Paper Machine Clothing
This is a time of unprecedented change for our PMC business. In late 2006 we launched a deliberate, planned process of transforming what had been a regionally based, fragmented structure of 12 independent profit centers, into what we refer to internally as One Albany… one unified global business with three major regions: Americas, Europe, and Pacific. In 2007, the short-term objective of this restructuring was to help restore profitability to the levels that we experienced before the mid-2006 disruption of European pricing. By the end of the year, we had achieved that objective and were already moving on to our broader, longer-term purpose, which, as I described last year, is to secure our position as the total leader in PMC: the one company in the industry that offers the best products and service across the entire paper machine, with the best quality and shortest delivery times.

The urgency of our pursuit of total leadership in PMC, and thus the urgency of our pace of internal change, is fueled by the recognition that in what have historically been PMC’s largest and most profitable sectors, North America and Western Europe, we will continue to face top-line pressure from the shrinking number of paper machines and the threat of competitive price pressure. This means that sustained growth in profitability and cash generation will be driven not as it has been in the past by market expansion in these traditional regions, but by performance-driven market share gains, coupled with growth in the emerging markets of Asia and South America and fundamentally lower costs.

By now, the dimensions of our restructuring effort should be familiar to our investors: consolidation of manufacturing in North America and Europe coupled with a $300 million expansion in South America and Asia; consolidation of European administrative functions into a single shared services center; implementation of a single, global ERP system; an overhaul and revitalization of R&D; elimination of layers of corporate management; reconfiguration of our raw material supply chain; and establishment of a global procurement organization and system. This restructuring effort will continue into the first half of 2009. By then, we have every expectation that PMC will be positioned to generate very appealing cash flows long into the future.

Any company that attempts to undergo this magnitude of change runs the risk of disrupting supply chains and relations with customers. As I look back on 2007, what is in my mind our single most important accomplishment is that we executed the first phase of this transformation without disruption in customer relations. In fact, even with all of the internal change, and despite accelerating consolidations in the paper industry in our traditional markets, we made excellent strides in the marketplace in 2007, with sales in PMC reaching record highs. We are determined to make the changes internally that drive us to that goal of total leadership, but we are acutely aware of the necessity to do so in a manner that is invisible to our customers…to deliver ever stronger performance in the marketplace even as we transform ourselves internally. In this sense, 2007 was a remarkable success in PMC, and a telling indicator of the quality and dedication of the PMC management team and workforce.

Applied Technologies
Our understanding of the magnitude of the opportunity that Albany Engineered Composites (AEC) represents continues to evolve. By early 2007, when I last wrote to you, we were increasingly confident that without acquisition, AEC had the potential to grow into a $150 million business by the middle of the next decade. The question we are now asking ourselves, and that should be answered with the experience of another year, is this: Does AEC have the potential to be a future core business for Albany International? The aerospace composites market is certainly large enough. Our technology is certainly distinctive enough. And the opportunities to apply that technology to the next generation of aerospace and defense platforms, such as the single-aisle aircraft and associated engines, are certainly plentiful enough.

One of our objectives for 2007 was to make AEC profitable. In what is the company’s most disappointing shortcoming in 2007, we did not achieve that objective. As I discussed in earnings releases during 2007, the poor bottom-line performance stems from the combination of the inefficiencies that accompany steep ramp-ups in production in a still small business, coupled with rapidly escalating expenditures in R&D and engineering. I want to reiterate here that we do believe that the processes and systems required to manage performance during surges of growth in a young business create precisely the managerial discipline that builds sustainable advantage for the long term. It is for this reason that we continue to press for a turn to profitability in the second half of 2008, even as we continue to ramp up our R&D and engineering expenditures in pursuit of long-term sustainable growth.

In addition to AEC, the Applied Technologies segment also included Albany Filtration Technologies, which is primarily focused on producing filtration bags for such industrial applications as coal-fired power generation, alumina refining, and smelting; PrimaLoft, which produces a synthetic, down-like insulating material for high-performance outerwear and home furnishings; and Albany Engineered Fabrics, which applies the conveying and dewatering permeable belt technologies of PMC to a broad array of process industries outside of the paper industry. The star performer in 2007 was Filtration Technologies. Building on the new operation in Zhangjiagang, China, sales in the business increased 71% to $41 million.

For a variety of reasons that we believe to be transitory, PrimaLoft had a disappointing year in 2007, with flat sales. But the business made good progress in laying the foundation for its next wave of growth, PrimaLoft yarn, and we expect a return to good performance in 2008. And while it was not reflected in 2007 operating results, the most important development in the Applied Technologies segment in 2007 was the opening of Engineered Fabrics’ (EF) new world-class manufacturing plant in Kaukauna, Wisconsin, and the emergence of this business by the start of 2008 as a fully capitalized, globally organized, $100 million business. Engineered Fabrics will play a unique role in the Albany “cash and grow” portfolio of businesses. Whereas, for the foreseeable future, PMC will grow cash but not sales, and AEC sales but not cash, we expect Engineered Fabrics to do both: we project it to grow on the order of 5% per year, with profit margins and cash-generating potential comparable to PMC.

Albany Door Systems
For the Doors business, 2007 was a good year. The strong performance was driven by across-the-board top-line strength, in both product and aftermarket, and in each region of the world. Looking forward to 2008, we expect continued progress in the European aftermarket; growing momentum in North America, as the consolidation of operations and product lines with R-Bac is completed; and progress in laying the foundation for growth in China, where we are now establishing a stand-alone manufacturing facility that will produce our full range of products. Keep in mind that this is not a capital intensive business; growth is driven primarily by breadth and performance of product line, and strength of distribution channels. On both fronts, we expect good progress in 2008. The only caution flag for this business in 2008 is the prospect of recession, which, in the past, has had a marked effect on demand for High Performance Doors.

In our Q3 2006 earnings release, I told investors that we expected the Doors business to grow at a rate of 5 to 7% per annum, barring recession. In 2007, the business grew by 23%, and in 2008, we expect another good year, bearing that caveat about recession in mind. We view Doors as an important part of the “cash and grow” portfolio. While it is less profitable than PMC and EF, it has the potential for rapid and profitable growth, and because of its relatively low capital intensity, it will generate cash as it grows.

In sum, we achieved in 2007 what we set out to achieve: continuing to solidify the foundation for “cash and grow” while improving profitability. In 2008, we face more of the same: continuing to position the company for a long-term, sustainable execution of “cash and grow,” and at the same time, continuing to improve short-term performance. This will require the same balancing act that we undertook in 2007—strengthening our competitive position in each of the markets we serve, even as internally we undergo radical and rapid transformation. The balancing act will be all the more challenging in 2008 because of the recessionary economic pressures, but this is a strong management team and a determined workforce. All of us are confident that we will complete 2008 in an even stronger competitive position than we were in when we started the year, and with the transformation to the “cash and grow” model nearly complete.

Sincerely,
Joseph G. Morone
President & Chief Executive Officer