Albany International Corp (AIN) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Albany International fourth-quarter earnings conference call.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (OPERATOR INSTRUCTIONS). At the request of Albany International, this conference will be recorded for webcast.

I would now like to turn the conference over to our host, President and Chief Executive Officer, Joseph Morone. Please go ahead.

Thank you, Donna. Good morning, everyone, and welcome to Albany International's Q4, 2006 conference call.

As usual, I will begin by offering you some comments that will give you our perspective of the operating and market conditions going forward, and then we will turn to Michael Nahl, our Executive Vice President and CFO, who will give you a detailed view of our capital investment strategy going forward. We think that combination should give you a pretty good sense of how we are viewing the Company and its prospects. After that, we will of course turn to your questions.

Our third-quarter 2006 financial release suggested that, excluding the effects of any special charges, we were hopeful that the trends forward would be for gradual improvement in revenue and operating income and that the operating income impact from the decline in European PMC revenue would be fully offset by the fourth quarter of 2007. The operating results and market conditions that we experienced in Q4 reinforce this view and suggest that we are on-trend toward gradual improvement.

In our view, what is most important about Q4 is the evidence of progress in each of the three primary factors that we identified in the Q3 release as contributing to this gradual improvement trend. First, excluding the effect of the previously announced change in contract terms with a major customer, PMC revenue grew by 5.5% from Q3 to Q4. In the Q3 release, we indicated that we expected the pricing gap in Europe to narrow and volumes to increase, and that we were cautiously optimistic that the combined effect would lead to flat or slight improvements in European PMC revenue over the next few quarters. Well, with most major contract negotiations in Europe now completed, those expectations have not changed. In fact, sales in Western Europe grew by 9% in Q4, compared to Q3 2006. Meanwhile, orders in all three corridors provide further evidence of the trend towards gradual improvement. This order picture is reinforced by continued market share growth in the Americas, where major contract negotiations have also been concluded, a promising array of new products in each product line, an increasingly strong R&D pipeline, and good progress toward completion of the Asian capacity expansion.

The one important caveat regarding PMC revenue is the continuing closures of paper machines in North America and Western Europe. Resulting pressure on the top line, which clearly affected PMC revenue in 2006 is likely to continue in 2007.

A second key factor that strengthened in Q4 and that should continue to contribute to gradual improvement was significant, companywide progress on the cost reduction and process improvement initiatives referred to in the Q3 release. We expect that the initial benefit of these activities will take effect by late Q1 2007 and that the magnitude of the benefit will gradually grow through the year. These performance-improvement initiatives reduced net income in the fourth quarter by $0.06 per share. The most significant charges related to these activities will likely be incurred in the first half of '07.

The third key factor driving the trend toward gradual improvement is the continuing growth of the emerging businesses. In the Applied Technologies segment, Albany continued composite sales grew by 17% in Q4 compared to Q3, so that's in one quarter alone it grew by 17%. Considerable progress was made towards building our manufacturing and engineering infrastructure, developing new business opportunities, and in positioning the business for profitable growth.

The remainder of the Applied Technologies segment, comprising a cluster of businesses that apply our advanced textiles and materials technologies to industries outside of paper grew a combined 9%, compared to Q3, and 11% year-over-year, excluding currency effects.

During Q4, as part of our continuing effort to build critical mass and global capacity in these businesses, we merged Engineered Fabrics and Industrial Process Belts. Orders in each of the Applied Technologies segment businesses are strong, suggesting a continuation of the sales growth trend into 2007.

As for the Door segment, Q4 is historically the strongest quarter of the year. Sales in Q4 2006 grew by 11% compared to Q4 '05 and by 24% compared to Q3 of '06. As with all of our businesses, door orders are strong and perhaps most significantly to the door business, considerable progress is being made in mapping out our strategy for approaching the aftermarket.

In sum, we entered 2007 with a continued sense of cautious optimism, as we appear to be on track for the gradual recovery of revenue and operating income that we discussed in the Q3 release.

Now, I will turn the mic over to Michael, who will give you his comments on our capital investment strategy. Michael?

Thank you, Joe. Good morning.

We refer you to the comment about forward-looking statements which is contained in the press release, and we note that the same statement applies to our remarks in this conference call. This is a copyrighted presentation of Albany International Corp. Any unauthorized rebroadcasting is strictly prohibited.

Joe, in his comments, has expressed a sense of cautious optimism that we are taking the steps necessary to restore the cash-generation capability of our core PMC business. He also spoke about the progress we are making all three of the primary factors contributing to the gradual improvement.

Our progress on those three factors is a reflection of what I believe is a major transformation underway within Albany International. I'd like to discuss a couple aspects of that transformation as I see it, including how we are looking at capital investment decisions and how our management of the balance sheet supports our corporate strategy.

Joe Morone's strategic vision includes increasing our leadership in Paper Machine Clothing, as well as accelerating our profitable growth in our emerging businesses. From our perspective, as shareholders, a principle outcome of implementing this vision should be a transformation of our company from a primarily steady cash-generator company into one with both dependable, steady cash flows from its powerful core Paper Machine Clothing engine and simultaneously ability to grow faster with very attractive returns on capital. We've already begun to see the first phase of the capital expenditures implications of this strategy.

The approximately $85 million capital expenditures in 2006 included about $72 million in Paper Machine Clothing, of which $29 million is for normal maintenance and $43 million is for our PMC growth initiatives. The balance of $13 million is for our emerging businesses, [nearly] all of which are for growth initiatives. In 2007, our capital expenditures are currently expected to be between 160 million and $180 million. In 2008, we expect capital expenditures to be around $100 million.

Now, with three [busy] years of capital expenditures, from 2006 to 2008, some people must be asking, how do you get the cash-generation part of your cash-generation with growth and attractive returns model? Here are some details that might be helpful. I know that there's more detail here than you can follow in our first oral transmission, but we will keep this conference call on our Web site for awhile to ensure you don't miss anything.

In each of 2006 through 2008, our normal maintenance capital expenditures for Paper Machine Clothing are only about $30 million per year. In 2006, we spent $29 million for PMC normal maintenance, and we spent 73 million for Paper Machine Clothing growth initiatives. 32 million of that 43 was in Asia. In the emerging businesses, we had capital expenditures of 12.5 million in 2006, almost all of which was for growth.

In 2007, we will invest 137 million in capital for our Paper Machine Clothing business, of which $30 million is for normal maintenance, 99 million is for growth. Of that 99, 91 of it is for growth in Asia. We will also make about $8 million in investments in Paper Machine Clothing for improving production efficiencies in selected Paper Machine Clothing plants. That is a total of 137 million capital expenditures for Paper Machine Clothing. The remaining 35 million CapEx is for our emerging businesses, and nearly all that is for growth initiatives. That totals 172 million capital expenditures planned for 2007 with some variation within the 160 million to $180 million range likely, depending on the exact timing of those investments and currency translation rates.

During 2008, we will largely complete our planned growth initiatives in Paper Machine Clothing with about a $38 million CapEx for PMC growth and about 30 million for maintenance. Capital requirements for PMC growth are expected to drop to around $10 million in 2009, while maintenance investments will remain at that same $30 million number.

In both 2008 and 2009, capital investment in our emerging businesses is expected to be around 20 to $30 million. After 2008, total PMC investments are likely to be in the 35 to $40 million range and capital expenditures for the emerging businesses around 20 to $30 million per year. That combined 55 to $70 million per year compares with the forecast for 2007 of approximately 60 million of depreciation and amortization expense of about $4 million. We expect depreciation to increase about $9 million in 2008, above the 2007 figure, and another $7 million above '08 in '09. Amortization figures for 2008 and 2009 are expected to be about $7 million and $10 million per year, respectively.

The capital requirements for our emerging businesses are substantially lower per million of cash generation that it is in the PMC business. Beginning in 2008, the cash-generation power of the combined PMC and emerging businesses is likely to begin significantly exceeding the capital requirements with resultant debt paydowns beginning to accelerate. By 2009, the effects of that cash generation have the potential to be very substantial.

We have a strong balance sheet. Our gross interest expense is likely to increase only modestly, even with the substantial capital expenditures we are undertaking. In the fourth quarter of 2006, our gross interest expense was $3.6 million. We currently estimate that our gross interest expense will peak at approximately $4.4 million per quarter in the fourth quarter of 2008 and will then declined as our free cash flow becomes positive in early 2008 and has the potential to become very substantial for a multiyear period. During that period, we believe that we are likely to generate attractive free cash flows, even if we identify additional opportunities to invest in our fastest growth businesses at attractive returns.

I believe in this management team and in the business model envisioned by Joe, and it's shared by all of us. We look forward to rewarding the investors who have the foresight to join us on this journey.

That completes the formal part of our presentation. We would be happy to take any questions now, Donna.

(OPERATOR INSTRUCTIONS). Charles Strauzer, CJS Securities.

Good morning. Just too quick questions for you, one is related to a little bit more color on your engineered composite segment. Obviously, you had some very good growth quarter-over-quarter. If you look to backlog, did you use up a lot of the backlog or do you still see continued success of kind of building the backlog?

Backlog is growing.

Excellent. Then if you look at the--your customers and the mergers that have been announced with for instance (indiscernible), can you talk about the impact there potentially for 2007, how big a customer book bill order and (indiscernible) are and your thoughts on industry consolidation amongst your clients?

Well, both companies are important and valued customers of ours. As is always the case when this kind of consolidation takes place, there will be some plant shutdowns that result with the less efficient plants presumably being the ones that get affected. So that's a good thing for the overall health of our customer base.

(indiscernible) effect that it has on all our sales depends on which particular plants are consolidated and what our share is in those plants. We won't really know that for at least a year. This is going to take a long time to play out. But we are reasonably optimistic about the aggregate effect of that merger on us, although it's fairly early in the game on that; they still have to go through a lot of work themselves, as you know, through antitrust deliberations before they consummate the merger. So we won't know which precise plants are affected for quite awhile.

Mark Connelly, Credit Suisse.

Thank you, I've got a bunch of questions. I will start with a couple. If we look at the China spend, now that you've given us more detail about how that money gets spent over time, can you also give us a little more detail about what you're going to end up with in terms of assets over there? You know, how many facilities, what they are going to be producing, how broad and how it lines up? Or is it too early to ask that?

I think we can give you a general sense of that, Mark. Good morning. We have a dryer plant in China already existing, which if I'm not mistaken is the largest dryer plant in PMC in the region. We will, by the end of the decade, we think we will have tripled capacity of that plant.

We are--the big investment is in a press plant, which by the end of the decade will have (indiscernible) capacity-- will have--first of all will be the only major press plant in Asia. It will be the most modern press plant in the world and will be at least as large as any of our existing plants.

There is a third plant, a forming fabric plant in Korea that has been in existence for some time, and we are substantially expanding the capacity of that plant. That will also be the largest plant of its type in Asia. We've had a history of very high-quality production in that plant and we expect that to continue.

So the three expansions are China and press new plant, China in dryers dramatic expansion of an existing well-established plant forming in Korea substantial expansion of a well-proven plant.

In addition, we have had a plant of long-standing in Australia which is doing a very good job. So we will have a substantial presence of world-class--the most modern capability in press in the world, but world-class capability in every product line.

Joe, I might mention that Mark has actually visited our plant in Korea.

So is there a significant difference in timing for when these pieces come online? Is the forming plant expansion coming at the same time or later?

The forming and drying expansion roll in more quickly since they are expansions of existing capacity. The press plant, which is a greenfield, starts rolling in--we are starting production in early '08, but you know, there will be some period of ramp up.

Okay, that's very helpful. Can we go back, Joe, to the contract stuff that you talk about? I mean, you said the contract season is over and we know that much. Can you characterize how you came out of that? I mean, certainly, it didn't start out all that great with the price spreads that we talk about. Can you give us a sense of how you came out of that and how you think the industry came out of it?

Mark, I would say that--

And of course we want you to name names! (LAUGHTER)

I think the best way to characterize how we're feeling about those contracts is we are pleased about the result of the contract negotiations. Both in the Americas and in Europe, we are feeling like our relationships with our customers are strengthening and are in a good place now. We are very oriented towards serving our customers and I feel like we've had an encouraging round of interactions.

I will just ask one more and then let somebody else go. Over the years, we've had relatively consistent R&D spend at Albany--R&D and technology. You call it what, RT&A. Is that number permanently bumping up? Do you have a new level of guidance for us on that?

No, Mark. I think I've mentioned before, we've gone through a major restructuring in R&D. I've tried to indicate, in my comments, that we are pretty enthusiastic about the effect of both the restructuring and some dynamic new leadership there. We think it's possible to get significantly better impact of our investment in technology with out a substantial ramp-up. There will be incremental ramp-up more on the product engineering side rather than the R&D side as we try to fill in some places where we had some weakness. But, no, we don't think you should change your guidance on that.

Okay, let me get back in the queue.

As a percent of sales.

Thank you very much.

John Emerich, Iron Works Capital.

First, my question (indiscernible) something I want to clarify. I may have heard you wrong, Michael. I think you said that interest expense was going to peak in the fourth quarter of '08 and then go down throughout '08. Did you mean it would peak in the fourth quarter of '07 and go down throughout '08? Because obviously the first one doesn't make (multiple speakers).

No, I did mean the fourth quarter of '08. I most of misspoken then, because I meant the fourth quarter--thanks for mentioning that, John. No, we're going to peak around 4.4 million in interest expense in the fourth quarter, as we (multiple speakers) pardon me. We will get it right this time--the fourth quarter of '08 as we have substantially completed the growth initiatives in PMC. Then some very interesting things begin to happen in terms of the cash flow, early the following year.

Yes, you can see that. Okay, then I just wanted to walk through the items you called out with respect to a paragraph of the first page to understand which runs or how much, just order of magnitude, are in SG&A versus COGS. For instance, the $0.07 you called out for the contract terms with a major customer, where would that be found in the GAAP report?

I will throw all these questions right at Dieter Polt. Dieter?

It would be a reduction of both revenue, topline, and gross margin.

So it's not a cost of goods sold; it was revenue hit?

A revenue hit that you can see on that table on Page 2, $[7.6] million.

Okay, got you. Then the correction for postretirement publications, is that in SG&A?

Yes, it is.

The income tax rate was obviously in the income tax section. What's the right tax rate to use next fiscal year, just approximately?

31% is the right rate to be using, based upon our current expectations.

Super. The cost--the $0.06 cost relates to performance-improvement initiatives. How much of that is in COGS versus SG&A?

Those are all in SG&A.

All in SG&A. Then the last question I had was, from a presentation perspective, the DSOs look very different. That's largely due to the fact that you've stopped factoring receivables, right?

Absolutely; that was a big number.

So from a working capital perspective, what is the right kind of (indiscernible) not from a standard presentation; we're done with that. What is the DSO target for the Company, given the business profile today?

Well, we have not publicly disclosed what that target is. We actually are going to be increasing our focus on various working capital items as the year 2007 progresses.

It's actually an overt part of the--an overt metric in our (indiscernible) comp (inaudible) for top management.

That's super. It's nice to hear you guys being so optimistic about the future again.

Ned Borland, Next Generation Research.

A couple of questions here--the spend on (indiscernible) initiatives, it dropped and it's going to reaccelerate. What about the benefits? Are those--I mean, those are more back-hand weighted if I understand your (multiple speakers).

I missed your question. The spend on the cost-improvement initiatives?

Yes, yes.

We gave, in Q3, we gave you a couple of estimates. In the Q3 release, I think we said that, in '07, we expected about $0.30 of charges and by '08, a run-rate or late the end of '07, a run-rate of benefit of about $0.45.

We're not ready to update those because we're still working through some negotiations on some of the initiatives. We are likely to have an update by next release. If I had to put a stake in the ground now, I would say that both estimates are probably a little light.

On both the spending on the cost-reduction initiatives and the anticipated benefits?

Right. Figure the gap between 30 and 45, that still looks pretty good. The absolute numbers are likely to change upward.

Okay, and the benefits would kick in, in 2008?

We should start seeing the initial benefits late in this quarter, late in Q1. Then it just gradually ramps up. We expect the full run-rate of the initiatives currently underway, the full run-rate in place by '08. (multiple speakers). So a gradual ramp-up of the benefits, whereas the cost is going to come in a big chunk. We said in this release first half, we're not ready to say whether we will get it in Q1 or Q2, so we can't get more precise than the first half right now.

Okay, fair enough. On the sequential improvement in PMC, would you anticipate--I mean, I know the price gap is narrowed, as you said. Is there going to be an anticipated response by your competitors regionally, especially in Europe, that would kind of cause sort of a back and forth between you guys on share? Or is this--I mean I guess how would you characterize things over there now?

The best what to think about it is the time when you get the--the most likely time for the funkiness, for the big swings in instability are when you get big contract negotiations. We are through--as I suggested in my comments, we are through just about all of those negotiations.

Now, you can never predict how other people will behave but ordinarily, that's when you would expect to see the (indiscernible) spasms of instability. So I think--and we won't have another wave of contract negotiations for a year and 18 months.

Okay. Then just a little discussion on raw materials--I know that oil is sort of the headline item and I know there's a lot of links in the chain there. But could you talk about maybe, you know, raw materials that we could expect in '07, the increased versus--the increase in magnitude, I guess, over '06 versus '06 versus '05?

Okay, let's just try to walk around this one in a few steps. First of all, figure there's a six-month lag between when we purchase raw material and when that purchase hits our operating statement, so it clears inventory. So you've got a six-month lag there. Then the purchase price is determined by contract negotiation. Our last round of contract negotiations, or our next round of contract negotiations really takes place this spring. So we're not going to see any significant opportunity for change in our raw materials prices until this spring with the new negotiation, plus six months when things have washed through, so figure Q4 is when--if we're going to see an effect of the reduction of the oil prices having a moderating effect on raw material prices, that's when it is going to kick in.

Okay. (multiple speakers)

(multiple speakers) point number two, and we think it is reasonable. The ramp-up was caused by the ramp-up in raw material--oil prices. So we think this should be a positive effect in the next round of contract negotiations. So that's point one.

Point number two, the increase in our raw materials prices occurred in the first three--in Q4 of '05 through Q3 of '06. Then we hit basically a new plateau and it's washed in. So now we are at that new plateau. So when we're going Q1-Q2, we are comparing it back to costs of quarters that already experienced the big increase. So, when we do our year-to-year comparisons now on materials costs, until we hit the effect of the new negotiation, we are not anticipating big increases. They are likely to be increases like inflation.

So two waves of change, incremental change between now and the fourth quarter, and then the change in the fourth quarter will really be dictated with how well we do in our negotiations that are forthcoming.

Okay. Thanks.

Enjoy the Super Bowl, Ned!

Michael Christodolou, Inwood Capital.

Inwood Capital. You've mentioned about the focus on working capital. I was wondering if you could just elaborate a bit. Clearly, you brought your receivables financing facility back on your balance sheet\ just because you've got such a great deal on the debt that you've raised. On the same line, I see that inventories are up about $30 million or 15% year-over-year. But I was wondering if you could just elaborate. I don't think you are suggesting that you're going to be penny wise and pound foolish in terms of squeezing a few million out of inventories at a time when your competitor has got downtime issues, delivery issues and fulfillment issues. I'm just wondering if you could just kind of walk us through where you think you could generate some reductions in working capital but not hurt your ability to service the customer.

Thanks, Mike. You're absolutely right. We do have the luxury, with the strong balance sheet, of using inventory as a strategic component in our relationships with our customers. Certainly, we have not had some of the problems that one could have with a weaker balance sheet.

The fact is that where we believe that, with the efficiency improvements that we've been working on over the last year or so, that there are opportunities, as we have simplified the delivery (indiscernible) logistical structure of our company, that we will be able to hold the right levels of inventory that are needed by our customers and that those levels can be significantly lower than they are right now. We're not going to disclose specific amounts, and frankly, we're not going for huge numbers here, Mike.

We are going for discipline, Mike. You know, particularly when you're talking about growth, we just want to make sure we don't lose discipline.

I mean, I would think, just given what looks like the sharp [V] bottom that happened between the third and fourth quarters in Europe, I mean, had you been under inventoried, you would have missed some of that snapback and not had the sequential game that you've shown us today.

We're looking at the world the same way, Mike.

Okay, very good. Just as China continues to grow, and again, I think we've all seen the statistics about per capita paper consumption over there is about a tenth of what it is in the U.S., would you envision having just a little more inventory as you start to ramp, one, as you're exporting over there now and, two, as you start to ramp local production just to handle what should be some great growth?

Yes. Then you can make the same arguments for the emerging businesses for precisely the same reason, I mean, if you just think about the rate of growth in our composites business, which I mentioned was that 17% quarter-over-quarter. Yes.

Thank you, gentlemen. Good luck.

Mark Connelly, Credit Suisse.

Just a couple of more things. If we go to the Applied Technologies side, you know, other companies that are doing carbon fiber have been hit, at least in terms of expectations, by all the delays we see at Airbus and some of the news we get out of the [Dream] liner. Can you talk about your relative exposure there? I mean, obviously it's not as big a business for you as it is for them. But how much of the business that you're targeting over these next couple of years is with customers who are seeing those kind of delays, maybe not quite as spectacular delays? But can you give us a little bit of a sense of your customer base and what the experience is in the markets you're targeting there?

A couple of points--number one, if you think about the value chain in the composites business with the raw material suppliers and the fiber suppliers at one end and the OEMs at the other, you know, we are somewhere in the middle. We are in a segment where there's a lot more value added in what we do than there is in what the carbon fiber suppliers are bringing. So we are actually in a segment of this industry where there is a ton of value-added. In our advanced composites activities, there are a couple of tons of value added. It's not really an apples-to-apples comparison.

Secondly, well, we're starting from a very small base. Our guidance last quarter was that we were expecting 25% compound annual growth rate in the composites business and we saw 17% in Q4. So we are not seeing any slowdown of growth. On the contrary, we are seeing explosive growth.

Third, we do expect that the OEMs that we will be supplying either directly or indirectly, Boeing and Airbus, will in the long-term, be very important indirect customers for us. We will be selling to the [Messier] (indiscernible) and to the (indiscernible) who in turn will be selling to the Boeings and Airbuses. In the short term, the short term order backlog, neither of those big airframe manufacturers play a significant role in our sales.

As you heard in Joe's earlier answer, even with a 17% increase in net sales between the third quarter of last year and its fourth quarter, our order backlog went up.

Our challenge in that business remains managing very rapid growth. This is an--for the segment we are in, that piece of the value chain we are in, this is an opportunity-rich business. That is not our worry. Our worry is keeping up with the (inaudible).

Joe, in that vein, you have talked about the constraints of skilled labor, etc., as you build the infrastructure for that business. Is that still an issue that you are struggling with? You know, we see, in other industries, rapid escalation of costs, like you are seeing in the ethylene business these days. Are you experiencing that same issue on a smaller scale here?

We think we are. For the moment, we are winning the battle. But if you project out the growth curves that we project, it's a battle that never goes away, that we will always be fighting to pull in talent to keep up with the opportunity. So we think there will be an inflationary effect of the scramble for talent, but it will be more than offset by what appear to us to be a high-return business because we are in this high value-added component of the value chain. Particularly, when you get to these advanced composite opportunities like the (indiscernible) and the landing gear and other things like that that we are exploring, we are making parts that other people have not been able to make out of composites. It's high value-added.

Joe, just one last question--over the last maybe six months or a year, you've said a couple of times that you see so many different opportunities here that you probably can't pursue them all; you'd ultimately run into capital constraints. How serious and how much time do you spend staying up at night worried about that issue of having the capital that you need to pursue all the growth that you are looking at?

With Michael as CFO? I don't lose sleep! (LAUGHTER)

All right, Michael, how much sleep are you losing?! (LAUGHTER)

Well, of course, I knew that question would be on investors' minds, and that's why I went into as much detail as I did today. I recognize that's (indiscernible) a lot of numbers that people, some people are going to have to relisten to the tapes, but (multiple speakers).

(multiple speakers) in there, Michael, of course, is acquisitions, too, so I'm just trying to get a broader view of--.

The constraints on the business, the constraints on the ability to grow this business is not capital in our minds; it is managerial talent and execution, and it's execution risk.

Absolutely.

It's not market risk. and it's not capital risk.

Correct.

Okay, that's very helpful. Thank you very much.

(OPERATOR INSTRUCTIONS)

Thank you all for participating in this call, and we look forward to doing it again next quarter. For those of you who will be seeing us at Investor conferences in between, we look forward to doing that. Have a nice day.

Ladies and gentlemen, this conference will be available on the Albany International Web site. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.