Albany International Corp

NYSE:AIN

Earnings Call Transcript 2021-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International Fourth Quarter 2021 Earnings Call. At this time, your telephone lines are in a listen-only mode [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to our host, Director of Investor Relations, John Hobbs. Go ahead, please.

[John Hobbs, Director of Investor Relations]

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

[Bill Higgins, President and Chief Executive Officer]

Good morning, and welcome everyone. Thank you for joining our fourth quarter earnings call. We're pleased to report another strong quarter capping on great year in 2021. Our employees performed remarkably well throughout the year. We continued to do a great job for customers, won new business, brought new products to market and navigated successfully through supply chain and COVID challenges. We generated record free cash flow of more than $160 million in 2021. Our highest cash flow in history of the company on sales of $929 million with over 40% gross margins, 27% adjusted EBITDA margins, and world class operational performance in delivery, quality and safety. At the segment level Machine Clothing’s operational performance and financial results continued to be exceptional with better than expected customer demand at year end, Machine Clothing was able to deliver fourth quarter sales growth of nearly 10% over prior year fourth quarter, and do have a great flow through to the bottom line at 52% gross margins and 38% EBITDA margins. Engineer composites also perform well in the quarter with solid program execution across the board. Commercial aviation recovery is underway and it's an initial stages in 2022, the recovery will be seen as a mix shift as our lead production volumes ramp back up to support narrow body aircraft demand. Beyond 2022, as the recovery progresses we are excited as growth is expected to continue for our lead and CH-53K programs, and the anticipated wide body demand recovery begins. We also expect new business wins will layer on top of that to provide a solid foundation for longer term growth beyond 2023. As we ended last year, demand in our end markets was healthy yet still recovering in a few areas. Machine Clothing demand was better than expected and appears robust entering 2022. Packaging, pulp and engineered fabrics have all been strong, especially packaging in the Americas in Europe, even publication enjoyed slight growth in 2021 perhaps a short term rebound as we expect publication will revert to the longer term downward or trend as digital media continues to replace printing and writing paper. While Machine Clothing demand is expected to remain healthy in 2022, we’re somewhat cautious as some customers may have built up on hand inventory of Machine Clothing belts to mitigate the risk of supply chain and logistics disruptions. The outlook for our engineer composites demand is improving as commercial aerospace gradually recovers from the pandemic, domestic airline travel is leading the way while international travel is still slow to come back. Consequently, narrow body demand has already picked up and we're ramping our lead production to meet the needs for the Airbus A320 Neo, and Boeing 737 Max Aircraft. We do not expect recovery in wide body production and specifically for our Boeing 787 composite frames manufacturing in 2022, it'll take longer. On the defense side, we have programs Joint Strike Fighter CH-53K, JAASM missile that have longevity. In the short term, we do see some temporary headwinds on the Joint Strike Fighter as inventories have been overbuilt. Longer term, however, as production plateaus and more aircraft enter service, we expect this to remain a healthy and attractive program for us. Now, let me make a few comments about our strategy. Our first strategic priority is to invest in R&D and product development for organic growth. As planned, we increased R&D investment by 10% in 2021. We added talent to our design engineering and customer pursuit teams. We continued to collaborate with key customers to design the next generation of advanced materials and bring new products to market. Our strategy is to position Albany as the technology leader and partner of choice in our segments end markets. This means we must be good at both advanced materials development and operational performance to win new business and to expand our market share with existing customers. Our Machine Clothing business has successfully used this strategy to establish a leadership position second to none in its industry. We've earned a longstanding reputation for producing products of exceptional quality and durability for our customers. We spend more on R&D than our nearest competitors, and we work intimately with customer to design solutions that address their biggest technical challenges. This results in a pipeline of new product introductions that our customers value. Furthermore, we support our customers with a technical sales team, assuring customers they get the best paper quality and production efficiencies that our products can deliver. About a decade ago, Machine Clothing’s management recognized the secular shifts in the paper industry and redirected investments to emphasize serving customers in the growth areas of the business. That strategy continues to pay-off. Today, sales of tissue and packaging produces account for the majority of our revenue, while sales to producers of printing and writing grades of paper degrades in secular decline, contribute only 17% of our sales, down significantly from over 30% 10 years ago. Machine Clothing’s focused on improving its global footprint, product technology, operations and continuous improvement has paid-off. As I previously mentioned, Machine Clothing delivered record adjusted EBITDA margins of 138% in 2021. That's nearly a 10 percentage point expansion over the past decade, reinforcing our strategy of providing the most advanced material solutions with great operational execution. In engineer composites were earlier in the journey. We’re executing a consistent strategy to bring the next generation of advanced materials to market and we're earning a reputation for operational excellence and great customer service. It builds on the application of 3D woven composites we developed by collaborating with Safran on LEAP fan blades and cases. The durability and performance of 3D woven composites exceeds those of any other fan blade materials, titanium or 2D composite blades, and the production rates we achieved have demonstrated the commercial feasibility of high volume production of 3D woven composite components. We're using the LEAP experience as a springboard to build a complement of composite design engineering and manufacturing capability and propagate the use of 3D woven structures across the aircraft. The strategy takes advantage of long-term secular trends, driven by climate change and energy efficiency that demand lighter and stronger materials that raise the bar for fuel efficiency and contribute to a more sustainable future. Our strategy is to be at the center of this shift to lighter composite aircraft. We believe it will include a range of composite materials and applications, the right material and manufacturing process for the job. Over the last 18 months or so, we've announced new business wins, partnerships and technology collaborations that advance this strategy to become the leading supplier of advanced composite technologies and solutions. We've been awarded more content on existing aircraft, including Boeing 787 composite frames, Lockheed Martin Joint Strike Fighter composite components now over 200 part numbers, and on Sikorsky CH-53K helicopter winning this additional share reflects the strength of our operational performance on time delivery quality and service, and how important it is to our customers. In 2021, we extended our technical collaboration with Safran for 25 years with the goal of developing the next-generation of 3D woven composite products for the revolutionary RISE engine to power, the next generation narrow-body aircraft. We are also working on the GE-9X Safran to develop a composite fan case for wide-body aircraft. In addition to engines, we are working on 3D woven composite application for wings as a partner with Airbus on the Wing of Tomorrow program. And in 2021, we also formed a technology collaboration with Spirit AeroSystems to develop 3D woven carbon/carbon composite materials for high temperature use on hypersonic vehicles, another application we are excited about the unparalleled benefits of 3D woven composites. And today, we are pleased to announce that Sikorsky has awarded Albany the CH-53K app transition manufacturing program. This program award reflects trust and confidence in our ability. It solidifies our strategic relationship with Sikorsky on a durable program critical to defense capabilities with a value of over $300 million. It also positions Albany as a major player in composite rotorcraft structures. We already manufacture the CH-53K sponsons and vertical tail. And with the app transition section, we essentially will manufacture the back half of the helicopter. This win adds to the foundation we are building long-term organic growth. Effective capital allocation remains a top priority and continues to be focused on driving long-term organic growth. It starts with research and development. And while these expenditures live on our income statement, we consider them an essential investment in our future success. Our capital expenditure for program focuses not only on maintaining our current capabilities, but advancing our production efficiency and growing our capacity and capabilities as our business base grows. Share repurchases supplement our regular dividend as a flexible method of capital return. Finally, targeted disciplined acquisitions will continue to be a key element of our long-term growth strategy, at the right price, of course. Historically, acquisitions have played an important role by enabling us to build on our technology leadership and global market positions, in line with our strategic priorities. As a company, we ended the year 2021 in great shape. Strong free cash flow generation, a robust balance sheet, a relentless focus on operational excellence and leading technologies in both of our segments. We continue to invest in R&D to position Albany for long-term organic growth. We believe long-term secular trends are favorable. Machine Clothing continues to advance its technology leadership position globally in an industry that is becoming more attractive as a sustainable resource, as paper replaces plastic. Engineer Composites continues to win new business as the emerging partner of choice for the next generation of advanced light-weight composite material applications on aircraft that will deliver on the promise of more sustainable aviation. So with that, I'll hand it over to Stephen.

[Stephen Nolan, CFO and Treasurer]

Thank you, Bill. Good morning to everyone. I will talk first about the results for the quarter and then about our initial outlook for our business in the coming year. For the fourth quarter, total company net sales were $239.9 million, an increase of 5.7% compared to the $226.9 million delivered in the same quarter last year. Adjusting for currency translation effects, principally the decline in the euro to the U.S. dollar, net sales increased by 6.4% year-over-year in the quarter. In Machine Clothing, also adjusting for currency translation effects, net sales were up 9.4% year-over-year, driven by growth in all grades of product. Engineered composite’s net sales, again, after adjusting for currency translation effects grew by 1.3% with growth on LEAP and other commercial programs offset by declines on the F35 and 787 platforms. During the quarter, the LEAP program generated revenue of just under 27 million compared to a little under 25 million in the same quarter last year. LEAP revenue was also up modestly sequentially as we had delivered revenue of around 25 million in each of the first three quarters of 2021. We finished the four quarter with about 115 LEAP 1B engine ship sets in contract assets, largely completing the destocking of LEAP 1B finished goods on our balance sheet. We now expect our production of LEAP 1B units to be more or less in line with our deliveries. Although, we should point out that there is still considerable uncertainty related to Boeing's demand and our planned production rate is still subject to revisions. Also from time-to-time, we do expect to see some periods of finished goods, inventory stocking and destocking in our customers supply chains for both LEAP 1A and LEAP 1B components. So there will not always be full alignment between aircraft production levels and our production of the respective engine components. Fourth quarter gross profit for the company was $96.1 million an increase of 5.2% from the comparable period last year. The overall gross margin declined by 30 basis points from 40.3% to 40% of net sales. Within the MC segment, gross margin improved from 50.9% to 52.3% of net sales driven by a 1x benefit from government refunds in certain international jurisdictions where we operate, and improved absorption due to higher production volumes, partially offset by higher raw material and logistics costs. Within AEC, the gross margin declined from 21.7% to 16.9% of net sales caused primarily by mixed effect due to a decline in revenues on our fixed price programs, while other lower margin programs grew, and the absence of reserve changes that improves the prior year growth margin partially offset by a slightly more favorable net change in the profitability of long term contracts. Fourth quarter selling technical, general and research expenses declined from $54.8 million in the prior quarter to $53.2 million in the current quarter, and declined as a percentage of net sales from 24.1% to 22.2%. You may recall that in Q4 2020, these expenses were hire than normal as the company made a special bonus payment to all non-executive employees. Total operating income for the company was $41.7 million up from $35 million in the prior year quarter. Machine Clothing operating income increased by $12.5 million, driven by higher gross profit and lower STG&R expense, while AEC operating income fell by $5.6 million caused by lower gross profit and higher STG&R expense. Other income and expense in the quarter netted to income of $1.2 million compared to income of about $500,000 in the same period last year. The improvement this quarter was primarily driven by a more beneficial foreign currency revaluation effect in this quarter. Income tax rate for this quarter was 27.3% compared to 13.5% in the prior year quarter. The rate this quarter is a little lower than our normal expectations, driven by discrete items, while the abnormally low rate in the fourth quarter of 2020 was due to a significant true-up of earlier quarter’s provisions recognized in that quarter. Net income attributable to the company for the quarter was $28.6 million, slightly higher than $27.5 million last year as the significantly higher operating income was largely offset by the significantly higher tax rate. Earnings per share was $0.89 in both this quarter and the same period last year. After adjusting for the impact of foreign currency revaluation gains and losses, restructuring expenses, and expense was associated with the CirComp acquisition and integration, adjusted earnings per share was $0.86 this quarter compared to $0.89 last year. Adjusted EBITDA increased 5.7% to $60.6 million for the most recent quarter compared to the same period last year. Machine Clothing adjusted EBITDA was $59.7 million or 38.1% of net sales this year, up from $50.9 million or 35.3% of net sales in the prior year quarter. AEC adjusted EBITDA was $16.1 million or 19.3% of net sales, down from last year's $21.3 million or 25.7% of net sales. During the quarter, the company generated free cash flow, defined as net cash provided by operating activities less capital expenditures of over $47 million and for the year, generated free cash flow of almost $164 million. The very strong free cash flow this year was driven by both strong operating performance in both segments and by the draw down of our finished goods inventory on the LEAP program. As we previously discussed, we recognize revenues and profit on the LEAP program as components are manufactured, at which point they are recorded in contract assets. As we subsequently shift those components, we then invoice and collect cash with no associated revenue or profit. This year on the LEAP program overall, cash collections were considerably higher than revenue, reversing the pattern we had seen in 2019 and 2020. During the fourth quarter, we returned about $30 million of our free cash flow to investors, comprised of roughly $6.5 million in regular dividends and over $24 million in share purchases. We repurchased about 285,000 shares during the fourth quarter at an average price of $85.42. Repurchases are continuing, in Q1 so far, we have repurchased a little over 200,000 additional shares. We will provide a full update on Q1 repurchase activity during our next earnings call. For the full-year 2021, we returned almost $50 million to shareholders, $24 million in share purchases and almost $26 million in dividends. Thanks to our strong free cash flow, our net leverage ratio is now about 0.25. This leverage ratio provides significant headroom to both continue to return cash to shareholders and as bill referenced explore acquisition opportunities. explore acquisition opportunities. As we execute our capital deployment strategy, we would be comfortable with leverage ratios on a sustained basis in the 2.5 range. Although as we have done in the past, we could from time-to-time consider assuming a higher leverage ratio, provided we see a path to returning to our normal comfort range. I would now like to turn towards the coming year and provide our initial financial guidance for 2022, which is expected to be another strong year for both segments. We expect to deliver another year of excellent performance in the Machine Clothing segment. Fundamental demand for paper products is strong, our older books are healthy and the segment's culture of continuous improvement continues to deliver results year in and year out. We are in a solid position as we enter 2022. As we began the fourth quarter of 2021, we saw some risk to top-line performance in the segment. At that time, we had been seen growing inventory at several of our customers of both our products and our customers’ finished goods, which raised the risk of an inventory de-stocking cycle, which would obviously impact our revenue. This risk did not materialize in the fourth quarter, resulting in strong and revenues for the segment above our expectations. However, these inventory levels have not reversed course, and in some cases, have grown as we enter 2022. Therefore, the risk of de-stocking cycle remains. We do not know when that risk will manifest itself in terms of impacts to our revenue. However, we have accounted for some impact from it in our 2022 outlook. Our revenue guidance for the segment also takes into account the significant weakening of the euro that has taken place over the past several months. We generated over $100 million of our 2021 segment sales in euros. We now expect an exchange rate that is 7% to 8% lower on average in 2022 compared to 2021. This creates roughly $10 million of headwind to 2022 revenues in our outlook. Finally, as Bill indicated, we do expect that the rebound we have seen in publication grades will be short lived and we expect that portion of the market to return to secular decline over the next 12 to 24 months. Combining all of these factors, with the typical variability in overall demand for Machine Clothing and other engineered fabric products, result in initial net sales guidance for the segment of $590 million to $610 million. From a profitability perspective, Machine Clothing had an exceptional year in 2021, delivering almost $237 million of adjusted EBITDA, equivalent to a record 38.2% of net sales. During the fourth quarter, we began to see the impact on the segment of higher input costs, including raw material, labor and logistics, hitting the P&L. However, these were more than offset by some non-recurring benefits, by higher fixed cost absorption and by a continued low level of travel due to the global prevalence of the Omicron variant. In 2022, we expect to be able to offset a modest amount of input cost inflation through pricing to our customers, and to be able to offset a more significant portion of it through continuous improvement. Overall, inflation is continuing globally and therefore we do not know the final impact on our profitability, but our current outlook assumes about $6 million of net impact through to bottom-line in 2022 compared to 2021. I discussed earlier that over 100 million of the segment’s 2021 sales were denominated euros. We do of course also significant expenses in euros. On the net basis, we expect the weaker Euro relative to the U.S. dollar will impact our bottom line by about $5 million. We will also see a profit hit from the modestly lower revenues in 2022 compared to 2021. On a currency neutral basis, the midpoint of our guidance range for 2022 is about $10 million lower than we generated in 2021. As you are no doubt aware, while our gross margins are typically slightly lower to 50%. We do have significant fixed costs in our cost of good sold, resulting in detrimental margins well lower to 50%. Therefore, this $10 million reduction in volume is expected to result in high single digit million reduction in profitability. Finally, this year, we are likely to see the long expected return to our normal level of travel, while we have expected the return to normalcy to occur before now, it has been repeatedly delayed as the instance of COVID variants has continued to constrain our ability to travel. We now hope that those travel restrictions are largely behind us, and we expect Machine Clothing travel and R&D will rise by close to $5 million in 2022 compared to 2021. Notwithstanding those concerns, we expect the Machine Clothing segment to deliver another excellent year performance and are providing adjusted EBITDA guidance for the segment of $205 million to $225 million consistent with or slightly above the EBITDA margins delivered in 2018 and 2019. Turning to engineered composites, the long term future is very bright. With the successful pursuit of the CH-53K app transition program and the ongoing recovery in the global aerospace market, AEC is now on track to deliver revenue in 2023 on par with that delivered in 2019, before the impact of the 737 Max grounding, and the COVID pandemic, which would be a terrific milestone for the segment. I will put AEC revenue in the ballpark of $450 million for 2023, which will be up over 40% from the $310 million delivered in 2021. The app transition program is expected to be very significant program for AEC for many years come. However, the revenue impact in 2022 is expected to be insignificant. In general, on most [six] programs, AEC recognizes revenue as it incurs costs. While this will also be true for the app transition program once AEC begins recurring production, we do not expect it to be the case for the non-recurring phase in 2022. Instead, we anticipate that the work performed on the non-recurring phase of the program in 2022, expected to represent the equivalent for over $30 million of revenue will be recorded as inventory and will be recognized as amortized revenue over the subsequent years of recurring production. On the ASE LEAP program, we do expect to see a significant found in volumes on the LEAP 1B portion of the program as we get the inventory destocking phase behind us and begin to produce components for that engine variant more in line with Boeing's demand. We also expect the LEAP 1A volume to remain robust as Airbus continues its meaningful ramp up in production volumes. I will note that revenue does not scale linearly on the LEAP program with volume due to the recovery of our fixed costs from our customer irrespective of the actual volume. As volumes declined in 2020 and 2021, this effect mitigated the impact of the reduced volumes on our revenue. Now, as we return to growth, it will somewhat mute the impact of that volume gain on our revenue line. We do not expect any recovery on the 787 program in 2022. In fact, volumes are likely to be down from the already low levels we saw in 2021. Although, the impact on the AECs results of any further reduction in the program will be modest given we finished 2021 with less than $10 million in total program revenue for the year. On the F-35 program, this time last year, we told you that finished goods inventory destocking at our customers and reduced depot consumption of spare parts would drive lower revenues on that program. Due to the timing of customer orders and deliveries, those impacts were stretched out, and only partially impacted our 2021 F-35 program revenues, which finished down only modestly from 2020. However, that previously expected dip and demand has not gone away and has instead shifted into 2022, when we expect F-35 revenues to be down close to $15 million from 2021. Overall, for the engineered composite segment, we are providing initial guidance for net sales of $330 million to $350 million. Turning to the engineered composite segment of profitability. We finished 2021 largely in line with expectations with full-year adjusted EBITDA of $68.4 million or 22% of net sales. As we look forward to 2022, we'll continue to see negative mix effects on our gross margins. The growth on the LEAP program is expected to exceed the total growth of the segment, implying a net reduction of revenue on the higher margin fixed price programs that make-up the remainder of our segment revenue. This will lead to a meaningful decline in our full-year average gross margin. Beyond the mix effects, we are seeing some impact from cost growth. First, similar to the MC segment, we are seeing inflation impacting all of our input costs. While we are contractually insulated from cost increases on many of our raw materials that is not true of all the materials we consume, nor is it typically true of labor and logistics. As a result, we'll see inflation driven increases in both cost of good sold and SG&A. Second, we expect to return to normal travel. And third, we continue to invest in both R&D and sales and marketing, predominantly to support near-term identified pursuits. While these investments will be pressed near-term profitability, we believe that the long-term benefits more than justify the expense. Overall, we are providing initial 2022 guidance for engineered composite’s adjusted EBITDA but of $65 million to $75 million. At the total company level, we are providing initial 2022 guidance as follows: revenue of between $920 million and $960 million; effective income tax rate of 29% to 31%; depreciation and amortization roughly flat with this year at $75 million; capital expenditures in the range of $75 million to $85 million; GAAP and adjusted earnings per share of between $2.80 and $3.30; and adjusted EBITDA of between $215 million and 245 million. I would like to add a few clarifying explanations for some of the company level guidance item. First, our tax rate guidance is a little higher than we finished last year. Most of this increase is driven by expected higher withholding taxes, as we return cash from certain overseas jurisdictions and the fact that we can not forecast discrete items, which ended up being positive in 2021. Second, a significant portion of the increase in capital expenditures is in support of the CH-53K craft transition program. Third, given the uncertainties around when and how many additional shares we might repurchase in the balance of the year, we have not assumed any such activity in our EPS guidance. So our EPS guidance is based on the latest share count of about 31.9 million shares, which includes the impact only repurchase activity already completed in the first quarter. And fourth, the company wide adjusted EBITDA implies a higher level of corporate spending, compared to guidance in prior years. While some of that expected expense growth is wage inflation due current labor market conditions, significant portion of the increase is driven by higher cybersecurity investments. While we do not provide explicit cash flow guidance, we expect free cash flow to be no more than $100 million in 2022 due to the rise in capital expenditures and the significant investment in new programs, most notably the CH-53K app transition program. Returning to the present, we are very pleased with how the company performed in 2021 overall. We are also excited about the long-term positioning of both segments and look forward to delivering another strong year of performance in 2022. With that, I would like to open the call for questions. Alan?

[Operator]

Thank you [Operator Instructions]. Our first question will come from the line of Steve Tusa with JP Morgan. Go ahead please.

[Steve Tusa, JP Morgan]

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

[Bill Higgins, President and Chief Executive Officer]

Maybe just a little bit, Steve, right up front. From where we sit, we are running at very low levels and we are gonna continue to run at a low level. And our customers work with us to keep the line running at a rate where we can actually run it. So we run it about as low as we can to not lose the technical capability that we have in the manufacturing process.

[Stephen Nolan, CFO and Treasurer]

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

[Steve Tusa, JP Morgan]

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

[Stephen Nolan, CFO and Treasurer]

As we mentioned, work close to our normal inventory levels on both LEAP 1A and LEAP 1B, it goes up and down a little bit, quarter-to-quarter, but there's not a lot of additional contract asset value to unwind on that program this year. We're more or less where we expect to finish 2022. The big working capital change in 2022, quite frankly is going to be on the CH-53K app transition program. As I mentioned, we will be putting in inventory the equivalent of over 30 million of revenue based on the anticipated revenue recognition approach on that contract based on the structure. So that will be the biggest growth of working capital this year on the AEC side.

[Operator]

Our next question will come from Gautam Khanna with Cowen.

[Gautam Khanna, Cowen]

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

[Stephen Nolan, CFO and Treasurer]

Right now, we're close to our desired level of inventory. We're within spitting distance of it. In 2022, we do not anticipate a need to build significant additional inventory, that could come in future years if both Boeing and Airbus continue to ramp up, but that's not in our current forecast for 2020.

[Bill Higgins, President and Chief Executive Officer]

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

[Gautam Khanna, Cowen]

And just to be clear on the guidance. At AEC, you're not assuming any assumed catch ups, is that right? Favorable profit adjustments…

[Bill Higgins, President and Chief Executive Officer]

I understood the reference, Gautham. We're not anticipating any significant, there's a normal level of cost savings that would be built through all of our planning assumptions. But in terms of outsized -- out period profit increases, no, there are no material ones assumed in 2022.

[Gautam Khanna, Cowen]

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

[Bill Higgins, President and Chief Executive Officer]

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

[Operator]

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

[Ron Epstein, Bank of America]

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

[Bill Higgins, President and Chief Executive Officer]

Yes, it's a hard question to answer, Ron. We're kind of taking it in periods, let's call it 6 months at a time here, where our outlook for this year is really just to run at a low rate, working with our customers in the channel and producing at a rate where we can keep the technology going. But as Stephen pointed out, running at single digits is kind of how we expect the year to go. We're hoping to get going after that next year, but it would be hard for us to opine on what that looks like.

[Stephen Nolan, CFO and Treasurer]

Look, and Ron to give you an idea, in fact, if you go back before the decline when Boeing was producing more in the 13 ships -- 13 units a month range. Our revenue was north of $50 million. As we mentioned, our revenue was less than $10 million in 2021, and we expect it to be flat to down in 2022. To give you an idea, we're less than 1/5 of the revenue. So you could -- since it's a fixed price program, you could just do the math and get a rough indications that we're somewhere in that 2 to 3 shipsets on average per month.

[Ron Epstein, Bank of America]

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

[Bill Higgins, President and Chief Executive Officer]

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

[Ron Epstein, Bank of America]

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

[Stephen Nolan, CFO and Treasurer]

It really varies, Ron. There are certain programs, obviously, in a program like LEAP since it's more of a cost type program, it's a pass-through. There are other contracts where we're buying the raw materials under an enabled contract negotiated by our customer, and therefore, that price is a pass-through. But to be clear, on those sorts of contracts, there are still a lot of raw materials, non-end-item raw materials that don't -- that aren't the resin or 5 that are in the finished product, but that are used in the production of the product, whether that be vacuum bags, or gloves, or release agents and the like. We typically do not have coverage for those. And we do not have coverage even for fiber and resin on 100% of our use of such materials, but we do on a lot. And obviously, labor other than on the LEAP contract where it's cost tight, labor inflation is not typically a pass-through either. So it's a mixed bag. The resin and fiber largely protected other input costs not protected other non-LEAP.

[Operator]

[Operator Instructions] We'll go to the line of Pete Skibitski with Alembic Global.

[Pete Skibitski, Alembic Global]

Stephen, I'm trying to just think through kind of where, I guess, EBITDA margin could go at AEC. You guys just talked about that a little bit. But from the standpoint of LEAP, likely to be your kind of most meaningful growth program through the midterm cost-plus program. I know there's some niche type of contract terms on that. But how do we think about where margin rate could go at AEC given the positive outlook for LEAP?

[Stephen Nolan, CFO and Treasurer]

We're seeing great growth in LEAP over, let's say, the next 12 to 24 months as the narrow body recovers. And during that time frame, it will put some downward pressure on those margins. However, during the back half of that 12 to 24 months and certainly beyond that 24 months, -- we expect to see a lot of growth on fixed price programs, CH-53K, particularly now with the addition of the Aft Transition content, F-35. While it's not within this calendar year and depending on how Boeing does maybe not even within next calendar year, we do expect to see a rebound on the 787 program. We still think that's a fantastic aircraft. We're still very happy to be on that platform. So as those rebound, those will offset some of the dilutive impact we're seeing of the growth in LEAP over the next 12 to 24 months. So I think you're seeing a bit of a dip in margins, particularly this year, but I do expect to see those margins start to increase again beyond this year and maybe into the middle half of next year as LEAP continues to add growth. So I think we'll start to get back. Our goal has always been north of 20% margins in that business. Clearly, we peaked well north of that in 2019 and 2020. And our goal is to gradually get back to those more sustained levels well above 20%. But in the very short term, the LEAP growth is just too much of a challenge.

[Pete Skibitski, Alembic Global]

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

[Bill Higgins, President and Chief Executive Officer]

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

[Operator]

The next question will come from the line of Michael Ciarmoli with Truist Securities.

[Michael Ciarmoli, Truist Securities]

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

[Stephen Nolan, CFO and Treasurer]

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

[Michael Ciarmoli, Truist Securities]

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

[Stephen Nolan, CFO and Treasurer]

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

[Bill Higgins, President and Chief Executive Officer]

No, it's a pretty conservative buildup program by program, number of aircraft by number of aircraft, looking at things like the growth in the CH53K, even for the existing work that we already do today.

[Michael Ciarmoli, Truist Securities]

And then just -- I think I'm pretty clear on this. The AEC margin pressure in '22, you're getting some good top line growth, you're getting that EBITDA margin compression. It sounds really like it's just overall mix with more of your cost plus work ramping up? And then is there significant -- you called out the CH-53K F program and $30 million of nonrecurring. But I'm assuming that's going to be sort of dilutive and even more of a margin headwind as you ramp that up in the beginning of the year here in '22?

[Stephen Nolan, CFO and Treasurer]

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

[Operator]

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

[Bill Higgins, President and Chief Executive Officer]

Thank you, everyone, for joining us on the call today. We appreciate your continued interest in Albany International. And of course, if you have any questions, please feel free to reach out to John Hobbs, our Director of Investor Relations. His phone number is(630)330-5897. Thank you, and have a good day.

[Operator]

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