Ladies and gentlemen, thank you for standing by. Welcome to the Albany International Q2 2022 Earnings Conference Call. [Operator Instructions] As a reminder, your conference call today is being recorded. I will now turn the conference call over to your host, Director of Investor Relations, John Hobbs. Please go ahead.

Thank you, Alan and good morning everyone. Welcome to Albany International’s second quarter 2022 conference call. As a reminder for those listing on the call, please refer to our press release issued last night, detailing our quarterly financial results. Contained in the text of the release is a notice regarding our forward-looking statements and the use of certain non-GAAP financial measures and their associated reconciliation to GAAP. For the purposes of this conference call, those same statements apply to our verbal remarks this morning. Today we 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 and the potential effects of the Russian invasion of Ukraine 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 our earnings release of July 25, 2022 as well as our SEC filings, including our 10-K. Now, I will turn the call over to Bill Higgins, our President and Chief Executive Officer, who will provide opening remarks. Bill?

Thank you, John. Good morning and welcome, everyone. Thank you for joining our second quarter earnings call. Today I will comment on our business conditions and then Stephen will cover our financial results in more detail. We are reporting another strong quarter, with revenue of $261 million, up on both a year-over-year and a sequential basis. The growth was driven by rebounding LEAP production and revenues from the CH-53K helicopter content we recently won with Sikorsky. We are excited about this growth program and our teams are doing a great job expanding our manufacturing capacity in our Salt Lake City facility. GAAP EPS of $1.25 per share includes $0.20 of foreign exchange revaluation gains. Adjusted EPS of $1.06 per share was higher than $1.01 adjusted EPS reported in Q2 last year. Our Machine Clothing segment had another great quarter. Overall, customer demand remained steady. Segment sales were down 1.8% on a constant currency basis from last year’s exceptionally strong levels, in part a result of our exit from the Russian market. Underlying business condition is that our customers remain strong. Our MC team has done an outstanding job maintaining margins, despite the inflationary pressures they have experienced, again delivering gross margins over 50% with adjusted EBITDA margins of more than 38%. Looking forward in the MC business, demand remains resilient with order levels up year-over-year going into Q3. In general, papermakers continue to enjoy attractive demand and they have been pushing price increases for the products, resulting in healthy cash flow from their operations. Machine Clothing is essential to our customer’s ability to keep their machines running and our teams have done a great job meeting that demand despite supply chain challenges that seem ever present. This ability to navigate dynamic logistics markets has become even more important to our…

Thank you, Bill. Good morning to everyone. I will talk first about the results for the quarter and then about our updated outlook for the balance of the year. For the second quarter, total company net sales were $261.4 million, an increase of 11.4% compared to the $234.5 million delivered in the same quarter last year. Adjusting for currency translation effects, principally the decline in the euro relative to the U.S. dollars, net sales increased by 14.6% year-over-year in the quarter. In Machine Clothing, also adjusting for currency translation effects, net sales were down 1.8% year-over-year compared to an exceptionally strong second quarter of last year, driven by declines in engineered fabrics, packaging and tissue grades. These declines were partially driven by our previously announced exit from the Russian market. Engineered Composites’ net sales, again after adjusting for currency translation effects, grew by nearly 50%, with growth on CH-53K and LEAP production partially offset by a decline on the F-35 and 787 platforms. During the quarter, the LEAP program generated revenue just over $40 million compared to a little under $26 million in the same quarter last year. Second quarter gross profit for the company was $100.6 million, a reduction of 1.1% from the comparable period last year. Similar to the first quarter, as a result of the mix shift due to AEC’s top line growth outpacing that of the MC segment, the overall gross margin declined by 490 basis points from 43.4% to 38.5% of net sales. Within the MC segment, gross margin declined by 90 basis points from 52.9% to 52.0% of net sales due to higher input costs and mix effects partially offset by a one-time accrual release. Within AEC, the gross margin declined from 23.0% to 19.8% of net sales caused primarily by a lower net…

[Operator Instructions] We will go first to the line of Michael Ciarmoli with Truist Securities. Go ahead please. One moment, Ciarmoli, we are having some technical difficulties. Go ahead please.

Hi, good morning, guys. Thanks for taking the questions. Nice quarter here. I guess, Bill or Steve, anything – just looking at the remainder of the year, and obviously there is a lot of cross-currents, a lot of unknowns. The second half, I guess, revenues flat to down, the EPS at the low end really implies a pretty big fall off versus what you did in the first half. What are the puts and takes that kind of drive the low end of the range there? What are you seeing in terms of risk factors that could really drive you down to that range?

Yes, I think as a start, in the Machine Clothing business, we kind of – we now move into the summer season and then into the fall typically is a little bit lower. Engineered Composites, we’re doing a really nice job there, but we had expected this Boeing 787 work to at least contribute a little bit. And we’ve kind of – as I said, we’ve idled that production line for now. So I don’t know, Steve, if you want to add anything to that.

Yes. Look, there are the pressures we have talked about in Machine Clothing, which we expect to be greater in the back half of the year than the first half of the year. Supply chain costs, our input costs, FX effect. As you know, FX continue to swing against us. This time through last year, we had averaged about $1.19 euro to the U.S. dollar. This year, we’ve averaged about $1.09 in the first half. But right now, we’re close to parity with, $1.01. So just currency, we’ve seen half of the effect in the first half than we expect to see in the second half, assuming it sticks around, this parity level at that right now. So those effects will certainly hit us more in the second half. They did in the first half of the year. And that’s certainly embedded within our guidance.

Got it. Got it. That’s helpful. And then just looking out to Engineered Composites in ‘23, you said you get back to that $450 million. Does anything change here? Obviously we’ve got supply chain complications, the 787 now idled, obviously small, but I guess even thinking, does the CH-53K become a bigger contributor in ‘23? Or just any moving parts to that $450 million? I’m assuming it’s still intact.

I would – there are moving parts. There are parts moving in both directions here, right? We have the CH-53K, which we’re really excited about, and that’s growing faster than we had anticipated. We had not anticipated the 787 line coming to a halt here. And we don’t know when that’s going to pick back up yet. So that’s just still a question mark in our mind. So we’d like to defer later in the year to come back with more information on that.

Yes. Certainly, the better performance on CH-53K this year, where we originally had not anticipated recognizing material revenue, I don’t want you viewing that as a pull forward from 2023. If you recall, the bulk of that revenue was going to be deferred over a 10-year period. And so it has a fairly minimal impact to 2023 on the downside from recognizing that revenue this year. As Bill said, the 787 is a bigger change. Quite frankly, look, we next do our full roll-up of 2023 in the back half of the year, so we’re prepared for getting our annual plan approved by the Board in the December timeframe. So as we do that, we will update you if we see any material change.

Got it. Last question for me on the 787, idling the frames. If we watch, maybe we will get news next week from Boeing, but if we hear about a restart there, can you give us any color in terms of how many frames are in inventory or what the burn-down period might be like, assuming they start back up here shortly at modest volumes?

I wish I could, Michael. I’m not sure I can. We supply to other companies that assemble frames into the sections and don’t have real good visibility on how the inventory in the system or at Boeing, what it looks like today.

Got it. Understood. Thank you.

We will go next to the line of Pete Skibitski with Alembic Global. Go ahead.

Hey, good morning, guys. Nice quarter.

Hi, Pete.

Maybe just to start, a follow-up on CH-53. Stephen, your comments about $50 million this year on CH-53, I wasn’t sure if that was the all-in program or just the Aft portion. So maybe you can clarify that. And just – so directionally into 2023, should we think about that program continuing to grow also?

Yes. So the $50 million I gave was just for the Aft Transition component of the program. The entire CH-53K program for us would be much, much larger. As you think about into 2023 on just the Aft transition program, we actually expect a bit of a dip from 2022 to 2023 as we move into production. Right now we’re incurring tooling expenses, non-recurring expenses, which are larger within the given year than the annual run rate, the production expenses are likely to be. So as we go into production, you’ll actually see a little bit of a different revenue before it starts to grow again. Look, the outlook, let’s say, for 2023, is not materially different than what we had previously embedded within the $450 million forecast we shared with you a couple of quarters ago. So I don’t think you should see what we’re recognizing this year CH-53K as changing that.

Right. Okay. Okay. And then just a follow-up on AEC margins. I mean, it was a strong number this quarter despite 787 being down. I feel like you guys were pretty cautious, so – coming into the quarter. So I’m surmising that CH-53 is a pretty healthy margin program for you and that directionally into 2023 you’ve got some tailwind there.

CH-53K has a fixed price program. Its margins would be more in line certainly. We’ve talked previously about a cost-plus program like LEAP being lower than average margin. That would not be true of CH-53K. It would be more like one of our typical fixed-price programs.

Alright. Okay, that’s great. Okay, I will get back in queue. Thanks, guys.

Thanks, Pete.

We will go next to the line of Gautam Khanna with Cowen. Go ahead please.

Yes, couple of questions. First, Machine Clothing, I just am curious if you still view that there is excess inventory in the channel? And if on currency – is currency actually any sort of headwind to demand, either pricing, what have you. Is there – if you could address those two, and then we could switch to AEC.

No. To answer the second part of your question first, no, I don’t think we are seeing any material headwinds to demand from currency. Other than, obviously, as we have discussed before, we have over 100 million of sales in euros. And therefore as the euro falls against the dollar, those sales in U.S. dollars fall. But it’s not driving underlying demand for our product. It’s just a translation effect as we recognize that in U.S. dollars. If you are concerned that we are pricing a lot of our products in U.S. dollars in regions where the dollar has now fallen against the local currency and our products are more expensive, that’s not really a material driver of our – of demand for our products and Machine Clothing at all.

And then on the inventory levels, previously you thought maybe $10 million of excess, what’s your current…?

Yes. We are still watching the inventory. It may not be as severe as we had expected. There is some inventory build in the system. I think it’s probably a natural reaction to all the supply chain, logistics, bottlenecks. And our customers don’t want to get caught without a belt. We have kind of heard that some of the other competitors in the industry that ship across Atlanta, across Pacific have struggled with delivery. So, I think there is a natural inclination right now to have a little extra inventory, but I don’t see it as possibly as a big a problem as we thought.

Yes, it’s certainly no larger than the number we communicated to you before, Gautam, in the $10 million range. From our current – that’s our assessment right now, is it’s no larger than that.

Okay. No, that’s helpful. And then switching to AEC, I had couple of questions. First, the – can you quantify the positive EAC in the quarter?

Sure. It was just over $1 million compared to the roughly $4 million positive range in the same quarter in 2021.

Great. And then want to be clear on the CH-53K. Can you give us a ballpark of the aggregate sales level for the program this year, Aft plus the original win? And then – and just so I understand what you said earlier about the $20-ish million of non-recurring tooling. Was that expected to be like $2 million a year or something because I think you said over 10 years. I just want to make sure I understand what changed? And then will the entire program grow next year? And if so, just thinking about that $20 million…?

Yes. Okay. Sorry for speaking over you. So, certainly, as we look at – coming into the year, we had expected to do non-recurring work, both tooling and non-recurring engineering, which would have been the equivalent of about $30 million in revenue. But we were not expecting to recognize any revenue. We were going to put that on the balance sheet in inventory so at a somewhat lower cost because we wouldn’t be putting margin on to it, would be just at cost. We will be putting in inventory. And then we would recognize that as revenue over the subsequent roughly 10-year production period. So, we had expected to recognize about $10 million a year – or sorry, $3 million a year of revenue over that 10-year period. Instead, all of that $30 million is being recognized this year as we incur the cost. We are also doing some additional work we had not anticipated doing this year, which is generating about another $20 million of revenue, which means in aggregate, the Aft Transition program this year will generate about $50 million of revenue give or take. The larger CH-53K program, if we include both Aft Transition and our – what we – for now, I will call legacy work. In the future, we are going to just talk about the program in aggregate, but the legacy work, which is really the sponsons and the tail structure. So, that legacy work is roughly the same size this year as the Aft Transition work. So, in aggregate, this year CH-53K will recognize – will result in something like $100 million of revenue.

And next year, in aggregate, will it grow or decline because of that $20 million of non-recurring?

Yes. Look, we haven’t finalized our plans for next year. There are puts and takes, as you indicate. I certainly don’t expect – I don’t expect a material decline, whether we will see some growth on that or it could be kind of flattish. I don’t have that.

There is a period there where – there was a dip, right, we have a dip for the tooling.

But we are seeing some growth in the legacy program. So, we don’t – we are not issuing guidance for next year yet, obviously, Gautam. But it certainly, there is not a material dip next year.

And I hate to do this, the last one on LEAP, because no one asked, just on LEAP, where are we with respect to, you said $40 million-plus of revenue in the quarter, but I am just curious, are you generally tracking with the shipment rates that GE disclosed today, or any – where are you ahead? Where are you behind, if at all, with respect to inventory and the like? Thanks.

Yes. Let me just remind everyone that when we set our plans with LEAP production, we set them for the year, pretty stable rate. So, when we look at the growth, it’s – you wouldn’t see us growing every month, every week, whatever with the airline production – with the aircraft production rate. So, we are on track for what we set our plans for this year. And then we will come back and reset at a higher level for next year.

But as I mentioned three months ago, we don’t expect to keep discussing inventory in the LEAP program because our inventory is effectively at the level we expect it, that we are targeting. And absent, as Bill talks about, somewhat level loading during the year, there is no excess inventory right now on our books for LEAP at all.

Thank you.

One moment please. We will go next to the line of Peter Arment with Baird. Go ahead please.

Yes. Good morning Bill and Stephen. Nice quarter. Bill, I want to know if I could circle back to you on the – on your supply chain comments. It feels like we are – last few months we have been hearing about actually, it feels like things have gotten worse, not better. But you guys seem to be managed through it quite well. Maybe if you could just describe maybe what you are seeing in terms of at least the trajectory of any improvement, or things have not gotten any better between MC and AEC. Maybe just a little color on how things are shaping out on both sides.

Sure, Peter. Yes, the supply chain has been a challenge for a while. It seems like, we do our business reviews. It’s a different story every quarter. It just continues. So, it has gotten a little better on the logistics side, and that was my comment. The shipping of material, the shipping of whether it would be raw materials or finished products, seems like it’s a little bit better. Some containers are available. But we are still watching the supply of materials. So, you think about raw materials, whether it’s yarns or resins or chemicals, we are still watching those. There is secondary effects that we are watching with what’s going on with the Russian gas supply into Europe and the availability that would put on resins or other chemicals used in the process. So, I think we are fortunate in the sense that we use a lot of basic materials. We build our products. We are not buying sub-components and embedded chips and things that other companies are struggling with. So, we have a little bit more control over our supply chain. But it has been an ongoing challenge. But I do sense maybe it’s a little bit better. We are looking for the optimism in it, but I think it’s a little better.

And just the labor piece as well. I know you mentioned that. I mean that’s, everyone’s dealing with the labor constraints. What are you seeing there on your ability to kind of ramp back up in AEC?

Yes, we have been ramping up. So, we have been actually adding people in multiple locations. And it’s been a challenge. The labor markets are still tight. We are watching compensation side as well. So, far we have been able to manage it predictably in kind of the way we thought it would play out. But it challenges our recruiting infrastructure and our training pipeline of bringing people in and onboarding them is, it’s not easy, we are working through it, but it is still a very tight labor market.

Appreciate the color. Thank you.

Thanks.

We have a follow-up question from Michael Ciarmoli with Truist Securities. Go ahead.

Hey guys. Thanks for taking the follow-up. Maybe just to piggyback on what Gautam was asking about the LEAP, it sounded like you guys had set your rates, we keep hearing, I guess engine, lack of supply being one of the bigger choke points. I mean are you guys effectively keeping in sync with your customer demands? Do you expect any kind of ramp-up or changes because the pending certification of the COMAC change anything on the LEAP program?

Yes, we can’t – Michael, yes, part of your question, yes, we are able to keep up with demand. We don’t have a capacity issue to Peter’s question about labor. We have added some folks to our workforce, and we will continue doing that. But we have the capacity, we have the machine capacity, we have the physical capacity to produce at the current needs. And even if it grows, we have the capacity to do that. So, we are not part of the supply chain bottleneck that you may be reading about or hearing about in the production of engines and aircraft. So, we are feeling pretty good about being able to keep up with demand. And we won’t get a new schedule until later in the year and for next year. So, I can’t really comment on what we might look like next year.

Got it. Perfect. Thanks guys.

We also have a follow-up from Pete Skibitski with Alembic Global. Go ahead please. Your line is open Mr. Skibitski.

Yes. Thanks. Couple of quick follow-ups, guys. And sorry if I missed this on Machine Clothing, but they are starting to talk about curtailing natural gas use in Europe in order to kind of prep for the winter and people think that that will kind of lead to a slowdown there. I am wondering if you are seeing – how things are going with Machine Clothing in Europe. Are you seeing any slowdown there yet? Are you planning for kind of flattish revenue there in the back half of the year? Just looking for color for that region. Thanks.

Yes. I would say, in general the markets have remained healthy. There are some pockets we have – we did see earlier in the year where there was some concern about the high gas prices and the impact that has on specific types of production. If you think about tissue production, it’s energy-intensive, as natural gas and other fuel prices went up, that would be – put a lot of pressure on the tissue manufacturers. But overall, the market has held up pretty well, and publication has kind of stabilized after a decline in the last few years. So, overall, we are feeling like it’s pretty good. When we think about the natural gas and the situation in Europe, it’s probably a little bit more on the supply of materials and chemicals and resins and things.

Okay. So, I guess that will be a watch item. Last one for me on Engineered Composites. It sounds like DoD is getting ready to award the new helicopter contract, FLRAA, this fall. I am not sure if I have asked you this, but do you guys have content on FLRAA, either on one of the teams or both of the teams? And could that be significant for you?

We love to be on it. I can’t really comment on who we are working with and what we are doing at this point. As we have said, we had a really good relationship with Sikorsky. So, that’s one we are working really closely.

Okay. It sounds great. Thanks guys.

Thank you.

[Operator Instructions] Speakers, we have no one else queuing up.

Alright. Thank you, Alan. Alright. Thank you, everyone, for joining us on the call today. As always, we appreciate your continued interest in Albany International. Thank you, and have a good day.

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