KAI - NYSE

Good day, and thank you for standing by. Welcome to the Fourth Quarter 2023 Kadant Earnings Conference Call. [Operator Instructions] Again, please be advised that today's conference is being recorded. I will now turn the conference over to your first speaker today, Michael McKenney, Executive Vice President and CFO. Please go ahead.

Thank you, Victor. Good morning, everyone, and welcome to Kadant's fourth quarter and full year 2023 earnings call. With me on the call today is Jeff Powell, our President and Chief Executive Officer. Before we begin, let me read our safe harbor statement. Various remarks that we may make today about Kadant's future plans and expectations, financial and operating results and prospects are forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks and uncertainties that may cause our actual results to differ materially from these forward-looking statements as a result of various important factors, including those outlined at the beginning of our slide presentation and those discussed under the heading Risk Factors in our annual report on Form 10-K for the fiscal year ended December 31, 2022, and subsequent filings with the Securities and Exchange Commission. In addition, any forward-looking statements we make during this webcast represent our views and estimates 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 views or estimates change. During this webcast, we will refer to some non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is contained in our fourth quarter and full year earnings press release and the slides presented on the webcast and discussed in the conference call, which are available in the Investors section of our website at www.kadant.com. Finally, I wanted to note that when we refer to GAAP earnings per share or EPS and adjusted EPS on this call, we are referring to each of these measures as calculated on a diluted basis. With that, I'll turn the call over to Jeff Powell, who will give you an update on Kadant's business and future prospects. Following Jeff's remarks, I'll give an overview of our financial results for the quarter and the year, and we will then have a Q&A session. Jeff?

Thanks, Mike. Hello, everyone. Thank you for joining us this morning to review our fourth quarter and full year results and discuss our business outlook for 2024. I'm pleased to report the fourth quarter was a solid finish to a record-setting year for Kadant. Despite the slowdown in overall manufacturing activity and continued macroeconomic headwinds in many regions, we had another well-executed quarter. This led to solid adjusted EBITDA performance and excellent cash flow in the fourth quarter. Organic bookings were steady in the fourth quarter with solid demand, as we delivered on our mission to provide technologies and engineered solutions that help our customers operate more efficiently. At the end of 2023, we were honored to, once again, be named by Newsweek Magazine as one of America's most responsible companies. This marks the fourth consecutive year of being included on this list, and it is rewarding to be recognized for our efforts in this area. With that, I would like to review our Q4 financial performance. Fourth quarter performance overall was solid and better than expected in several areas. Q4 revenue and adjusted EPS were both up 3% compared to the same period last year, while bookings were comparable with the prior year period. Although a large portion of our Q4 revenue was from capital shipments, excellent execution resulted in an adjusted EBITDA margin of 20.3%. I'm particularly pleased with our operating cash flow, which was the second highest in our company history at $59 million. Our fourth quarter earnings performance contributed to exceptional full year financial results, which I will review next on Slide 7. The record demand we experienced in the first quarter of 2023 provides an excellent start to the year and contributing to our record-setting revenue performance for the full year. Adjusted EPS increased 9% to a record $10.04, exceeding the prior record set last year at $9.24 per share. Our full year adjusted EBITDA was a record $201 million and a record 21% of revenue. Our strategic focus on improving our margin performance continues to deliver results, and we are pleased with the progress of ongoing initiatives to grow our businesses. Our workforce around the globe deserve tremendous credit for these results as they performed exceptionally well throughout the year. I'm extremely proud of our employees for the innovative work they have done and continue to do to serve our customers. Next, I'd like to review our performance in our three operating segments. I'll begin with our Flow Control segment. Q4 revenue declined 4% to $87 million compared to the then record fourth quarter of 2022. Aftermarket parts revenue was up slightly compared to the prior period and made up 68% of total revenue. Product mix within both parts and capital negatively affected gross margin, and this led to an adjusted EBITDA margin of 27% in the fourth quarter. Bookings were up 8% compared to the same period last year. This strong finish to the year positions us well entering 2024. We believe the fundamental drivers of end markets remain healthy, though business activity continues to be influenced by geopolitical and macroeconomic challenges around the globe. Turning now to our Industrial Processing segment. Our performance in the fourth quarter was solid, despite the softening in some of our core end markets. Revenue declined 3% compared to the same period last year, due largely to fewer capital shipments of our stock prep equipment used to process recycled fiber. Aftermarket parts revenue, however, was up 5% and represented 64% of total revenue in the fourth quarter. Adjusted EBITDA margin declined 110 basis points compared to the prior year, but remained strong at 23.8% of revenue. This decline was largely attributed to a decrease in operating leverage associated with lower capital revenue. Looking ahead to 2024, we expect demand in this segment to shift towards aftermarket parts versus capital, particularly with the addition of our recently announced acquisition of Key Knife. Key Knife is a manufacturer of engineered knife systems used in various wood processing applications. More than 90% of its revenue is aftermarket parts. And addition of Key Knife to our Industrial Processing segment is expected to further strengthen our aftermarket position in this segment. In our Material Handling segment, revenue increased 27% in the fourth quarter to a record $64 million. Strong bookings in the first half of the year contributed to this record-setting performance. Capital equipment revenue was exceptionally strong and represented 55% of total revenue in the quarter, led by our conveying product line. Despite the large portion of revenue attributed to capital business, we achieved excellent operating leverage and adjusted EBITDA margin increased 350 basis points to 22.1% in the fourth quarter. The integration of KWS Manufacturing acquired a few weeks ago is underway and progressing well. We are pleased to have this leading manufacturer of screw conveyors and related equipment in part of Kadant. Looking ahead to 2024, we believe this segment will continue to see good business activity, particularly as new infrastructure projects are executed and demand for Kadant-made equipment remained strong. As we look ahead to the first quarter of 2024 and the full year, ongoing project activity is healthy, and demand has been solid as we entered the year. That said, we are seeing continuing economic uncertainty around the globe and expect demand in 2024 to be similar to 2023. Our strong backlog and ability to generate robust cash flows have us well positioned to capitalize on opportunities that may emerge as the year unfolds, and we expect to deliver a solid financial performance again this year. I'd now like to pass the call over to Mike for his review of our financial performance and outlook for 2024.

Thank you, Jeff. I'll start with some key financial metrics from our fourth quarter. Gross margin decreased 40 basis points to 42.7% in the fourth quarter '23 compared to 43.1% in the fourth quarter '22, due primarily to lower margins achieved on capital projects at our Industrial Processing and Flow Control segments. Our overall percentage of parts and consumables revenue was 60% of total revenue in both the fourth quarters of '23 and '22. As a percentage of revenue, SG&A expenses increased to 25.1% in the fourth quarter of '23 compared to 24.5% in the prior year period. SG&A expenses were $59.8 million in the fourth quarter of '23, increasing $3 million or 5% compared to $56.8 million in the fourth quarter of '22. The fourth quarter of '23 included a $0.9 million unfavorable foreign currency translation effect and an increase of $1.3 million of acquisition costs and a decrease of $0.8 million in indemnification asset reversals compared to the fourth quarter of '22. Excluding these items, SG&A expense increased $1.6 million or 3%, primarily due to increased selling-related costs. Our GAAP EPS increased 4% to $2.33 in the fourth quarter compared to $2.23 in the fourth quarter '22, and our adjusted EPS was up 3% to $2.41 from $2.33. Our fourth quarter '23 adjusted EPS of $2.41 exceeded the high end of our guidance range by $0.29 due to higher-than-anticipated aftermarket revenue, especially at our Industrial Processing and Flow Control segments. We had record operating cash flow and adjusted EBITDA in '23, which I will cover on the next slide. For the full year '23, gross margins increased 40 basis points to 43.5% compared to 43.1% in '22, due to higher margins achieved on our aftermarket products, especially at our Material Handling segment. Our percentage of parts and consumables revenue was 62% in '23 compared to 63% in '22. As a percentage of revenue, SG&A expenses decreased to 24.7% in '23 compared to 24.8% in '22. SG&A expenses were $236.3 million in '23, increasing $11.9 million or 5%, compared to $224 million in '22. Excluding a decrease of $1.2 million of expense from indemnification asset reversals, SG&A expenses were up $13.1 million or 6% compared to '22, primarily due to annual wage increases as well as incremental travel and consulting costs. Our GAAP EPS was $9.90 in '23, down 4% compared to $10.35 in '22, which included $1.30 gain on the sale of the Chinese facility. Our adjusted EPS was a record $10.04, up 9% compared to $9.24 last year. Aside from being a record, our adjusted EPS also exceeded the 5-year target of $8 to $9 a share we set back at the beginning of 2019. In the fourth quarter of '23, adjusted EBITDA decreased 2% to $48.5 million or 20.3% of revenue compared to $49.5 million or 21.3% of revenue in the fourth quarter '22. Our Material Handling segment had a record adjusted EBITDA in the fourth quarter '23 and a notable 350-basis-point improvement in adjusted EBITDA margins compared to the prior year. This was offset by the performance in our other segments. As you can see on the slide, our annual adjusted EBITDA has grown significantly compared to 2019, up 58%. For the full year, adjusted EBITDA was a record $201.3 million and a record 21% of revenue in '23 compared to adjusted EBITDA of $189.1 million or 20.9% of revenue in '22. Our Material Handling segment had record adjusted EBITDA of $53.6 million in '23 and a 210-basis-point improvement in adjusted EBITDA margins compared to the prior year. Our Flow Control segment also had record adjusted EBITDA of $105 million in '23 and a record 28.9% adjusted EBITDA margin. Adjusted EBITDA is an important metric for us. We set a 5-year target for adjusted EBITDA margin of 20% back at the beginning of 2019, and I'm happy to see that we've exceeded this target with a record 21% in '23. Our adjusted EBITDA margin has increased 300 basis points since 2019, due in large part to contributions from subsidiaries participating in our 80/20 program. This program provides revenue growth through a highly focused sales approach and profitability improvements as a result of dynamic pricing and streamlining product offerings. Once adopted, subsidiaries continue to follow the 80/20 program yielding incremental benefits the longer they have followed the tenets of the program. Average adjusted EBITDA margin for subsidiaries under the program have consistently exceeded our other subsidiaries. Over 50% of our revenue is from subsidiaries currently under or starting our 80/20 program. One of the highlights for the fourth quarter and full year was our operating cash flow, which increased 68% to $59.2 million in the fourth quarter of '23 compared to $35.2 million in the fourth quarter '22. For the full year, operating cash flow was a record $165.5 million, up $62.9 million or 61% from '22. We also had strong free cash flow, increasing 114% to $49.5 million in the fourth quarter '23 and increasing 80% to $133.7 million for full year '23. We had several notable nonoperating uses of cash in the fourth quarter of '23. We repaid $22.1 million of debt and paid $9.8 million for capital expenditures and a $3.4 million dividend on our common stock. For the full year, we repaid $94 million of our debt and paid $31.9 million for capital expenditures, which included a $7.4 million for our facility project in China. Let me turn to our EPS results for the quarter. In the fourth quarter of '23, GAAP earnings per share was $2.33 and adjusted EPS was $2.41. The $0.08 difference relates to $0.10 of acquisition costs, $0.05 of other income and $0.01 of relocation costs, both related to the facility project in China and $0.02 of restructuring costs. $0.05 of other income is associated with cash received for remaining assets of the old facility. In the fourth quarter of '22, GAAP earnings per share was $2.23 and adjusted EPS was $2.33. The $0.10 difference relates to $0.09 of impairment and restructuring costs and $0.01 of acquisition costs. The increase of $0.08 in adjusted EPS in the fourth quarter '23 compared to the fourth quarter '22 consists of the following: $0.17 due to higher revenue, $0.09 due to a lower recurring tax rate and $0.05 due to lower interest expense. These increases were partially offset by $0.17 in higher operating expenses, $0.05 due to lower gross margin and $0.01 due to higher weighted average shares outstanding. The $0.09 impact from the lower recurring tax rate was due to a slightly higher tax rate in '22 related to the timing of certain incentive compensation payments. Collectively, including all the categories I just mentioned, was a favorable foreign currency translation effect of $0.03 in the fourth quarter '23 compared to the fourth quarter of last year due to the weakening of the U.S. dollar. Now turning to our EPS results for the full year on Slide 17. We reported GAAP earnings per share of $9.90 in '23 and our adjusted EPS was $10.04. The $0.14 difference relates to $0.10 of acquisition costs, $0.05 of other income and $0.05 of relocation costs, both related to the facility project in China and $0.04 of restructuring costs. We reported GAAP earnings per share of $10.35 in '22, and our adjusted EPS was $9.24. The $1.11 difference relates to $1.30 gain on sale related to one of our Chinese facilities, impairment and restructuring costs of $0.11 and acquisition-related costs of $0.08. The increase of $0.80 in adjusted EPS from '22 to '23 consists of the following: $1.41 from higher revenue, $0.26 from higher gross margins, $0.08 from a lower recurring tax rate and $0.01 from lower noncontrolling interest. These increases were partially offset by $0.86 from higher operating expenses, $0.07 from higher interest expense and $0.03 due to higher weighted average shares outstanding. Collectively, including all the categories I just mentioned, was an unfavorable foreign currency translation effect of $0.09 in '23 compared to '22. Now let's turn to our liquidity metrics on Slide 18. Our cash conversion days, calculated by taking days in receivables plus days in inventory and subtracting days in accounts payable, was 130 at the end of the fourth quarter '23, down from 138 at the end of the third quarter of '23, but up from 126 days at the end of '22. The sequential decrease in cash conversion days was principally driven by a lower number of days in inventory. Working capital as a percentage of revenue decreased to 12.8% in the fourth quarter '23 compared to 15.4% in the third quarter '23 and 13.9% in the fourth quarter '22. Net debt, that is debt less cash, at the end of '23 was $4.4 million, the lowest level since 2017, representing a decrease of $117 million compared to net debt of $121.4 million at the end of '22. Our interest expense increased 30% to $8.4 million in '23 compared to $6.5 million in '22 due to an increase in borrowing rates. Our leverage ratio, calculated as defined in our credit agreement, decreased to a very low 0.27 at the end of '23 compared to 0.74 at the end of '22. After our recent acquisitions, our borrowing capacity is $71 million available under our revolving credit facility and an additional $200 million of uncommitted borrowing capacity. Now I'll review our guidance for '24. We expect to achieve records in a number of key metrics in '24, including revenue, cash flow and adjusted EBITDA. Our earnings performance in '24 will be affected by increased borrowing costs and noncash intangible amortization expense associated with our recently announced acquisitions. As we look beyond '24, the increased borrowing costs will continue to decrease as we have demonstrated our proven track record of paying down debt. For the full year, our revenue guidance is $1.04 billion to $1.065 billion, that is $1.04 billion to $1.065 billion, and our adjusted diluted EPS guidance is $9.75 to $10.05, which excludes $0.20 related to the amortization of acquired profit and inventory and backlog. Looking at our quarterly revenue and EPS performance for '24, we expect the first quarter will be the weakest quarter of the year due to the timing of capital projects, and the second half of the year will be stronger than the first half as a result. Our revenue guidance for the first quarter of '24 is $238 million to $246 million and our adjusted diluted EPS guidance for the first quarter is $1.90 to $2, which excludes $0.14 related to the amortization of acquired profit and inventory and backlog. I should caution here, there could be some variability in our quarterly results due to several factors, including the variability of order flow and the timing of capital shipments. Guidance includes our acquisitions of Key Knife and KWS, which we completed in January. Aside from the impact of intangible amortization, there is a negative impact in the initial post-acquisition period associated with the amortization of profit in inventory and acquired backlog as these amounts are reflected in the income statement when the underlying order is fulfilled and inventory shipped to the customer. Our GAAP and adjusted EPS guidance include our initial estimates of purchase accounting adjustments, which are subject to change as we review and finalize the valuation work for these acquisitions. I'd like to give some additional metrics on our EPS guidance. We borrowed $230 million in January for the acquisitions of Key Knife and KWS. We'll work diligently throughout '24 to pay down that debt. As a result of the borrowings, we project our interest expense will increase by approximately $0.70 over '23. In addition, Key Knife and KWS transactions have significant amounts of recurring noncash intangible amortization expense, which is reducing our EPS guidance by approximately $0.50 in '24. While the noncash intangible amortization does have a significant impact on EPS, it will not impact our cash flow or EBITDA for '24. '24 guidance includes a favorable foreign currency translation impact of approximately $11.6 million on revenue and $0.15 on adjusted EPS due to the weakening of the U.S. dollar. We anticipate gross margins for '24 will be approximately 43.5% to 44.5%. As a percentage of revenue, we anticipate SG&A will be approximately 25.5% to 26.2%, and R&D expense will be approximately 1.3% to 1.4% of revenue in '24. We anticipate net interest expense of approximately $18 million to $18.5 million, and we expect our recurring tax rate will be approximately 26.5% to 27.5% in '24. We expect depreciation and amortization will be approximately $46 million to $48 million in '24, and we anticipate CapEx spending in '24 will be approximately $29 million to $31 million, which includes $2 million related to the final payments on our facility project in China. Approximately 15% of the CapEx spending in '24 relates to final payments for CapEx projects approved in '23. We were a little bit above our normal CapEx as a percent of revenue metric as we continue to invest in automation projects and upgrades to our manufacturing capabilities. That concludes my review of the financials, and I will now turn the call back over to Victor for our Q&A session. Victor?

[Operator Instructions] Our first question will come from the line of Gary Prestopino from Barrington Research. Your line is open.

Hi, good morning, everyone. Just want to go over some of the puts and takes on your outlook in 2024. What you're basically saying is that the capital part of your business will be sluggish in the first half, and then you're anticipating that to come back in the second half. Is that a good read on...

Yes, Gary. Yes, that's a good read. We expect capital activity to pick up here in the second quarter and be stronger in the back half.

And what's driving that thought process? Or are you seeing any empirical evidence in terms of orders or anything that back half of the year, we're going to see that pick up?

Yes. I think there's a -- I hear there's a fairly strong kind of activity, quoting these projects tend to be -- take a little longer to develop. And so there's a lot of back and forth between our engineers and our customers. And so there's a fair amount of discussion that's going on. I would just say the time from quote to booking the order is a little longer than normal. And I think that's essentially because of the kind of the general economic uncertainties out there. People are really trying to guess when the Fed is going to start reducing rates. There's a lot of pent-up demand in many of our markets. And so our customers are trying to get ready for that. And it's really just a bit of a guessing game on how quickly they pull the trigger to start making investments to get ready for what they expect to be an increase in demand. So a fair amount of a lot of project activity, a lot of quoting, a lot going on. It's just that people are a little slower to actually book the order as they're trying to gauge kind of the pace of the recovery.

Right. As I look at your guidance, I mean, the two acquisitions, I think what did they add about on an annualized basis, $110 million of sales. Is that about right if you get a full year run rate?

Yes. I would -- I think that's a decent marker, Gary. The caveat to that, as I mentioned, the KWS transaction didn't close until three weeks in the first quarter here.

Right. No, I understand that, puts and takes there. But I mean, if you add that number into what you actually did, looking at rather de minimis growth in sales this year, and I just want to make sure I'm understanding this right, that that's really more or less a function on the capital side of the business?

Yes. That's correct. Yes, organically, when we take out the $11.6 million of FX and revenue, it would be down about 2% in revenue, organic.

Okay. And I'll just say real quick.

Sorry, go ahead, Jeff. I'm sorry.

I was just going to say the challenge we have, and this is -- it's more challenging, obviously, at the first of the year and kind of forecasting what's going to happen then as the quarters progress. But I would say this year, it's particularly challenging because there is a lot of uncertainty, right? Everybody is trying -- even the Fed from -- it seems like from week to week, their position on the economy changes. And so for us, as you know, Gary, we're a fairly conservative organization and certainly, the beginning of the year, we tried to be pretty cautious. And we're just trying to get a little -- to get better visibility on kind of the timing of some of this activity. And it's just challenging when you're coming out of a slower period.

No, I get that. I just wanted to make sure. I was confirming it. And then just some of the other figures that you guys talked about, especially Mike, you said $18 million to $18.5 million of net interest expense for this year?

Yes. Well, just interest expense, purely interest expense.

Okay. So that's $18 million to $18.5 million of interest. And then you said D&A is going to run to $46 million to $48 million, right?

Yes, that's correct, Gary.

And what was your CapEx this year? I didn't see that in the -- in any of the releases, or maybe I missed it. Did you mention that?

Yes, one second. We're at essentially $32 million.

Okay. Thank you very much. Appreciate it.

You're welcome.

Thank you. One moment for our next question. And our next question will come from the line of Kurt Yinger from D.A. Davidson. Your line is open.

Great. Thanks, and good morning, everyone. I just want to follow up on one of the prior questions in terms of the strengthening in the back half of the year and -- is that a situation where you feel like you need to see improving capital equipment bookings over the next couple of quarters in order for that kind of sales improvement to materialize? Or based on the bookings activity that you've seen in Q4 and what you're expecting for Q1, any further improvements could actually be a source of upside to what you're kind of assuming for the full year? How should we kind of think about those booking trends? And what that means for the back half performance?

Yes. You are right on your first assumption, Kurt. It really is predicated on us seeing strengthening in the capital bookings as we go forward.

Okay. Got it. And then one of kind of the bright spots this year, I think, has been parts and consumables. And it's had a steady performance despite some choppiness in some of the end markets, containerboard being kind of a big one. I mean we haven't yet seen a lot of those trends really improved very much. Is there any concern that that could catch up and start to weigh on parts and consumables going forward? Or do you expect the solid performance in 2023 sets you up pretty well for 2024 as well?

It's interesting. When you think of our parts, of course, it's through the -- all of our businesses have it. But in particular, we're expecting a big recovery on the containerboard side this year. So they think containerboard was probably flat last year, and it was down for the first time, demand, I'm talking about was down for the first time in a very long time in '22. But they're forecasting containerboard demand increased 4.3% this year. Tissue to be up 4% this year and then even '25, 3.8% for tissue and 3.7% containerboard. So we're really expecting to see a recovery on that side of the business. And I would say also on the wood processing side, things have slowed down. Of course, housing starts were, I think, about 1.46 last month, but permits were about 1.5. So we are starting to see some improvement there. And certainly, if interest rates start to come down, there's tremendous pent-up demand for housing. And we have a lot of activity going on with our customers, a lot of discussions about projects. They're really trying to get ready for what they think will be a pretty robust improvement in the market demand once interest rates start to decline. So I think it's our belief that the parts business actually could continue to strengthen throughout the year, assuming things go as most economists are currently forecasting.

Right. Okay. And I guess sticking with the wood piece, I mean there was a lot of capacity added. And to your point, I think there's a lot of optimism that demand is going to continue to improve. But at the same time, some of that new capacity is being absorbed. I guess as you think about your capital equipment, how important is new greenfield facilities and new capacity versus just better utilization at existing facilities in terms of the overall kind of sales and demand picture for wood processing?

Yes. I think there's both. And of course, because we're global, and we have an extremely high market share, globally, it varies. So if you look at North America, it may be more just upgrading tired equipment. The average age of a lot of the equipment out there is pretty old. And so there's just upgrading. But then there's a lot of new greenfields going on in Asia, in particular. Our stranding guys are very busy in Asia. A lot of projects, a lot of activity. We booked another order in China a few weeks ago. And then you've got the situation in Russia. A lot of product came out of Russia. And of course, that's got to be replaced now. So we're seeing activity in Europe and in particularly, in Scandinavia area as they start to invest to offset the lost supply out of Russia. So the wood side, it really depends on the region you're looking at. But I would say the activity level right now is as high as it was before the pandemic for us with the tired equipment out there. And frankly, more and more, in particular, on the stranding side, more and more products using stranded material. That's held up extremely well for us, and demand still looks quite good.

Got it. Thanks for that Jeff. And then just my last one, I guess, bigger picture. You're coming off two of kind of your strongest organic growth years in '21 and '22. This past year was still very solid as well. I mean where do you think the business is from kind of a cyclical standpoint entering '24? And I guess is there anything that's changed in terms of how you think about the organic growth profile of the business longer term relative to what you've kind of outlined in the past?

Well, we had -- as you know, we had tremendous organic growth from, say, kind of '18, '19 on. It was -- we were -- I think 7.5%?

Yes.

About 7.5% organic growth for several years, which is substantially higher than global GDP. So we would never budget and assume that was going to be the case, say, for the next five years. But I would tell you, when I look at our three sectors, the Material Handling side, I think, is in a good position. The money that's going to be spent on both the infrastructure bill and the CHIPS Act is just starting to flow. And so we think that our Material Handling sector will benefit from that. The billing side has been quite strong in Europe and in the U.S. from a recycling standpoint. On the paper side, we just talked about the fact that operating rates from operating rates really bottomed out, we think, in '23, globally, running at about 79%, is forecasted to get back into the mid-80s over the next couple of years. So we expect kind of some recovery growth in that market. And the Flow Control has always been very steady. It just is a very stable, steady business. The guys always do a great job in finding new end markets. Our biggest market -- right, our biggest sector right now is our industrial sector. It's bigger than all of our others. So I mean there's a lot of industrial markets out there that we're taking our products to. So we think the next few years, assuming that something doesn't happen, black swan event doesn't happen, we think that growth actually should be pretty solid in the next few years. But we've got to see that start to materialize, I think, this year, as the year progresses.

Well, appreciate all the color guys. Thank you.

You're welcome.

Thank you. One moment for our next question. Our next question will come from the line of Larry De Maria from William Blair. Your line is open.

Thanks. Good morning, everybody. Just a few quick sort of clarifications. I know it's not unusual, but it was a little bit bigger for the second half than first half. Can you give us kind of order of magnitude second half versus first half? And secondly, maybe you could talk to the financial flexibilities you have after the recent deals. And just the M&A pipeline if we're out of the market for a while or if it's still relatively healthy?

On the split first half, second half, Larry, I'd say there's about a 5% delta there.

Yes.

And then on the -- I would say on the activity side, we're still quite busy. There's still -- our corporate development people, I think have said that there's still a tremendous amount of deal flow out there. Our balance sheet, even though we took on a little bit of debt for these most recent acquisitions, our balance sheet is still pretty strong. We think we have good capacity left. So we're full speed ahead. We won't be slowing down even though we just did a couple of transactions. As you know, we're always looking for opportunities that are good strategic fits at a fair value, and that can be challenging from time to time. But our corporate people were very busy, and we've got the capacity. And frankly, our current debt agreements were put in place when we were smaller. So if we needed to free up those at higher levels, we could easily do that, and we'll do that if needed as we go out and pursue opportunities. So we're full speed ahead on looking at opportunities.

Okay. Sounds good. And then now shifting gears a little bit. I know you obviously talked about this a bit already but curious about kind of the order expectation from here and how we've done so far. It's a little bit odd to talk about, I don't know, the strength in capital equipment term it will get orders restored in 4Q and solid demand, but there's some certainty keeping the outlook down seems overly conservative. So can you discuss why this isn't overly conservative, considering the comments and the print you just did? Maybe what areas of the end markets are showing you the weakness and order expectations from here, which -- if they could stay flattish or not?

Yes. I would say, Gary.

I pointed to Mike and said you can handle this one, Mike.

The biggest thing that we're looking at is capital, capital order flow, and seeing that we get some traction and get some firmness there. That's the biggest thing that we're waiting to get some clarity on.

Our guys are very busy. As I mentioned, project discussions and activities are actually pretty strong. But the time to close is lengthened. I think as our customers are, again, trying to gauge how quickly rates come down and demand starts to pick up. And so because those discussions are taking longer than normal, it obviously introduces added degree of cost on our part.

And anything on the order expectations from here? And have we done so far this year? I assume, obviously, capital has been slow.

Yes. I mean I think right now, things are as expected. Right now as we look through last week, demand is kind of on track with where we would expect it to be.

Okay. So is it safe to say that given the comments on the pipeline and the time to close, it's a little longer, I mean those potential orders don't go away, right? They either hit in the second half or they get pushed out to next year. Is that fair to say? Or ultimately, it's the same timing.

Exactly. It's very, very seldom that a project gets canceled. We had one canceled, a big project canceled I think back at '22, I think it was. We had a project canceled. But it's very unusual for that. You're exactly right. They typically just get -- they get delayed. These are -- these big projects are quite lengthy from a board review standpoint anyway. And so once they get to that point, they normally don't disappear forever. It's just a question of timing on them. And so -- and that's what has introduced the level of caution that we have is we just don't know where the timing is going to be next quarter or third quarter or fourth quarter, the customers just aren't quite sure yet.

Okay. Fair enough. Last quick question. Parts and consumables and flow and industrial process, given the mothballing that we've seen, is it like -- does it matter it's just around overall volume and parts and consumables? Are you more or less guided up, whereas capital is guided down? Is that a fair way to think about it?

Yes. I mean what happens is, as you know, we operate in almost every paper mill in the world. And I know some people get hung up when they hear about a closure. And we never like to hear about closures, but I just mentioned overall demand is forecasted. If you look at total paper demand, in '24, globally, it's supposed to be up 3.3%, and it grows every year. So what happens is they just shift that to other more efficient mills, and we're there, too. So we just picked the business up in one mill versus the other. And so we don't get nearly as hung up on a mill closure announcement here or there. As long as overall demand continues to grow, we're going to be there to get our fair share of that.

Okay. Very good. Thank you. And good luck this year.

[Operator Instructions] Our next question will come from the line of Walter Liptak from Seaport Research. Your line is open.

Hi, good morning, guys. Good end to your year. Wanted to try one on the Flow Control bookings, the plus 8.4%. I wonder if you could just give us some incremental color. Was that parts related? Was that capital projects? Maybe regionally, where the orders were coming from?

I'm looking for my schedule here on that. It was really -- we had -- it was both in parts and capital, but capital and Flow Control was quite strong in the fourth quarter. Actually, in December, we closed some nice projects. So I'd say that bookings beat was really led by capital and flow control.

Okay. Great. And is -- you think that's the start of a trend? Is there some follow-through? People are drawing down inventory, I think, and being cautious into the end of the year. But it sounds like its buck the trend a little bit.

Yes, it did, Walt, but I happened to know that we had our -- the projects that came through those capital projects, they were on our board for '24. So the orders were a little bit early.

Okay. Okay. That helps. And then I wonder, as you kind of alluded to this in some of the other questions. Last year, this time, you were getting that big 42-mile conveyor project in Material Handling. And that probably has already shipped now. That's probably already through your process. But I wonder if it's something you've got more in the funnel that are some of these bigger Material Handling projects. Is that right?

Well, on the large project that we booked in the first quarter, Walt, you're correct, most of that shift of that $12 million, there's still, I think, about $2 million to go. And a good chunk of that actually went in the fourth quarter, which is why you saw their revenue and other metrics margin and EBITDA were so good because we had excellent -- on the EBITDA front, we had excellent operating leverage there.

Okay. That's great. And it sounds like you've got -- there's a potential for some more of these big conveyor projects in the funnel?

Yes. That was the second longest in the world. So we don't -- we wouldn't expect -- although there are discussions for projects, we wouldn't expect anything soon of that magnitude. That's a pretty rare project. But generally speaking, the group has been strengthening over the last, I would say, 1.5 years. And the prospects -- if housing picks up, certainly, that's going to help them. The CHIPS Act is really a very large construction act. If you look at it, it's mainly building plants. So that's good for them as well as infrastructure. And then the recycling side, the baler business in the U.S. continues to be very strong and as well as Europe and other parts of the world. So all other segments have -- I think, have had nice steady demand, and we expect that they'll continue to be in good shape throughout this year.

Okay. Great. And maybe I'll try one or two on the 80/20. Congratulations with the profit improvement that you guys have been seeing. And I thought that you might be further along than 50% of the plants started. I wonder if you could just refresh us how many P&Ls do you have? How many P&Ls -- half of it, that half of the P&L, I guess, have started. But how many P&Ls do you have? And for 2024, do you have more that will be starting the 80/20 process?

Yes, one -- the -- so we have around, I think, about 24 kind of companies with P&Ls, and I would say kind of half of them are in it. The thing that's impacting it now, which, frankly, is a little frustrating for us is that you really can't have an ERP project going on at the same time as 80/20 because they're both so significant in scope and the resources that they require. And so as it turns out, what's controlling our -- some of our 80/20 implementation now is companies that are either in or getting ready to start ERP projects. It just as luck would have it, we've got companies that are end of life with the current ERP systems, where we were forced to implement new ones, and that really has delayed implementing 80/20 in some of those businesses. And so that's been something we've been wrestling with, I would say, over the last kind of 18 months trying to decide, okay, which ones can we delay the ERP project until 80/20 is finished, and which ones are we going to have to delay 80/20. And so that's really controlling some of the pace. The other thing, of course, is we continue to build up our internal team, the expertise, but it also has some limitations. Just the available expertise to implement projects. So we still have -- I've been saying for some time, I think we still have probably another, say, three years, four years for this to run out, and that's, of course, not including new acquisitions. Every time you acquire a new company, then you take on a new future project. And so we have a couple of new future projects, which we just added this year. So it will never stop. But I think -- we will, I think, in three to four years, have almost all of our businesses that we currently have kind of coming out of the back end of the process.

Okay. Good. Okay. Good. Maybe one last one for me, just switching gears to the pricing environment. And in 2020 -- I don't remember that there was ever any issues because your niche markets with selling price. But are you taking up prices again? Are you still seeing inflation?

Well, I would say that a lot of the inflationary pressures we've seen in raw materials have subsided. They've improved. I would also say that with demand down somewhat, customers are very reluctant to accept big price increases. As we mentioned before, back in '21, '22, we were all just trying to get the materials from a supply chain standpoint to provide. And so it was more can you get me something and what's it going to cost us to do it. And that was a thing for us buying our raw materials. So things have stabilized there. And so I think we're returning back to a more normal environment from a pricing standpoint. And as you know, we -- if you look at our improvement that we've made, it's almost all been on the -- on our SG&A side. Our margins have held very steady, which is an indication of our pricing. So what we've really worked hard on is reducing our kind of our operating cost, and that's really where we've gotten the improvement from reducing our internal expenses.

Okay, great. Thank you.

Thank you. I'm not showing any further questions in the queue. I would now like to turn it back to Jeff Powell for any closing remarks.

Thank you, Victor. So before wrapping up the call today, I just want to leave you with a few takeaways. 2023 was another record-setting year for Kadant, and our employees deserve a lot of credit for achieving these results. I want to thank all our employees around the world for the commitment to serving our customers' needs. I also want to welcome our newest employees, from both Key Knife and KWS manufacturing. We're excited about the value you add to Kadant and the opportunity to build upon the successes you have achieved. In 2024, we will continue to seek new opportunities to create value as we focus on meeting our customers' needs with innovative technologies and solutions that drive sustainable industrial processing. Lastly, our financial health is excellent, and our market positions remain strong. We look forward to delivering exceptional value for all our stakeholders again in 2024. With that, I want to thank you for joining the call today.