Xerium Technologies Q3 2007 Earnings Call Transcript

Nov. 9.07 | About: Xerium Technologies, (XRM)

Xerium Technologies Inc. (NYSE:XRM)

Q3 2007 Earnings Call

November 9, 2007 8:30 am ET

Executives

Mike O'Donnell - CFO

Tom Gutierrez - President and CEO

Analysts

Chip Dillon - Citigroup

Ned Borland - Next Generation Equity

John Haushalter - Robert Baird

Michael Prouting - 10-K Capital

Operator

Good day, ladies and gentlemen, and welcome to the ThirdQuarter 2007 Xerium Technologies' Earnings Call. My name is Nicole, and I willbe your coordinator for today. (Operator Instructions).

I would now like to turn the call over to Mr. MikeO'Donnell, Chief Financial Officer. Please Proceed.

Mike O'donnell

Thank you and good morning, everyone. Welcome to the XeriumTechnologies' third quarter 2007 earnings conference call. We are pleased youcould take the time to join us today. With me here is Tom Gutierrez, ourPresident and Chief Executive Officer. Tom will start by discussing ouractivities and performance during the third quarter and then share his thoughtson the current market conditions.

I'll follow up Tom and provide some additional financialdetail with respect to the quarter. And then we'll open the floor to anyquestions you might have.

Xerium Technologies' financial results for the quarter wereannounced in a press release after market closed yesterday. The press releaseis available on our website. Notification of this call was broadly disclosed.And this conference call is being webcast using the link on our InvestorRelations homepage on our website.

I would also note that we will make comments today about thefuture expectations and prospects for the company that constituteforward-looking statements. Our actual results may differ materially from thoseindicated by those forward-looking statements as a result of various importantfactors that are described in yesterday's press release. The forward-lookingstatements represent our views as of today, November 9th, 2007, and wespecifically disclaim any obligation to update these forward-lookingstatements.

Lastly, on this call we will plan to discuss supplementarynon-GAAP financial measures such as adjusted EBITDA that are a key metric forour current facility and debt facility covenants, and that we use internally toassess liquidity and financial performance and therefore believe will assistyou in better understanding our company. A reconciliation of those measures tothe comparable GAAP numbers is available in our press release.

With that, I'll turn the call over to Tom Gutierrez.

Tom Gutierrez

Thanks, Mike and good morning. I will start by stating theobvious. We are very pleased with our results this quarter. They provide solid evidencethat the growth in cost structure improvement initiative that we have beeninvesting in are starting to pay off. To put our performance into perspectivethis quarter, I should note that in each of the last several years the thirdquarter has proven to be challenging as our customers have generally takenadvantage of the summer vacation period, particularly in Europe, the reducedproduction levels and initiate other measures aimed at reducing cost andbalancing production and inventory levels in the market.

Viewed against this background you can understand oursatisfaction with the results. In our clothing segment, sales increased significantlyover last year's third quarter, gross margins improved and segment earningsincreased 22.5% over the same period last year.

Sales in Europe grew approximately 14%, in South America byapproximately 14%, in Asia by approximately 12% and in North America by about 6% over the same period last year, a verybalanced growth profile.

Although, pricing was a bit softer than we have seen forsometime, it's clear that we continue to improve our market position and thatthe restructuring and growth investments we have made are helping us offsetnegative market pressure.

In clothing, we've talked about initiatives intended toexpand our market position in Asia and in South America.We have also talked about our drive to transition production to lower cost manufacturinglocations. Along these lines, our capacity additions in Brazil are moving ahead as planned and we aremaking good progress in Vietnamwhere we remain on track to begin production in mid-2008.

In our roll covers business sales continue to be soft astechnology continues to extend the life of our products, the number of papermachines decreases and the competitive environment intensifies in the face of aslowly shrinking market.

The sales decrease in our rolls business was predominantlyin North America were the impact of industryconsolidation has been the greatest.

We've taken many steps to improve our cost structure in therolls business. The combined impact of these initiatives has helped tostabilize gross margins and we were able to produce a small increase in segmentearnings in spite of the lower sales in the quarter.

In addition to our continued attention to cost structureimprovement, our strategy in the roll covers sector revolved around regionalexpansion in Asia and South America, combinedwith expansion of our product and services portfolio.

In South America, in particularly, our rolls investments arefocused on expanding the business to include new polyurethane technologiesalready successfully released to the market in Europe and North America. We are pleased with our early success in South America, where roll covers sales grew over 20% thisquarter versus prior year.

Our plans in Asia, as we discussed, to establish our rollcovers manufacturing presence in China by mid 2008. We believe theroll covers market and related services market in China will grow to be more than$100 million per year over the next several years. As I noted before, our currentmarket share in Asia is relatively small, aswe don't have manufacturing facilities in the area.

We believe that our consolidated market share worldwide iswell over 33%, over time we would expect to achieve a similar market share in China as wehave built throughout the rest of the markets we serve.

We are confident in our strategic initiatives in clothing,and in rolls we'll continue to provide short-term financial benefits andposition us to capitalize on the long-term growth opportunities that we'veidentified. However, as we've indicated before, and has been the case for severalyears, our enthusiasm is tempered by the market environment in which weoperator.

Specifically, we continue to anticipate customerconsolidation and intense competitive pressures in Western Europe affecting our businesses for the foreseeable future. We believethat the investments we are making will minimize the impact of these negativefactors and create no opportunities for growth.

Before I turn the discussion over to Mike, I want to discusstwo issues that I know are on your minds. First, I share the concerns some ofyou have expressed to me directly about Xerium stock price. I will be kiddingyou, if I told you that I had any rational explanation of why our share priceswhere it is. As you can now see our results are solid and we have demonstratedan ability to generate healthy margins and profits. We intend to intensify ourwork to increase awareness of our potential of the investment communities suchthat the value of our company is appropriately recognized.

Second, we are frequently asked our precision on thedividend and I thought it appropriate to remind you of our policy. The policywe announced in May, in conjunction with the amendments to our credit facilityand a reduced quarterly dividend payment, is still in force. Under this policy,dividends will be paid and an amount will be determined by the Board on aquarterly basis. As you know, we announced payment of dividend for thisquarter. Factors that the Board considers in making this determination includesuch matters as the availability of cash, the fund growth opportunities, reducedebt and pay dividends.

Well, we firmly believe that enhanced growth is the best wayto deliver lasting value to shareholders, we will continue to carefullyconsider how to best allocate the company's cash resources on this basis eachquarter.

Now, I will turn the discussion over to Mike O'Donnell, whowill review our financials in more detail before we move on to questions. Mike?

Mike O'Donnell

Great, thanks Tom. I hope everybody had a chance to reviewthe press release that we issued last evening. I will supplement thatinformation by providing some more detailed insight into certain key areas ofour financial performance.

Net sales for the third quarter of 2007 increased 5.6% fromthe third quarter last year, reflecting a substantial increase in our clothingsegment, offset somewhat by decline in our roll covers. When adjusted forcurrency translation and currency effects on pricing, sales for the thirdquarter of 2007 increased 1.4%, as compared with the same period last year.

Sales in the clothing segment for the third quarter of 2007were $104 million, compared to $93.2 million in the third quarter of 2006, andaccounted for 68% of total company sales in the third quarter of 2007.

Sales in roll covers segment for the third quarter of 2007were $49.6 million, compared to $52.3 million in the third quarter of 2006, andaccounted for 32% of total company sales in the third quarter of 2007.

The total effect of currency on net sales for the thirdquarter of 2007 was an increase of $6 million, of which $8.3 million was afavorable currency translation on net sales, and this was partially offset bythe $2.3 million unfavorable effect of currency on pricing, that is, thepricing impact of currency movements between the time of pricing commitmentsand the sale recognition in U.S. dollars from some of our non-U.S. operations,most notably in Brazil.

In the clothing business, the effects of currencytranslation on sales for the third quarter of 2006, was an increase of $6.1million and the effect of currency on pricing was a decrease of $2.3 million.Excluding these currency effects, sales in our clothing business for the thirdquarter of 2007 increased 7.5% over the third quarter of 2006.

Sales in the roll covers business were down $2.7 million or5.2% from the third quarter last year. This decrease continues the trend wehave seen over the last two quarters, as paper producers placed an increasinglystrong emphasis on maintenance cost reduction, where the cost replacing a rollcover resides and are, as a result, squeezing additional life out of rollcovers, extending them through additional maintenance cycles before replacingthose roll covers.

We are also starting to see a trend of paper machinerebuilds and new machines with fewer actual rolls in the paper machine, whichalthough not having a meaningful impact at this time is contributing slightlyto the sales performance of our roll covers segment.

Whereas we expect our clothing business sales to continue tocorrelate more closely with overall paper production trends, we believe theunderlying economic paper industry and the focus on lowering maintenance costwill continue to make our roll covers segment a more difficult business to growin its current form.

This explains our focus on identifying and bringing on boardadditional products and services in the roll covers segment as well astargeting new markets, both designed for growth as Tom discussed earlier.

We experienced price decreases in our roll covers businessof approximately 1 percentage point in third quarter of 2007, as compared tothe same period last year.

In our roll covers business, the effect of currencytranslation on sales for the second quarter of 2007 was an increase of $2.2million. The effect of currency on pricing was negligible. Excluding thesecurrency effects, sales in the rolls business decreased by $4.9 million or 9.4%in the third quarter 2007, when compared to the same quarter in 2006.

For the total company, gross margins for the third quarterof 2007 improved to 41.2% from 40.1% in the third quarter of 2006, which Ibelieve is particularly impressive given the pricing and inflationary pressuresthat we are facing, and a lower sales volume in our roll covers business.

In our clothing business, gross margins improved in thethird quarter this year, compared to the same quarter last year, as unfavorablecurrency effects and a deterioration of pricing levels were more than offset byhigher sales volume. With our strong variable contribution margin, this highersales volume provided improved operating margins.

Clothing gross margins also benefited from lower costsrelated to shift in production to lower cost locations, lower material cost andthe improved cost structure due to measures taken late last year and earlierthis year.

Clothing segment earnings in the third quarter of 2007 were$27.8 million, an increase of 22.5% versus the $22.7 million in the thirdquarter of 2006, or if you exclude currency translation and the effect ofcurrency on pricing, 28.6% higher than last year's third quarter, reflectingthe higher sales volumes and the positive impact of our restructuring andefficiency programs.

The total currency effect on clothing segment earnings wasan unfavorable $1.4 million, of which currency effects on pricing were anunfavorable $2.1 million and the currency translation was favorable impact of$700,000.

In the roll covers business, gross margins in the thirdquarter of 2007 increased slightly compared to the third quarter of 2006,primarily reflecting the improved cost structure due to restructuring actionstaken late last year and earlier this year, which were offset by the lowersales volumes and lower pricing levels that I mentioned previously.

Segment earnings of $13.1 million in the roll coversbusiness increased eight tenths of a percent from $13 million in the thirdquarter of 2006, and would have decreased 1.5% percentage points, excluding thetotal impact of currency. Roll covers segment earnings benefited from a favorabletotal currency impact of about $300,000, all of which was currency translation.

We are continuing our efforts to improve our cost structureand streamline our operations. Restructuring and impairment charges associatedwith these activities in the third quarter of 2007 were $800,000 versus $1.3million in the third quarter last year. We expect, we many incur as much asanother $1.8 million of these costs during the remainder of 2007.

As you recall, we had expected to be done with most of our2007 restructuring activities by this point, but we are consideringaccelerating some of the additional opportunities we have identified for usnext year, as we continue to be aggressive with our efforts to better align ourglobal footprint with the shifting market trends.

We believe our cost reduction and restructuring effortscarried out in 2006 and during the first nine months of 2007 eliminated about$2 million in cost that we would otherwise have incurred during the thirdquarter of 2007 when compared to the company's cost structure for the thirdquarter of 2006.

For the nine months ended September 30, 2007, these savingstotaled $3.7 million compared to the same period last year. We expect therestructuring efforts we have completed this year will provide additionalbenefits for the remainder of 2007 and into next year.

We reported operating income in the third quarter of 2007 of$24.1 million, an increase of 31% over $18.4 million in the third quarter of2006, again, reflecting higher net sales, improved gross margins and thebenefits from our restructuring and efficiency programs.

I would like to spend a minute reviewing with you theeffects of the change and how we account for the interest rates swap contractsthat we entered into in June, 2005. Interest rates swaps do not qualify forhedge accounting under US GAAP, and the change in their fair value is subjectto mark-to-market accounting through earnings.

As a result of the mark-to-market accounting throughearnings, the company reported an increase to interest expense of $2.7 millionin the third quarter 2007, as compared to an increase of $4.4 million for thethird quarter of 2006.

For the nine months year-to-date 2007, we reported anincrease in interest expense of $4.2 million as compared to a decrease tointerest expense of $1.5 million for the comparable period 2006. Although,these interest rate swaps are subject to mark-to-market accounting throughearnings, the interest rate swap contracts are affectively fixed from a cashflow hedge perspective, the interest rate on 86% of the term loan portion ofthe credit facility through June 30, 2008.

The mark-to-market accounting through earnings has no effecton cash flows from operations, investing or financing activities. The fairvalue of the interest rates derivative contracts was approximately $5.5 millionand $9.7 million at September 30, 2007 and December 31, 2006 respectively andis included in our other current asset.

We intent to enter into new interest rate hedgingarrangements in the near future that extend beyond the second quarter of 2008,and in connection with these arrangements, also intend to cancel the existinginterest rates swaps in consideration for their cash value. We intend that suchnew interest rate swaps will affectively fix the interest rate on approximately85% of the term loan portion of our credit facility through 2010.

Additionally, we intend that such new interest rates swapswill qualify for hedge accounting under US GAAP and accordingly the changes intheir fair value will not be subject to mark-to-market accounting throughearnings. To the extent that we do enter into these new hedging arrangementsthat effectively fix the interest rate on a portion of our senior debt in thenear future, we expect the effectively fixed rate to be higher than theeffectively fixed rate as of September 30, 2007.

Based on the recent indicators of interest rates we expectthe effectively fixed interest rate on debt covered by these new interest rateswaps to be approximately 1 percentage point higher than the rate as ofSeptember 30, 2007.

While our existing interest rate hedges do not qualify forhedge accounting under US GAAP, for the purposes of calculating our covenantratios under our senior credit facility, we treat them as if they did qualifyfor hedge accounting.

Xerium incurred tax rates of 31% in the third quarter of2007, and 34% for the first nine months of 2007. We expect the full year 2007effective tax rate to be approximately the same as the rate in first ninemonths of the year, assuming similar earnings patterns between taxingjurisdictions.

Net income in the third quarter of 2007 was $7.1 million or$0.16 per diluted share, compared to $2.2 million or $0.05 per diluted share inthe third quarter of 2006. Third quarter 2007 earnings per share is calculatedusing 45 million diluted shares, whereas the third quarter of 2006 calculationsused 43.9 million diluted shares. The increase in the shares is primarily theresult of shares issued to Apax Partners, our largest shareholder under ourdividend reinvestment program.

Net cash generated from operating activities was $18.4million in the third quarter of 2007 and that compares to $22.6 million in thethird quarter of 2006, due to changes in our working capital to support ourgrowth, primarily on the clothing side of the business. We remain confident inthe ability of our business to produce strong cash flow going forward.

Adjusted EBITDA increased 19.3% from $32.2 million in thethird quarter of 2006 to $38.4 million in this year's third quarter. There havebeen changes in the definition of adjusted EBITDA in our amended creditfacility, and I encourage you to review the reconciliations we've provided inour press release.

Capital expenditures in the third quarter of 2007 were $8.9million, compared to $6.8 million in the third quarter of 2006. As Tom noted,we're continuing to develop our clothing manufacturing facility in Vietnam and expanded production capacity in Brazil.And we continue to expect capital expenditures of approximately $50 millionthis year and for the next few years as we pursue growth opportunitiesthroughout the world.

Our long-term debt position, including current maturities,at the end of the third quarter of 2007, were $656.5 million, and that comparesto $628.5 million at the end of 2006, a change reflecting primarily unfavorablecurrency translation effects, partially offset by debt payments of $9.1 millionthat we've made during the first nine months of 2007.

In closing, we believe that we're continuing to take thesteps necessary to adjust to changing market conditions. Invest in those areasthat will produce both long and short term benefits and overall position Xeriumas a leader in the marketplace.

With that, operator, I'd like to open up the call forquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes from theline of Chip Dillon from Citigroup. Please proceed.

Chip Dillon -Citigroup

Yes. Good morning.

Tom Gutierrez

Good morning, Chip.

Mike O'Donnell

Hi, Chip

Chip Dillon -Citigroup

Tom, you mentioned earlier in the call about where yoursales growth was coming from. Could you just repeat those real quickly? Yougave it kind of by region I believe.

Tom Gutierrez

Sure. Well, just a second. I think it's 14% in Europe, 14%in South America, 12% in Asia and 6% in North America.

Chip Dillon -Citigroup

Got you. And that was in both -- that's the whole company,is that right?

Tom Gutierrez

No, that was clothing only.

Chip Dillon - Citigroup

In clothing, okay. That's makes sense. And then, Mike youmentioned the new hedging transaction, again, that will take what is yourfloating rate exposures in fixed sum, is that correct?

Mike O'Donnell

Yeah. Actually, that's correct Chip. But just to clarify, wecurrently have fixed our clothing interest rate under the current interest rateswaps and that is effective. In spite of the fact, we don't have hedgeaccounting and the change in deferred value of those hedges goes throughearnings. We have effectively fixed the interest rate and so if we take out newderivative instruments, the swap instruments, we would, in fact, go from afixed to a 1 percentage point rate higher fixed level.

Chip Dillon -Citigroup

Starting in mid-2008.

Mike O'Donnell

Well, we have indicated here and what I clarify is, weintend to do that in the near future. The current swaps actually expire in June2008 and we are indicating we would do something sooner than that.

Chip Dillon -Citigroup

Oh, I am sorry. That's absolutely right. Now, just to play alittle bit of a devil's advocate, if you look at the bombshells coming out ofthe banks everyday, including one in Charlottethis morning. And the Fed's Chairman said yesterday, why would you want to fixwhat is a floating rate at this early date -- were they paid up, that doesn'tseem to be. Is there any kind of urgency to do this?

Mike O'Donnell

Yeah, your question is, what do we think interest rates aregoing to do? And that's a fair question, Chip. Our belief is that any cominginterest rate changes by the Fed really factored into the forward curves andyield curves. And so, our expectation is that whether the Fed changes interestrate, reduces interest rate or doesn't, that's effectively priced in, and overthe period of time between now and June 2008, we don't think that there wouldbe any significant advantage or disadvantage to waiting.

Chip Dillon -Citigroup

That make sense, okay. So you are taking the queue from themarket. Now, you mentioned or you admit us that interest expenses $14.4 millionin the third quarter and $2.7 million of that was this mark on the hedgeaccounting. Is it correctly to think about this, if you were to just fix forthe following two years today, basically terminate the current hedge and dothis new one? Is it right way to think about that is that your interest expenseto be about a $1 million less per quarter like around $13.4 million and againthe way you get there as you no longer have the mark, hurting you $2.7 million,but on the other hand, it looks like your per quarter interest would one extrapoint would be about $1.7 million?

Mike O'Donnell

I think that that math is right. The way I would come at itfor your calculations, Chip is that right now we are fixing on our current swapsor fixing our interest rate around 6.1%. And so, it is not being prognosticatorof interest rates, but assuming that we have a 1 percentage point change inthat, it would be a 1 percentage point difference over what has been theunderlying interest rate without effect of the fair value.

Chip Dillon -Citigroup

And that's when 85% of the whole -- how much of the debt isat 85%?

Mike O'Donnell

Yeah, $658 million.

Chip Dillon -Citigroup

Got you, okay. But then on the other, so again that portiongoes up, but the offset if you are using the third quarter as a base, is thatyou wouldn't be having this big $2.7 million per quarter mark on the hedge?

Mike O'Donnell

Exactly.

Chip Dillon -Citigroup

Okay. And then last question. You mentioned there was avalue in this contract you have of $5.5 million, I guess if you terminated itthen, that's in your favor so you would in essence that would be income to you?

Mike O'Donnell

It would be positive cash for us now and then over theperiod of time between now and when our original swaps would have expired,actually we are going to pay higher interest rates. So, I would view it that$5.5 million is something that would, it would be an immediate cash positive,but they would burn off so to speak over the next four quarters.

Chip Dillon -Citigroup

Got you. And so in a sense we should also amortize eventhough it's positive cash. We should take a little under $2 million and assumethat's going to be what per quarter for the next three quarters will be sort ofthe amortization of that?

Mike O'Donnell

That's right. And the way it works as you know Chip is likeit doesn't amortize to use your word equally, it will depend on really whathappens with propelling interest rates.

Chip Dillon -Citigroup

Okay, got you.

Mike O'Donnell

It will be plus and minus, so that the general effect willbe as you described.

Chip Dillon -Citigroup

Now, if you could just. You mentioned the capital spending,did you suggest that you will be spending 50 a year through '09, is that rightor did you mention, did you go up that far, I didn't get that?

Tom Gutierrez

No, we said that we would spend 50ish this year and that weanticipate about two more years of that type spending in order to execute theplans that we have in place to expand our position in Asia, complete thecapacity increase in pieces in South America and add some of the new productsthat we're bringing into manufacturing.

Chip Dillon -Citigroup

Okay. I thought it was only going to be in '07 and '08. Wasthere a change that made that, extended that level through another third year?

Tom Gutierrez

No, I think our view has changed in terms of how large of acapacity we want to put into low cost locations and so. As we looked at ourinvestment over the next three or four years, and we have pretty good year nowup to 2012 or what we need to do. We did had another year of 50ish likespending to ensure that we were in a position to take maximum advantage of thegrowth opportunities particularly in Asia that we foresee.

But as you know, we take a very measured pace in terms ofhow we invest money in these programs which is one of the mindsets that youinvest at a rate where the return then comes back to you within a reasonableperiod time and so. But it's really more of the same for one year longer inorder to ensure that we don't miss out our own opportunities.

Chip Dillon -Citigroup

And then, if you look at year-to-date you've spent, actuallyit's not even half of the 50, I mean is it realistic to think you're going toget 50 spent by year end?

Tom Gutierrez

We believe that we will spend the rest of it, because it'svery chunky when you start, as you start to equip that operation that we havein Vietnam, the spending becomes very, very chunky in the last quarter of thisyear and then the first part of next year in order to get it completed by mid2008, which is what we were talking about. So, I'd say, we are certain as youcan be that we are going to spend those [further].

Chip Dillon -Citigroup

And then, one more the quick thing, you said that, I think,currency actually caused your net debt to go up. How much of your net debt isdenominated in other currencies or…?

Mike O'Donnell

Yeah. I can give you an off the top of my head, but it'saround 30% of the total debt is in Euro denomination.

Chip Dillon -Citigroup

Is in Euros. Okay.

Mike O'Donnell

Yeah, yeah.

Chip Dillon -Citigroup

Alright, got you. Okay, thank you.

Mike O'Donnell

Yeah, thanks.

Tom Gutierrez

Thanks.

Operator

Your next question comes from the line of Ned Borland fromNext Generation Equity. Please proceed.

Ned Borland - NextGeneration Equity

Good morning guys.

Tom Gutierrez

Good morning, Ned.

Ned Borland - NextGeneration Equity

Just another covenant question here, your total debt used inthe calculation, that is 12-month average right with an average exchange rateattached over the next 12 months…

Tom Gutierrez

Can you speak couple…

Mike O'Donnell

Yeah, sorry, we lost you there at the end.

Ned Borland - NextGeneration Equity

I am sorry. The total debt calculation for the covenantcalculation, that's an average of the last 12 months, right?

Mike O'Donnell

That's correct. Yes.

Ned Borland - NextGeneration Equity

Okay. And then, that's using an average exchange rate on that,right?

Mike O'Donnell

Right.

Ned Borland - NextGeneration Equity

Okay. Okay, I just want to clarify that. Operationally inthe clothing sector, I guess, there is a big contract season coming in thespring of next year. Do you see pricing kind of remaining stable in that periodas you enter those negotiations?

Tom Gutierrez

Ned, I think that it's sort of normal to think of it thatthere is contract fees. And contracts are an ongoing every month, every quarterthing. And they actually sort of play out pretty evenly across the year. Andso, we are seeing contracts go up for our Q and be flat almost every month ofthe year. And our view is that there isn't a lumpy season coming up, and thatthe dynamics of most of those contracts have not changed from the environmentthat we've been describing.

Intense competitive environment in Europe,I think it's a more crowded market. In terms of competitors, I also think thatthe health of our customers from a financial standpoint is a key driver of howthis plays out. And in Europe, we are startingto see some of the restructuring and mill closures and things like that, thatultimately are necessary in the long-term and help the health of the industry.But, I think from a contract standpoint, I think it's more of the same.Business is usual as it has been over the year, and we expect it to continuethe same way through the balance of 2008.

Ned Borland - NextGeneration Equity

Okay. But, is it fair to say that the pricing is stabilizedversus a year ago? I mean…

Tom Gutierrez

Ned, it's sort of a little bit cyclical and we saw a littlebit more pricing erosions than we expected this quarter in the clothing sector.Actually, we have been able to maintain it pretty close to the 1% range. Weexpected that to stabilize and improve a little bit better. But, it comes andgoes. Because, I think the ebb and flow of our prices go up and down, onequarter versus the next quarter, has a lot to do with the competitive bids andthe particular type of customers that are involved in that particular sector.

But on average, I would say, that in the clothing sector,that remained reasonably stable. And on average, in the rolls sector we seecontinuing erosion at a faster clip than we've seen in the clothing sector. AndI know that's sort of like a wordy and sort of complicated answer to yourquestion. But, I don't see and I don't expect the sigh of relief that says,aha, everything is going to be rosy and wonderful and prices are going to startgoing up in the clothing sector.

I see a continuation of an environment that we have been inover the last year, hence the actions that we are taking to really focus on ourcost structure, and the actions that we are taking to move in to territorieswhere the growth is healthier. So, as I said in the press release, we remainpretty cautious. And our caution leads us to take cost structure action, newproduct action, and expansion action in the areas where the expansion is goingto give us better results.

Ned Borland - NextGeneration Equity

Okay. And then on the cost structure, in '08 what's yoursense of restructuring actions versus what you have done in '07 or you expectto do in '07?

Tom Gutierrez

Ned, we generally don't comment on that. But, I think whatwe said is that we have seen that the actions that we undertook in 2007 areessentially near there end. The way that we operate and the way in which wehave been able to maintain the kind of margins that we have versus everybodyelse, is because we are constantly looking at our cost structure. But, we lookat it also with the intend that investments in our cost structure to reduce, weneed to payback pretty quickly. And so, we don't project what it's going to be,but we will continue to be opportunistic about things that we see, that couldpotentially accelerate our ability to not only maintain the good gross marginsthat we have, but perhaps improve upon them as we move in to next cycle.

Ned Borland - NextGeneration Equity

Okay. That's all I have, thanks.

Mike O'Donnell

Hey, Ned. I had a bit of a clarification, because I wasn'tsure I heard your questions, in fact, properly at start.

Ned Borland - NextGeneration Equity

Okay.

Mike O'Donnell

In regards of the covenant calculations, it's based on thedebt outstanding at September 30th based on the average over the last year'sinterest rates.

Ned Borland - NextGeneration Equity

Okay.

Tom Gutierrez

I am sorry, exchange rates.

Ned Borland - NextGeneration Equity

Exchange rates, yeah.

Tom Gutierrez

Exchange rates, yeah.

Ned Borland - NextGeneration Equity

Okay. Yeah, that'swhat I was getting at. Okay. Thanks.

Mike O'Donnell

Yeah.

Tom Gutierrez

Appreciated.

Operator

Your next question comes from the line of Peter Lisnic fromRobert Baird. Please proceed.

John Haushalter -Robert Baird

Good morning. It's actually John Haushalter, in for Pete.

Mike O'Donnell

Hi, John.

Tom Gutierrez

Hi, John.

John Haushalter -Robert Baird

Questions for you on the clothing side, with the unit volumegrowth you guys got, is that just industry growth in general or is that youguys, kind of, taking positions on paper machines and were really kind ofseeing a flow through from what's you've been doing in the past two years orjust what's behind that kind of the very gross number there?

Tom Gutierrez

I mean, I would have to say that the market is not growinganywhere near those rates. And so, the only way that you're going to get thatkind of growth is to be improving your position. And I'd pretty much say thatin the press release that we believe that we are continuing to improve ourposition in the marketplace, in order to achieve those kinds of growth rates.

John Haushalter -Robert Baird

Okay. And then, just turning to the numbers in the quarter,I mean, you've historically have kind of a bump in the fourth quarter from thethird quarter. And was there just a change in order pattern so, should we kindof expect that to continue this year?

Tom Gutierrez

John, that almost sounds like forecast that you are askingfor.

John Haushalter -Robert Baird

No, it's my questions, yeah.

Tom Gutierrez

Yes, its excellent question. I'd say that what happened inthe third quarter, happened in the third quarter. And I think I would leave itat that. We had a good solid second quarter and so it wasn't slippage from thesecond quarter to the third quarter. But, without going into forecastterritory, all I can tell you is that I think that the third quarter was anabnormal quarter in terms of what we have normally seen in third quarters,because of our past. But, it's not abnormal because of things that we've stolenfrom the future in general.

John Haushalter -Robert Baird

Okay. Thanks for that. Mike, can you just go into the rawmaterials side just, I mean oil kind of continues to creep up. And just howhave you been able to kind of offset it to-date to some extent and just whatyou can do kind of going forward there?

Mike O'Donnell

Yeah, and then difficult to predict, nor could I about thefuture, John. But what we have been able to do this year in particular, buteven in 2006, is be more effective in the way that we buy.

And some of those things that come to mind is leveraging ourpurchasing power in sort of our key commodities, standardization of some ourcommodities that we purchase such that instead of buying many variations of thebeam, buying many fewer variations of the beam, and I think just being moreconscious in general because of the petroleum-based products that we have andwhat's happening with oil prices, just being much more focused and conscious.

And that's kind of a roundabout way of saying that we werenot very efficient or as effective as we could have been really prior to 2006in our buying practices. And I'd say that's been the key driver of being ableto hold our cost increases on raw materials at or about just general levels ofinflation.

John Haushalter -Robert Baird

Okay. Thank you.

Mike O'Donnell

Yes. Thanks, John.

John Haushalter -Robert Baird

Thanks.

Operator

Your next question comes from the line of Michael Proutingfrom 10-K Capital. Please proceed.

Michael Prouting -10-K Capital

Yeah, good morning.

Mike O'Donnell

Good morning, Michael.

Michael Prouting -10-K Capital

I had a question, it's a follow-up question on the pricing.I mean certainly in your commentary, it sounds like roll covers is a morechallenging market right now, and yet it seems so on a relative basis, pricingactually deteriorated more on the clothing side this last quarter than rollcovers. I am wondering if you could maybe just elaborate on that.

Mike O'Donnell

I think if you look at a single point, you might come tothat conclusion. But I think as you look at the roll covers business, what I amsuggesting is that we see the roll covers business on a continuing curve wherestability will be more difficult to maintain on the pricing side of it andwhereas the pricing and rolls on a year-to-date basis has actually been heldfairly steady.

In clothing I am saying versus prior years, it's stillrelatively steady. And so, we feel the clothing sector, probably having morestability going forward than the roll covers sector where we expect to seecontinuation and perhaps slight deepening of the pricing environment that wesee.

Michael Prouting -10-K Capital

Okay, that's helpful. And then I am wondering, could youjust comment on the dividend and how secure the dividend is at this point?Thanks.

Mike O'Donnell

I think my commentary at the end of my session today isintended to say, the Board reviews the dividend every quarter and our policiesstates that we review it on the basis of looking at our cash and the potentialusers for investments in the company for paying down debt or paying down thedividend.

I think I've been fairly clear saying that at this stage andagain it's really critical to and we think a good investment for the company tofocus on growth because that provides longer lasting value to shareholders. Andso, we decided to pay dividend this quarter and we have for quite some time.But, I wanted to make it very clear to everybody that it is aquarter-by-quarter decision, that's made by the board, and it's made on thebasis of what is going to provide the longest lasting shareholder return to thecompany.

And so I can't -- I know I didn't give you the answer youwere looking for, but I hopefully have given you the parameters that you shouldconsider and making your decision as to what our intentions are over thedividend.

Michael Prouting -10-K Capital

Okay, great. Thank you.

Mike O'Donnell

Thanks Michael.

Operator

Your next question comes from the line of Chip Dillon fromCitigroup. Please proceed.

Chip Dillon -Citigroup

Yes, two questions, one is the $800,000 in the restructuringcharge, was that mostly in the paper machine clothing area or all in that area?

Mike O'Donnell

It was a combination, but I would say, yes, it was moreweighted towards the clothing side of the business.

Tom Gutierrez

We have the two plant closures happened earlier in the year.

Chip Dillon -Citigroup

If halt just a second.

Mike O'Donnell

Yeah, actually, it was fairly weighted toward the rollcovers, so I correct what I said.

Chip Dillon -Citigroup

Okay. So it was in roll covers. Okay.

Mike O'Donnell

Yes. But let me add to that Chip the fact that in ourcorporate segment which you'll see when file our Q, there is also a fairly bignumber there, so about half that number will be in the corporate segment. Andthat's for things at the total company level that we have done and are doing.

Chip Dillon -Citigroup

Got you. And you mentioned in terms of the previous questionthat obviously the Board shouldn't look at the growth opportunities as well ascash balance when you go ahead with the dividend. If it turned out where theBoard felt that the cash couldn't support both at current levels and theydecided okay we want to make the more balanced approach. Would that balancedapproach be, would they be inclined to eliminate the dividend or just make it atoken dividend if they decided to go that way?

Tom Gutierrez

I think it'll be difficult for me to sort of project exactlywhat the Board would do in that circumstance. We haven't had to face that sortof circumstance up until now. I can talk about what's important to thebusiness, and in the long-term what's really important to the business is toensure our position in the strongest growing regions of the world and thatrequires investment, and that has long lasting impact on the bottom line.

But I think to prejudge what the Board would do in a choicelike that, it would be very difficult for me to do on the spot like this. But Ihave sort of made it pretty clear that growth is one of the key drivers ofshareholder value, that's going to get our share pricing moving in the rightdirection and that's of paramount importance for us to ensure that we completethose growth investments.

Chip Dillon -Citigroup

Got you. Thank you.

Operator

And now I'd like to go ahead and turn the call back over toMr. Mike O'Donnell for closing remarks.

Mike O'Donnell

Okay. I want to thank everybody again for joining us thismorning. One upcoming event to mention, we will be presenting at The WallStreet Analyst Forum on November 27th in New York City. This event will also be webcast and weinvite you to listen in.

Thanks again for your support. We look forward to speakingwith you again.

Operator

Thank you for your participation in today's conference. Thisconcludes the presentation and you may now disconnect. Good day.

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