Kadant Inc (KAI) 2009 Q1 法說會逐字稿

Good morning. My name is Chris and I will be your conference operator today. At this time I would like to welcome everyone to the Kadant, Inc. first-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator instructions.)

I will now turn the call over to Chief Financial Officer, Thomas O'Brien. Please go ahead, sir.

Thank you, Chris. Good morning, everyone and welcome to Kadant's first-quarter 2009 earnings call. With me on the call today is Bill Rainville, our Chairman and Chief Executive Officer.

Before we begin let me read the safe harbor statement. Various remarks that we may make today about Kadant's future expectations, plans, and prospects are forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from these forward-looking statements as a result of various important factors, including those discussed in our Annual Report on Form 10-K for the fiscal year ended January 3, 2009, which is on file with the SEC, and is also available in the Investors section of our website at www.kadant.com under the heading SEC Filings. In addition, any forward-looking statements we make on this call represents our views only as of today. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and you should not rely on these forward-looking statements as representing our views on any date after today.

During this call we will refer to some non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is contained in our first-quarter earnings press release issued yesterday which is available in the Investors section of our website at www.kadant.com under the heading Recent News.

With that, I will turn the call over to Bill Rainville, who will give you an update on Kadant's business and future prospects. Following Bill's remarks I will give an overview of our financial results for the quarter and we will then have a Q&A session. Bill?

Thanks, Tom. Good morning, everyone. Thank you for joining us as we review Kadant's 2009 first-quarter results and comment on our outlook for the rest of the year.

For those of you who closely follow the pulp and paper industry, you are well aware that the global economic climate has resulted in a significant drag on paper demand and paper machine operating rates. In every major industrial region across the globe, reports of temporary and permanently idled machines are commonly cited and reflect the dismal nature of the current economy. This, in turn, has impacted our first-quarter results across all areas of our business.

There are, however, some early indications that business levels may be stabilizing, as our customers work diligently to reduce inventory levels to reflect market demand. We believe that the unusually low machine utilization rates are highly abnormal and are not indicative of the longer-term business environment. Following a review of our financial performance in Q1, I'll provide an overview of the state of the pulp and paper industry and highlight several developments that lead us to believe that conditions should improve towards the end of 2009.

I'll start with our financial performance. Revenues for Q1 were $65 million, or 16% lower than Q1 2008, excluding the effect of foreign currency. This revenue decrease was across all our business units except our fiber-based products business, which was up 14% compared to a year ago. Our bookings for the quarter were $48 million, a sharp decline from $90 million in Q1 '08, which was a relatively strong bookings quarter. We believe that the lower operating rates of paper machines around the globe, reflecting a depressed paper and paperboard demand, is a primary driver, resulting in weak bookings for the quarter in all of our major product lines in all regions of the world.

Our spares and consumables bookings were substantially lower than we had forecasted and we have not seen any recovery so far in the second quarter. In addition, over the past few months numerous capital projects, including several where we have signed contracts but have not recorded as bookings, have been postponed due to market conditions or a lack of financing.

Backlog at the end of Q1 '09 stood at $46 million, a 61% decrease from our record level set in Q1 '08. Adjusted diluted EPS for Q1 was $0.02, excluding restructuring costs and incremental tax provision. Although we met our diluted EPS guidance on an adjusted basis, our first-quarter 2009 results clearly reflect the tough economic environment facing our customers.

On a more positive note, we had another solid quarter of cash flow from operations which generated nearly $14 million in the first quarter, more than double our cash flow from the same period last year. Our net debt position at the end of the first quarter was $7.3 million compared to more than $15 million at the end of the fourth quarter 2008.

Before I talk about Kadant, I thought it would be helpful to review the current condition of the paper industry. Recent industry news, market conditions and operating statistics clearly show the pulp and paper industry was responding to serious reductions in market demand and, in some cases, downward pressure on prices.

A positive factor impacting mill operations and supporting mill profitability despite the pricing pressure has been the declining input costs of energy, recycled fiber, wood fiber, and chemicals. The drop in energy and fiber costs has improved the cost competitiveness of recycled containerboard mills, and virgin furnish mills in the US are now being additionally helped, albeit temporarily, by the alternative fuel tax credit for burning black liquor.

While the 41 machines permanently idled in the US in 2008 is nearly the same as the number in 2007, there is a significant decline in operating rates compared to one year ago. For example, the operating rate of the US containerboard segment dropped to 79% in Q1 '09. The operating rate for the same period in 2008 was 96.4%, slightly higher than the 95.7% operating rate from 2003 through 2007 in this segment.

The operating rates are similar for other paper grades and the large deviation from the historical rate suggests that the current operating rates are not the new standard. Rather, this is an unusual period where paper companies are reacting to sluggish market demand and downward price pressure through aggressive supply side management.

However, extensive and widespread downtime has struggled to keep pace with the reduction in demand, resulting in increases in mill inventories in newsprint and kraft paper, while containerboard and printing and writing-grade inventories decreased in March. Coated paper producers are facing the sharpest decline in demand of all paper grades, yet permanent capacity shuts have been slow to happen in 2009. We believe that this phenomenon is due to producers believing that some of the downturn in demand is cyclical and will eventually recover from the levels of the past few months.

On a more positive note, demand for tissue continues to be relatively resilient and operating rates in the first quarter this year were at 91%, down slightly from 93% during the same period last year. Although abnormally low current operating rates have been reported in every region of the world, we believe that the depressed operating rates are a temporary occurrence and the market will eventually return to more traditional levels of 92% and 96%. The medium- to long-term trends in the paper industry are still positive, particularly in emerging markets were low per-capita consumption and urbanization will stimulate demand in the coming years.

As a result of the lower operating rates and the desire of our customers to conserve cash, our replacement parts and consumables business, as well as capital equipment shipments and bookings, have experienced significant headwinds in Q1. As I noted in the beginning of my remarks, our bookings in Q1 were well below what we anticipated. Our spare parts and consumables were off due to lower operating rates and many capital projects were postponed due to market conditions and the lack of financing.

We have not seen a turnaround in the first part of Q2, and do not expect bookings to improve until the second half of the year. However, while the prognosis of the economy in general, and the paper industry in particular, is uncertain, we are beginning to see some moderately encouraging signs in the marketplace. In particular, our businesses have noted increased quota activity during the second half of March and into April. And we are seeing increased optimism from our selling team. Supporting this point, Packaging Corporation of America, in its first-quarter conference call a few weeks ago, noted that bookings for the first 10 days of April were up almost 15% over March, and about equal with April 2008. A similar report of increased demand was also made by Temple-Inland.

Our large installed base continues to serve us well, offering a less volatile flow business that provides healthy cash flow within our operating units. For example, in early April we booked an order for more than 500 spare rotary joints from one of China's largest steel-producing companies. A typical steel production run lasts up to 18 months, after which time the machine segments are rebuilt and consumable equipment such as rotary joints are replaced. At this particular mill there are nine continuous casting machines, with more than 2,000 Kadant rotary joints in operation. The recent order we received for 500 rotary joints is for a routine rebuild of two of the nine steel-producing machines.

On a similar note, we have recently begun shipping doctor blades to a major printing and writing-grade producer in China as a result of the annual contract we were awarded earlier this year. This accomplishment, as well as the successful expansion of our water management and accessory product lines in China is allowing us to capture increased share in this critical market at a faster pace than originally planned.

Another positive development with respect to our accessories product line is our market share rose in various regions of the world. For example, in the first quarter we won two new significant doctor blade accounts in North America and Europe and were told that the customers chose Kadant because of our application expertise and the customers' confidence in our long-term viability.

And, finally, recent reports issued by the European Organization for Packaging and the Environment and the American Forest and Paper Association have indicated increased use of recycled paper in Europe and North America. Not only is this increased use of recycled content good for the environment, as less paper and packaging products are discarded in landfills, we believe this is also good for Kadant because of our process knowledge and application expertise in recycled stock preparation and the type of paper machine equipment that is required for the more demanding cleaning, filtering, and doctoring processes involved with recycled fibers. We believe that increased use of recovered paper products will lead to increased demand for Kadant products and technologies.

Capitalizing on this increased use and apparent demand for recycled paper, Kimberly-Clark recently launched its green tissue paper products called Scott Naturals. This toilet tissue is made from a blend of materials that is 40% recycled fiber. Scott Naturals paper towels include 60% recycled material, and napkins contain an 80% mix of recycled fibers. We believe this presents yet another opportunity for Kadant as Kimberly-Clark is one of our better customers.

As these examples demonstrate, we continue to leverage our deep application expertise, process knowledge, and global presence to capitalize on revenue opportunities. Although we do not know when market demand for paper machine (technical difficulty) rates will return to trend upward, we do believe that we are very well positioned for growth when global capital equipment markets recover.

In the meantime, Kadant enjoys a position of relative strength with respect to our healthy cash flow, large installed base, and experienced management team, operating with a well-tested business model. Our business strategy is particularly appropriate for difficult times. We are continuing our focus on our after-markets and consumables business, and on delivering products and technical solutions that provide our customers a compelling return on their investment.

Specific initiatives include expanding our market share of stock prep parts in China, growing our global market share of screen baskets, and further penetrating markets with our accessories and water management products in Germany and China. In addition, we continue to emphasize the energy-saving opportunities available with our fluid handling products marketed to paper and non-paper industries.

Looking ahead to the coming months, we expect to see a moderate increase in business activity in all of our business units late in 2009. The increased quota activity we are currently experiencing, coupled with the restrained consumer spending, lead us to believe that spending will improve later this year, with consumables leading the recovery. What's more, we believe the weakness in paper and board shipment is not sustainable. These conditions further reinforce our belief that buying patterns of our customers will begin to return to more normal levels as we work through these tough times.

As outlined during our March earnings call, we have taken aggressive steps to streamline our operations and reduce costs in response to the market we are facing. We have made considerable progress on these initiatives, with most of the restructuring efforts now completed, or well under way. One of the major initiatives, integration of our US water management, accessories, and fluid handling sales forces, was completed in February. This action served to eliminate territory overlap, increase our mill presence, and reduce selling expenses. The integration has been well received by the market, and we believe we are able to better serve our customers with this new, lower-cost structure.

In early March we began the process of consolidating the US manufacturing operations of our water management product line to our manufacturing plants in Massachusetts and Mexico. Once the transition is completed later this year, we expect to achieve economies of scale, greater operating efficiencies, and reduced overhead costs. Also in March our fluid handling division in the US reduced its workforce by approximately 16%, while our operations in Europe and China implemented a reduction in force along with reduced working hours. Cost savings resulting from these and other actions are contributing to projected reduction in our manufacturing overhead spending and operating expenses of nearly $29 million in 2009 compared to 2008, including an estimated $9 million favorable effect from currency translation. We expect these actions, as well as other internal performance improvement initiatives, to provide even greater contributions once demand from paper consumers and machine utilization rates return to traditional operating levels.

Based on a substantially lower than forecasted first-quarter bookings, unusually low operating rates in the paper industry, and a delay of numerous large capital projects, we have adjusted our 2009 guidance accordingly. For the second quarter of 2009 we expect to report a GAAP diluted loss per share of $0.24 to $0.26 from continuing operations in the second quarter of 2009 on revenues of $50 million to $52 million. For the full year, we expect to report a GAAP diluted loss per share of $0.55 to $0.65 from continuing operations on revenues of $220 million to $230 million.

Both the second-quarter and full-year EPS guidance include an incremental tax provision, as well as estimated restructuring costs that Tom will cover in his financial review. Tom?

Thank you, Bill. I'll begin with our revenue performance. Consolidated revenues were $65 million in the first quarter of 2009, 24% lower than last year, including an 8% unfavorable translation effect from foreign exchange resulting from the stronger US dollar for the first quarter of 2009 compared to the first quarter of 2008. The revenue results are at the upper end of our guidance for the quarter, which was $62 million to $65 million.

In general, revenues were lower in all our major product lines, with the exception of our fiber-based products business, which was up 14% compared to a year ago. The worldwide paper industry continues to be besieged with extended production curtailments and slowdowns. Our customers have temporarily reduced their spending to absolute minimums, candidly, to levels that we had not anticipated even a few months ago. Consequently, this has significantly affected our bookings, revenues, and outlook, both in our after-market and our capital businesses.

Let's now turn to each of our product lines for a few more details. Stock prep revenues were $29.2 million in the first quarter of 2009, down 20% from last year, including an 8% unfavorable effect from foreign exchange.

Our stock prep revenues in China, where our capital business remains particularly weak, were $1.3 million, a decrease of 90% from the first quarter of 2008, including a 1% favorable effect from foreign exchange. Revenues in North America, which are less dependent on the capital business, were down 44% from last year. In our European business on the other hand, stock prep revenues of $20.6 million increased 87% from the first quarter of 2008 and more than doubled if we exclude an unfavorable effect from foreign currency. Revenues here included approximately $11.7 million from a large recycling system which was manufactured in Europe and will be installed in Viet Nam. You may recall that we made mention of this order in previous earnings calls.

Despite this large system order, a portion of which will be shipped later in the year, we expect weaker sales of our stock prep products for the next several quarters, not only in our European business, but also in China and North America, as there appear to be few major system projects on the horizon.

Our revenues in our water management product line were $5.1 million, a decrease of 36% from last year, including a 6% unfavorable effect from foreign exchange. Revenues in Europe were down 66% versus the first quarter of last year, including 10% from the unfavorable effects of foreign currency, largely due to lower demand for capital products. Revenues in North America decreased 23% compared to the first quarter of 2008, including a 4% unfavorable impact from foreign currency.

I'm turning now to our accessories product line. Revenues were $11.5 million in the first quarter of 2009, down 27% from last year and included a 10% unfavorable effect from foreign currency. Revenues declined in North America by 28%, including 4% from the unfavorable effect of foreign exchange, and by 26% in Europe, including a 23% unfavorable effect from foreign exchange.

Our operations continued to be severely affected by unprecedented levels of production curtailments and machine shutdowns, as our customers react to lower demand to their products and adjust their operating rates accordingly. In addition, many mills are using blades and other consumables much longer than they would in normal times.

Revenues in our fluid handling product line were $15.7 million in the first quarter of 2009, down 30% compared to last year, including an 8% unfavorable effect from foreign exchange.

As was the case last quarter, all the major geographic areas in which we market these products experienced significantly lower demand due to the worldwide recession. China, for example, was down 54%, including a 4% favorable effect from exchange. The shortfall here was predominantly from the paper industry, as sales to customers in other industries were relatively flat compared to last year.

Revenues in the US were down 18%, and Europe declined 40%, including a 12% unfavorable impact from foreign currency.

In addition to reductions in the parts business, all these operations are experiencing a lack of new project orders, with especially sharp declines in small capital projects.

And, finally, in a more positive vein, albeit it on a smaller scale, revenues in our fiber-based products business were $3 million, up 14% from last year. This business is also benefiting from markedly lower natural gas prices, which will contribute to improved operating income results in 2009 compared to last year.

And turning now to our product gross margins, consolidated product gross margins were 37.9% in the first quarter of 2009, down 180 basis points compared to last year. Most of this decline was attributable to our papermaking systems segment, where gross margins of 38.1% were 160 basis points lower than last year. Margins are slightly lower in our stock prep and fluid handling product lines, and slightly higher in our accessories product line, but declined significantly in water management, due primarily to under-absorption of overhead due to the reduced volumes.

As Bill mentioned, we are currently in the process of consolidating the US water management manufacturing facility and we expect continued pressure on these margins until that combination is completed early in the fourth quarter of 2009. Also, approximately 30 basis points of the gross margin decline in the papermaking systems segment was due to an unfavorable mix as higher-margin fluid-handling revenues accounted for a smaller proportion of total segment revenues.

Gross margins were lower than last year in our "other" category and adversely affected our consolidated gross margins by 20 basis points. The impact of the lower natural gas costs will begin to have a more pronounced effect in our next few quarters and, as a result, we expect higher gross margins for this business in 2009 compared to last year.

Now let's look at our SG&A expenses for a moment. SG&A expenses were $22.2 million in the first quarter of 2009, down $3.2 million, or 12%, from last year. This decrease includes $1.7 million, or 7%, from the favorable effect of foreign exchange, offset partly by increases of $300,000 in legal expenses associated with a customer dispute and $400,000 in bad debt expense associated with a customer bankruptcy. Due to lower revenues in the 2009 period, SG&A as a percentage of revenues increased from 29.5% in the first quarter of 2008 to 34.2% in the first-quarter of 2009.

As we noted on our March 2009 earnings call, we have undertaken a number of initiatives beginning in the fourth quarter of last year to reduce our SG&A expenses. As a result of these actions, we expect SG&A for the full year 2009 to be approximately $86 million, down $14 million, or 14%, from last year.

Now, let me turn to our EPS results in the first quarter. Before explaining those results, I first want to address our tax provision, which had the effect of magnifying our loss more than what the operating results would ordinarily suggest. Throughout 2009 we expect to incur tax expense even in quarters where we may have pre-tax losses because for accounting purposes we are not able to benefit the book losses which we are currently incurring in our US subsidiaries.

Briefly, the reason for this relates back to the impairment charge we took in the fourth quarter of 2008, and the allowance we established at that time for our US deferred tax assets. Of course, not benefiting the US losses has the effect of increasing the net loss compared to what it otherwise would have been.

In addition to this negative impact, in the first quarter we incurred $1.2 million of nonrecurring discrete tax expense associated with establishing a valuation allowance for our Kadant (inaudible) subsidiary's deferred tax assets, as well as for certain foreign tax assets which we generated and normally would have tax benefited in the US.

Importantly, none of these items will affect our cash flows in 2009 and, moreover, we believe that we will ultimately realize economic benefit of our deferred tax assets and the foreign tax credits once our profitability returns to historical levels. Also, these tax effects have no impact whatsoever on our compliance with the debt covenants under our bank borrowing facilities.

In total, these extraordinary tax items served to reduce our first-quarter diluted EPS results by $0.21. They will also affect our total-year results and I'll discuss that more fully in a moment when I add some details on our guidance for the full year.

So with that as background, let me now analyze the change in our EPS results from the first quarter of 2008 to the first quarter of 2009. We reported GAAP diluted loss per share from continuing operations of $0.23 in the first quarter of 2009 compared to income per diluted share of $0.36 in the first quarter of 2008.

Included in these results is a restructuring charge of $0.04 in the 2009 period and a net gain of $0.02 in the 2008 period. Also, as I just noted, the 2009 period includes $0.21 of extraordinary tax expense. So excluding the restructuring charge, the gain, and the tax expense in the appropriate periods, adjusted EPS was $0.02 per diluted share in the first quarter of 2009 compared to $0.34 in the first quarter of 2008, or a decrease of $0.32. You can see the calculation of adjusted EPS in tabular form in the earnings press release which we issued yesterday.

This decrease of $0.32 includes the following items, each of which decreased diluted EPS in the first quarter of 2009 compared to the first quarter of 2008 -- $0.04 from the unfavorable effects of foreign currency translation; $0.03 from the impact of lower shares, which increased the loss per share; $0.03 from higher net interest expense; $0.02 from a customer bankruptcy; and the remainder, or $0.20, due to lower operating results.

Now turning to our balance sheet, we ended 2008 with a solid balance sheet and I'm pleased to report that it improved further in the first quarter of 2009. As an overview, we ended the first quarter with $7.3 million in net debt, which is a decrease of $8 million from the fourth quarter of 2008. Any amounts borrowed under our revolving credit agreement are not due until February 2013. The weighted average cost for outstanding debt at the end of the first quarter was 3.4%. We are in compliance with all our debt covenants and we ended the first quarter with $46.9 million in cash.

Our liquidity position in these turbulent times remains solid with, in addition to the cash, approximately $33.5 million available under our committed revolving line of credit. We also have an additional $75 million which could be available in uncommitted lines under our multi-bank five-year credit agreement, and another $100 million in uncommitted lines under our three-year Pru shelf agreement.

I should note that we are restricted to a consolidated debt level no more than 3.5 times our last 12-month EBITDA under these committed and uncommitted lines. Due to the forecasted reduction in our EBITDA we may need to pay down some debt with our cash balances in 2009 in order to remain compliant with this covenant. Assuming that our financial performance does not deteriorate significantly from our guidance for 2009, we expect to remain in compliance with the bank covenants throughout the year.

Let me also note that the maximum cost of borrowing under the revolver is 120 basis points over LIBOR, which is well below market and that, fortunately, particularly in this credit environment, we have approximately four years remaining under our revolving debt agreement.

We had one of the best quarters for cash flows in the history of the Company. Cash flows from operations more than doubled, from $6.3 million in the first quarter of 2008 to $13.8 million in the first quarter of 2009. We have provided more details on the balance sheet in our press release, and you can see that we had significant reductions in accounts receivable and inventory, offset partly by reductions in payables and other liabilities.

Our working capital, which we define as current assets less current liabilities, excluding cash, debt, and the discontinued operation, was 15.3% of our last 12 months' revenues, down from 19.2% at the end of 2008, and from 16.9% in the first quarter of 2008. As we noted during our March earnings call, we still expect strong cash flows in 2009.

Also, we purchased $2.9 million of our common stock in the first quarter of 2009, which represented approximately 290,000 shares at an average price of $9.98 per share.

Before concluding my remarks, I'd like to give you some additional details on our earnings guidance for 2009, particularly in light of the situation with our tax provision which I described a moment ago. Now, in an effort to be as clear as we can in providing guidance, given the economic uncertainties caused by the recession, we plan to supplement our earnings guidance by also providing forecasted operating income results, keeping in mind that the EPS guidance will be somewhat more difficult to forecast given the situation with our tax attributes.

So with that as background, we expect the GAAP operating loss in the second quarter of 2009 to be between $1.8 million and $2.8 million, including approximately $1.1 million of restructuring costs and an additional $400,000 of nonrecurring expenses associated with closing the US water management manufacturing facility. We estimate that our GAAP diluted loss per share for the second quarter of 2009 will be in the range of $0.24 to $0.26 per diluted share. This includes the negative impacts from the tax issues I have previously explained of $0.08 per diluted share, and restructuring costs of $0.06 per diluted share.

In the second half of the year we are assuming a gradual improvement in our bookings and operating income results. For the full year, we expect GAAP operating loss to be between breakeven to a loss of $2.2 million, including $2.5 million of restructuring costs and another $0.8 million of nonrecurring expenses associated with combining US manufacturing facilities.

We estimate that our GAAP diluted loss per share for 2009 will be in the range of $0.55 to $0.65 per diluted share. This includes the negative impact of $0.39 per diluted share from not benefiting the US losses and the discrete tax items already incurred in 2009. Also included is $0.14 of restructuring costs for the year.

I want to add here that this is an extremely challenging forecasting environment and that there may be more variability than usual between our guided and actual results.

Finally, we have revised our CapEx spending downward to $3 million to $4 million for 2009. Most of these investments will be to support the consolidation of our manufacturing facilities in the US and to enhance our ability to manufacture aftermarket products in China.

That concludes my review of the financials and I will now turn the conference back to the operator for our Q&A session. Chris?

(Operator instructions.) Tyler [Old]; JP Morgan.

Good morning. It sounds like you're seeing some signs, encouraging signs, of activity in Asia right now. It would be helpful if you could talk maybe about recent trends since quarter end in North America and Europe.

Okay. I'll hit Asia first. I think what's encouraging for us in Asia at this point, although we're not benefiting from it yet, is that the GDP in China continues to be fairly active. Most of it is internal. China's been doing fairly well with their stimulus package, I guess. And which is going to drive some consumer needs, both -- in all grades of paper. And we do see potential for perhaps some, especially in the [white grades] of paper, where they really do not have the capacity to handle any increase. So that's an encouraging sign for us.

And on the other -- offsetting that, however, is that on the running of the linerboard mills have been curtailed and then a lot of the newer machines have not been put on line yet. And that impacts us on some of the parts off of the stock prep. But we are making -- we're ahead of expectations on accessories and water management and penetrating the market. We're very encouraged by that market penetration at this point.

Now, concerning North America, we see -- I've been in the business a long time, Tyler. I've never seen such a rapid drop-off in capacity in the US, for example. And we see linerboard was really cut down and that ties into manufacturing in the US. I guess that had been somewhat expected, but not to the extent that it had in running in the 70% range on operating rates. And plus, and that includes a number of the mills that had shut down machines. So that really has impacted us very negatively. And, as you know, we've got a large installed base in the US and that's impacted our accessories, a lot of our parts business has been impacted by that. I do not think that's sustainable. And what is encouraging is the fact that writing and printing grades, as well as linerboards, have relatively low inventories in the chain. And I think that when there is any pickup at all within the economy in the US, I think that that should be a leading indicator, at least. It has in the past.

I guess the lack of visibility right now for us that we see -- and again, looking at RICI and all the indicators out there, I mean, no one really called this big rapid drop. And so I guess we're just lacking a lot of visibility looking forward. So based on all the information we have at this point, this is the best guidance that we could give.

Okay. And just assuming that we're sort of at the low point here for operating rates and we do see some gradual improvement, what's the typical lag between when operating rates begin to improve and when mills resume ordering blades, clothing, and just the other consumable [products]?

Oh, I think that would be very rapid, Tyler, especially now because what they have done is really depleted their inventories of parts and blades. So I would expect that to be a very rapid pickup for us. When they start improving at all, I think that -- because, again, they're running the parts longer than they should and they cannot do that forever, even at the low operating rates. So I would expect a very rapid pick-up for us.

Great. And then, just looking at the guidance for second quarter with sales down roughly 20%, is there any reason that, as revenues come in, that we should not expect to see working capital come down as well?

Yes, I think we would. Yes, that should also come down.

We had a good quarter for cash. Most of that was, obviously, from reductions in working capital. So we actually did a little bit better than we thought on working capital in the first quarter. And there's still some room to go.

Okay. And then just two last quick ones. Do you have the share count at the end of the quarter?

It's around 12.5 million.

Great. And then just how much natural gas do you buy each year?

I don't know in terms of the decatherms, but obviously the prices are down from $10, $12 to $3 a decatherm. But I don't actually recall how many decatherms --

No, I don't either. But I do know that the lower cost is certainly helping our income stream coming out of our composite business and GranTek, because that's a big operating cost component in production there. But outside of that, that's the only one that would really impact it.

Okay. Thanks very much.

Walt Liptak; Barrington Research.

Good morning. Yes, tough to be upbeat with some of the markets as bad as they are, but good cash flow generation. I guess the first question is on the working capital. It looks like receivables came down quite a bit. Is that because of the Viet Nam order or was there some other large receivable that was brought in?

We collected a piece of that Viet Nam order. We had already had progress payments on it. So we did get $5 million to $6 million of cash from that order in the quarter. But we generally had very good collections across the business.

Okay. And when you talk about working capital, again, for the next quarter or two, is it inventories that you work down? Is there -- how much more cash can you take out of the business on working capital?

Well, that's a tough question. I mean, it's difficult to forecast that. But we -- I think the main opportunities are in inventory, somewhat also in receivables. I'd say mainly in inventory. And I would say there should be conservatively another $5 million of cash that we can squeeze out of our working capital this year.

Okay. And then with the cost reduction, you talked about $29 million in total and I thought I heard you said $9 million of that is from the FX assumption?

Yes.

Okay. So $20 million -- were does the $20 million of hard costs come out of? Is it out of overhead or is it out of manufacturing costs, or a combination?

Well, about -- it's roughly half out of our operating expenses and the other half out of what I would call our manufacturing spend, so our indirect spending in cost of sales.

Okay. And I mean, you gave us the SG&A number, which is helpful, and I guess I could back into it, but I wonder if you could talk about the gross margin and maybe the puts and takes that would go in there. Product pricing, the cost take out -- what kind of level of gross margin are you thinking about for the rest of the year?

Well, in terms of our guidance, Walt, just to calibrate it a little bit, last year our margins were about 40%, product gross margins across the business. And we expect -- and this is baked into our guidance -- about the same level this year, so about 40%. So on the plus side of that, obviously we're doing things like continuing to outsource to -- source more product from our Mexican operations from China. So there's some good things happening there. On the other side of that coin, obviously we've got some under-absorption issues, some of it in the US, which we've talked about, with consolidating this plant in the US, and also some under-absorption in our Chinese facility at this time because of the reduced volumes. So there's lots of different cross currents going on in there. There's some mixes as well. But overall, we expect about the same level of gross margins in '09 as '08, about 40%.

Okay. And when steel costs and things were going up, were those surcharged pass-alongs, or were those price increases sticking?

Those were primarily surcharges that we passed along, Walt.

Okay. Okay. And if I could just switch topics again a little bit, in the US over the last 10 years a lot of capacity has come out. And I wondered if -- was bankruptcies or potential bankruptcies, if you see the capacity continuing to come out or accelerating, and how that might impact what kind of recovery you get in the US?

That's a good question. I would expect that the capacity, most of the capacity that's been taken out of North America, especially in the US, I don't see much more capacity being taken out. In fact, on a pick-up I would expect -- I think what we're going to get the gain on immediately is on the operating rates, once they start getting up into the 90s again. Getting out of the 70s would be a big help to us. I don't see much more capacity being taken out, because there's been a lot -- you're right, there's been a lot taken out in the last few years. So I think it's going to be pretty much -- and, in fact, some of it, couple grades like tissue and [toweling] and some of those we see as having some increases, so.

I will also say that when there is any recovery, we're going to -- the income stream that we're going to generate out of that should be much stronger as well because of all the expense we're taking out this year.

Okay, good. Yes, that sounds positive for the long term. Okay, thanks very much, guys.

(Operator instructions.) Paul Mammola; Sidoti & Company.

Good morning, everyone. Bill, you talked a little bit about utilization rates domestically. What do you think utilization is in China? And do you expect China to recover before the US?

That's a good question, Paul. One of the things that's more difficult to get out of is current information on the utilization rates in China. I can tell you that there's a number of machines that are not running right now. And my guess would be somewhere, probably operating at around 75% to 80%. And that's just a guess on my part, until we get some current information. And as far as their response and coming up, I do think that they may come on perhaps quicker than we do in the US, simply because their GDP is stronger now and they're getting some internal consumption which will feed that. And as the US starts to improve we're going to start buying more products from them. And we're still their number one customer.

So, and again, the long-term outlook for China, by the way, is still very, very positive. The hit a big bump in the road here that could set back some of that capacity expansion again for maybe one or two years yet, but when -- they're going to get back on track again. So I would expect that they could probably start up quick- -- get some pick-up quicker than we could.

Okay. That's helpful. Has Black Clawson specifically seen increased inquiries for black liquor technology, given the tax credit? Is that fair to say?

Yes, they have not really seen that to my extent yet, because what they're doing right now is the mills are just getting the tax credit for using it as a fuel source. And we haven't seen anything yet. On the other hand, as the pulping, the virgin pulping operations, start to make more money, there could be some opportunities for us as they start to upgrade some of the evaporators and so forth that they have.

Okay, that's fair. What has been the overall headcount reduction so far on a head or a percentage basis?

It's about 300 in headcount reduction so far. And besides that, we also have some what I call rolling layoffs in China and in France. So that also contributes to that. But we had about 300 total reduction in headcount so far.

Okay. And then, finally, what percentage of sales do you think right now are coming from non-paper customers?

Probably --

Probably -- I don't know if that's changed that much. Maybe it's gone up a little bit, Walt, but I think what we've said before, you know --

Yes. It's gone up a little bit as a percentage maybe --

Yes.

-- but not that much. I think it's still around a level around 25 million or 25 to 30 million.

Okay, that's fair. And then, finally, last one from me, you guys are still obviously very well capitalized. With respect to that Prudential shelf agreement, are you evaluating opportunities in the paper industry versus non-paper more? Or how are you viewing the markets right now?

You're referring about --

In terms of acquisitions.

In acquisitions? Actually, we still see some good opportunities within the paper industry. And right now we're keeping -- but we're exploring all avenues right now because in the past we've done well in looking at acquisitions during downtimes and com- -- in fact, any down cycle -- of course, we've never faced one like this before. But any down cycles we've been in before we've always come out a little bit stronger. So we're keeping all options open at this point.

Okay. Thanks for your time.

There are no further questions at this time. I will now turn the call back over to Management for closing remarks.

All right. Thank you, Chris. 2009 certainly, as you can see, is a challenging year, one that requires discipline. And we're trying to balance the short-term challenges and sizing our company to reflect the current marketing conditions, with the longer-term goal of maintaining the resources we need to capitalize on opportunities when the market recovers. And I think so far all the steps we've taken, I think we're accomplishing that.

As we have outlined in this call, we have taken a number of steps to reduce operating costs, both in manufacturing and SG&A. We believe these actions will pay dividends when markets recover. We also believe that our installed base, large parts and consumable business and healthy balance sheet will continue to serve us well during these times of economic uncertainty. I look forward to reporting on our progress as we work toward meeting our operational and financial goals.

Thank you for joining us today and for supporting Kadant.

This concludes today's conference call. You may now disconnect.