Albany International Corp (AIN) 2005 Q4 法說會逐字稿

Welcome to the Albany International fourth-quarter earnings call. At this time, all participation lines are in a listen-only mode. Later, there will be an opportunity for questions and answers, with instructions given at that time. (Operator Instructions). At the request of Albany International, the conference will be Webcast and recorded.

Our hosts for today are President and Chief Executive Officer, Dr. Joe Morone, and Executive Vice President and Chief Financial Officer, Michael Nahl. I'll now turn the conference over to our host, Dr. Morone.

Good morning. The fourth quarter 2005 tells both a short-term and long-term story about Albany International's performance and prospects. As we discussed in the release, the short term was influenced by two negative factors -- cost of materials due to petroleum prices and PMC pricing in Europe -- and two positives, strong sales and cash generation.

And for the long term, the Company made two major strategic investment decisions, one directed at emerging markets in PMC, one at an emerging business outside of PMC. And of course, the Board of Directors significantly increased its authorization of share buybacks.

So this quarter is about both short-term and long-term performance, and in our minds, the two are tightly connected. We would not begin testing for long-term growth if we were not convinced about our short-term strength.

Now I'd like to discuss both of these aspects of our recent performance, but first, I'd like to turn the call over to Michael Nahl, Albany's Executive Vice President and CFO, to discuss our results in more detail. Michael?

Thank you, Joe. Good morning. During the course of this conference call, we may make statements that constitute expectations, beliefs, or similar forward-looking statements. We'd like to caution you that the Company's actual results could differ materially from the results anticipated or projected in any such forward-looking statements. Additional information concerning the factors that could cause actual results to differ materially from the information we will share with you is set forth in the earnings release itself, which has just been filed on EDGAR under Form 8-K.

The difference between our prerelease estimate on January 17th and the final earnings release last night was $0.08 per share. About half of that was due to final calculations associated with compensation accruals, and the other half resulted from the final tax calculation, which was also more favorable for the shareholders than we had anticipated. We described the tax effects for the quarter and the year in detail in the financial release, so we don't plan to elaborate on them any further in this call.

The difference between the prerelease estimate of results and the actual reported today was sufficiently wide for us to conclude that under most circumstances, in future quarters, we would not expect to release anything about earnings in future quarters until our scheduled release date, even if the early results suggested we were below analysts' expectations by a substantial margin.

Joe referred to both the positive and the negative news in the fourth quarter. There were two major negatives in the release, and they have significant, but different, implications for our outlook for 2006. In my opinion, the worst effect was the material cost increase, which was substantial, and is likely to continue in 2006. This reduced earnings per share by $0.11 in the quarter in comparison to the fourth quarter of 2004. We don't expect these material costs to go away, and Joe will have more to say about these.

He will also address the second significant negative effect, the increased pricing competition in Europe. That $0.09 per share effect compared to the fourth quarter of 2004 will also have continuing effects in 2006, but we expect it to diminish in importance over the course of the next year or so. We've been in similar situations before, and we know how to address the problem.

So those are the two negatives. The temporary first-quarter 2006 effect resulting from an anticipated changes in inventory practices with a major customer is just a timing difference, and is not expected to affect any other quarter.

There were several positive results and events included in our earnings release. The first was the strong revenue line. Paper Machine Clothing sales, which we refer to as PMC sales, were up 4.2% as reported in U.S. dollars compared to the fourth quarter of 2004, and were up 6.5% excluding the effects of changes in currency exchange rates. For the full year, PMC sales were up 6.5% in U.S. dollars and 4.7% excluding the effects of changes in currency exchange rates.

If you go back and look at our quarterly results for each of the four quarters, you'll see that something very good is clearly going on with regard to the trend in sales growth in PMC. The sales growth has accelerated in the second half of 2005. I believe that is attributable to the strategic shift to growth which Joe will describe to you in his comments, and that it is an important initial validation of Joe's strategic vision for our Company.

Equally important has been the acceleration in sales and earnings growth in Applied Technologies businesses. Fourth-quarter sales for our Applied Technologies businesses grew 9.0% in U.S. dollars and 11.0% excluding the effect of changes in currency translation rates. For the full year, Applied Technologies sales grew 8.9% in U.S. dollars and 6.8% excluding the effect of changes in currency exchange rates.

As in PMC sales, growth in Applied Technologies clearly began accelerating in the second half of 2005. While the recent acceleration of sales in the Applied Technologies businesses is an encouraging results of our new focus on growth and attractive returns on investment, an even more important milestone was reached recently. We've been working on developing proprietary technologies for aerospace composites applications for over seven years. Over the past two years, we have passed a number of important tests which have validated the advantages of our technologies.

We have recently achieved a successful long-term major milestone by demonstrating through rigorous tests the advantages of our proprietary 3-D woven complex net-shape preform technology or resin transfer molded composites in a highly loaded aerospace structure application.

We believe that we have important sustainable competitive advantages in aerospace composites. There may be absolutely nothing added to the profit line from this business in 2006, because this business takes time to develop and ramp up. But we believe that the long-term opportunity will ultimately prove attractive to our shareholders. If we didn't believe that we wouldn't have entered into the share purchase agreement with Texas Composites, Inc. Whether we are correct in our assessment should become clearer as the year progresses.

Our continuing strong cash generation strengthened our balance sheet again in 2005. With 122.4 million net cash provided by operating activities, our leverage ratio as defined in our principal credit agreement with our banks declined to 0.6 compared to 1.1 at the end of 2004. The Company's strong balance sheet and cash-generating power enables us to support shareholder-friendly initiatives on several fronts simultaneously.

In the fourth quarter, we closed on a $150 million 10-year average life bond in a directly negotiated placement with Prudential Capital Group. We didn't pay any arrangement fees or closing costs in connection with this financing. With an interest rate of 5.34%, that compares rather favorably to the U.S. Treasury bond rate this morning of 4.48% as I speak. We can finance the $150 million strategic investment for PMC growth projects in Asia and Latin America quite comfortably, and we can support strategic investments for growth in our Applied Technologies and other businesses wherever we are convinced we have sustainable competitive advantages using our core technologies, and where we can accelerate growth at attractive returns on investment. And we can finance all those investments while retaining the capacity to make substantial investments in our own stock.

Now I'd like to turn over the remainder of the presentation to our President and Chief Executive Officer, Joe Morone.

Thank you, Michael. What I'd like to do for just a couple of minutes is highlight and perhaps add a little emphasis to some of the points that Michael made. As I suggested earlier, the results of this quarter tell you a great deal about both our short-term and long-term performance and prospects. Let me begin with the short-term, and with those two primary negative factors, materials costs and PMC pricing in Europe.

First, pricing in Europe. We understand the reasons for it, and we know what we need to do to respond to it. [Look,] we have learned a great deal in the Americas about overcoming price competition and we intend to the apply those lessons in Europe.

The key to pulling this off -- what we have been referring to as the Albany value concept. And the basic idea of the value concept is this -- our Paper Machine Clothing generates enormous value for our customers. When you compare the cost to them of our Paper Machine Clothing to the benefits to them of that clothing -- the impact on the efficiency of their operations, their energy consumption, the quality of their paper, you begin to understand the magnitude of the value we are creating for them.

Now, our job is to demonstrate to them in concrete terms that value that our products create for them, and then to price those products accordingly. We now have a new management team in Europe that understands this Albany Value Concept, that insists on it, and that will drive it. We've learned that it takes time to instill value pricing in a market, but we are doing it in the Americas and we are now focused on getting it done in Europe.

As for that second negative, the increases in material costs, we think those are here to stay. We're assuming that what we saw in Q4 is what we're going to see going forward. And it wouldn't surprise us at all if next Q4, we start seeing the impact of even more increases.

Now, that doesn't mean we're just sitting still accepting the margin erosion. Our operating plan for this year emphasizes a number of companywide initiatives that, over time, especially toward the end of the year, should contribute to higher margins that will partially offset the impact of these higher material costs.

Now I don't want to discuss here what those initiatives are, other than to say this -- think about all the ways in which we can influence customer value. In every one of those ways, we can improve our performance. We're the market leader, but that doesn't mean there isn't plenty of room to improve performance in ways that add value to our customers, and that's exactly what we've targeted for the year ahead.

So our near-term strategy in Paper Machine Clothing is very simple -- improve performance on every dimension of customer value; demonstrate that value to our customers; and price accordingly, especially in Europe. As we execute to this strategy, two things should happen over time. The topline should get even stronger. And our margins should improve.

Let me turn now to what this quarter indicates about our long-term performance. The continued strong sales and cash generation validate our strategic shift away from consolidation toward growth. And the clearest indicators of that shift are the two investments that we just announced.

The logic of that $150 million investment in Paper Machine Clothing is very simple. The rapid growth of paper production and consumption in Latin America and Asia are shaping the future of this industry, and therefore, our future cash flow. We need to be a force in those emerging markets. We need to be close to our customers, we need to grow with them, we need to provide them with distinctive value. And that means we need a large-scale presence in those markets with world-class operations.

At the same time, we are equally committed to accelerating the growth of our emerging businesses. We have a clear philosophy here. Candidates for growth need to build off our core strengths in advanced textiles and materials. They need to demonstrate a sustainable basis for differentiation, and they need to have significantly higher growth rates than our core PMC business. Our long-term goal here is to transform Albany into a family of related advanced textiles- and materials-related businesses.

The first candidate out of the [blocks] is our advanced composites business for aerospace. Texas Composites, the acquisition we have just announced, complements Techniweave's unique technical strengths -- Techniweave is our existing composites business -- and Texas Composites complements Techniweave's unique technical strengths and adds important downstream manufacturing capabilities. Their products and customers are complementary, as well.

Look, this is a small acquisition. But in our view it represents a large step toward the development of a differentiated aerospace composites business that builds off our advanced textiles capabilities in unique ways and offers significant, long-term growth potential. We are renaming the combined businesses Albany Engineered Composites. And we continue to explore additional near-term steps into accelerating the development of this business.

Finally, I think it's important to take note of the Board's decision to increase the authorization to buy back shares from 1 million to 3.5 million. The message here should be pretty clear. We believe that because of the strength of our balance sheet, because of the cash-generating capacity of our core business, we are able to simultaneously invest in the future of our core PMC business, invest in promising emerging businesses, and buy back shares.

Michael, unless there are any last points you'd like to highlight, let's turn over to your questions. Thank you.

I think let's just get started with the questions.

(Operator Instructions) Mark Connelly, Credit Suisse First Boston.

When we look back to the guidance you gave a couple of weeks ago of $0.36, I'm trying to figure out what a clean comparison is. What I'm doing is taking the $0.44, $0.01 of dilution, adding $0.05 of restructuring and then adjusting for the taxes and getting to 45 versus your 36. So two questions on that. Does that sound reasonable? Am I missing anything? And second, can you explain why I'm coming to a different spot than the guidance?

Firstly, each of the pieces that you pointed to are clear and obvious, and we actually agree with each of the pieces that you pointed to. I think your conclusion is reasonable.

As to the difference between the guidance, approximately one-half of that is attributable to the compensation-related accruals that were done after we had the final numbers. Some of those are performance-based, for example. And so until you actually know what the profits were, you can't calculate them.

Right, fair enough.

And the second, of course, was in connection with the final tax calculation, which can only be done after we have all the pieces from all over the world. And that can vary and swing around quite a bit at the end.

Okay. So if I used the same approach last year, I'd get to $0.39. The taxes is a big question. I mean, some people include it, some people don't. But if we just did apples to apples it would be 45 versus 39?

That would be correct.

Okay. Now if I can get onto some bigger questions -- thank you for that -- I'm trying to put this 150 million of spending in context. In the last couple of years, we've seen what we thought were some relatively big investments like the big $40 million in Europe, which had a lot of impact in that operation. I'm having trouble wrapping my hands around 150 million in that context. You know, Frank Schmeler thought that spending $40 million in Europe was a lot. So can you give us a sense of how this 150 compares -- if you could characterize it for me?

Mark, let me take that on. Here's how we think about that investment. First of all, the investment by all of our analysis generates returns in excess of our cost of capital, so leave that aside. But all -- the future of this industry is going to be dominated by the growing markets, particularly in Asia. That's where all of the growth is going to be, or most of the growth is going to be.

We have learned already that we gain significantly higher margins by selling in that market and in those emerging markets with products made in those markets than we do by exporting products into those markets, significantly higher margins. That's point one.

Point two -- you have to keep in mind that Paper Machine Clothing is a highly customized business. Every sale is customized to the particular mill that it's being sold to. So if we're serious about generating value, we have to be close to the customer. We need to know them well. We need to be working carefully with them.

Each time we look at this, we come to the same conclusion. A smaller plant, a smaller set of plants, a smaller investment means more exports into that region, means lower margins. So if we're serious about being a leader in where the growth is in this industry -- and we are -- and if we're serious about maximizing our earnings, then the logic overwhelmingly drives you to being there in scale large enough to keep up with the growth. That's how we got to the size of the investment that we decided to make.

Now, fortunately, thanks to the hard choices that Frank and his team has made over the past few years, we have the balance sheet to be able to pull this off But (multiple speakers) -- go ahead, Mark.

I'm sorry. Are the Brazil and Korean investments different from the rest of it? Because you've already got a base of operation in Korea, and --

The Brazilian and Korean investments are expansions of existing capacity. So they are more incremental investments. But the logic is the same. The expansion is driven by our desire to meet growing demand close to the market.

Okay. And if we could jump to the acquisition -- in the comments, we heard you say things are going to become clearer during the year -- or should become clearer during the year. But Michael, I think, said that we shouldn't really we expect anything in terms of revenue. So are we thinking in terms of additional announcements that you're likely to make with respect to this acquisition or -- I'm just trying to get a sense of benchmarks.

What both of us tried to indicate is that we have a very demanding screen on our new business opportunities. And we are insisting -- before we make serious efforts to accelerate their growth, we are insisting that we see clear evidence of sustainable basis for differentiation.

The big news over the past year in this aerospace composites business is we have gotten about as strong a set of validating information as I've ever seen associated with an emerging business. And it's not coming from us. It's coming from a major customer, a household name in the aerospace business. And I think the information -- Michael went as far as he could in giving you the information that we can give today. But what should become more apparent as the year goes on is the nature of that validation, the nature of the customer, and the nature of the application that we're working on. It gives us so much confidence that this is a horse we're going to ride for a long, long time -- this aerospace composites business.

Okay, that's helpful. Question probably for Michael -- we obviously missed the raw material hitting -- we knew it was coming, you told us was coming. But I'm trying to get a sense of why it hit so hard right now as I try to figure out what to do with my numbers.

Well, I missed one of the effects too, Mark, and I feel kind of stupid at the end of the year in thinking about it. The fact of the matter is we hit spot on the amount of the effect for the year, but we were not focusing on the obvious, in retrospect, fact that it was accumulating in inventory. And because the inventory was under control through that period, we did -- some good efforts were made at containing inventory at the right levels -- it didn't pop out on the balance sheet that something was accumulating there.

So what happened was by the time it finally flows through into the sales chain, it hits the sales line, and we realize the expense. So I feel more stupid than you do on this one.

And so that's what you're not anticipating any improvement in this (multiple speakers)

That's exactly right.

Okay, got it. I was a little bit surprised to see the door business do well. We tend to think of that as principally a German operation. We haven't heard a loss of great things about Germany. Are you seeing something different, or is it happening somewhere else in the business?

I have to laugh, because the German economy, as you know, has been dreadful over the last couple of years. And clearly, we have begun to see some signs of life in the German economy. But in spite of the slow economy in 2005, the German profitability went up, largely as a result of driving efficiency improvements.

The big improvement came about by a major sales increase in the Americas, and particularly in the United States and Canada. We really think the team in the United States and Canada have really got their act in order, and are moving forward at a terrific pace. We've done some things with regard to reorganizing our European management for 2006 and we feel very optimistic that we're going to see some significant improvement in the year ahead.

Okay. Well, starting to hear some slightly better things about Germany now, I guess, too.

And just one last question. When we look at the amount of stock you've bought back, if my numbers are correct, it's not quite 3 million shares over the last year or so. But it's a lot of money. Now you're going to be spending way more money than that, though, on this expansion and acquisition stuff.

I hear what you're saying about being able to do all the things you want to do. But does this mean that stock buybacks are going to have to take a back seat as you go into this accelerated spending mode?

Well, as I try to imply in my comments, we certainly don't think stock buybacks are going to take any back seat. Let's just think about the numbers here. You referred to the almost 3 million shares we've purchased since March of 2004. Well, that was $82.7 million worth of stock that we bought 2.87 million shares.

Think about what's happened since the fourth quarter -- or since the third quarter of 1999 when we acquired Geschmay. Since that time, in spite of spending $83 million buying our stock, our net debt has declined $448 million. If we did not aggressively go out and buy shares in the next two years, our net debt in spite of the capital expenditures that Joe described would continue to decline.

We don't think that's a shareholder-friendly thing to do. We think that we have a real opportunity to add to the value of long-term shareholders by buying a very attractive company to give those long-term holders a greater share in the earnings and future cash flow of this corporation. And frankly, I believe that there are some investors who are going to look at a fourth quarter of 2005 that was well short of Street expectations and see that, oh, my gosh, there's going to be another effect of the first quarter of 2006. You know, I don't think I want to wait around to find out if in 2007, 8, 9, 10, is going to be anywhere near as good as Joe and Michael think it might be. And I'm just going to be happy to help them out.

The other point here that is worth re-emphasizing, all of these initiatives are connected. That is, the better we do at improving our performance in PMC, the stronger our leadership position in PMC becomes, the stronger our cash generating cash capacity becomes, the more we're able to invest back in the business, invest in the growth businesses, and invest in our shareholders. So these are all tightly connected in our minds.

You guys both own stock here. I mean, do you think that there's enough debt on this Company at this point?

(laughter) I've got to speak to this one, because I guess I'm Attila the Hun when it comes to this particular issue. I think that it's ridiculous for a company that has the stability of earnings and cash flow from our core business to have a leverage ratio of 0.6. I don't think we're doing our shareholders any favors.

That's funny, our bankers feel the same way.

(laughter) Our bankers have been very supportive of us, and are quite happy to help us with the initiatives that Joe has described.

Okay. Thank you very much.

[Ryan Harkins], Credit Suisse First Boston.

I wanted to start on this composite business that you've spent some time talking about. Can you give us a little bit of information on the competitive landscape there? What kind of products are currently being used and would essentially compete with the product that you're currently developing?

At this stage, we really can't go there. The primary message is this -- we believe -- and more importantly, our partners in the aerospace industry believe that we have a unique source of technical advantage. And it grows out of our core competence in high-tech textiles, in weaving. At this point, until we're able to announce the partnerships we're developing with customers, we really can't go farther than that.

Okay, fair enough. Would this have more of a commercial aerospace application, or would it be on the defense side, or both?

Yes, both.

Okay, terrific. And I had a question about the door business. I'm just curious to know what your thinking is there. We have a new CEO in place, and just curious to know what your commitment to the business is, whether or not you would look at this business as a potential source of funds, if you will, at some point in the future to fund some of these growth initiatives that you talked about.

Let me repeat what I said earlier about how we think about the emerging businesses. Does it build on our strengths, does it have a unique source of differentiation that's sustainable, and does it have a growth rate that's significantly greater than PMC? And that's the screen we're applying to all of our businesses.

And we have a good management team in place in the door business. They know what they need to do to grow that business. And we'll see if they do. They are certainly showing some evidence of pulling that off.

Okay. So you really view that as kind of a third leg of the stool then from a growth standpoint -- at least at this point?

Yes. But I think we're still in the very early stages of understanding how the family of businesses is going to evolve. What we're feeling with great confidence right now is we know that one big first step in that family is going to be aerospace composites. Now we're starting to look at all of our other businesses. And our hope is that all of them become legs of the stools, in which case it's going to be a multilegged stool, and not just three legs. But it's too early to draw for you the complete outlines of that stool.

Okay, fair enough. And then on the pricing issue that has popped up here recently in Europe, can you help me understand that a little bit better? You pointed out that your product is rather customized; I'm just curious to know how does pricing kind of factor into the equation, if you will? If you lose a customer to a competitor for pricing reasons, how long does it take, how difficult is it to get the business back, just given the fact that the product is fairly customized? And I assume it would require some switching costs on the part of the customer. Can you help me understand that a little bit better?

I think you're reading it correctly. It's a lot easier to renew sales than it is to win them back after you've lost them.

Look, let me try to approach it this way. We're really unhappy about what went on there with pricing. We have a new management team in place that has a real clear sense of what's going on, what needs to be done. The head of our European corridor, [Daniel Hoffmeyer], used to be running our Canadian operation. So he knows from firsthand experience what it takes to build, to instill a sense of value and value pricing to the marketplace. And that's what he's intending to do there. So I'd just as soon leave it at that.

Okay. So you have a new senior management team in place in Europe?

Yes, we do.

That's been installed since this pricing issue popped up?

The new management team has really just come fully into place in the fourth quarter.

Okay, all right, so that's a pretty quick response on your part, okay. Terrific. I don't think I have any other questions -- appreciate all the information.

(Operator Instructions) Ned Borland, Next Generation Research.

A couple of questions -- on this Texas Composite acquisition, I see here that there's two payments, and one of them that has just closed. Could you just sort of walk us through the mechanics of that -- I mean, how much was paid and what does that entitle you to --

We paid $6.7 million yesterday at the first closing. By virtue of the share repurchase agreement, we will begin consolidating the results effective essentially February 1st. And so you'll see those sales getting reflected in our sales beginning right away.

The second closing will occur later in the year some time, either the third or the fourth quarter. And the balance of the payment will occur at that time.

Okay. And then over to the raw materials side of things, we had sort of -- kind of extrapolate the fourth quarter impact for the next few quarters. Is that a fair way to look at it?

We're looking at it that way.

Okay.

It's more than raw materials, Ned. And we were careful to word the release as materials costs, because the petroleum prices also had an impact on freight.

Right, okay. And then finally on the PMC competitive landscape and these areas that you are expanding into, I know the PMC market as a whole is pretty consolidated. But what does it look like -- are your competitors active over in those regions -- if you could elaborate on that?

Well, it really is the same set of competitors. There are some signs of an emerging local industry. But the dominant competitors, the primary competitors in Asia are the same competitors that we face in Europe and in the Americas.

Okay, but are they as established over there as they are in other parts of the world, or --?

Well, it's an emerging market, so in a sense, it's all still shaking out.

Mark Connelly, Credit Suisse First Boston.

Just two quick things. Coming back to the question about doors -- and you guys know I happen to like that business -- but just an outlook question. It's my understanding that that business has historically earned its cost of capital. And is it your expectation based on what you see in that business now that it will earn its cost of capital?

Yes, (multiple speakers) yes, absolutely.

Okay, fair enough. And second, is back to selling, general, technical, administrative -- up a little bit, but perfectly strong in terms of percent of sales -- curious if you have any guidance for us on how that may shift with the new investments? Are we going to see an increase in selling/technical that's not going to be matched by revenue growth for a while, or is there anything I should be taking into account there?

We think that the selling, technical, general, and research expense should go up more that's in line with the normal wage and benefit inflation going forward, which we are very hopeful will be well below our sustainable growth rate.

Okay, so no big extra investment you've got to make to get ready for ramping up these businesses?

Well, we clearly are going to put people in. But we believe that -- we certainly would not be putting people in if we did not think that we could have a higher growth rate in sales than the growth rate in the cost.

At this time, there are no further questions in queue. Please continue.

Well, I'd like to thank all of you for participating in the call today. We are pleased to give you a comprehensive look at both what we believe are the short-term and long-term outlook for the Company. Thanks for your participation.

Thank you.

Ladies and gentlemen, this conference will be made available for replay at the Albany International Website.

That does conclude the call for today. Thank you very much for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.