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Executives

John Cozzolino - VP, Corporate Treasurer & Strategic Planning

Joe Morone - President & CEO

Analysts

Jason Ursaner - CJS Securities

Mark Connelly - CLSA

Ned Borland - Hudson Security

Paul Mammola - Sidoti & Company

Jason Ursaner - CJS Securities

Albany International Corp. (AIN) Q3 2010 Earnings Call November 4, 2010 9:00 AM ET

Operator

Ladies and gentlemen, thank you, for standing by. Welcome to the Third Quarter Earnings Call of Albany International. 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. At the request of Albany International, this conference call on Thursday, November 4, 2010 will be webcast and recorded.

I would now like to turn the conference over to Vice President and Acting Chief Financial Officer, John Cozzolino, for introductory comments. Please go ahead.

John Cozzolino

Thank you, operator and good morning, everyone. As a reminder for those listening on the call, please refer to our detailed press release issued last night, regarding our quarterly financial results with particularly reference to the Safe Harbor notice contained in the text of the release about our forward-looking statements and the use of certain non-GAAP financial measures and associated reconciliation of GAAP.

And for purposes of this conference call, those same statements also apply to our verbal remarks this morning. And for a full discussion, please refer to that earnings release as well as our SEC filings, including our 10-K.

Now, I will turn the call over to Joe Morone, our Chief Executive Officer, who’ll provide some opening remarks, before we go to Q&A. Joe?

Joe Morone

Good morning, everyone. Thanks, John. Welcome to Albany International’s Q3 2010 Earnings Call. Q3 was another good quarter for the company. If you take out the effects of currency, the $6.7 million of revaluation gain in Q2 and the $7.6 million of revaluation loss in Q3, you get basically comparable quarters; the same EBITDA in Q3 as in Q2 and roughly, the same sales, despite summer seasonal effects.

Q3 was particularly strong for PMC; gross margins hit 44%, operating income margin 25%, sales were steady from Q2 to Q3, despite the summer. Orders were strong; backlog has grew and actually hit their high for the year. And perhaps most important, pricing continue to be stable. We successfully concluded another important contract negotiation and there are no other major contracts pending for two years. The net effectible that is, we are feeling better about the short term outlook for price stability, than we have at any time since basically Q2 of 2006.

Turning to A2, Albany Engineered Composites were still on track, to double sales from Q3 ‘09 levels by the end of 2011 or early 2012 and making excellent progress on new product development that Q3 press release on the ceramic matrix composite substrate for Boeing engine nozzle was just one example. And we continue to prepare for the LEAP-X program, as we our recent announcement of the site selection for new plant in New Hampshire suggests.

On the profitability front, the losses in AEC continued in Q3, but we made good progress in turning operation around and we’re working closely with our customers to finish that effort. And our advanced composites operation in Rochester continuous to perform well and we’re still expecting Albany Engineered Composites to be EBITDA positive in 2011, operating income positive in 2012, the cash flow positive, but middle of the decade.

As for our other three businesses as expected, the top line in doors is clearly improving with the economy, sales and order backlogs are well ahead of Q3 ‘09 and we expect towards to hit its usual seasonal high point in Q4. Engineered Fabrics was hit very hard by the summer slow downs, remarkably weak August, at here too we’re expecting a normal seasonal rebound in Q4 and PrimaLoft continues to perform exceptionally well, although it hits its seasonal low of Q4.

So overall, if you control for the impact of currency revaluation, this is another strong quarter, despite the seasonal effects and what we see based on Q3 type trends and historical seasonal patterns, we see an outlook for Q4 and beyond, that’s encouraging across the board.

So, that’s a quick summary. Why don’t we turn right away to your questions? Operator?

Question-and-answer session

Operator

(Operator Instructions). We’ll go to the line of Jason Ursaner at CJS Securities. Please go ahead.

Jason Ursaner - CJS Securities

So, EBITDA or adjusted EBITDA, I just want to make sure that I’m understanding it right. After all the adjustments, based on your commentary and John’s commentary, it sounds as if excluding all the effects of currency, if we looked at it on a steady state rate, EBITDA is essentially in line with Q2.

Joe Morone

Yes.

Jason Ursaner - CJS Securities

So, my question is if EBITDA is holding steady on flat revenue, but flat revenue for the quarter is a pretty strong performance when I incorporate Q3 seasonality.

Joe Morone

Yes.

Jason Ursaner - CJS Securities

I think the question is, with another quarter to evaluate sort of new normal across your various operations, is a 50% incremental EBITDA margin on revenue growth from here, a target we should still be kind of holding you accountable to?

Joe Morone

Yes, we think so. Yes.

Jason Ursaner - CJS Securities

And then I guess, from there is the seasonal effect of Q3, do you think that, that’s masking accelerating trends or was there really just no seasonal effect this year?

Joe Morone

Jason, you can’t get around summer shutdowns or slowdowns in Europe. They might be shorter, if inventory levels are low or delivery times are high. But there still are slowdowns in the summer in Europe. So, I think the reasonable interpretation is activity is masking the effect.

Jason Ursaner - CJS Securities

Okay. And can you talk a little bit more about the ratio of orders to sales as it strengthen, just because I know that, this has been a trend, that you’d actually call that in Q1, which you don’t normally kind of separate out. Just if you can give any more detail on that?

Joe Morone

We think the backlog is probably a better indicator than the order to sales ratio, because the order patterns among our customers are changing. The lead time between order and expected delivery is shrinking dramatically. So, orders that might ordinarily have come in Q2 are coming in, in Q3. So, better to look at the backlog and if you look at the backlog particularly in PMC, its high for this time of the year. Usually, the backlog is highest at the beginning of the year and gradually declines and we hit our annual high in Q3.

Jason Ursaner - CJS Securities

So in PMC in particular, revenue actually increased sequentially, but as I look towards Q4, with no contract renewals, pricing firm and I mean, I guess if you could speak a little bit to customer inventory levels, but how should we be thinking about growth going forward and may be into 2011? And with revenue growth, are there any structural impediments to continued operating improvement, are we still getting leverage out of the China facility or has this really played out already in to the (audio gap)

Joe Morone

So, the effects you’ve been seeing on EBIT, on revenue dropping through the EBITDA should continue from what we...

Jason Ursaner - CJS Securities

But I guess, I’m asking with 40% gross margins in the business at PMC, is it 25% operating margin, at what point do we really max out? Have you said any long-term target there?

Joe Morone

Yes, if revenues remain at this level, would maximize. And what you see is the run rate of the profitability of the business.

Jason Ursaner - CJS Securities

Okay. And then, just looking at AEC. Without any specific programs, can you talk a little bit more about what’s giving you confidence for the longer term, in terms of sales projections and longer term margin projections and just some of the development projects or whatever is going on and that’s I mean still giving you the confidence longer term, besides just maybe what we’re seeing publically?

Joe Morone

Right, for both short term growth and long term, as we’ve discussed before, our two biggest programs. Well, two of the important programs of the LEAP-X engine and the landing brace. And those are contributing significantly to the short term growth and particularly LEAP-X will contribute significantly to the long-term growth. If you go out a few years, there is about leaving aside LEAP-X and brace. There is about six families of product applications that we’re working on and that are in various stages of development. But all of them have the potential to develop into multiple applications. Now, we’ve mentioned the ceramic matrix composite substrate for the engine nozzle, that is part of a broader family of broader technology platform, that has fairly wide-spread applications beyond just the nozzle. So, that’s just one family of application that we’ve disclosed with it.

We’ve mentioned that, as if and when, one of the airframe manufacturers takes on development of a whole new airframe, which will have significant composite application, we’ll see a wide array of applications for our technology on the airframe, on applications like airframe, frames and beams, joints. So, that’s two examples of application families that we see driving long term growth and we have at the moment, leaving aside LEAP-X and brace as I said, we have about six of those families that we’re working on and they keep expanding. I would say if I were giving this answer a quarter or two ago, I would have probably said four additional families.

Jason Ursaner - CJS Securities

Concentrating a little bit more on the potential for a new single-aisle aircraft. If we were talking about entering to service before 2020, can you talk a little bit about the next generation engine landscape and would LEAP-X still consider it, just how does that plan to it and would there be potentially other developments for a new aircraft, if it got pushed back a little bit?

Joe Morone

Contending an engine in the first class associated with the single-aisle aircraft, whether it’s a re-engined, existing A320, 737 or it’s a whole new single-aisle aircraft and will replace 737 or A320. If we’re talking this decade, the engine, the contending engines are the LEAP-X and the Geared Turbofan by Pratt & Whit, those are the contenders. It’s not until you get out until, the second half of next decade, that a new contender possibly emerges. And that’s the unducted fan. So, now, what’s interesting is that if you go to a whole new generation of engine, you need a completely different aircraft design. And the aircraft design for the unducted fan would be completely different from an aircraft design to take on more conventionally configured engines like the Geared Turbofan and LEAP-X. Anything built this decade, any new aircraft built this decade, is going to have to be configured to take on the engines that we see in front of us, LEAP-X, Geared Turbofan.

Jason Ursaner - CJS Securities

Okay. So, a new aircraft really I mean, in terms of your view it just pushes out the inflection point, but really wouldn’t make you any issues on whether the LEAP-X really would be?

Joe Morone

Right.

Jason Ursaner - CJS Securities

Okay.

Joe Morone

No on the contrary, it does several things simultaneously. We’re in speculation mode here. So, several things simultaneously. Number one, it brings forward the window of opportunities for new applications on the airframe, which as I just mentioned is an important family of potential applications.

Number two, it dramatically extend the life of LEAP-X because, if they’re building the new airframe this decade is going to use LEAP-X and Geared Turbofan and then those planes will be configured to use those engines for the life of plane, just like 30 years. And number three, since it pushes back the introduction of those engines, there’s more opportunity for us to get more content on it.

So, if you look at this from a pure timing of revenue point of view, re-engining work, that of course because the revenue come sooner. If you look at this from a net present value or future cash flow’s point of view, a whole new aircraft sometime this decade is clearly superior; you maybe have to wait a little longer.

Jason Ursaner - CJS Securities

Okay. And just last question real quick on Engineered Fabrics. Obviously, the quarter was disappointing, but you mentioned suggesting a normal seasonal rebound in Q4. Is the rebound coming from some of the end-markets in housing or is it really being driven by the non-wovens section and just any other...

Joe Morone

There’s been non-wovens, particularly in Europe, partially in Asia, working very closely with the equipment manufacturers, but non-woven equipment. That’s where the rebound is being driven by.

Jason Ursaner - CJS Securities

Okay so, I mean, have you seen a pick up in maybe September or October that would really make you more confident that this is kind of a temporary drop in that segment?

Joe Morone

Well, we want to resist the temptation to comment on October, Jason, but...

Jason Ursaner - CJS Securities

Okay.

Joe Morone

What we know with certainty is August was a miserable month and was really clobbered by the seasonal effects. And we know those seasonal effects aren’t there and we see what the demand picture and order picture is like in Europe, it’s a small way agent.

Operator

Our next follow-up from the line of Mark Connelly at CLSA. Please go ahead.

Joe Morone

Good morning, Mark.

Operator

Mr. Connelly, your line is open, if you’re on speakerphone, please pick it up.

Mark Connelly - CLSA

So, when we look at the PMC business and the shift from your normal pattern, clearly there’s been a lot of changes structurally in the paper business and a return to better operating levels in the last couple of quarters.

So, when you think about your backlog, are your customers telling you that they’re confident in the sort of extended cycle fees just that, that they’re going to be able to maintain the levels that they’ve been running recently? Just trying to get a sense of the feedback you’re getting from paper companies versus what we’re hearing?

Joe Morone

I think Mark that the way we’re thinking about it, which is integrating across what we’re seeing and hearing from our customers and what we’re seeing and hearing across geographies is we’re still relying on the broader structural, sectoral trends to understand what’s going on in this business, more than the shorter term cyclical pattern.

So, if you look at our sales patterns, that we’re seeing growth in Asia and South America offsetting decline in Europe. North America is kind of flat, but then when you get underneath that, if you look by grades, you see exactly what you’d expect to see, like the packaging grades are showing incremental growth and the printing and writing grades are still under pressure. So, some of the short cycle patterns might be obscuring things a bit, we still use the sectoral trends both geographic and by grade as a pretty reliable guidepost on understanding what’s going on.

Mark Connelly - CLSA

Okay. So, when you look across geographies right now, you spent the last couple of years getting your cost position stronger in Europe. You’ve always been strong in Latin America. Can you give us a sense of where you think you stand in terms of where you can be in those geographies? And then also, can you talk about PMC margins in China, which historically haven’t been as good as elsewhere?

Joe Morone

Second answer is easy. We’re very happy with the margins in Asia. That is if you take the pricing in Asia and cost of goods sold manufactured there, our margins are again it’s our Asian operations are helping to drive the kind of margins that in the aggregate that we’re seeing in PMC.

Mark Connelly - CLSA

Okay, okay. And in terms of your cost position in other parts of the world did, is there more work that you’ll need to do? I mean, there is always work you want to do, but is there more work that you’ll need to do? Couple of years ago, you needed to make changes in Europe?

Joe Morone

No, I think at this point, the work we need to do is to keep offsetting inflations with productivity improvements. But the structural changes, unless there’s going to be another major recession that leads to another step down in production levels in our customer base, we think the kinds of changes that we have to manage our way through over the next few years are much more continuous productivity improvement so, we don’t allow inflation to rule the game that we may.

Mark Connelly - CLSA

Okay and just two more quick questions. Your SAP spending program now has outlasted two CFO’s and I’m just curious, where you are in that implementation?

Joe Morone

Just for the record, our first CFO was in place for 28 years SAP started late in his cycle.

Mark Connelly - CLSA

But we still blame them.

Joe Morone

We have one major step, which is on schedule which is to go-live in Eurasia and that is scheduled for the beginning of Q2. And after that, we’re in the maintenance and steady improvement, most of the projects will be over, once we get through that go-live.

Mark Connelly - CLSA

In Q2.

Joe Morone

Yes.

Mark Connelly - CLSA

Okay. And then, very last question. It’s taken you roughly 50 years to get PrimaLoft to where it is, if my math is correct. I’m trying to get a sense of what meaningful growth opportunity you’ll see in that market? I mean, should we just be looking at this maybe get a couple of percent year out of it or is there more that you can do with that business?

Joe Morone

No, I don’t think its 50 years. Hopefully close to..

Mark Connelly - CLSA

Wasn’t that 1962? I maybe wrong. Let’s call it more than 40.

Joe Morone

This still has a lot of growth in it. And it’s two forms of growth. One is penetration of the basic insulating product into new applications, particularly in outerwear and the second which is and new geographies. For example, it’s growing very fast in New York right now. And the second wave of growth is a whole new product family, in which we essentially integrate PrimaLoft into yarn, which allows our customers to make water-resistant insulating socks, sweaters, outerwear, which has the potential to potentially double the size of the business. I mean, it’s that bigger product category. So, we think there’s plenty of growth left of it in this business.

Operator

Thank you. Next, we’ll go to the line of Ned Borland at Hudson Security. Please go ahead.

Ned Borland - Hudson Security

Yes, just quickly a follow-up question on Mark’s question about Asia. Are you guys maxed out your capacity in Asia or do you still have a little more running room?

Joe Morone

In one of our plants, we still have more running room.

Ned Borland - Hudson Security

Okay. And then, I guess we haven’t really talked about market share in a while and there’s been a couple of negotiations, one of them I guess was just completed, everybody seems to be kind of lots in place for a while. I mean, where does your market share stand versus where it was, say back in ‘06 before all the disruption happened?

Joe Morone

Pretty much in the same place. But we don’t spend much time thinking about market share. We’re happy with the customers we have and the geographic mix we have and we’re really focusing on serving them effectively and beating inflation year-over-year. We don’t spend much time focusing on share, internally.

Operator

Thank you. Our next, we’ll go to the line of Paul Mammola with Sidoti & Company. Please go ahead.

Paul Mammola - Sidoti & Company

If I can take you back to China as well, I think Heimbach established an operation in Suzhou over the past twelve months. So, is that had any impact on your volume or pricing in the region?

Joe Morone

No.

Paul Mammola - Sidoti & Company

Okay, that’s good to hear. And as we look 4Q, I think some of the operating costs you warned about over the past couple of months certainly came in this quarter. Do you think 67 or 68 million is a fair run rate for FTG&R for 4Q and maybe early 2011?

Joe Morone

Well, if you go carefully through everything we described in the release, I think you’ll get a very good Page 2 of the release as you’ll get, if you do all that math, you get a pretty good sense of the run rate and percent of sales. But it certainly need the wild card in everything. This quarter, last quarter and maybe even Q4 will be the sharp swings in currency. And the revaluation effects and that shows up in two places, one of which is FTG&R. So, you really need to take that if you’ve got and by the way, those revaluation effects are mostly non-cash effect. So, it’s really important to try to control them.

Paul Mammola - Sidoti & Company

And you gave some information as to what those revaluation effects are, but does that same from the fact that, they’re non-functional currency assets service or I would assume are in Asia. Is that right to assume?

Joe Morone

It’s in every geography, I’ll just give you simple example in Mexico, where we make, which is our plant for making dryer fabrics for all North and South America. The costs are in pesos, the sales are in dollars. And so, if there’s any significant change in the relative values of those two currencies, we’re going to have the revaluation effect.

Paul Mammola - Sidoti & Company

And it’s principally on the receivables and payables, right?

Joe Morone

And also into company loans.

Paul Mammola - Sidoti & Company

So, I got to assume that maybe there is a mark, month-to-month or quarter-to-quarter, that you kind of have to flow through as you go all right?

Joe Morone

Yes and ordinarily, if currency markets are in their normal range, there will be, if you go back and look at prior releases, you’ll see 0.5 million, 600,000, maybe $700,000 affect one way or the other. But it’s basically in the noise and so we’ve never called that out. But I was just talking about an order of magnitude larger affect. Last quarter, the Q2 was positive this quarter negative. The euro stays where it is. There’s going to be another big effect. So, it’s an unusual period of volatility and it’s only then that you can see this kind of mark-to-market, largely non cash effect on earnings.

Joe Morone

Okay, thanks for your help there. And then, finally is there anything new with the comprehensive review you have for the month-end close process, I think it was put in place in 2Q?

Joe Morone

No, there’s nothing newer. We’re felling fine about that. It’s certainly something we pay a lot of attention to, that’s fine.

Operator

Thank you. (Operator Instructions) And we have a follow-up from the line of Jason Ursaner at CJS Securities. Please go ahead.

Jason Ursaner - CJS Securities

Hi Joe. You talked a lot of outpacing inflation in Asia. And I’m assuming this is in terms of wage inflation finding and keeping good people on the region. And it’s bit of a strange question, but do you have any caution on the longer term potential currency inflation in the region?

Joe Morone

Well, first of all take your overall question. We’re not just concerned about inflation in Asia. If you take, we’re actually more concerned about inflation in the no growth markets that we serve. So, if you take North America and PMC, no growth or slow growth. If inflation is growing faster than the top line, we’ll very rapidly get margin erosion unless we’re able to offset inflation with productivity gains. That’s really what our focus is on.

Jason Ursaner - CJS Securities

Okay. In terms of the relative value of certain currencies and have you taken any steps to try and mitigate long-term potential blacks found out there in terms of no currencies can revaluate?

Joe Morone

Cozz can elaborate on this. But essentially, we try to hedge against the impact of translation effects which are real cash effects. But we do not hedge against or take any steps to protect against these non-cash effects, because we would be using cash to protect against the non-cash effect, which we think does not serve anybody’s interest, at least of our own shareholders. John?

John Cozzolino

Yes and Jason, specifically related to the R&D, to the extend that we may can sell in China and invoice our sales in R&D, that actually access a hedge against the costs. So, the more we grow there and more we sales against those costs that actually access kind of a natural hedge against the consolidated results from China as we convert them into dollars.

Operator

And there are no further questions in queue. I will turn it back to our host for closing remarks.

Joe Morone

Thank you, all for joining us this morning and John and I look forward to meeting many of you in conferences coming up over the next few months and if we don’t talk to you, see you then. See you at our next earnings call. Thank you.

Operator

Thank you and ladies and gentlemen, a replay of this conference call will be available at the Albany International website beginning at approximately noon Eastern Time today.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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