Albany International Corp. (AIN) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Albany International First Quarter 2020 Earnings Call. [Operator Instructions] And as a reminder, your conference is being recorded. I would now like to turn the conference over to your host, John Hobbs, Director of Investor Relations. Please go ahead.

Thank you, Lois, and good morning, everyone. As a reminder, for those listening on the call, please refer to our detailed press release issued last night regarding our quarterly financial results with particular reference to the notice contained in the text of the release about our forward-looking statements and the use of certain non-GAAP financial measures and associated reconciliation to GAAP. For the purposes of this conference call, those same statements apply to our verbal remarks this morning, where we will make statements that are forward-looking and 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 that earnings release as well as our SEC filings, including our 10-K. And now I'll turn the call over to Bill Higgins, President and Chief Executive Officer of Albany International, who will provide opening remarks. Bill?

Thank you, John. Good morning. Welcome, everyone. Thank you for joining our first quarter earnings call. First, I'd like to start by thanking our employees around the world. To all of them, I send my sincere gratitude for their individual and collective efforts. I'm humbled by their commitment to making our facilities safe, helping each other, and despite all the stress around us, doing a great job for our customers. These are unprecedented times, and I couldn't be more proud of our employees. Now let me make a few comments on the pandemic and our approach to navigating these uncharted waters. After my remarks, Stephen will discuss the details of our Q1 performance. The rapidity and breadth of the impact of the coronavirus is historic. In less than a couple of months, we've witnessed COVID-19 spread globally and the most severe aviation slowdown in history. This time is different. So we need to constantly assess our end markets and adjust our operations based on the best information we have. We have experienced leadership and the operational capability we needed to serve our customers as things change. And I'm happy with our demonstrated ability to do just that over the past couple of months. So how are we navigating these uncharted waters? First, we are working tirelessly to ensure the safety, health and well-being of our employees. Right from the start, in January, the leadership of our Machine Clothing business alerted us to what was happening in and around our plants in China. We took immediate action to put safeguards in place for our employees there. And communicated how we should prepare for other facilities around the world for the approaching pandemic. As a company, we opened lines of communication across both segments and put an organized process in place to manage communications and to accelerate decision-making. We formed a task force at the corporate level that is cross-functional and cross-business. The COVID-19 task force is charged with a responsibility for finding and recommending best practices that we deploy company-wide to safeguard our employees. The task force communicates with managers and employees on the front lines as well as experts outside and prepares communication and training materials. Senior leadership meets with the task force on a regular basis, every few days in the beginning, to review what is happening on the ground, plant by plant around the world. We expedite decision-making so we can quickly adapt our facilities and modify work procedures to keep people safe. We also update our Board of Directors on a regular basis with information flowing from our COVID-19 task force briefings. The changes we have made collectively in such a short time are profound, and we continue to take these improvements to a new level. Any employee that can work remotely is working from home, which has worked well, with great support from our IT teams. Our plants have adopted a host of new operating procedures so we can run them as safely as possible. In addition to social distancing, extra cleaning, wearing masks, taking employees temperatures at the gates, we've adjusted work shifts, changed how we run meetings in cafeterias and how lock rooms are used. We've segmented plants into zones, what I call zone defense. Each zone has dedicated entry and exit points, restrooms, cleaning stations and hand wash stations. Employees work within a specific zone and feel safe for knowing that people aren't crossing zones. And that we've added another layer of protection by limiting and tracking travel within facilities. In one case, where we had an employee who tested-positive, who had been at work, we managed it according to our plan. We worked with the appropriate health authorities, sent all the employees from that zone home with the recommended period of self-isolation, deep-cleaned the facilities and all were back to work after the self-isolation period. It didn't disrupt the rest of the facility. And our employees knew exactly how it would work because of the communication and planning beforehand. Now let me make a few comments about our approach to managing in such a fast-changing marketplace. We don't have clear visibility beyond the near term. So we are preparing to respond to business conditions as they evolve. We anticipate that our end markets may be affected differently and at different times over coming months and quarters. Therefore, our intention is to adjust our operations to meet new levels of demand, to build on our strengths for the long term and to manage risks looking forward. In Engineered Composites, for example, when the Boeing 737 MAX was delayed last year, we worked closely with our customer and partner, Safran, to adjust our workforce and operations accordingly. We had already planned for low levels of manufacturing of LEAP-1B products in 2020 and had reduced our workforce in early January. With the accelerated spread of the coronavirus and a hit to commercial aviation in Q1, we continue to rework our lead production plan in close coordination with Safran, taking into account lower production levels for LEAP-1A as well. We jointly agreed to temporarily close our three Albany Safran Composite manufacturing sites in New Hampshire, Mexico and France and furlough most employees. We currently expect these plants to reopen at different times depending on the latest production plan, which will likely continue to evolve. The takeaway here is that we continue to work in close coordination with Safran and all of our customers to modify our production plans and operations accordingly. In general, we believe narrow-body production will resume over time and is a great place to be with our partner, Safran, in the LEAP engines. Our 3-D woven advanced composite material is a next-generation technology, poised for growth in the long run. In the larger AEC business, about 1/3 of this segment serves the military defense industry. And we're on solid platforms, including the Joint Strike Fighter, Sikorsky CH-53K helicopter and Lockheed Martin's JASSM missile program. In the Machine Clothing segment, we have a seasoned leadership team that has demonstrated it can be successful at managing within a tough marketplace. For the last 15 years, we've adjusted our capacity and global footprint as the end market for publication and writing grades in favor have declined. We've established a global footprint with a strong regional presence that serves our customers locally and focuses on higher value-added opportunities. We've continued to be at the leading edge of technology in the industry and support our customers with new and improved products and services. MC's excellent financial results in Q1, particularly the strong gross margins of 53%, despite the coronavirus disruptions, reinforced this point. Currently, demand for toilet paper, tissue, paper towels, packaging and pulp has outstripped supply, creating immediate demand for our customers and paper companies who serve these product markets. Orders for PMC belts are stronger than we expected, and all our MC plants are open and operating around the world to support this demand. We're watching these markets carefully, though, as we expect the demand may fluctuate as supply catches up. We expect the decline of publication grades to continue with everyone working from home and schools and offices are closed and because of the accelerated shift to digital communications. As we've noted in the past, this portion of our business has already shrunk to under 20% of our MC segment's revenues. In short, I have confidence in the leadership we have across the company. We've demonstrated that we can work together to communicate, to plan, to execute well and to adjust as our market shift. This is not to say managing will be easy or predictable, far from it, that we have great experience in place that has demonstrated our ability to tackle tough challenges and deliver great results. As I hand off the call to Stephen, let me point out that our first quarter results were solid, with expanding gross margins, both year-over-year and sequentially quarter-over-quarter. We have a strong balance sheet, good liquidity and exited Q1 with record gross margin in MC of 53% and adjusted EBITDA margins of 22% in AEC. Stephen?

Thank you, Bill, and good morning, everyone. I will talk first about the results for the quarter, and then about our current outlook for our business in 2020. For the first quarter, total company net sales were $235.8 million, a decrease of 6.2% compared to the $251.4 million delivered in the same quarter last year. Adjusting for currency translation effects, net sales shrank by 5.4% year-over-year in the quarter. In Machine Clothing, also adjusting for currency translation effects, net sales shrank by 4.3%, caused by declines in pulp, publication and tissue grades, partially offset by growth in packaging grades and in engineered fabrics. Engineered Composites net sales, again, after adjusting for currency translation effects, shrank by 6.8%, primarily caused by significant declines in LEAP program revenue, partially offset by growth on the F-35 and CH-53K platforms and the acquisition of CirComp. First quarter gross profit for the company was $89.5 million, a reduction of 2.5% over the comparable period last year. The overall gross margin increased by 140 basis points from 36.5% to 37.9% of net sales. Within the MC segment, gross margin improved from 51.6% to 53.2% of net sales, principally due to the reduced depreciation expense. Within AEC, the gross margin improved from 16.1% to 17% of net sales, driven primarily by mix benefits and a little under $1 million in net favorable change in the estimated profitability of long-term contracts. First quarter selling, technical, general and research expenses declined from $51.2 million in the prior year quarter to $49.1 million in the current quarter, but increased slightly as a percentage of net sales from 20.4% to 20.9%. The reduction in the amount of expense was driven primarily by the revaluation of nonfunctional currency assets and liabilities, which resulted in reduced expense of $3.7 million in Q1 2020 compared to a negligible effect in the same period last year, and by just under $1 million in lower R&D expenses in the most recent quarter. These reductions were partially offset by $2.7 million in CEO severance costs and by $1.5 million in additional reserves recognized under ASC 326 or CECL, the new accounting standard for credit reserves that the company adopted on January 1, 2020. Total operating income for the company was $39.6 million, down from $40.1 million in the prior year quarter. Machine Clothing operating income increased by $2.9 million, driven by lower STG&R expense, partially offset by lower gross profit, while AEC operating income fell by $1.9 million caused by lower gross profit and higher STG&R expense. Q1 2020 other income and expense was an expense of $15.6 million compared to income of $1.2 million in the same period last year. The increase in the expense was primarily due to the revaluation of nonfunctional currency balances, which had resulted in a gain of $2 million in Q1 of last year, but a net loss of $14.8 million in Q1 2020. This loss principally resulted from the effects of a much weaker peso on an intercompany loan payable in U.S. dollars by a Mexican subsidiary. The income tax rate for the quarter was 62.1% compared to 20.3% in the same period last year. The higher rate in 2020 was primarily caused by a 24.8% impact from the nondeductibility of the foreign currency revaluation loss I just described, which occurred in a tax jurisdiction where we are not recording the potential benefit of loss carryforwards and a year-over-year change in other discrete tax items. Other discrete tax items increased income tax expense by $1.5 million in Q1 2020 compared to a reduction in expense of $3.4 million in Q1 2019. Absent the impact of the foreign currency revaluation and the other discrete items, the tax rate in the most recent quarter was roughly 30%. Net income attributable to the company for the quarter was $9.1 million, a reduction of 68.8% from $29.2 million last year. The reduction was driven by the higher other expense and the higher tax rate. Earnings per share was $0.28 in this quarter compared to $0.90 last quarter - last year. After adjusting for the impact of foreign currency revaluation gains and losses, the former CEO severance costs, restructuring expenses and expenses associated with the CirComp integration, adjusted earnings per share was $0.78 this quarter compared to $0.87 in the comparable period last year. Adjusted EBITDA grew 2.6% from last year to $59.1 million for the most recent quarter. Machine Clothing adjusted EBITDA was $49.2 million or 36% of net sales this year, down from $50.5 million or 35% of net sales in the prior year quarter. AEC adjusted EBITDA grew from $20.5 million or 19.1% of net sales last year to $22.1 million or 22.3% of net sales this quarter. Turning to our debt position. Total debt, which consists of amounts reported on our balance sheet as long-term debt or current maturities of long-term debt grew from $424 million at the end of Q4 2019 to $491 million at the end of Q1 '20, and cash increased by about $27 million during the quarter, resulting in an increase in net debt of about $40 million. Under the definition of leverage ratio used in our credit agreement, which limits us to $65 million of cash netting against gross debt, we finished the quarter with a leverage ratio of 1.69. While disregarding the limitation on cash netting, results in an absolute leverage ratio of 1.09. The increase in total debt during the quarter was principally caused by the previously disclosed $50 million drawdown on our credit facility. The increase in net debt was principally caused by normal seasonal variation in cash generation, where Q1 has traditionally been a low point in the year, the impact of foreign exchange rates on the value of our cash and cash equivalents, and the completion of the facility purchase associated with the CirComp acquisition. Capital expenditures in Q1 2020 were about $13 million, down from almost $21 million in the same period last year, due principally to a reduction of capital expenditures on the LEAP program. Overall, as Bill indicated, given the ongoing impact on the global economy and our markets, in particular, of the coronavirus pandemic, we were pleased with the performance of the business last quarter. Looking forward to the balance of 2020. As previously disclosed in our April 6 press release, we have withdrawn our previously issued financial guidance. We will not be replacing that withdrawn guidance at this time. There is simply too much uncertainty in our end markets to provide reliable guidance for the full year. However, we do want to provide as much insight and color as we can. In the Machine Clothing segment, notwithstanding the decline in revenue from Q1 of 2019, orders were strong and were up over 3% from the same period last year, with particular strength in packaging and tissue grades and in engineered fabrics. We do continue to see declines in publication grades, which represented about 19% of our MC revenues in the most recent quarter. Our order book over the trailing 4 quarters for publication grades at the end of Q1 2020 was down close to 15%, compared to the equivalent period last year. It would not be surprising to see that trend in publication grades continue or even accelerate throughout the balance of this year. While the overall strong MC order book bodes well for the second quarter, which we expect to be up sequentially from the first quarter in the segment, but down year-over-year, we are cautious about the balance of the year. As we have discussed previously, the volume of our PMC sales is tied to the volume of sales of pulp and paper products, which is, in turn, generally correlated with overall economic activity. The current compression in global GDP is likely to manifest itself in the PMC market later this year and into 2021. All of our Machine Clothing facilities are currently operational. As we discussed on our last earnings call, our 2 Chinese facilities did see a few weeks of disruption, which impacted our Q1 results modestly, but those plants are now back online. We have not seen any other material disruptions to MC operations. Turning to Engineered Composites, where the second quarter and likely the third quarter will be challenging. We recently announced the temporary closure of all 3 of our LEAP production facilities, in New Hampshire, Mexico and France, resulting from depressed demand due to the ongoing 737 MAX situation and a decrease in production of the Airbus A320neo family. The resumption of operations at these facilities will be undertaken in coordination with Safran and in compliance with all local, state and provincial and national guidelines or directives. However, we do expect that these closures will continue through much of Q2 and in some cases, well into Q3. As a result, the year-over-year comparisons for LEAP revenue in Q2 and likely Q3 will be very unfavorable. While we do expect to see some recovery in the later part of the year, our overall expectations for LEAP for the full year are that it will generate under half of the $210 million in revenue we generated from that program in 2019. However, as I pointed out before, the cost-plus nature of our LEAP contract will partially mitigate some of the profit impact of such a sizable drop in revenues. While there have been some other non-LEAP challenges in the Engineered Composites segment, such as a decline in demand for our relatively small wastewater tanks program that supports most Boeing commercial aircraft, and a pandemic-related, government-mandated shutdown of our other small non-LEAP composites manufacturing facility in Mexico, we have been very pleased with the performance of much of the segment. Looking forward, we will also likely see an impact from Boeing's recently announced reduction in the build rate for the 787 program. We do not yet know the full impact of that change on our build rate, particularly since our content is focused, primarily on only 2 of the 3 variants of the aircraft. However, any impact is likely to be seen in Q3 and Q4 and into 2021. Overall, it will be a challenging year for top line performance in the AEC segment. As Bill indicated, we are taking actions such as a reduction in capital expenditures and certain cost reduction measures to help drive the continued profitability and cash flow generation potential of the segment. Turning to the company level. Our current capital allocation priorities are largely focused on cash accumulation to ensure that we have a significant buffer relative to any expected requirements. We previously guided capital expenditures for the year of $75 million to $85 million. We now expect to spend $55 million to $65 million this year. We are also carefully monitoring working capital needs and usage. Notwithstanding the challenge that certain of our businesses face, we do, as a result of the ongoing strong performance in several areas and the continued focus on cash, still expect to generate significant free cash flow this year. The recent drawdown on our credit facility was not due to any expected near-term need for those funds, rather we drew down that cash out from the abundance of caution and to help ensure that should we have an unexpected need for the cash, we had it available immediately. Additionally, we do not have any current plans for deploying cash for any M&A activities. I would like to highlight that with significant cash in hand, almost $225 million at the end of Q1 and an undrawn balance of almost $200 million on our credit facility, we have sufficient liquidity, and our balance sheet remains strong. With that, I would like to open the call for questions. Lois?

[Operator Instructions] And our first question is from the line of Peter Arment from Baird. Please go ahead.

Thanks for all the details on the quarter and nice results. I guess, just to start with AEC, because the top line was better than we anticipated. When did you actually officially close down the three LEAP facilities and how that kind of impacted? Or did it not impact the first quarter top line results?

It's been a couple of weeks now since we closed the 3 facilities. We had worked prior to that beginning in January to reduce the workloads we had. So it was kind of an ongoing discussion and then the close down.

The first closures, Peter, hit at the tail end of March, so there being a slight impact in Q1, but the full closures were solidified here in the month of April, but there was a slight impact at the tail end of Q1.

So that - just that's what I was looking for because, obviously, you kind of alluded to that even at Q2 and probably Q3 is when we're going to feel the brunt of these shutdowns on the top line.

Yes, we would expect to see a significant sequential decline in AEC revenue from Q1 to Q2.

Okay. And then if I could just ask quickly on the MC. So that's helpful. You've always talked about volume growth of paper being a good correlation to MC belt. So a pickup in Q2 from a sequential basis. Any aspect of why you think the second half is going to be weaker? Or is it just - you don't have the visibility and you're just cautious based on the kind of economic activity that we're currently seeing in the lockdown?

I think it's a mode of caution, but there is a general, I think, question out there if the demand right now - plants are running full out. There's probably less stoppage right now for full-scale, large maintenance programs. There's ongoing maintenance. And sometimes when there's - those regularly planned large maintenance downtimes, we might see more consumption of belts. But I think in general, it's driven by the economic demands in the different end markets and how we see supply catching up with demand as the channels get filled.

As I think we've discussed before, Peter, we don't carry a huge backlog in Machine Clothing, typically. Right now, we certainly have some backlog but the bulk of the backlog is for delivery in Q2. And so we have good insight into Q2 to a first order approximation. But right now, not a lot of insight into Q3 and almost none into Q4 in terms of what the order flow will look like. So part of it is, to your point, we just don't know yet, but we are certainly concerned given the level of economic activity that we could see not only the big declines we're seeing right now in publication, but that the burst of tissue activity could cool down in the back half of the year and publication - or sorry, packaging grades could decline in line with the economic activity broadly.

Understood. And just lastly, Bill, have you guys had any supply chain disruptions? I know that there's - it's early on in this kind of lockdown. But have you seen that across any of your businesses that's impacted you so far?

We really haven't - we've seen a couple of minor things that we worked around and our supply team, early on, did a great job of bringing extra supply in. So we have probably a larger-than-normal inventories of raw materials. And our supply, as you know, it's not so complicated and it depends on a few raw materials that we've been able to deal with pretty well.

And our next question is from the line of Caitlin Dullanty from Bank of America. Please go ahead.

As you mentioned, defense is clearly a bright spot and as customer demand is relatively insulated for macroeconomic pressures there. Can you discuss any opportunities you guys are seeing to potentially expand your position in defense?

That - I think it's a little too early to say right now on defense. We have some good programs, and we're working them. If we can do a great job with our customers, we can possibly expand our work with them. But we're watching the defense right now, and we're relatively new to these programs, the CH-53K, for example, we've been ramping that up. So we're happy with how that's gone, and we'd love to do more work on it. But we'll just have to wait and see.

Okay. Fair enough. And then just one quick question on gross margins at MC. You guys mentioned that the expansion was mainly driven by lower depreciation. So I'm just wondering how do you think we should think about gross margins there going forward? And is this level sustainable, maybe not much expansion left, but just trying to help us understand the profit - profitability profile there?

As Bill mentioned, gross margins are really close to an all-time high in this business, and we're very pleased with the margins. Underlying it, while year-over-year, as we discussed, one of the significant changes was depreciation. We still are benefiting from a good mix of business within Machine Clothing. That's the first point. Second point is the gross margin is sensitive to the volume of sales in that business. So we are concerned if sales were to decline materially in the back half of the year that, that could certainly put pressure on gross margin. We obviously, as Bill mentioned, have a fantastic team in place who are used to managing through ups and downs and have done so for the past 15 years as that market has gone through significant changes. So we've confidence in their ability to maintain good gross margins. But I certainly wouldn't - if I was looking forward, expect them to remain in the 53% on a go-forward basis. That certainly seems higher than is realistic on a go-forward basis. But I believe we will maintain them at a historically strong level.

[Operator Instructions] And we'll go to Gautam Khanna from Cowen. Please go ahead.

I had a couple of questions. First, can you talk about the mechanism by which you'll get reimbursed for the lower weak volume? Just, it's a cost-plus contract. Is it just made up on volumes once you restart production that you'll get a higher unit cost? Or is there some relief you get in the intervening period when the 3 facilities are closed. Just how does that work mechanically?

Yes. Good question, Gautam. So 2 things we need to separate here, revenue from cash collection because they are quite different on this program. Under ASC 606, the revenue recognition standard, we are required to recognize revenue on a percent complete basis on this program. So as we incur costs, we recognize revenue on those costs equal to the cost we incur, plus the expected overall profit level for the year. We deal with each year as a separate accounting period for the purposes of the LEAP contract. So how - so revenue, to the extent we have costs, which are ongoing during the shutdown period, whether they be fixed costs related to the plants themselves or as some of those employees who are remaining at work, as we mentioned, we furloughed the bulk of our employees, but there are still some working in critical roles. While we are incurring costs on those folks during the shutdown period, we will still be recognizing revenue in those costs. We will, obviously, every quarter, look at our expected revenue for the full year and our cost for the full year to make sure we're applying the right profit rate on top of those costs that we are incurring for the purpose of revenue recognition. So that's how revenue works. It is spread with our costs over the year. Cash is a little different. In general, I'll talk generally how this works. At the start of the year, we will work with our customer, Safran, to identify the expected demand for the year from Safran. And to - and then we will look at what our expected costs are for the year to produce the demand that Safran has identified. We will then calculate the expected unit price based on that demand level and our expected costs. We will add the appropriate profit on top of that as allowed for the contract. And then as we ship each unit, we will bill Safran that amount, and that happens throughout the year. At the end of the year, we will - we go back and look at what was the actual volume we supplied during the year to Safran, what were our actual costs and to the extent our actual costs were above or below what we collected during the year, based on the actual volume, there's a true-up at the end of the year, where either we invoice Safran for additional amount or we write a check to Safran if we've collected more than our total costs based on the expected price at the start of the year. So cash is a little different from revenue. And as you go through a period where volumes drop unexpectedly, if there is no adjustment in the unit price that we are charging Safran for each unit as we deliver, we will be building in effect, if you want to think about it, an unbilled receivable recognizing that we collected as part of the true-up at the end of the year. So on that portion of our business, our cash flow conversion would not be great until you get to the end of the year and collect that through a payment.

That's actually a very helpful explanation. Is there - when you went about shutting the 3 facilities down for a period of time, is there a time frame by which if you do not bring it back up online, you end up losing effectively the learning curve you've already developed with that staff working on that equipment? So is it like we can't go longer than 6 weeks or else? The re-ramp becomes much more challenging. How did you kind of think about the maximum duration of the facility closure?

Yes, Gautam, that - that's a really good question. And that is part of our discussions. And as we bring facilities back up, it also varies by individual product, and we're looking at each production process, the technology behind it. We've done a great job developing those processes and the technology, and we don't want to lose it. So part of the strategy looking forward is deciding what's an optimum, but a minimum production rate that we can format and still continue, not only to keep the technology, but to improve the production process and the technology and cost and efficiency of the process. So we're - we're fully cognizant of that as we work through discussions with Safran. And jointly, we want to continue to improve the technology. As of - at the end of last year, we were on a great run, improving the throughput, the yield, the quality and reducing costs of the material. And we believe that's important to the future and growing the 3-D woven composites, spreading it across other products. So it's important to us that we maintain that technical capability.

But I guess you haven't yet defined what that time frame is? Like...

I think that - we have defined when we expect each of the facilities to come back up and each of the product lines over certain periods of time. And some of them may - we may bring them back up earlier and then have a period where there's kind of a low period so that we continue to run the line. So we don't have particularly a drop-dead date, but we do - we are planning so we maintain the technology and the process capability. And also, as we go forward into the future, the ability to ramp back up.

Okay. And then 2 others, please, if you wouldn't mind. When it comes down to - so Airbus has given us an A320 rate, so we can discern 18 production rate and Boeing made comments yesterday. So - on the MAX ramp. At what point do you guys actually expect to be back to - it looks like you're going to - I'm just curious, when will you actually see year-over-year growth in production? I mean this year, obviously, you have a shutdown for some period of time. But when you get back to some level of production, will it be a fairly low level that stays flat for a year or 2 off of a low rate? And if that's the case, do you then ratchet back up that price per unit way above what we were experiencing last year because the units were much higher? And then separately, at the Salt Lake facility, can you remind us of your 787 content? Because obviously, that rate looks like it's headed to drop by 50%. And if you could just help us frame what the revenue content on each 87 is.

Sure. So let me start with the LEAP program and then we'll come to Salt Lake and 787 frames program, and Stephen can chime in here with detail. The - obviously, I wish I knew exactly what the demand was going to look like going out through next year and into the future. And when we'll get to a production rate that is where we left off at and where we - grow from there. We're watching what Boeing and Airbus and Safran are saying in their releases and the numbers, and we're going to work all that into our plans as we go forward. So we expect this year, as we've communicated, is a relatively low year for the LEAP program with some growth into next year. And we'll adjust the plans as we go forward and recommunicate what those are when we know more clearly what they are. So yes. And as we go to these lower volumes, obviously, our price per unit cost goes up significantly. We were running at a good pace, as I said, at the end of last year, and the price per unit had come down significantly as we achieved our goals in operations and improving the process and efficiency. So yes, so there will be higher price per unit as were these lower volumes, there's less absorption of overhead and more cost in general. So we'll work through that. And it's a great program longer term. So we're glad we're on the narrow-body aircraft with Safran as a partner, and we will see that growth again, but I can't tell you exactly when it will be. Stephen, I don't know if you want to add any comment on the LEAP program?

No. I think you've said it correctly. We do not yet have insight. And the challenge in answering your question, Gautam, we do not have insight into what Boeing slope will look like when it gets back into production. They have obviously put a rate out there that they would like to build at. There's still uncertainty over when, obviously, our plane reenters. But also the rate at which they slope up, that ramp once they start, so it's a little difficult to answer your question right now. I'm hoping that a quarter from now, we'll have more insight into where Boeing is, and we'll be better able to answer your question. But we can't answer the LEAP portion today. And I didn't know, Bill, if you wanted to go back to the 787 question or if you'd like me to take it?

Yes. I was just going to add commentary that, as Stephen pointed out in opening remarks, the - we're on two of the three variants. We've watched the news from Boeing on the 787 numbers, and we'll work to discern what they mean for us as we adjust production. They're actually a little better than we expected, I think. But I don't know, Stephen, if you want to add to that on the 787?

Yes. The only thing I'll add, Gautam, I'm not sure we've ever publicly disclosed the shipset value for 787, but it's in the few hundred thousand dollars per shipset.

Our next question is from Pete Skibitski from Alembic Global. Please go ahead.

Just a couple of quick questions. Can you remind us - I know your exposure to business aviation is fairly small. But could you remind us what that is and kind of what you're seeing there? We've seen pretty uneven results from the OEMs.

Yes. It's fairly small. Stephen...

Yes, sorry, our primary exposure would be really on some Rolls-Royce programs that we perform in our Boerne, Texas facility, where we support a variety of engines that support Gulfstream and other business jets, but small in terms of our impact on our overall revenue, very small. Even within AEC, I think, it would be low single-digit percentages of our overall revenue.

Okay, great. And on the 777X, are you seeing any real kind of changes to your workflows there? It seems like that's largely on track to maybe deliver late next year. I'm just wondering if that seems kind of a business-as-usual on that program.

Yes. We're still working through that. We haven't, I guess, put in any big changes yet. But I don't know, Stephen, if you want to add any color to that? We're just still working through it. It's hard to tell.

Yes. So there were certainly significant slips in that program to date, which have pushed our revenue out. I think if you'd gone back a couple of years ago, we would've expected 2020 to be a year of reasonable production rates, where we would have been making dozens of fan cases this year. We're obviously not in that position where the program is, as you said. Back end of next year certainly looks likely. It's not a material driver of our revenue this year. And it may be in 2021, but we'll see where we stand 9 months now as we enter 2021, just to see where the program is. Obviously, Boeing has established build rates for the combined 777 and 777X deliveries that they announced, I guess, yesterday, that were much lower than the previous numbers. So I think the ramp-up in that program, even when it starts, will be more gradual than we'd originally anticipated.

Okay. Okay. And last question for me, I guess. I'm trying to figure out if it's - as I think about second quarter margin at AEC, it sounds like the LEAP facilities will be closed for quite a bit of the quarter. Is it reasonable to think that we'll see margin compression to AEC in the second quarter? And maybe that's the trough and we start to come out of it a bit in the second half. Is that a reasonable line of thinking? Or because of you've got the defense strength and because LEAP is cost-plus, is that the wrong way to think about it?

So we will have 2 competing factors at play in the second quarter. First off, as you say, LEAP will certainly be smaller. Where LEAP is operating right now, the gross margin we are recognizing on LEAP is a little lower than the average gross margin for this segment. And so in some ways, there's a slight mix benefit. Not materially. It's not hundreds of basis points lower, but it is lower than the average. And that certainly results in, I'd say, a mixed benefit for that segment. However, the lower volume overall that we expect in Q2 is going to significantly compress our margins as a result of the fixed cost we have in that segment. SG&A is going to become more of a challenge in Q2 on the compressed revenue, we'll see. So those competing factors will be at play. It is going to be difficult, I think, challenging to maintain the EBITDA margins. We've seen here year-to-date in Q1 where we delivered over 22%, really fantastic results. I think in the lower volumes, that is - it's going to be a challenge to replicate that sort of performance.

Our next question is from Patrick Baumann from JPMorgan. Please go ahead.

I hope you're well. Sorry, I missed some of the beginning of the call. I'm not sure if you've got into detail on this stuff, but I just want to kind of rehash it. So the gross margins by segment in the quarter, just wondering, if you could talk to the drivers and if there is anything unusual impacting results. In the past, you have talked about mix for the MC segment or the cost adjustments in aero segment. Just want to touch on that. And also just how we should think about gross margin performance in the near term? You just mentioned competing factors within aero, I guess, that seemed like more an EBITDA margin comment. Just curious if you could focus on the gross margin and also within MC, the gross margin.

Sure. Absolutely. So looking segment by segment, Machine Clothing, you're completely correct. We have in the past talked a lot about mix benefits in that. And those benefits that we saw in 2019 from a mix perspective, continued. So it's not as if - if you missed the start of the call, I didn't call out mix benefits. It's one of the drivers of our performance, but that's more because there was a change year-over-year. We're seeing a continuation of the good mix benefits we saw last year. And the primary change we called out year-over-year was a reduced depreciation charge in this quarter compared to Q1 of 2019. But as I mentioned a few moments ago, we are concerned about our ability to maintain that strong mix benefit on a go-forward basis. We're also concerned just about overall volumes. The Machine Clothing, obviously, with the 10 significant facilities they have around the world, much fewer than they used to have. And so a significantly leaner operation we used to have, but there is still a lot of fixed costs associated with running our Machine Clothing enterprise. And so we are sensitive to volumes in terms of the gross margins we can deliver because of that fixed cost. So we are - concerned is a strong word, but cautious about the back half of the year if, as we discussed earlier, revenues were to drop significantly in Machine Clothing on a sequential basis, our ability to maintain gross margins. Certainly, the 53% we have right now does feel a little like over-earning in that market. It's a historic all-time high. I think we can maintain numbers, which on a historical basis are still very good. But the 53% range feels like a bit of a reach on a go-forward basis. But it's largely dependent of what overall top line volumes do. And as we mentioned earlier in the call, while we have good insight into Q2, Q3 and Q4, are much less certain. So we'll kind of have to see what develops there. On AEC, it's largely what I just talked about. Gross margin, there is a significant fixed cost also on the AEC side. We do have significant amount of equipment leaving aside the LEAP production facilities for a moment because of the fact that they're cost-plus. We are less sensitive to volumes and absorption of the fixed cost from a gross margin perspective. I mentioned a few moments ago, the challenge with absorbing SG&A at those lower volumes. But focusing on gross margin outside of LEAP, we are very capital-intensive still in that business. If you look at our Salt Lake City operation, for example, we have significant investments in fiber placement machines, in order plays and in other automated production equipment, everything from lay-up to curing to inspection. And if volumes were to drop, we talked about potentially the risk, for example, on 787, it would put pressure on our gross margins. So we expect gross margins to still be strong in that business, but they're certainly under some pressure on a go-forward basis if volumes outside of LEAP were to drop significantly.

Were there any contract adjustments in the first quarter in that segment?

We had less than $1 million this quarter. So there were some there that was positive. So there were some positive adjustments, it was less than $1 million. So much lower than the numbers we saw in the, let's say, the last 3 quarters, where, I think, we averaged closer to $3 million a quarter. So still very positive. And we're very pleased with the fact that there are positive adjustments because they still indicate we're heading in the right direction and programs becoming more profitable over time. But they were not a significant driver of the margin level we delivered in the quarter.

And what was the depreciation benefit? How big was that? And is that a onetime? Or is that sustainable in MC?

In MC. So we saw a depreciation benefit in a couple of ways last year. A lot of this is related to the investment we made in our Chinese facilities, 10 to 12 years ago, where those are now being fully depreciated and rolling off the books. So I think it was a couple of million dollars year-over-year.

Okay. And then last one for me is on cash. Just if you could talk to - I don't know if you already did, the drivers of the working capital drag in the first quarter and how we should think that - look at that to play out for the rest of the year from a working capital perspective?

Yes, part of this is normal first quarter, just seasonal variation. We had a fantastic first quarter last year. But that was really an aberration, if you look historically, we typically consume cash in the first quarter, including building some working capital. So it's nothing terribly unusual in this quarter. There were a handful of programs, let's - particularly on our defense side, which have some milestone payments. Where a lot of expense was incurred in the quarter, but those milestone payments were beyond the end of the quarter. And so we built a larger contract asset during the quarter in those programs. But nothing terribly unusual that I believe is indicative of any sort of long-term trend. As I mentioned in my remarks, we still expect at the company level to generate significant free cash flow this year. And nothing I saw in the first quarter changes my opinion of that.

[Operator Instructions] We do have a follow-up question from Gautam Khanna. Please go ahead.

Sorry to keep asking questions. But I wanted to ask, how many - at the end of last year, if I recall, you guys were building inventory on the LEAP program. And presumably you built in Q1 as well. How many units - unit equivalents do you have, shipset equivalents, of inventory at this point on - however, you want to give them, 1A, 1B or just in aggregate?

Gautam, this is Bill. We did build up inventory last year. We talked about it at the end of the year, and we sort of planned for it internally as a number of shipsets on a weekly basis. We - that all changes as the demand plans change on what's 1 week worth. And so we're looking at the inventory as we look at our production plans going forward. But we haven't released specifically what those numbers are. And as we go through this year, we - some of that inventory is taken into account as we develop our plans. Looking backward, we've probably built a little bit more than we should have. So we have extra inventory in place now, which will slow down a little bit of production this year as we go into 2021, but that's all part of the plan.

Yes. Gautam. We released numbers, as you alluded to, as part of our fourth quarter results. They're directionally similar to what we saw then in terms of the number of aircraft to add. It's not the exact, but directionally in the same range today.

And at this time, there are no further questions in queue, please continue.

Thank you, everyone. I'd like to thank you for joining the call, and we appreciate your time today and your continued interest in Albany International. I hope that all of you and your families are staying safe, and we'll conclude today's call by recognizing the entire Albany team for another strong quarter of performance in a challenging environment, and we thank them for their continued focus on health and safety. Thank you, everybody.

Thank you. And that does conclude our conference for today. Thank you for your participation and for using AT&T Event Conferencing. You may now disconnect.