Kadant Inc (KAI) 2003 Q4 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Kadant Inc. fourth-quarter year-end 2003 earnings conference call. At this time, all participants have been placed on listen only mode and the floor will be open for your questions following today's presentation. It is now my pleasure to introduce your host, Mr. Thomas O'Brien Chief Financial Officer. Sir, you may begin.

Thank you, operator, and good morning everyone and welcome to Kadant's fourth-quarter and year-end 2003 earnings call. With us on the call today are Bill Rainville, our Chairman and Chief Executive Officer and John Painter, our Executive Vice President of Kadant and the head of our composite and fiber-based products segment.

Before we begin, let me read the Safe Harbor statement. Various remarks 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 September 27, 2003, which is on file with the SEC and is also available in the investor section of our web site at the 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 anything 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 the fourth-quarter and year-end earnings press release issued yesterday, which is available in the investor section of our web site at www.Kadant.com under the heading news releases. With that, I'll turn the call over to Bill Rainville, who will give you update on Kadant's business and future prospects. Following Bill's remarks I'll give an overview of the financial results for the quarter and we will then have a Q&A session. Bill?

Thank you, Tom. Good morning, everyone, and thank you for taking the time to join us today. We're pleased to report a strong finish in 2003 with annual increases in revenues and earnings and strong cash flow performance for the year. As you can see in our press release, our adjusted earnings per share increased 37 percent to 85 cents in 2003. We're focusing on adjusted EPS to show a more meaningful comparison for 2002 which included the effect of a significant accounting change. Let me point out here that we met our earnings guidance for the year and we either met or exceeded our earnings guidance in every quarter of 2003. Our revenues for the year increased 10 percent. We generated 23 million in operating cash flow, all from the paper-making segment. We ended 2003 with a net cash position of approximately $74 million, which translates to $5.20 per diluted share. This leaves us well capitalized to fund acquisition opportunities. We currently have a full-time employee dedicated to exploring potential acquisitions in the paper industry as well as outside the industry. With a focus on industrial water businesses that would complement our expertise and process water filtration and separation.

For the fourth quarter, adjusted EPS met our expectations of 16 cents. Revenues were better than we expected, up 10 percent to 50 million. Total bookings for the fourth quarter were up 10 percent over last year. For the papermaking segment alone, bookings were up 18 percent in the quarter. And what you don't see in the press release is that our year-end backlog was up 13 percent over 2002 at more than 37 million.

The solid performance by our papermaking group in the second half of 2003 would lead us to believe that the pulp and paper industry is on the road to recovery. After the last few years of lackluster spending by the paper industry, we do feel like the environment is improving. The total sum of our major customers has been positive, although they acknowledge ongoing cost and pricing pressures, especially in North America and Europe. Our best guess is that the recovery is going to be slow and uneven at least through 2004. But we haven't been sitting back and waiting for our markets to improve. We have positioned Kadant for growth in spite of the difficult environment and we stand to benefit from even a slight recovery in some of our markets.

In North America, we continue to focus on active market sales of repairs, rebuilds and services to upgrade aging equipment and prevent costly (indiscernible) downtime. Our latest generation of pulping rotors called a Vortex (ph), is a great example of a retrofit opportunity. This new design offers improved performance and lowers energy cost when installed in existing pulping (ph) equipment. We sold a dozen units so far. Products like this also provide the opportunity to grow our repair business, which went from 600,000 in 2002 to 2 million in 2003. Tissue and toweling grades continue to grow, driven by our customers' need for quality to preserve consumer brand equity. Our pulp (indiscernible) blade (ph) is showing steady growth in sales to the big three tissue producers since its introduction. Revenues increased 51 percent in 2003 to more than 1.5 million. More important, the pulp (indiscernible) blade gives us access to a valuable $30 million market opportunity.

For North America, the reality is that the aging paper mill equipment will eventually need to be replaced. Kadant has maintained a strong presence in domestic markets and will serve us well as those markets improve. We are encouraged by an increasing capital business in the fourth quarter.

Now let's go Europe. In Western Europe, our game plan is similar to North America with a focus on after market sales to upgrade existing equipment. In Eastern Europe, some capacity expansion will fuel capital equipment orders. It's interesting to note that industry analysts predict strong growth in sales of stock prep systems in Europe as paper mills invest in new technology to cope with the falling quality of recovered paper. The quality of wastepaper tends to decline as collection rates increase. Our global presence allows us to take advantage of these opportunities when and where they arise. For example, our operation in France recently received orders totaling more than $5 million for stock prep equipment to be used for tissue production in Algeria and to process the ink pulp (ph) at a mill in India.

Now let's go to China. Sales of our stock prep systems to China continue to be the primary contributor of our growth with record-breaking performance in 2003. Revenues were 30 million, nearly double those of 2002. We reported more than 8 million in revenues in the fourth quarter. Bookings reached 37 million, again, double that of the previous year. We've been successful in China for a number of reasons. Currently, it's the world's fastest-growing market. Demand for packaging materials has led to capacity expansion in all grades, especially recycled containerboard. According to industry analysts, China will need to add 30 million more tons of annual capacity by the year 2010 to meet the needs of its domestic market. We have leading technology for recycled paper production, especially strength in ground fiber recycling to through Kadant Black Clawson, which has been a respected name for more than two decades in China. Customers prefer to work with a leader. Our Beijing office has done a terrific job of working closely with the leading producers to build on their excellent reputation. We've been involved as a key supplier to nearly all the major recycled containerboard projects currently underway. Last month, we announced another large order for 3.8 million of our recycling systems. It's important to note, we have built one of the largest bases of stock prep installations in China, if not the largest, with a broad range of reference applications. This breadth of experience is a tremendous advantage to us when we compete for business in that part of the world. We're positioning Kadant for long-term growth in that region by placing an emphasis on aftermarket sales and services to support stock prep sales. We are increasing our local presence. Our assembly facility will be in operation by the year and. This will also serve as a platform for growing sales in our water management and accessory products. We plan to leverage our leading position in China to become the principal supplier for stock prep systems in Asia.

While the papermaking equipment side of our business gains momentum during 2003, the second half of the year proved to be more challenging for our composites business. What happened? The delayed start to the building season because of bad weather caused inventory levels throughout the distribution chain to rise and forced us to reduce production rates. Warranty issues that developed midyear on certain installations of our decking products was an additional setback for us and resulted in disappointing operating losses. Higher-than-expected claims and lower production rates in Q4 were the primary cause of the 1.4 million loss in composites.

Now the status of the warranty issues. We've implemented production changes to correct the problem. Our quick and thorough response protected our reputation in the marketplace. Although there's some seasonality associated with the claims, we are encouraged by the significant drop-off in a number of claims we've seen so far this year. We've had some disappointments in this business, but we continue to believe that the composites market offers an opportunity for Kadant. The demand for (indiscernible) remains strong and in a brand analysis survey recently conducted by a leading industry publication, professional builders chose GeoDeck (ph) as the number three brand expected to drive their business this year.

We also continue to expand our distribution network through programs we initiated to sign up new dealers in the winter and spring. We ended 2003 with approximately 80 dealers we (ph) stock our product. Our goal is to have 250 stocking dealers by the end of this year. With the warranty issue largely behind us, operating rate's likely to rise as inventories depleted, a new deck railing product is being introduced, we expect composites to regain profitability in the second half of this year. To date in 2004, our bookings in composites are already higher than all of Q1 last year. We will continue to report (indiscernible) composites for the first quarter in the range of 800,000 to 1 million on revenues of 3.5 to 4 million. For the full year, we expect a loss of 800,000 to 1.2 million on revenues of 15 to 17 million. For Kadant overall, we expect to report GAAP diluted EPS of 18 to 20 cents in the first quarter of 2004 on revenues of 48 to 50 million.

For the full year, we expect to achieve from 90 cents to $1 of GAAP EPS on revenues of 205 to 215 million. Now I'll turn it over to Tom for more detail on our financials. Tom?

Thank you, Bill. I will start with the fourth-quarter revenue results.

Consolidated revenues were 50.5 million in the fourth quarter of 2003, up 10 percent from last year. The consolidated revenues include a favorable foreign currency translation effect of 2.6 million, or 6 percent in the quarter. Our revenues in the fourth quarter exceeded our guidance, which was 45 to 47 million, due to stronger than expected revenues in our papermaking equipment segment. Our revenues in this segment were 47.5 million, 12 percent higher than the fourth quarter of 2002 due equally to increases of 6 percent from currency translation and 6 percent from internal growth. It's worth noting that this internal growth was obtained in what continues to be weak market conditions in the North America and European paper industries. Our stock prep product line accounted for much of the increase, up 3.3 million, or 17 percent over last year, including 6 percent from the favorable effect of foreign exchange. This was entirely due to our business in China where revenues of 8.3 million were 65 percent higher than last year.

In the rest of the world, stock prep revenues in the fourth quarter were flat with last year in North America and increased 2 percent in Europe, including a 17 percent favorable effect from foreign exchange. Revenues in our accessories product line were up 11 percent compared to last year, including interest 8 percent from the favorable effect of currency. Water management product line revenues were flat with last year, including a 5 percent favorable effect from exchange. Revenue growth in the accessories and water management product lines continues to be hampered by machine shutdowns and spending constraints by our customers in both North America and Europe.

Now let's turn to our other reporting segment, composite (indiscernible) products. Revenues here were 3.0 million, 15 percent lower than last year. This decline was entirely attributable to our composite building products business where revenues declined 32 percent from the fourth quarter of 2002 to 1.8 million but we are within our fourth quarter '03 guidance range of 1.8 to 2.3 million. Remember that the fourth quarter is traditionally the weakest sales quarter in the seasonal composites decking business. That said, however, the decline in revenues from last year reflects stronger (indiscernible) results in 2002 compared to 2003. The winter volume in 2002 was stronger partly due to concerns throughout the industry at the time concerning product availability.

Offsetting this revenue weakness slightly, our fiber-based granular products business achieved 30 percent revenue growth over the last year with revenues of 1.2 million in the fourth quarter of 2003. The revenue gain here were largely due to stronger sales of BioDeck, our biodegradable granules that we produce from papermaking by-products.

Turning to product gross margins, consolidated product gross margins were 36.9 percent in the fourth quarter of 2003, down 190 basis points from last year's 38.8 percent. Most of this decline is due to higher warranty provisions than last year in our composites building products business. We've provided a little over 770,000 for warranty expense in the fourth quarter of 2003, reflecting higher-than-expected warranty claims in the quarter. More encouragingly, decking warranty claims have declined significantly over the past six weeks. With the provisions taken in the fourth quarter, along with changes in our production processes which were instituted in August 2003 to solve the contraction issue causing the warranty problems, we should begin to see lower warranty claims for decking beginning in the first quarter 2004.

Product gross margins in our papermaking equipment segment remain solid. Product gross margins in this segment were 40.2 percent in the fourth quarter of 2003, up slightly from 40.0 percent last year. This performance was positively affected by higher parts and consumable gross margins, offset by an unfavorable product mix to relatively lower margin capital products. As part of our ongoing initiatives to improve our product gross margins, we have now relocated some key production equipment to our facility in Mexico to ship more North American production to that lower cost facility. In addition, we continue to make progress in establishing our assembly facility and wholly-owned subsidiary in China. We expect that the subsidiary will begin outsourcing operations in mid-2004 with the building slated for completion later in the year.

Working our way down the P&L, SG&A expenses were 14.1 million in the fourth quarter of 2003, an increase of 1.5 million over last year. Approximately half of this increase was due to the unfavorable impact of foreign currency translation compared to fourth quarter '02. For the full year, SG&A expenses were 53.8 million, up 7 percent compared to last year. This increase consists of unfavorable foreign currency effects of 6 percent and internal SG&A expenses increases of 1 percent. Again for the year, SG&A as a percentage of revenues was 26.4 percent in 2003, down 70 basis points from last year.

Now, let's turn to our operating income and EPS results. On a GAAP basis, consolidated operating income was 3.4 million in the fourth quarter of 2003, down from 4.1 million last year. On the plus side, operating income in our core papermaking equipment segment was 5.9 million in the 2003 period, up (indiscernible) last year. Offsetting this increase, however, were higher operating losses in our composite building products business of 1.4 million, versus a loss of 400,000 in the fourth quarter of '02. The losses in this product line were largely due to higher warranty provisions in 2003 compared to last year, which I have already talked about, as well as lower revenues and operating rates in the 2003 quarter.

For EPS, we reported diluted EPS of 16 cents in the fourth quarter of 2003, compared to 15 cents last year. There are no adjusting items in the 2003 results, but I included in the 2002 results two small adjustments which, when excluded, bring the adjusted diluted EPS to 16 cents in the fourth quarter of 2002. You can see a reconciliation of the GAAP to the adjusted EPS in the chart included in the press release. Although the adjusted diluted EPS was 16 cents in both periods, there were several factors that affected the comparison between the 2003 and 2002 results. First, EPS increased 3 cents due to the shift from net interest expense in fourth quarter '02 to net interest income in fourth quarter '03. Another 1 cent increase was due to foreign currency translation gains in the 2003 period. These combined improvements of 4 cents were entirely offset by higher after-tax lawsuits in our composites building products business.

Now let me spend a few minutes on the balance sheet and our operating cash flows. We ended the fourth quarter with 74.5 million in cash and 600,000 in total debt, giving us a net cash position of approximately 74 million. As Bill noted, this net cash position represents over $5.20 per share based on the diluted shares outstanding at the end of the quarter. Our net cash position improved by 8.8 million in the fourth quarter of 2003 and by over 30 million for the full year. Net cash is up by approximately 79 million since our spin-off from Thermoelectron over two years ago, including 17 million from our public offering. For the full year of 2003, cash flows from operations were 23 million compared to 27 million in 2002. That's 50 million in cash flows from operating activities in the past two years. Our working capital position remain strong. Here of course, the lower the percentage to better and working capital as a percentage of the last 12 months revenues was 16 percent in the fourth quarter of 2003, up from an exceptionally low 13 percent in the third quarter of 2003, but down from 17 percent a year ago. Note that the definition of working capital here excludes our net cash position.

Before I conclude my remarks, I'd like to make a few additional comments on the guidance for 2004 which Bill gave earlier. First, we expect our effective tax rate to be 35 percent for 2004, down 300 basis points from 2003. This rate reduction has a favorable effect on diluted EPS of approximately 4 cents in 2004, or roughly 1 cent per quarter. I should add that we have several projects underway to further reduce our effective tax rate and the onetime implementation costs associated with these projects will be approximately 2 cents in 2004, most of which will be incurred in the first quarter.

I'd like to note two other nonrecurring items which are included in our first quarter guidance. The first of these is a gain of approximately 4 cents per diluted share which is connected with renegotiating a series of agreements with one of our licensees. In addition to this onetime gain, there will be ongoing benefits arising from this renegotiation but they will not be material to our results. The second is a small gain affecting diluted EPS by approximately 1 cent from the sale of a building and one of our subsidiaries.

Next, we have the implementation costs which we will incur in 2004 in order to comply with the internal control requirements of the Sarbanes-Oxley Act. We estimate that outside audits and consulting fees will reduce diluted EPS by 2 cents in 2004. In addition to these outside costs, we expect to expend a significant amount of internal staff time to meet the act's new requirements. These costs will be expensed throughout the course of the year. With regard to our quarterly performance throughout 2004, we expect sequential improvement in every quarter of the year.

Finally, planned CapEx in 2004 will be approximately 4.5 million, including 1.7 million for the new facility in China and 0.3 million in the composites building products line. Regarding composites, I would like to add one point to Bill's comments on the expected operating loss of 800,000 to 1.2 million for 2004. The expected cash flows from operations should be better than the P&L results since depreciation and amortization will be approximately 1.1 million and we plan to reduce inventory levels by the end of 2004 compared to 2003, both of which will serve as sources of operating cash. Further, CapEx (indiscernible) composites in 2004 as I just mentioned will be approximately 300,000, significantly lower than 2003's 2.0 million. And 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). Claudia Shank, J.P. Morgan Chase.

Hi, how are you? Good. I just wanted to get maybe a little more color if I could on the warranty issue and maybe the warranty provisions. You talked a little bit about what they were in the fourth quarter and how maybe that compared to what they were in the third quarter, and I guess expectations for those going forward.

Okay, Claudia I'm going to ask John Painter to respond to that. He's closer to the issue.

I think as we talked a little bit in the third quarter, the nature of the problem is that our boards experienced a onetime contraction when they were supposed to heat and we put a fix in place in August of 2003, but of course the claims lag. Tom mentioned the $770,000 provision we took in the fourth. I think we ended up to a reserve of around 850 at the end of the year, which I think should cover us going into 2004 where we expect claims to drop as the quarter goes on, the year goes on.

Okay, just on the composite side as, I was curious about resin costs and what you are seeing there.

We are seeing resin costs increase a little bit. We have -- typically -- a lot of times in the winter, resin costs go up and in anticipation of that, we do buy kind of forward, if you will. There's no futures market, but we will order a more extensive amount of plastic to kind of insulate us from that.

Just on the core business, just curious a little bit about what you're seeing in terms of capital spending in North America paper industry and on the European side. We're getting the sense that that's picking up a little bit. Is that your sense as well, I guess?

Yes, Claudia. in fact, I think most of our units are sensing that there is -- certainly in the wind, there's signs of a pickup and we have, even in North America, even in stock prep line, we receive some small orders in stock for capital orders, which are encouraging. We also see Western Europe I think may even rebound a little bit stronger yet. They're quicker than perhaps North America, but that's very encouraging for us because, again, we have a large installed base here that really needs more parts components and replacement of equipment. So we are seeing some signs of improvement. Now it's always difficult to look way out and say is this going to be sustained, but it's also encouraging to see the GDP in general is going up and I think the paper industry -- also, with all the capacity that has already been taken off line, which impacted us in a couple of ways in the last couple of years because it also take off (ph) some equipment from time to time and cannibalized on the shutdowns. I think they're really at the lot end of the line on that. So I would expect that -- also, it doesn't take much of a pick up in operating rates for us to really get a major gain out of that because just a point or two extra in operating means a tremendous amount.

(OPERATOR INSTRUCTIONS) Michael Hutchinson, Barrington Research.

Good morning. I was wondering, in your core business do you believe the revenues are going to continue to be sporadic over the long-term, or do you think this is some temporary situation that is going to change because of industry conditions?

That is a good question and one that we look at is that when we get -- the lumpiness in our business comes from the large capital orders, and especially in the stock perforation systems which tend to be large orders, and difficult to predict. And right now, the majority of that activity is taking place in China for us. On the other hand, we see if we take a look at China, putting on 30 million tons of capacity over the next six years is like, it reflects about a third of the U.S. capacity. And (indiscernible) really have an appetite right now for the packaging grades as well as getting into tissue and finer paper. So it will be lumpy, but I think the timing in general is going to be very positive for us. And I think if you look out over the next few years, I think we believe that the trend is going to be positive, both on a continuing in China, which could be lumpy from time to time, but as well as I think we have sensed that there will be a pickup in North America and in Europe. And we also see pockets of opportunity throughout the world as I commented on. Whether it be in India or Algeria or South America, we continue to see some great pockets of opportunity for us. We're also looking to really try to smooth things out as well by focusing more on aftermarket, which really helps us because each time we increase our installed base, that represents an opportunity for us in parts and consumables.

What about the growth in China this year? Do you expect probably not nearly the growth that you had this, or in 2003 but --

It's a tough call, Mike, because it's lumpy, but we certainly have some encouraging signs in China. There certainly, our activity over there is at a high rate right now and we are even starting off the year with a nice order. And I think that China is going to continue to be relatively strong this year. There's a lot of momentum going. It's just a question of calling the timing and when the orders are really being placed but you really don't see any downward trend at this point.

Could you talk about the competitive landscape in the composites business and contrast that to where the company was a year ago?

Okay, that's a good question. I'm going to turn this one over to John Painter.

Sure. As we talked about, there are a number of players in the composite business and we were actually quite pleased with this brand awareness study that Bill referred to because we've been focusing on professional builders and you know there's (indiscernible) is again number one player and there's a couple of others. But we're definitely in that top group of people who address the professional builders. The other segment is people who are selling into the big boxes, the Home Depots, that kind of stuff. And they're as much addressed at the do-it-yourself market and we are less of a player, I would say, in that market.

You don't think with the new competition, that that hurts, represents less market share for you guys, do you?

We are currently growing faster than the marketplace. So, that really hasn't hurt us at this point. Other people are growing quickly as well.

Peter Park, Park West Asset Management.

Good morning. How much of the pickup in Western Europe and North America that you're starting to see are you factoring into the 90 cents to $1 guidance?

I'll tell you, it's very difficult for us to look way out in the year, Peter, because whether it's a sustained position or what, because budgets are just being formed and a lot of budgets are being released at this time at the mill level that we participate. So that's a difficult one to call. The pickup we see (indiscernible) is not a huge pickup in these regions, but it's enough to give us some real encouragement. And I think that our hope is that it will continue on throughout the year. And as far as factoring that in within our guidance, I think we're just a little reluctant to call a recovery in industry at this point.

Should I interpret that you mean that if you have a recovery that's consistent with what you have been seeing the first couple of steps of, that essentially your guidance is low or conservative?

Probably so, yes, and I hope it is and I hope we have an opportunity to increase it throughout the year. Just right now, it's difficult to call.

Given the change in tax rate that you have for '04 and the 90 cents to $1 would include essentially a 2-cent impact, the positive 4 cents less the cents of the expenses that it would take to do that.

That's correct.

A couple more. Corporate expenses -- historically, they've been $1 million a quarter. Just with Sarbanes-Oxley and all these things that are out there, what do you expect that to be going forward?

Peter this is Tom. I think it's going to be a little bit higher than that. It will probably end up 1.2-1.3 million a quarter. And some of that will go away in 2005. Some of these costs we're talking about here are obviously one-time. There'll be some ongoing costs, but they won't be to this extent in the future.

What was the full amount of capital that it's going to require to open up that office in China? You said the 1.7 this year. Is there anything more next year?

That's the entire amount. We had been forecasting a little bit higher than that, but as we get closer to it now, we think it will be around 1 7.

Again, what we're doing, Peter, is it's going to be primarily an assembly facility. We will be manufacturing some of our -- eventually some of our blades (indiscernible) our consumables we will manufacture and probably some of our AS equipment, which really does not require a large capital investment. And our objective there is to outsource as much as possible and assemble at that facility, so it's not a huge investment for us.

Last question -- given the capital equipment typically has a lower gross margin, is it possible that with a pickup in the economy or a pickup in capital spend that your gross margin could actually spend lower initially?

I think, Peter, that's a good question. I think if we see most of the growth coming on the capital side, we may see product gross margins decline somewhat on the paper side, that is correct.

What kind of differential is there in gross margin between the capital and the services or --

We don't really disclose that, but obviously, the parts and consumables margin are better than the capital margins. But I think in the fourth quarter and also for the whole year, just to give you to sense if you're doing a model, the parts and consumables business was about 50 percent of our total paper segment business.

Also to offset some of that, Peter, we're also focusing on increasing our parts and consumables business in China, which will also help us.

Jason Cranshaw (ph), (indiscernible) Specialized Funds.

Good morning guys, how are you doing? I just have a number of questions here. The first would be just on the core business, okay? Clearly, that's been a nice performance on the top line this year. And the question relates to -- how much more leverage is there in the paper business in the sense that -- let's say the cycle turns and things start to pick up there and you are able to grow the top line 15 or 20 percent. How much sort of leverage is there in the operating model? What's sort of operating sort of operating margins could we see in the paper business?

The operating margin I think, certainly as Tom was commenting, initially as we go grow with the capital sales, one could expect the less margin we get off the parts and consumables. But overall, I would think that we've got a tremendous leverage. Back a few years ago to give you a sense, we had operating income of about 16 percent of revenue. And so we have -- and we have also taken out a lot of cost out of our operations. I mean we've been operating very lean. And I would think that as revenue continues to grow, I think we can really optimize on the income side.

Okay, so if we did see a pickup, it's not out of the realm of possibility that we could see some of that previous 15 or 16 percent level at the operating level.

That certainly is our goal.

Next question would be on the composite side. Now I believe the commentary you posted the bookings there for composites I guess at the end of December and they were down I think the number was like 4.7 vis-a-vis 7 million last year. But I think in the commentary, it said sort of year-to-date 2004 bookings are ahead of Q1. Can you just sort of clarify what that means? Does that mean you've seen a material pickup in composite for the first 6-8 weeks in the quarter? What's happening on the margin side?

Sure, Jason, I'll John comments on this.

We have, you know, the explanation as Tom kind of referred it is really, you've really got to look into 2002 where there was concerns in the industry of product just not even being available. There was also great enthusiasm. So we had a very strong $8 million kind of Q4 bookings in Q4 of 2002. And as the winter dragged on, bookings kind of dropped in the first part of 2003. I think this year, we've had what I would describe as a more normal winter buy program. So it doesn't look good in comparison to Q4 of '02, but it also allows that you're going to continue bookings at a more normal rates in the first part of '04.

So really what we're saying is that the 2002 year-end booking number was a shortage type situation.

And it has the effect of reducing the bookings in the earlier parts of '03.

Sure, okay. Next question -- obviously I love the way the paper business is going. Clearly, the composites business seems to still be battling. What is the endgame for composites? I know we've had this discussion in the past clearly you're not prepared to carry this business indefinitely, but you've made a reasonable amount of investment in time, effort, money and energy to date. At what point do you decide that, A, this is going to turn the corner or, B, this isn't working and then what do you do?

I'll tell you, Jason, you can tell by the way we operate in our balance sheet, we operate the company very conservatively. And cash and money is extremely critical, so we watch it very carefully. We're watching this investment. And you know, we do believe that we can still optimize it and certainly, our expectations are that by the second half, we're going to be turning the corner and earning profitability. If not, we reassess at that time where we go with the business as we do with any business that we have. But I think that right now under any circumstance, by continuing at this point, I think we're going to enhance the value of that business in any case. And also, I should point out too, it's not going to be taking cash a lot of cash this year. It's not like in terms of our cash, it certainly our P&L, but not on the cash position.

If I look at that gross margin from composites Q4 of minus 14 percent, I assume that's really due to the warranty issue. Is that correct?

yes it is.

Low operating rates as well.

If you didn't have the warranty issue, what with that gross margin -- what would that have looked like.

We would have added around $700,000 to gross margin, or $780,000 to gross margin. But we also did operate, and that has another effect, we operated at a much lower rates in the fourth quarter, in terms of production of finished goods, which also impacted the margins.

What do you think the revenue breakeven sort of run rate is for the composite business?

You know, it depends on a lot of factors -- resin prices and that kind of thing. We kind of peg (ph) it at around $13 million.

$13 million for the year?

Yes, and that means you are producing $13 million and you're selling $13 million.

Okay. You're talking about that for the decking and tiling business, I assume.

Exactly.

So you guys report (indiscernible) composite and fiber-based together, the number was 17.8 (ph) for the full year, how much of that was decking and tiling for 2003 rather?

We did -- for 2003?

Yes.

We did about 12.

So you're not that far off getting this thing to breakeven on those metrics.

We have a couple of issues. In the first quarter, I think as Tom mentioned, we are going to operate at a lower rate than our sales rate which will hurt margins. But we will reduce inventory for us. Provide cash, but at least reduce -- provide cash from inventory, but it will hurt in our P&L.

Excuse the last couple of questions (indiscernible). CapEx for '04 is going to be what?

Tom can answer that.

CapEx for '04 will 4.5, Jason. There's 1.7 million in there for the new facility in China and about 300,000 for composite.

What do you expect for working capital for '04? I mean you've given guidance at the EPS level, so I guess the question I'm really getting at is what do you think cash flow from operations will be in '04 if you meet your guidance?

had you asked ma a year ago if I thought we do 23 million in cash flow from operations for 2003, I'd have given you a very bad forecast because I would have missed that too. It's really hard to forecast cash, but I can give you some of the components and then you can decide. Just to make the arithmetic easy, if we take the dollar in earnings, just make it easy, that would be 14 million in net income, D&A is about 5.2 million, add at that. CapEx we said here was 4.5. And then the issue is working capital. Now this year, we had another good year for working capital. I think we still have some opportunities, but that's a tough one to forecast and I will have to leave everyone to do their --

Do you think you'll be sort of the negative rather user working capital in '04?

The only way we will do that I think is if the business is really picking up steam in the second half. And I'd like that to happen. I wouldn't mind using a little bit working capital because the business is growing in the second half. But other than that, I think we will be -- we do have opportunities in working capital (indiscernible) still working on those.

Lastly, clearly the balance sheet is looking great, free cash flow will be positive in '04. What is the status of the share buyback currently? Is that -- I believe you went through your previous authorization. What is the status on the buyback?

We have a $25 million authorization to buy back Jason and stock buyback. This is something we continue to watch. It's just another alternative for our cash.

Did you guys buy back stock in Q4?

No, we did not.

Alan Fournier, Pennant Capital Management.

Good morning. A couple of more housekeeping questions on the cash flow. Of the 23 million in '04, did you say how much of that was from working capital?

I didn't, but I could give you that. Hold on one second. You know, I would say it is about 5 million -- just adding quickly in my head here.

Okay. Did I hear you correctly that the CapEx -- I guess in last fiscal year, CapEx in the core business was 1.75, and that's increased to 4.5?

The CapEx for 2003 in total was 4 million. You should see that on the press release, that's on the press release.

It says 1.75 in pulp and papermaking equipment and 2.25 in composite and fiber based.

That's for the whole segment of the composite and fiber based. The composites alone, the composite building products, was about 2 million. And then we have some additional CapEx in the other product line in that business. So I think the important point we're drawing here is that 2004 CapEx as a composite, just the composite building products business, is going to be 300,000 versus 2 million in 2003. So we have significantly lower CapEx requirements in 2004. Okay, is that clear?

Yes, I think I have got it. I guess I wanted to also echo some of the concerns bridged by the last caller regarding the composites business. I understand the warranty issue and it sounds like you have your arms around that. But it isn't a very, very competitive business and it just doesn't look like you're gaining traction from a revenue standpoint. So I'd like to get a sense for at what point you can commit to shareholders you're going to decide to fish or cut bait here?

Alan, I can tell you this, that this is something a we constantly keep an eye on. If we get disappointed in the second half of the year, we will just consider other options on this business at that point. And you know, I am convinced we traded something of value here. What we're trying to do now is optimize it.

I understand and we've talked in the past about potential joint ventures and so forth. It sounds like there's a good technology, but you have to get it to market. So, I guess I would encourage the company to think about ways to leverage the technology, but get a partner to get it to market in a more efficient way.

We're certainly considering all options to optimize that, and you're absolutely right.

One of the things were focusing on this year really is to broaden our dealer base. In the last couple of years, we increased our wholesale distribution base, but it's really the dealer base itself, that's where people can go and see it. And I think we got a little ahead of ourselves in some ways in the sense that wholesale distributors bought a lot, but they didn't have the outlets below them to get it out to the market, which is what our focus is at this point.

I have looked at this business in the past and I have heard from dealers it's just a matter of -- we have three or four of these products, we're not going to carry another one. It's just very hard to get in and differentiate yourself in the marketplace.

I think it is a tough and competitive market.

I guess again I just reiterate that it's really not going to rate require a great deal of cash this year. We expect and we think that certainly by the second half of this year, we're going to have more value in that business than we do now, and no matter what option you look at.

I got you. You had mentioned in the call that China is going to need 30 million more tons. Is that paperboard capacity by (indiscernible) 20 cents?

Yes, that's paper and paperboard and --

What base is that off of today?

Today, their production is right around something like around 35 to actually running at this point, but they're right around 35 million tons.

Okay, so you're talking about a doubling (multiple speakers)

What they have been doing is sometimes it's difficult to get exact information from China because they also shut down a lot of real old ancient machines. And something they keep them running for a little while, but eventually, they shut them down.

And remind me again, my recollection is that a lot of the FX benefits in the top line are offset by operational costs that are also overseas to the bottom line -- is that the right way to think about it?

That is correct Al, because we have subsidiaries overseas, so their revenues are obviously in the local currency, euro, Sterling, whatever, and also their costs are as well. That's why the FX impact was about a penny in the quarter.

Okay, so would it right to assume that there's not a big competitive advantage because of the euro/dollar relationship in Europe?

I would say the only thing we have is that our China business we sell in China (multiple speakers). You're right -- in the rest of the world, we pretty much have natural hedges because of the fact that we have the expenses in the same currency as the revenues, so that's good because we're basically isolated for the most part from translation swings.

The final question I had is on acquisitions. I think you mentioned something specific about industrial water. Can you expand on that?

We believe that we have equipment that handles processed (indiscernible) water in the paper industry that applies to other industries. And what we lack is market access to those industries. We do very well in the paper industry. And from time to time, we sell equipment -- we don't sell it, somebody will buy equipment from us because of familiarity through their experience in the paper industry. And the other technology, one of the core technologies in our core business is separation technology which we have in recycling systems where we separate a lot of the bad things off the fiber as well as in the water area, and that technology does apply. And we know we can do well in an industrial market. So what we're looking for are companies that have market access that have equipment that -- in fact in some cases, we looked at some of their equipment, looks very similar to what we have. We could apply that some of their products would probably complement our line in the paper industry and we could take our products introduce it into their industry. So an acquisition that would make a lot of sense for us, that's a huge market but we're focusing primarily on customers that deal with industry.

I see. So you think the opportunity here would be potentially to get a distribution capability, and then you could sell existing product into expanded markets.

Right. Someone that has a product line and a good reputation and say some market (indiscernible) in the industrial markets.

Okay I guess I would encourage that as long as the characteristics look as attractive as the core business.

I agree with you. We do not want to dilute the value of our core business. And I hear what you're saying and that's exactly what were doing. And in fact, to give you some comfort Alan, that's one reason, we've been sitting here with cash for sometime looking at a number of companies. And as I commented on the call, we engage, we have an employee now who has a tremendous amount of M&A experience and he's working full-time at it. But to give you little bit of comfort, we've said no a lot in the last number of years.

No, I appreciate that. I guess the easiest acquisition to always make is your own shares, it's what you know best. I guess I would like to see more activity there if we keep building cash the we're building cash.

That's a good point, and that's always an option for us.

(OPERATOR INSTRUCTIONS) Wayne Arcambo (ph), Black Rock.

Good morning. Just reiterate what Mr. Fournier mentioned on the composite business. I think there has to be a line in the sand here on this business. And I don't know if that's the beginning of the first half or the second or -- the back of the second half or next year, but I do think that at some point, you've got to fish or cut bait on that business.

You're absolutely right. And again, I will reiterate, we're watching very carefully. We are not going to -- we do not have a record of continuing with weak businesses and we're not going -- if that business gains some strength -- and again, we're looking at all options on that business at this point. So, Wayne, I agree with that. And we're not going to let that become a losing business for us to carry.

Peter Park, Park West Asset Management.

I won't talk about composites. This goes to the cash balance. How many deals do you have to say no to in order for you to finally buy some shares back? Is there a point in time where you would actually buy shares back, or should we not assume that you really will, because you -- in the same way that you haven't done any deals, you haven't really bought stock back either.

We certainly would. And we evaluate that, because again, there's competing interest where certainly for our cash. And if we -- we're not going to turn ourselves into a bank, it's just carrying a lot of cash. Eventually we'll take a look at buying stock back, but that's why we continue to keep authorization added in it, as well as if we really see stock become depressed or whatever, that really becomes a buying opportunity. That's something we watch, but we really believe that we can generate some real shareholder value and grow this business by doing it properly and we're starting to zero in on some population of companies that may look attractive to us. And our goal would be to put that cash to work one way or another by the end of this year.

So presumably, if by the end of the year you've looked at that list and you've decided to pass on all of them, you will do some type of shareholder activity?

I can't really commit to that, Peter.

I would now like to turn the call over to speakers for any further remarks.

Okay, I'd just like to close. And in closing, I have to say that we're proud of our solid overall performance in 2003, despite the industry challenges that we continue to face and we are optimistic about 2004 for several reasons -- very strong bookings in the fourth quarter and all of our paper equipment product lines give us positive momentum going into the year. Also, with our global strength in technology and markets, we are positioned to benefit from even a slight recovery in North America and Europe. Our stock prep business in China remains very strong and it will serve as a base from which we can expand our presence in growing Asian markets. We also have a strong balance sheet that will allow us to complement internal growth with strategic acquisitions that broaden our markets served. That said, thank you for your support and joining us today.

Thank you, this does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.