Kadant Inc (KAI) 2009 Q2 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 second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions.) Thank you. I will now turn the call over to Thomas O'Brien, CFO of Kadant. Please go ahead, sir.

Thank you, Chris. And good morning, everyone. And welcome to Kadant's second 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 quarterly report on Form 10-Q for the period ended April 4, 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 represent 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 second 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.

And 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?

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

Since our last earnings call, there have been a number of industry and company reports suggesting an improvement in demand and the general feeling that the economic recession may be at a turning point. While we have seen some indications that business levels are stabilizing and leading economic indicators in the US and Europe have trended upward during the second quarter, consumer spending remains modest. Our customers' access to capital is still limited, and paper machine operating rates remain below historical levels. Every major industrial region across the globe continues to report market-related downtime, suggesting a continued focus on supply-side management.

The weak demand for paper and paperboard and the relatively low operating rates that continued from Q1 into Q2 are reflected in our second quarter results. However, we believe that the unusually low machine utilization rates are not indicative of a longer-term business environment.

We are encouraged by the recent reports of improving business conditions coming from producers such as Packaging Corporation of America, Temple-Inland, International Paper and many others. We are hopeful the positive developments reported by these companies will continue to spread throughout the industry. We are also encouraged by the increased business activity and orders we have received in June and July from paper producers in Russia, Brazil and especially China.

Following a review of our second quarter financial performance, I will provide an update on industry developments and our business activities around the globe, and conclude with comments on the progress made in our restructuring efforts that we believe have positioned us well for market recovery.

I'll start with a review of our financial performance. Our revenues for the second quarter of '09 were $50 million, or 46% lower than the same period in '08. This revenue decrease was across all of our businesses, except our fiber-based products business, which was up 9% compared to a year ago.

Our bookings for the quarter were $47 million, a sharp decline from $84 million in Q2 '08, which was a relatively strong bookings quarter. Encouragingly, Q2 bookings in our paper-making systems segment experienced a slight up-tick compared to Q1 of this year. While still too early to predict, we see this as an indicator of market stabilization. And based on current activity, we expect a more significant sequential increase in Q3 bookings.

Gross margins in Q2 remained strong at 41%. Our SG&A expenses were 29% lower than Q2 last year, showing the impact of our restructuring efforts. When markets do recover, we expect to see improved profitability of our businesses as a result of the actions we have taken to align the Company's cross structure with current market conditions.

EPS for Q2 was a loss of $0.10 compared to our GAAP EPS guidance of a loss of $0.24 to $0.26.

Despite the challenging economic environment, we had another solid quarter of cash flow from operations, which generated nearly $5 million in the second quarter and nearly $19 million for the first half of '09.

Our net debt position at the end of the second quarter was $2.3 million. I'm pleased to report that as of today we are in a net cash position.

I would like to take the next few minutes to provide some insights into the business environments we are operating in around the globe, and also share with you the progress we have been making on the business development front.

Across all paper and paperboard grades and in every major geographic region, market demand remains soft. For the most part, we have seen paper producers take aggressive actions on supply side to manage inventories by taking market-related downtime, delaying the startup of new lines and permanently idling machines. Similar to the market environment found in the first quarter of '09, operating rates in Q2 hovered in an 80% to 85% range in most grades, and output is approximately 20% lower than the same period in '08.

We believe that the aggressive supply-side management and the demand-driven price increases being implemented in various grids are yet another indicator that the industry has responded appropriately to the economic recession and that the broader economy may have stabilized.

What's more, the medium to long-term trends in the paper industry are still positive, particularly in emerging markets where low per capita consumption and urbanization will stimulate demand across all paper and tissue grades in the coming years. This is particularly significant in India and China, where relatively healthy economic performances combined with rising incomes and literacy rates should positively influence demand growth.

As a result of the relatively low operating rates and the desire of our customers to conserve cash, our replacement parts and consumables business as well as capital equipment bookings continued to experience significant headwinds in Q2. That said, we believe the steps necessary to allow the industry to recover are in motion.

The apparent stabilization in market demand combined with paper producers reporting operating profits in the most recent first quarter is welcome news. While spending by producers has not picked up, they are using their positive cash flows to de-leverage and strengthen their balance sheets. We believe the next logical step is for producers to replenish their consumables inventory as operating rates begin to return to historically more sustainable levels. The anticipated increase in consumables spending is expected to be followed by increased spending on spare parts and, finally, capital projects. Our large install base puts us in a unique position to capitalize on spending increases early in the recovery stage, particularly with our paper machine accessories and food-handling product lines.

While the prognosis of the economy in general and the paper industry in particular is uncertain, we do see some encouraging signs in our businesses. For example, a few weeks ago, one of Latin America's largest tissue producers selected us to supply a turnkey compact stock preparation system for approximately $8 million. The system's efficiency, performance characteristics and small footprint for installation make it a compelling investment for our customers, particularly those producing tissue and toweling grades from recycled fibers with a high level of contaminants.

Also, in Latin America, our food handling business secured an order just after the second quarter closed for the replacement and installation of dryer section hardware for a liner board machine in Brazil. The order includes the supply of our patented Steam Joint and Stationary Cycling System, along with our dryer bars used to increase drying capacity and maximize energy utilization. The equipment is scheduled to be installed by the fourth quarter of this year.

What we find most encouraging, however, is the increased business activity in China. Many industry analysts and economists have indicated that recovery in the paper industry will first be found in China and then move on to the Western economies. At the end of June, we booked a major order for a steam and condensate system from a paper board producer located in Southeast China. This order was followed by two additional orders for doctor systems from two paper and board producers, also located in Southeast China. These accomplishments, as well as the successful introduction of our water management products in China, are allowing us to capture increased share in this important market.

On the stock credit side of our business, we're also seeing increased activity in orders in China. We've received orders in June for two OCC Stock Prep systems with a total value of approximately $1.8 million. Both systems are scheduled to be shipped before the end of '09. In addition, we've received a signed contract for another Stock Prep System in July for $2.7 million from a China-based producer, and will book this order once the down payment is received.

In the US, our Stock Prep business is experiencing increased quota activity and booked two orders for pulping loop upgrades at the end of the second quarter for approximately $650,000. These upgraded systems will allow the liner board producers to increase efficiency and production capacity.

We also booked an order of similar value at the beginning of July for a de-inking cell for a major tissue producer in the US. This order was received based on the product's demonstrated performance at the tissue producer's other mills. Although these new systems are relatively small capital projects, we believe they are representative of the economic momentum being generated.

Looking to business developments in Russia, our food handling business received three major orders for paper drying hardware and steam systems at the end of Q2 valued at approximately $2 million. And the beginning of the third quarter, we booked yet another order from Russia for dryer system components for approximately a million.

While the capital business remains soft in North America and Western Europe, we continue to pursue opportunities outside of the paper industry. For example, we recently expanded our doctoring product line to include doctoring systems with hand blades designed for use in the corrugating, printing and converting industries, among others. These new systems extend our reach beyond the paper industry and allow us to capitalize on the established distribution channels and customer relationships of our food handling business, which generates approximately 40% of its revenue from markets outside the paper industry.

As these examples demonstrate, we are seeing some bright spots developing around the globe. However, we remain cautious about the timing of a market recovery. Although our booking rates appear to have stabilized, we have yet to see an overall increase in global bookings.

We will continue our focus on managing our businesses to reflect the economic uncertainties, and believe that we are 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 install base and experienced management team.

As we have outlined in previous calls, our business strategy is particularly appropriate for difficult times. We are continuing our focus on our aftermarket and consumables business and on delivering products and technical solutions that provide our customers a compelling return on their investments. Our initiatives to expand our market share of stock prep parts in China, grow our global market share of screen baskets and further penetrate the markets with our accessories in water management products are bearing fruit.

In addition, we continue to emphasize the energy-saving opportunities available with our food handling products marketed to paper and non-paper industries.

While the activities just mentioned offer encouraging signals of economic recovery, we do not expect to see a significant increase in business activity until 2010. The increase in operating rates in some sectors coupled with the restrained consumables spending during Q1 and Q2 lead us to believe, however, that spending will improve later this year, with consumables leading the recovery.

As outlined in our Q4 '08 and Q1 '09 earnings calls, we have taken aggressive steps to streamline our operations and reduce costs in response to the economic environment we are facing. We have made considerable progress on these initiatives, with most of the restructuring efforts now completed or well underway.

One of the major initiatives, the integration of our US water management accessories to include handling sales forces, has allowed us to cost effectively extend our products into non-paper markets without increasing the direct selling expense to develop these new markets.

Another initiative, the consolidation of the US manufacturing operations of our water management product lines in our manufacturing plants in Massachusetts and Mexico, continue to go according to plan. Following the completion of this consolidation, we expect to realize economies at scale and greater operating efficiencies.

Now on to our guidance. For the third quarter of '09, we expect to report a GAAP diluted loss per share of $0.28 to $0.30 from continuing operations in the third quarter of '09 on revenues of $46 million to $48 million. For the full year, we expect to report a GAAP diluted loss per share of $0.60 to $0.65 from continuing operations on revenues of $210 million to $220 million.

Tom will provide additional details of our financial performance in his review. Tom?

Thank you, Bill. I'll begin with our revenue performance. Consolidated revenues were $50.1 million in the second quarter of 2009, 46% lower than last year, including a 5% unfavorable translation effect from foreign exchange. The revenue results were at the lower end of our guidance for the quarter, which was $50 million to $52 million.

In general, revenues were lower in all our major product lines, with the exception of our fiber-based products business, which was up 9% compared to a year ago. Revenues in our paper-making systems segment continued to be negatively impacted by extended production curtailments, mill closures and paper machine shutdowns as paper companies buy only items they deem absolutely essential to their day-to-day operations. Our capital businesses have been particularly affected since our customers have decreased their project spending to minimal levels until their balance sheets improve.

Nevertheless, we have noticed with encouragement that several of our customers have reported solid earning (inaudible) in the second quarter and are directing their free cash flows to paying down debt, the first step in what we expect will be a return to future capital investments in their operations.

Let me now spend a few moments discussing revenues in each of our major product lines. Stock prep revenues were $16.4 million in the second quarter of 2009, down 56% from last year, including a 2% unfavorable effect from foreign exchange. Stock prep revenues in China remained very weak, and at $3.9 million were down 65% from the second quarter of 2008. Revenues in North America were 56% lower than last year. And revenues in our Europe-based operations decreased 48% from last year, including 7% from the unfavorable effects of foreign exchange. As you would expect, all these geographic regions saw somewhat larger declines in the capital portion of their businesses, and relatively smaller declines in aftermarket revenues.

We continue to expect weak revenues in the stock prep business in the second half of 2009 as there are few major projects under way. Revenues should begin to increase sequentially in the fourth quarter if we achieve our third quarter bookings forecast, which includes the large pending order from a major tissue producer.

Revenues in our water management product line were $5.2 million, a decrease of 33% from last year, including a 7% unfavorable effect from foreign exchange. Revenues in North America decreased 42% compared to the second quarter of 2008, including a 2% unfavorable impact from foreign currency. And revenues in Europe were down 25% versus the second quarter of last year, including 19% from the unfavorable effects of foreign currency. This is our only product line which reported a sequential increase in revenues, albeit it small, from the first quarter of 2009.

Revenues in our accessories product line, where capital products are a lower proportion of our business than in water management, were $10.9 million in the second quarter of 2009, down 35% from last year, including a 7% unfavorable effect from foreign currency. Revenues declined in North America by 29%, including 3% from unfavorable foreign exchange, and by 47% in Europe, including a 15% unfavorable effect from foreign exchange. Worldwide, our accessories business continues to be affected by production curtailments and machine shutdowns, which have in turn reduced the mills' usage of consumables and spare parts.

Revenues in our fluid handling product line were $15.1 million in the second quarter of 2009, down 46% compared to record levels last year, including a 5% unfavorable effect from foreign exchange. All the major geographic areas in this product line reported significant declines from last year, and have been especially impacted by a lack of paper dryer rebuild projects as customers continue to restrict spending, despite relatively short investment paybacks for our equipment. Our European business is especially sensitive to project revenues, and this is where we saw the largest revenue declines.

Now turning to our product line outside the paper-making systems segments, revenues in our fiber-based products business were $2.1 million, up 9% from last year. Fortunately, this business, whose customers are primarily in the home, lawn and garden and agricultural markets, has been less affected by the economic recession, and continues to benefit from markedly lower natural gas prices, which we expect will contribute to better operating results in 2009 compared to last year.

Now turning to our product gross margins, consolidated product gross margins were 41.5% in the second quarter of 2009, down slightly 20 basis points from a strong margin quarter last year.

In our paper-making systems segment, gross margins of 41.3% were 70 basis points lower than last year, largely due to lower margins in our water management product line.

Margins in water management were significantly lower than last year, and had the effect of decreasing our consolidated gross margins by 170 basis points due to under-absorption of overhead caused by lower sales volumes. Water management gross margins were also negatively affected by nonrecurring costs associated with consolidating the US water management manufacturing facility into our US accessories manufacturing facility, a combination which is under way and which we expect to complete early in the fourth quarter of 2009.

Partly offsetting this decline was a favorable product mix towards higher-margin parts and consumable products in the second quarter of 2009 compared to last year.

Gross margins were significantly higher than last year in our other category, and served to increase our consolidated gross margins compared to last year by 80 basis points, largely due to the lower natural gas prices, which I just mentioned.

Now let's look at our SG&A expenses for a moment. SG&A expenses were $19.2 million in the second quarter of 2009, down $7.7 million or 29% from last year. This decrease includes $1.5 million from the favorable effect of foreign exchange, as well as expense reductions throughout the Company, including $2.1 million in our corporate office. Importantly, SG&A was $3 million lower in the second quarter of 2009 compared to the first quarter of 2009, largely due to the expense reduction programs we have initiated over the last several quarters, which have taken full effect. As a result of these reduction programs, we expect SG&A for the full year 2009 will be approximately $83 million, down $17 million from last year, including $3.6 million from the favorable effect of currency translation.

Now let me turn to our EPS results in the second quarter. We reported a GAAP diluted loss per share from continuing operations of $0.10 in the second quarter of 2009, compared to income per diluted share of $0.50 in the second quarter of 2008. The second quarter '09 results included a restructuring charge of $0.06. Excluding this restructuring charge, adjusted EPS was a loss of $0.04 per diluted share in the second quarter of 2009 compared to income of $0.05 in the second quarter of 2008, or a decrease of $0.54.

You can see the calculation of adjusted EPS in tabular form in the earnings press release that we issued yesterday. This decrease of $0.54 includes the following items, each of which decreased diluted EPS in the second quarter of 2009 compared to the second quarter of 2008 -- $0.02 from higher net interest expense, $0.01 from the unfavorable effects of foreign currency translations and $0.01 from the impact of fewer outstanding shares. The remaining decrease, or $0.50, was due to lower operating results in the second quarter of 2009 compared to the second quarter of 2008.

Let me also take a moment to compare the actual diluted EPS results in the second quarter to the guidance which we issued during our May 2009 earnings call. Our GAAP diluted EPS guidance for the second quarter of 2009 was a loss of $0.24 to $0.26, and this included $0.08 of incremental tax expense and $0.06 of restructuring costs. Excluding the tax and restructuring items, therefore, the adjusted diluted EPS guidance was a loss of $0.10 to $0.12. And this compares to the actual adjusted EPS loss of $0.04 that I just referenced.

Now turning to the balance sheet, we decreased our net debt by $5 million in the second quarter of 2009, ending the quarter with $27.1 million in cash and $29.4 million in total debt, or net debt of $2.3 million. This net debt position is down or improved by $13 million from the end of 2008. We measure our net debt position internally at the end of every week. And as Bill mentioned, as of last week our consolidated cash balances exceeded our total debt, although I have to caution that these interim results are not necessarily predictive of our position at the end of the quarter.

During the second quarter of 2009, we used a portion of our cash balances to pay down almost $25 million of debt as we position ourselves to remain in compliance with the financial covenants in our debt agreements. Towards that end, we expect to pay down smaller amounts of debt in the third quarter as well. If we achieve our operating income guidance and implement other potential actions we are contemplating in the second half, we do expect to remain in compliance with the financial covenants throughout 2009, although the margin of error is small. As a result, we may seek an amendment to the credit agreement, which would allow us some more operating flexibility as our EBITDA recovers from the recession.

Encouragingly, we had another solid quarter for operating cash flows on top of an outstanding performance in the first quarter of 2009. Cash flows from operations were $4.8 million, 4% higher than last year. And for the first six months of 2009, operating cash flows were $18.6 million compared to $10.9 million in the comparable period last year, an increase of 70%.

Our working capital, here defined as current assets less current liabilities, excluding cash debt and the discontinued operation, was a healthy 16.1% of our last 12 months' revenues, down from 18.3% in the second quarter of 2008.

Before leaving the balance sheet discussion, I do want to take note of our $100 million universal shelf registration, which was declared effective by the SEC on July 24, 2009. This shelf gives us the financial flexibility to raise capital using a wide basket of securities. Although we have no immediate plans to take down any amounts under this shelf, we do consider it prudent to have it filed and available as a potential additional source of funds for working capital, investment in our business or an acquisition over its effective three-year time period.

Now before concluding my remarks, I'd like to give you some additional details on our earnings guidance for 2009. Last quarter, we began supplementing our EPS earnings guidance by also providing operating income guidance. And I'd like to update you on those forecasts for the remainder of 2009.

Before I do that, however, I'd like to first note that we are in a very challenging forecasting environment for two reasons -- one, the severe recession which has especially affected the industrial sector of the economy, and two, the increased variability in our effective tax rate, which is due to a number of factors. In some quarters, such as the third quarter, this may result in consolidated tax expense, even though we expect to report a pre-tax loss. Of course, this has the effect of magnifying reported loss per share beyond what one would normally expect when in a pre-tax loss position.

So with that as background in the third quarter, we expect a diluted EPS loss of $0.28 to $0.30, including approximately $0.14 of additional net tax expense associated with repatriating cash from our overseas subsidiaries to pay down debt and the valuation allowances established for our US deferred tax assets. It also includes approximately $0.04 of restructuring costs. For the year, the diluted loss per share of $0.60 to $0.65 includes approximately $0.37 of additional tax expense and $0.15 of restructuring costs.

It is important to recognize here that the additional GAAP tax expenses had no impact on our operating cash flows, nor do they affect in any way the calculations used to determine compliance with our debt covenants.

Now with that, with respect to operating income, we expect a GAAP operating loss in the third quarter of 2009 to be between $2 million and $3 million, including approximately $800,000 of restructuring costs. With an expected return to profitability in the fourth quarter, largely due to revenue increases in stock prep and fluid handling, the operating loss for the full year will be in the same range, that is $2 million to $3 million, including $2.8 million of restructuring costs.

And finally, I just mentioned that we may decide to seek an amendment to our revolving credit agreement due to the sharp reductions in our operating results over the past several quarters, including restructuring costs, which have also contributed to the decline in EBITDA as followed -- or as is defined in our debt agreement. Any additional financing costs or fees associated with an amendment have not been included in our earnings guidance.

I want to emphasize that this is an extraordinarily challenging forecasting environment for us. And there may be more variability than usual between our guided and actual results.

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

(Operator Instructions.) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Claudia Hueston with JPMorgan.

Morning. Thanks, guys.

Good morning, Claudia.

Claudia.

Just a couple of questions. One, I was just curious on what you're seeing in terms of activity in North America? I know you said you had seen some increases and indications. And I know we've been hearing from some of the paper companies that the extra cash they've gotten from the fuel credits may be released towards some capital projects. I was just wondering if -- what you're hearing there and what kind of inquiries you're getting?

Well, Claudia, certainly our sales forces are somewhat enthusiastic about the potential of it. We have yet to see that develop into any orders. But we have had a number of quotes and proposals, which I think that windfall that they're getting on -- from the black liquor, I think -- hopefully, some of that's going to turn into some capital equipment for us. We're also starting to see signs that their -- even their inventories -- they've been running blades longer than normal. It's non-sustainable. Inventories on blades, parts and everything -- they've been diminishing their supply on hand at the mills. So we expect -- we expect to see sequential pickup in the business. And hopefully, by the end of the year we'll start seeing at least some smaller capital projects develop. If not then, certainly in early 2010.

Okay. And then, obviously you've felt the impact of delayed orders, particularly in China. And are you seeing any of those projects sort of dusted off or being revisited at this point?

Well, the big ones are basically still in a delayed state. But we are -- what we are seeing is some smaller projects. Just as we indicated, we did pick up some smaller orders, as well as we see signs that they're going to start more projects, perhaps opportunities for projects in the white grades -- the tissues, the towelings, the uncoated free sheet and lightweight coated grades. So we see some opportunities there coming first. I think that they still have some capacity to really put on line and fully utilize before they start the big major projects again, which probably should happen within the next year or two.

Okay, that's helpful. And then just finally, can you just comment on the competitive environment you're seeing? How are prices holding up? How's the overall environment?

Well, certainly I think that in this competitive environment we've done fairly well. It's -- if anything, I would say we have not lost any market share. We have -- in some of our areas, we've increased our market share, if anything. And the -- our -- certainly, our gross margins reflect the fact that our pricing has been staying pretty solid. You know, I've been encouraged by that as well. And I think that goes back to we do -- we really do sell a better piece of equipment and have better products. And I think that helps. Plus our install base -- mining our install base on the parts and on the consumable business also helps as the product mix is more into those areas at this point.

Okay, thanks. Oh, and just one more for Tom. As we think about the tax rate for 2010, is there any sense of what we should be using? Sorry.

Nobody hopes this more than I do, Claudia, but I hope in 2010 we're providing taxes again in the US, and -- because we're profitable in the US -- and we're providing in international. So we should be back to a late -- a rate, rather, in the low 30s.

Okay.

That'd be a little bit more normalized than where we are right now.

Yeah, a little bit. All right. Thanks a lot, guys. Take care.

Yeah.

Thank you, Claudia.

Your next question comes from the line of Walt Liptak with Barrington Research.

Hi. Thanks. Good morning, guys.

Good morning, Walt.

Good morning, Walt.

Let me ask another one on Claudia's 2010, at risk of looking out too far. But can you talk a little bit about the operating loss this year? And next year how much cost out would result in positive delta for operating earnings? So all things being equal, if revenue is--?

I think a way to think of that, Walt, is let's kind of just do a theoretical P&L here. I mean, this is not necessarily predicting 2010. But let's say our revenues, which at one point were $367 million, let's say at some point it recovers to $300 million. Whether that's in 2010 or whatever, let's just go theoretically for a moment. I think we're clearly seeing margins in the 40% range. So let's just say 40%. That gives you $120 million of gross margin dollars.

Yeah.

And we've taken, as you can see, our SG&A down significantly. And let's say our SG&A plus our R&D, that totals around $90 million. So that could get you to an operating income of around 30. And 30 plus some D&A and a few other things gets you back into the low 40s for EBITDA. So I'm not saying that's what's going to happen in 2010. There's a lot -- a lot of time between now and when we actually look at 2010. But I think clearly the economics of the business is such that when the business does come back to levels, even if it doesn't come back to levels that we saw in 2007, we've positioned the Company to a point where we can regain significant profitability when that does happen. We've --

Yeah. Yeah, right. Right. With the -- yeah, the hard work that's gone on this year with the cost actions, it looks like next year is at least stable and with some profitability.

Right.

All right. You know Caterpillar a couple of days ago talked about emerging markets, especially China, growing -- China growing at 11%. And maybe even faster than that on recovery in 2010. And you talked possibly about China as well. The question I have is -- and I talked about -- I asked about this last quarter, too, with capacity utilization in China. Does the -- does the US consumer have to recover and box shipments -- does the US have to recover for the capacity to be reached in China?

Yes. Yeah, Walt.

Or with growth in China, can they get to a level of capacity where they would start investing again?

Yeah, I think that -- I think what it really -- I think the real impact on the liner board business is going to be a growth in the US economy, because we're their biggest customer. We're the consumers. Although, on the other hand, with the GDP growth that they have, even this year and forecasted for next year, they are developing an internal market as well. And again, you've got 1.3 billion people. And so -- and that's certainly impacting the white grades right now. Because they really didn't have the capacity to serve the growing internal market. And on the -- and -- but for the internal growth to absorb all that liner board capacity, I think that they're going to have to rely on some pickup from the US.

Okay. Okay, yeah, that's what I was afraid of. If I could skip around again, just looking at third quarter guidance being lower, it implies that profitability for the fourth quarter -- is something changing? Is it volumes and better absorption of manufacturing costs? Is that why we would get a profit in the fourth quarter?

I think that's part of it, Walt. I mean, I mentioned the consolidation of our water management facility in the US into the accessories US manufacturing facility. That should be done in September. And rather than having under-absorption, we should start to see the benefits of that. And that's one of a few items. Also, we are expecting higher bookings in the third quarter, as Bill mentioned in his remarks. That tissue deal, if we can finalize that, which we expect to, and a few others, we should see better bookings in the third quarter. So I think all of that combined leads to an improved profitability in the fourth.

Okay, got it. Okay, thanks.

Thank you, Walt.

(Operator Instructions.) Your next question comes from the line of Paul Mammola with Sidoti & Company.

Hi. Good morning, everyone.

Good morning, Paul.

Good morning, Paul.

I would assume that there are still absorption costs in the US and Europe in the quarter. But were Asian operations more fully utilized?

Well, we've had some under-absorption there as well. We certainly resized the Company there. But there would certainly be some under-absorption in the second quarter there, as well. So that's another hopeful for us going into the second half that as that comes down, we'll see better profitability there as well.

Okay. And looking at fluid handling products that were obviously a very profitable piece of your business last year, where do you think we need natural gas prices to be for there to be a sort of resurgence in sales of those products?

I think that independent of the gas prices, Paul, I think the driving force for that is within the mills themselves. Because although gas has a strong -- a major influence on it, energy being the number two cost in the production of paper, I think what has slowed that business down has been more the operating rates and some of the curtailments that have happened in the profitability of the paper companies. Because there's still a very, very compelling return on investment and -- even at lower gas prices. And so, I think it's just more their ability to fund such projects. And we are encouraged by the increased profitability that we've seen, as I commented on, in a number of our major customers. And I think eventually that's going to start turning into some orders. And I know that the -- there was just a sales meeting that was held at the food handling business. And the sales force, they were pretty encouraged on the activity that they're seeing now, certainly, in proposals.

Okay, that's helpful, Bill. And then finally, on customer financing, do you think that's improved at all over the past three months? Or do you still see that as an impediment to booking right now?

Well, I think they just had their real first quarter announcements where they're starting to show profitability again. And I think that -- I think eventually that's just going to start turning into business for Kadant. And I think they also have used some of that in cash to strengthen up their balance sheet as well, which puts them in a healthier financial condition.

Okay. I'm not sure if you said it. Is financing the issue on that South American tissue project? Or no?

No.

No. No, it's not at all.

Okay. (Inaudible.)

It's just -- it's just the formalities of getting the contract at this point. Although, unusually, we have the deposit. So that's a very good sign for us.

Yeah, normally we get the contract and then the deposit follows.

Yeah.

This is a little backwards. So that gives us more encouragement, actually.

Okay, perfect. Thanks again for your time.

Thank you. Thank you.

Thanks, Paul.

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. Two thousand nine, as we commented, continues to be a challenging year, one that requires discipline to balance the short-term challenges being driven by our current market conditions, with the longer-term goal of maintaining the resources we need to capitalize on opportunities when the market recovers.

As we have outlined in this call, there are various sectors and regions that seem to be picking up momentum as market conditions improve. We believe that the cost reduction actions that we took earlier this year to reduce operating costs both in manufacturing and SG&A will pay dividends when markets recover. We also believe that our install base, large parts and consumables business and healthy balance sheet will continue to serve us well during these times of economic uncertainties.

That said, we remain extremely cautious about the global economy, and will continue to deliberately manage our businesses to reflect the market environment. I look forward to reporting on our progress as we work towards meeting our operational and financial goals for the remainder of '09.

Thank you again for joining us today and for supporting Kadant.

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