Kadant Inc (KAI) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. My name is Ian and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Kadant Incorporated third quarter, 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, please press star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. It is now my pleasure to turn the floor over to your host, Mr. Thomas O'Brien, CFO. Sir, you may begin your conference.

Thank you. Good morning, everyone and welcome to Kadant's third quarter earnings call. With us on the call today is Bill Rainville, our Chairman and Chief Executive Officer. Before we begin, let me read the safe harbor statement. Various remarks that we may make today about Kadant's future expectations, plans and prospects are forward-looking statements for purpose 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 July 2, 2005, which is on file with the SEC and is also available on the investors section of our website at www.kadant.com under the heading "SEC Filings." In addition, any forward-looking statements which we make on this call will represent our views only as of today. While we may elect to update forward looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change and you should not rely on these forward-looking statements as representing our views on any date after today.

During this call, we will refer to some non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principals. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is contained in our third 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."

Let me also remind you that in discussing our financial performance, all references are to our continuing operations and do not include the performance of our discontinued operation, the products business, unless we expressly state otherwise. With that, I will turn the call over to Bill Rainville who will give you an update on Kadant's business and future prospects. Following Bill's remarks, I will give an overview of our financial results for the quarter and we will then have a Q&A session. Bill?

Thanks, Tom. Good morning everyone, and thank you for joining us today. As you can see in our press release, the third quarter estimate start us off in North American pulp paper industry and continued weakness as well in Europe. We also announced that we significantly lowered our guidance for the year based on a less favorable outlook for Q4, which is the result of several issues that I'll cover in my overview.

First, let's review the financial highlights in Q2. Revenues from continuing operations increased 33% to 64.8 million. That includes a $17.7 million contribution from the Kadant Johnson acquisition. Our diluted EPS from continuing operations was $0.19. We reported EBITDA performance of 7.2 million, including 2.7 million from Kadant Johnson. In addition, we generated excellent cashflows in the quarter with 6.3 million in cash from operations compared with negative 2 million a year ago. We also continue to buy back our stock with 3.4 million of repurchases in the quarter. These results do not include the discontinued composite building products business which was recently sold for slightly above book value.

Now I'd like to review our papermaking system segment by our key geographic markets, outlining where the opportunities are, what issues we face, and the actions we are taking to improve our competitive position. North America. Early this year, pulp and paper producers in North America indicated that the increased spending, based on a modest line of demand in operating areas. Unfortunately, the level of CapEx has been far less than anticipated due to continued spending constraints. Soft demand for capital products have affected our North American operations, especially our paper machine accessories and water management product lines. We've taken several steps to lower our operating costs in response to these conditions. For example, we've combined our water management and accessory sales force in North America. These two units call on the same customers and the product lines are complementary. By taking the best from each group and forming one sales organization, we were able to improve the caliber of our sales force and reduce the size of individual territories. Smaller territories means less drive time and more face time with customers. We view this structure successfully in other parts of world.

We're also closing our facility in Rayville, Louisiana, where we manufacture stock preparation equipment for markets in North America and China. Rayville operations are being consolidated with our facility near Mobile, Alabama, for outsource. A reduction in manufacturing in North America is necessary as we shift toward lower cost regions such as China. In total, we plan to take approximately $700,000 of charges in Q4 to implement this restructuring. We expect these actions to yield approximately 2.4 million in annual savings in addition to allowing us to more effectively serve our customers.

North American producers have postponed many critical investments, but will eventually need to upgrade equipment to lower their operating cost to remain competitive. The higher cost of energy underscores the need to increase process efficiencies. This is where we see opportunities for Kadant. As an example, we recently received a $4 million order from a major North American pulp and paper producer for evaporation equipment and related installation services. Our system is designed to reduce energy consumption, as well as recover and reuse more chemicals during the pulping process. We are seeing stronger quarter activity for a number of our capital products, especially in our accessories product line. These quotes have not yet translated into orders, but we are encouraged by modest sequential increase in accessory orders this quarter over last.

The Western European market is facing issues similar to those in North America, and in some areas, is even weaker. As you know, our Kadant Lamort subsidiary in France has been struggling in this environment. We expected Kadant Lamort to regain profitability by year end following implementation of their major restructure initiated earlier this year. The restructuring is expected to be substantially completed by the end of this year, but it's progressing somewhat slower than we had planned.

In addition, a major order from a Middle East customer, which we expected to record as fourth quarter revenue, was delayed. This combination has led to a projected loss for Kadant Lamort in Q4 and will push their profitability into 2006. On a positive note, we were notified yesterday that we did receive the Middle Eastern order for a $6 million de-inking system that is part of a major expansion product. This order will not contribute to Kadant Lamort's Q4 results, but it does help that business get off to a good start in 2006. Kadant Lamort not only serves Western Europe, but also has a strong presence in growing markets in Eastern Europe, South America, as well as Africa, Southeast Asia, and the Middle East, as evidenced by the recent order. In a press release announcing the order, the customer cited that Kadant was chosen, "on the grounds of their extensive experience in recycling of waste paper and de-inking technology." Armed with a growing technology, a global presence, and a lower cost structure, we believe that Kadant Lamort will emerge a stronger competitor in the marketplace.

China remains Kadant's most significant growth market and we continue to experience strong demand for stock preparation systems used to produce recycled paper and packaging. In the third quarter, we booked $10.4 million in orders, our largest booking quarter since Q4 of 2003. The timing and forecasting of orders in China, however, remains a challenge due to government- imposed delays on customer financing. Several prospective orders that we expected in the quarter as revenues in the fourth quarter have not been booked in time. Tom will cover the breakdown here in more detail. But the point is that the resulting shortfall in revenues from China in Q4 is a primary cause of our lower expectations for the quarter and 2005 overall. Still, Asia presents a major long-term opportunity, with China alone expected to add approximately 30 million tons of capacity in the next five years. This represents more than one-third of current U.S. capacity. As a result, we continue to strengthen our position there in all our product lines.

In a significant new development, today we signed a non-binding letter of intent to a well-known supplier in Asia. If completed, this acquisition will add a low cost, state of the art production facility located between Beijing and Shanghai that will become Kadant's manufacturing base in Asia. This will greatly expand our market coverage there. This is a manufacturing facility that is only two years old and has 400,000 square feet. It has complementary technology addressing and serving smaller paper mills. The expected purchase price is approximately $20 million, subject to change. As usual, the acquisition is subject to signing a definitive agreement, customary conditions, and regulatory approvals. We've known this company for a number of years and have worked with them on developing a wet stream basket. This basket is advanced technology, it is labor-intent, and it is a key part of the screening process. In baskets represent the most important component in the aftermarket sales of stock prep. This facility is ideal to serve the Asian market as well as being a stock prep component supplier to North America and Europe. We will also use this facility to manufacture accessories and water management capital equipment.

We're also continuing to capitalize on Kadant Johnson's market presence and fluid handling systems and the ability to cost effectively manufacture in Shanghai and outsource to North America and Europe. Our increased manufacturing capability will support the introduction of our accessories and water management products in Asia. By leveraging the Kadant brand, we plan to take advantage of growing market, after market opportunities that become available as we expand our base.

We are also exploring opportunities to address other industrial markets for all their product lines by taking advantage of Kadant Johnson's process knowledge, their market penetration in the mechanical field. I'm pleased to note that integration of Kadant Johnson is progressing as planned and this business continues to perform very well. We are already starting to see benefits from collaborative sales tactics from Kadant Johnson fluid handling group and other Kadant product lines.

Most of Kadant Johnson products are used in the drier section which requires more energy than any other paper making stage. With today's focus on lowering energy costs, the payback to customers for this type of equipment is even more compelling.

We have clearly a number of opportunities for the long-term, even though recent developments have affected our near-term outlook. As you saw in the release, we are expecting to report GAAP EPS of $0.04 to $0.07 on revenues of 60 to 62 million in Q4. As I explained, the primary factors for this decline are the timing of orders in China, a soft demand in North America which is restructuring, and the delayed profitability at Kadant Lamort. The fourth quarter estimate has caused us to significantly lower our guidance for the year, which we now expect to be in the range of $0.67 to $0.70 of GAAP EPS on revenues of 240 to 242 million. Our solid financial performance so far this year has been affected by these recent developments. However, we expect to accomplish the majority of the goals we established at the beginning of 2005 and this will improve our performance going forward.

Early in the year, we set out to sell a composites building products business, to complete the restructuring in France, to increase our manufacturing capabilities in China, to integrate Kadant Johnson, and to leverage our installed based and market sales as well as expand market penetration outside of paper. We've achieved a number of these objectives and continue to make good progress on the rest. Most important, our actions this year position us to take advantage of future opportunities for growth. I'll now turn the call over to Tom for the financial overview. Tom?

Thank, Bill. I'll start with our revenues. Consolidated revenues was 64.8 million in the third quarter of 2005, 33% higher than last year, including a 36% increase from our recent acquisition, Kadant Johnson, which added slightly under 18 million in revenues in the quarter. There was no material effect from foreign currency translation on the consolidated revenues in this quarter compared to a year ago. I should also note that these consolidated revenue results are the low end of our guidance for the quarter, which was 65 to 67 million.

Now let's turn to the third quarter revenue performance in more detail starting with our papermaking system segment. Revenues in the papermaking system segment were 62.9 million, 32% higher than last year, due entirely to the additional revenues from Kadant Johnson which had the effect of increasing revenues by 35% compared to the third quarter of 2004. With the acquisition of Kadant Johnson, we are now recording four product lines in this segment -- accessories, stock preparation, water management, and fluid handling. Fluid handling includes most of the Kadant Johnson revenues with a small portion of the products business included in the other category. So beginning with accessories. Revenues in our accessories product line were $13.4 million, down 5% compared to last year's third quarter. Revenues were down 3% in North America, including a 2% favorable impact from foreign exchange. European revenues were down 7%, including a 1% unfavorable impact from exchange. The European decline included a 12% decrease in our Kadant Lamort subsidiary. Demand in this product line remains soft, particularly in the capital portion of this business, as our customers continue to focus on reducing capacity and cutting costs. On a more encouraging note, as Bill mentioned, we have seen stronger quarter activity for our capital products reflecting what we believe are the unaddressed equipment replacement needs of individual mills, although they are still under tight spending constraints.

In our stock prep product line, revenues are 24.3 million in the third quarter of 2005, down 7% compared to last year. Revenues in China and in our North America based operations were up 9% and 2% respectively, offset entirely by a 30% decline in Europe, again due to lower capital equipment revenues. Revenues in our water management product line were 7.1 million, up 17% from last year, including a 2% favorable effect from foreign currency. Revenues in this product line continue to be quite weak in Europe, down 9% from last year, including a 1% unfavorable impact from exchange. We are starting to see signs of improvement in North America, however, where revenues increased 20% compared to last year's third quarter, including solid performances in both parts and capital equipment.

Our newest product line in this recording segment, fluid handling, which includes most of the Kadant Johnson business, reported revenues of 16.7 million in its first full quarter as part of Kadant. This was somewhat below our internal targets and the shortfall occurred principally in the U.S. based operations, particularly in the southeast region, which is based in New Orleans, and which had significant operating disruptions caused by the hurricanes there and in Texas.

Now let's turn to the revenue performance in our other category. Revenues here include our privately product line as well as the results of Kadant Johnson's casting parts operations. Revenues in our granular product line were $0.9 million in the third quarter of 2005, down 26% from last year's quarter. This follows a strong first half performance where revenues increased 43% over the comparable period last year. The third quarter overall decline was widely due to the timing of buy back orders from two large customers. The remaining revenues from this category, approximately 1 million, were from the casting products business of Kadant Johnson.

Turning to our product gross margins, consolidated product gross margins were 30.5% in the third quarter of 2005, up 130 basis points from last year's 39.2%. In our papermaking system segment, product gross margins were 41.5%, up 260 basis points from last year. There were several major items that affected our product gross margins this quarter. First, the inclusion of Kadant Johnson had the effect of increasing margins in the segment by approximately 340 basis points. Next we reduced quantity reserve on our North America stock prep business, largely due to significantly improved claims experience and this had the effect of increasing margins by approximately 100 basis points. Partly offsetting the favorable effects, however, were lower margins in our Kadant Lamort subsidiary, which reduced consolidated product gross margins by approximately 110 basis points. The Lamort decline was largely due to lower margins in the stock prep product line, partly as a result of labor variances and an underabsorption of overhead associated with the lower sales volume. Consolidated margins were also decreased to a lesser extent by an unfavorable product mix in our lower margins on [inaudible].

Product gross margins in the other category were down from 31% in the third quarter of '04 to 7% in the third quarter of '05, mainly due to inclusion of Kadant Johnson's casting products operation, which is a low gross margin business, and to lower gross margins in our granular product line. We expect margins will continue to come under pressure in this product line due to significantly higher costs of natural gas which is used in the manufacturing process.

Now let's look at our SG&A expenses for a moment. SG&A expenses were 20.3 million in the third quarter of 2005, up 6 million from last year. This increase includes 7.1 million of SG&A from Kadant Johnson. Excluding this amount resulting from the acquisition, SG&A expenses were down 1.1 million compared to the third quarter of 2004, partly due to a reduction in incentive compensation accruals and also to various expense reductions in the papermaking equipment system segment.

Turning to EBITDA. With the acquisition of Kadant Johnson earlier this year, we are incurring several significant non-cash charges in our consolidated P&L as required by U.S. GAAP Purchase Accounting Standards. Since these charges are the resulting reductions in operating income are aggregate material to our results, we believe that reporting of EBITDA is now instructive to a better understanding of our operating results. You will see the EBITDA numbers and the reconciliation to the most comparable GAAP measure, which is operating income, in the table included in our press release. Consolidated EBITDA was $7.2 million in third quarter '05, an increase of 2.2 million from last year. Of the 2.2 million increase, 2.7 million was due to the acquisition of Kadant Johnson. It is important to note that Kadant Johnson's quarterly EBITDA excludes approximately 700,000 of fixed asset depreciation resulting partly from a revaluation of the assets upon acquisition, and approximately 500,000 of intangible amortization, again largely a result of U.S. GAAP purchase accounting requirements.

In addition, during each full quarter of 2005, we are incurring a non-cash charge of approximately 400,000 which represents the amortization of the profit and inventory at the time of acquisition. This will be largely amortized by year end. It will not be material in 2006. The total of these non-cash charges for Kadant Johnson, which reduced operating income but are added back into the EBITDA results, were approximately 1.6 million in the third quarter of 2005 and a similar amount will be incurred in the fourth quarter.

Our papermaking system segment of EBITDA was 8.4 million in the third quarter of '05, up 36%, or 2.2 million from last year. Again, this increase was entirely due to the inclusion of Kadant Johnson's EBITDA of 2.6 million in this segment.

In our corporate and other category, which includes the results of the Kadant Johnson casting products business, plus our fire based granular business and our corporate expenses, we reported an EBITDA loss of 1.2 million equal to last year's result.

Let's go to EPS. We reported GAAP diluted earnings per share, including the discontinued operation, of $0.03 in the third quarter of 2005 compared to a loss of $0.03 last year. Due largely to the warranty provisions recognized in both periods, the discontinued operation incurred losses of $0.16 and $0.25 in 2005 and 2004, respectively. Excluding the results from the discontinued operation in both periods and gains of $0.01 in both periods associated with reductions in our tax reserves and a gain in the 2004 period from the sale of a small subsidiary in Latin America, adjusted diluted EPS was $0.18 in third quarter '05, compared to $0.20 last year. You can see these amounts in the reconciliation from GAAP to adjusted diluted EPS in the chart attached to the press release. The $0.02 reduction of adjusted diluted EPS in 2005 compared to last year consists of approximately $0.04 attributable to higher losses in our Kadant Lamort subsidiary offset partly by improved results in our other operating units. e addition of Kadant Johnson had no material effect on our consolidated diluted EPS results in the third quarter of '05, after taking into account the lower interest income and higher interest expense associated with having made the acquisition. The impacts from foreign exchange, lower diluted shares and a slightly higher recurring effective tax rate were all immaterial to diluted EPS in the third quarter of 2005.

Let me spend a few moments on the balance sheet and our cash flows. We ended the third quarter with slightly less than 43 million in cash and 58 million in debt, leaving us with a net debt position of around 15 million. Net debt as a percentage of our total capital is approximately 7%, virtually the same as last quarter. During the quarter, we paid off 3.3 million of our debt. We spent 3.4 million to buy back our common stock, and we purchased 1 million of property plant and equipment. As planned, we also purchased the remaining minority interest in one of Kadant Johnson's subsidiaries for approximately 1.1 million.

Now changing focus from to cash for a moment, we have strong cash flow from operating activities in the third quarter of 2005. Operating cash flow was 6.3 million in 3Q '05 compared to a negative operating cash flow of 2 million last year. For the first nine months of 2005, cash flow from operating activities was 11.2 million, up 77% from the year ago period. Our cash balance will further increase in the fourth quarter of 2005 as a result of the recently announced sale of the composite building products business. We sold the business for approximately 11.1 million and the assumption of 1.4 million in liabilities by the buyer. Our net proceeds after selling costs will be 10.5 million. We expect to record an immaterial gain from the sale in the fourth quarter. Of the 10.5 million in net cash proceeds, 3.5 million has been deposited into an escrow account, which the buyer will administer to pay claims and approximately 1.3 million has been deposited in escrow in similar accounts set aside for potential associated with the sale. We will see a net increase in our nonrestricted cash of approximately 5.7 million in the fourth quarter of 2005, resulting from the sale.

Before concluding my remarks, I'd like to give you some additional details on the significant reduction in our guidance for 2005. As you've already heard, we are taking our EPS guidance for the year down from a range of $0.92 to $1.00 to a range of $0.67 to $0.70. This means that at the low end of the range, we are taking EPS down by approximately $0.25 from our previous guidance and I'll now summarize some of the major factors contributing to that decline. First, we have several major prospective orders from China, which we expected to close early on in the third quarter so we would be taking revenue on them in the fourth quarter. For various reasons, including delays incurred by the customers in obtaining their project financing, these prospective orders are now expected to book either late in the fourth quarter or in early 2006. In total, they resulted in a fourth quarter EPS decline of $0.09, including a favorable manufacturing and engineering absorption associated with the lower volume.

Similarly, in Kadant Lamort, we had expected to book in the third quarter of '05, a 6 million stock prep order which is part of the 10 million in orders we announced today in our press release. We had planned to begin recognizing revenue by a percent accounting in the fourth quarter on this order. Hearing the delay on receiving the order only a small portion will be taken to revenue in the fourth quarter of 2005. The EPS impact in 4Q '05 of this delay, combined with the somewhat slower completion of the restructuring plan in Kadant Lamort, contributed to lower earnings there which affected the consolidated fourth quarter '05 EPS by approximately $0.05.

Next, as Bill noted, we are undertaking restructuring actions in several of our operations in response to the continuing weak market conditions in North America and Europe. These actions will cost approximately 1.1 million in pretax restructuring and other nonrecurring costs including approximately 400,000 of additional restructuring costs in Kadant Lamort. They will decrease fourth quarter '05 EPS by $0.05. Accordingly, once these are implemented currently in the first quarter of 2006, these actions will generate approximately 2.4 million in annual cost savings, all in North America.

Another factor effecting the reduction in fourth quarter '05 guidance is weaker than expected performance in our North America accessory business. We had expected an upturn in this business in the latter half of the year which we do not now believe will materialize and this will reduce EPS by $0.04 from earlier guidance.

Finally, our EPS guidance was lowered by $0.01 due to higher natural gas prices affecting the profitability of our granular products business. So to briefly recap, EPS was lowered $0.09 due to China, $0.05 due to Kadant Lamort, $0.05 due to restructuring, $0.04 due to the weak conditions in the North America accessory business, and $0.01 due to the fiber based granular products business.

In light of what I just reviewed, let's look beyond the fourth quarter of 2005 for a moment. Although predicting the receipt of large orders is always difficult, we expect a solid performance in the fourth quarter for stock prep bookings, including several large orders from China and the large order recently booked by Kadant Lamort. These orders should be recognized as revenue throughout the first half of 2006. Further, in addition to the restructuring costs I noted a moment ago of $0.05, there are approximately another $0.05 of nonrecurring items which are decreasing our EPS in the fourth quarter '05 and which will not recur in the first quarter of '06, including the writedown of the acquired profit of Kadant Johnson's inventory, the underabsorption in our North America stock prep operation, the remaining cost associated with our closure of our manufacturing facility in Louisiana, and several other one-time costs.

We are about to embark on our annual budgeting process with our subsidiaries and plan to give you guidance for 2006 during our February, 2006 earnings conference call. Although we are not in a position now to give you that guidance, we do want to convey our expectations that the fourth quarter of 2005 reflects a number of unusual circumstances and by no means represents our expectations of the quarterly run rate going forward in 2006.

Further, looking at the full year, when we acquired Kadant Johnson, we noted that we expected an increase of approximately $0.25 in 2006. This would result in an increase of approximately $0.20 over the expected contribution in 2005. Also, a return by Kadant to more than just break even results in 2006, a level which quite frankly would be a disappointment to us, would increase 2006 EPS by approximately $0.16 over 2005. Operating income of 4% there in 2006 would increase EPS by approximately $0.27. As you can see, we have a number of opportunities to improve our performance significantly next year. With that, I will conclude my review of the financials and turn the conference back to the operator for our Q&A session. Operator?

Thank you, at this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. Once again, if you do have a question, please press star, then one on your telephone at this time. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Claudia Shank with J.P. Morgan.

Good morning.

Good morning, Claudia.

How are you?

Just fine, thanks.

Just a couple of questions. One, in terms of the North American restructuring and the 2.4 million in savings, is there a timeframe associated with that as we look out to '06?

Yes, in fact, that's all going to be completed this quarter and we're going to get the full benefit of that in 2006.

Okay. And then, could you just maybe give us a little bit more color on the Asian/Chinese acquisition that you just sort of mentioned, the timing, the financing, I know it's sort of non-binding and a bit preliminary right now, but a little bit more color would be helpful.

I'll just give you a couple of additional comments on it. We're still in a process of negotiating the final terms so I don't want to give away too much on some of it, as you can understand. But I can tell you this. This is a company that we've known for many years and have worked with. As we were looking to put a facility up in Beijing, this became a very desirable alternative for us because what it provided was a brand-new modern facility, state of the art manufacturing, that really is a solution to a number of issues for us because we've been manufacturing from high cost into low cost areas shipping from the U.S. So this allows us to really continue to penetrate the Chinese market, as well as gives us the ability to even provide the outsourcing for Lamort because we sized it properly so we can have outsourcing capability for Lamort. So we'll be sending components in similar to what Johnson has been doing in the North America and into Europe. As well as the basket business, it's a huge market opportunity for us and we've tested those baskets over the past couple of years in Europe and North America, and basically they can outperform any basket that is presently in the marketplace. Concerning the financing and so forth, I don't know if Tom would like a say a couple of words on that. I'll pass it to Tom.

Basically, Claudia, we'll finance part of it with our existing cash balances and we also intend to borrow some of the purchase price as well. We may borrow locally to do that.

Okay. And then, just with regard to China, I was wondering if you're -- obviously the capital side of the business is doing quite well there. Is there any presence yet on the accessory side and sort of the annuity portion that comes?

Yes. In fact, this operation that we just signed this letter of understanding with, this letter of intent, really would provide us a nice base to continue to serve on star base with after market products, as well as they have after market value on their own. I might add as well that they've actually been serving the smaller, lower tier mills throughout Asia and have a very good market presence there. Concerning accessories and water management, they certainly would have the capability to manufacture the capital side of that business, the doctors and the big showers and the plumbing devices and the filtration equipment. Now we would have between that operation and Johnson, ideal capabilities to really penetrate the market with our accessory business and our water management business, because for that type of business, you really do need a very strong, local presence, both in manufacturing service and in sales, as you know.

Thank you. I just had a couple more sort of financial questions. One, was just in terms of -- it looks like there was a restructuring charge in the quarter, relatively modest, but did that have any EPS impact? I think it was about 7, 8 million.

Yes. It was a small gain but it was immaterial, I think, to EPS. Didn't even round to a penny.

Okay. What should we be thinking about for the tax rate since it was a bit higher this quarter versus sort of prior quarters?

With the new accounting rules, we basically have to true up our effective tax rate now every quarter. We used to do a lot of it at year end. But anyway, you'll see most companies, I think, their rate will vary a little bit quarter to quarter. So ours did go up slightly this quarter and I would use about the same rate for the fourth quarter.

Okay. And then just on the share buyback, how much have you guys bought back now? What's left under the authorization?

Basically in the quarter, we bought back 3.4 million. The one thing we really have to look at more than the authorization is the limit under our credit agreement.

Right.

e would have left about 10.6 million left under that so with that agreement.

Thank you very much.

Okay. Thank you, Claudia.

Once again, if there are any remaining questions, please press star, then one on your telephone at this time. Our next question comes from Alan Fournier with Pennant Capital Management.

Good morning, gentleman.

Good morning, Allen.

I missed some of the comments you made towards the end of the call, Tom, regarding 2006 and potential upsides. I guess I would like you to sort of go over for me, it looks as if a number of these issues in Q4 will be positive as we head into 2006 and I was wondering if you could give us some overall levels of revenue and margin that would be sort of target ranges for next year.

Well, let me try to do it this way. Let me say that just to repeat that when we did the acquisition of Johnson, when we announced the acquisition of Johnson, we said that we believe that it would be accretive $0.25 cents in 2006. We're still on that target and that would represent an increase of say $0.20 in 2006 over last year. At the same time, we turned to Lamort, just some of the major items we had. Lamort basically was dilutive to us by $0.16 in 2005. They lost $0.16 in 2005. So simply breaking even as I noted, which isn't our goal, but if they were to simply break even, that would be a turn around of $0.16 in 2006 and if they were at 4% profitability, which even that isn't terrific, it would be a turnaround of $0.27. So we had some major opportunities to improve the results in 2006 over 2005 and as I mentioned, we're in the process of going through our budgets now with our subsidiaries. We're starting shortly and once we are through with that exercise and get into our February call, we'll announce our guidance at that time to you.

Well --

The fourth quarter, the fourth quarter does have a number of one time charges. The restructuring charges we had talked about, $0.05, and there are additional one-time items of about $0.05 as well. I think I mentioned those in my remarks. The underabsorption that we had in the stock prep business. We had to accelerate the write-off of our facility in Louisiana that we're consolidating into Theodore, things like that. Those all accumulated another about $0.05 in the fourth quarter. There's another item, well, it's included in the $0.05 cents, but I do want to point out that when we did the acquisition of Kadant Johnson, you had to write up basically the inventory, the acquired profit in that inventory, is amortized over a period. We're reducing our quarterly results by about $0.02 as a result of that charge. It's a non-cash charge and that will go away completely in 2006 as well. About $0.05 we are taking in 2005 will go away in 2006. As you can see, there are a number of these items that are impacting our 2005 results.

Well, it would also seem as if the delays in recognition of revenue would reverse the absorption issues.

Right.

Unless you think that there's a weak revenue environment moving into the 2006 and thus this will just sort of replace what would otherwise be a very weak environment. You understand what I'm saying?

Yes. I understand what you're saying. I don't think we're looking at -- of course, we have these large orders and it's hard to determine when they will fall. As we've announced, we have a number of these that we have recently bought. So that's going to help us going into 2006. I don't think we're looking at a -- we're not looking at a revenue shortfall here in the other businesses. So that's one item. But the other item I would mention is that part of the underabsorption came about in our stock prep, North American stock prep businesses, and we're consolidating that Louisiana business into another one of our facilities. That will mitigate that underabsorption anyway.

Right. But plus, so you get cost savings from restructuring, you get higher revenues and some of these other positives that it -- I guess I'm trying to figure out if I should -- if it's wrong to assume that the first half of 2006 would look very strong.

Well, again, I think we like to wait until we issue our guidance for 2006, but we're trying to give you some of the factors that would influence the whole year here.

Okay. The next thing I wanted to delve into a little bit is what is going on in France. It seems as if things have gotten much worse and the initial actions that you took to try to right the ship have not been borne out. Has the turmoil there caused a significant revenue issue and how would you view that going forward?

I think to answer that, Allen, I would say that, certainly France, I think the problem we had with France is we're going to get to where we want it to be. We don't see any more hurdles. We see the light at the end of the tunnel. It was more a delay in the process, not really due to our people or anything else, it was just the process within France. And the region that we are in in France, in Champagne, they had high unemployment. There were more government hurdles to get to where we wanted to go. We're going to complete that.

Now concerning the revenue base. It was hitting at a time when their primary market, Western Europe, was soft. But they were also, I think, I would say they probably had some slight distraction in the sales area, but on the other hand, certainly encouraged by what I see as their activity within the marketplace and also, I think they're off to a good start in 2006 with the $6 million order that they just booked. And their profitability will really be a help as we start to -- as we get capability in 2006 to be outsourcing from low-cost areas such China in the feed operations which would include as well as North America. So I think we're going to get to where we wanted to go and where we wanted to be. I look at it as a delay rather than anything else. They really are armed with great technology. As an example, on the $6 million order, all the major suppliers were in there competing for this and we were selected really on expertise and technology clearly.

Okay, Bill, it just seems as though the issues that were dealt with over time take a lot longer to fix and it seems as if we're responding to failures as opposed to getting ahead of issues.

Yes, I guess, I certainly -- if we take a look at France as an example. It certainly is one that I share. On the other hand, just because, if that would have been in North America, that would have been dealt with early on and would have never gone into a loss position, I can tell you that. Because we face some of the same issues in North America and we prevent that our units from going into a loss position. I think we responded very quickly ahead of the wave. In France, on the other hand, just to give you a sense, we would not have been able to undertake the sizable restructuring we did until they were into the red. That's just government blockage on that. We had our hands tied on trying to react quickly. Once they did hit the red, we still had to go through this long government procedures to get there. If that would have been in North America or anywhere else in Asia, we could have dealt with it ahead of time. It was frustrating for us to go through as well. We're behind that, I think. Certainly in 2006, you know, with our benefiting from that very painful slow process that we experienced in 2005.

I realize the industry has been tough and, but it seems as if also, there have been execution issues here. We've been a shareholder for quite a while as you know and these bumps in the road seem to be to be fairly regular and significant.

We have, in fact, we talk about that often. Just like in North America. The paper industry started out last year announcing our CapEx they're going to be investing and how good things are going to be and then all of a sudden everything on the CapEx side kind of collapsed. On the other hand, we still have belief that they're going to be returning in North America and especially now that energy costs are really impacting a number of mills. We are really well-armed with technology to help them reduce energy in all of our product lines, and especially in product lines like Johnson. So I think we're armed with the right technology, but the timing certainly, certainly has been tough to call. And we've been trying to follow with the paper industry is saying, what the corporate executives are saying, and from our customer base. And even, you know, our consultants that follow the industry. We share that disappointment. I think on a good note for a company our size, I think the fact that we are so global and involved in areas all over the world, whether it's South Africa, the Middle East or certainly Asia right now, I think we're well-positioned to take advantage of growth and I think one of the challenges we had was the shift into more low-cost manufacturing areas to serve those markets, but we have a high market penetration and -- but I can certainly understand sitting from the outside where you'd say, yeah, they fixed one thing and now they're going to face another problem and another issue. But hopefully I think we've addressed a number of issues this year and are looking forward to 2006. I think we're in far better condition than we've been and even if the market stays as it is, I think we're going to have far better results and yet we see some pockets of opportunity for growth for this business.

Okay. I certainly hope so. The China acquisition, I think you said is going to be $20 million in outlays. Is that total outlays or will there be other performance payments or anything else associated with that?

No, that's an approximate number, but it will be right around that. Because we haven't finalized it yet, the final negotiations yet. No, there won't be any other outlays .

What would the revenue opportunity be, the trailing revenue from that facility?

Yes. Basically the revenue is around 15 million at this point, but the big thing we're going to inject is that -- that's going to be our manufacturing. The modeling we put together on this business is very compelling for us. This is one of the reasons we were kind of delaying, trying to put up a small facility of our own. This is a solution not only for Asia, but for serving North America, optimizing North America margins as well as European.

There'll be an opportunity to move some North America manufacturing, labor intensive manufacturing into this facility in the future?

Absolutely. Very quickly. Absolutely.

Okay. Okay. Thanks for taking my questions and I hope that you're very focused on execution and that we continue to have a conservative view of where the markets are as we're executing so when things turn up we have upside instead of sort of responding to continued difficulty in the environment.

Yes, and I think we are well-prepared for that. But thank you, Allen.

Our next question comes from Brent Miley with Rutabaga Capital.

Good morning. I have a few questions for you. One, on the sales force changes, would you just go over those? Is that worldwide or just North America and kind of what did that -- it sounds like you went to a geographic orientation. Can you just talk a little bit about that, what does that actually do to the number of folks on the street?

Sure. I'll just give you some round numbers on it. This is out of our operation and web systems for North America. They talked of identical same people in mills and in the past, both companies had each other's products going way back in time. They've been selling each other's products, I mean, we were the same sales force throughout the rest of the world, very successfully. But in North America, since we acquired AES in '93, we allowed them to have their separate sales force. But market conditions the way they are, the units got together, the management of each unit, the web system and Rios got together on their own, and the objective was initially to see what they could to do to get better coverage because there's some pretty large territories and at the same time reduce costs. You could go from over 20 salesmen, down to 14 or 15 salesmen, and provide better coverage with smaller territories and select the very best salesmen. And that really was the process. Out of it, we generate a savings and as as well as, we actually wound up with better coverage. And the feedback and I happened to see a couple call reports coming back from the customers was extremely positive. For example, if AES had a salesman in Louisiana that had excellent coverage and a couple of real great mills that he was getting all of their business and web systems he wasn't getting as much, then the wet salesman was selected. That would be his territory for both products. As a result, because technology is great and having better technology certainly helps the salesman, but at the end of the day, a salesman also plays a very key role with his expertise and how he gets along with the customer who he knows. We expect to get a big benefit out of that with the cost reduction as well coming forward. And the customer, importantly, is going to come -- look at it as getting far better service. He's going to see a Kadant person more often. It also reduces our drivetime. The time they spend behind the windshield is really nonproductive time for a salesman. That's the big benefit we get out of that.

Did you change the compensation system much or is it just, obviously, you reduced, if you've gotten better coverage and reduce the number of bodies, has the comp formula or whatever changed?

Not really, no. We kept the same salaries in place and we also have a bonus that's tied into various factors such as after market sales that we target them on. That's pretty much stayed the same.

Okay. Just to go back to the Chinese acquisition or potential acquisition there, it sounds like if -- should we expect incremental charges probably next year if this were to go through, just as you were talking about, if there are some manufacturing shift from North America to the Far East?

No. No, we've really restructured North America and Europe for outsourcing. And always, we outsource as much as we can manufacturing to low-cost areas. And laying out, solutions that are outsourcing rather than working with a number of suppliers spread around which can be a lower cost area that we could find anywhere. It's going to be a Kadant facility that will provide the outsourcing feeding into North America and Europe. And we have a great model as well from the acquisition of Johnson because Johnson had been doing this very successfully out of their Chinese operation, feeding components into Europe and North America.

Is this, their current main product, is that these baskets you were referencing?

That's something we worked on women them jointly, Brent. And helping with their technology. We've tested them at most of the major paper companies throughout the last year or so. That's part of it. That's a very valuable part for us because we had very limited basket manufacturing on our own. We were buying them from other sources. This is by far the big advantage, by far the lowest cost, because a lot of labor is involved in this. It is a superior technology to anyone else. It's the latest type of technology for baskets for screening. As far as the other value, they also had products that we did not have. For example, different types of pulping that could be used. They have had some complementary ones. Their technology is not at the same level as Kadant's and we would have two brand names going out, we would have the Kadant brand going out to the high end mills on our existing technologies, and we would have their technology feeding to numerous mills throughout Asia that are smaller mills that don't necessarily require our technology that it's really going to expand dramatically our market in Asian coverage.

Okay. A few -- a couple financial questions too if I could, Tom. Did I hear you say you had a reserve reversal in the quarter?

That was in the third quarter, it was a minor item. It really involved the timing with the Lamort restructuring.

Okay.

Basically, they had a pension plan there and we basically have to reflect the curtailment of that pension plan as people are leaving, but it was pretty immaterial.

Okay, I thought you said it was a hundred beats or something. I must have misunderstood. Wanted to know, you mentioned the percentage of completion revenue recognition. Can you just review with me again, I know we talked about this a long time ago. 's not as though these have real, the lead times are pretty long, but in terms of installation and so forth, the cash roughly will match the accounting in the quarters. Is that correct, or do I remember that incorrectly? I'm talking about the cash received as opposed to what's going into the income statement.

Yes. The cash flow and the actual recognition of the income are different. They can be, we try to roughly match those with the progress payments. Basically you're recognizing revenue on the P&L as you're incurring the costs associated with that particular job.

No, I understand. But typically the lags aren't going to be huge, is that right?

In terms of the cash flows?

Yes. Exactly. In other words, maybe it's back end loaded, I was just trying to remember.

Yes. We do get progress payments as well. We're not recognizing the revenue on those progress payments, but we try to match that as best we can with the P&L.

We can talk more about that. The last question I had was I know you had some work to do on the systems side on Johnson. It sounds like the integration has been pretty good there. Can you talk about where you are in terms of matching up systems and all that kind of thing?

Sure. In fact, that acquisition has gone very well. What we have been doing, the units have been doing, for example, we've had combined sales meetings throughout the world so they can exchange and know who each other are and how they can help each other. Also, there's been seminars that have been conducted where they will address, they bring in customers and we show all of our Kadant product lines. We are getting a real benefit out of that. We're in the process of exploring because they have, part of their business is outside the rotary joints. A number of industries outside of paper. All of our products, whether it's in stock prep, accessories, or water management can play a role in that and we're trying to score opportunities there because the missing ingredient for us historically in the past has been process knowledge in other industries as well as understanding the market and having access to it. There's a number of initiatives that we have ongoing where we expect to get some nice benefit out of going forward.

Okay, and then Tom, this is regards to actual systems and getting your broker financial data, all that kind of stuff. I think there were some upgrade going on. Is that progressing nicely, or is that still a work in progress?

Well we've made a lot of progress on that. We have -- we've transferred the Director of Finance into that job, a person who was a controller of another large subsidiary for ten plus years. He's heading the finance efforts there now. We expect good things from him. He's done a nice job wit us in the past. I think that is a major plus. He knows our systems, he knows our procedures, he knows our expectations. That's going to help. We've done a number of improvements to just the basic nuts and bolts, blocking and tackling on the accounting and finance side. We still have a ways to go, particularly on the forecasting process, forecasting for private company, they didn't do a lot of forecasting on a quarterly basis or reporting on a quarterly basis. That still could stand some improvement. Those are things we're working on. I'm pleased with the progress we've made so far.

Okay. Great. Thank you.

Thank you, Brent.

Our next question comes from Wayne Archambo of BlackRock.

Good morning. I'd like to echo, I believe it was Mr. Fournier's comments, regarding the operational issues. About being a large shareholder, I think I might be the largest shareholder, we're disappointed that operation issues continue to persist. I want to get some sense from you as to how accountable management is in these operational issues. How is this going to affect how management is going to be compensated this year because we're very frustrated with these operational problems.

I can tell you that all of management, including Tom and I and everyone in the units that have underperformed, are going to be impacted this year as well as we should be. The incentive is to get things, things going. I think the one that gave us the biggest problem and the biggest headache was the one in France. That was the most difficult one for us because we wanted to make a change there prior to them even going into the red. And because of different regulations and government involvement over there, we had our hands tied. I can't tell you how painful that was for all of us. But nevertheless, we got through that. And I would think right now, that we have taken the right steps in the restructuring and taken a look at all of our businesses. And now that we no longer have composites, we're really focused on trying to grow our businesses and we see some nice opportunities for income growth in 2006 that we're going to focus on. But I hear you Wayne, and I understand.

If we're this frustrated twelve months from now, is it -- obviously, you're certainly there to do what's in shareholder's best interests. I assume at some point if operational issues persist that the board would seriously consider realizing value by hiring a banker to see if value can be realized through an acquisition.

That's also a possibility. Anywhere where we can increase shareholder value, and that is one approach. But sitting here next year at this time, I would -- I can't tell you how disappointed we would be if we're in this kind of box. We expect to have a good year in 2006. I think we worked hard and I have to say our units worked extremely hard to try to get to this level. And I think that the restructuring that we've done, we're going to get the benefit out of that in 2006. I think we paid the price this year and it's been painful, but I think next year we'll get the payback.

I want to clarify, when I said an acquisition, I meant the Company. I don't mean you making an acquisition.

I understand what you meant.

I want to be clear. Thank you.

Thank you, Wayne.

Once again, if there are any final questions, please press star one on your telephone at this time. Okay, gentleman. It appears we have no further questions.

All right. With that, I'd like to thank everyone for listening in today and I just want to add that without question the fourth quarter outlook is a major disappointment for us. But we are taking steps throughout the Company that will allow Kadant to address the needs of our global markets and put us on a path towards growth. With that, thank you.

Thank you. This concludes today's Kadant conference call. You may now disconnect your lines and have a great day.