KAI - NYSE

Good day. And thank you for standing by. And welcome to Kadant’s First Quarter 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Michelle. Good morning, everyone. And welcome to Kadant's first quarter 2025 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 30th, 2024 and subsequent filing for 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 our 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 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 first quarter earnings press release and the slides presented on the webcast and discussed in the conference call, which are available in the investor section of our website at 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're 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 first quarter results and discuss our business outlook for 2025. Before I get into my remarks on our Q1 performance, I'd like to take a few minutes to outline the actions we've taken so far to understand the implications of the tariffs on our industries, supply lines, customers, and how we might respond based on a variety of scenarios we considered. Each of our operating teams is assessing their supply chain vulnerability to understand our exposure to potential tariffs and the impact it could have on our operations. This assessment includes potential changes in cost, impacts on production and lead time, and how we would address these factors. I should note that one of the strategic benefits of our decentralized structure is our ability to respond quickly to changing economic circumstances. We're also exploring alternate supply sources with the feasibility of switching suppliers in response to change trade relationships and tariffs. While we have a good handle on the known alternatives, the fluidity in the trade policies make decision making more complicated in the short term. At Kadant, we are fortunate to have experienced operations leaders around the globe who base decisions on local conditions and information from our global network of companies. Based on our analysis to date, we believe we are well positioned to react to changes in trade policy and relationships while maintaining our high level of support to our customers. As you know, Kadant, with few exceptions, manufactures in the regions we sell in. Currently, we do not believe any of our competitors gain a benefit from the tariffs. Later in our review, Mike will provide our estimate of the financial impact tariffs could have on our business. Now let's go into the first quarter performance. I will begin with operational highlights. Despite the high level uncertainty fueled by the global tariffs and stiff economic headwinds in Europe and China, our first quarter came in as expected across most financial metrics. Demand for aftermarket parts was robust and our operations teams around the globe once again executed extremely well in a challenging environment and delivered high value to our customers. This led to strong margin performance and solid free cash flow. Turning now to our first quarter financial performance in slide 6, I would like to highlight a few metrics that I believe are fundamental to our growth story. First, our new order activity was up in the first quarter despite the relatively low capital business, and certainly created by the rapidly evolving tariff situation has delayed capital equipment orders as our customers assess potential impact on their businesses. Aftermarket parts bookings represented 74% of our total bookings and was a record $190 million. As many of you know, the first quarter of the year is often our strongest quarter in terms of parts bookings as our customers prepare for annual maintenance shutdowns. This strong demand benefits from our large installed base and our ability to deliver exceptional value to our customers. Second, our free cash flow remained healthy at $19 million. Our asset light operating model enables us to capture solid cash flows even during challenging and volatile economic times. Revenue in the first quarter declined 4% compared to the same period last year due to weaker capital shipments in our industrial processing segment. Our aftermarket parts revenue made up 75% of Q1 revenue and was up 5% to a record $179 million. While our gross margin performance was excellent, our adjusted EBITDA of $48 million was down 8% and lower operating leverage led to a decline in adjusted EBITDA margin of 100 basis points compared to the same period last year. Next, I'd like to discuss the performance of each of our three operating segments, beginning with the Flow Control segment. Flow Control segment experienced solid demand in the first quarter led by North American businesses. Bookings of $100 million were up 6% compared to Q1 of last year. Q1 revenue increased 7% to $92 million with strong performance in our fluid handling product line, which includes our most recent acquisition. Aftermarket parts revenue made up 76% of total Q1 revenue and is expected to remain stable as the year progresses. Our high percentage of aftermarket parts revenue helped drive adjusted EBITDA up 8%, resulting in adjusted EBITDA margin of 28.3%. We expect to deliver strong performance again this year in our Flow Control segment, despite transitory headwinds being introduced by the current geopolitical climate. Turning now to our Industrial Processing segment in slide 8, our aftermarket parts business was relatively stable, which helped offset the weaker capital business in the first quarter. Q1 revenue declined 15% compared to then record $106 million set in the same period last year. This was largely due to a significant decline in capital shipments that was expected based on the relative softness in capital projects through 2024, particularly in our wood processing product line. Aftermarket parts revenue of Q1 made up a record 80% of total revenue in this segment. Q1 bookings, on the other hand, were up 3% compared to the prior year period to $92 million. There continues to be significant capital project activity developed in this segment, though the current chaotic geopolitical environment makes the timing of these orders even more uncertain. The weaker revenue volume led to reduced operating leverage and adjusted EBITDA margin of 24.2%. Overall, our first quarter performance in this segment was soft. This segment has high exposure to large capital business, and the elevated uncertainty in global trade policy has significantly impacted the timing of capital projects. In our Material Handling segment, we experienced solid demand for aftermarket parts, which helped offset a softer capital environment in the first quarter. Revenue of $57 million was up slightly compared to the prior year period, with aftermarket parts making up 65% of Q1 revenue. Demand for capital equipment was down from the prior year period, and overall bookings were flat. We are seeing growing activity in this segment, particularly in our high-performance Beller product line, and expect a number of capital projects to be executed in the coming quarters, although the timing can be somewhat uncertain. Adjusted EBITDA margin of 20.2% of revenue was flat compared to the same period last year. Despite the geopolitical and trade uncertainties, the outlook for this segment remains positive, as the end markets we serve, such as aggregates, mining, waste management, and recycling, are fundamentally strong. As we look to the second quarter of 2025 in the full year, we remain focused on strengthening our businesses around the world and adapting to navigate these challenging times. Despite the increasing uncertainty that limits our visibility, the longer-term underlying fundamentals of our markets remain strong. Our aftermarket business continues to provide strength and stability, even as capital project activity is affected by global trade and tariff uncertainties. We are confident in our ability to deliver our value proposition, and our balance sheet remains healthy, and our ability to generate strong free cash flow is solid. And with that, I'll turn the call over to Mike.

Thank you, Jeff. I'll start with some key financial metrics from our first quarter. Gross margin was 46.1% in the first quarter of 2025, the highest gross margin since 2017. Gross margin was up 150 basis points, compared to 44.6% in the first quarter of 2024. Over half this increase relates to the negative effect of acquired profit and inventory amortization, which lowered gross margin in the first quarter of 2024 by 90 basis points. The remaining increase is primarily associated with a higher overall percentage of aftermarket parts, which represented 75% in the first quarter of 2025, compared to 69% in the prior year. We only had a minor impact in the first quarter from tariffs. I'll discuss the prospective tariff impact when I review the guidance. SG&A expenses, as a percentage of revenue, increased to 29.8% in the first quarter of 2025, compared to 28.2% in the prior year period, primarily due to the comparatively lower revenue performance in 2025. SG&A expenses increased $0.9 million, or 1%, to $71.2 million in the first quarter of 2025, compared to $70.3 million in the first quarter of 2024. This included an increase of $3.2 million from our acquisitions, partially offset by a $1.4 million favorable foreign currency translation effect, and a $1.2 million decrease in acquisition related costs. Our effective tax rate in the first quarter was 24.3%, and included tax benefits related to the vesting of equity awards, which lowered the effective tax rate by 1.3%. Our GAAP EPS decreased 3% to $2.04 in the first quarter, and our adjusted EPS decreased 12% to $2.10, which exceeded the high end of our guidance range by $0.05. Adjusted EBITDA decreased 8% to $47.9 million, compared to $52.2 million in the first quarter of 2024, principally due to lower capital revenue at our Industrial Processing segment, which led to reduced EBITDA performance. As a percentage of revenue, adjusted EBITDA was 20%, compared to 21% in the first quarter of 2024. Operating cash flow at $22.8 million was flat compared to the first quarter of 2024. Free cash flow increased 15% to $19 million in the first quarter of 2025, compared to $16.6 million in the first quarter of 2024. The first quarter tends to be the weakest cash flow quarter, as was the case in 2024, due in part to the payment of management incentives. Other nonoperating uses of cash in the first quarter of 2025 included $14 million of repayments on our debt, $3.8 million for capital expenditures, $3.8 million for dividends on our common stock, and $6 million for tax withholding payments related to the vesting of stock awards. Let me turn next to our EPS results for the quarter. Our adjusted EPS decreased $0.28 from $2.38 in the first quarter of 2024 to $2.10 in the first quarter of 2025. This included increases of $0.08 due to a higher gross margin percentage, $0.07 due to lower operating expenses, $0.05 from the operating results of our acquisitions, and $0.05 due to lower net interest expense. These increases were offset by decreases of $0.52 due to lower revenue and $0.01 due to a higher noncontrolling interest expense. Collectively included in all the categories I just mentioned was an unfavorable foreign currency translation effect of $0.08 in the first quarter of 2025, compared to the first quarter of last year, due to the strengthening of the U.S. dollar. Looking at our liquidity metrics on slide 15, our cash conversion days, which we calculate by taking days in receivables plus days in inventory and subtracting days in accounts payable, increased to 130 at the end of the first quarter of 2025, compared to 128 at the end of the first quarter of 2024. Working capital as a percentage of revenue was 16.8% in the first quarter of 2025, compared to 15.7% in the first quarter of 2024. Our net debt, that is debt less cash, decreased $10 million sequentially to $183 million at the end of the first quarter of 2025. Our leverage ratio, calculated in accordance with our credit agreement, decreased to 0.95 at the end of the first quarter of 2025, compared to 0.99 at the end of 2024. At the end of the first quarter of 2025, we had $133 million of borrowing capacity available under our revolving credit facility, and an additional $200 million of uncommitted borrowing capacity. Before I review our guidance for 2025, I'll make some comments on tariffs. As you are well aware, in the first quarter, the Trump administration initiated tariffs, modified tariffs, added new tariffs, and then reduced tariffs for 90 days on most countries, while leaving a baseline tariff rate of 10% in place, in addition to the tariffs put in place on steel and aluminum. The administration has imposed a very high tariff rate on imports from China, with China initiating a retaliatory tariff on U.S. exports to China. Among the various impacts from the announced tariffs, the most significant impact to Kadant, related to import of products from China and tariffs on imports of steel and aluminum. Specific to the steel and aluminum tariffs, the impact on steel is important to us. We noted that regardless of the country of origin, steel prices in the U.S. increased 20% to 30%, essentially right after the tariffs were put in place. We believe we'll be able to mitigate the impact of the steel price increase by working with our suppliers and cost sharing with our customers. The China tariffs will impact us over the short term while we work to realign our supply chain. We are estimating incremental material costs of approximately $5 million to $6 million, or $0.32 to $0.39 per share, in our April forecast, associated with tariffs that cannot be mitigated in the short term. The majority of this impact is occurring in the second and third quarter prior to the full benefit of mitigation efforts being realized. This estimate is obviously subject to change based on the ongoing tariff negotiations. We'll continue to pursue opportunities to reduce the impact of these costs by finding alternative suppliers, through cost sharing, and in some cases, making investments to change our manufacturing capabilities and manufacture components at different Kadant facilities. Another significant impact related to tariffs is the resulting uncertainty in the market, which has impacted our customers' decision-making process for our capital equipment. We have a very healthy level of quote activity for our capital equipment, and we have seen little disruption to capital order activity related to maintenance and mission-critical equipment. However, if customers have flexibility with the timing for their equipment purchase, they are delaying placing the order until there is more certainty and stability in the markets they serve. Some projects have already been delayed into the back half of 2025 or into next year. This is especially true for larger projects and greenfield projects, where it is critical for the customer to understand how tariffs may impact future input and output costs. This environment has made it extremely difficult for our operations to forecast the timing of capital orders requiring significant judgment on order timing and future material costs. We will continue to monitor these tariff changes and will provide further updates as the year progresses and there is more clarity with the new regulations. As a result of these tariff-related impacts, we are revising our full year 2025 guidance. We now expect revenue of $1.020 billion to $1.040 billion in 2025, revised from our previous guidance of $1.040 billion to $1.065 billion. We now expect adjusted EPS of $9.05 to $9.25, which excludes $0.08 of acquisition-related costs, revised from our previous adjusted EPS guidance of $9.70 to $10.05. The revised adjusted EPS guidance includes a $0.32 to $0.39 impact directly from tariffs. The remainder of the guidance change is due to delays in capital orders as a result of the uncertainty created by the tariffs. Looking at our quarterly revenue and EPS performance in 2025, we expect that the second half of the year will be significantly stronger than the first half. Our revenue guidance for the second quarter 2025 is $243 million to $250 million, and our adjusted EPS guidance for the second quarter is $1.90 to $2, which excludes $0.01 of acquisition-related costs. The second quarter adjusted EPS guidance includes an estimated $0.14 to $0.18 impact from tariffs. We now anticipate gross margins for 2025 will be 44.2% to 44.7%. As a percentage of revenue, we now anticipate SG&A will be approximately 27.2% to 27.7%. For 2025, we now anticipate slightly lower net interest expense of approximately $12 million to $12.4 million, and we now expect our recurring tax rate will be approximately 26% to 27%. In addition, the following guidance estimates remain unchanged for 2025. R&D expense will be approximately 1.5% of revenue, depreciation and amortization expense of $49 million to $50 million, and CapEx spending of $24 million to $26 million. That concludes my review of the financials, and then I will now turn the call back over to Michelle for our Q&A session. Michelle?

[Operator Instructions] Our first question will come from Ross Sparenblek with William Blair.

Hey, good morning, gentlemen. Maybe just starting high level on the order book. I can appreciate it sounds like there's a bit of a pause. It also sounds like you guys have some pretty strong visibility to maybe just $20 million to $25 million of orders being deferred into 2026. Kind of as we think about your customer conversations and the sensitivity to that push out is there anything else we should look for or be aware of that might cause further deferrals in the next year? And you get the sense that the overall kind of project funnel is still pretty strong? Or is there any risk of contraction here?

Yes, Ross one of the issues, of course, is if the projects come get pushed off a quarter to the revenue recognition sometimes pushes it into next year, and that's part of what we're dealing with here. I would say the discussion level and activity level actually is reasonably strong before the craziness of the tariffs kicked in several weeks ago, we, there was I would say an increase in activity. We signed a nice order early in the second quarter, a big capital order. And we're in discussions on a few more. So I think it's still yet to be seen how much of a pause the current environment will cause. I think we haven't seen any projects canceled. I think it's just an issue that they just say, okay, I'm going to wait another two weeks here and see where things fall out. So I would tell you that, and we've been saying this for some time, that we're really in the beginning of the third year of what we consider to be a capital equipment recession. Started really in second quarter of ‘23. And our experience within this business for our companies have been around for 100 plus years, we know that you can't continue to go without investing in equipment. And so they're going to have to start making these investments. One of the reasons we're still booking record levels of parts and consumables, even though the operating rates aren't at record levels right now, is because they're running old tired equipment and it's taken a lot more parts and consumables to keep it running. So they're going to have to start to invest in the business. And we thought that this year, certainly the back half of the year, that was going to be the case. And it still might be, but there's just an added level of uncertainty now with all the chaos that these trade negotiations are causing. And as you obviously know, they depending on the day and the time of the day they're different everywhere. So it's just a very chaotic time right now. But we don't see any signs that projects are going away. If they get delayed a quarter, it can push back our revenue recognition by a quarter on them. Some of that, if it comes late in the year, we'll slip into next year.

Yes, I know that that's a good segue here. I mean, kind of thinking about that maintenance cycle. I mean, I believe last year, the order book on the capital equipment side was a lot more Greenfield related. Do you have a sense, I mean, is this a year, two years of excess demand for kind of the maintenance spend? We, yes, the average age of the installed base elevated by an excess couple of years. And then are we still kind of thinking 10% to 20% order growth for 2025 in the capital equipment?

Well, we know that the average age of our equipment is older than historical, than historical norms, which is often the case when you get economic uncertainty everybody pulls back. And so we are benefiting from our parts consumable aspect because of that. But I think we also put a lot of brand new capital out in ‘21, ‘22. And it takes a couple of years before that starts to generate parts business. And so we will start to see over the next couple of years, I think we'll start to see that new, all that new installed equipment that we booked and sold in 2021- 22, we'll see that start to generate parts as it starts to get some age on it. Consumables will pick up, of course, if operating rates start to pick up. They're kind of a function of economic activity and operating rates. But what we really, so I don't, we don't expect a big drop off in parts consumables, but what we do expect is to see an increase in capital because capital is clearly performing below market and they can't do that forever. And so it's just a question of when they start to get the comfort level to start to make those investments. As I said, we're seeing a little activity. We booked a big project a couple of weeks ago and we're in discussions on a few more. So we're seeing some activity. Just a question of timing.

And the next question will come from Gary Prestopino with Barrington.

Good morning, Jeff and Mike. Mike, would you have the percentage of the revenue of consumables by segment for last year's first quarter handy?

Yes. See, in Flow Control, it was 74%. In Industrial Processing, it was 69%. In Material Handling, 62%. And then overall, as I mentioned in my comments, 69%.

Okay, great. Everything's in a quandary here because of these tariffs. And I guess, do you get the sense that once there's clarity on these tariffs, if there ever will be, that your, at least discretionary capital projects will then kind of move ahead? Or is there any potential that some of these things could just overall be canceled just because the tariffs become so onerous? Just trying to get an understanding of what your end markets are feeling, doing, and saying.

Yes, reason, it's pretty rare for projects to get canceled. And we do see projects every few years, you'll see a project go away. But as far as significant a large number of projects getting canceled, it just doesn't happen in this business. It's very, even in ‘08, ‘09 we had the financial crisis, things got put on hold for a couple of years, but then they came back pretty strong after that. So they just, now, is it possible that the tariffs so disrupt global trade? Yes, but what's going to happen is, of course they're going to source from other places. And because we're international, we operate in every country in the world we'll benefit, we'll pick up that business elsewhere. If it's not being produced in Europe, then it'll be produced in the U.S., or if it's not being produced in China, it'll be produced in Europe. So we'll chase that business. And because we're active everywhere in the world to the extent that there's still global growth, we'll benefit from that. Although, there could be some disruptions and relocations associated with this.

Okay. So very few of these things ever do get canceled.

Not usually. Normally when things get canceled, it's because frankly, it's been in the developing world, and it's mainly been because of lack of financing, not so much demand.

And most of this impact on the capital side is going to be felt in the industrial processing segment this year.

If you look at the first quarter, Flow Control had a very good first quarter, really, and Material Handling was flat. It was really Industrial Processing on the capital side.

That's the segment where we believe we'll have the strongest level of capital bookings this year.

And the next question comes from Kurt Yinger with D.A. Davidson.

Great. Thanks, and good morning, everyone. I just wanted to start off if we look at the Q2 guide and some of the pressures there, how much of that is maybe bookings in Q1 that some of those projects have been deferred in the back half, and you have pretty good visibility at this stage? And then I guess as we think about the ramp that's kind of assumed in the back half for sales, what would that suggest in terms of the level of capital bookings that you'll need to see kind of in Q2 and Q3?

Yes, you're right, Kurt, that the weakness here in the first quarter is really has impacted some of what we thought we'd start to see some revenue in the second quarter, along with good bookings in the second quarter, which would really lead us to a very strong second half. So I think when you looking at, what we're looking at currently on the bookings front, we are going to really need, you've heard me mention kind of that 10% to 20%. We are going to need, I'd say, 15% to 20% increase in order flow on capital to really make the back half of the year. As Jeff said, there are, we've seen some good activity thus far in the second quarter. So, and we have a number of projects that we're tracking, so we know they're there. I think my overarching concern, and you saw that in the guidance, is I think we could end up with a case where we actually get the orders, but because they have incrementally moved out, it'll get pushed to revenue in ‘26. So, we could end up with a year with really quite good orders, but some of that revenue is going to be ‘26 revenue.

Got it. Okay. And I guess generally since the big tariff announcements at the beginning of this month, have you seen a little bit of shock and awe at the start from customers and maybe some acceptance and realization that it's not the end of the world? Let's continue to move forward. Or I guess what are you hearing in those conversations in terms of the pushout you've already seen and maybe what gives you confidence that those are still on the board this year?

Yes, it's you're exactly right. Everybody's kind of still in shock, so I don't know if they fully informed their thinking right now because it changes every day. Literally, I remember we were in a meeting two weeks ago, and we went in the morning and we had one tariff for the project, and we came out in the afternoon and we had a different set of tariffs for the project. So literally the cost, input cost changed in one day. So it's, I think it's just right now, people are still trying to figure out exactly what's going on. And as you know, it's just human nature when there's that kind of uncertainty, you just don't do anything. And so they're just, even things that were very close to being let, they just are sitting on their hands okay, we got the contract, we're negotiating the contract, we're waiting for the signatures. They're just signatures are coming more slowly because everybody's saying, well, let's understand what all this means. So it's, I think it's just the chaotic nature of it that I think is causing the pause. But I think that most of our customers believe ultimately, as we do, frankly, that this is going to get sorted out. There probably will be some tariffs that do survive, and we'll have to try to mitigate those as much as possible. But I think people think that it probably is going to get sorted out. The issue you have now, though, of course, is you saw that they just released the first quarter GDP, and it was down. And so that clearly and this chaos kind of started really late, right, in the quarter, although there were some hints that it was coming. So now the question is are we going to see a further economic slowdown in the second quarter because of all of this? And I wouldn't be surprised if we do. And again, that always, it adds another layer to the decision making process, okay, now we're in a technical recession, how does that factor into our thinking? But as I said a few minutes ago these projects, our equipment tends to be part of a very expensive project. We're a small piece of it. We're $5 million or $10 million in a $200 million or $400 million project. And so normally when these things get started, these guys are long-term planners, just like we are, and they don't let short-term disruptions kind of totally stop the project. They just slow it down.

Okay. That makes sense. And then just with the revision to guidance, Mike, maybe you could just update us in terms of kind of what you're assuming in terms of parts versus capital mix in terms of sales this year. And I guess implicit in that question would be do you expect the strength in parts and consumables that you saw here in Q1 to persist? Or maybe was there any pull-forward benefit given that maintenance dynamic or even maybe some anticipation by customers that prices for parts and components would go up and maybe a little bit of an inventory build?

Yes, I do think, Kurt, that there were some folks who pre-bought. When I talked to the people in the field there was some of that. But I think it ended up just really being a few million. It wasn't anything that I felt like I really needed to, oh, I better make sure this is in the column. That, of course, is factored into our guidance for the second quarter. But on your question in regards to parts and consumables as it relates to percent of revenue going forward, in the back half of the year where we hope to have better capital revenues than in the first half, I'm looking at, I have right now third and fourth quarter at 68% and 64%, and the year on parts and consumables coming out at 69%. So as you recall some of the businesses, we bought were heavy parts and consumable business. So that is giving us a little bit of an uplift here. We finished out last year at 66%. And if our forecasts are correct, we'll end up this year at 69%

And the next question comes from Walter Liptak with Seaport Research.

Hey, good morning, guys. So Trump just started a cabinet meeting. So maybe the tariffs will change again by lunchtime.

We were thinking about putting the tariff charge on all of our prices. But after he hammered on yesterday, we rethought that and said, okay, we probably won't show the tariff impact on our pricing. He doesn't seem to like that.

Oh, okay. All right. Well, I wanted to ask about that specifically. You called out some numbers, I think $36 million, and you put an EPS bracket around it. What is that exactly? Is that price, is that tariff that you're expecting that you're going to have to absorb into margins? Or is that selling prices that you're expecting? Or is that volume that you don't think you'll get because of the tariffs? What is in that estimate of the tariff hit that you presented?

Yes, so it's $5 million to $6 million, and that will be included in our material cost. So these are the direct impact of the tariffs that, as best we can estimate, we will end up having to incur before our mitigation efforts are completed. So kind of when you look at the guidance, we're down, say, on the low end $0.65 on the high end $0.80, and roughly half that decrease is the impact of what we believe we'll have to pay in tariffs as we procure material for jobs.

Okay. But won't you, as you invoice customers, put in a surcharge or something for those incremental costs?

Yes. We have a number of levers we are pulling. Surcharges will be one of them. But the issue is that isn't instantaneous. So although the divisions have those plans and will execute on them, most of the units are saying we'll start to have traction. Frankly, they've, I believe, essentially already addressed the steel issue, which was a blow in and of itself, with prices going up 25% to 30%. So now we're down to, I'll say, the rest of the tariffs and where you're sourcing from. And again, they can't be mitigated instantly. So what we're planning on doing, hoping to do, is we'll pull the levers. And as we go through the year, hopefully, by the time we get to the end of the year, we'll be able to largely mitigate to any impact of the tariffs on a go-forward basis.

Okay. With the tariffs, do you hope to be, I guess, tariff price cost neutral by the end of the year, so this is just a catch-up? Or do you think you'll have to absorb some of those tariffs permanently?

Yes. It's a great question. I mean it kind of remains to be seen. But our goal, of course, is to be neutral. But that remains to be seen. As Jeff mentioned, we think our competitors are essentially in the same boat as us. So we don't think we're at a competitive disadvantage.

Okay. All right. I appreciate that. And then just one follow-up for me on understanding the back half and the full year guidance. So in the guidance, you're expecting that there's going to be some recovery in capital projects. But it sounds like you need to get some of those projects that are in the funnel right now to get let go or to get awarded to you by in the second quarter. Or we'll be looking at the numbers coming down again for the back half of the year. Is that right?

Yes. We do need some to come in here in the second quarter, for sure. Some. And then we need that activity on the capital side to continue in the third and fourth quarter. We took down the revenue is really by the, on our guidance ranges by the low-end $20 million, the high-end $25 million. Because basically, in the first quarter, we had very soft capital activity. But the projects are still there. And now we are seeing some projects, better activity here in the second quarter. But even just that delay, and that, as I said, answering a question a little bit earlier, that's kind of my overarching concern, is we may end up having a great booking year on capital. But it may come in later, late enough that it causes the revenue to go into ‘26.

Okay. Because of the percentage of completion for the long-cycle projects.

Well, that's a good comment on your part. On the percent complete, or now they call it overtime, that is really largely in our fiber processing. So when you hear us say, oh, we got a fiber processing order, those tend to be on an overtime basis. But on the other areas, like I'll say wood products, where we see a number of good order possibilities, those will be point in time, which basically means we're going to recognize revenue when we ship it. And that's my concern. If those projects, say, move out a few months or a quarter, then instead of it being delivered in the fourth quarter, ‘25, could be first quarter, ’26, so.

And our next question comes from Kurt Yinger with D.A. Davidson.

Great. Thanks. Appreciate it. Just two quick follow-ups. The $5 million to $6 million, I guess if we were to think about the overall cost impact without mitigation efforts and kind of the current tariff environment, what would that kind of total additional cost be?

Well, it's $0.32 to $0.39. We're mitigating a lot of the tariffs. $0.05 or $0.06 is what we haven't mitigated. We know what the total tariff is for mitigation. Excellent question, Kurt. And the people in the field were swimming upstream to keep up with all the changes. So I boiled down the request to just tell us what you won't be able to mitigate in the near future immediately. And we'll put that into our guidance. So I can't tell you it's twice this number. But like I said, the steel is 25% to 30%. And I think our folks have largely addressed that.

And that's our single biggest cost. Single biggest input cost is steel.

Got you. So it's more of a steel dynamic as opposed to some of the imports versus China. The steel would be the much larger bucket of those two. Is that the right way to think about it?

Well, overall, steel is significant. It's significant to us. When we look at sourcing, of course, in terms of what hasn't been mitigated yet, the biggest piece of that is both coming in from China and stuff from US to China.

We were surprised. I was surprised at how much we still sell into China from here when we started looking at the numbers. We know, I knew we were going to have the tariff hit for the things we bring in from our divisions there. You'll remember that about 80% of what we build in China stays in the China market. And then about 20% they build for their sister divisions, some in the US. And that's where we're getting the hit. But I was a little surprised, actually, because China put a reciprocal tariff on. I was surprised at how much that was for stuff we're sending to China still. It was a lot more than I would expect it. So to the extent that the US and China can get this under control, that would be pretty impactful for us.

Right. And not to get too sidetracked, but in terms of what you might be making here and shipping to China, would that primarily be related to acquisitions you've done over time where you've leveraged some of the sales force there and brought businesses that previously weren't international over there? Or is that maybe too general?

Well, there's some critical parts that we still make here that our Chinese divisions incorporate into their products. There's some technology that we've kind of safeguarded here that they don't engineer, that we send over fully built just as an IP protection standpoint. So that's a lot of it.

Got you. Okay, perfect. And then thinking ahead potentially a little bit, can you, I guess, size for us how much of Karmana's business that's manufactured in Canada kind of ultimately gets shipped down to the US? And I mean, it doesn't seem like any of that's exposed to tariffs at this stage, but if something were to change, how would you think about kind of framing that?

The capital equipment, the machines that are made, are made in Canada, and they come in under the USMCA. So there's no tariffs on those currently.

But if something was to go, was to flip on the USMCA, then it would be impacted by that. And if we thought it was long term, then we'd have to look at other alternatives. But as of right now, they qualify under our trade agreement.

I am showing no further questions at this time. I would now like to turn the call back over to Jeff Powell for closing remarks.

Thanks Michelle. So before wrapping up the call today, I just want to leave you with a few takeaways. The newer activity was up to the start of ‘25. It was kind of broad based. There's still a lot of discussions going on around new projects, although the timing of these projects is more uncertain than normal because of the issues that we've just discussed here today. Despite the continued geopolitical and trade policy uncertainty, our employees around the globe continue to focus on meeting our customers’ need and finding new ways to deliver long term value to our stakeholders. And lastly, our financial health is still excellent. We still have strong free cash flows. Our balance sheet is in very good position. And we look forward to delivering good value to our stakeholders again in 2025. So with that, I want to thank you for joining us today. And we look forward to talking to you in the future.