Xerium Technologies, Inc. (NYSE:XRM)
Q3 2007 Earnings Call
November 27, 2007 10:30 am ET
Tom Gutierrez - Chief Executive Officer
Mike O’Donnell - Chief Financial Officer
James McCahon - Investor Relations Counsel.
[Audio Begins Abruptly] …from the production of paper, clothing and roll covers. The company utilizes a broad portfolio of patented and proprietary technologies to provide its customers with tailored solutions and products integral to paper production, all designed to optimize performance and operational cost.
With 33 manufacturing facilities in 14 countries around the world, Xerium has sales of $601 million in 2006 and is traded on the New York Stock Exchange.
For further introduction, I’d like to introduce Tom Gutierrez, Chief Executive Officer of the company, accompanied by Mike O’Donnell, Chief Financial Officer, and they are accompanied by James McCahon, who is their Investor Relations Counsel.
Thanks Gerry. You actually just gave my presentation. I’m Mike O’Donnel, I’m the Chief Financial Officer for Xerium. I hear it pronounced a lot of different ways. We pronounce it Xerium as a take off on the Xerox name. Thanks for taking the time to join us this morning.
I’m going to share some overview comments with you about the company. A little bit of the background, if you will. And then Tom Gutierrez, our CEO will get up and share with your our strategic outlook, or strategic vision, for the company going forward.
As always, any forward-looking statements we make today, our actual results may materially differ from those, which I’m obliged to say.
Just a snapshot of the company; as Jerry said, $600 million in sales, that’s 2006 sales. There are around 3,700 employees, and 37 manufacturing sites in 14 countries. We manufacture and sell technically complicated, complex products to the paper making industry. They are consumable type of products, and I’ll talk a little more about that.
Parts of our company, parts of the operations around the world, are well over 50 years old. We came into being as a single entity in 1999, as a leverage buyout from Invensys Plc., and then in May 2005 we did an IPO on the New York Stock Exchange.
Two business segments in which we manage; the first is the clothing, what we call paper machine clothing segment, not to be confused with clothing, although it is a textile type of product. The second is the roll cover product.
Paper machine clothing, I don’t know how many people are familiar with the paper machine, I’ll show a picture of that in a few minutes. But these are products that can be up to 40 feet wide, hundreds of feet long. They are synthetic textile belts that are the basic means of conveyance of the paper through the paper machine.
Our roll cover products, and that covers product and auxiliary services that go with those products are also sold.
Both these products are consumable products as I mentioned before. The clothing products are about 64% of our total sales in 2006, and that’s a leading market share, we are a strong number two in global market share.
The roll cover business is about 36% of our sales in 2006, and we are a clear market leader. Far greater than 33% of market share in the roll cover business.
This is a picture of a paper machine. Just to give a scale, we’ve put a box around the machine operator, a man who’s standing beside the machine, just to give you a sense of the scale of it.
The paper manufacturing process itself, is basically using the input that you see on the left-hand side of the chart, so it’s pulp, it’s chemicals, it’s primarily water at the front of the machine, which is dumped onto a moving textile belt, that’s our paper machine clothing product, moves it through the manufacturing process. The primary function of the paper machine itself is to remove water, and to form the paper and give it the attributes and characteristics that the paper makers are trying to achieve.
Both of our products touch the paper manufacturing process. They actually are the main means of conveyance. And as I said, our products are consumed in the process of manufacture of the paper.
In that respect, I show here at the bottom of the chart, the replacement cycles for each of our different product lines. The clothing replacement cycle, the primary products are forming fabrics, pressed felts and dryer fabrics. I said we’d discuss the life of those in the on average in the paper machine.
On the right-hand side are the roll covers and the roll cover servicing, things that we sell. And you can see the respective life of those things.
These are technically very complex products. They are highly engineered, and highly engineered to derive savings and quality benefits for the paper manufacturers.
To back up the technology that we have, in which our customers consider us to be a technical leader. We have an extensive portfolio of intellectual property that we use to protect our technology around the world.
Talking a little more about the clothing products. One of the things in which the clothing products are distinguished from our roll cover products, is that they are easily transported around the world. In other words, from the point of manufacture to the point of use, there can be a pretty good separation, which we take advantage of in terms of the efficiency of our manufacturing footprint, which I’ll talk about later.
The products range in average selling price from $13,000 up to $45,000 per unit. But some of the more exotic or larger fabrics actually can be close to $200,000.
Sales volume is driven by paper production globally. Tom will talk a little more about it in terms of a dry refurbishment business. But from a clothing product standpoint, it gets used up on a pretty linear basis, with the production of paper.
We focus on the higher value products within the clothing segment. So the forming fabrics and the press felts, which are at the front end of the paper machine, that really is where a lot of the quality characteristics, use of raw material, use of energy, where the paper makers are benefited by our product.
We also sell some of our clothing applications into some industrial applications in different parts of the world.
Breaking down the clothing segment by sales. By product line you can see that the forming fabrics and the press felts, which is where we focus, is at the higher value added part of the paper machine. This is where we focus our efforts. We also carry a dryer fabrics and dewatering devices, which is a smaller segment, that’s by design. And then 10% of our business on the clothing business is for industrial application.
On a geographic breakdown, you can see that our strong position is in North America and Western Europe. On the clothing side of the business, we also have a very strong position in Asia. I’ll show our footprint, but we support that primarily out of our Japanese and Australian manufacturing plants. But we also import into Asia from Western Europe and other parts of the world to that region.
In South America we have 4 floating manufacturing plants, there is a strong position and strong market share in that region.
Moving to roll covers. Roll covers, if you can imagine, there’s around 200 rolls in a paper machine. And we resurface those and service those rolls through the life of the manufacturing process for papermaking. It’s a synthetic compound that we apply to the surface of a roll cover, and these roll covers weigh from 5,000 to 140,000 pounds. You have to be close to your customer with your manufacturing footprint because of the logistics of transporting the sized rolls.
The sales volume in roll covers is a little bit different; it’s driven a little bit differently than the clothing product. Both are driven primarily by paper production, but also with roll covers, there is an effect of the number and the type of machines, paper making machines, that are actually in use.
And also the longevity, the product life of the roll covers is longer than the clothing products, so you see a different affect on the demand cycle standpoint. And as in the clothing business, we also have industrial applications for our roll cover business, roll cover products and services.
The price breakdown for roll covers is dominated, as you see, by the roll covers and the roll cover refurbishments. So this is services around the roll cover itself. So imagine a large stainless steel roll, we apply a surface to it, we regrind that surface, we can surface. We provide mechanical services around the mechanics of the roll cover itself.
The second largest product segment for us is in Spreader rolls. And Spreader rolls are a bowed roll, if you can imagine, in the paper machine, that we manufacture, that has the benefit of smoothing the paper and spreading it to the outside of the sides of the machine. For quality purposes and consistency of material usage and so forth.
I mentioned mechanical services, that’s about 6% of our total roll cover business. And industrial applications into other than non-paper making applications.
From a regional standpoint, a little bit different in the pie chart than the clothing. Primarily the difference is that we don’t have as strong a presence in Asia because of the demand for being closer to the customer and having a physical presence there. And again, Tom will talk about the opportunity that we have in Asia. But a strong presence in North America and Europe we’ve had in clothing. We also had a strong presence and a strong market share in South America, and you can see the numbers for Asia here as well.
I guess, before we go to Tom, there’s two points I’d like to make in terms of the key strengths of Xerium. One of them is that we are diverse across all customers, grades of paper, and geographic presence. We really have a strong presence across all of it.
If you look at this graph, the bar on the left hand side is paper production by the region of the world. So it’s North America at the bottom, Europe’s in the yellow, South America is in the green, and Asia is the top, which is the lighter blue.
That’s where paper is produced. And you see how well matched we are, particularly in the strength of our markets in North America and in Europe, with some underweight, if you will, in Asia, primarily caused by the lack of physical presence in roll covers, which Tom will address.
The second point I’d like to make is, when you look at our physical presence of manufacturing plants, and the first thing I’d like to remind you is that we had well over 40 plants four or five years ago, we now have 33. So we spent a lot of time investing in making our footprint more efficient, matching what’s needed in the market, becoming much more manufacturing cost structure driven in terms of reducing our cost structure.
So you can see, the strong presence that we have in North America and in Europe with both clothing and roll cover plants. As I mentioned earlier, manufacturing for clothing out of Japan and out of Australia and Asia, and we have begun the construction of a plant for clothing in Vietnam. And in other parts of the world, in Greater Asia, we have licensees for our roll cover products.
With that I’d like to turn it over to Tom to share with you his [pro] strategy.
Good morning, I think that Mike has presented a pretty good overview of the business in terms of what we do, our footprint, the strength of the business in terms of how we go to market around the world.
Before I jump into some of the details or some of the initiatives that we’ve put in place in order to stimulate growth going forward, I think it’s important to talk about our customers, what drives the industry in general, the industry that we serve, which is the paper and board making businesses throughout the world.
And lastly, go into some of the challenges that we face, so you can put the initiatives that we put into place into better context.
The first slide here really talks to paper production, and we noted that paper production is indeed the key driver in the clothing side and a key driver on the roll side of the business. If you go all the way back to the early 1980s, paper production has continued to grow at roughly a 3% annual rate, all the way back to the 1980s. And in fact, during that period of time, there’s only been two years, 1983 and 2001, where paper production actually decreased year-over-year versus the prior year. And in the following year it increased again.
The other thing that you’ll note here is that between 2000 and 2007, there’s been a slight decrease in the growth rate, that have been experience back to the 1980s. And I’ll talk a little bit about what’s driving that. Even more importantly to us, is that if you forward over the next decade, growth is expected to resume about a 3% rate all the way out to 2020.
If you were to superimpose a graph on this chart of paper products, you’d see a considerably different picture, because paper products are very volatile, and that’s really what drives the financial performance of our customers, is paper prices as well as volume, obviously.
But paper prices, given that they’ve been declining through his period, and the fact that they are very volatile, makes for customers that are not in as strong a financial state as we are as a supplier. We’ve got a very stable demand curve that’s driving us. They, on the other hand, have got, but unfortunately because of supply and demand issues, have not been able to get the same level of stability in pricing, and therefore, their financial performance.
If we analyze the growth that’s coming, a little bit more discreetly, what we’ll find is that, if you look at Asia, some 60%. What we care about is the tonnage of paper that’s being produced, and some 60% of the increase of production between 2004 and 2015, this is a slightly different scale than on the previous chart, is going to occur in Asia. And yes, China is a big driver of that, but there is a very significant amount of growth in Greater Asia, outside of China. So it’s important for us, paper production volume is important for us, to continue to drive at being able to take advantage of that growth in Asia.
If you look at Europe and Eastern Europe, and include Russia in that picture, what you’ll see is that most of the growth is going to happen in Eastern Europe and in Russia, where a lot of our customers are starting to put really heavy investments into it.
And even if you look at the growth that’s slated for Western Europe, a significant amount of that is slated for export, either into Eastern Europe or into other geographies throughout the world. And so the real strength of growth is going to occur in Eastern Europe and Russia.
And then if you move to the Americas, while it says that there’s 10.5 million tons of growth, the bulk of that is in South America, and in North America, particularly in Canada, you’re seeing some real slowing down of the growth of paper production going forward. Obviously this is a very important graph for us, because it tells us where we have to be in order to drive our growth, and if you recall Mike’s picture earlier of how we are positioned throughout the world, what you will find is that we are very, very strong in Western Europe and in America, and in the Americas in general.
We are very strong in South America but that’s our challenge, one of our key challenges going forward is going to be to take advantage of the growth in South America, Eastern Europe and Asia. And therein lies one of the key challenges that we have going forward, is that our footprint is very heavy and very strong in Western Europe and North America yet the growth that is going to occur, we need to move our footprint and continue to expand our position in Asia, particularly in rolls where we have almost no position.
The second point that Mike made about what drives our roll business is that in addition to paper production, the roll covers business is driven by the type and number of paper machines that exist. During that period of 2001 to 2007, what’s occurred in the paper industry is that paper makers have – there’s too much capacity in the world for producing paper and so the reason that the prices move up and down in such a volatile manner is that the industry is not particularly good at keeping supply and demand in balance and prices go out of whack.
So between 2001 and 2007 particularly in North America, papermakers took a very, very heavy amount of restructuring and consolidation in order to try and drive some of that capacity out. Some of the older less efficient machines have been taken out of service and there’s been consolidation among players, and capacity’s been taken out.
That’s a good thing in the long term for the industry, and we are starting to see some of the good benefits of that in the financial performance of some of our customers. There’s still some of that work to be done particularly in Canada and some in Western Europe but we feel that for us the key outcome of that has been that in the roll cover business, there’s less opportunity because the types of machines that were taken out were the ones that utilized our most profitable products in the roll cover business.
And so as we look forward, technology and the life of our products which is extending as the result of technology and the shift in the types of machines that are in service, are countering some of the growth that occurs because of paper production in the rolls and so that’s one of our challenges that we have to address and then I’ll talk about what we’re doing as we move into the strategic section.
The last part is, to get customers who are fundamentally fighting for every nickel of profit that they can get, whose margins are much thinner than the suppliers that supply them. You have a dynamic that if you’re not careful, can turn against you, and the dynamic obviously is that we have to be able to deliver more value to that customer than what they perceive is the cost of our product because they’re looking to improve their cost, their performance.
And so our view is that we need to become a partner in cost reduction instead of the target of cost reduction. And therein also lies our – this is the way we sell and so we’ve actually faced this during this period of contraction in the paper industry, a contraction of growth I should say, because volume has gone up between 2001 and 2007. Because our basic proposition is, we develop products; we have a direct sales force that’s very technically competent.
They live in those mills; frequently they know more about the paper machine that’s being run than some of the customers themselves because they’re in there every day and it’s the nature of what they do. And so our view is we can help them speed up the machine. We can help them take energy out of the process by giving them a dryer sheet before it gets to the dryer section. We can help them improve the type of raw materials that they use so they can use cheaper raw materials.
And one of the things that’s occurring is more and more papermakers are shifting to recycled fiber which presents special challenges during the papermaking process. And so in many instances we’ve been able to deliver value, given that we’re only 3% of the cost of making paper. Even if you cut our cost in half it doesn’t wiggle the needle very much. But if we can cut the energy costs or cut the raw material costs in conjunction with our customer that really makes a big difference.
We’ve got one key customer in particular where in the last four years we have generated savings that far exceed the annual costs of what they buy from us and so in a circumstance like that I would like to walk in and say, gee our products are free. That doesn’t work for every customer obviously, but I think they get the concept of how we sell and that has allowed us to have the kind of margin, to have the kind of stability that we’ve had during a fairly tough period in the paper industry.
So, moving on to the strategy itself, we analyze our strategy on the basis of this four-quadrant opportunity analysis that we do. And the first area that we really focus in on is taking care of home base. That is, we have a very profitable business that is cash generative, it’s been stable and so it’s really critical before you go chasing additional growth that you maintain stability in that core part of your business and our view is that the best way to do that is to remain the lowest cost supplier and the best value provider. That doesn’t mean the lowest price provider, that means the lowest cost provider in the industry and we believe that our gross margins are substantially better than any of our competitors.
So, moving forward, we’re going to do more of what we’ve done in the past. We’ve taken out close to ten manufacturing facilities. We’ve restructured the business, flattened it out, it’s a very lean organization. We’ve been able to drop our cost structure substantially. And we will have an extreme focus on cost reduction going forward and we believe that we’ve just scratched the surface of the opportunities that exist within our infrastructure.
The second part of that equation is, once you’ve done that, it is also critical, as I say, given the financial performance of our customers, for us to really drive helping them improve their profitability. So the whole value selling approach, having customer cost improvement engineers that live in the plants with our customers and help them apply our products in a way that saves them costs, that’s a critical part of defending the homeland, so to speak, and that’s one quadrant of opportunity that we have.
Now once you leave that, you say, alright, now we can drive growth and our second area of focus is regional expansion. I talked about the fact that Asia has got very significant growth that is occurring and is going to continue, everybody believes, over the next decade. And so our view is that in South America, in Eastern Europe, and in Asia, it is important for us to move our footprint and make investments that pay back at a reasonable level but that give us the ability to participate in that growth.
The second part that’s obvious is particularly in clothing. In clothing we’re able to ship products from one location to another and so over the last three years one of the things that we’ve done is we’ve taken the footprint out of North America and we’ve put the footprint into South America where we have a very low cost manufacturing capability and we’ve been able to shift that product back into the North American continent.
As far as the roll side of the business, you can’t ship those across oceans, and so that’s a different challenge that I’ll talk about here in just a moment. And in the clothing area as Mike said, we’re building a plant in Vietnam that we believe will give us a very low cost infrastructure and one of the first things that we’ll do is, we’ll ship a substantial amount of product out of Germany, out of Austria and out of Italy, very high cost locations, and Asia happens to be the lowest price location in the world for our products. And so we believe that we can shift that manufacturing into our Vietnam operation and not only take advantage of future growth but also at the same time improve our cost structure even more. I’ll talk a little bit more about the specific projects in those areas.
In parallel with the regional expansion that I’m talking about, differentiation is key. Not only do you deliver value to your customers, you want to deliver it with products that are better than anybody else’s, that deliver capabilities that no one else can and we have a very strong patent portfolio and a lot of internal knowledge as to how to apply these products. But, we believe that the industry has not done a good job and we’re speaking of ourselves as well, in really focusing on research and on finding new materials and new ways of constructing these products, not only to give better performance but also have the secondary effect of doing it in a more economical fashion.
So we’ve increased our R&D spending and intend to continue as we drop costs elsewhere to put investments into the research and development world in order to advance the differentiation over time. Mike didn’t mention it but we have been the innovator in this industry. We created the first synthetic fiber forming fabrics. We created some of the newest technologies in terms of how we make our felt smooth and so we have a history of doing it and this is just basically more of the same with perhaps a stronger focus on the research side of it so we can find additional breakthroughs.
The other thing, and this is really relevant in the roll covers side of the business, is that as the roll cover opportunities diminish, we have a sales channel that is second to none in terms of its presence in the mills and we believe that there are other products and services that we can offer through that channel that will allow us to basically build that business up in a faster cliff than the erosion is occurring. And we’ve done some small bolt-on acquisitions; we did a company by the name of Coldwater. We’ve just recently announced some new service and new capabilities that we’re offering to our customers in that realm.
And so that’s another one of the avenues of expanding our current offerings in order to improve and to add to our growth capability.
The last area I’ll talk to is our business outside of the paper industry. In the charts that Mike put up you’ll notice that about 10% of our business, roughly, is in industrial sectors. And that’s occurred with some effort but it’s not been really a focus of ours over the last twenty years or so, to grow the industrial side of the business.
As we’ve sat back and analyzed it, what we find is that there is a significant amount of opportunity for us not to stray too far from home, use the technology that we have, in a way that is not capital intensive, it doesn’t require a lot of new cash and to expand our business. And so the focus here is particularly in the oil and gas industry, packaging and converting and in industrial packaging where we believe that there are some substantial opportunities.
We have projects ongoing right now and as time goes on and we pass the technical hurdles to be able to demonstrate that we can penetrate those markets we will disclose what those projects are. But at the moment we believe that we can take that 10% and substantially improve it over time.
So now for some of the specifics; in the clothing segment we are building a manufacturing facility in Vietnam and it’ll be one of the most modern facilities for clothing products in the world. We believe that the choice of Vietnam versus putting it into China, we did a significant amount of research into our customers preferences, that wasn’t an issue. We believe Vietnam is lower cost, more stable and we believe that the reception that we’ve got from the Vietnamese government is very strong.
We already expanded our capability in South America. Just recently we added some polyurethane capability in South America and the early results of that are very powerful. We’ve got some very good order flow out of that so we expect to continue to build on that. And then, the same thing that I talked about, industrial applications, some of the key projects actually that we’re working on are in the roll cover side, not in the clothing side but on the clothing side we believe that there are also some opportunities to expand our business.
In the roll cover side, we’ve announced now, several times and we’ve made it fairly clear that we expect to have a presence in China by mid next year. And the importance of that, I’ve just talked about Vietnam and where Vietnam was a better decision than putting it into China, in the roll cover world you can’t shift 40 ton rolls very easily or very far from the paper mill and so its important to be in the market itself. But even more importantly for rolls, we have almost no presence in a $100 million market we believe that is what China is going to be and we’d be competing against the same individuals and the same companies that we compete in the rest of the world where we’ve been able to garner up 33% plus market share.
And so we believe through this physical presence in China that we can enter what is going to be $100 million plus market for our products and make some substantial movement in improving our growth in the roll cover business.
In addition to that, actually earlier I misspoke; we added our polyurethane capability on the rolls side not on the roll cover side. On the clothing side what we’ve done is we’ve made a major expansion of our capacity in South America to support selling product that’s manufactured in South America and in North America. And we’re expanding, as I said. What’s critical in the roll business is we have such a superb sales channel that’s physically in the plants that we believe that adding product to that bag that they carry into the plant is a critical way of expanding out business, and then the last part is that most of our significant industrial development projects are in the roll cover side of the business.
I think all of this is great if you have a management team that can pull it off, and we think that we have one of the best management teams in the industry. Mike and I have been together pretty close to eight years. Before this we were responsible for a few billion dollar global businesses.
We have a combination of other people with us that have been in the paper industry most of their lives. That adds balance to our new ideas as to how to grow this business, and just about everybody has run multinational businesses throughout their career, so we think that this is a pretty powerful team that we’ve put together. I think before I wrap it up and I talk about a summary of everything that we’ve talked about here today I’ll sort of briefly go through our third quarter results.
We had a very good third quarter. We think that that the third quarter represents somewhat of a turning point in terms of all of the investments that we’ve made in taking cost structure out, taking facilities out, driving for new growth, is starting to show up. Now I have said publicly that there is variability quarter to quarter, and so, you can expect there to be variability going forward.
But we see in the third quarter, very good sales increase, gross margins improved, and 40% margins, 41% margins, we believe, are close to 10% higher than our nearest competitor at a gross margin level. And that again is a measure of the quality and the impact of the work that we’ve done over the last four or five years. Earnings per share went up, we are cash centered as company, and we are in a good cash position going forward.
So if I were to summarize, and I said if you could only take one page away from here this is the page I’d like you to take away. We’re a global player, we sell consumables. These consumables are highly technical, value adding consumables. We are highly diversified, so we are not open to one customer or one region going south on us and us having a really, really difficult time. There are significant opportunities, both on the cost side as well as the revenue side and there are some very good opportunities for us as we reach into the Asian growth that’s forthcoming.
We have a very experienced management team, and I think we’ve demonstrated our ability over the last five or six years. And the last point is a critical one. We think we’re at a turning point here. We think in terms of all the actions that we’ve taken and we’re by no means done in terms of the things that we perceive can be done with this business, but we believe that the work that’s starting to be done is starting to pay dividends.
So with that I’ll open it up to questions. Yes sir?
Question and Answer Session
Unidentified Audience Member
With what (inaudible) about the paperless society and the spread of computers, and so sorry, nobody is going to use any paper any more?
Okay, the question is that the gentleman has heard about the paperless society and the concern that people aren’t going to use paper anymore. In fact, what’s happened is if you own a computer you probably print things out, you read them and then you throw them away, and then you print them out again. And what’s actually happened is the computer industry, the information age has actually been good for most grades of paper in terms of the growth, and the size of the growth continues at that average 3% rate.
Where there has been some impact is in the newsprint sector of the industry where you’re starting to see, I’ve got young sons. They don’t read a newspaper, they get their news online. And so you’re starting to see the information technology starting to have an impact on the newsprint side. But on the packaging side, on the printing side, on the tissue side, it’s just a world consumption as the world industrializes and you have new regions in the world that are moving up the use curve. You’re seeing a continuing growth of paper.
Unidentified Audience Member
Unbalanced, you’re not going to see more than 2% or 3%, which is what’s being projected. And you’re going to see it regionally shift from one region to another, as I indicated. But at the moment, it doesn’t appear to be a paperless society, I think, short term impact, but who knows in 25 or 30 years.
Unidentified Audience Member
A two-part question, if I may. Earnings estimates, if I’m not mistaken for this year from six to nine months ago were over $1, now $0.60-$0.65, so you have a big set of events that lowered earnings estimates, and pushing dividends was cut in half, and so what caused that?
Secondly, if you are articulating a growth strategy going forward it sounds like you’re going to jettison your dividends at some point.
I think the first part of the question is what’s happened to our earnings per share, where as at the beginning of the year it was over $1 per share with the estimates that were on the marketplace, and they’ve recently gone down to the $0.60 range, I believe. The most significant even. I’ll let Mike talk about it. We’ve had a restatement that we had to do relative to the way in which we categorize our hedges.
The restatement of the, let me step back. We took out interest rate swaps on our senior debt. At the time we initiated our current credit facility, which was in May of 2005. That had a variable rate on liable work, and we took out interest rate swaps, which at the time we adopted what’s called hedge accounting, where we took the fair value changes to those swaps to the balance sheet rather than the P&L. The accounting turned out to be an incorrect interpretation, we had to go back and restate out results in the third quarter of -- actually restated the first two quarters of this year and each quarter back to June of 2005. To reflect taking those fair value hedges, the fair value fluctuations were to the P&L instead of to the balance sheet. In 2007, that was around an $8 million effect through the third quarter.
Unidentified Audience Member
Any other factors in pressures of volume?
Operation, I mean, we don’t provide forecast, so I’m responding to the question in terms of history to a large extent. And the most significant thing that’s really occurred is the restatement. If you look at our operational performance we believe we are on track to what our expectation was for the year. There have been price pressures on the marketplace, particularly in Western Europe. There have been significant price pressures, but we’ve been able to offset some of that as our third quarter showed with some of the things that we’ve done with our cost structure, and some of the new revenue that we’ve gotten in other areas.
We have a variable contribution level that’s up there in the 50% plus category, and so to the extent that you get a dollar of new revenue it drops to the bottom line pretty well, and so leverage is pretty quick. So we’ve been able to offset some of the pricing pressure through that, and pricing, we’ve been able to hand onto most of our pricing because we don’t sell on the basis of cost, and we certainly, as I indicated earlier value, delivered value is the key to our business, and as a result of that we’ve been able to maintain a pretty good hand on our pricing although there’s been pressure.
You asked a question about whether or not we were going to cut our dividend or not in view of our plans for growth. What I can tell you is, what I’ve said publicly, which I think is pretty clear. That is, the Board meets; our dividend policy is the Board meets once a quarter. We sit down and look at our opportunities for growth investments, we look at our debt, we look at the dividend and we make a decision. We, because Mike and I are both members of the Board, we make a decision on what is going to be the best driver of value for shareholders.
And what I have said, and I’m going repeat this again, is that we view investment and growth for the company to have a priority over the other items, okay? And to an extent, up until now we’ve not had to change our view, we did cut out dividend in half last year. But at the moment what we’re saying is we’ve paid a dividend this quarter, we’ll analyze it again next quarter on the basis of our cash needs and our cash on hand and depending on our growth opportunities that is the priority, growing the business. And I think beyond that I really can’t say more about the dividend. It’s a quarter-to-quarter decision.
Unidentified Audience Member
Would you talk about your balance sheet and how much income was affected by the rise in foreign currency? And how did you adjust your top line and your bottom line by (inaudible)?
Currency for us is -- has two facets. One of them is the operational facet and in terms of how it affects our sales and our EBITDA, and the other one is how it affects our debt and our debt payments. And so I’ll speak to the first part of it, which is, as far as operational performance is concerned, we’re very well matched in terms of how, where our sales occur and where our cost at.
And so what we see is that we have a pick up on the pop line when we get, for example the Euro moving up. On the flip side of that, we sell in US dollars our of our Euro locations into Asia, and we have a negative drag. And so what tends to happen to us, we have similar kinds of things in South America where we sell in US dollars, and in Australia is another good example, and in Canada.
So what tends to happen to us is that currencies inflate the top line. We get a little but of a benefit on the bottom line, if you include the effect of pricing it’s actually almost negated completely, and when the currency flips in the other direction we have a similar approach. So we’re not, we don’t believe ourselves to be hostage to currency in terms of our operational performance.
Unidentified Audience Member
You said you had a 5% top line growth last quarter, how much in currency was that?
I think 1.4% or thereabouts was real growth and the rest of it was currency, but by the time you get to the bottom line, where we had a very good improvement in profit, that wasn’t generated by currency, because by the time we got to the bottom line currency actually hurt us, during that period, slightly, but not a lot.
The other piece of it is how it affects our debt, and how it affects our interest payments and all of the above. On an actual cash basis what I’d say to you is we have our debt where our cash flows are at, and so we pay our Euro debt with Euros, we pay our Canadian debt with Canadian Dollars, and so from a cash standpoint there’s not much of an impact to us.
From a translation standpoint, in terms of how it affects our covenants and how they are viewed there is an affect because currency makes our debt go up and it has an impact on interest and so there is an impact on that. But in terms of absolute cash performance of the business and operating performance of the business we feel that we’ve done a pretty good job of balancing it so that it doesn’t hurt us or help us in either direction. And on the interest rate side, and I anticipate another question in this, we hedge 85% of our interest and so because we don’t like the volatility of living quarter to quarter and what’s going to happen to the interest rate and what’s going to happen to currency.
Unidentified Audience Member
I guess that’s guidelines for the time (inaudible) for consolidation, where are you at in supply? Are you a consolidator or are you a consolidatee in the paper industry?
I think the question is, what is our view of consolidation in the paper industry? Well, let’s talk about what’s possible in the industry first. I think you have to speak of the customer separately than you do about the suppliers. In the customer side of it there’s a significant amount of consolidation yet to occur.
AbitibiBowater, there’s a bunch of them that I think that probably are going to be good for the industry to happen. On our side of it, in the roll business, there are three of us. There are the two paper machine makers and us.
Between the three of us we probably have significantly more than 90% of the market and we’re twice the size of our nearest competitor. So that give you a view of how much other consolidation there is in the roll business, and our view is that there’s not much. We think that the opportunities are more bolt on opportunities for adding product lines or adding technology.
On the PMC side, or on the clothing side, the paper machine clothing side, we’re number two. The number one player is twice our size, beneath us there are a couple of players that are in the 10% to 12% range and there is potential for consolidation. We don’t comment on whether we’re active or whether we’re going to be active or what the possibilities are, but there’s probably a limited amount of consolidation that can occur on the clothing side of the business. In North America, the supplier base is pretty consolidated already.
There’s only two or three of us with a large significance. If you go into Europe and this is typical I think of most industries, you have the French players and the German players and the Finnish players and you have all your little boutiques in each of the different countries. Our view is that over time the same type of consolidation of some of those players will occur as it occurred in North America. But it’s difficult for me to comment on what we will or won’t do, what we’re able to do without commenting about our intentions, which we don’t talk about.
Okay very good questions. Thank you.
Other questions? Yes sir.
Unidentified Audience Member
Just a very quick one; could you just name, don’t say anything about their parents or anything, the number one competitor on the clothing side? And then just looking at your balance, clearly you’re not uncomfortable with the debt you’ve had, you’ve had more obviously. What is your ideal capital structure here?
I’d say no debt would be really good. Ideal capital structure I think it all goes back to what is your comfort level to do the things that you actually need to execute. The moment that you’re not able to execute the things that you need to do in order to grow the business then you have a level of discomfort with that leverage level to the extent that we’re able to do the things that we think have to be done and we’re very conservative too, we take a very measured approach. Our view is if you make an investment you’ve got to get it back in a reasonable period of time and so we’re not into making investments as in we’re going to pay back in 20 years so at the moment we’re comfortable with where we’re at. Okay? I think that depending on opportunities come up at later then we’ll go from there
Unidentified Audience Member
Who’s your competitor that they’d want them to pay back?
Albany International, they’re public. Okay AIN in case you didn’t know the marker. Okay? Other questions. [You just have my blood rolling, come on there’s got to be more questions.]
Unidentified Audience Member
(inaudible)You mentioned about partnering with your customers and creating a value added for your customers. Do you find them receptive when their financials are poor and possibly deteriorating?
We find that there are customers and there are customers. We find the ones that are improving and the ones that are really focused on improving their business in conjunction with their suppliers are very receptive because it doesn’t cost them anything. We provide continuous improvement engineers. All we want is business from them. We provide them with a very competitive level because we have very competitive cost structure.
So, we view it as a way of cementing these relationships for a long period of time because if you’ve been walking into the room at the end of the year and I’ve said listen, I’ve sold you $10 million and you spent 12 with me or you’ve spent 15 with me, and so I’ve gotten you most of that back and that’s permanent savings that you’ve got going forward. That’s a very powerful thing and not all customers have that level of cost savings available to them, and some grades of paper, like tissue, have less than some of the printing and packaging grade, but we’ve played on the fact that our customers are very desirous of us helping them reduce their costs.
Unidentified Audience Member
Do you find going to a customer, or, do you have an exclusive contract with them on your products? Do you find like all three players when they’re pushing their wares on to customers?
On the clothing side, yes. The question is – do we have exclusive contracts with our customers and the answer to that is not really. And on the clothing side of the business, typically there are no mills that I know of in the world where there’s one clothing supplier that supplies everything from dryers to forming to press outs just typically a position by position assignment that you’ve won and you have a 50% share of that particular mill or 60% share or some share that you fight to keep everyday, but the - and the cost of change is very high and so market shares move very slowly in this industry.
On the low cover side we’ve got a couple of situations where we are practically 100% or 90% plus player and we have some contractual agreement or understandings with those customers that we’re primary supplier but its very, very rare to have one supplier own an entire mill or an empire paper machine.
Unidentified Audience Member
I was wondering if you could show us your (inaudible)
Sure. There are really two triggers for what we call the mandatory. The question was, what’s our debt repayment schedule in the years coming forward with the term coming due in 2011. Basically there are two things that occur outside of what we would call voluntary prepayments. First we have a 1% maturization every year on the outstanding debt and the second is what we call an excess cash sweep. So at the end of the year we do a calculation of freer-cash flow. We have a mechanism of by which we would take some portion of that in this case form the definition in our credit facility, free cash flow access cash is what we call it. We take 50% of that at our current level of cash and pay that… [Audio Ends Abruptly]
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