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Xerium Technologies Inc. (NYSE:XRM)

Q1 2008 Earnings Call

May 8, 2008 8:00 am ET

Executives

Michael Stick - EVP and General Counsel

Stephen Light - President and CEO

Mike O'Donnell - CFO

Analysts

Ned Borland - Next Generation Equity Research

Chip Dillon - Citi

Christopher Glynn - Oppenheimer

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2008 Xerium Investors' Conference Call. My name is Dan, and I'll be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session toward the end of this conference. (Operator Instructions)

I would now like to turn the call over to your host for today's call, Mr. Michael Stick, General Counsel. Please proceed, sir.

Michael Stick

Thank you, and good morning, everyone. Welcome to the Xerium Technologies first quarter 2008 conference call. We are pleased you could take the time to join us today. Also on the call this morning are Stephen Light, President and Chief Executive Officer, and Mike O'Donnell, Chief Financial Officer.

Stephen will start the discussion this morning with commentary regarding the company's operating initiatives. Next, Mike will provide further financial details with respect to the quarter. Then after Stephen provides some further remarks, the floor will be open to questions.

Xerium Technologies' financial results for the quarter were announced in a press release after the market closed on Wednesday, May 7, 2008. The press release is available on the company's website. Notification of this call was broadly disclosed. This conference call is being webcast using the link on the Investor Relations homepage on our website.

Comments will be made today about future expectations, plans, and prospects for the company, that constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. The company's actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those described in yesterday's press release and those described in the 2007 Annual Report on Form 10-K filed on April 8, 2008. The 10-K is also available on the company's website.

The forward-looking statements represent views as of today, May 8, 2008, and the company specifically disclaims any obligation to update these forward-looking statements.

Lastly, on this call, we plan to discuss supplementary non-GAAP financial measures, such as adjusted EBITDA. Adjusted EBITDA is a key metric for the company's credit facility covenants and one that the company uses internally to assess liquidity and financial performance. And therefore, we believe it will assist you in better understanding the company. Reconciliation to the comparable GAAP measures is available on our press release.

With that, I will drop off, and Stephen Light and Mike O'Donnell will handle the rest of the call and the question-and-answer period. Stephen?

Stephen Light

Thanks, Mike. Ladies and gentlemen good morning, and thank you for joining us today. It's been a very busy month at the company's headquarters and its many global locations since our last call. As Mike O'Donnell will detail shortly, we've been fully engaged in the process of obtaining an amendment to our credit facility, while in parallel we've been working on improving our operational focus and organizing to attack our burdensome debt. I'll speak to some of the initiatives related to those topics and then hand the call over to Mike to review the company's financial performance.

As a new CEO, one of my first challenges is to identify the key controls I can use as levers to guide the performance of the company. Of course, one of those levers is our global organization and the human resources within it. Other levers include product pricing, new product investment, production capacity alignment, capital investment, operating cost reduction, and our balance sheet account.

To assess how working on each of these levers might impact the company's performance over the next five years, the time horizon of our loan agreement, we needed a financial model that replicated the company's behaviors. Our long-range forecast model, which we've recently completed, is a key element in our work with our lenders. It has also helped us to prioritize our internal action. We're using it to test operational assumptions and identify specific leverage points to address. Many of these actions we've already taken and will be taking will be crunched through the model before implementation in order to bolster our probability of success and avoid surprise sensitivities.

As I began to describe in our last call, the first lever we are pulling is focusing management's attention onto improving free cash flow generation from enhanced operational controls, and an all-out attack on cash presently trapped on our balance sheet. We've developed a to-be model of our trade working capital, which for this purpose consists of receivables, payables, and inventory. The difference between our present trade working capital performance and the specific targets assigned to each of our global operating units is now referred to as trapped cash. This year's management incentive plan is heavily weighted to the reduction of trapped cash, which at the end of 2007 was approximately $73 million.

I'd like to think the results you're beginning to see in our improved cash flow, is an early response by management to this new focus. But I think that would be premature. Based on the projects being developed by the teams throughout Xerium, I'm confident in our ability to continue to make solid progress on reducing trapped cash by, for example, reducing production lead times, decreasing set-up times to be more responsive to customer needs, reducing or eliminating consigned inventories, and by negotiating fair terms with customers and suppliers related to days of sales and payables outstanding. Then we'll aggressively monitor and control our performance. We expect to use the money released by the reduction in trapped cash to further reduce debt.

Our second operational improvement area focuses on our organization. In February, we announced the consolidation of the clothing and rolls businesses in Europe and those in North America with the result being, we have two operating units where we had four and two individuals, one in each of these two regions completely responsible for the activities within that region. The effect of these consolidations is expected to be reductions in duplicate overhead expenses, improved marketing, more targeted selling, more consistent and realistic pricing, and improved customer service levels. Workforce reductions resulting from these two consolidations are already underway.

Another immediate result of these consolidations was the identification of additional potential plant closures that may occur as early as this year. We'll be able to assess our performance improvement through the metrics we've developed for division-level performance. Additionally, we've recruited an experienced operations executive to begin the process of leveraging our common corporate activities with our key suppliers.

Over the past three months, I've learned that notwithstanding that our consolidated revenues exceed $600 million annually frequently, our four divisions have operated as autonomous portfolio companies. This has had the effect of leaving many purchasing, production, and selling opportunities unrealized. It's my intention to draw our four operating divisions more closely together to leverage their resources anytime we can.

I've recently begun to tour our production facilities to see the manufacturing of our products first hand. Our production capabilities and technology are truly impressive, as is the dedication of the people I've met. Our processes are complex and require a considerable amount of skill and learning.

Over the years we've been in business, safety cushions have crept into these processes that occasionally result in unreasonable delays. As in all other industries, these delays result in increased inventories. So I believe the improvements in process controls we're planning will help reduce cost and attack trapped cash. As a result, I'm confident our manufacturing capabilities will enable us to make many improvements, including shortening our order-to-delivery lead time, while substantially improving our delivery date reliability. This change alone would have a substantial favorable impact on our cash management initiative.

I've also now had the opportunity to personally review our new product portfolio. And I found it well thought out and promising but, frankly, much too limited. Our development processes are under intense internal review, with an eye towards shortening the time spent between development launch and first sale. We have very impressive technology coming to the market in both the clothing and roll segments. And I'm certain we'll have more after these products are launched. At the same time, we'll be mindful that the products whose development we fund will have to have measurable value to our customers and to have an accretive ROI to Xerium.

As we become more efficient in the development of our new products, I expect that we'll be able to refresh our product portfolio more frequently for the same investment, which will give us a further lift in the market. Those are just a few of the initiatives and plans we've been working on the last few months, that I believe will begin to show results in the current fiscal year. There are many more. Now I'll turn the call over to Mike for a review of our first quarter.

Mike O'Donnell

Thanks, Stephen. I hope everybody has had a chance to review our 10-Q and the press release that we issued last night. Today, I'll supplement that information by providing some details into certain key areas of our financial performance. But before I do that, I'd like to update you with the status regarding our credit agreement amendment process. Under the waiver amendment negotiated in April, we are working to develop a comprehensive amendment to our credit facility. We expect that this amendment will be based upon a revised financial plan derived from the model Steve had mentioned that will bridge us to the end of the note in 2012.

It's premature to describe what the terms of the amendment may be, but we are addressing the elements that you would expect, including debt paydown, covenant ratios, fees, and interest rates. We're pleased with the progress thus far. And while, of course, we can give no assurances, we do expect to reach a successful amendment within the allotted time.

Our current credit situation had a direct bearing on our first quarter results related to charges for the interest rate swap contract that we entered into during the fourth quarter of 2007. These interest rate swaps initially qualified for hedge accounting under SFAS number 133, as we told you at that time. But due to financial covenant non-compliance for the first quarter, if the April waiver is not made permanent, the company classified as current on its balance sheet the long-term debt under its senior credit facility as of December 31st, 2007, and March 31st, 2008. This amounted to a $658.8 million as of March 31st, 2008.

This debt is potentially payable prior to the expiration of the underlying interest rate swaps because the recent default waiver amendment we've secured is only temporary. Therefore, under the relevant accounting rules, hedge accounting was no longer applicable for these interest rate swaps. The non-cash mark-to-market decrease in their fair value of $12.2 million was recorded as a charge to interest expense in the first quarter of 2008.

So with that as background, let me review our performance for the first quarter. Our operating results for the first quarter of 2008 were good. Asia and Europe exhibit strength and that helped mitigate softness in North America and some flatness in South America. This condition was seen in both rolls and clothing.

Net sales for the first quarter of 2008 increased $15 million, or 10.4%, from the first quarter of 2007, reflecting an 11% increase in our clothing segment and a 9.3% increase in roll covers. The total effect of currency on net sales for the first quarter of 2008 was an increase of $11.6 million, of which $14.7 million were the favorable currency translation on net sales. This was partially offset by the $3.1 million unfavorable effect of currency on pricing. And that is the pricing impact of currency movements between the time of pricing commitment and the sale recognition in US dollars from some of our non-US operations, especially in Brazil.

While adjusted for currency translation and currency effects on pricing, sales for the first quarter of 2008 increased 2.4% as compared with the same period in 2007, reflecting a 2.7% real increase in the clothing segment and a 1.6% real increase in roll covers. Gross margins for the first quarter 2008 were $63.3 million, or 39.8%, down from the prior-year quarter's 42.2%, primarily due to the effect of price reductions, inflation on our cost structure, and the effect of currency as compared to the same quarter last year. However, on a sequential basis, first quarter gross margins were just slightly higher than the 39.7% that we reported in the fourth quarter of 2007.

Income from operations increased by 21.2% to $20.6 million in the first quarter of 2008 from the $17.0 million in the first quarter of 2007. Lower restructuring expenses increased volume, improved product mix, and increased productivity more than offset the negative effect of price reductions, inflation, and negative currency effects. Restructuring and impairment expenses in the first quarter of 2008 were $500,000, as compared to $4.1 million in the first quarter of 2007.

Now I'd like to move to the results for our clothing segment for the first quarter. Clothing sales for the first quarter of 2008 rose $10.3 million, or 11%, to $103.6 million. And that compares to $93.3 million in the first quarter of 2007. And that accounted for 65% of total company sales in the first quarter of 2008. This increase resulted from the favorable impact from currency and increased sales in Asia and South America, more than offsetting decreased sales in North America and flatness in South America.

The effect of currency translation on clothing sales for the first quarter of 2008 was an increase of $10.8 million, and the effect of currency on pricing was a decrease of $3.1 million. Excluding these currency effects, sales in our clothing business in the first quarter of 2008 increased 2.7% over the first quarter of 2007. Overall, pricing levels for the clothing segment in the first quarter of 2008 decreased approximately [0.1%] compared with first quarter of 2007.

Clothing gross margins declined to 39.8% for the first quarter of 2008, compared to 43.9% for the same quarter in 2007 due primarily to unfavorable currency effects. For clarification, when I refer to currency effects, generally, I am referring to the net effect of currency translation and the effect of currency on pricing. Segment earnings for clothing in the first quarter of 2008 were $23.9 million, an increase of 0.8% versus the $23.7 million in the first quarter of 2007. The negative impact of currency effects on clothing segment earnings was $1.4 million.

Looking next to the roll cover business, sales in roll covers for the first quarter of 2008 increased by $4.7 million, or 9.3%, to $55.4 million. And that compares to $50.7 million in the first quarter of 2007 and accounted for 35% of total company sales in the first quarter of 2008. This increase was primarily the result of currency translation and the inclusion of sales from the two roll cover plants that we acquired in China in November 2007. Regionally, this segment experienced similar patterns as our clothing business. The effect of currency translation on roll cover sales for the first quarter of 2008 was an increase of $3.9 million. The effect of currency on pricing was negligible. Excluding these currency translation effects, sales in the roll cover business increased by $800,000, or 1.6%, in the first quarter of 2008 compared to the same quarter in 2007.

Overall, pricing levels in the roll covers segment declined by approximately 3% in the first quarter of 2008, compared to the same period in 2007.

In our roll cover business, gross margins in the first quarter of '08 increased to 39.9% compared to the first quarter 2007 levels of 39.1%. Currency movement has had less of an impact on margins than in our clothing business, due to the fact that almost all sales in our roll cover segment occur in the same currency as our manufacturing costs. First quarter segment earnings of $14 million in the roll cover business increased 15.7% from the $12.1 million that we reported in the first quarter of 2007. The improvement was primarily a result of higher sales and improvement in the cost structure due to our restructuring efforts. Currency movements had no material impact on earnings in this segment.

Moving onto the cost side of the business, we remain committed to improving our cost structure and streamlining our operations, primarily in North America and Europe to match our cost structure and capacity to those slower-growth markets. While restructuring and impairment charges in the first quarter of 2008 were only $500,000 as compared to the $4.1 million in the first quarter of 2007, we expect to incur an additional $4.4 million over the remainder of 2008 as part of this effort.

Following on my remarks that I made earlier about the $12.2 million non-cash charge associated with the interest rate swaps, the company's net loss in the first quarter of 2008 was $4.7 million, or $0.10 per diluted share, compared to net income of $3 million, or $0.07 per diluted share in the first quarter of 2007. First quarter 2008 earnings per share is calculated using 46 million diluted shares, whereas first quarter 2007 calculations used 44.1 million diluted shares. The increase in shares is primarily the result of shares issued during 2007 to entities associated with Apax Partners, our largest shareholders, under our dividend reinvestment plan.

Net cash generated from operating activities was $29.8 million in the first quarter of 2008, and that compares to $15.3 million in the first quarter of 2007, due primarily to improvements in working capital. This strong cash performance once again illustrates the ongoing ability of our business to generate cash flow. Adjusted EBITDA increased 6.1% to $34.8 million in the first quarter of 2008, compared to $32.8 million in the first quarter last year on the basis of increased revenue and reduced cost structure. There have been changes in the definition for adjusted EBITDA in our amended credit facility, and I encourage you to review the reconciliations that we provided in our press release and the 10-Q.

Capital expenditures in the first quarter of 2008 were $12.1 million, and that compares to $7.1 million for the first quarter of 2007. Approximately $9.8 million of capital expenditures in 2008 first quarter were directed towards projects designed to support the company's growth objectives, with the remaining $2.3 million used to sustain the company's existing operations and facilities. As you know, Xerium is building a clothing manufacturing facility in Vietnam, which we began constructing in the fourth quarter of 2007. Expenditures associated with our Vietnam project were approximately $4.7 million of the total quarterly CapEx of $12.1 million. As we discussed in our last call, we have decided to slow the pace of planned capital expenditures for the Vietnam facility. And we now expect the plant to begin production in 2009.

We currently expect aggregate company capital expenditures to be approximately $10 million less in 2008 than in 2007, when they were $48 million for the year, and then lower in 2009 than they are in 2008. Our cash position at March 31st, 2008 was $31 million, and that compares to $24.2 million at the end of the year of 2007 and $17.7 million at March 31, 2007. The cash position at the end of the first quarter 2008 was net of total debt principal and interest payments of $24.8 million during the quarter compared to debt principal and interest payments during the first quarter of 2007 of $13.7 million.

Xerium's total debt, including current maturities at the end of the first quarter of 2008 was $672 million, and that compares to $666.8 million at the end of 2007, a change reflecting unfavorable currency translation effects, partially offset by net debt repayments of $12 million that we made during the first quarter of 2008.

So let me summarize. Our core business performed well in the first quarter in a challenging operating environment. We began to generate increasing levels of cash through working capital improvement, and during the process of developing our new long-range operating plan with the management team, I've become confident about negotiating suitable amendments to our credit facility and our abilities to deliver the required results.

Stephen Light

Thanks, Mike. I expect that our tightened cash controls will fund debt reduction, that the improved operational controls we're implementing will reduce unnecessary expenses across the company, and that our new attention to more realistic pricing will help drive revenue and gross margins to better levels.

But as you'd expect, much of management's attention and energy has been diverted from operational matters, while we've worked on completing negotiations with our lenders by May 31st. I'm also optimistic we'll be able to explain our position and plans to our lenders over the next few weeks and reach an agreement we and they can live with.

To facilitate that effort, Mike and I are personally meeting with many of the lenders. I expect to get past this hurdle in good order and then apply all of our effort to delivering the results all of us believe are possible from this company. Thank you for your attention. And, Dan, we're ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ned Borland from Next Generation Equity Research. Please proceed.

Ned Borland - Next Generation Equity Research

Good morning, guys. Just a question on the $12 million charge for the interest swaps. Forgive me I'm not that familiar with these. Am I to assume that you will keep incurring charges from this in the event that negotiations with the lenders -- I mean, that you can't get past the May 31st deadline?

Mike O'Donnell

Yes, Ned, the charges related to the mark-to-market swings on the interest rate hedges that previously when we had hedge accounting allowed us to take those swings to the balance sheet. And so the fact that we have recalled our -- reclassified our debt to current actually causes us to not be able to state that we're committed to those hedges through the period in which they expire, which is in 2010. And so that's what's driving us to not have hedge accounting. The movement that you saw of the $12.2 million in the first quarter is really dependent upon what happens with curtailing interest rates. So I cannot predict what the future quarters will have in that respect.

Ned Borland - Next Generation Equity Research

Okay. But it's entirely possible you're going to see future charges.

Mike O'Donnell

Yes, that's correct, Ned. And they can go either way. But that's correct.

Ned Borland - Next Generation Equity Research

Okay. Switching to the PMC market, things were down in North America and they were good in Asia and Europe. I was just wondering what your outlook is for the North American PMC market.

Stephen Light

The long-term outlook, Ned, is slightly down. But there are some bright spots. In fact, tissue is forecasted to grow between 0.9% and slightly over 1% for the next several years. Xerium's product line is particularly heavy in tissue, and we anticipate doing quite well there. Further, I would expect that you'll see firming prices in North America, particularly from our company. Don't know, can't speak for the rest of the industry. But you'll certainly see that going on. And you'll see margin recovery as a result of that.

Ned Borland - Next Generation Equity Research

Okay. Thanks.

Stephen Light

Sure.

Operator

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

Chip Dillon - Citi

Yes, good morning, Stephen and Mike. Mike, I had a question just on the interest rate hedge thing. Obviously, no one can predict for sure what that does from quarter-to-quarter. But are we right to assume that I guess when the yield curve -- I guess when short-term rates go down, that hurts. Or is it more of a yield curve steepening that hurts? And by contrast, if short-term rates go up or the yield curve flattens, does that go the other way?

Mike O'Donnell

Yes, in simple terms, Chip, you have it right. If the interest rates continue to go down from a mark-to-market standpoint, then that will have a negative effect that will be an expense to us. Now over the life of those hedges, that will come back to a net neutral effect, of course. But it's the interim periods that you're asking about.

Chip Dillon - Citi

And as it comes back, will you sort of take -- will you have like interest income? Or will you reverse that in your earnings statement?

Mike O'Donnell

Yes, sir.

Chip Dillon - Citi

Okay. So in [your words], we should utterly and completely and totally ignore this.

Mike O'Donnell

My view is that it is a direct impact on the EPS, so we can't ignore it. From an operational standpoint, it doesn't have an effect. And over the term of the hedges, it does not have an economic effect.

Chip Dillon - Citi

Nor a cash effect.

Mike O'Donnell

That's correct.

Chip Dillon - Citi

Okay.

Mike O'Donnell

Most importantly, Chip, that's right. It does not have cash effect.

Chip Dillon - Citi

I know, Stephen, you've said a few things about cash. So we hear you. Now in terms of the hedge life, how long is that? And could that be modified? Or would it likely be modified in this renegotiation of the agreement?

Mike O'Donnell

Yes, the hedges themselves, Ned, run through mid-2010. And we would undoubtedly look at renewing those for whatever level of debt and whatever level of interest rates are prevailing at that time. The question I think that you may be asking that's more pertinent is, is there any chance of recovery of hedge accounting which allows us to take those mark-to-market swings to the balance sheet rather than the P&L? I cannot answer that at this point. I need to have the amendment process completed, and we have to be able to determine what amount of debt would actually be paid down of the hedged amount that would be paid down so that we can fix that. So there is some chance that some portion of the hedges could achieve hedge accounting, allowing us to take some of those swings to the balance sheet.

Chip Dillon - Citi

Okay. And then I missed one thing. You mentioned there's like $4.4 million in costs for the rest of the year. Was that tied to just restructuring? Is that what you were saying? I just missed it.

Mike O'Donnell

Specifically, Chip, that was for restructuring.

Stephen Light

Chip, that's our estimate as we see it today.

Chip Dillon - Citi

Right. Based on the things you said at the beginning about where there could be some plant closures and some of the organizational consolidation.

Stephen Light

Right.

Chip Dillon - Citi

Okay, got you. And then as you look at the second quarter, I mean, it's certainly encouraging to see the -- even when you X out the currency effects, the sales numbers given the economy, what does your backlog look like for the second quarter? And could you just remind us of any seasonal things we need to look for, especially I guess in the third quarter, Europe slows down a little bit.

Stephen Light

Well, I guess I'd answer that question with a dodge first. And that is that we don't give guidance. So we won't tell you what the second quarter looks like. But we feel that the order intake is very strong right now. I'd like to expand a little bit on pricing because I think that's really material to what's going on here. In 2007, total company price impact net of currencies was negative 1.4. In this quarter, we've seen negative 1.7. But if you refer back to 2007 in that negative 1.4, there was negative 1.5 in clothing.

In the first quarter 2008, net of currency, total clothing was negative 0.1. It's positive 3.8% in South America. So we see significant firming already happening. The message is out inside our organization. We're not giving stuff away anymore. We're charging fair prices and with fair terms. And frankly, most of the customers are very understanding of that. So I think the prospect -- maybe the best guidance we'll give you is the prospect is we think this is going to be a pretty decent year. Without quantifying it, we think we're working on the right things and that we're getting traction with the initiatives, both internal and external.

Chip Dillon - Citi

Got you. And then lastly, when you look at the -- now that you've been there a bit longer, Stephen, and you're obviously making some changes already and you're seeing the potential of the business. Is your view toward the need for equity changed any since, say, mid-March? I mean, obviously, at some price, you're a seller, and at some price, you're a buyer for anything. But do you see that as something that is going to be required at this point in terms of running the company or getting the credit agreement lined up? Or do you think that's something that you can be more opportunistic about?

Stephen Light

Sure, I think I can address that. But let me answer it with the caveat that, yes, I have been here a little longer. I've now been here 90 days as opposed to about 50 days when we did our last call.

Chip Dillon - Citi

Twice the experience.

Stephen Light

Exactly, but who's counting? Our view of the financial model of the company and my improved appreciation of the levers of the company suggests that there's absolutely no requirement for additional equity. The reason we went out for equity initially was as you look at the total leverage covenant, defined as debt over EBITDA. Since we had already completed fiscal '07, there was no way to change the EBITDA. The only thing that we could change for the covenant calculation in the first quarter would've been debt. And an infusion of additional cash to pay down debt before the end of the first quarter would have gotten us through the covenant. That's not to say that we would not have wanted to change the operational expectations of the business.

At this point, with the business model we've got and the performance that we see and anticipate from the company, I can see no justification, quite frankly, for going out and selling equity at this time.

Chip Dillon - Citi

Got you. Thank you.

Stephen Light5

You bet. And, Chip, just to further clarify, let me be sure and state, there is absolutely no activity going on to raise equity at this time. All of that has stopped.

Operator

Your next question comes from the line of Christopher Glynn from Oppenheimer. Please proceed.

Christopher Glynn - Oppenheimer

Good morning. Thanks. Just a little bit more on the cash flow strategies and prospects, obviously very nice in the quarter. And I know cash flow can be lumpy from quarter-to-quarter. But maybe just on the sustainability some comments around the sustainability of these types of levels as a quarterly run rate, not forever but near-term and then maybe time horizon on the $73 million of trapped cash.

Stephen Light

Sure, let me perhaps give you a little better insight into what we define as trapped cash, because there actually are metrics behind it. We have defined as a model for the company six inventory turns, 50 receivable days, and 48 payable days. Now as familiar as you likely are with industrial companies, you'll recognize none of those are world-class numbers. But for us, they are an aspiration and a direction as today we have 3.5 turns, well north of 60 days of receivables, and high 30s, very low 40s in payable days. So we've got a lot of work to do.

The trapped cash that I refer to is the difference between our current performance and what our trade working capital would look like if we were to achieve those metrics. And at the end of December 31st, that was $72.6 million. So we believe that it's entirely reasonable to capture all of that over the next few years

To enhance the focus of the management team on that concept and on that direction, we've totally revamped the incentive compensation for the corporation. Since the corporation became public, the only senior management annual incentive metric was EBITDA. This year, we are dramatically shifting that, and frankly, we have full approval of the Board to do it. We finished our most recent board meeting just this week where the Board endorsed this plan. And more than 50% of the weighting of the 2008 management incentive is focused on the capture and release of that trapped cash from the balance sheet.

The management team understands that very personally, as you might imagine. And the steps that are already being taken, which I identified, such as changes in consignment inventory, trying to reduce the cycle time from order to shipment, and most importantly or very importantly, the reduction in set-up time inside our factories, where we run some really remarkably complicated machinery and very sophisticated machines. All of those things I think are now front and center on the management team's attention list.

This is a process that I've used historically, frankly, that I was trained to in virtually all of my prior industrial experience. This process works. Is it sustainable? You bet. Is the current trapped cash or are the current trapped cash metrics a stretch for us today? Yes. Will we use the same metrics two or three years from now? No, we'll be much tighter than that. I would expect better turns than six a few years from now. But right now, this looks like a real stretch. But it's one that the management team has signed up to. I hope that helps a little bit.

Christopher Glynn - Oppenheimer

Yes, yes, very much. And I guess no comment on the sustainability of the current run rate of free cash flow.

Stephen Light

I can't tell you that it's going to instantly jump up or sag. It's going to, as you pointed out appropriately in your question, it's going to ebb and flow from quarter-to-quarter. But I think the trend is going to be to reduce trade working capital. But right now, the balance sheet is our friend.

Christopher Glynn - Oppenheimer

Right. Okay. And then on just the competitive dynamics and the capacity existing, projected to come online in Asia, what are you seeing as the dynamics there? I think at one point we viewed it a little bit as a land-grab type opportunity. Maybe that's come off a little bit?

Stephen Light

Well, our analysis -- it's interesting. You must be peeking over our shoulder at the office because we've been working on exactly that question. Maybe I can -- let me rephrase the question, and hopefully, it's the one you're thinking. There are many capital initiatives, capital investment initiatives, by us, by Albany, by Voith. Everybody who's in the business is building something or buying something in Asia today. As we model the known projects and those that we have heard through the grapevine are going to occur and compare that to Asia's very rapidly growing demand for the paper products, the end paper products, we believe there's almost a perfect match between capacity coming online and the growth rate in Asia.

Now it may not come on -- and that's over a five-year window. It may not come on exactly to match the timing of the capacity or the market appetite, but by the end of five years, it's almost perfect, which surprised us, quite frankly. That I think is a good situation. We believe that we're in an industry with responsible competitors. We'll not comment about any of their initiatives. But we probably pay as much attention to them as they are to us. So I think we collectively have a very good opportunity to serve the market without getting all tied up in overcapacity in Asia.

Christopher Glynn - Oppenheimer

Okay, great. Thanks very much.

Stephen Light

Thank you.

Mike O'Donnell

Thanks, Chris.

Operator

(Operator Instructions). At this time, there are no further questions in queue. I would now like to turn the call back over to Mr. Stephen Light for closing remarks.

Stephen Light

Ladies and gentlemen, we appreciate your attention this morning. We look forward to our next call. We would hope to have an announcement about our work with our lenders here in the next couple of weeks. Certainly, by May 31st, we'll have something to say about that. And we look forward to that discussion as well. Thank you very much for your attention this morning. Goodbye.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Xerium Technologies Inc. Q1 2008 Earnings Call Transcript

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