Kadant Inc (KAI) 2004 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Kadant earnings conference call. At this time, all participants have been placed on a listen only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Thomas O'Brien. Sir, you may begin.

Good morning, everyone, and welcome to Kadant's fourth quarter and year end 2004 earnings call. With us on the call today are Bill Rainville, our Chairman and Chief Executive Officer, and Jon Painter, Executive Vice President. 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 provision under the Private Security 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 2, 2004, which is on file with the SEC and is also available in the investor 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 may refer to the non GAAP financial measures. These non GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non GAAP measures to the most directly comparable GAAP measures is contained in our fourth quarter earnings press release, issued yesterday, which is available in the investor section of our website at www.kadant.com under the heading "News Releases".

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

Thank you, Tom, and good morning, everyone. Thank you for joining us on the call today. We'll review both our Q4 and year end results and talk a little bit about our prospects for 2005.

First, our performance at the end of 2004.

Let me remind you that all these results exclude composite building products, which is not classified as a discontinued operation following our announcement last October of our plans to sell that business.

For the fourth quarter we reported revenues of $45.9 million from continuing operations, down from last year's 48.7 million but better than we expected. This doesn't include $1.5 million from the favorable effect of foreign currency. We also exceeded our guidance for adjusted EPS which was 10 cents, once you exclude the large restructuring charge we took in the quarter.

In addition, we generated strong cash flows from operations. $6.6 million in the quarter. For the full year, revenues from continuing operations were 195 million an increase over the 191 million in 2003 but down when you factor in the 7.5 million favorable effects of FX. Adjusted EPS was 82 cents excluding the restructuring charge.

We finished the year with $82 million in cash on our balance sheet. A strong cash balance gives us the means to reinvest in the business and generate growth going forward.

While we did exceed expectations for the quarter, we are disappointed that we were unable to deliver top and bottom line growth. We began 2004 with strength across the business but suppressed industry conditions in North America and Europe presented a more challenging second half that affected our overall performance.

Although market conditions are beginning to improve, with production rates rising from many paper grades and our major customers reporting increased profits, we have yet to see a pick up in demand in North America and Europe as paper producers continue to closely control their spending. We do believe that their focus on cost will ultimately benefit Kadant since many of our products are designed to lower operating costs and deliver value to quick returns on investments and noticeable quality improvements.

Following our decision to sell composites we are now completely focused on our core papermaking equipment business. We are working hard to position Kadant for growth in that industry in 2005 and beyond primarily by restructuring our French operation, maintaining our technological edge, reinforcing our global presence, focusing on sales of parts and consumables, and pursuing strategic acquisitions.

Let me start with France where we took a $9.2 million pretax charge to restructure our Kadant Lamort subsidiary so it can more effectively operate in the paper industry environment that exists today.

Much of the earnings weakness we experienced in Q4 was due to operating losses at Kadant Lamort. So it is important for our future growth to implement a plan to turn that business around. In late November, we approved Kadant Lamort's restructuring plan which is designed to strengthen that operation's competitive position by lowering its cost structure. The charge cover's anticipated cost related to the reduction of the workforce including legal costs and reorganization expenditures.

We expect these actions to yield more than 4 million euros in annualized savings once the plan is fully implemented but should occur in the latter part of the year although the timing is difficult to predict.

This is a very significant and difficult process that will have a major impact on local employment. But legal constraints in France, however, are such that we cannot provide detailed information on many aspects of the procedure. We can say that it is progressing according to our expectations. We firmly believe that these changes will allow Kadant Lamort, which represents about a quarter of our business, to return to profitability levels in line with other Kadant operations. We believe that a stronger business will emerge once the restructuring plan is implemented and market conditions in Europe improve.

Over the years, we have made substantial investments in this operation. It remains our center for stock corporation R&D worldwide; and markets are (indiscernible) water management product lines throughout much of Europe as well. In fact, higher sales of our water management products in the fourth quarter were the result of orders secured through Kadant Lamort from customers in India and Europe for a pretax filtration (indiscernible) jet cleaning and conditioning systems.

Our technological edge continues to be recognized in markets around the world. Especially in China where we booked $7.5 million in orders for our advanced stock prep systems in the fourth quarter, the largest bookings quarter for China in 2004. Included in these was a major order for advanced pulping, cleaning and screening systems that will be used to process recycled fibers in the production of white top linerboard which is a high-quality packaging material.

The timing of orders in China will continue to be a challenge, due to project financing delays instituted by the government. We have just over $11 million in contracts, awaiting financing approval; and we fully expect these contracts to be recognized as revenue.

Our global presence (indiscernible) have to capitalize on opportunities wherever they emerge. We continue to expand our geographic reach by strengthening our sales coverage around the world. A recent example is the order we just announced for Chemi-Washer System, valued at more than $3 million. The equipment is to be installed in South Africa at a mill operated by a division of Sappi, a multinational paper and forest products company.

The mill produces chemical cellulose also known as dissolved (ph) pulp which is used in the manufacture of a range of products such as textiles, chemicals and plastics. Our proprietary Chemi-Washer technology offers a highly efficient solution for removing impurities from pulp in a single enclosed system. It requires far less water use and offers greater control of emissions and pulp washing systems currently on the market.

Let me mention here that we continue to leverage our capital equipment sales with additional aftermarket products. In fact, all of our units have teams focusing on expanding our parts and consumables business which can significantly enhance the value of our large installed base of equipment.

Last, we are continuing to search for strategic acquisitions that could help us extend our technological and geographic reach. We are carefully evaluating potential targets with an eye towards companies that have complementary products, global recognition, are leading players in their markets and have a large aftermarket business. Importantly, our strong balance sheet possessed the means to reinvest in the business whether through a technology development, stock buybacks, strategic acquisitions or any combination of the three.

Let me remind you that our cash balance is (technical difficulty) equipment approximately $5.90 per share based on a number of weighted average shares outstanding in Q4.

Looking at 2005 as a whole, we expect great strength in China to continue. Although with ongoing uncertainty in the timing of orders and revenues, we also expect our Kadant Lamort operation in France to regain profitability once the restructuring is completed later this year. In addition, we believe that even a modest increase in capital spending in North America and Europe would greatly benefit Kadant and all our product lines.

Since we expect losses to continue in France over the next few months, we estimate GAAP diluted EPS of 13 to 15 cents in the first quarter of 2005 on revenues of $47 to $49 million. Our estimate for 2005 which is soon to turn around in France later in the year is 80 to 90 cents of gas diluted EPS on revenues of $200 to $210 million.

With that I will turn the call over to Tom for his review of the financials. Tom.

All amounts that I refer to during my financial review this morning, unless otherwise noted, will be for our continuing operations which consist of one recording segment, papermaking equipment and one product line, our fiber-based products business.

Our continuing operations exclude the results of our composite building products business, which is recorded as a discontinued operation in the financial statements.

Revenues were 45.9 million in the fourth quarter of 2004, down 6 percent from last year, and include a favorable foreign currency translation effect of 1.5 million or 3 percent.

Our revenues in the fourth quarter were stronger than we had expected, exceeding our guidance which was 40 to 42 million. Revenues in the papermaking equipment segment were 44.2 million, 7 percent lower than last year including a 3 percent favorable effect from foreign exchange.

Now let's look at the revenue performance in each of the three product lines in this segment, beginning with accessories. Revenues in our accessories product line were 15.7 million, down 6 percent compared to the fourth quarter of 2003, including a 4 percent increase attributable to foreign currency. This entire shortfall occurred in our European businesses where revenues were 19 percent lower than fourth quarter '03 including an 8 percent favorable effect from foreign exchange.

The accessories performance was better in North America where revenues were up 2 percent from a year ago, including a small favorable impact from foreign exchange. Our performance in this product line especially in Europe continues to suffer from weak sales of our accessory capital products.

In our stock prep product line, revenues in the fourth quarter of 2004 were 20.7 million, down 12 percent from last year including a 3 percent increase from foreign currency translations. As with accessories, we had quite different results in our major geographic territories. European stock prep revenues were 2 percent below fourth quarter '03 including a 9 percent favorable effect from foreign exchange. Stock prep revenues in China were 5.3 million in fourth quarter '04, 35 percent lower than fourth quarter '03.

Financing approvals continue to be slow in China, although we see some signs of this easing as evidenced by our fourth quarter '04 bookings of 7.5 million, the highest bookings quarter for China in 2004.

Finally stock prep revenues were up 3 percent in North America compared to last year, largely due to higher sales of our Chemi-Washer products. We are currently working on a number of Chemi-Washer proposals; and you may have seen our press release earlier this week announcing a Chemi-Washer order for over 3 million to a customer in South Africa.

Revenues in our third product line in the papermaking equipment segment, the water management business was 7.4 million, 8 percent higher than last year, including a 2 percent favorable effect from foreign currency. Here our geographic performance was reversed as North American revenues were down (technical difficulty) percent fourth quarter '03 while European revenues were up 59 percent including a 13 percent increase from foreign exchange, led by stronger sales by filtration products in the fourth quarter of 2004.

Now let's turn briefly to the revenue performance in our fiber-based business. Revenues in this business were 1.8 million in fourth quarter '04, a 41 percent increase over last year's 1.3 million. The revenue performance here was largely due to stronger sales of BioDeck, our patented family of biodegradable granular products that we produce from papermaking byproducts.

Turning to our product gross margins. Product gross margins in our continuing operations were 36.4 percent in the fourth quarter of 2004, down from last year's 39.7 percent. This decline was entirely the result of lower product gross margins in our papermaking equipment segment. Product gross margins in this segment were 36.6 percent, 360 basis points lower than last year. This decrease was entirely due to lower margins from sales of our capital products, most of which occurred in our Kadant Lamort subsidiaries headquartered in France.

Excluding the Kadant Lamort results, product gross margins would have been only 70 basis points lower in the fourth quarter of '04 compared to the fourth quarter of '03. Product gross margins in our fiber-based products business were up substantially in the fourth quarter of 2004 to 32.9 percent from last year's 23.9 percent, largely due to better fixed cost absorption with a higher revenue than 2004.

Now let's look at our SG&A expenses for a moment. SG&A expenses were 13.9 million in the fourth quarter of 2004, up 400,000 from last year's 13.5 million. This increase includes approximately 500,000, due to the unfavorable impact of foreign currency translation. In addition, and as we forecasted during our October 2004 earnings call, our Sarbanes-Oxley implementation costs were approximately 400,000 in fourth quarter '04 and totaled approximately 1.1 million for the year. We expect the ongoing cost of complying with the internal control provisions of the Sarbanes-Oxley Act will be approximately 5 to 600,000 in 2005.

Turning to our operating income and EPS results. We reported an operating loss of 7.5 million in the fourth quarter of 2004, compared to operating income of 4.8 million last year. The 2004 results include 9.5 million of restructuring charges; and excluding these charges the adjusted operating income was 2.0 million in the fourth quarter of 2004, compared to last year's 4.8 million.

Virtually all of this decline was in our papermaking equipment segment where adjusted operating income was 3.2 million, down 2.7 million from fourth quarter '03. Approximately half of this decrease in adjusted operating income occurred in our Kadant Lamort subsidiary which, as we have announced, is undergoing a significant restructuring of its operations. Corporate expenses and other were approximately flat with last year.

We reported a GAAP net loss per diluted share, including discontinued operations, of 38 cents in the fourth quarter of 2004 compared to earnings of 16 cents last year. As I just mentioned, in the fourth quarter of 2004 we incurred a pretax charge of 9.2 million to restructure our Kadant Lamort subsidiary as well as a pretax charge of 300,000 associated with restructuring one of our U.S. subsidiaries.

Excluding these charges on an after-tax basis, as well as the after-tax losses from the discontinued operation in both periods, adjusted diluted EPS was 10 cents in fourth quarter '04 compared to 22 cents last year. You can see our reconciliation from GAAP to diluted EPS -- adjusted diluted EPS -- in the chart attached to the press release. Of the 12 cent reduction in adjusted diluted EPS from 2003 to 2004, approximately 7 cents is attributable to our Kadant Lamort subsidiary.

Now let me spend a few moments on the balance sheet and our operating cash flows. We ended the fourth quarter with 82.1 million in cash and no debt. Our net cash position -- that is, cash less debt -- improved by approximately 8.3 million in 2004. As Bill noted earlier, our net cash represents approximately $5.90 per share, based on the diluted shares outstanding for the quarter.

In my comments during our October 2004 earnings call, I remarked that we expected strong cash flows in the fourth quarter and indeed that was the case. Cash flows from operating activities were 6.6 million in the fourth quarter of '04, compared to last year's 3.6 million. Despite this strong finish, cash flows from operating activities for the full year 2004 of 12.9 million were down significantly from last year's 25.6 million, largely due to lower net income in 2004.

Our working capital position remained strong. For this measurement where a lower percentage denotes better performance we ended the fourth quarter of 2004 with working capital as a percentage of the last 12 months revenues of 12 percent down 310 basis points from last year.

Before concluding my remarks, I'd like to give you a few additional details on the guidance for 2005 which Bill gave earlier. First, our effective tax rate in 2004 was 30.5 percent, down from 38 percent last year. The recurring tax rate in 2004 -- that is, the rate excluding certain non-recurring items that reduce the tax provision -- was approximately 34 percent.

This rate is slightly lower than 35 percent effective rate we forecasted for 2004 during our earnings call a year ago.

For 2005 we expect our effective tax rate to be 31 to 33 percent, compared to the recurring rate of 34 percent in 2004.

Now with respect to our quarterly EPS performance in 2005, as you have already heard, we do not expect Kadant Lamort to return to profitability until the latter part of the year. As we begin to realize the cost savings associated with the plan we expect significantly better EPS results in the second half of 2005.

We expect CapEx spending to be approximately 4.0 million in 2005 including a 1.5 million amount for our assembly facility in China. Construction of this facility has been delayed due to a slowdown in investment approvals by the Chinese government. We believe that we will receive approval to begin construction in the next few months and anticipate having the facility in full operation by the end of the year.

Finally, the Financial Accounting Standards Board has issued a new statement which requires us to expense the fair value of employee stock options on the income statement. This new standard will be effective beginning in our third quarter of 2005. Based on the number of options outstanding at the end of 2004 and the related estimated number of unvested options as of the third quarter, we expect the impact on EPS in 2005 will be immaterial.

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) Wayne Argento (ph) with Blackrock.

Do you have any outlook for the paper industry in general on CapEx for '05 and '06?

Yes, in fact, all indications are from the major paper corporations in, certainly, in North America and the U.S. in particular have indicated and stated that they are going to be increasing their CapEx somewhere between 15 and 20 percent, which if they go through with this, I think there would be a nice gain for Kadant. I also note that we certainly have had lot more interest from the corporations on the various products in terms of given quotations and presentation from them. So, we are just patiently awaiting I guess to see if they can convert that into orders for us.

Was that in some published report that you quoted? That number?

Some of that came about, IP had indicated that they would. We had certainly, I think in general there's been some reports and I'm trying to recall where. But even some of the trade magazines indicated in some of the presentations they have been giving indicated they are going to start releasing some more for CapEx. I do think this way and I think when they do I think we are in a good position because we've really focused on -- their products, I think they could be very beneficial to them, it wouldn't reduce their cost and answer productivity. Listening to their earnings calls in particular there were all talking about increasing their CapEx this year.

I know they're reluctant to announce an increase in CapEx, certainly but we're starting to see some signs of that just by their increased interest in our products.

Could you just jump to France? It just seems things are in a bit of disarray over there right now for you. What control do you have in place, how did it get to this point and is there any way to expedite getting that situation turned around?

I can tell you this, that it is a very complex process that you enter in on and I have to say that it was the management of LaMort that really presented us with this restructuring program. And that was based upon they had certainly some softness that taken place in Europe; and since we had owned LaMort this is the first time where we really went into a loss position. And the plan is in place, they're doing everything they can to expedite it, but the timing is such that the government is involved and a lot of that gets out of our hands. I will say this, we are very confident that, certainly, by the end -- we are going to start seeing the benefit of that by the end of this year.

So is the management team going to be in place that got you into this mess over the next 12 months?

We have a great management team there right now. I did replace the top management team that was there and we have a new unit president and a new management team in place that has really put a plan together that makes a lot of sense.

(MULTIPLE SPEAKERS) give the floor to someone else. On the decking business. Can you break out the EBIT for the quarter, for the year, on the business for us?

The EBIT for that business?

Yes.

Hang on one second. I think you can actually for the EBIT, we are disclosing -- you can see on the press release -- let me start with that, the impact on us on an after-tax basis. So if you go down to the middle of the chart you can see that the loss from the discontinued Ops was 4 cents in the fourth quarter and it was 35 cents for the entire year.

In terms of the actual EBIT results, again for the quarter we lost 1.1 million on revenues of 3.2 and for the year the operating income loss was a little over 8 million on revenues just shy of 17 million.

I met with you a year ago about that decking business and it was my sense a year ago that you stated that your sense was that if you couldn't grow that business if you couldn't make it a more profitable party overall bottom line, you'd consider getting out of that business. I know there are a lot of people out in the marketplace that would be very interested in that business. What is the timeline on that business?

For the sale of that business right now I'm going to pass this off to Jon Painter who is responsible for it, but I can tell you this. We are putting all of our effort in that business right now to sell it. I am going to let Jon comment as he is closest to it.

As you may know at the end of the third quarter we did announce that we intended to sell this business and we're sort of moving through that process. And at the time of the call where we announced it, we did receive a note from qualified and very interested parties who were currently in discussions with us, so --

Is that something we could see in the first half of the year or --?

It's always difficult -- I think, at this stage. It is difficult to put some timing on it. My experience is that from the time you've gone from a letter of intent with someone it is at least a couple of months and we are not at that point yet.

Claudia Shank with J.P. Morgan.

Just a couple of questions. One, what was the earnings impact of foreign exchange gain in the quarter?

That is an interesting one, Claudia, because normally with a weaker dollar you would expect the impact would be favorable. But because of the losses in Lamort the impact actually is unfavorable. Translating that back into higher U.S. dollar losses. So the impact was 2 cents actually unfavorable to us in the quarter.

Just if we could maybe dig in to the China issue a little bit and comment on how things are going. I think you said that you had 9 million in contracts at the end of the third quarter that hadn't been booked. Did that then translate to the 7.5 million in bookings in the fourth quarter?

That did not.

Of that 9 million, Claudia, none of those orders actually were booked in the fourth quarter. They are still -- again we are very confident of those orders. We have the contracts but we still -- the customers have still not been able to arrange their financing yet. So those are still pending and again we have high confidence level in getting those bookings I would say during the first half of the year.

Then comments, generally, on how conditions are in China and how overall demand in order indications looking right now?

From the information we're getting out of China it still looks very strong for us and we anticipate another good year in China. I think that the delays in issuing some of those by getting financing for some of those projects and that pipeline is now going to start to come through and we can see there's other projects that are coming on the earlier stages in the process. So we continue to be encouraged on China.

Did you buy back any shares during the quarter?

No, we did not.

Any update on what you're doing with cash? Thoughts on the cash?

That's a question we get often and we do. We are taking the cash very seriously. We worked hard to earn it and now that we have it, we want to put it to work and get a good return. We do look at -- certainly we have authorization in for stock buyback which is always an option for us. We take a look at some R&D activity for internal growth. But, also, we are looking very carefully and focusing as well on acquisitions and acquisitions that would again fit what we do within the paper industry that have the same type of aftermarket value, that they have a good global approach, and it's something I would add a lot of value to the papermaking process. Either through reduction of cost or enhancing the value of the product and that has a very good technology. So we certainly have identified some potential candidates and we are looking carefully at them right at this point.

Edmond Griffin with Blackrock Capital.

Follow-up to her question on the cash flow. As a company you -- year after year, you produce free cash flow. So it seems sort of -- that's a decent amount of cash on the balance sheet that I would think you would want to put to work and when you talk about get a good return, investing in your own stock would be a good return to shareholders. I know it is hard to put a timeframe on things but I guess what sort of timeframe would you expect investors to see you do something with that cash instead of just building up on the balance sheet?

I would say that certainly if you look at it, certainly something within the first half of this year. (MULTIPLE SPEAKERS) because I agree with what you said and also this is -- the stock buyback program certainly is something that we have authorization for. Last year we didn't buy back over $10 million of stock and we intend to look at that very carefully as well as as a company, we are looking very carefully at acquisitions at this point.

So in the first half of this year we should see some sort of cash deployment?

Yes, you should.

Following up on the restructuring in France, I think the charge was about 9 million. Can you break that out for us and provide a little more color what's all in there?

One of the things we can say is typically people want to know is, is it all cash or is there some asset write-offs and things like that involved. I would say it's virtually all cash. We expect that cash flow will happen sometimes toward the middle part of the year. It's all related to employee severance and related types of expenditures.

So there's no actual -- it didn't flow through on the cash flow statement? That will be -- .

It hasn't yet because the cash hasn't been expended yet. (MULTIPLE SPEAKERS) provided for in the fourth quarter and the cash impact will be taken sometime in 2005.

And then it's all related to the restructuring. It's, certainly, we got legal issues, consulting issues, we got severance pay (inaudible). A whole series of expense to get to where we want to be.

Then I guess while we are talking about the cash can you just walk me through the primary differences between your cash flow around the 20 million cash from operations in '03 to the 13 million in '04? I think you said -- you mentioned one item that represented I think maybe 3 or 4 million.

I'm going to let Tom respond to this.

I think the two biggest items in there, No. 1, would be the reduction in net income. And then the second item would be, we did in 2003 reduce working capital by about $4 million approximately. So we pulled about 4 million in cash out of working capital. I think those 2 items combined are really the two major items in (MULTIPLE SPEAKERS) from year-to-year.

But it wasn't a reflection of any sort of cash that actually went out the door due to the restructuring?

No. (MULTIPLE SPEAKERS) hasn't really been any cash (inaudible).

Lastly looking at your guidance, you put in there that in terms of turnaround in France, in the second half of the year, is that a turnaround in the operations -- manufacturing operations? Or is that in the end markets or both?

It's primarily within our operations within that Lamort itself internal operations and, again, it is the plan that was put together by our French team which I think really gets Lamort on solid footing. That's independent of any -- and improvement is going to come about independent of any market improvement.

Okay, so completely independent (inaudible).

Right. That's something that is in their hands for change.

That you can actually control.

Right.

Brent Miley with Rutabaga Capital.

In Europe, the weakness kind of the accessory side, is that all Lamort related and is that something to do with a market share loss? Or is that more or less execution thing or is it a secular weakness in that geography?

It's primarily related to a couple of factors. One is, there is a softness in the European market which is impacting us and so it is all related to that and in that market, even though it is starting to show some small signs of recent improvement, especially in a couple of areas like magazine and so forth, coated grades, in general it has been a softer market. Our market share that we can figure out on all of our product lines has been maintained.

So this is more or less -- they are not running the same operating rates as say they are here in the U.S. at this point?

Right, they're a little bit softer. And on top of that we also -- there is some impact coming out of Lamort because of the cost structure we have in place at this point.

On the composite spec'ing the sale of that business you mentioned in your discussions and obviously I understand you can't say a whole heck of a lot. Have you been able to maintain your market position as you have been in these discussions in terms of keeping your distributors and actually having reasonable success with the product?

We have been very encouraged by that. I'm going to let Jon respond to that.

I would say, Brent, I did have a concern about that given the amounts that we made in November. But I'm happy to report that we have kept all of our distributors and in fact, we booked in the fourth quarter just under $9 million, which is our highest booking quarter. So we did end up talking to all of our customers and -- but I was very pleased by the way they responded.

In terms of resolving the claims that you had outstanding that was kind of led to this, the whole thing, have those been -- in other words again that's related to keeping your distributors and your customers happy -- have those been resolved to their satisfaction I take it?

That is an ongoing thing; and I think one of the reasons they have been so supportive of us is we have been supportive of them. And we have continued to take care of the problems as they arrive. And the charge that we took at the end of the third quarter was really to -- in anticipation of that.

And that has proved adequate to this point?

Yes. The bottom line, we did increase the warranty reserve by around $800,000 in the fourth quarter. That has as much to do with the returns that we had from the fee we had a little bit larger, where we were turning product from our distributors.

So that's (indiscernible) better that then having it be installed?

Yes. We are actually pleased about that. Because it's better to get it before it's installed (inaudible).

Just to go back to the China business. Is it fair for me to interpret what you said earlier? The financing delays have been -- the delays have been there but they have been steadily releasing things. Should that just be termed where it's slow but steady? Is that a fair way to look at it? Obviously that is not the biggest part of your business but it's nice to get that kind of whole new system business into the P&L. Is that kind of a fair way to characterize it?

Yes, it is. And they slowed the process down but they certainly have been releasing the projects. And like I said, we have got a number of those within the pipeline right now and some further down that we see, so we are very encouraged by that. They really do have a need to build up the paper industry and I think that the outlook survey for the next decade is very strong in China. We are fortunate to have a great market position that will take advantage of that growth. That's a nice opportunity for us.

One last thing, again, somebody asked earlier the paper industry outlook and that is, obviously, a broad question. Have you seen an uptick in either RFQs or actually are folks actually talking about potential capacity additions at this point? Or are they just happy that they are not continuing to get really have difficult conditions or just not condition -- sorry. The difficult conditions are not continuing?

I think what we see in North America and in Western Europe, primarily, is more fixing up what they have, enhancing their present equipment as opposed to capacity expansion. There is going to be some replacement of that capacity, they're operating with a very aged (ph) machine base; and I think that is where we see the opportunity. We see capacity being added in areas like Eastern Europe, India, South America and suddenly China, but the whole Southeast Asia is becoming a very attractive market.

Okay so North America and Europe are primarily upgrade markets, still?

Which to us I think can be very very valuable because we are really armed, I think, with the right products to help enhance the operation of the paper machines as well as help them reduce the costs. And we have had some products that can very quickly turn that can be measured in a matter of months. I think they're now getting healthy enough that hopefully they are going to take advantage of that.

One last thing I would just mention is that, obviously, with the cash on the balance sheet in earlier call was mentioning that they'd love to see that get put to work and I would disagree with that but I would like to say that obviously we'd much rather see the buying shares or pay a dividend or even let it sit there as opposed to rushing into an acquisition and I know you know that but I thought I'd just echo that because your acquisitions can be tough. And any way be patient if need be obviously like I say I have no problem if you want to buy shares or pay dividends or use it some other way but just sort I guess like I said I'd rather see them (indiscernible) acquisition.

Thank you very much. In fact I can second that. Those are -- as you well know, we are really conservatives in the way we operate and to give you some comfort, the last acquisition we made was in 1997. We have been looking for a long period of time and, again, we have said no a lot. There have been a lot of acquisitions out there we've turned down and won't even look at. It has to be a very high-quality acquisition. I can also tell you that the acquisition we've made in the past have been very successful for us as well. So we share your sentiments.

John Griffin with Wedge Capital.

A few disparate questions. Could you give a little more color on the increase the warranty (ph) reserve? Are there -- are the problems just a little bit more widespread than you had thought or are there new issues cropping up or is this not a big deal?

I should tell you that each quarter we do an assessment with new data in terms of the size of actual or two reserve for future clients. That's readjusted every quarter. The bigger adjustment in the fourth quarter was the fact that we had more returns than we anticipated. When we brought back stuff in the field, we actually ended up using around $800,000 in the fourth quarter associated with bring material back that was in distribution. Actual claims are maybe about the same.

Another question. You mentioned something about the plant that you are building in China and I think that was to make accessories and there has been a delay due to bureaucratic factors. Could you explain that a little more and give us a sense of how long you expect those delays to be? Or if this is the serious issue or not?

No we know believe we can start construction on that probably sometime this spring. Delays were caused by the zone that we were in. They slowed everything in the permitting down for that zone. So we anticipate that going in and that plant initially is going to be because we are now shipping product to U.S.

And we're going to be outsourcing more of those components that we outsource now in the U.S. within China and do some assembly there for our recycling systems. That will also become a base as well, you're right, for our accessories and modern management. We are going to take advantage of the brand-name recognition of Kadant to penetrate that market as well.

Last question I had. The new booking that you announced recently to Sappi in South America. Do you happen to know is that a new plant or is that a replacement of old equipment or --?

This is in Sappi in South Africa and it is for an existing mill.

(OPERATOR INSTRUCTIONS) Allen Fournier (ph) with Penn & Capital.

I don't want to beat a dead horse but I am just trying to understand the situation in France and your description of what happened there as a little softness that was identified by the management team doesn't seem to be consistent with the charges that are being taken in the P&L hit and so forth that we are seeing on an ongoing basis. Could you try to help me get a little more comfortable with what happened there?

To do anything in France is just restructuring, it's a very expensive process.

No I'm not talking about that. I was talking about what happened to drive the need for this restructuring? It sounds like it's a lot more significant than a little softness in the business.

You're right. It is not only the soft market. It's just that the cost really has gotten out of hand over the last couple of years and this is why I replaced the management team that was in place. At the same time, I can tell you, Allen, that we would -- we did the same thing throughout all of our operations in North America and in Canada. But it's just a much quicker process because it is the process that has really harmed us as well. But also I can tell you that we have a management team in place and have had in place since this summer that has been very responsive to this.

As we look into '05, your revenue and margin guidance. There's a disconnect versus a history that I think is attributable to those operations. Could you help us understand the order of magnitude these operations are impacting margins versus other factors in '05?

Tom?

I think if you look, Allen, at our operating income for the paper segment now in 2004, excluding the restructuring charge, it is a little over 11 percent. And we would have expected that to have been at least at a couple of hundred basis points higher in 2005. I'd say they are impacting the operating margin by at least a couple of hundred basis points in 2005.

These are the French operations only?

Yes, the French operations. I made the remark in my comments that on the product gross margins alone, had we factored out the Lamort operations from both periods, the product gross margins would have been roughly the same in the fourth quarter of '04, fourth quarter of '03, be roughly 41 percent. Product gross margin side was up 3 to 4 points there.

So all else being equal in '06, we should see several hundred basis points of margin improvement?

Yes yes. I mean, we have targeted -- I know we have talked to you and others in the past that our goal in the paper segment is to get back to 15, 16 plus percent operating margins in that business. I think quite frankly, I think we would have been well on our way to doing that in 2005 were it not for the situation with Lamort. But I think we (indiscernible) for 2006 for sure.

What should give some confidence as well, Allen, is we are going to take Lamort back to the level -- return them to their level of profitability that they had in the past.

I guess, given, if you think you can achieve this given the amount of cash in the balance sheet and what I calculate to normalized earnings power, it strikes me as waiting for that acquisition to come along which you have been waiting for for, I guess eight years, and holding our cash prior to this '06 improvement doesn't make sense. Can you help me understand why that makes sense?

Why we would hold the cash?

Yes. If you have $2 in earnings power plus $6 in cash and the balance sheet your stock theoretically would trade at 50 percent higher than where it is today. So why continue to wait for an acquisition to use that cash when we haven't seen anything that has been interesting for eight years, given the sort of abnormally low earnings power the business is earning today? And therefore the opportunity we have to invest in operations that we understand very well?

I can tell you and let me answer this way. We have been looking a long time for acquisitions. And right now we see some opportunities out there and this is also -- I would say it's a good time for us to acquire because the industry is in Europe and North America has been relatively soft. And so we are not buying at the top of the market and we believe that there may be some opportunities out there for us to deploy the cash that we have and achieve a good return.

I, guess given what happened with the decking business and now the French operations I would like to say I have complete confidence in exploring acquisitions, but I would vote with your other shareholders that (indiscernible) you on the call that investing in your Company and your operations at this point given the stock price makes me a lot more comfortable than taking on an acquisition. Just as an editorial comment. I will leave it there.

Nope. I can understand that and I can tell you this. We continue to invest in our operations as we see a need to and continue to invest in R&D. But I understand what you're saying. This is also why we are investing in China by the way, as well. But thank you Allen.

Bob Zniewsi (ph) with Charwell Investments.

I have to just reiterate what the last caller and the other callers are saying. You have a situation where you are rationalizing over in France which I'm having a hard time understanding what is going on. And then you're trying to sell another business. And yet you want to go out and purchase a new business that is something that may be unrelated to what you have. And I think that right now would be best for shareholders if that cash and -- great for the stock price, I might add -- and we went through this in our meeting last December when you came through is either a onetime dividend initiation of dividend or a large stock buyback.

It sounds as if you are stretching yourselves fairly thin and the best way to get the stock up and make shareholders happy is to follow the route of the path of least resistance.

I understand that as well and we look at that very seriously. On the other hand, I just want to reiterate there is some sort of misunderstanding, that any business that we are looking at is directly related to what we do within the paper industry. And it would relate to more to what we do and say in our accessory, water management side of the business as a great aftermarket. So it is aligned, it's a business that we know very well. And I will tell you that all the operations that we have had, with the exception of France -- and if that would've been in a different location it would been dealt with much differently than it needs to be dealt with because it is in France -- we have certainly responded very quickly in optimizing those businesses. And as a result when there is a pickup in the market we're going to get a big game. So if there's anything that we would have, it would be high-quality (indiscernible) we know we would get very good returns on.

Again as many other shareholders have said, we look forward more to a stock buyback or a dividend and then fix the problems that you have now. And then you have such a healthy balance sheet, you can go on and do an acquisition later once you've gotten these things behind you. So that's all I want to say. That's my comment.

Okay. Fair enough.

Thank you. At this time I would like to turn the floor back over to Mr. Rainville for any closing remarks.

Thank you operator. I just want to close by saying first off, thank you very much for your interest in the questions that you presented because we take all your input very seriously. I would just close by saying that we believe that Kadant has a number of opportunities to generate growth this year and beyond. Although demand for our products has lagged (ph) industry improvement we stand to benefit from any increase in CapEx as well as the industry's focus on greater productivity for which our equipment is ideally suited. Our restructuring activities in France as we discussed will lead to a significant improvement there, independent of market conditions. We plan to put our strong balance sheet to work through the various options available to us for generating shareholder value. We look forward to reporting on our progress next quarter. Thanks again for your time.

Thank you. This does conclude today's conference.