Albany International Corporation

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International Third Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the call, please press star, then zero. I would now like to turn the conference over to our host, Mr. John Hobbs, Investor Relations. Please go ahead.

Thank you, Taliesha. 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. 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. Now, I will turn the call over to Olivier Giraud, our Chief Executive Officer, who will provide some opening remarks. Olivier? Thank you, John.

Good morning. Welcome, everyone, and thank you for joining our third quarter earnings call. Albany International delivered another very good quarter in Q3 2019, outpacing our expectations. I want to congratulate all of Albany's employees for contributing to these very strong results. We delivered solid year-over-year growth. Total company net sales increased 8% or 9%, excluding the impact of currency translation effects. We also continued to deliver strong profitability. Compared to Q3 2018, operating income grew by over 36% and adjusted EBITDA by almost 14%. Overall, we are clearly running ahead of the expectations for the full year that we shared with you on the Q2 earnings score. This outperformance is fundamentally driven by three factors. First, as I am sure you are aware, we are the exclusive supplier for the life of the program of components, fan cases, fan blades, and spacers for both the LEAP 1A variant used on the Airbus A320 NEO family and the LEAP 1B variant used on the Boeing 737 MAX. We mentioned on the last call that we were reducing our second half production rate for the LEAP 1B components as we await the return to service of the Boeing 737 MAX and we expressed concern about the risk of potential additional cuts to production in the second half of the year. However, since then, while we have reduced our production rate, we have reduced it by less than we had anticipated. During the recent quarter, we worked with our customer to maintain a production rate of LEAP components higher than the delivery rates of those components. This action, which has been taken to ensure that we can retain our talented and experienced workforce, is expected to continue for the balance of the year. Due to the terms of our contract with our customer, the relevant accounting standards require us to recognize both revenue and gross profit on that production. As a result, this action has contributed to some overperformance for the second half of the year compared to what we were expecting last quarter. Once again this quarter, the AEC segment benefited from a favorable net change in the estimated profitability of certain long-term contracts, reflecting improvements in labor productivity and operational efficiency. By the nature, while the results from improved operational performance, the timing and the magnitude of this type of adjustments are difficult to forecast. Third, we also talked on the last call about softness in the paper products and markets in the first half of the year, which we expected to result in weakness for machine clothing business in the second half of the year. While we have seen corresponding declines in our revenues in several markets, most notably in Europe and Asia Pacific, we have been fortunate that the softness has not yet resulted in a reduction in our machine clothing volumes in North America, which is our largest market. In fact, we delivered mid-single-digit revenue growth in North America this quarter, and we have also managed to maintain and even grow our overall segment growth margin. I should note that this does not mean we're immune to the pulp and paper market softness in North America. Instead, it's likely timing, and we do still expect to see some softness in machine clothing revenues in that market and our overall segment profitability in future periods. All that said, I could not be more proud of the company's results this quarter and of the efforts made by our talented, dedicated, and experienced workforce. Turning now to the current state of each of our segments. In Ingenious Composites, we continue the streak of strong quarterly growth. Net sales grew by 27% compared to the same quarter last year, or 28% when excluding currency translation effects, another remarkable achievement. We remain on track to meet the full-rate production demands of our key programs, including LIP, Boeing 787, F-35, and CH-83K. In terms of current period profitability, AEC delivered 23.9% adjusted EBITDA margin for the quarter, well ahead of our expectations. We delivered strong productivity and operational efficiency gains achieved through our relentless focus on operational excellence, which helped drive both the favorable net change in the estimated profitability of long-term contracts, and additional profitability improvements. I already mentioned that we currently are producing LEAP components at a rate higher than that at which we're delivering them and expect to continue to do so through the end of the year. We are monitoring very closely the ongoing situation with the Boeing 737 MAX program, to which we are a key supplier through our joint venture with Safran on the lip engine. We do not have additional insights beyond what has been publicly reported into the likely path for that aircraft return to service. As we have indicated before, the somewhat unique structure of that program, which is being operated under a cost plus fee arrangement, mitigates some of the financial impact of any LEAP production changes. However, while our gross profit rate on the LEAP program is likely to be relatively stable, If the slowdown were to extend significantly into 2020, it would clearly create top-line pressure for the segment. Overall, I continue to be very excited about the future for AEC. I believe that our focus on new business development, advanced technology, operational excellence, and meeting customer needs position us for ongoing future success. Turning to machine clothing, for Q3 2019, on a currency neutral basis, we delivered net sales almost 3% below a strong Q3 2018. However, year to date, on the same basis, net sales are roughly flat to the prior year. We have previously said that we expect more than packaging, tissue and towel, and pub-grade PMC cells increases to more or less offset decline in publication-grade PMC cells. This quarter's currency neutral results supported that expectation. We delivered low single-digit year-over-year growth on products for both packaging and with significant double-digit declines in products for publication brands. We are very pleased with our profitability this quarter. Even with the lower volume and resulting lower fixed cost leverage this year, we delivered gross margins of 52.4% compared to 50% last year. We monitor the competitive environment very closely, particularly at times like this when there is toughness in the end markets, and we remain confident in our competitive position. We believe that our cost advantage, driven by both scale and continuous improvement manufacturing initiatives, combined with our superior customer service and technology leadership, position us well to compete in the marketplace and are driving our exceptional profitability. With that, I would like to turn the mic over to Steven, who will provide more details on the quarter and our guidance for the full year. Steven?

Thank you Olivier. Good morning everyone. I will talk first about the results for the quarter and then about the outlook for the balance of the year. For the third quarter, total company net sales were 271.1 million, an increase of 7.6% over the 251.9 million delivered in the same quarter last year. Adjusting for currency translation effects, the growth in net sales was 9.0%. In machine clothing, also excluding currency translation effects, and in part due to the strong Q2 in 2018, Net sales declined by 2.6%, caused primarily by a decline in sales of publication and pub grades, partially offset by a modest net increase in sales across all other grades. AEC net sales grew at 28.3%, primarily driven by growth in the LEAP, F35, and Boeing 787 programs. Third quarter gross profit for the company was 104.1 million, an increase of 12.7% over the comparable period last year. The overall gross margin increased by 170 basis points from 36.7 to 38.4% of net sales. Within the MC segment, gross margin improved from 50.0 to 52.4% of net sales due to reduced depreciation expense, foreign exchange impact, mixed benefit, and material savings, partially offset by lower net sales driving reduced fixed cost leverage. Within AEC, the gross margin improved from 14.6% to 20.8% of net sales, driven by a higher favorable net change in the estimated profitability of long-term contracts, higher net sales driving increased fixed cost leverage, and improved productivity. Third quarter, selling, technical, general, and research expenses decreased from 49.0 million in the prior year quarter to 48.7 million in the current quarter, and also decreased as a percentage of net sales from 19.5% to 18.0%. The reduction in the amount of expenses was driven primarily by the revaluation of non-functional currency assets and liabilities, which resulted in a loss of $400,000 in Q3 of 2018, but a gain of $700,000 in Q3 this year. Total operating income for the company was $55.7 million, an increase of 36.4% from $40.8 million in the prior year quarter. MC operating income increased by 2.2 million, driven by lower STG&R expense, lower restructuring expense, and higher gross profit, while AEC operating income grew by 380% to 17.3 million, driven by higher gross profit, lower restructuring expense, and lower STG&R expense. The income tax rate for the quarter was 24.7% compared to 28.9% in the same period last year. Discrete tax items and the change in the estimated annual income tax rate reduced income tax expense by 1.5 million in Q3 2019 and by 400,000 in Q3 last year. Net income attributed to the company for the quarter was 40.0 million. an increase of 44.2% from 27.7 million last year. The increase was driven by improved operating income and the lower tax rate. Earnings per share was $1.24 in the quarter compared to 86 cents last year. After adjusting for restructuring expenses and the impact of foreign currency revaluation gains and losses, adjusted earnings per share was $1.17 this quarter compared to 85 cents in the comparable period last year. Adjusted EBITDA grew 13.9% from last year to 71.4 million for the current year quarter. MC adjusted EBITDA was 55.8 million or 36.9% of net sales this year down from 57.8 million or 36.6% of net sales in the prior year quarter. AEC adjusted EBITDA grew from 16.5 million or 17.5% of net sales last year to 28.6 million or 23.9% of net sales this quarter. As Olivier mentioned in his remarks, AEC results for this quarter benefited from a favorable net change in the estimated profitability of long-term contracts. At the risk of repeating my remarks from last quarter, we reviewed the estimated profitability of all long-term contracts every quarter, and while we frequently report net changes, sometimes positive, sometimes negative, in estimated long-term contract profitability, the $3.3 million favorable adjustment in this quarter was again unusually large. Several of our contracts on which we've been executing successfully for several years achieved cost or revenue objectives during the quarter that caused us to increase the gross profit rates at which we are recognizing profit on those programs. Those increased rates affect not only the profitability of those contracts in the current and future periods, but require that we record in the current quarter the effect of those higher profit rates on revenue previously recorded on those long-term contracts in prior periods. The $3.3 million I referenced a moment ago represents those incremental profits associated with revenues previously recognized in a prior period. Therefore, while the improvements result from strong operational performance both in this and earlier quarters, And while we will recognize profit on the affected contracts at a rate higher than we had done previously, the overall profit recognized in this quarter on those contracts is not reflective of the ongoing level of profit. Turning to our debt position, total debt, which consists of amounts reported on our balance sheet as long-term debt or current maturities of long-term debt, decreased by $58 million to a balance of $424 million at the end of Q3, and cash decreased by about $41 million during the quarter, resulting in a reduction in net debt of about $17 million. Under the definition of leverage ratio used in our credit agreement, which limits us to $65 million of cash netting against gross debt, we finished the quarter with a leverage ratio of 1.42. While disregarding the limitation of cash netting, results in a leverage ratio of 1.01. Our reduction in net debt this year has been in part driven by our working capital initiatives. For the first nine months of the year, cash provided by operating activities increased from $61 million in 2018 to $127 million in 2019. Capital expenditures in Q3 2019 were about $14 million, reflecting continued investments in equipment to support multiple ramp-ups in AEC. The lower levels of capital expenditures this quarter and last have been driven by the timing of some projects, some of which will now be completed in 2020, and does not represent any material change in our investment plans or priorities. Looking forward to the full year, we now expect MC revenue of $595 to 605 million, in line with prior guidance of relatively flat revenues on a currency neutral basis compared to 2018. But we are raising our EBITDA expectations for the full year. We now expect the segment to generate adjusted EBITDA in the range of 205 to 215 million, 10 million higher than our previous range. In the fourth quarter, A higher proportion of MC sales are typically generated from inventory destocking, causing seasonal compression of MC gross margins as lower production rates lead to underabsorption. We now expect AEC to generate revenue for the full year in the range of $445 to $455 million within the prior guidance range of full year growth of 20% to 25% over 2018, with adjusted EBITDA of 95 to 105 million. We had not previously provided quantified guidance for 29 AEC EBITDA, other than to indicate the adjusted EBITDA margins would be higher than in 2018. Our current guidance range implies adjusted EBITDA margins of 20.9 to 23.5%, significantly exceeding the 2018 level of 17.1%. During the fourth quarter, even with the production of LEAP components running ahead of deliveries, as Olivier mentioned, we expect to see a significantly larger impact than we did in Q3 from the previously disclosed reduction in LEAP 1B production, as we use extended holiday shutdowns to manage production level while retaining our talented and experienced workforce. resulting in significantly lower segment revenue in Q4 compared to Q3. At the company level for 2019, we are also revising our prior guidance for a number of metrics. For the full year, we now expect revenue of between 1.04 and 1.06 billion, down from prior guidance of between 1.05 and 1.08 billion, Adjusted EBITDA of between $250 and $260 million, up from the prior guidance of between $225 and $240 million. An effective income tax rate, including tax adjustments, of 26 to 27%, down from the prior guidance of 27 to 29%. Depreciation and amortization of between $69 and $73 million, slightly below prior guidance of 70 to 75 million, capital expenditures in the range of 70 to 80 million, down from the prior guidance of 80 to 90 million, gap earnings per share of between $3.81 and $4.01, up from the prior guidance of 304 and 334, and adjusted earnings per share of between $3.75 and $3.95. up from the prior guidance of $3.05 and $3.35. Looking forward, while we will not be providing 2020 guidance until our Q4 earnings call next year, I do want to provide some color on what we are currently seeing that may impact that year's results. While we currently expect another good year in 2020 in terms of overall performance, we do see several headwinds. First, As Livia mentioned, in AEC, for this quarter and the balance of the year, our production rate for LEAP components is higher than the rate at which we are delivering those components to our customer. Due to the nature of the contract with our customer, under the relevant accounting standards, we are recognizing revenue and gross profit on that extra production in 2019, even though the produced components will be delivered to the customer in future periods. This is generating a pull forward of revenue from those periods into 2019. In addition, considerable uncertainty still exists with respect to the return to service of the 737 MAX and the subsequent ramp up in our production of LEAP 1B components, which may lead to additional impacts to our revenues from LEAP 1B components in 2020. Second, as you are aware, our AEC segment profitability this year has benefited from net favorable changes in estimated long-term contract profitability with almost $9 million of net benefit recognized year to date. While often difficult to forecast, these types of benefits are unlikely to be recorded in the same magnitude in 2020. Third, in machine clothing, We continue to expect that the softness we are seeing in global pulp and paper production will eventually ripple through to our results in the North American market. We've been fortunate that this has not yet occurred due to the timing lag between paper product production and machine clothing deliveries, but impact does it likely will, possibly to some extent in Q4 this year and more probably into 2020. This will impact both MC's top-line performance and the segment's overall profitability. As I mentioned a moment ago, we will provide a more complete update on the outlook for 2020 when we next get together for our 2019 Q4 earnings call. With that, I will pass the call back to Olivier for further comments.

Thanks, Stephen. In closing, I would just like to reinforce how good we feel about the business I am proud of the accomplishments of both the MC and AEC teams, and we are thrilled to be able to increase our guidance for the year. We think we are well positioned for fiscal year 20, and I am particularly excited about the opportunities for profitable growth over the long term. Overall, I feel very good about the business and our ability to hit our expectations. Let's go to the line for any questions. Operator?

Ladies and gentlemen, if you wish to ask a question, please press 1, then 0 on your touchtone phone. If you are using a speakerphone, please pick up the handset before pressing the numbers. I will now go to the line of Pete Skibitsky. Please go ahead.

Let me start out, I guess, on Leap 1B just so I understand the accounting. So you guys are obviously booking revenue and profits, but you're not receiving cash. So we're building working capital, I guess, for some amount of time. Is that correct?

Yeah. Listen, you got it correctly. I mean, you know, I just would like to, however, to be clear that the – inventory build that we're proceeding with after having agreed, right, with our customers, is not something, you know, really big. I mean, we're talking about only a few weeks, I would say, a few weeks, not months, a few weeks of inventory build across fan cases, fan blades, spacers, a few weeks increase versus what we had, you know, at the end of June 2019. And, of course, a week of measured in expected 2020 demand. Now, when you look at the expected ramp-up of the Boeing 737 MAX 257, it's quite a few weeks, right, increase. is quite acceptable and also you have to remember also that we started early 2019 with a pretty lean inventory across all components. We also have on the A320 in regards to the LEAP 1A variant to be ready for the expected wrap up of Airbus on the A320 and EO as they move gradually from 63 to higher numbers.

Yeah, and Pete, just from an accounting perspective to make sure you understand what you will see on the balance sheet as we go through this. While we talk about building inventory, given the nature of our accounting treatment where we are recognizing revenue and profit, those finished goods do not appear in the inventory line in our balance sheet. Rather, they will appear in the contract assets line on our balance sheet. Since they are really owned by our customer, we just have not yet invoiced those customers for those parts, but we have termination coverage should we ever need to, so those parts are appropriately treated as contract assets. You will see a slight build in the inventory line, really unrelated to this ramp up in production and it's really due to the overall slowdown that we previously discussed where there are certain raw materials which have a long lead time which we ordered up to six months ago which are currently getting delivered and which are in excess of our current needs. So you'll see some build in the inventory line but that is really just raw materials and so that is not the finished good and that will start to come down because obviously we slowed our order rate of those products and that inventory is all still good as well. We'll use it well within the shelf life of any raw material we get and then you'll see a slight uptick in the receivable line and this is really just related to the true up on our contract as production rates have come down. Our current cost is in excess of our predicted sales price at the start of the year. That true-up that we address with our customer at the end of the year builds in accounts receivable during the year. But by far the largest impact will be on the contract assets line where that finished goods inventory will appear.

Okay, that's really helpful, guys. I appreciate it. Can you share with us the rate you're actually at on the 1A, whether it's 42 a month or 52 or 57?

Our customer is not authorized us to do so.

We cannot really, you know, and we cannot really know can we really speculate, right, on whether the burn will be into 20, right? I mean, our customer is not going.

Yeah, understood. And, Olivier, just so I'm clear, you are getting upward demand signals on the 1A, right? I mean, we all saw the 300 unit order they just got yesterday, so that's a fair statement.

Well, you know very well about the now expressed for a very long time, right, by Airbus. I mean, they're intense, right, to move up, right, the production rate of the A320. Of the A320 NEO, the overall A320 family, and I think, as you heard again, you know, this morning, I mean, they really want to, you know, keep on ramping it up. So that's why we're getting ready on our side, right, to make sure that we will never be any reason, like we have never been in the past, and we continue to never be any reason, right, for preventing our customers, right, to ramp up.

Not very helpful. Thanks, Chris. Thank you.

Thank you.

We'll now open the line of Christine Leeway. Please go ahead. Hi, good morning, guys.

Thank you for joining the call.

Sure. I just wanted to get a little bit more clarity about how your cost plus incentive fee contract structure for the LEAP engine works. Basically, can you discuss what costs would not be recoverable if production rates decline? And then also, If you have lower production volumes, do your incentive fee hurdles adjust? Meaning if volumes are low but you operate well relative to that low volume, are there incentive fees that you could get on the LEAP program?

Okay. I think we'll – let me first answer you at the high level, and, of course, Stephen will jump in with more color right into it. But at a very high level, it means – our, you know, contract cost plus fee contract structure arrangement with Saffron really mitigates, as I was saying, as you understood that hook well, I mean, mitigates any downside financial impact on our bottom line because fixed costs, right, are recoverable. Therefore, the... the gross profit rate, right, the gross margin on these very same products is relatively stable, right? So when our production decreases, any production change on the components would drive fluctuation and downside pressure, right, on the top line. However, right, our gross profit rate stays constant. As we drive productivity, as we lower our manufacturing cost, of course, the revenue per unit drops. At the same time, the incentive fee kicks in. Therefore, the gross profit rate percentage, gross margin increases. And as a result of volume demand for the LEAP engines growing over the years, I think we're talking about growing LEAP engine shipments or manufacturing rates moving from 1,800 this year to about 2,500 engines in 2025, volume increases. Therefore, our total recognized revenue increases. And therefore, as a result of gross profit rates increasing because of the incentive thing kicking in, our total dollar gross margin, right, increases, right? That's at a very high level. And now, I'll leave it to Stephen if you can give more accounting, you know, flavor to it, right?

Sure. Christine, in terms of your concern about our costs, which we would not recover if demand really slowed down, the short answer is there are no incremental costs. The costs which are unallowable under that contract are largely variable costs related to production such as costs of poor quality where we do not get to recover all of those in our contract. And that is typically a percentage of revenue irrespective of volume rather than some fixed costs which would start to overwhelm our gross profit rate on the program were volume to go down. Right now, You're correct, and Olivier is correct in terms of describing how the incentive fee works, how our profit rate can step up as we get our products down. Given where we are right now, there is not a huge amount of room for our rate to move down as our production rate goes down and our average cost per unit goes up, because we're still relatively early in that program. We were sitting in a position where there was far more headroom for increased gross profit rate on a go-forward basis as we got our production rate, as our production cost went down. So I don't think you should expect to see some significant reduction in the gross profit rate if we're recording profit on that program as the production rate declines.

That's really helpful, and that's a lot of color. Thank you for that. And maybe switching gears to a different program, Boeing also recently announced that they're cutting the 787 production rate from 14 per month to 12 per month. Can you discuss how we should think about when that would hit your revenue outlook? I think they've said end of 2020 is when they would see this, or end of 2022 is when they'd see this rate cut. And then also how we should think about margin impact of that lower rate for you.

Well, I would not overreact much about these announcements. I mean, first of all, we have to wait and see, you know, the outcome of the trade negotiations, right, between U.S. and China. Basically, the slowdown, expected slowdown reduction in bills by Boeing was driven by the potential drop in Asian demand, right? So let's wait and see really what happens. Anyway, when you look at the grand scheme of things, I mean, the Boeing 787 demand for us, I mean, it's a very important program, but it's in the, I would say, single, high single digits, right, of our sales, about total revenue, right? So, therefore, you know, I don't see any major impact. We'll address that in the second half of 2020, but we're not, if you will, very preoccupied with that announcement.

Great. And if I could ask one more program question. On another large program you have exposure for, the F-35, this week Lockheed finally secured the agreement for a $34 billion order that seems to span production rate for lots 12, 13, and 14. So that stretches for a few years, and it seems like they're on target to increasing their production rate for that aircraft in the next few years. Do you need to spend more CapEx to meet the expected production of the F-35, or are you already at the CapEx that you need to deliver for that program?

Listen, it's very good news, first of all, right? We're very pleased, right, about this announcement from CapEx. I mean, the F-35 is indeed one of our greatest programs, growth platforms, and we're always very, very happy to support and we keep on supporting that program as we have done in the past, both from an engineering standpoint and productivity and production standpoint. We have, we produce all those components, , you know, fixed wings, skins, and tooling from our Salt Lake City business. We have invested quite a lot, right, in the past few years toward that program. We have the capacity, right, and we do not presently, we do not foresee any, you know, significant CapEx increase to support, right, the growth of the expected now for a very long time, expected growth, right, of that program.

Thank you very much.

Thank you, Christy.

Thank you.

I'll now open the line of Peter Armit. Please go ahead.

Hey, this is Asher Carey on the line for Peter. I just have a question about machine clothing. If you could talk a little bit about the machine clothing market, which has its challenges. It showed up in some softness, but the margins were about as high as they've ever been. Could you highlight some of the operational metrics you're seeing that drove that improvement, and would you be able to pull similar levers in the case of some of that softness? spread to North America?

Thanks. Yeah, thank you. Great question. Listen, first of all, from a margin standpoint, I mean, we're very pleased, right, to have been able to drive 52.4% gross margin versus 50% last year. That increase in gross margin year over year was predominantly driven by a decrease in depreciation amortization. was basically driven by a more favorable mix, and I'll come back to that from a market standpoint, was driven by some nice procurement savings, material savings, offset somewhat by, as you saw, as Stephen mentioned, about 2.6% decline in volume, driving lower prices. Now, very nice productivity gains also that we're continuing to drive in, that the business is rising and will continue to drive quarter after quarter in the years to come. That being said, from a market standpoint, you know, I don't want to change. I want to be very pessimistic and change the fundamentals of the market, right? And market, the paper market, is still a market that will be growing, as we see and recently confirmed it, at about 1% a year, right? You have all demand of paper and paper board, 1% a year on average, right, between 18 and 23. And, of course, you can have some up and down. Continuously, we also continue to believe that our sales, of publication-grade PMC products, both newsprint and publication and writing, will continue to erode at about 5% to 10% a year in the next few years. And by the way, we have seen that already. We're seeing that today, September 19 year-to-date, right? And we also continue to... really think, as it is the case also year-to-date, we continue to think that the increases in board and packaging, tissues and towel paper grades, pub grades, PMC sales, will also more or less offset the decline in publication grades. Now, so that's true that the fundamentals of our market, we're still seeing it. We're seeing it on a year-to-date basis, actual, and we'll keep on seeing that. If you, however, as Stephen was expressing, you need, however, to be cautious, right, looking at the next few quarters. You know that the top line of PMC sales, right, is really driven by the GDP, right, the GDP growth, right? And if you look at what's happening here today by region, really, you know that the U.S. economy is still expected to grow, but will definitely slow down next year. The GDP growth in 19 is 2.4%, down from the 2.9% in 18, and currently projected to be 1.1% in 20. If you switch to Europe, you very well know that Europe will be decelerating this year and also next year with GDP, GDP growth going down from 1.2% in 2019, expected 0.9% next year, right? So we have to be careful. And also, you know China. China, as you very well know, China is slowing down, slowing down because of X number of reasons such as high environmental pressure, reduction of exports, from China into North America within the U.S. with the trade war, and we're seeing a continuous decline in China growth from 6.6% in 18 down to 6.1% in 19, and I believe expected to go down to 5.8% in 20. So therefore, we need to be careful. We need to look at it by market. We enjoyed in the third quarter, and actually year to date, some pretty strong growth, year over year growth in North America in the packaging drug. We're very pleased about it, very pleased to see it, especially in Q3 where we saw some producers of the holiday season for Thanksgiving and the end of the year holiday. So we saw some nice influx rate of packaging and machine clothing. However, the packaging rate production in North America, according to RISI, has dropped about in the mid single digits. We know that the container board producers will continue in the U.S. to take a substantial amount of market-related downtime during the next few months and also in 20. And therefore, our view is that the packaging growth will be kind of anemic, right, going into 20. So we might not see, as Stephen was expressing, the same growth the same increase year-over-year in packaging rates, PMC sales in the U.S., and also coming back to China, we have to watch out. We have to see, you know, how long those environmental regulations, very strict regulations, will last. and we have to see, you know, how the trade war, trade between U.S. and China will, the effect of it, and how long China will keep on reducing, right, their exports into U.S. So that's all those factors that we have to watch very, very carefully. In Europe, you also have the Brexit, of course, the Brexit issue that we're watching very carefully. That explains why, if you will, when we look at 20, we're staying cautious, if you will. But I repeat, the fundamentals of the industry have not changed. OK? Thank you. Thank you, Ashwin. Thank you.

As a reminder, if you'd like to ask a question, please press 1, then 0 at this time. Now open the line of Gautam Khanna. Please go ahead.

Hi, this is Jeff Molinari on for GOSM today. Good morning, Olivier and Stephen. Congratulations on the strong quarter and thank you for taking my questions. You covered a lot here already, but I wanted to come back to the long-term contract revisions. In this quarter, there was a $3 million positive favorable revision. Last quarter was $5 million. Were those related at all or do they span multiple programs? And then I have a follow-up after that one.

So for Dan's first part, no, they weren't related in that. Certainly they're not the same issue appearing in multiple quarters. Each quarter we measure the impact of everything we know about that at that point in time. And so there were new facts between Q2 and Q3 which led to that change in Q3. They do span multiple programs. The one where you typically don't see much change, particularly on the positive side, is in the LEAP programs in Albany-Safran, because as we mentioned, the gross margin is relatively stable there, unless we trip over something where we kick into an extra layer of incentive fee, but normally we would project that. So it would be unusual to see a major positive pickup on the LEAP programs, But other than that, it's crossed multiple programs in our Salt Lake City and our Bernie operations, and there's no single common thread between the pickups we saw in Q2 and the pickups we saw in Q3.

However, and thank you, Stephen, for that explanation, but however, what I would like also to point out that, you know, those benefits, right, $8.8 million today, 3.3 million pre-tax before in the quarter, are really the result of a very strong, right, a continuation of a very strong labor productivity improvement and operational efficiency gains, right? I mean, it's really what we're working on. what we have been working on relentlessly since the past couple of years, deploying a very disciplined operational system across our manufacturing network, driving every day labor productivity improvement and key assets OEE improvements, equipment effectiveness improvements, driven by three fundamental operational drivers, process productivity through technology initiatives, manufacturing productivity through lean manufacturing initiatives, and reduction, intense relentless reduction of our known quality costs. So I think it's very important to And we're very happy, and I cannot thank more my team at each of our plants worldwide to drive and deploy these operating systems, and we're very, very happy to see the results.

I appreciate the call. That's very helpful to hear. And if I may, I have another question for you. On the production rates for LEAP, you've been above Boeing's rate. So they've been at 42 since March. And I think you guys hit as high as 57 in advance of prior to the grounding. So have you guys been pretty much above them all year? Or can you give any other color about how your rate has trended throughout the year? Thank you. No, thank you. It's a good question, Noam.

But we don't, how could I explain to you, we produce, right, and we ship those components against a demand coming from Safran. Not from Boeing, that's point number one, right? And I can't really, it's not public, I cannot really explain you, right, or I don't even, we don't even know with clarity, right, the variance between the Boeing production and the Safran's production, right? So, our production schedule is driven by Safran's demand, once again. We had a very lean inventory across all variants of Leap Prime early in the year. And as I said earlier, we have only, and we will have only increased by a few weeks, not a few months, right, our inventory at the end of finished goods and WIP at the end of the year. We are, we will reduce, as Stephen explained in his remarks, we will reduce in Q4 versus Q3 our production rates, so therefore our inventory build. Leveraging, by the way, leveraging the seasonal, the calendar. We have a lot of many, many holidays in France in November. We have Thanksgiving in the US. We have the end of the year holidays. We will be therefore extending holidays shut down in order to produce less than in Q3, naturally, still producing a bit more than the delivery rate, but we're doing that once again in accordance with the flow, and we're doing that to basically maintain and maintain employees are very talented, experienced, and dedicated, you know, team across the world in Mexico, in the U.S., And in France, until, you know, we see a recovery rate from Cephron, an increase, a pretty quick recovery and return to service of the Boeing 737, right? Okay? Okay, thank you.

Thank you, Jeff.

I'll now go to the line of Jonathan Franzup. Please go ahead. Mr. Fransup, your line is open.

I think we should go on. Yeah, is there anyone operating? Is there anyone else in the queue?

Yes, I will open the line of Pete Skibiski. Please go ahead.

Hey, guys, just was wondering if you could give us the update on how the M&A pipeline is coming along, maybe how valuations look in this environment. That's it. Thanks.

Oh, the M&A, well, you know, listen, you heard certainly about what Dennis Willenberg said. M&A, sorry. Oh, I'm sorry. Oh, I'm sorry. You spoke about the M&A. I'm sorry. M&A, listen, we don't publicly disclose, of course, any... any potential strategic transaction, right? But as I've mentioned many times, we keep on exploring, we keep on exploring inorganic growth opportunities. Whether we act or not on it would depend on a variety of factors. Most importantly, how they would fit with our strategic and financial criteria, and as I've shared with many of you in the past, I mean, our strategic criteria are pretty clear. It really means looking at opportunities that would enhance our technology, that would fit well our existing competencies, thinking about potential product or differentiated materials adjacencies, process adjacencies, and also definitely targets that would bring very strong materials, product, process, know-how, and niche. as well as niche IP, right? That's really what we have been sharing with you right in the past in order to enhance, right, and increase our profitable growth. And on the financial criteria, you know, we want to be very cautious, very, very prudent, and we would be targeting, you know, strong IR, single, I mean... double-digit IRR, and we believe, Stephen and I and the entire team really believe, you know, in how could I say, in very well-defined synergies rather than models, I would say model synergies, right? So that's really what we do and what we're doing, and we are We have brought in, as you know, a very talented individual working for us who is basically devoted, this time he's devoted on exploring opportunities throughout all our end markets, especially aerospace. And we'll continue to do so, right?

Yeah, and from a valuation perspective, Pete, look, we've seen some assets transact lately at very high prices. There is one in particular in the you're really approaching the high teens when you put down multiple perspectives. Those are not prices that we are willing to chase. And so that may limit us in some opportunities. We may have to walk away because we're not going to chase prices like that. And it's nor are we, by the way, a bottom feeder that we're looking for, you know, just the lowest multiple asset out there, because as Olivier describes, we want high IP, we want high technology, which implies a fair and reasonable price. But we're not going to chase something up in the, you know, 15, 16, 17, 18 times EBITDA. That's just not the level at which we intend to transact.

I appreciate all the callers. Thank you. You're welcome.

There are no more calls. Thank you for Q&A.

Again, thank you all for joining us on the call. We really appreciate your time today and your continued interest in Albania International. I would like to conclude today's call by recognizing the entire Albania team for another very strong quarter of performance. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.