Albany International Corporation

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International Third Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If you should require assistance during the call, please press star followed by the zero. As a reminder, today's conference is being recorded. I would now like to turn the conference over to the Director of Investor Relations, John Hobbs. Please go ahead, sir.

Thank you, Brad, and good morning, everyone. Welcome to Albany's third quarter conference call. 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 their associated reconciliation to GAAP. For the purposes of this conference call, those same statements apply to our verbal remarks this morning. We will make statements that are forward-looking that contain a number of risks and uncertainties, among which are the potential effects of the COVID-19 pandemic on our operations, the markets we serve, and our financial results. For a full discussion, including a reconciliation of non-GAAP measures we may use on this call to their most comparable GAAP measures, please refer to both our earnings release as well as our SEC filings, including our 10-K. Now I'll turn the call over to Bill Higgins, President and Chief Executive Officer. He'll provide opening remarks. Bill?

Thanks, John. Good morning and welcome, everyone. Thank you for joining our third quarter earnings call. We delivered another solid quarter. Our Q3 revenues were as expected, and our profitability was better than expected. A little bit of echo there echo there. All right, I'll continue continue. We're especially pleased with our operational performance doing a great job for our customers and our ability to drive profit to the bottom line. Before going into more detail, let me say a few words about the COVID pandemic environment. Our employees health, safety and well being remains our top priority. We continue to adopt adapt our operations and offices to ensure our employees are as safe as possible, commend our leadership teams and our employees who have remained disciplined and created safe environments inside our facilities, and have also provided support, advice, and supplies to our employees at their homes to encourage safe behaviors in their communities. In spite of these challenges, our management teams have done a remarkable job delivering commendable Q3 results. In Q3, we delivered adjusted EPS of 96 cents, better than expected with both segments contributing to the solid performance. Our customer performance is outstanding in both segments. We offer a range of value-adding products, strong customer technical support, and best-in-class on-time delivery performance. In the quarter, we continue to adjust our operations to right-size production levels to new levels of expected demand. We work closely with our customers to be prepared for demand shifts. This intense focus on the customer, complemented by our strong operational excellence programs, technology development, and productivity have resulted in our ability to continue to execute well and to deliver historically attractive margins despite the effects of the pandemic on our top line. Now, let me talk about the segments. Our machine clothing segment continues to deliver exceptional operational performance with gross margins over 50% and adjusted EBITDA margin of nearly 38% while revenue declined about 10% year-over-year due to the global economic slowdown. Machine clothing continues to execute well in all of our plants around the world, navigating the ups and downs in various end market segments. As expected, demand for writing and printing grades of paper is declining worldwide, according to some estimates by over 20%, driven by the acceleration of digital technologies with many people working and schooling from home. Consequently, a number of publication grade machines around the world have been titled, some permanently. Tissue and packaging are mixed markets. At home tissue demand for residential consumption is very strong. with tissue machines running at full capacity and new machines coming online. On the other hand, away-from-home tissue is weak because of the drop-off in consumption at restaurants, bars, schools, hotels, airports, office buildings, et cetera. And some custom machines for these grades are temporarily idled. While there are tissue machines being converted to at-home production from away-from-home, it is time-consuming and expensive for capabilities to switch from one type of grade to the other. In summary, the net effect for Albany is a slight decline in tissue revenues, with growth in at-home tissue demand being more than offset by the decline in away-from-home demand, as well as other factors. Packaging is also a mixed picture. We're likely experiencing the negative effects of the lockdowns and production slowdowns earlier this year, as our orders lag the cycles of paper demand by several quarters. The good news for the longer term is that the market is reporting stronger year-over-year packaging demand throughout the summer months. Another positive trend is the demand pickup in our engineered fabrics business. While engineered fabrics is a small part of our revenues, we've seen strong orders for our consumable belts used in the manufacture of sanitizing wipes, medical PPE products such as gowns and gloves, and for the construction materials as home construction rebounded after the initial slowdown earlier this year. In general, we're very pleased with the performance of our machine clothing business. It continues to perform well and provide a strong foundation of recurring cash flow that complements our aerospace composites portfolio in these volatile times. We expect the machine clothing segment to report a solid year of performance despite the pandemic, with adjusted EBITDA to be $200 million or more in 2020. Our Albany engineering composite segment also performed well this quarter and delivered a healthy adjusted EBITDA margin of 26.6% in the quarter. As planned, our Albany Safran composites business worked closely with our partner Safran to successfully reopen our LEAP production facilities and gradually restart production in the quarter. Our manufacturing focus in ASC will be mostly on the LEAP 1A engine blade and fan case production since demand for the Airbus A320neo engine is expected to increase more quickly as production of the Airbus A320neo aircraft recovers. LEAP-1B production will take longer to recover while the Boeing 737 MAX gets certified and existing aircraft are brought into service. In addition to great safety and customer on-time delivery performance, I was favorably impressed with the number of lean Kaizen for the AEC business executed during the quarter, using video and other creative tools to conduct Kaizen safely. This lean mindset and leadership persistence is critical for us to continue to drive process improvements, better quality and productivity. all of which lead to improved profitability and enhanced growth opportunities as we pursue new content on existing platforms or new production programs. AEC continues to work with a number of customers on new growth opportunities in both commercial and military applications. We continue to invest in R&D to advance the next generation of composite materials and develop efficient manufacturing process to bring these materials to market. We look at the downturn in commercial aerospace as a time to develop a broader portfolio of technology and product applications for advanced composites, so we're well-positioned with key customers when the market comes back. The good news is that our elite production supplies narrow-body aircraft, which are expected to recover first as domestic travel resumes before international travel. It's been reported, in fact, that Airbus A320MIA aircraft are being flown at a rate approaching levels similar to a year ago. In general, we're very pleased with both segments, how they performed in Q3, and expect to end the year with solid results, despite the challenges of the pandemic globally. Financially, we're in great shape. We continue to generate free cash flow, have a strong balance sheet with low leverage and excellent liquidity, all of which allow us to continue to invest in organic growth opportunities, such as the next generation of machine clothing belts for our tissue and packaging customers, and longer-term applications for the next generation of 3D composite structures. And now Stephen will provide more detail on a quarter of financials and outlook. Stephen?

Thank you, Bill. Good morning, everyone. I will talk first about the results for the quarter and then about our revised outlook for our business for the balance of the year. For the third quarter, total company net sales were $212 million, a decrease of 21.8% compared to the $271.1 million delivered in the same quarter last year. Adjusting for currency translation effects, net sales declined by 22.6% year-over-year in the quarter. In machine clothing, also adjusting for currency translation effects, net sales were down 9.5% year-over-year, driven by declines across all major grades of product. Sales of publication grades, which declined over 14% compared to last year, represented only 18% of our MC sales in the quarter. However, we also saw declines in packaging caused partly by declines in overall economic activity earlier in the year. In tissue grades, as Bill referenced earlier, the shift in consumer demand from away-from-home to at-home products has caused demand to exceed supply in at-home products, limiting the upside in our sales of products for the at-home market. While our customers were forced to idle or run at lower capacity, a number of their lines serving the away-from-home market resulting in an aggregate decline in sales of our tissue grade products. Engineered composites net sales, again after adjusting for currency translation effects, declined by 39.2%, primarily caused by significant reductions in LEAP and Boeing 787 program revenue, partially offset by growth on the F-35 and CH-53K platforms. During the quarter, the LEAP program generated a little under $17 million compared to $54 million in the same quarter last year. This quarter's LEAP revenue was up only marginally from the $15 million generated in the second quarter of this year due to the fact that the reopening of our three LEAP facilities took place very late in the quarter with very little increase in production in Q3 compared to Q2. Third quarter gross profit for the company was 87.3 million, a reduction of 16.1% from the comparable period last year. The overall gross margin increased by 280 basis points, from 38.4% to 41.2% of net sales. Within the MC segment, gross margin declined from 52.4% to 51.5% of net sales, principally due to lower absorption of fixed costs due to the lower net sales, partially offset by favorable foreign exchange rates. Within AEC, the gross margin improved from 20.8% to 21.2% of net sales, driven primarily by a favorable mix in program revenues. The net favorable change in the estimated profitability of long-term contracts this quarter of about $3.5 million is is almost the same as that recorded in the third quarter of 2019. Third quarter selling technical, general, and research expenses declined from $48.7 million in the prior year quarter to $47.8 million in the current quarter, but increased as a percentage of net sales from 18.0% to 22.6%. The reduction in the total expense was primarily due to lower travel expense, partially offset by higher impact from foreign currency revaluation, higher incentive compensation expense, and the addition of SERCOMP. Foreign currency revaluation resulted in additional expense of 1.3 million in the current quarter, compared to an expense reduction of 1 million in the third quarter of 2019. Total operating income for the company was $38.8 million, down from $55.7 million in the prior year quarter. Machine clothing operating income decreased by $6.2 million, caused by lower gross profit, partially offset by lower SDG&R expense. And AEC operating income fell by $10.5 million, caused by lower gross profit and higher SDG&R expense. Other income expense in the quarter netted to income of 2.7 million compared to income of 1.6 million in the same period last year. The higher income in the current quarter was primarily driven by a successful claim for a rebate of foreign sales tax paid in previous years. The resolution of this claim resulted in other income of 2.6 million in Q3 of 2020, and additionally a reduction to interest expense net of 0.9 million. The income tax rate for Q3 in both this year and last year was 24.7%. While this year a higher share of our global profits were generated in jurisdictions with higher tax rates, this was offset by a higher level of favorable income tax adjustments. which reduced income tax expense by 3 million in this quarter compared to a reduction of 1.5 million in the same quarter last year. Net income attributable to the company for the quarter was 29.6 million, a reduction of 26% from 40 million last year. The reduction was primarily driven by the lower operating income. Earnings per share was 92 cents in this quarter, compared to $1.24 last year. After adjusting for the impact of foreign currency revaluation gains and losses, restructuring expenses, and expenses associated with the Surcomp acquisition and integration, adjusted earnings per share was $0.96 in this quarter, compared to $1.17 last year. Adjusted EBITDA fell 13.5% to $61.8 million for the most recent quarter compared to the same period last year. Machine clothing adjusted EBITDA was $52.6 million or 37.9% of net sales this year, down from $55.8 million or 36.9% of net sales in the prior year quarter. AEC adjusted EBITDA fell with $19.5 million, or 26.6% of net sales, down from last year's $28.6 million, or 23.9% of net sales. Turning to our debt position, we continue to use our solid free cash flow to pay down debt during the quarter. Total debt, which consists of amounts reported on our balance sheet as long-term debt or current maturities of long-term debt, declined from $435 million at the end of Q2 2020 to $418 million at the end of Q3 2020, and cash increased by about $11 million during the quarter, resulting in a reduction in net debt of about $28 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 1.5%. up slightly from 1.48 at the end of Q2, both well under the cap of 3.5 allowed for under the credit agreement. Disregarding the limitation on cash netting results in an absolute leverage ratio of 0.89, down from 0.95 at the end of Q2. The reduction in total debt during the quarter was principally caused by continued paydown of our revolving credit facility enabled by strong operating cash flow. The reduction in net debt was principally caused by the strong operating cash flow generation in both segments. I would like to note that in engineering composites, there were no cash collections during the quarter related to the roughly $17 million of LEAP revenue during the quarter. The cash associated with that revenue will be collected during the fourth quarter of this year and the first quarter of 2021, as we collect on both invoices for shipments during the fourth quarter and the true-up invoice that we will be submitting under our Cost Plus contract to our customer at the end of the year. I should note that the interest expense was unusually low this quarter, which is a result of the interest received on the rebate of prior period sales tax expense I referenced earlier. That particular benefit will not be repeated in future quarters. While occurring after the end of the quarter, I would like to note that our strong balance sheet and operational performance have allowed us to extend the term of our revolving credit facility by two years to October 2024. Capital expenditures in Q3 2020 were a little over 9 million, down from almost 14 million in the same period last year, due principally to a reduction of capital expenditures on the LEAP program. Looking forward to the balance of 2020, we have revised our financial guidance. In the machine clothing segment, we have seen a continuation of the order weakness we called out last quarter. During Q3, orders were down almost 8% compared to Q3 of 2019, and on a year-to-date basis, orders are down almost 4% compared to the same period in 2019. While our orders for publication rates continue to show the greatest declines, declining by about 15% this quarter compared to last year, We also saw year-over-year declines in all other grades other than engineered fabrics during the quarter. These declines are broadly in line with the expectations for the back half of the year that we shared on our second quarter earnings call. This trend in lower orders manifested itself in lower machine clothing revenues this quarter. However, certain risks to revenue in the quarter failed to materialize, resulting in us delivering somewhat higher revenues than had been envisaged in our prior guidance. We do expect the impact of lower orders on revenue to be greater in Q4, and as a result, we expect fourth quarter revenues to be down sequentially from the third quarter. While there are some signs that certain markets, such as the North American packaging market, are showing additional signs of recovery, a lag between end product production and machine clothing sales means that any rebound, should it be sustained, would not be seen on our current orders. For the full year 2020, due to the stronger than expected performance in Q3, we are increasing segment revenues to a range of $555 to $565 million, up slightly from prior guidance of $545 to $555 million. From a margin perspective in machine clothing, while we did continue to enjoy during the quarter the benefits of very favorable exchange rates, we did start to see minor signs of margin erosion due to the change in the previously favorable mix of business. However, that impact was not as great as we had expected when we last provided guidance. Instead, the biggest headwind to margins during the quarter was the lower fixed cost absorption associated with lower revenue, which led to a 300 basis point compression in segment gross margin compared to the second quarter, which was less overall than had been expected. However, this impact will be exacerbated by the further erosion in revenue projected in Q4. We also expect that the impact of absorbing fixed SG&A expenses over a lower revenue base, in conjunction with some expected growth in SG&A and R&D expenses, will cause additional compression of EBITDA margins in the fourth quarter. For the full year, again due to the strong Q3 performance, We are now guiding segment adjusted EBITDA of 200 to 210 million, up from prior guidance of 190 to 200 million. Turning to engineered composites, in the fourth quarter, we expect to see modest recovery in revenues from our ASC LEAP program as a result of all three of our facilities now being back in operation. However, even with that recovery, program revenue in the fourth quarter is expected to be less than $25 million, compared to almost $50 million that was generated in the fourth quarter of last year. There will be some marginal improvement in 2021, as we expect to have continuous production through all four quarters to support LEAP 1A deliveries for the Airbus A320neo family. However, with respect to the LEAP 1B variant that powers the Boeing 737 MAX, We expect that, given the number of finished engines already on completed aircraft, the amount of our finished goods in Safran's inventory, and the volume of finished goods inventory on which we have already recognized revenue in our facility, that Boeing's planned return to service of the 737 MAX will provide very limited upside to our 2021 revenue as compared to 2020. We also expect to see further sequential declines in our 787 frames program where revenue in the fourth quarter may be close to half of that generated in the fourth quarter of last year caused by Boeing's slowdown in production of that aircraft. We expect that low level of revenue to continue throughout 2021. From a positive perspective, our defense programs continue to perform well in Q3 and represented almost 49% of the segment's Q3 revenues, up from just over 45% in Q2. For the full year, we are now guiding segment revenues of between 315 and 325 million, down slightly from prior guidance of 325 to 335 million. From a profitability perspective for the full year, we are now guiding engineered composites segment adjusted EBITDA of 75 to 85 million, consistent with prior guidance. Turning back to the company level, we have slightly lowered our tax rate guidance for the year, driven by the income tax adjustments, including a true-up to prior year taxes recorded in Q3. Turning to cash flow, notwithstanding the LEAP program's consumption of cash during the quarter due to the lack of invoices and shipments, We delivered another good quarter with about $30 million of positive free cash flow, roughly in line with our net income for the quarter. We expect to finish the year overall with strong free cash flow. At the company level, we are updating 2020 guidance as follows. Revenue of between $870 and $890 million, unchanged from prior guidance. Effective income tax rate of 34% to 36%, down from prior guidance of 36% to 38%. Depreciation and amortization of between $70 and $75 million, unchanged from prior guidance. Capital expenditures in the range of $45 to $55 million, unchanged from prior guidance. Gap earnings per share of between $2.72 and $2.82 cents. up from prior guidance of $2.26 and $2.51, adjusted earnings per share of between $3.35 and $3.45 compared to prior guidance of $2.85 and $3.10, and adjusted EBITDA of between $240 and $250 million up from prior guidance of $220 to $235 million. Returning to the present, It was once more, given the ongoing pandemic and the resulting impact on the rent markets, a very strong quarter, the credit for which is due to the hard work put in by all of our employees across the globe. With that, I would like to open up the call up for questions. Over to you, Brad.

Of course. And ladies and gentlemen, if you wish to ask a question at this time, please press 1 and 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1 and 0 command. Once again, if you have a question, please press 1 and 0 at this time. Our first question today comes from the line of Peter Arment with Baird. Please go ahead.

Yes. Good morning, Bill. Good morning, Stephen. Hey, Stephen. Thanks for all the details on kind of the LEAP dynamics and congrats on obviously a strong quarter just given what's going on. Can you help us just understand a little bit? I understand on the LEAP A kind of faster recovery, LEAP 1B taking a long time. Do you expect, I guess, qualitatively speaking, should LEAP revenue be higher in 2021 versus 20?

I would say it's very marginally higher. If you recall, we had a good first quarter of this year. We were producing both significant 1A components and a modest amount of 1B in the first quarter. Obviously, Q2 and Q3, no production, but revenue recognized on the fixed costs in that business. So I would expect it might be marginally up next year, but we really expect very little 1B revenue. If you will recall, Peter, we said three quarters ago, we said we finished 2019 with about 200 engine shift sets of LEAP 1B on hand. Today, we have a little more than that on hand on LEAP 1B. meaning we've produced a few more this year than we actually shipped, marginally higher than the 200. But that still is a lot of shipsets on which we've already recognized revenue that will, you know, power the first, you know, Boeing aircraft completed for which there are not already engines either, you know, on the aircraft today or in the Safran supply chain. Leap 1A is obviously a much different situation. We have lower inventory today than we had before. at the end of 2019 when we had about 100 engine chipsets on hand. But still, just looking at the trajectory, I would expect next year to be only marginally higher than this year. Okay.

And just the dynamics around kind of the margin, adjusted EBITDA margin guidance, it's quite a range, I guess, in AEC for Q4. What are some of the puts and takes there that we should be thinking about?

You know, as you know, there's always a little uncertainty in a business like AEC, which is long-term program accounting, about whether there may be adjustments one direction or the other. And so even in a relatively short time period, there can be quite a broad range of potential outcomes because those numbers could be positive or negative in any given quarter. And so some amount of it is to leave allowance for that from an operational perspective. I don't think we need as wide a range as we have suggested there because there's not a huge amount of uncertainty in terms of production rates here in fourth quarter. All of our production rates and programs is pretty much locked in. It's large just on the profit rate we recognize on some of those long-term programs.

Appreciate that. And just if I could squeeze in one more quickly, just on MC, thanks for all the details there, but you said on the terms of different grades and what you're seeing on orders that How is the pricing environment? Have you seen any kind of material change, I guess, sequentially, and how should we be thinking about that? Thanks.

Yeah, no, Peter, look, as we've said before, it is a very competitive market. It always has been. It has been a competitive market for years. We face very strong competitors there. Every day is a knife fight out there for every single bid that's available, and we always have to make tradeoffs in terms of, price or market share, and that is certainly true today. However, we have not seen a significant uptick in that, you know, driven by the pandemic and overall economic conditions. It's more or less today in line with what we have seen, you know, over the last, let's say, 12 to 18 months.

Appreciate that.

Thanks, Stephen.

Thanks, Peter.

And we do have a question for the line of Caitlin Delante with Bank of America. Please go ahead.

Good morning, guys. Bill, you mentioned that the commercial arrow downturn should be a good opportunity for Albany to ramp up technology capabilities so that you guys can be well positioned for recovery. Can you tell us a little bit more about your strategy for that in terms of what technology areas are you evaluating Do you see only incremental investment driving this, or would you consider some maybe small M&A? And then kind of tangentially, how do you see OEM spending on advanced materials development?

Sure, Caitlin. Great question. It is a time where we're working sort of a broad spectrum of opportunities, commercial, military, defense, too. see where we can develop materials and then the processes behind the materials manufacturing processes to bring, you know, next generation of composites to the marketplace. So we're working, you know, across the board, there's probably a little bit less work now on the large OEM opportunities as there's more opportunity in the near term on defense, military defense opportunities. we're going to continue working that you know, we're we've we've positioned ourselves really well in the lead program on the engine, but we're also looking at wing and fuselage and other applications. So it's, it's challenging. One of the things we've learned through the pandemic is it's challenging just to get into customers facilities and have customers get into ours. But we've committed to the R&D and development to do that. We're doing a lot by video and, and a lot of meetings. So there's a number of, you know, programs that we're working on currently. And as you as you stated, and we as part of our strategy, is we want to get through this downturn and have a broader portfolio of applications as we go forward. And certainly, from an inorganic standpoint, we would consider technology companies the right type of M&A. As we noted before, we bought a small company in Germany last year, Surcomp, that brings some other capabilities around thermoplastics and thermoset technology to Albany that perhaps we didn't have before. And we can develop that further as well. So, yes, we'll continue working it. The OEM environment, we're watching it to see how that pans out, and we want to be there at the table. And I think we've demonstrated we have the capability and the operational backing behind it to make things happen. So we're going to take every advantage we can.

Okay, well, thank you very much.

And we do have a question from the line of John Franzrup with Sidoti. Please go ahead.

Good morning, guys. I'm curious about your thoughts on the reopening of the office place in 2021. How did that mix change hurt you or benefit you in the machine clothing side of the business? Is there any reason to think that MC wouldn't have a better 2021 than 20?

Well, certainly the reopening of offices and other, you know, other avenues, as I mentioned in my opening remarks that have been heard at the away from home marketplace, we would certainly benefit from that longer term as that comes back. The at home business, you know, has been real strong, but that the away from home market for machine clothing has certainly suffered through this downturn. And we would enjoy that coming back.

So should we think about resetting maybe our our margin contributions and EBITDA contributions from machine clothing. It just seems to me that over the past year and a half, you know, for every good quarter, we've kind of reset the bar lower only to see them exceed those lower bars. I'm just wondering maybe if the way the mix change has been going on for the past five years, that our starting point maybe should be a little bit higher now in MCI.

I would caution a little bit on it's early. This is an incredible marketplace and economic environment to try and predict things. Just look at what has happened through this year. We have a mixed effect that didn't occur like we expected. Our mix actually turned out to be a little better than we expected in this quarter, but we're still kind of watching the long-term effects of the lag between when machines are idled and and start back up, and when, you know, belts are consumed. Getting into customers' facilities right now on the MC side is difficult as well. Trying to run trials of new products is very difficult right now, and we're trying to commit to that, you know, next generation of belt technology, and it's a challenge in this environment. So I would just be cautious. I wish I had the crystal ball that says I knew exactly what this was going to look like going into next year, but I don't think any of us do, and with the lag effect and the different mix and different – impact globally, it's a little hard to call right now. So I think I'd be patient for another quarter or two. Let's see what next year looks like.

And certainly, John, you know, irrespective of, you know, what the top line looks like next year in machine cloud, certainly the first half of this year, the margins we delivered in that business were, you know, outstanding, even, you know, by historic norms. And certainly you've seen they've been somewhat lower here in the back half of the year. repeating the margin performance we delivered in the first half of the year may be a challenge, just as you think about next year, even if it's another strong top-line year. We had a particularly good mix in the first half of the year. We benefited from exchange rates, as you know. It was overall just a very good first half of the year. Those margins where we got to the end the mid-50s on gross margin and, you know, high 30s to 40% range on adjusted EBITDA margin, they may be tough to replicate. So I'd be careful about just kind of rolling that sort of margin performance forward.

Yeah, but I guess where I was at the beginning of the question was that, you know, next year we're going to see, you know, schools reopen. We're going to see, you know, offices coming back online. I would assume that would be a margin beneficiary, but maybe I'm not understanding that properly.

You would certainly get some increased fixed cost absorption, absolutely, if revenue rebounds. You certainly get that benefit. It's just there are other factors such as mix and FX impact, which benefited us in the first half of the year, which may not have the same outsized impact on us next year if some of these other, you know, markets such as the publication rate for office and school recovers. So, again, we do not yet, you know, we're not guiding for 2021, so... I'm not suggesting any specific numbers you use. Certainly, we have said before that MC has stepped up from its traditional historical, you know, level of EBITDA. If you go back to what we might have thought three or four years ago, that it certainly jumped to a, you know, higher plane. But I wouldn't jump to automatically considering that we can replicate the first half of this year again in subsequent years.

And I think it's a little bit longer term, but we also have to think about, I don't know if there's going to be any pricing, if anyone's going to be able to get pricing as we go into this environment next year, and then there's all this inflation. So things we're going to have to think about as we go in that will affect margin.

Okay. I'm just switching over to EC for a second. Could you just talk to us about what's going on as far as labor retention? A lot of downtime. I'm wondering if that's been a problem or not. and how you see yourself ramping up in the coming year as things start to come back online at maybe at a quicker pace?

Yeah, I can comment on that. We've been very methodical in how we've restarted the Albany Saffron Composites venture business, which was shut down Q2, Q3. As we started those back up, very careful on how we're bringing people back on in training. We've had excellent progress so far in how that's occurred. So I think we feel like we're in good shape with our employees and bringing them back online with extensive training and support as they come on. So I don't feel like that's an issue. If your question is longer term, as capacity comes back up, one of the things we are still continuing to do, even though we're running very low rates of production on that, on the LEAP program, we're still working on improving the processes, improving the efficiencies and the quality of the throughput so that as things do come back up, we've got plenty of, you know, capacity that we've already installed to work with. Great. Thanks for taking my questions, Bill.

Thanks, Sean. And if there are any additional questions at this time, please press 1 then 0 on your telephone keypad. And we do have a question from the line of Patrick Bowman with J.P. Morgan. Please go ahead.

Hi. Sorry, I was on mute. Good morning. Thanks for taking my question. Sorry, I missed the beginning of the call. Why were the margins in AEC so strong in the quarter? Was there a reason that you discussed as to why that was the case and why you know, the fourth quarter is, I guess, guided to be a little bit softer? Is it maybe like the leap coming back and that's mixed, you know, that hurts mixed a little bit? I'm just curious what you've said on that. And sorry if you're repeating yourself.

Yeah, so two factors I would point to, and we didn't really give an explanation for it, Patrick, so you didn't miss much in that respect. First off, you know, from a year-over-year perspective, we had a roughly comparable level of net favorable adjustment to long-term contract profitability of about $3.5 million during the quarter. So that certainly contributes to the level of margin. And also, certainly if you're looking, and again, it depends what your comparison point is, if you look in a year-over-year basis, we certainly get a mixed benefit on a year-over-year benefit basis from a margin perspective. due to LEAP being a smaller share of our revenue this quarter. I mentioned LEAP was only $17 million this quarter, where it was almost three times that a year ago. So it was a much greater share of our revenue. If you go back a year ago, it was close to half of AEC's revenue. And as we discussed, it is a somewhat lower share. lower margin, whereas this quarter it was only about 24% of our revenue, so much lower share. So those were the two primary things if you're looking on a year-over-year comparison basis.

Okay, so if I do the math on the favorable contract adjustments, which you seem to be continually getting, so I'm not even sure if that's not recurring anymore. It just seems like you're executing well, I suppose, on contracts. Yes. But if I adjust that out in the third quarter, it's deep at that margin, like, closer to, like, 23% that's out in the ballpark?

Yeah, look, you know, as you know, we've been targeting – if you go back a few years ago, we had said we were looking for adjust deep at that margins in that business of 18% to 20%, and we've beaten those. Kind of right now, I think it'd be safe to say, absent, you know, those long-term favorable – Justin's long-term contracts, that the EBITDA margins typically are somewhere in those low 20s, let's say 21%, 22% range. So your calculation is not far off the kind of normalized EBITDA margin.

Yeah, no, that's what I'm looking for, yeah. So basically when we think about next year, we shouldn't be – I mean, this year was – it looks like ending up being more mid-20s. But if we normalize things, you would kind of talk, you would think about more low 20s as the right level, you know, going forward to model.

Yeah, and look, in future years, as LEAP certainly grows, as we've discussed, that's a lower margin business, that will put some downward pressure on those numbers. But as we mentioned, next year, LEAP should be, you know, only marginally higher in terms of revenue than this year. So that will not be a significant factor next year.

Got it. And then the cash flow this year, I think, has been reasonably solid given the environment. How should we think about free cash flow and CapEx, you know, normalize any change in kind of your view on you know, conversion or CapEx to sales ratios? How should we think about those, you know, going forward?

So a couple of things there. You know, one, clearly CapEx has taken a significant step down and consistent with the slower ramp we expect in AEC where we're really in a recovery mode rather than just a ramp-up mode, particularly on a program like LEAP. So CapEx certainly steps down, which certainly helps conversion. I will say CapEx is a little lumpy right now because of the LEAP program. And as I've mentioned in my remarks, the revenue, a lot of the revenue we generated in Q2 and Q3 from LEAP was cashless revenue because we will not collect that cash anymore. some of it in the fourth quarter as we invoice in shipments, but the majority of it, quite frankly, will not be collected in the fourth quarter, but will be collected as part of the true-up invoice we submit to Safran at the end of the year, and we'll expect to collect early in Q1 of 2021. So there's certainly a shift of cash out of this year into next year, and that's an artifact of the significant reduction in volumes that we saw on the leaflet as we went through the year because the rate at which we're invoicing saffron on shipments is based on a production volume far higher than the actual production volume. And that means that that cash collection shifts out of the years or early next year. So Q4 will be a little unusual given that shift of cash out of it into Q1. But overall, we certainly don't see any – if you normalize that, we don't see anything which is significantly impacting the cash conversion of the underlying business. We expect to, you know, maintain our strong free cash flow conversion for a foreseeable future.

Last year, you did about $50 million of free cash flow. I mean, how much of an impact is this shift of payments, you know, into next year?

You know, look, the exact number is yet to be determined, but it's certainly a double-digit number in terms of millions of dollars that will shift out of this year into 2021.

Got it. Okay. That's helpful. And, yeah, I'll jump offline. I'll let someone else ask a question. Appreciate the time.

Hey, thanks, Patrick. And if there are any additional questions at this time, please press 1 then 0 on your telephone keypad. And it does appear at this time there are no further questions from the phone lines. Please continue.

Thank you, Brad. I'd like to thank everyone for joining us on the call. We appreciate your continued interest in all the international. And on behalf of the entire management team, we wish you all a safe and healthy end of the new year. Thank you.

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