we put out a number externally on F-35 of about $85 million in 2020. down slightly in 2021, and now we see this $15 million reduction. We believe that the primary driver of the $15 million is inventory destocking, both at the OEM level and also at the depot sustainment level. And so we would expect that largely to be one time as these stocks that we would then start to replenish. But we don't have clear insight yet into our customer's order level for 2023. But we would certainly expect a rebound from 2022. Assuming this reduction does materialize in 2022 as we expect.

Sure. Okay. Thank you.

Thanks, Scott. Thanks. Next, we'll go to the line of Ron Epstein with Bank of America.

Hey, Jack. Good morning. I just want to follow up on your commentary on the frames for 787. What are you seeing there, and where do you expect those rates to go as we go through the year into next year?

Yeah, it's a hard question. Question to answer, Ron. We're kind of taking a period, let's call it six months at a time here. Our outlook for this year is really just to run at a low rate, working with our customers in the channel and producing at a rate where we can keep the technology going. But as Stephen pointed out, running at single digits is kind of how we expect the year to go. We're hoping it gets going after that next year, but it would be hard for us to opine on what that looks like.

Look, and, Ron, to give you an idea, you know, in fact, if you go back before the decline when, you know, Boeing was producing more than 13 units a month range, our revenue was north of $50 million. As we mentioned, our revenue was less than $10 million. in 2021, and we expect it to be flat to down in 2022. To give you an idea, you know, we're less than a fifth of the revenue, so you could, you know, since it's a fixed price program, you could, you know, just do the math and get rough indications that we're somewhere in that two to three ship sets on average per month.

Gotcha, gotcha, gotcha. And then, you know, changing gears here on the machine clothing side, As the economy continues to recover and, you know, people get out and, you know, start living their lives again and maybe in a more normal fashion, do you have any sense in what that's going to do to that business? Are you expecting any, you know, outward pressure, upward pressure? I mean, just, you know, at a very high level, how are you thinking about that?

Yeah, it's an interesting question. There's a mix that we think is going to take place. The away-from-home business that has suffered over the last couple of years will probably come back some more. And then we've already seen, and if you look at the industry, tissue, for instance, had kind of a flat to down year in 21 because it was such a high growth year in 20 with everybody running off to the grocery store to buy extra tissue. That will come back in line. So I think it will come off the sort of the slowness of 21. So going forward, things look pretty good. One area we're cautious on is just has there been some inventory built up. But I think globally the demand looks pretty solid going forward. Got it, got it, got it.

And then maybe just one last one if I can. Your input costs on the aerospace side, does that pass through to your customers or how does that work on your raw materials?

Yeah, look, it really varies, Ron. There are certain programs, obviously in a program like LEAP, since it's more of a cost-type program, it's a pass-through. There are other contracts where we're buying the raw materials under an enabled contract negotiated by our customer, and therefore that price is a pass-through. But to be clear, on those sorts of contracts, there are still a lot of raw materials, non-end items, raw materials that aren't the resin or fiber that are in the finished product, but that are used in the production of the product, whether that be vacuum bags or gloves or release agents and the like. We typically do not have coverage for those. And we do not have coverage even for you know, fiber and resin on 100% of our use of such materials, but we do it on a lot. And obviously labor, other than on the LEAP contract where it's cost-type labor, inflation is not typically a pass-through either. So it's a mixed bag. The resin and fiber, largely protected. Other input costs, not protected, other than on LEAP.

Got it.

Great. Thank you, guys. Thanks, Rob. And if there are any additional questions, please take this opportunity now to press 1, then 0 on your touchstone phone. We'll go to the line of Pete Skibitsky with Alembic Capital. Pardon me, Alembic Global. Go ahead, please.

Hey, good morning, everyone. Morning, Pete. Steven, I'm trying to just think through, you know, kind of where, I guess, EBITDA margin could go at AEC. You guys used to talk about that a little bit, but You know, from the standpoint of LEAP likely to be your kind of most meaningful growth program through the midterm cost plus program, I know there's some, you know, niche-y type of contract terms on that. But how do we think about where marginally could go at AEC given the positive outlook for LEAP?

Yeah, look, we're seeing great growth in LEAP over, let's say, you know, the next 12 to 24 months as the narrow body recovers. And during that timeframe, it will put some downward pressure on those margins. However, you know, during the back half of that, you know, 12 to 24 months and certainly beyond that 24 months, We expect to see a lot of growth on fixed price programs. CH53K, particularly now with the addition of the app transition content. F35, you know, we do, you know, while it's not within this calendar year and, you know, depending on how Boeing does, maybe not even within next calendar year, we do expect to see a rebound on the 787 program. We still think that's a fantastic aircraft. We're still very happy to be on that platform. So as those rebound, those will offset some of the dilutive impact we're seeing of the growth and leap over the next 12 to 24 months. So I think you're seeing a bit of a dip in margins, particularly this year, but I do expect to see those margins start to increase again. you know, beyond this year and maybe, you know, into the middle half of next year as LEAP continues to grow itself. So I think we'll start to, you know, get back. Our goal has always been, you know, north of 20% margins in that business. Clearly, you know, we peaked well north of that in 2019 and 2020. And, you know, our goal is to, you know, gradually get back to those, you know, more sustained levels, well above 20%. But in the very short term, the lead growth is just too much of a challenge.

Right. Okay. Okay. And then just given, you know, the relationship you have with Lockheed Sikorsky right now with the CH-53K, do you have a similar relationship with them on the Army, you know, new programs, FLARA and FARA? And do you guys view those as big opportunities? And any call you could provide there would be great.

Yeah, it's certainly something we're interested in, Pete, and the relationship with Sikorsky is so important to us, so we're going to keep working on it. We're very interested in those programs going forward. And, you know, as we talk about with advanced composites, one of the great benefits is we can bring 3D woven composites into the actual design up front. Then we can really maximize the benefits we get from the material advantages. So Yeah, we're pretty excited about our relationship with Sikorsky longer term.

Great. Thanks, guys. Thanks. Peace. One moment for our next question. That will come from the line of Michael Charmoli with Tourist Securities. Go ahead, please.

Hey, good morning, guys. Thanks for taking my questions here, and thanks for all of the detail here on 22. But not to blow right past 22, I think you said AEC revenues can get back to $450 million in 23. That implies a very healthy 32% growth rate at the midpoint of this year's guidance. And I'm just wondering, you know, with unknowns around, you know, the 787 and wide bodies in general and, you know, just even where narrow body production is going to go. going to go from here, you know, what gives you that confidence to get back to that 450? Presumably the 19, you know, you guys were overbuilding to catch up to the engine manufacturers to support the rate. So I'm just trying to, you know, figure out what kind of line of sight you have into that growth rate into 23.

Look, there's always some uncertainty, Mike. You know, we're not at stage for providing, you know, formal guidance for 2023 yet. And, you know, we'll see where we sit 12 months from now. But certainly on a risk-adjusted basis, we see good line of sight to the 450. You have to realize, you know, if you're reckoning back to 2019, you know, clearly we were building at very high rates on the engine side in 2019. As we look at 2023, we see a lot of new business that we did not have in 2019. Not only the app transition, but other programs on which we have been successful or expect to be successful in the coming months. So I think that I would say we have, you know, Better than average line of sight, but there's obviously no certainty looking out 12 to 24 months in this sort of market. We are making projections on what we think will happen on 737, on 787, on other programs. And I'd say we have built in some amount of risk in those programs, but there could always be downsides to that outlook at this stage.

Are there certain, you know, program milestones we should track. I mean, clearly you're assuming narrow body rates get to some monthly level. I don't know if we need to see, you know, the GE9X, you know, really start to ramp up, you know, and you mentioned the new programs. I mean, you know, anything else, you know, I mean, if, you know, if we see – Max rates, you know, get to 42 and hold 42 into next year, you know, for example. Is that enough to get to $450 million?

Yeah, we're certainly not expecting rates. on any program above what the Prime's published rates have. And in some cases, we have factored that somewhat, certainly on a program like GE9X, while we expect that to be a great program in the future, that's not a near-term revenue driver, so that's not a material portion of our even 2023 outlook at this stage. So we're not making any heroic assumptions. on ways to get to that.

No, it's a pretty conservative build-up, program by program, number of aircraft by number of aircraft, looking at things like the growth in the CH-53K, even for the existing work that we already do today.

Got it. Got it. That's helpful. And I think I'm pretty clear on this. The AEC margin pressure in 22, you know, you're getting some good top-line growth. You're getting that EBITDA margin compression. sounds really like it's just overall mix with more of your cost plus work ramping up. And then is there significant – you called out the CH53KF program and $30 million of non-recurring, but I'm assuming that's going to be, you know, sort of dilutive and even more of a margin headwind as you ramp that up in the beginning of the year here in 2022?

Yeah, now we won't be recognizing any revenue or profit on that here in 2022. I think the real way to think about the mix is take F-35. We said it's down $15 million, and that's a fixed-price program. We have said before that typically fixed-price programs have a higher average gross margin than LEAP. which is growing. But that's at the average level. The way to think about the decremental margins on fixed-price programs, obviously, not only is it delivering the average margin, but it's absorbing some fixed costs, which it no longer does. So the decremental gross margins, we've talked before that it's not unusual on fixed-price programs for there to be decremental or incremental gross margins in 30%, 40% range. after you factor in the fixed cost absorption of the programs. So losing that 15 million of revenue, there's a significant loss of EBITDA that goes with it. On the flip side, as LEAP grows, because of the fact that LEAP recovers all of its fixed costs irrespective of the volume, the incremental gross margin on LEAP is effectively equal to the average gross margin on LEAP. We don't get those economies, those benefits from additional volume. And so you're adding revenue at a somewhat lower average gross margin, but losing revenue at a far higher decremental gross margin on the fixed price programs. And that's what's driving the lack of EBITDA growth on the increased revenue.

Yep, perfect. Makes sense, guys. Appreciate the caller. Thanks a lot.

Thanks, Mike.

And with no further questions in queue, I'll turn the conference back to Bill Higgins.

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, please feel free to reach out to John Hobbs, our Director of Investor Relations. His phone number is 630-330-5897. Thank you, and have a good day.

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