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…

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…

[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…

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.…

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.