Thomas O’Brien – EVP and CFO Jon Painter – President and CEO.

Rudy Hokanson – Barrington Research Associates, Inc. Swanee Vitnes – Global Hunter Securities, LLC.

Good day, ladies and gentlemen, and welcome to the Q3 2014 Kadant Inc. Earnings Conference Call. My name is Whitley and I’ll be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Thomas O’Brien, Chief Financial Officer. Please proceed, sir..

Thank you operator and good morning everyone and welcome to Kadant’s third quarter 2014 earnings call. With me in the call today is Jon Painter, 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 expectations, plans and prospects are forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Our actual results may differ materially from these forward-looking statements as a result of various important factors including those outlined at the beginning of slide presentation and those discussed under the heading Risk Factors in our report on Form 10-Q for the fiscal quarter ended June 28, 2014.

Our Form 10-Q is on file with the SEC and is also available in the investor section of our website at www.kadant.com under the heading SEC Filings. In addition, any forward-looking statements we make during this webcast represents 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 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 third quarter earnings press release issued yesterday which is available in the investor section of our website at www.kadant.com under the heading Investor News.

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

Jon?.

Thanks, Tom. Hello everyone. It’s my pleasure to brief you on our third quarter results as well as our outlook for the remainder of the year. Overall, we had another solid quarter with strong cash flows, gross margins and better-than-expected revenue and earnings per share performance.

I’ll begin today’s review with the financial highlights of the quarter. We finished the third quarter with revenues of 99 million which was up 8% compared to the third quarter of 2013 and the second highest in our history. In addition, we set a record for parts consumables revenue at $63 million. Gross margins in the third quarter were strong at 45%.

Our adjusted EBITDA was also the second highest in our history at 13.4 million or 13.5% of sales, up 9% compared to Q3 of last year. Our GAAP diluted earnings per share of $0.60 in the third quarter included $0.03 of expense related to restructuring. Our adjusted earnings per share was up 11% to $0.63.

Our bookings increased 23% over Q3 of last year to 100 million and we ended the quarter with a near-record backlog of 128 million. And last but certainly not least, we had excellent cash flow from operations of over 15 million, up 20% compared to the same period last year and we ended the quarter with net cash of 19 million.

The bookings and revenue trend chart on Slide 6 shows our quarterly revenue which is the red line and our bookings which it the blue bars. Q3 revenue was up 8% from Q3 of last year to 99 million, boosted by our recent acquisitions.

Revenue from all of our product lines was up except stock prep which saw a revenue decline of 20% compared to last year due to lower capital revenue. Our fluid-handling product line revenues from the third quarter were up 16% compared to the third quarter of 2013, driven in large part by strong aftermarket sales in the U.S. and Europe.

In our doctor and cleaning filtration line, strong bookings during the first half of the year contributed to a 10% increase in Q3 revenue compared to the same period last year.

Our bookings of 100 million in Q3 were up 23% over the third quarter of last year due to contributions from our recent acquisitions and several large capital orders booked during our stock prep line. Excluding the impact from acquisitions, our Q3 bookings were up 12% compared to the third quarter of 2013.

This internal growth was due primarily to capital bookings in our stock prep product lines which were up significantly compared to a relatively weak Q3 of last year, while our fluid handling and doctoring cleaning and filtration lines had modest increases in Q3 bookings compared to last year.

If we look at our ninth month internal growth and bookings, compared to the first nine months of last year, we’re up a very strong 13%. We’ve been working hard on several initiatives, so generally internal growth and it’s good to see these efforts bearing fruit. I will share a few examples of these successes later in my remarks.

Our revenue for parts and consumables in the third quarter set a new record at 63 million, up 21% from Q3 of 2013 and made up 64% of our Q3 revenues. Acquisitions were a major contributor to these record results contributing 76% of the increase. Excluding acquisitions, our parts and consumables revenue was up a very healthy 5%.

This increase was driven in large part by our doctor cleaning and filtration product lines in Europe which was up 27% and our fluid handling product line in the U.S. which was up 19% compared to the third quarter of last year.

We also had solid parts and consumables bookings which were up 9% over Q3 of last year but down 11% compared to last quarter’s record parts and consumables bookings. As you may remember, we have a bit of seasonality in parts and consumables bookings with Q1 being one of the stronger quarters and Q3 one of the weakest.

Before I leave this slide, I wanted to take a moment and draw your attention to the success we’ve had over these last several years drawing our parts and consumables business. As you may remember several years ago, we identified growing our parts and consumables business as a strategic objective.

We’ve worked hard to achieve this objective not only through acquisitions like Carmanah and Knot [ph] but also through internal growth initiatives such as growing our market share for parts and consumables in China as well as R&D programs focused on improving the ease of use, reliability and safety of our parts and consumables.

One example of our success in this area is an order we received a few weeks ago from a major producer in China for 40 slide out doctor holders which we recently introduced to that market. These holders reduced the mills time to change a doctor holder from eight hours to one hour. They are also lighter, safer and easier for mill personnel to handle.

The customer justified the price for this premium product because of the increased productivity and safety in its mills. I could tell you this is a significant accomplishment because customers in China are the most price sensitive in the world and they don’t like paying a premium price for anything.

Individually, the effective efforts like these is relatively small but collectively they’re having a major impact not only on growing our business but also increasing our overall profitability and enhancing the stability of our earnings.

Our parts and consumables now make up more than 60% of total revenues and it has made our business fundamentally stronger. I’d like to make the next few minutes to provide a brief review of our business activities in each of the major geographies of the world. Let me start with North America.

The North American market is our largest and continues to be the strongest in the world for us. North America container board and tissue producers and doing extremely well and seeing historic levels of profitability.

These producers have a big advantage both in fiber quality and cost and this has led to a positive investment environment particularly for chemical pulp projects.

In addition, the market for oriented strand board or OSB continues to be strong with expected demand growth of 10% per year or more for the next several years driven by the continued recovery in the U.S. housing market.

Our revenues in North America were up 47% compared to the third quarter of 2013 to 54 million and were up 2% sequentially from a very strong Q2. Acquisitions were a major contributor to revenue growth in Q3.

In addition, our fluid handling product line led our internal growth, up 30% compared to Q3 of last year drive by increases in sales to customers in both paper and industrial markets.

In our industrial markets, we started up several industrial steam systems and on the paper side we recorded revenues for several machine rebuilds that included hardware and system components.

While we’ve seen it stepped up from this strong bookings levels we’ve had in Q1, the overall market conditions for both capital and parts and consumables is still quite good. Bookings in North America were 46 million, up 22% compared to the same period last year but down 11% sequentially compared to a relatively strong Q2.

We saw a good level of activity in the third quarter including a $5 million order for a chemical pulping system. I can also tell you that prospects in the fourth quarter are encouraging with several large capital projects for chemical pulping, recycling and wood processing systems in the works.

If we are successful on converting these projects to orders, we’ll have a very nice sequential bookings increase in Q4. In Europe, we had a relatively weak third quarter and we’re seeing a general sense of caution in the market due to the growing uncertainty found in the macro economy.

Our Q3 revenue in Europe was 21 million, down 19% from Q3 of last year and 23% sequentially due to reduced capital sales particularly on our stock product line. Q3 bookings of 19 million were down 2% compared to Q3 of last year and 13% sequentially.

This is our second quarter of sequential bookings to clients in Europe which is something we’re watching very closely. In general, however, while market conditions are weak, we do see a business as usual attitude with several projects being discussed.

It’s times like these that I appreciate our business model which has a large percentage of sales of the more stable parts and consumables. I was in Europe earlier this month visiting several of our operations and I was reminded how resilient our businesses in Europe are despite some significant headwinds in the macro environment.

Next pick, let’s take a look at China. As you may recall, despite the oversupply in the market, we’ve seen increased project activity in 2014 and we continue to see this activity being converted into bookings.

Many of these projects are for mills located in the western or central part of the country where there is still demand for additional capacity as it is not economic to ship line aboard great distances in China.

I will say, however, our pipeline of new potential projects is smaller than earlier in the year due to the large capacity additions coming online and a slowing macro environment. Our Q3 bookings in China were very strong at 20 million, up 38% compared to the same period last year.

The bookings performance is led by our stock prep product lines where we booked several large OCC system orders with a combined value of nearly 8 million. In doctor cleaning and filtration product lines, we were successful on penetrating several large mills where we had no prior business activity.

As a result, we continue to grow our market share, particularly in our new-to-China [ph] products that have a strong consumables element to them. Our Q3 revenues in China of 11 million was down 27% compared to a strong Q3 of last year.

This decrease in revenues was due primarily to our stock product line and attributed in large part to lower capital bookings at the end of 2013 and the first quarter of 2014. As you can see on Slide 11, our book-to-bill in China has been 1.8 and 2.1 respectively for the last two quarters and our backlog in China at 43 million is very strong.

Turning to South America, our smallest region, you can see the third quarter of 2014 shows an improvement in terms of bookings and revenue.

That said, the economy of the region continues to be soft due in large part to the sluggish global commodities market, ongoing restraint in consumer spending and the uncertainty leading up to the presidential runoffs. During the third quarter we restructured our operation in Brazil to adjust to market conditions.

We believe this action was a result in annual savings of approximately $1 million per year. We continue to believe the medium and long-term outlook for Brazil is good, driven by a growing middle class and rising standard of living.

Our revenue in South America was $7 million in Q3 down 13% compared to the same period last year by about 15% sequentially. Bookings in Q3 were solid at 7 million down 4% compared to Q3 of 2013 by about 33% sequentially. I’d like to close my remarks with a few comments on our guidance for Q4 and the full year 2014.

For the quarter, we expect to generate $0.72 to $0.74 of GAAP diluted earnings per share on revenues of $104 million to $106 million. For the full year, we expect to generate $2.47 to $2.49 of GAAP diluted earnings per share on revenues of $401 million to $403 million, which is lower than our prior EPS guidance of $2.50 to $2.60.

$0.03 of the EPS reduction is due to the restricting I just mentioned that we did not include in our prior guidance. And additional $0.03 of the reduction is due to the strengthening of the U.S. dollars from the rates we use in our July earnings guidance.

In addition, our outlook for Q4 has been impacted by the timing of capital orders including both revenue that we expected in Q4 that ended up in Q3 as well as revenue that we expected in Q4 that was flipped into Q1 of 2015. Finally, we’ve also tempered our outlook in Q4 due to weaker market conditions in Europe and South America.

Despite this, we have a near-record backlog at the end of Q3 and we expect that we will have a very strong backlog going in to 2015.

As a reminder, our full year 2014 GAAP earnings per share guidance include $0.17 of purchase accounting charges related to profit and required inventory and backlog associated with business that we acquired last year and $0.06 of restructuring charges taken during the year. When I adjust for these one-time charges, we end up in the range of $2.72.

I’ll now pass over the call to Tom for additional details on our financial performance in Q3.

Tom?.

Thank you, John. I’d like to give you an overview of our financial results this quarter beginning with our gross margin performance. Consolidated product gross margins were 44.7% in the third quarter of 2014, up 80 basis points compared to the third quarter of 2013.

The increase in consolidated gross margins from last year’s third quarter was due to a favorable product mix, offset partly by slightly lower margins in our parts and consumables business. Looking ahead, we expect that full year 2014 consolidated gross margins will be approximately 44%. And let’s turn to Slide 16 in our quarterly S&GA expenses.

SG&A expenses were $31.9 million in the third quarter of 2014 up $33.3 million from last year’s third quarter principally due to a $2 million associated with the SG&A of acquisitions. SG&A expenses as a percentage of revenues were 32.3% in the third quarter of 2014 compared to 31.3% in the last year’s third quarter, an increase of 100 basis points.

Looking forward, we expect that SG&A spending in 2014 as a percentage of revenues will be approximately 32% compared to 34% in 2013. Let’s now turn to our EPS results for the quarter.

We reported GAAP diluted earnings per share from continuing operations of $0.60 in the third quarter of 2014 compared to $0.57 in the third quarter of 2013 or an increase of $0.03. This increase of $0.03 in diluted EPS consist of the following.

Increases of $0.14 from the combined effects of the operating results of the acquisitions and lower acquisition transaction expenses; $0.06 due to higher gross margin percentages and $0.01 from lower weighted average shares outstanding.

These increases were partially offset by decreases of $0.10 due to higher operating expenses, $0.03 due to lower revenue, $0.03 due to restricting expenses and $0.02 from a higher effective tax rate. Now let’s turn to our cash flows, working capital and debt leverage starting on Slide 18.

We had strong operating cash flows from continuing operations of $15.2 million in the third quarter of 2014 up from $12.6 million in the third quarter of 2013. Free cash flow, defined as cash flows from continuing operations less CapEx was $13.5 million in the third quarter of 2014, up from last year’s $11 million.

We had several notable non-operating uses of cash during the third quarter of 2014; the most significant of which was $5 million, a repayment of debt. It is worth noting that during the quarter we paid off the remaining debt associated with our acquisition of Carmanah which we acquired in the fourth quarter of 2013.

We also purchase $1.9 million of our common stock, expended $1.7 million in CapEx and paid a dividend of $1.6 million. The stock repurchases in the quarter represented 50,000 shares at an average price of $38.18 per share.

Over the past 12 months, we have returned $21.1 million of capital to our shareholders, $15 million from share repurchases and $6.1 million from dividends. This represents approximately 83% of our net income during that period.

Our working capital metrics of DSO, inventory days and accounts payable days were in combination slightly weaker than last year.

Our cash conversion days measure calculated by taking days and receivables plus days in inventory and subtracting days in accounts payable was 117 at the end of the third quarter of 2014, up eight days and seven days from the second quarter of 2014 and the third quarter of 2013 respectively.

Working capital as a percentage of revenues decreased in the third quarter of 2014 to 14% from 15.7% in the second quarter of 2014 and 14.4% in the third quarter of 2013.

Our net cash position increased by 9.2 million in the third quarter of 2014 compared to the second quarter of 2014 despite the debt repayment, stock repurchases, CapEx and dividends noted earlier.

Net cash, that is cash less debt, at the end of the third quarter of 2014 was $18.7 million compared to $9.5 million in the second quarter of 2014 and $58.7 million in the third quarter of 2013.

And finally, as you can see on Slide 22, our leverage ratio calculated as defined in our credit facility was 0.32 at the end of the third quarter of 2014 down from 0.42 in the second quarter of 2014, mainly due to the repayment of the remainder of the debt which was associated with the Carmanah acquisition.

Under the credit facility, this ratio must be less than 3.5. That concludes my review of the financials. And I will now turn the call back to the operator for our Q&A session.

Operator?.

(Operator instructions) Questions will be taken in the order they are received. (Operator instructions) Your first question comes from the line of Rudy Hokanson of Barrington Research. Please proceed..

Good morning..

Good morning..

Questions, could you talk a little bit more about the activity you’re having in China and the success on the products and consumables, what you’re able to do there right now?.

Next question and Rudy can dial back.

Is there another question?.

(Operator instructions) Our next question comes from the line of Swanee Vitnes [ph] with Global Hunter Securities, LLC. Please proceed..

Oh, hello, guys. Thank you for taking my question.

Can you please quantify the parts and consumables business revenue in Europe?.

I didn’t quite get that.

What was the question?.

Parts and consumables in Europe..

The parts and consumables business revenues in Europe?.

The parts and consumables business in Europe?.

Yes, that is correct..

And what is the – I’m not sure I understand.

What’s the question on that?.

What is your revenue in the parts and consumables business in Europe? If I’m not audible maybe I can just call back again..

No, I think we hear you okay. I could tell you the businesses, our businesses in Europe, okay, which is primarily in Europe but no exclusively, their revenue was around – well, their bookings is around $15 million collectively..

Okay. Okay.

And I may have missed out on duties questions, but then, can you just walk us through the initiatives that you will be taking to offset the softness in South America and China?.

Sure. I mean, part of it is doing things like growing our parts and consumables business. I mean, that’s just a more stable business. So, for example, in China, something like that example that I gave you where we’ve essentially partnered with a customer and we’re helping them become more productive.

So this is kind of a trend we’ve seen in China before where as they move away from growing capacity at a rapid rate, they focus more on increasing the productivity of their mills and we’re in a great position to help them do that and many times that involves using our parts because they actually have a better pay back.

And that same kind of thinking really can go on in South America. We did, as we mentioned, do a small restructuring in South America; but I think over time that market will recover. It has kind of everything going forth that a lot of developing markets have. The other – go ahead..

No, go ahead..

So, some of the other stuff we work on with customers is we’ll focus on, for example, in China in particular they may have problems with water. There is more and more restrictions on mills for using water. So we have a number of products that help them to be more efficient and recycle more water within their mills.

So this is something that’s more regulatory driven and that even in a market where there is a soft demand for new capacity, they have to do these kinds of things..

Okay, sounds good.

And do you have any sizeable project in hand to support the Europe growth?.

Sizeable projects in Europe?.

Yes..

Yes, there are still projects going on in Europe. That’s why I was kind of saying, and I kind of refer to it as a business as usual attitude. There are still projects being discussed. It’s not like it was sort of during the Great Recession or financial time back in ‘08 where there was no discussion of projects. People are still getting stuff done.

I would just say there’s a little heightened sense of caution..

Okay..

We still definitely have a project pipeline if you will. I would just say it’s moving a bit slower than it was earlier..

Sounds good. Thank you, guys..

You’re welcome..

Your next question comes from the line of Rudy Hokanson with Barrington Research Associates, Inc..

Can you guys hear me now?.

Yes, we can hear you..

Okay, good, sorry. My question was focused on what was going on in China.

We’ve been talking about the capacity issues there and them closing down inefficient plants et cetera, and I was just wondering – on the paper-making side, and I was just looking for what you see in terms of overall activity in China and demand for the consumables and the products.

Since you had used as an example and you just repeated it about working with a particular customer, I was wondering if you could give us a little more color on the dynamics of China considering the conversations we’ve had the last year or two..

Sure. And just to remind sort of other listeners, there’s a few things going on in China that all impact capacity additions. One of them of course is the economy is growing at 7%, right? So that’s going to continually require new capacity to be added. One of the phenomena’s of China is they tend to add it in kind of weights.

So we’ve got a lot of capacity going on. So I would say that the overcapacity that we’re seeing right now is as much an aspect of the supply side as the demand side. There is some demand there, maybe not as strong as it was two years ago but there is some demand side.

The other side which you kind of refer to, Rudy, is the fact that the Chinese government is mandating the closure of smaller, high-polluting inefficient mills. And this, from our perspective, is like creating more demand because those aren’t our customers. And that’s continued this year. I have no reason to think it won’t continue next year.

And it’s hard to quantify exactly what impact – how much of our bookings are tied to that versus expectations of general higher demand. And the other things which I’ve kind of probably first talked about in this call is just the geographic distribution of the mills. If you look at – China is one entity.

There is some overcapacity particularly in things like printing and writing grades. But a lot of that overcapacity is in the south, kind of in Guangzhou province, the export area.

And the government is interested in encouraging investment in the western part of China and the central part of China, and it really doesn’t make sense to move liner board and other grades that far. So you might have a case where you actually have demand in the west even though you have some oversupply in the east..

Okay..

Then on – I don’t know really what I could add to the parts story. It’s a definite factor that the Chinese operators are focused much more on the productivity of their mill and that’s a great opportunity for us that we’ve worked on seizing to improve our parts and consumables business in China..

Okay. Thank you. And also, just a quick follow up, again on to China.

You had talked about the opportunities for OSB in China and that you – after the acquisition was made at the end of last year about how you were already starting to do some exchanges in China in terms of discussions about what could happen, is there anymore color on that?.

Sure. Well, you’re absolutely right. OSB is kind of a newish product in China. We bought Carmanah, and then in April they got two strander orders in China in April of this year. That’s actually a lot. And those mills will be starting up in the coming months. And that is really going to be up to the producers of that OSB to find markets for it.

And I believe they will because it makes total sense for China. It’s a less expensive product. It doesn’t need large trees and so forth. So they should do well, but I will say there’s probably a little bit of pioneering work that those customers will have to do and they haven’t really – they’re pre-selling now but those aren’t fully up and running.

So it’ll take a little bit of time..

Okay. Thank you. Those are my questions..

Thank you..

(Operator instructions).

Operator, is there any other folks on the line there?.

There are no further questions in queue..

Okay, thanks. Well, thanks. I want to conclude today’s call of what I think are several key takeaway points. First, we had another solid quarter with excellent cash flows and gross margins.

Second, we continue to make progress in growing our parts and consumables business, setting a new revenue record in Q3, a quarter in which 64% of our revenues of some parts and consumables. And third, we’re seeing good business activity in North America, although some weakness overseas.

And finally, although we’ve reduced our GAAP guidance, we do expect 2014 to be a record-setting year in terms of bookings, revenue, adjusted EBITDA and adjusted earnings per share. I look forward to updating you next quarter. Thanks very much..

Ladies and gentlemen, that conclude today’s conference. Thank you for your participation. You may now disconnect. Have a great day..