Albany International Corporation

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International Fourth Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. If you wish to ask a question during the call, please press 1 and then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. If you are using a speakerphone, please pick up the handset before pressing the numbers. If you should require assistance during the call, please press star, then zero. As a reminder, this conference is being recorded. Our knowledge in the conference over to our host, John Hobbs, Director of Investor Relations. Please go ahead.

Thank you, Grace, 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 purposes of this conference call, those same statements also 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 gap measures, please refer to both that earnings release as well as our SEC filings, including our 10-K. Now I turn the call over to Bill Higgins, Chief Executive Officer, who will provide opening remarks. Bill?

Thank you, John. Good morning. Welcome, everyone, and thank you for joining our fourth quarter earnings call. I'm happy to be here on my first earnings call as CEO of Albany, as I'm sure you saw in last night's press release. We delivered another strong quarter, capping a great year. While I let Stephen go through the details, let me point out a few highlights from the quarter and then give my perspective on our strategy and my priorities. The company delivered strong results in the fourth quarter and met or exceeded all the revenue and profitability guidance we had issued in our third quarter earnings announcement. I'm particularly pleased with the adjusted EBITDA margins in both segments. In the fourth quarter, We delivered margins of 35.1% in machine clothing and 22.6% in engineered composites. I'm also proud of the company's cash performance this year. The company generated over $130 million in free cash flow, and for the first time since beginning on our growth trajectory several years ago, the engineered composite segment delivered positive free cash flow for the year. I'd like to thank our employees across the globe for their contribution to the growth and success of the company. And while on the board, I've had the opportunity to visit our operations around the world, and I've been impressed with the talent and dedication I've seen. I'd also like to thank my predecessor, Olivier Jarreau, for his pursuit of operational excellence and contributions. As you may know, I've been on the Albany board since 2016 and was appointed chairman last year. I appreciate the trust the board has now placed in me, and I'm honored to be responsible for the success of this great company. In parallel with my transition and to ensure continuity and consistency at the board level, my predecessor, Herky Kilbourne, is stepping back into the role of chairman. I've known Albany for a long time. In fact, when I completed engineering school, what is now way too many years ago, I had a job interview with Albany in upstate New York. Preferring aerospace at the time, I went to work as a jet engine engineer at Pratt & Whitney Aircraft in their advanced technology group. Since then, I held a variety of technical, manufacturing, and business roles within Allied Sigla and Honeywell. And after Honeywell, I was privileged to serve as CEO and Chairman of Surcore International, a public company that is similar size to Albany, and like Albany, has global manufacturing businesses that serve both aerospace and industrial end markets. So I bring to this role not only prior experience as a public company CEO and as a director on multiple public company boards, but also considerable experience with our markets, technology, and operational excellence. With the full support of the board, I intend to continue executing on the two-pronged strategy that was first established by the company several years ago. First, we'll continue to focus on growing our engineering composites business. While there are obviously near-term challenges driven by the ongoing grounding of the Boeing 737 MAX fleet, our longer-term vision and objectives have not changed. Most important, we need to continue to perform on our LEAP contract with Saffron to support both the continued ramp on the LEAP-1A engine for the Airbus A320 NEO family and the return to future ramp that will be required for the LEAP-1B engine once the Boeing 737 MAX returns to production. Saffron is a critical customer of ours with whom we've had almost a 20-year history. We deeply value the relationship with Saffron and look forward to strengthening it further over time. We'll also continue to grow the balance of our engineered composites business by ramping with our existing platforms, by winning new competitions, and by finding new applications for our industry-leading composite technologies across addressable market segments, including the next generation of commercial aircraft. The recent announcement of Albany's participation in the Airbus Wing of Tomorrow collaborative development effort is testament to the value that our technologies offer additional customers in the future. This proven strategy remains sound, and we believe it will deliver strong long-term returns to our shareholders. Second, we'll continue to solidify and build upon our leadership position in the machine clothing segment. We're the clear leader based on our technology and the strength of our offerings to our customers in the paper machine clothing market. That said, we're not resting on our laurels. In order to maintain our PMC leadership position, we're constantly investing in this business, leading to new product solutions to meet our customers' changing needs, to new manufacturing processes, and to improve support for our customers. We expect to continue investing in machine clothing consistent with past investment levels to maintain our leadership position and profitability. This two-pronged strategy has served our shareholders well. Today we have two strong, profitable businesses – In 2019, our machine clothing segment performed extraordinarily well, delivering even higher-level EBITDA than we had expected after a very strong 2018. The engineered composites business, even with the challenges caused by the 737 MAX situation in the back half of the year, delivered over $100 million of EBITDA and, for the first time ever, delivered positive free cash flows. We continue to believe that at this time, given the technology overlap and resource sharing of people, ideas, and funding between the two businesses, we're stronger as one Albany. So with that continuation of our existing strategies in my backdrop, my priorities for the business are threefold. First, I'll continue to focus on operational improvement across both segments that has helped drive the improvement in our financial results over the last few years. I'm fortunate to have two strong operational leaders who themselves are supported by strong teams. Daniel Heftermeyer has a long history of driving continuous improvement across the machine clothing segment. The strong margins that the segment has delivered demonstrate our commitment to delivering shareholder value. Leading the engineer composite segment, we're now fortunate to have Greg Harwell, who joined us late last year. Greg brings extensive experience managing and operating global aerospace businesses. Second, we'll continue to focus on growth with a renewed focus on winning new business in the engineered composite segment. Not too long ago, we were in a position where we had won so much business on LEAP, on the F-35, on the 787, on the CH-53K, that we had to demonstrate to our customers our ability to ramp and execute on those programs before expecting them to trust us with additional work. We've accomplished a lot, are tracking well on existing programs, and are actively pursuing and winning new opportunities in aerospace. Third, I firmly believe in our long-term vision to advance the state-of-the-art in composite technologies and find new applications in aerospace and beyond, as well as to maintain our leadership position in machine clothing. I believe that successfully executing on our vision represents a tremendous opportunity for our shareholders. We'll continue to deploy return-seeking capital to maintain our leadership positions and to drive organic growth. We've achieved strong returns for our shareholders from the investments we've made in working capital and capital expenditures across both of our segments. At the same time, we've got the balance sheet and wherewithal to complete acquisitions that extend our capabilities and support our strategy. In fact, we've recently completed a small high-tech acquisition in Germany, Surcon, which brings us new technologies and capabilities. However, our strategy doesn't depend on completing acquisitions, and we're not prepared to chase some of the pricing we've seen in the M&A market. we do not believe that it would be a prudent use of our shareholders' capital to overpay for assets. Looking forward to 2020, our strategy is continuing to bear fruit. We expect another strong year with continued high margins for our machine clothing business, and but for the current production health in the 737 MAX, we would be expecting to provide guidance for the AEC segment that meets, in the case of revenue, or even exceeds, in the case of margin, the long-term 2020 objectives we established and published for that segment several years ago. However, the continued grounding in the recent suspension and production of the Boeing 737 MAX will obviously have an impact on our 2020 financial results. The 737 MAX, through the work we perform on LEAP-1B engine components, is a very important program for Albany. While we're heartened by the public reports of Boeing's progress toward safely returning the 737 MAX platform into service, there continues to be a significant lack of clarity into the return-to-service timeline and the subsequent production ramp for the aircraft. While I do not have any additional insight into the status of the program beyond public reports, we believe that our guidance for 2020 reflects a realistic approach with respect to the demand for the LEAP 1B components in 2020. In 2019, we were able to overcome the impact of a 737 MAX grounding through a combination of overperformance elsewhere in AEC, build ahead of LEAP finished goods inventory, and the structure of the LEAP contract with Saffron. However, in 2020, the magnitude of the impact of the 737 MAX will be too large for us to overcome, resulting in a material reduction of AEC revenues in 2020 compared to the long-term 2020 objectives we established several years ago. It's important to note that notwithstanding this impact, the balance of AEC is continuing on its growth trajectory, and also the guidance for 2020 reflects adjusted EBITDA margins for the segment higher than than those that had been reflected in our long-term 2020 objectives. These are both strong indicators that our strategy for AEC remains sound, that the revenue reduction in our 2020 guidance is only because of the 737 MAX grounding, and that the long-term outlook for the business remains strong. On a separate note, we're, of course, monitoring the coronavirus situation in China. As you may be aware, we have two large machine clothing manufacturing locations in China. Our first priority is the safety and well-being of our employees at those facilities, and we've taken actions that we felt were appropriate to help mitigate the risk to our employees. Both of our facilities have been significantly impacted by the ongoing situation, so we're seeing a real-time impact of the situation on our machine clothing segment's performance. If the travel and work restrictions were to continue for a meaningful period, not only would that significantly exacerbate the impact on machine clothing and force us to execute contingency plans, but we would also likely see an impact on the aerospace industry demand and global supply chain, which could start to impact the energy and composite segment. At this time, it's too early and there are too many unanswered questions for us to size the full potential impact on the company's 2020 results. However, we have incorporated that the guidance Stephen will provide, the direct impact we're seeing on the current disruption. With that, I'd like to turn the call over to Stephen, who will provide more details on the quarter and our initial guidance for 2020.

Stephen? Thank you, Bill.

I will talk first about the results for the quarter and then about our initial outlook for our performance in 2020. For the fourth quarter, total company net sales were 257.7 million, an increase of 2.4% compared to the 251.6 million delivered in the same quarter last year. Adjusting for currency translation effects, net sales grew by 3% year-over-year in the quarter. In machine clothing, also adjusting for currency translation effects, net sales grew by 0.7%, driven by strong growth in tissue and packaging grades, partially offset by declines in publication and pulp grades and in engineered fabrics. Engineered composites net sales, again after adjusting for currency translation effects, grew by 6.4%, primarily driven by growth in the CH53K program. The acquisition of Surcom, which was completed in the back half of the fourth quarter, contributed an immaterial portion of fourth quarter AEC sales. Fourth quarter gross profit for the company was 96.6 million, an increase of 9.9% over the comparable period last year. The overall gross margin increased by 260 basis points, from 34.9 to 37.5% of net sales. Within the MC segment, gross margin improved from 48.6% to 50.2% of net sales, principally due to reduced depreciation expense. Within AEC, the gross margin improved from 14.5 to 19.6% of net sales, driven by a $3.3 million favorable net change in the estimated profitability of long-term contracts, by higher net sales driving increased fixed cost leverage, and by improved labor productivity. Fourth quarter selling, technical, general, and research expenses increased from $48.7 million in the prior year quarter to $51.3 million in the current quarter, and also increased as a percentage of net sales from 19.3% to 19.9%. The increase in the amount of expense was driven primarily by the revaluation of non-functional currency assets and liabilities, which resulted in a loss of $1.4 million in Q4 2019, while it had only a negligible impact in the same period last year, and by $600,000 in expenses related to the acquisition of Surcomp, including just over $100,000 of the deferred purchase price, which is being treated as an expense for GAAP purposes due to the fact that its payment is dependent on certain future obligations being met. These increases were partially offset by a decline in R&D expense for the quarter. Total operating income for the company was $43.6 million. an increase of 16.5% from $37.4 million in the prior year quarter. Machine clothing operating income increased by $3.4 million, driven by higher gross profit and lower restructuring expense, partially offset by higher STG&R expense, while AEC operating income grew by 63.8% to $10.9 million, driven by higher gross profit partially offset by higher restructuring and STG&R expense. The income rate for the quarter was 24.8%, compared to 37.9% in the same period last year. Discrete tax items and the change in the estimated annual income tax rate reduced income tax expense by 1.3 million in Q4 2019, while the same factors had increased the expense by 1.8 million in Q4 2018. Net income attributable to the company for the quarter was 29.1 million, an increase of 65.7% from 17.6 million last year. The increase was driven by the improved operating income and the lower tax rate. Earnings per share was 90 cents in this quarter compared to 55 cents last year. After adjusting for restructuring expenses, the impact of foreign currency re-evaluation gains and losses, pension charges related to de-risking initiatives, and expenses associated with the Surcomp acquisition, adjusted earnings per share was $0.97 this quarter compared to $0.69 in the comparable period last year. Adjusted EBITDA grew 10.8% from last year to $63.9 million for the most recent quarter. Machine clothing adjusted EBITDA was 52.8 million, or 35.1% of net sales this year, up from 51.2 million, or 34% of net sales in the prior year quarter. AEC adjusted EBITDA grew from 18.1 million, or 17.9% of net sales last year, to 24.2 million, or 22.6% of net sales this quarter. Turning to our debt position, total debt, which consists of amounts reported in our balance sheet as long-term debt or current maturities of long-term debt, remains steady at $424 million at the end of Q4 and cash increased by about $22 million during the quarter, resulting in a reduction in net debt of about $22 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 finish the quarter with a leverage ratio of 1.35, while disregarding the limitation on cash netting results in an absolute leverage ratio of 0.89. Our reduction in net debt this year has been in part driven by our working capital initiatives, partially offset by a significant working capital investment in the LEAP program. primarily to support the build-up of finished goods inventory in the back half of the year. For the full year, net cash provided by operating activities increased from $132 million in 2018 to $200 million in 2019. Also for the full year, free cash flow, which we define as net cash provided by operating activities less capital expenditures, increased from $50 million in 2018 to to $132 million this year. I would like to point out that, as Bill alluded to in his remarks, this cash performance included AEC delivering positive free cash flow for the year in spite of the LEAP working capital investment. Capital expenditures in Q4 2019 were about $19 million, reflecting continued investments in equipment to support multiple ramp-ups in AEC. We mentioned last quarter that capital expenditures for the full year would be lower than initially expected, driven by the timing of some projects, some of which will now be completed in 2020, and that the lower level of spending does not represent any material change in our investment plans or priorities. Overall, across both segments and all metrics, we were very pleased with the performance of the business last year. Looking forward to 2020. As previously discussed on prior calls, machine clothing faces its ongoing weakness in its end-use markets, where the latest RISI data suggests that in the third and fourth quarters of 2019, global production of paper and board products declined by between 2% and 2.5% on a year-over-year basis, with declines in North America, Albany's most important market, of over 5%. As Bill indicated earlier, while we cannot yet anticipate the full impact to the segment of the coronavirus situation in China, we have also incorporated into our expectations a modest impact from the current disruption to those operations, assuming that those operations face some degree of disruption for about four weeks. To put this impact to our Chinese operations in perspective, we disclosed in our 2018 10K that our sales directly to customers from operations in China were around $50 million. And while we have yet to disclose them, our equivalent sales in 2019 were roughly similar. Our overall expectations for the machine clothing segment take into account the anticipated impact of machine clothing demand of the lower level of paper production globally over the last few quarters, the current impact of the coronavirus situation I just referenced and the impact of ongoing currency weakness in several markets where we generate machine clothing revenues in local currencies. As a result, we are guiding 2020 revenues for the segment of between $570 and $590 million. However, notwithstanding the slightly weaker revenue compared to 2019, we still expect the margins to remain very robust and are guiding 2020 adjusted EBITDA for the segment of 190 to 200 million. Before I provide 2020 guidance for AEC, it may be helpful to highlight a few items from AEC's 2019 results. First, in 2019, including the impact recognized in the fourth quarter, we recorded a cumulative total of over $12 million in net favorable changes in estimated long-term contract profitability. This resulted in both recognized revenue and gross profit of $12 million in 2019. While we review the estimated profitability of long-term contracts every quarter, any changes recognized as a result of that process may be either favorable or unfavorable, and we've seen changes in both directions over the last several years. These adjustments to profitability are usually difficult to forecast. However, these types of benefits are unlikely to be recorded in the same magnitude in 2020 as we recognized in 2019. Second, in 2019, the full impact of the grounding of the MAX fleet and Boeing's subsequent decision to suspend production of the aircraft had yet to be felt in our results. In 2019, we recognized LEAP revenues in our Albany-Safran joint venture of just over $210 million. Of this, just over 60% or almost $130 million was recognized on LEAP 1B components destined for the 737 MAX with a balance related to the LEAP 1A engine. The outlook for components for the LEAP 1A variant that powers the A320neo family remains strong. However, as Bill mentioned earlier, there is a continuing lack of clarity into the return to service timeline and subsequent production ramp for the 737 MAX. We believe that our assumption with respect to demand from our customer for LEAP 1B components this year, which is at a level much lower than in 2019, is realistic, but it remains uncertain. This reduced demand expectation will drive significantly lower levels of production of LEAP 1B components. A secondary but less important driver of our LEAP fan case, blade, and space of production levels in 2020 relates to the finished goods inventory we had on hand at the end of 2019. As we have previously disclosed, in the second half of 2019 we made a decision with the full support of our customer Safran and based on our mutual expectation that the return to service of the 737 MAX was only months away, that in order to minimize any workforce disruption at our ASC facilities, we would maintain a production rate of components for both LEAP 1A and LEAP 1B variants at a rate higher than would meet Safran's immediate demand and would allow for a modest increase in finished goods inventories. Due to the current gap revenue recognition requirements for contracts like our LEAP contract with Safran, we were required to recognize revenue on those components at the time of production rather than at the future point of delivery, resulting in the recognition of those revenues in 2019 and the reporting of the finished goods inventory on the balance sheet as a contract asset. As a result of this action and in line with our expectations from the time we made this decision, we finished 2019 with sufficient finished goods inventory on hand to support 50 aircraft from the Airbus A320 family and 100 737 MAX aircraft. However, as you all know, Our expectation for a near-term return to service for the 737 MAX was not met. And in fact, Boeing announced a pause in production of the aircraft in December. Following Boeing's announcement in early 2020, we reluctantly began to implement reductions in force at our ASC facilities. We are now assuming that during 2020, we will start to burn down the excess finished goods inventory for both Leap 1A and Leap 1B in place at the end of 2019, which will flip the impact we saw in the back half of 2019. This finished goods inventory burndown will result in recognized revenues in 2020 that are lower than actual shipments to our customer in the same period. I would like to point out that the structure of our contract with Safran, where we recover actual costs, means our revenues will not go down directly proportionally to any reduction in the quantity of produced LEAP 1B components, since a portion of the revenue recognized on those components in 2019 was related to fixed costs and associated fee. If, as expected, we deliver fewer LEAP 1B components in 2020, those fixed costs will be absorbed by and recovered on the remaining LEAP 1A and LEAP 1B components that are produced in 2020. However, we will experience a reduction in ASC revenue caused by the absence of the variable costs and associated fees that we had incurred in producing the higher quantity of LEAP 1B components in 2019. Third, outside of the ASC joint venture, We do also support the LEAP program with traditional laminated composites under another small fixed price contract. While we would have previously expected revenues from this program to grow in 2020, in line with the expected ramp for both LEAP 1A and LEAP 1B engines, we now expect 2020 revenues from this program to decline by $5 to $10 million compared to 2019. I would like to point out that much of AEC is performing in line with or ahead of expectations. In fact, as Bill mentioned earlier, were it not for the 737 grounding and production flaws, our AEC guidance for 2020 would be at or above the prior long-term objectives we had set for the segment. For non-leap programs overall, we are experiencing significant improvements in 2020. Additionally, we expect that the segment overall even after the impact of the 737 max slowdown, will, for the second year in a row, generate positive free cash flow in 2020. However, the impact of the three factors I just discussed, the absence of net favorable changes in estimated long-term contract profitability in our expected 2020 performance, the lower revenues for the ASE joint venture, and the lower revenues from the smaller fixed-price LEAP program, are too great for those other improvements to offset. As a result for 2020, we are guiding AEC revenue of 400 to 420 million and AEC adjusted EBITDA of 80 to 90 million. At the total company level, we are also providing initial 2020 guidance as follows. Revenue of between 970 and $1.01 billion. adjusted EBITDA of between 210 and 235 million, an effective income tax rate, including tax adjustments of 26 to 28%, depreciation and amortization of between 750, or sorry, between 75 and 80 million, capital expenditures in the range of 75 to 85 million, gap earnings per share of between $2.69 and $3.08, and adjusted earnings per share of between $2.75 and $3.15. The difference between our GAAP and adjusted EPS guidance ranges represents a known charge, which will be recorded in Q1 of $3 million related to severance payments for our outgoing CEO. While we do not formally guide R&D spending, I would like to note that we do expect to increase R&D expenditures in 2020. Most notably, in the engineered composite segment, we will continue to demonstrate the applicability of our advanced and unique composite solutions to the production of a variety of aircraft components to support our customers' needs. As Bill mentioned earlier, our long-term vision for success in that market has been unaffected by the current 737 MAX situation and we are continuing to invest in support of that vision. We continue to believe that the strategic outlook for both of our segments remains strong and will lead to significant long-term value creation. With that, I would like to open the call for questions. Grace?

Thank you. Once again, ladies and gentlemen, if you wish to ask a question, please press 1 and then 0 on your telephone keypad. And our first question is from John Franzer with Seidati and Company. Please go ahead.

Good morning, Bill and Steven. Welcome back, Bill. Thanks, John. Good morning. My first question is embedded in your guidance, how long do you assume the production halt will continue for the MACs?

So, John, thanks for the question. In terms of the 737 MAX, our guidance, and, John, I know if you can put your phone on mute because we're getting some background noise, our guidance is based not on necessarily any expectation of what Boeing does with the 737 MAX program, either in terms of its return to service and the subsequent production ramp, Our guidance is based more on an expectation of demand we anticipate seeing from our direct customer, Safran. So it is somewhat removed. There are various levels of removal from, you know, what Boeing does to what Safran does in terms of, as we say, not only Boeing's return to service and Boeing's clearing of the backlog of existing aircraft out in, and also aircraft that is yet to deliver, but also clearing through of the backlog of finished goods inventory that lies not only on our books that I discussed, but also within the supply chain within the SAPRAM and CFM joint venture.

Thank you and next we'll go to the line of Christine Leweg with Bank of America. Please go ahead. Hi, good morning guys.

Good morning.

For the 737 MAX, what production rates will you be producing through 2020 and at what point do you restart production and what rate are you producing?

Yeah, so as we've discussed before, at the request of our customer, we do not talk about our specific build rates for the 737 MAX. And so I can't answer that question directly. We are still in production for LEAP 1D components. So near today, we are still producing, but obviously at a much lower rate than we had previously been producing. which is, you know, not only a result of the demand from our customer, but also exacerbated, as I mentioned, by the finished goods inventory we already have on hand, on which we have already recognized revenue.

I think, Stephen, it's probably important to emphasize, too, just as we noted in our comments, the lack of clarity. It really is difficult as we look at the year to try and figure out exactly what it will be. So we've taken an approach we think is a realistic approach, and it's probably something we'll just have to update everyone on as we go through the year.

Thanks. And in the non-AEC portion of engineered composites, can you discuss your cost-cutting initiatives there and how we should expect you to balance growing F-35 rates but declining 787 rates? How does that net out?

Yeah, as we mentioned, we have a number of programs that we're ramping up on right now. So we're watching each of those. We're watching the 787 and how that will play out. But we also have growth programs. So we'll be shifting appropriate workforce as needed as the growth shifts.

I will point out that outside of LEAP 1B and the impact of that program, on our AEC results, the balance of AEC. We anticipate double-digit revenue growth in 2020, and that is embedded in our guidance.

Thank you. And then, taking gears to machine clothing, Bill, you mentioned that you have two facilities in China that could have been affected by coronavirus. Can you quantify the magnitude of the possible effect of this? And when, you know, should we see some resolution on when activities normalize is there a dollar amount that you can save, too, in terms of per quarter? And then also once things normalize, do you expect to recover all of that so that the full year is intact?

It's really hard to make a call right now because the situation is so fluid. We do have two facilities there. One is basically shut down. The other is running at a very small rate. And then there's the logistics problem of shifts and delays. Shipping is just not running yet, so we're just going to watch it as we go.

I don't know if we want – Yeah, in terms – so, Christine, to answer your dollar question, as I've mentioned in my remarks, last year we disclosed we generated roughly a million dollars a week of sales from Chinese operations directly to customers. We're seeing kind of two types of impacts right now. One, we're seeing reduced sales, obviously – So not only are we shut down, but our Chinese customers are shut down. So sales to Chinese paper mills or any of our other Chinese customers, obviously on hold, and that's causing a direct revenue impact. The secondary impact we're seeing is there are some products which go from outside of China from those Chinese facilities, some elsewhere in Asia and some even to Europe. Those customers still need those products. We are having to come up with – contingency plans for reduction of those products, which is causing that product to be produced at a higher cost than it would have been produced in China, which is causing additional EBITDA impact beyond the revenue hit we're seeing from just the overall slowdown in China.

Thank you very much.

Thank you, Christine.

Thank you. And next we'll go to the line of Pete Sabitsky with Alembic Global. Please go ahead.

Yeah, good morning, Bill and Steven. So understanding, you know, confidentiality with the customer and stuff, but to that end, to go further on the LEAP 1B, guys, should we expect first-half revenue? You know, just to talk about timing, should first-half revenue at AEC be, you know, fairly, you know, meaningfully below second-half revenue? No.

That depends on, you know, too many unknowns, quite frankly, Pete, because we really don't know, as Bill had alluded to, when we're going to be able to step up production rate. So I don't think – I think it's too early to say that, given the uncertainty around League 1B.

Okay, okay. And then I was just curious about free cash flow conversion rates. Steven, just given it sounds like you did have the big working capital build that it sounds like it'll reverse. I'm not exactly sure of the timing, but are you expecting free cash conversion to be maybe greater than one this year, given the working capital build from last year?

We obviously had very strong free cash flow conversion in 2019. We expect another strong year in 2020. We don't guide free cash flow, so I'm not going to you know, to tell you whether it's, you know, above or below one. But it should be a strong year. We certainly will see some unwinding of the working capital position we've taken in LEAP. And obviously, the balance of AEC delivered very meaningful cash in 2019, given the segment overall was positive free cash flow. And obviously, as always, machine clothing was a very strong cash generator, and we expect that to continue in 2020.

Okay. Okay, great. And maybe one for Bill. Bill, in your opening remarks, you kind of were alluding to, you know, the M&A market being a little pricey, but it sounds like you were really looking at, you know, kind of new bids on projects on kind of current aerospace platforms. And I'm not sure whether that's more commercial and realtor or not, but how, you know, kind of active is the new bid opportunity set? How How, you know, in terms of the size, how big is the new opportunity set? I'm just curious because, you know, a lot of these programs are very long-lived, and so, you know, we don't necessarily see a lot of new opportunities at the high level, but maybe at your level they're more active. So I'm just curious as to what you're seeing there.

Well, and as we announced, Pete, the – the wing of tomorrow is it's a long-term program. So it really speaks to the long-term technology investment and our belief in the technology and our customers' expected benefits from the composite technology. So we'll keep working on it. We're working on other long-term opportunities. We'll disclose them when our customers are ready to do that. But in nature, I would say they're longer term. They're not something that's going to happen within a year.

But there is a fairly full pipeline, though, and we were successful in some opportunities in 2019. But to put these in context, these tend to be ones which are either military in nature, which means they're by somewhat definition smaller because the build rate is lower, or they're takeaways from another supplier. And these programs tend to be smaller. These are certainly not LEAP-type programs. that we're pursuing and winning right now in terms of its revenue impact. But they are meaningful. Some of them are certainly in the $10 million to even $30 million of revenue per year we could potentially get out of these programs that we're chasing today. And given the size they see, we only need to win a handful of those every year to have a meaningful impact on our growth rate. Okay.

Okay. That's great. That makes sense. Thanks for the call, guys. Thank you, Pete.

Thank you. And next we'll go to the line of Peter Arment with Bayard. Please go ahead.

Yeah, thanks, Maureen, Bill, Stephen. Hey, Stephen, just a quick one on the forecast for machine clothing. The global production, you said, down 2% to 2.5%, 5% down in North America. Have you already started to see weakening order rates from North American customers? Yes.

You know, it's tough to tell right now here in Q1, I do say. The early part of Q1 is always fairly weak in order flow. It's an order where, and I haven't lived through this before, typically, you know, the corporate staff starts to feel panic at the lack of order flow, and it all comes in the back half of Q1. So it's a little early to tell right now. It is a little weaker today. at this point in Superfund that we would ordinarily expect service to be. But it's not service needed for this. And, you know, obviously, you know, this is not like aerospace. We get orders with very long lead times. These are fairly quick-turning orders. And so it's not, we don't typically carry a large backlog.

Okay. No, that's helpful. And then just quickly on AEC, I know we've talked a lot about leads. Are you getting more pull, though, at least to fill in for the LEAP 1A from your customer? I know there was expectations that they were going to accelerate some production on their end.

So LEAP 1A is certainly up from 2019, absolutely, and we're seeing some modest increases in LEAP 1A demand. I think there are a couple of factors going on. One, as we've discussed before, if you look at some of the more recent orders for the A320 NEO family, the proportion of those aircraft which are LEAP-powered, as opposed to being powered by the alternative engine, has increased over time, and therefore we would expect to see, even for the same A320neo build rate, a larger number of LEAP-1A engines being produced. And secondarily, Airbus has talked about increasing the actual build rate of the A320neo. Now, that takes time. I don't think it's It's reason to expect to see the impact of a higher build rate of A320neo in our current numbers. The global supply chain for aerospace takes time to move, and I'm sure Airbus will trickle it up over time, but we're not seeing that impact today.

Yeah, I was going to add, Stephen, to answer the question, I don't think we're seeing an impact to the max order rate slowdown or the production rate slowdown, and is there a competitive reaction on the A320? We're not seeing that yet. There is an increase in elite business, elite 1A.

Okay, that's helpful. Yeah, Bill, maybe just a quick one for you. Given that, you know, you were on the board and you've had kind of a front row seat of the improvements, you mentioned operational improvements where you're expecting for both segments to continue. Maybe just give some perspective on, you know, kind of the runway that's still in front of the front from your seat now.

Yeah, we're going to continue to focus on operational improvements. We've got strong teams in place, a number of leaders put in place last year. There's still plenty of opportunity to continue improving quality, performance, cost, productivity, service to our customer. You know, we've got, I'll say, the foundation there, but there's still a lot more work to do on top of that.

Appreciate it. Thanks for all the comments.

Thank you. And next we'll go to the line of Patrick Bowman with J.P. Morgan. Please go ahead.

Oh, hi. Good morning, gentlemen. Just maybe starting with, you know, the midterm 2020 targets that you guys have provided some time ago, I think you had mentioned that you'd be at or above those numbers absent these max issues. Is there any reason to believe that when max gets back to where it was supposed to be that you won't be able to achieve those levels. I guess I'm asking, is the supply chain impaired in any way from the issues, such that it would make it difficult to normalize back to what you thought the impediment might be for that business? I'm talking about, you know, the $500 to $550 in revenue and $100 in EBITDA, as you guys said, you know, put out there, I guess, a couple years ago.

Certainly, just taking them in reverse order, certainly the EBITDA guidance range of the 18% to 20%, our guidance that we are providing for 2020 certainly implies a rate above that 18% to 20% range. So we don't see a challenge with that. In terms of 500 to 550 million of revenue, we do not see anything which has permanently impaired the business in any way. We do see this as a short-term effect. Obviously, we're not guiding beyond 2020, so I'm not going to – predict the future, but there's nothing in what we're seeing right now which should be lasting in nature. It is directly driven by reduced demand for LEAP-1B engines caused by the 737 grounding and production pause, and that should reverse itself once the 737 comes back online.

Okay. Any update on progress for the GE-9X for the 777?

So we are obviously in low-rate production of the aircraft. We are very pleased to see the first flight of the 777X here, you know, a month ago or so. And so we expect to be producing that this year. There was a delay in that program. It slipped about 12 months to the right, which obviously impacted our production ramp. But we are expecting to increase production this year in that program in line with our customer's demand. We are facilitating for that ramp, and there are no particular challenges in that program today.

And then what about the 787? What's the outlook for that within your business for 2020?

Yeah, obviously there have been the two step-downs, 14 to 12, 12 to 10, and that will not have any material impact here in 2020. There could be some impact in 2021. But it does depend on the mix of aircraft. As you know, there are three variants for the 787. We provide frames for two of the three variants today. And so it really depends on the production mix in a given year how significant that impact would be. Even worse, though, to all be felt in our variants, It is not as if it would have a material impact on our overall AEC revenues. It's an important program, but it is, you know, much, much smaller than LEAP, obviously, and one of a handful of other significant programs in that, but not significant enough that any reduction of program is going to materially drive revenues up or down.

Well, maybe if you could just, and the last one for me, by order of importance, I think you mentioned the double-digit revenue growth you expect for the segment, the euro segment, excluding saffron business for 2020. So by order of importance, what are the big drivers? Maybe you said this earlier, and then I just missed it. What are the big drivers of that double-digit growth program-wise?

Yeah, so we don't get into guiding specifically by program, but outside of LEAP, the other big programs we have in AEC are 787, CH-53K, the F-35 program, JASM, which is the Joint Air-to-Surface Standoff Missile for Lockheed Martin, our Waste Water Tanks program for Boeing aircraft, And then a variety of smaller programs. Those are our most significant programs, and the bulk of the growth will be coming out of those programs.

Okay. Very good. Thanks a lot. Good luck.

Thank you.

Thank you. And we do have another question from John Fransroad. Please go ahead. Thank you.

Yeah, I'll ask quickly and mute myself again. But could you just discuss, it's been over a year that you're in Michigan. How has that impacted the pricing environment in machine clothing? And secondly, recycled pulp has come down considerably in pricing. Has that impacted your customer spending or demand at all? Let's talk to those issues. The margin profile in machine clothing remains outstanding. I just wanted to get your thoughts on that.

So thanks, John. So in terms of the Xerium acquisition, obviously that was, as you say, completed some time ago. We have not yet seen a significant impact in the market. It obviously strengthens that competitor of ours. Xerium is a strong competitor, and they remain a strong competitor in the market. The pricing environment in machine clothing has been fairly stable, but we are always very mindful of that and watch it. We have not seen significant impacts of that yet. In terms of your question about pulp, and the pricing is obviously down, we've seen a bit of a shift. with some of our pulp customers, the markets for our products that they acquire being down somewhat at various points in time during the year, but not material at the top line level when we roll it all up. It hasn't meant a material shift for the year. Overall, during the most recent year, pulp was up for the year, compared to 2018, slightly low single digit growth in pulp for the year on a constant currency basis. The bulk of the growth, as we typically see in the machine clothing business, was driven by primarily growth in packaging and tissue with, again, for the full year, as you would expect, full year declines on a constant currency basis in publication grades of roughly 10% for the year. But we did see some growth in pulp for the year. So while there were a specific customer impact of what you talked about overall that didn't affect our top-level sales.

Thank you. And next, we'll go to the line of Radham Kahana with Cowan Company. Please go ahead.

Hey, thanks. Good morning, guys.

Morning, Gotham. Morning.

Great. Hey, thank you. So... A couple questions just for clarification. First, in terms of EAC adjustments, Stephen, what are you expecting in the guidance for 2020?

We typically take a neutral stance on EAC adjustments, really don't embed them either positive or negative in our planning. As we've seen in the past, we've had years where we've had significant unfavorable adjustments We were very fortunate. And fortunate is probably the wrong word because it's due to the hard work of our employees and leaders in the business. But we enjoyed some very favorable adjustments this year. But in a typical year, we would assume a neutral position.

Okay. And then you gave some color on the LEAP 1B revenue last year at $130 million. And then you made a couple comments. Something was down $5 to $10 million, and I wasn't clear if that was the 1B component's that was not in the 130? And maybe can you just frame what you're anticipating, what revenue expectations embedded in the EC guidance for 1B revenue in 2020?

Thanks, Gotham. So to answer your two questions, the first part, the reduction of 5 to 10 million, we have a small program that, you know, a customer request we don't typically talk about externally and I don't divulge the exact nature of the program, which is a fixed price contract for traditional laminated, so 2D composites. So this is outside of the Albany Safran joint venture. We would have expected that program to grow from calendar 19 to calendar 20 in line with just the ramp of LEAP. In fact, that program is declining by about 5 to 10 million from 19 to 20. So that's the first question. So this was not in the 130, because the 130 was only LEAP 1B revenues within the Albany Safran joint venture. To answer your second question, in terms of LEAP 1B revenues for calendar 2020, we're not going to break those out. They are clearly down appreciably, very significantly from 130 we recognized in 2020. But we don't want to get into issuing guidance down at the product line or business unit level. at the segment level is as low as we're comfortable going.

Okay. Can you give us some framework on how much the EBIT dollars associated with the 1B reduction compares to that of the revenue decline? Obviously, it won't be as big, but any order of magnitude? So, look, as you see, so if we look at 2019,

and if you strip out $12 million of profit and revenue associated with the EAC adjustments we just talked about, you're going to come out with, depending exactly how you do the calculation, an EBITDA margin for the year somewhere north of 20%, in the 20.3% to 20.5%. The midpoint of our guidance on AEC for 2020 implies that an EBITDA margin for 2020 of 20.7%. So north of 2019. So basically what that tells you, since we said we weren't assuming EAC pickups in 2019, we're assuming that the margin overall expands. Embedded in that is an assumption that while the revenue will go down within ASC as a result of the LEAP-1B productions, our EBITDA margin, certainly our gross margin that that business will generate, will not decline appreciably. As we've talked before, given the cost plus nature of that business, our gross margin percentage is relatively immune to shifts in volume. And I think relatively immune, there can be slight changes, but relatively immune, it's fairly stable. So our Dollars of profit, gross profit dollars that the ASE business generates will go down, but effectively pro rata with the revenue line. So we will see a percentage reduction in gross profit consistent with the percentage reduction in revenue we're seeing, and that's because we will still absorb our fixed cost over the remaining business, so we'll not see any margin compression within that business.

Okay, and my last one, sorry, is just on re-ramping. now that you've had some workforce reductions, what is your level of concern about, you know, Albany's ability to re-ramp? You know, obviously these decisions are made with some production ramp in mind, you know, what that profile looks like. But in terms of your ability to kind of hire those folks back, preserve learning curves, I'm just wondering how this impacts kind of your longer-term thinking on the margin profile of this contract? I mean, does it severely impair, you know, the ability to get to a point where you're in a position to negotiate a fixed-price contract down the road? I mean, I'm just curious, how do you think about re-ramp potential given this?

Yeah. Let me try that a little bit. I think the words we used are reluctance to reduce the workforce contract. was precisely because of some of the reasons you state. It's a growing business. It's a developing technology we have a lot of promise with, so we wanted to keep the expertise that we've developed and continue to develop. As Stephen went through in detail, the production of the inventory at the end of 2019 provides us with some time as we burn off that in our assumption we're producing today, Leap 1B, but we'll also have the inventory that we can burn off as we go through 2020, we believe gives us enough time to look ahead and see as the ramp comes to shift people around and bring people back on as needed. So we've given that a lot of thought. You know, if it was a more normal business, we probably would have taken deeper cuts, but we're We're trying to protect the production capability and the technology as we go forward.

Thank you. Thank you, Bob.

Thank you. We'll go back to the line for Patrick Baumann. Please go ahead.

All right. Thanks for sticking in here. I just had one quick follow-up. When you said the arrow business was free cash flow positive for 19 and you expect it to be for 20, I just want to be clear on the definition. How do you build to that? Is Is it EBITDA minus CapEx, and if it's more than that, how do you treat, like, you know, all the other components like corporate, and how do you allocate all the other stuff, working capital and taxes and all that stuff? Very good question.

No, very good question. So our free cash flow for this purpose is just the free cash flow from operations for that business, less CapEx for that business. So this does not include the corporate elements. And so it's, you know, leaving aside for a moment that free cash flow is not a gap measure. This is even, you know, kind of less of a gap measure, which is why we're not giving you actual hard numbers, because it is somewhat artificial at the business level. But it just says at the end of the day, that business sent corporate a check for cash at the end of the year, which was very positive. In prior years, it has consumed, you know, as much as, you know, $50 million of cash in a given year. So it has been a remarkable turnaround for that business.

Okay. So the statement is basically an EBITDA minus CapEx number.

No, no, no, not EBITDA. Free cash flow from operations less CapEx. So not EBITDA. So it's much more of a true cash flow measure than EBITDA minus CapEx. So it is, you know, the operating profit less all of the changes in working capital for that business less CapEx.

Oh, got it. Okay. Okay. But it's excluding, you know, the, you know, the corporate is what you said. Got it. Okay. Exactly. Yeah. Understood. And then as you look at 2021, like as you ramp back up, you know, hopefully with Safran, with the max, would you expect to be able to say that again at that point? Or is this a function of kind of, you know, a little bit of a pause in the growth trajectory more than, more than kind of a statement on, you know, the business itself?

So obviously we're not guiding 2021 and beyond, but I would say that the positive cash flow we expect in 2020 is not really a result of the pause. It's more a result of the underlying strength of the business.

Okay. Thanks so much.

Thanks, Pat.

Thank you. And I have no further questions in queue at this time.

All right. Thank you, Grace. This is Bill Higgins. If I can, I'd like to thank you all for joining the call. We appreciate your time today and your continued interest in Albany International. I'd like to conclude today's call by recognizing the entire Albany team for another very strong quarter of performance. Thank you, everyone.

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