Kadant Inc (KAI) 2009 Q4 法說會逐字稿

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kadant's earnings update 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).

Thank you. I would now like to turn the call over to Mr. Thomas O'Brien, CFO. Please begin, sir.

Thank you, operator. Good morning, everyone. Thank you for joining us today, and welcome to Kadant's fourth quarter and full year 2009 earnings call. With me on the call today is Jon Painter, our President 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 fiscal quarter ended October 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 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 fourth quarter and full year 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 Jon Painter, who will give you an update on Kadant's business and future prospects. Following Jon's remarks, I will give an overview of our financial results for the quarter, and we will then have a Q&A session. Jon?

Thanks, Tom. Good morning, everybody. It's my pleasure to provide you with this update on Kadant's fourth quarter and full year results in my new role as CEO. Following a summary review of our financial performance, I'll update you on what we're seeing in the market, I'll review our growth strategy, and finally, I'll give you some guidance on our outlook for 2010.

Without a doubt, 2009 was a challenging year for the global economy in general and the paper industry in particular. We took actions throughout 2009 to streamline our operations and adjust our cost structure to reflect a new economic environment, and we are clearly a stronger company today than when we entered the economic crisis.

Let me begin by offering you a few highlights from our fourth quarter and full year results. I'm pleased to report that we are seeing modest improvement in market conditions, and as a result, improved financial performance. Revenue for Q4 was at the top end of our guidance at $57 million but was down 15% compared to the same period last year. All of our paper-making system segment product lines were down in 2009 Q4.

Incidentally, due to the severity of the economic downturn in 2009, I think it's helpful to talk about sequential changes in quarters in addition to the traditional year-to-year comparisons.

On a sequential basis, our revenues increased 6% from Q3 to Q4. This revenue increase, our second consecutive quarterly increase, was due largely to improved performance in our water management and fluid handling product lines, which increased 23% and 10%, respectively. The uptick in sequential revenues from Q4 to Q3 was driven by a 23% increase in capital revenue, while revenue from our parts and consumables business dropped by approximately 5% over the same period.

We did expect that the recovery of our business would be slow and uneven, with some quarters sequentially up and others down. We expected our capital business to lag in the recovery, but we have now had two quarters where our capital revenues, albeit from very low levels, is recovering faster than we thought. I think part of the answer for this is that, in general, our capital orders are coming predominantly from the developing world, which is further along in the recovery than North America and Europe.

Our bookings for the quarter were $64 million, an increase of 27% compared to the relatively weak level of bookings during the same period last year. More importantly, we are pleased to see bookings were up 3% sequentially from Q3, despite the fact that Q3 had several larger stock prep orders. Our fluid handling and water management product lines saw double-digit booking increases in most regions of the world, and they were a big contributor to the increase.

Capital bookings were down 5% from Q3 to Q4, while parts and consumable bookings were up 9%. This was the second consecutive increase in sequential parts and consumable bookings, and that is an important positive development for us.

Gross margins were 41% in the fourth quarter and remained relatively stable throughout 2009, despite the significant drop in our annual revenue. Adjusted EPS for Q4 was $0.09 compared to our adjusted guidance of $0.06 to $0.08 for the quarter.

We had another very strong quarter of cash flows from our operations and generated $11 million in the fourth quarter and a record $43 million for the year. While this strong cash flow performance is partly the result of our revenue decline, it also reflects better working capital management throughout the Company. As a result, our net cash position at the end of the fourth quarter was $22 million, and we paid down $32 million of debt during the year. One of our strengths has always been our healthy balance sheet, and it certainly became stronger in 2009.

We also implemented cost savings and other measures that we expect will continue to provide benefit in the years ahead. For example, the integration of our US sales team was completed in the first half of 2009, not only provides better market coverage but also reduces our selling costs. Also, we completed the consolidation of our US manufacturing operations for our water management and accessories product lines and expanded our manufacturing operations in Mexico.

In the fourth quarter, our Kadant Lamort business initiated a significant restructuring plan. While this restructuring process is ongoing, it is expected to result in a workforce reduction of approximately 40 employees in Europe, or 23% of the Kadant Lamort work force. We incurred a $2.1 million charge, primarily in connection with this restructuring, and we expect to yield annualized savings of approximately $2.6 million once this restructuring is completed. Although these actions are never easy, this step was the right one to take to ensure the long-term success of the business.

Now let me give you a sense of what we are seeing in the markets as we look ahead into 2010. Reports from industry analysts, economists, and most importantly, our customers, suggest a modest recovery in the paper industry is beginning to take hold. 2010 so far started off on a positive note for us with increased business activity in most regions of the world.

Asia, and in particular, China, was the first region to recover from the economic downturn, and GDP growth in China in 2009 was a very strong 9%. However, more recently, the government of China is taking steps to slow down the pace of economic growth to reduce bank lending.

While we can't be certain what impact these steps will have on our business in China or how the market there will progress in 2010, we do believe that the fundamental growth drivers in China are real, and that this will continue to be the most important growth market for our business in the years ahead.

While our Q4 bookings in China were one of the highest since early 2008, they were down 21% compared to Q3, primarily due to the large stock prep orders we received in Q3 that I referred to before.

During Q4, we were encouraged to see continuing success in our water management and accessory product lines in China. This is a key growth driver for us. We booked several significant orders for docking systems and received our largest single order in China at approximately $350,000 for showers and filters. On a related note, our industrial sales team in China secured orders in January for two steel producers for 300 rotary joints to be installed on their continuous casting machines.

Europe, on the other hand, has been the slowest region to recover for our business, but we are seeing some signs of improvement there as well. We received an order valued at more than EUR500,000 in January for a fine filtration system for a mill in France. We were also very pleased to receive commitment from an OEM of corrugating machinery to begin sourcing its composite doctor blades and holders from Kadant. This, incidentally, is an example of leveraging our fluid handling customer relationships to develop our accessories business in markets outside the pulp and paper industry.

Although we are encouraged by the activity we are seeing in Europe, there is new concern about the strength of the economic recovery due to the sovereign debt problems of Greece and the other Mediterranean countries. We're watching closely to see what impact this may have on the general economy in Europe and in our business in particular.

North America is showing solid signs of improvement in all of our product lines. Our stock prep business secured an order from a Canadian producer of recycled linerboard for a stock prep system valued at approximately $2.5 million. In addition, our fluid handling business picked up orders valued at approximately $500,000 for steam and condensate systems for two paper machines in Wisconsin.

As in other regions of the world, we are encouraged by the activity we are seeing in North America, but we remain cautious about the pace of recovery going forward.

Before I talk about our outlook for 2010, I'd like to comment on our growth strategies. Broadly speaking, we're pursuing the growth strategies similar to those we've been executing during the last several years. We have five key areas of focus.

First and foremost, we will continue to focus on developing new products and technologies. Our customers are under tremendous pressure to reduce their cost per ton, and our products can help them to reduce energy consumption and improve fiber yields. Our latest development in stock preparation is a good example of progress in this area. We are completing field trials of our dense de-inking system designed to reduce fiber processing capital and operational costs and optimize output quality. We are very excited about this development and believe it will be a significant advancement in de-inking technology.

Second, we will seek to enhance our cost competitiveness through manufacturing products in low-cost countries such as China and Mexico. We've made good progress in this area, and our manufacturing facilities in these low-cost regions are a big competitive advantage for us. But there is still much more we can do. As part of this effort, we recently completed the expansion of our manufacturing operations in Mexico, and we continue to shift manufacturing of high labor content products to that location.

Third, we're committed to growing our spare parts and consumable business. This is the most stable and profitable part of our business, and it is important to maximize this revenue stream. The market successes I've highlighted earlier demonstrate that we continue to make progress in this area.

Fourth, we intend to focus on penetrating markets where we have low market share. Although we have good market share in most pulp and paper markets, there do remain opportunities for growth in several regions. For example, while our accessories and water management products have strong market share in most regions of the world, we have relatively low market shares for those products in China and Germany. Similarly, although we have a large installed base of stock prep equipment in China, we have relatively low market share for our spare parts and consumables for that product line. Our goal is to grow share in both these areas.

Outside of the paper industry, we are leveraging relationships in industrial markets with our fluid handling business to expand our other businesses beyond the paper industry.

Finally, we continue to look at potential acquisitions to further strengthen our market position. As our EBITDA improves, we can take advantage of the attractive borrowing facilities we established in early 2008. This, combined with our healthy balance sheet, gives us increased opportunity to become more active in seeking acquisitions to complement our business. Some characteristics that we look for in a potential acquisition are strong market position, low capital intensity, and a large aftermarket business.

Now on to our guidance. As I outlined earlier, we have taken a number of actions to align our cost structure with anticipated business levels and to strengthen the position of the Company. This will undoubtedly benefit the Company in 2010. However, the continued uncertainty about the strength and sustainability of the recovery leads us to maintain a cautious outlook for the coming year.

We expect to report adjusted diluted earnings per share of $0.06 to $0.08 from continuing operations in the first quarter of 2010 on revenues of $56 million to $58 million. We expect market conditions will improve through the year, and for the full year we expect to achieve GAAP diluted earnings per share of $0.45 to $0.55 from continuing operations on revenues of $240 million to $250 million.

Now I will turn the call over to Tom for a more detailed review of the financials. Tom?

Thank you, Jon. I'll begin with our revenue performance. Consolidated revenues were $56.8 million in the fourth quarter of 2009, 15% lower than last year, including a 4% favorable translation effect from foreign exchange. The revenue results were at the higher end of our guidance for the quarter, which was $55 million to $57 million.

Revenues in our paper-making systems segment declined 16% when compared to last year's fourth quarter, with decreases in all the major product lines in that segment, ranging from 10% in accessories to 26% in water management. For the first time in two years, however, paper-making systems revenues increased sequentially for the second consecutive quarter.

In fact, all our major product lines increased in the fourth quarter of 2009 compared to the third quarter of 2009, with the exception of the accessories product line, which was down slightly. Most notably, water management and fluid handling revenues increased 23% and 10%, respectively, on a sequential basis. You can see more details of our product line revenue results and the comparisons to last year, with and without giving the effect of currency changes, in the schedule attached to the press release that we issued yesterday.

In general, the fourth quarter revenue performance provides us with another important data point which suggests that our revenues may have bottomed out in the second quarter of 2009 and are slowly recovering.

An additional positive trend in this regard is our bookings performance in the fourth quarter. Consolidated bookings were also up sequentially for the second quarter in a row, increasing 3% over the third quarter of 2009. We were especially encouraged with the bookings performance in the fourth quarter, since they originated from a wider and more diverse base of customers than in the third quarter of 2009, which included several large stock prep system orders in China and Mexico. Further, fluid handling bookings were $18.4 million in the fourth quarter of 2009, the highest level since the third quarter of 2008, and 15% over the third quarter of 2009.

When we look at our revenues by major geographic regions, it is clear that the economic recession has affected these regions differently and that Europe continues to be our weakest region compared to last year. Paper-making systems segment revenues in Europe were 24% lower than the fourth quarter of 2009 compared to last year's quarter and included a 7% favorable effect from foreign exchange. North America revenues were down 14%, and China revenues were down 1% from last year, including immaterial effects due to foreign currency translation.

And finally, to end the revenue discussion, revenues in our fiber-based products business were $1.5 million, up 28% from last year, largely due to higher sales of our Biodac products. As we've noted before, this business, which serves a diverse customer base outside of the paper industry, has been less affected than our paper-making systems segment by the economic recession. In fact, it is our only product line where revenues increased on a full-year basis, growing 7% in 2009 compared to 2008.

Now turning to our product gross margins, consolidated product gross margins were 41.3% in the fourth quarter of 2009, down 180 basis points from last year's 43.1%. Despite the decline when compared to the very strong margin quarter last year, we were encouraged with the gross margin performance in the fourth quarter of 2009, which increased 50 basis points over the third quarter of 2009.

In our paper-making systems segment, gross margins at 41.6% were 190 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 segment gross margins by 130 basis points due to incremental costs associated with consolidating the US water management manufacturing facility into our manufacturing facilities in the US and Mexico. We do expect a gradual improvement and return to historical margin levels in this product line throughout 2010.

Also decreasing margins was an unfavorable product mix--that is, proportionately less sales of higher-margin parts and consumable products in the fourth quarter of 2009 compared to last year.

Partly offsetting these declines were higher gross margins in our stock prep product line. Gross margins were significantly higher than last year in our other category, largely due to lower natural gas prices in our fiber-based products business.

Now let's look at our SG&A expenses for a moment. SG&A expenses were $20.2 million in the fourth quarter of 2009, down $3.4 million, or 14%, from last year. This reduction includes the effects from the restructuring initiatives that we began in the fourth quarter of 2008 and which were fully implemented in 2009, offset partly by a $900,000 increase from the unfavorable effect of foreign exchange translation. For the total year, SG&A was $81.2 million, which was slightly less than we expected, and decreased $19.1 million from 2008, including a $3 million favorable effect from foreign exchange. In 2010, we expect a 2% to 3% increase in SG&A at current exchange rates.

Now let me turn to our EPS results in the fourth quarter. We recorded a GAAP diluted loss per share from continuing operations of $0.14 in the fourth quarter of 2009 compared to a loss of $3.25 in the fourth quarter of 2008. The fourth quarter of 2009 results include an incremental tax provision of $0.11 and a restructuring charge of $0.12. As Jon noted in his remarks, most of this restructuring was incurred in our Kadant Lamort subsidiaries and was not included in the guidance for the fourth quarter.

The reported results in the fourth quarter of 2008 include a goodwill impairment charge of $2.10, an incremental tax provision of $1.21, and a restructuring charge of $0.18. Excluding these items in both quarters, adjusted EPS was $0.09 per diluted share in the fourth quarter of 2009 compared to $0.24 in the fourth quarter of 2008, or a decease of $0.15. You can see the calculation of adjusted EPS in tabular form in the earnings press release that we issued yesterday.

This decrease of $0.15 in adjusted EPS includes $0.02 from the unfavorable effects of foreign currency translation and immaterial effects from fewer shares outstanding and less net interest expense. The remaining decrease of $0.13, therefore, was due to lower operating results in the fourth quarter of 2009 compared to the fourth quarter of 2008.

Let me also take a moment to compare the actual diluted EPS and operating income results in the fourth quarter to the guidance which we issued during our November 2009 earnings call. Our GAAP diluted EPS guidance for the fourth quarter of 2009 was $0.02 to $0.04, and this included $0.03 of incremental tax expense and $0.01 of restructuring costs. Excluding the tax and restructuring items, therefore, the adjusted diluted EPS guidance was $0.06 to $0.08, and this compares to the actual adjusted EPS of $0.09 that I just referenced.

In terms of our operating income, our GAAP operating income guidance was $1 million to $2 million in the fourth quarter of 2009, and this included $200,000 of restructuring costs, giving us adjusted operating income guidance of $1.2 million to $2.2 million. We reported an operating loss of $300,000 in the fourth quarter of 2009, including $2.2 million of restructuring costs, or adjusted operating income of $1.9 million, which compares to the adjusted operating income guidance of $1.2 million to $2.2 million.

Turning to the balance sheet, we had another impressive quarter for operating cash flows, our tenth consecutive quarter of positive cash flows from operations. Cash flows from continuing operations were $11.4 million in the fourth quarter of 2009, up by a factor of five compared to last year's fourth quarter. For the full year 2009, operating cash flows of $43.1 million not only exceeded our expectations, but were also the highest ever achieved in our Company's history.

Reductions in working capital contributed $39.4 million to operating cash in 2009. Our working capital is a percentage of the last 12 months. Revenues decreased to a record low 10.5% at the end of the fourth quarter of 2009 compared to 19.2% last year. This decrease in working capital was a result of both decreases in revenues and, importantly, improvements in working capital management achieved by our subsidiary management teams around the world.

For example, our days sales outstanding in receivables decreased to 63 days at the end of the fourth quarter of 2009 compared to 86 day in the same period last year. Our inventory turns improved to 3.5 from last year's 2.7. And while the trend here is certainly in the right direction, there is still room for improvement in 2010.

Looking at our free cash flows, here defined as operating cash less CapEx, for the full year 2009, we generated $40.3 million in free cash, more than tripling over last year's $13.2 million. As a result of these solid cash flows, our net cash position at the end of the fourth quarter of 2009 was at the highest level in almost five years. We ended the quarter with net cash--that is, more cash than total debt--of $22.4 million, an improvement of $11.7 million compared to the third quarter of 2009. At the end of 2008, we had $15.3 million more debt than cash, so for the full year 2009 we improved our net position by almost $38 million.

I should also note that during 2009 we paid down over $32 million in debt, including all our borrowings in China. Our remaining debt of $23 million, all of which is in the US, consists of $15 million under our revolver and $8 million under our real estate loan. We expect to pay down an additional $5 million in debt on the revolver by the end of 2010.

At the end of the fourth quarter of 2009, we were well in compliance with the financial covenants in our $75 million credit facility. Assuming we achieve our income guidance in 2010, as our EBITDA increases during the year we will start to build higher levels of borrowing capacity under our credit agreements, although we have no plans to utilize these facilities at the moment.

To recap those facilities briefly, we have approximately $54 million of availability under our committed credit facility, which runs to 2013, another $75 million in uncommitted lines under that same multi-bank five-year credit agreement, as well as another $100 million in uncommitted lines under our Pru shelf agreement, which runs to May 2011. In addition, you may recall that we filed a $100 million universal shelf registration, which became effective in July 2009 and which expires in July 2012.

Now, before concluding my remarks, I'd like to give you a few additional details on our earnings guidance. As we noted in the press release issued yesterday, in the first quarter of 2010 we expect GAAP diluted EPS of $0.06 to $0.08, including approximately $0.01 of restructuring costs. For the year, the expected GAAP diluted EPS of $0.45 to $0.55 includes $0.02 of restructuring costs.

Now, with respect to operating income, we expect GAAP operating income in the first quarter of 2010 to be between $1.5 million and $2.5 million, including approximately $200,000 of restructuring costs. GAAP operating income for the full year 2010 is forecasted to be between $9 million and $11 million, including $300,000 of restructuring costs.

Looking at our quarterly EPS performance in 2010, we expect some choppiness from quarter to quarter, both due to the economic uncertainty and to the timing of revenue recognition for several larger systems orders in China. As such, we believe that the second half of the year will be stronger than the first half and that the second quarter may in fact be stronger than the third. Further, the benefits associated with the Kadant Lamort restructuring plan are expected to take full effect towards the latter half of the year.

Now, with respect to our effective tax rate, our tax rate has been more variable than normal during 2009 due to several factors, including the effects of establishing valuation allowances in several taxing jurisdictions, most notably the US and China. One byproduct of these valuation allowances is that we have not been able to benefit pre-tax losses in those jurisdictions, and this has made predicting our quarterly and annual tax rates somewhat challenging. In addition, any changes in the mix of pre-tax income between taxing jurisdictions will also affect the quarterly tax rates.

So with those caveats and cautions, we expect that the tax rate will be approximately 32% to 34% in the full year of 2010. We estimate that the effective tax rate in the first quarter of 2010 will be approximately 40% due to a forecasted loss which we cannot benefit in one tax jurisdiction outside the US.

We anticipate our CapEx spending in 2010 will be $4 million to $5 million with most of the non-maintenance portion of the spending associated with continued investments in our manufacturing capabilities, particularly in China.

Our 2010 guidance includes approximately $0.17 per diluted share associated with our estimated non-cash equity compensation expense compared to $0.22 in 2009.

And finally, we expect depreciation and amortization to be approximately $8 million in 2010.

And that concludes our review of the financials and I will now turn the call back to the operator for our Q&A session. Operator?

(OPERATOR INSTRUCTIONS.) Your first question comes from the line of Claudia Shank Hueston with JPMorgan.

Good morning. Thanks very much.

Good morning, Claudia.

Hey, Claudia.

How are you?

Very well.

We've been hearing a lot from the paper companies in North America this earnings season about just a modest sort of $100 million or less kind of investment at their mill sites for consumption reduction, fuel switching, electricity self-generation. Does that help you at all, and have you seen any translation into interest levels and in terms of orders in North America on that kind of stuff?

You're talking about--I'm not sure I quite understand the question. You're talking about spend that they're doing on--?

They're contemplating doing on this kinds of smaller type projects, but is that stuff that you're going to benefit from, or are you seeing any indication or pull-through in terms of--they're talking a lot about it. Are you guys seeing anything?

What we are seeing is that our fluid handling stuff, which has an energy component to it, certainly saving energy, has done well everywhere, but quite well in North America.

Okay.

So I think that's, if that's primarily how we're seeing that. We're actually pleased with how we're doing so far in the end of 2009 and the beginning of 2010.

Okay. And then, just in terms of the accessories business in China, could you talk a little bit about where you are now and maybe where that is versus your expectations and where you think you can go in terms of market penetration over the next one to two years, maybe, there?

Yes, as you can imagine, any time we try to displace established competitors, it's going to be a slow road. So our percentages are up pretty solid, if you look at Q3 to Q4, particularly in water management. But we're still talking about numbers, low-single-digit million-dollar numbers per quarter.

Okay. And in terms of the growth trajectory there, how are you thinking about that?

I think we're making good progress. I think we'll have pretty good growth in 2010. I wouldn't necessarily put a number on it, but we've got, I would say, double-digit expectations for growth there in 2010.

Okay, great. And then just finally on Lamort, can you just talk a little bit about the restructuring? I seem to remember a restructuring plan there the last couple of years. Can you just talk about what drove this?

As you know, Claudia, we've had restructuring everywhere in the world, and Lamort is really no exception. France is an area where you've got more regulatory things and worker's comp and stuff you walk through, so it takes a bit longer. But they did a little bit last year, but this is the principal response to the economic downturn of 2009. So the people we have worked with--the union, the workers' council and all those people--I think they all understand that something needs to be done. And it's actually gone, I think, fairly cooperatively.

Okay, thanks.

Your next question comes from the line of Rick Hoss with Roth Capital Partners.

Hey, good morning, gentlemen.

Hey, Rick.

Tom, SG&A, I think you talked about your target being about 2% to 3% higher than 2009, so that implies adding about $1 million. You're looking at approximately $83.5 million, is that right?

That's correct, yes.

Yes. Should I look at this as, as far as the addition to SG&A, about a $500,000 per $10 million type of addition? Is that what it requires?

I don't know if it's that variable. There's a big piece of our SG&A, I guess, that you could say would be a little bit more fixed, I suppose, than variable. There is some variability with respect to volume as we get higher sales commissions, et cetera. But I don't think it should be quite that variable. I think the restructuring that Jon talked about in 2009 that we did kind of established what we would do as a base here, and this 2% to 3%, I think, is largely due just to inflationary pressures around the world that would grow it. So I don't think it's all that variable right now with the volume. And that will be good going forward, obviously, because we'll have some good operating leverage when the volumes start to grow even above the guidance numbers that we talked about.

Right. Okay, so there's still a lot of operating leverage left in the model, and assuming that your growth trajectory continues from, comparing your expectation for 2010 versus 2009, and say it applies to 2011, then there's still a lot of operating leverage left in this business model?

Right, we think so. Absolutely, Rick.

Okay. And then the second question, accessories were down for the quarter. Why? Did you say that already? I'm sorry if I missed it.

They were slightly down. I think a lot of it is more variable. I don't think there's anything particularly going on. I would call it more flattish.

Okay, so just more like a timing issue in the quarter.

Yes.

Now, do you view the strength in emerging markets as enough to offset stability, I guess, in the US and then contractions in Europe? Is there enough juice in the emerging markets--South America, China, et cetera--to offset this trend?

That's the big question, of course. I think if I were to broadly characterize it, we're certainly seeing the strongest growth in emerging markets, the US second, and Europe's lagging the pack. And I think that what you're seeing in our growth right now to some extent reflects that. It's nice to see North America starting to pick up a little bit of steam, and that's helping us. And I would say Eastern Europe started picking up--I'm sorry, Asia started picking up steam the middle of last year. It's hard to say at what pace any of those economies will really go forward, but I think it adds up to our guidance for 2010. That's a mix of Asia growing a bit faster and Europe lagging and America certainly stronger than 2009.

Okay, and then, Jon, what are you seeing as far as on the M&A front?

Obviously, we're not going to talk about anything specific, and it's not like we've got any active plans or anything like that going on, but what I'm really commenting on is, is that we do have, we are in a position, and particularly as we get a little EBITDA, that if we did want to do an acquisition, we could.

So we've had a history over the last bunch of years of every once in a while doing an acquisition that we find one at an attractive valuation. I think our first priorities would be to do something in the paper industry because we understand that the best. I talked about the kind of acquisitions we like, which you know well, but we love aftermarket businesses, we love businesses that have a good standing in the paper industry in particular. We don't particularly like asset-intensive businesses.

So that's probably really all I can say to you at this point. It's just something that we view as one of our potential opportunities for growth and along with the other things that I've talked about.

Okay. Valuations are, how would you characterize valuations right now?

It depends. They're better than they were the last few years, and I think the financial players are not as aggressive as they were, certainly. But a lot of private people, you know, the value of their business hasn't dropped because they're not publicly traded shares. So sometimes it takes a little time before their expectations come around.

Okay, perfect. Thanks, guys, for your insight.

Thank you.

Your next question comes from the line of Eric Glover with Canaccord Adams.

Hi, Eric.

Good morning. I was wondering if you could talk about what opportunities you may have for gross margin expansion in 2010. It seems like there would be some, given the bookings pickup in the parts and consumables business.

Yes, I mean, I'll comment and maybe Tom will comment as well. We have a couple of areas. You know, we commented that our gross margins in general in 2009 held up pretty well, and one of the reasons for that is, there's a few things going two ways. One is that we're benefiting, as Tom said, normally in 2009 we've benefited from improved product mix, i.e., higher parts and consumable percentage versus capital. But on the other side, we do have facilities that are not fully absorbed, and we still have facilities that are not fully absorbed. So that's something that's hurting our margins.

I think, as we go forward, if we can hold the mix we're at now, when we start to fully absorb those facilities, that should help our gross margins.

The other opportunity for improvement in gross margin, as I mentioned in my remarks, is just moving more content to areas like China and Mexico. And that's a long, slow road, but we're committed to it, and we keep increasing the percentage of our content that's made in those areas.

Yes, I think the only thing I would add to that, Eric, would be--you know, I mentioned in my comments that in the fourth quarter, the consolidation of the water management facility into our US facility, and actually some of that down into Mexico, cost us about 130 basis points at the margin line due to, you know, incremental costs associated with that consolidation. So that should go away in 2010. We should get back to situation normal in 2010, and when that happens, that's a good opportunity for us to increase our margins in 2010.

So another way of saying it is our margins would have been 130 basis points higher in the fourth quarter had we not had those incremental costs. So that's a nice opportunity for us that I think is realizable in the near future here.

Okay, great.

That's a pretty fully utilized facility, it looks like right now, so that will be a big help.

Okay, thanks. And the second question is if you could just give me a rough idea of where your parts and consumables business is now in terms of a geographic breakdown. You mentioned that China was relatively small but you aim to grow it. But how about the other areas of the world?

I'll answer more broadly. The areas where we have the strongest parts and consumables business are the more mature markets--North America and Europe, particularly North America. So we have opportunities to grow our parts and consumables business in Asia, but the paper industry in those regions, and particularly China, have not had a pattern of buying the Western parts and consumables. So it's an education process. I think we're making great progress, and you see that in the accessories and water management as well as the stock prep parts. But it's definitely significantly lower, our parts and consumable percentage, in Asia and the developing world than it is in the US in particular and Europe as well.

Can you think of a reason that they wouldn't want to buy Western parts?

I would say, broadly speaking, they are a very cost-conscious, price-sensitive area, and that's their standard feeling on everything. They really do like to get the cheapest possible anything they can get. I think they've learned that they're going to have, particularly in the paper industry, they're going to have a better facility by using Western stock preparation, paper machines, that kind of stuff. For whatever reason, they haven't taken it quite as far to the parts. But I think that will improve.

Interestingly enough, that is a group that we've got a very consultative sales approach in the sense that when we sell doctor blades or water management, whatever it is, half of what they're buying is service from us. And because of in Asia and a lot of the developing worlds, they don't have quite the operating history that people have in the West, they actually can benefit from our advice more than other customers. So I do think it's an area that has promise, but it's something that we really have to prove ourselves and establish.

Okay, thanks a lot.

Thank you.

(OPERATOR INSTRUCTIONS.) Your next question comes from the line of Paul Mammola with Sidoti and Company.

Hi, good morning, everyone.

Hi, Paul.

If we could continue on parts and consumables, could you give us a sense of how sales have trended over the past few months? Are you seeing any sort of discernible trend there?

I'll go even further than that a little bit. The wheels came off the bus in late 2008, and we saw that in the middle of 2009 was the first time we started to see our sequential parts and consumables bookings pick up. So we saw it in Q3, we saw it again in Q4. I would say that the latter parts of Q4 and early 2010 are continuing that trend. It's way too early to say we've got a trend going in 2009, but it is encouraging so far, that the more recent period is stronger, particularly in North America than the older periods.

That's good to hear. Were there any changes to pricing, positive or negative, to parts and consumables early on in the year here?

No, nothing significant. You know, parts and consumables are the most price-resistant, I would say. Some of our larger parts, I will say in Europe we have had some price pressures. But by and large, we've held up okay. The exception would be some larger stock prep stuff in Europe.

Okay. Given your cost cuts and capacity rationalizations over the past, say, year or so, would you say most of that is permanent at this point? Or how much, rather, how much is permanent?

A lot of our--Tom commented on the SG&A side. It's hard to say anything's permanent, obviously, but we should get some great leverage on the SG&A. We should get some great leverage on things like when we rationalized the sales force, we actually shrank those territories, so those guys can actually handle more volume, and that should be, it's a permanent structural change. Closing some of these facilities is a permanent structural change. Obviously, things like direct labor, when you get busier, you're going to end up potentially hiring more direct labor and using more material and all that kind of stuff.

That's understood. So have you given thought to how much you could earn on a $350 million to $400 million sales run rate on this cost structure with some costs scaled up for volume?

Thank you, Paul, that's one of my favorite questions. I won't go as high as $350 million, but if we go back to the $300 million model, and you say, "Okay, we'll have some margin growth in there," say, 42% to 43% margin, which we think is achievable--.

Reasonable, for the reasons we talked about.

Yes, a couple of years out. As I commented before to the earlier question, the SG&A isn't going to be all that variable with volume, because most of that--I would look upon it now as a base, so we'll have inflation pressures, but that's about it. So I think you can reasonably see an operating income of $300 million of, you know, in the $35 million range.

Okay, that's very helpful. And then finally, how many employees are actually left at Lamort? I think Claudia's alluding to the fact that, I think, 320 was scaled down to 160 in 2004, and now you're pulling another 40 off. So what's left there?

The whole organization is about 175.

Okay, thanks for your time.

That's Lamort and its subsidiaries throughout Europe.

Thanks, Paul.

And there's no further audio questions at this time. I'd like to turn the call back over to Mr. Jonathan Painter for any closing remarks.

Okay, thank you, operator. I'd like to thank everyone for participating on the call today, and I look forward to reporting on our progress throughout the year. Thanks a lot. Bye.

Thank you for joining today's conference call. You may now disconnect your lines.