Mike McKenney - CFO Jon Painter - President & CEO.

Dan Jacome - Sidoti Anthony Young - Macquarie.

Welcome to the Third Quarter 2015 Kadant Incorporations' Earnings Conference Call. [Operator Instructions]. I would now like to turn the call over to Chief Financial Officer to Mike McKenney..

Thank you, operator. Good morning, everyone, and welcome to Kadant's third quarter 2015 earnings call. With me on 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 our slide presentation and those discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 3, 2015 and subsequent filings with the Securities and Exchange Commission.

Our Form 10-K is on file with the SEC and is also available in the Investors section of our website at www.kadant.com under the heading SEC Filings. In addition, any forward-looking statements we make during this webcast represent our views only as of today.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our estimates change and you should not rely on these forward-looking statements as representing our views on any date after today. During this 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 Investors 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, Mike. Hello everyone, it's my pleasure to brief on our third quarter results and our outlook for the remainder of the year. Overall despite significant currency headwinds we had another strong quarter with excellent cash flow operating margins and better than expected earnings per share performance.

I will begin today's Business Review with a financial highlights of the quarter. We finished the third quarter with revenue of 92 million down 7% compared to the third quarter of 2014. Foreign currency translation had a large impact on Q3 revenue and excluding the effect of FX our revenue in Q3 was up 2%.

Gross margins in the third quarter continue to be very strong at 48%, operating income with some 25% to 13 million or 14% of sales which is the highest operating margin since our spin off in 2001. Our adjusted EBITDA was 15 million or 17% of the sales up14% compared to Q3 of last year.

Our GAAP diluted earnings per share was up 30% to $0.78 in the third quarter despite an $0.11 negative impact from foreign currency translation. Our adjusted earnings per share was up 24% to $0.78 excluding the impact of the FX are adjusted earnings per share increased 41%. Our bookings of 99 million were down 2% compared to Q3 of 2014.

However our bookings performance was matched by the impact of the strong dollar as our bookings are up 8% when excluding the impact of FX. Cash flow for the third quarter was excellent at 16 million and we ended the quarter with net cash of 27 million.

During the quarter we repurchased approximately 118,000 shares or $5 million at an average price of 41.27. As you can see from slide 6. FX continues to have a significant effect on our results when compared to Q3 of last year. Our internal growth for Q3 which excludes acquisitions and FX was up 6% for bookings and essentially flat for revenues.

Our internal growth for Q3 and parts a consumables revenue was up 6% while bookings growth was up 8%. Earlier this year. I talked about how FX versus affects us versus how it may affect other companies [indiscernible] repeating. We have operations all over the world which for the most part have revenues and cost denominated in the same currencies.

This reduces the impact of changes in currency on the financial results of our domestic and foreign subsidiaries although we do have translation exposure associated with converting revenue and profit of our foreign-subs into U.S. dollars for reporting purposes.

It's far better to have a business that is doing well and growing in local currency even if it translates into less U.S. dollars due to FX than to have a business that’s declining in local currency and benefiting from favorable FX.

And it's much better than having a business has margins are squeezed by FX because costs and revenues are in different currencies. The strength of our gross margins this year in this year currency volatility is a testament to this.

Turning to our bookings and revenue trends slide, bookings and revenues are relatively strong in Q3 despite the strong dollar. Our third quarter revenue of 92 million was down 7% year-over-year entirely due to F.X. translation excluding the impact from FX back our growth was 2% compared to Q3 of last year.

Strong performance in our stock prep and wood processing product lines particularly North America was largely responsible for this grow, our stock prep product line in North America is benefitting from investments in pulp mills and our wood processing product line is benefiting from strength in the housing market and growth in parts and consumables.

Our bookings of 99 million in Q3 were down 2% from the third quarter of last year. Excluding the impact of FX our Q3 bookings were up 8%. Project activity in our stock prep business in both North America and Europe were the primary drivers of solid bookings performance in Q3.

Turning now to our part and consumables business, our revenue for parts and consumables in the third quarter was essentially flat compared to Q3 of last year and represented 69% of our total revenue, excluding the impact of FX and acquisitions are internal growth was 6%.

Our strong parts revenue performance to Q3 was driven by our stock prep product line in North America which had an exceptionally strong quarter. Growing our parts and consumables business continues to be a strategic focus of ours and we're seeing solid results from both our internal initiatives as well from acquisitions.

Parts and consumables booking were up 3% compared to Q3 of last year to 61 million. This increase was tempered by the strong dollar when excluding the impact of the FX bookings were up 12%. Next I'd like to take a few minutes to provide an overview of our business activities and our performance each of the major geographic regions of the world.

Let me start with North America, the North American market is our largest and continues to be the strong in the world for us. Overall paper industry producers particularly those in containerboard are enjoying excellent profitability and this makes for a good environment for investment.

In addition housing starts in the first nine months of 2015 are up 12% compared to last year and they're on track to finish the year at the highest level since the recession. Our revenues in North America were up 1% compared to the third quarter of 2014 to 55 million.

Our stock prep product line led the growth in this region up 62% compared to Q3 of last year driven by strong demand for our stock prep parts as well as several large capital orders for [indiscernible] pulp mill upgrades.

Our wood processing product line was also up 8% despite considerable FX headwinds and I'm pleased to announce that we are recently awarded supplier of the year from the Engineered Wood Association, a group consisting of producers of OSB and other engineered wood products.

On the other hand our doctoring, cleaning and filtration product line had a 24% revenue decline compared to a very strong Q3 of 2014 which included a very large capital order. The majority of this revenue decline was in our capital business which tends to be more volatile.

As I noted last quarter weakness in the printing and writing grades also has negatively affected this product line. Q3 bookings in North America were 54 million up 17% compared to a relatively weak Q3 of last year led by our stock prep and fluid handling product lines.

During the quarter we booked several large orders for the rebuild of the dryer sections for two large container board machines in the southeast and a large order for an OCC recycling system.

Outside paper we're seeing growing market penetration of our industrials steam systems offerings During the quarter we booked a $0.5 million order for a steam system using our advantage control technologies for Newport [indiscernible] going into Canada and we continue to see good project activity in this adjacent market.

In addition in the fourth quarter we received an order from a major producer of carbon fiber in the U.S. for 66 veralight [ph] doctoring assemblies to be installed in five of its manufacturing lines. Both of these orders are example of expanding our technology into new industrial markets which is one of our growth initiatives.

Between internal growth initiatives and acquisitions our growth rate outside the paper industry has been faster than our growth rate inside the paper industry. At the rate we're going there will be a time when the majority of our business will be customers outside the paper industry.

In summary 2015 is shaping up to be the best year in our history for our North American businesses for revenue and income and this region has been a major driver of growth for Kadant this year. As I look to 2016 I expect another good year although I will say 2015 will be a tough act to follow.

In Europe we’re increasingly encouraged by the positive trend in bookings over the past four quarters and the upward trend in revenues spike FX headwinds.

As I mentioned in earlier calls we're seeing increased project activity in Southern Europe and some of that activity was converted to orders in Q3, our Q3 revenue in Europe was 18 million down 12% from Q3 of last year but when excluding the impact of FX our revenue was up 4%.

Q3 bookings of 23 million were up 22% compared to Q3 of last year due entirely to our stock prep product line which saw 63% increase in bookings. Excluding the impact of FX we had even larger increase of 46%.

The increase in bookings was led by an approximately $7 million order for recycled fiber processing equipment which we announced several weeks ago to be using the conversion of a mill in Southern Europe for printing and writing to packaging.

There continues to be reasonable project activity in Europe and I'm pleased to announce that we booked an order in early Q4 for a turnkey dryer system rebuild for award [ph] machine in Eastern Europe with an approximate value 1.1 million.

These orders and other project activity are indicating a positive trend emerging in Europe as the region begins to recover. As I look ahead to 2016 the building, bookings and backlog momentum in Europe should lead to a stronger revenue and income performance in 2016. Next, let's take a look at Asia.

In contrast to North America and Europe Asia is continuing to experience an overall sluggishness that has resulted in delayed projects and creating financing challenges for some producers. Our Q3 revenue in Asia was 12 million down 18% compared to Q3 of last year.

Our Q3 bookings in Asia were 15 million down 41% from a very strong third quarter of last year which included several large stocked up capital orders.

While new system activity was somewhat restraining Q3 we are seeing increased demand for upgrades of existing equipment to improve mill efficiency and we booked several smaller OCC system rebuild orders with a combined value of just over 1 million.

This is a pattern we're see in the more mature and stable markets such as Europe and North America were smaller projects are implemented to operating efficiencies rather than increase capacity. The nice thing about these types of orders they do not depend on capacity expansion and that as a result they can provide a more stable revenue stream.

China's, a dominant market in Asia and China's overcapacity conditions and its recent forecasts of containerboard demand growth slowing to 2% per year for the next few years suggest new capacity and new capital activity will remain at reduced levels in the coming year.

For the last several years we've sought to minimize the volatility of large capital swings in China by growing our spare parts and consumables business and I'm pleased to report that we've made good progress on this initiative.

For the first nine months of 2015 our parts and consumables revenue made up 58% of our total revenue in China, compared to 35% in 2010. As I look into 2016 in Asia we have several advantages that we expect to mitigate the soft market conditions in China.

But first I just mentioned is the growth of our parts and consumables business in China which tend to be more stable as it's tied to operating rates rather than capacity expansion. The second is a very strong backlog of 57 million a good portion of which will be shipped in 2016.

And the other positive factor we’re seeing is the relative strength of other powered parts of Southeast Asia such as Vietnam and Taiwan. Finally let me make a few comments above the rest of the world. As a reminder this region includes South America, Africa, Australia and the Middle East.

Our revenue in the rest of the world with 7 million in Q3 down 25% compared to the same period last year due entirely to FX excluding the impact of FX revenue was essentially flat. Rest of the world bookings were down 29% to 7 million in Q3 of 2015 from a strong Q3 of 2014.

FX translation also had a major impact on the results and excluding FX rest of the world bookings were down 6% compared to the same period last year. This region continues to be weak overall largely due to the relatively severely recession of Brazil but I can tell you that there is still is some project activity.

Let me close my remarks with a few comments on our guidance for Q4 and the full year 2015. The first three quarters of 2015 has positioned us well for record year in a number of categories including growth margin, EBITDA operating income and earnings per share.

Our outlook for Q4 however has been impacted by reduced revenue expectations and our doctoring, cleaning and filtration and fluid handling product lines due to delays in capital bookings and shipments. In addition the strong U.S.

dollar has reduced our full year revenue and earnings per share expectations by 3 million and $0.05 respectively since our last call. For the fourth quarter of 2015 we expect to achieve gap diluted earnings per share of $0.79 to $0.82 on revenue of 105 million to 107 million.

We’re lowering our full year revenue guidance to 388 million to 390 million and our full year guidance for GAAP diluted earnings per share to 295 to 298. As I've mentioned in the past FX has had a significant impact on our expected growth rate versus 2014. Reducing revenue by 31 million and adjusted earnings per share by $0.33.

Excluding the negative currency impact we expect our revenue to grow 4% to 5% and our adjusted earnings per share grow 19% to 20% to 2014. I will now pass the call over to Mike for additional details on our financial performance in Q3.

Mike?.

Thank you, Jon. I'll start with our gross margin performance. Consolidated product gross margins were 47.5% in the third quarter of 2015 up 280 basis points compared to the third quarter of 2014. The increasing gross margins from last year's third quarter was due to higher margins in our capital business as well as a favorable product mix.

Our higher margin parts and consumables revenue represented 69% of total revenue in the third quarter of 2015 compared to 64% in the third quarter of 2014. Looking ahead we expect the full year 2015 consolidated gross margins will be approximately 46%.

Now let's turn to slide 17, our quarterly SG&A expenses, SG&A expenses were 29.2 million in the third quarter of 2015 down 2.7 million from last year's third quarter and included a favorable foreign currency translation effect of 2.5 million.

Excluding the translation effect of 2.5 million, the SG&A from acquisitions as well as the transaction expenses of acquisitions SG&A expenses were down 600,000 or 2% compared to the third quarter of 2014. SG&A as a percentage of revenue was 31.8% in the third quarter of 2015 compared to 32.3% in last year's third quarter.

Looking ahead we expect that SG&A spending in 2015 as a percentage of revenue will be approximately 31.5% compared to 32.2% in 2014. Now let's turn to slide 18, adjusted operating income.

Our adjusted operating income which excludes restructuring costs and expenses related to acquired inventory and backlog was 12.7 million or 13.8% of revenue for the third quarter of 2015 compared to 10.7 million or 10.8% of revenue in the third quarter of 2014.

Adjusted operating income was up 2 million or 19% principally due to improved gross margins as well as a modest 50 basis point improvement in SG&A expenses as a percentage of revenues. As John mentioned our third quarter operating margin is the highest we've achieved since our spinoff in 2001.

We've worked hard to continue to improve the profitability of the business and I think this chart shows we've made good progress. Let me turn to our EPS results for the quarter.

We reported GAAP diluted earnings per share from continuing operations of $0.78 in the third quarter of 2015 compared to $0.60 in the third quarter of 2014 or an increase of $0.18.

This increase of $0.18 and diluted EPS consists of the following, $0.18 due to higher gross margin percentages, $0.17 due to lower operating expenses, $0.03 due to a lower effective tax rate, $0.03 due to the absence of restructuring costs in the third quarter of 2015 and $0.02 associated with acquisition operating results.

These increases were partially offset by a decrease of $0.25 from lower revenue. Collectively included in all the categories I just mentioned was an unfavorable foreign currency translation effect of $0.11 in the third quarter of 2015 compared to last year's third quarter due to the strengthening of the U.S. dollar.

Now let's turn to our cash flows and working capital metrics starting on slide 20, we had strong cash flows from continuing operations a 15.9 million in the third quarter of 2015 up 700,000 compared to the third quarter of 2014.

Free cash flow defined as cash flows from continuing operations less CapEx was 14.5 million in the third quarter of 2015 up from last year's 13.5 million. We had several notable non-operating uses of cash during the third quarter of 2015.

We purchased $4.9 million of our common stock, we paid a dividend of 1.9 million and we expended 1.4 million in CapEx. Over the past twelve months we’ve returned 17.9 million of capital to our shareholders, 10.9 million from share repurchases and 7 million from dividends. This represents approximately 54% of our net income during that period.

Now let's look at our key working capital metrics on slide 21. Days in inventory were a 123 in the third quarter of 2015 compared to 97 in the third quarter of 2014 and 107 in the second quarter of 2015. We have several large capital orders scheduled to ship in the fourth quarter of 2015 and in the first half of 2016.

Once these orders are shipped the days and inventory should return to historical levels, Our days and receivables measure was 63 days in the third quarter of 2015 and compares to 66 days in the third quarter of 2014 and 57 days in the second quarter of 2015.

Our AP days were 51 in the third quarter of 2015 compared to 46 in the third quarter of 2014 and 49 in the second quarter of 2015.

Looking at our overall working capital position our cash conversion days measure calculated by taking days and receivables plus days and inventory and subtracting days and accounts payable was 135 at the end of the third quarter of 2015, up 20 from the second quarter of 2015 and up 18 days from the third quarter of 2014.

Working capital as a percentage of revenue was 14.7% in the third quarter of 2015 compared to 14% in the third quarter of 2014 and 15.8% in the second quarter of 2015. Our strong cash flows in the third quarter led to an increase in our net cash position of 7.4 million compared to second quarter of 2015.

Net cash, that is cash less debt at the end of the third quarter of 2015 was 27.5 million compared to 20.1 million in the second quarter of 2015 and 18.7 million in the third quarter of 2014. That concludes my review of the financials and I will now turn the call back over to the operator for our Q&A session.

Operator?.

[Operator Instructions]. Our first question comes from the line of Walter Liptak from [indiscernible] Global..

Just a couple of quick questions here, first with regard to the guidance you guys mentiobned larger delays in capital bookings and shipment I was wondering if you can provide a little more color on the expectations there..

Sure. We've had over the years we've had delays in capital before and typically the typical pattern of those delays it's a large stock prep order in China. It's probably happened to us many times over the years.

This is a little different in that these projects and delays are more related to our doctoring, cleaning and filtration and our fluid handling lines, so they're smaller projects these are kind of the million dollar in under range. So there's more of them and they're not all in China.

I would say probably Europe, North America, China and maybe even probably a little heavier in Europe, nothing particularly special in terms of the reasons for the delays, I would say the typical types of delays you see. You know the usually part of a larger project so other things can often cause a delay.

There is some in the projects in China there is some projects which I would call financing delay but nothing like that in North America and Europe..

And then just kind of switching gears talking about North America little bit. Obviously part sales continue to be strong and could you talk a little bit about your guidance expectations, obviously you continuously said that it's continued be a priority.

Can you talk a little bit about your expectations for that and where you see those going, will they maintain the level they're currently at and then on the other side of that could you also just provide a little color on just in sales in North America and what kind of quote activity, it sounds like Jon in your prepared comments like.

It seems to be a kind of a healthy environment if you could just provide a more color on the system--.

Sure. In my remarks I said North America is having an outstanding year driven largely where our stock prep business. I mean they are really both in capital and in parts doing incredibly well and I would say the other one is doing quite well as our wood processing.

And frankly when I also said that I think 2015 will be a tough act to follow I was largely talking about our stock prep business in North America. They had a number of capital projects this year which will be hard frankly to repeat in terms of revenue and income for that product line next year.

What was the other parts of your question?.

Just kind of about system sales, the environment and just talking about--.

Good environment in North America it continues to be a good environment. There is always a little bit to sort of timing of capital orders. They can make one year like frankly our doctoring, cleaning and filtration product line. You know they had a very, very strong '14. So they had some tough comparisons this year because last year '14 was so good.

So that kind of comes and goes I actually take it as a little bit of a positive that those two product lines tend to cycle a little differently I would say our fluid handling and our doctoring, cleaning and filtration product line cycle more similarly -- our stock prep product lines maybe cycles a little different from those other two..

Next question comes from the line of Dan Jacome from Sidoti..

Just a couple here, well guess cermanic blades any update on that just I'm curious about the response rates or what traction you're seen in that product line as we enter the New Year?.

Sure. I mean you know just kind of update you, we’re -- we did this acquisition in the beginning of last year and we spent much of the time here really building a production facility here in the U.S. and I'm hoping that that will be done first quarter next year.

We in the meantime we're sort of taking the blades out for trials, they're all going it extremely well. I mean they're performing.

technically quite well so we couldn't be more pleased with that, quite understandably our customers want to see the production facility up and running before they're really going to commit and so that's kind of I would say where we are. .

And then just turning to North America obviously very strong, containerboard robust, I was just curious what your initial thoughts were when you saw Westrock, I guess over a million tons of capacity last week.

Just curious what you were thinking when you saw that?.

This happens all the time. I'm frankly is interested in anything I'm sort of overall containerboard demand and how they're doing and I was sitting just limiting to containerboard.

So we're really interested kind of overall tons produced and sometimes if they can maintain their profitability and prove it by closing some mills down that's life, I'd rather there were more mills but ultimately we need them to be very profitable which they are..

And then lastly hate to sound like a nag but you're sitting here a record backlog, looks like highest cash earning margin ever, I mean stocks kind of been lagging I was wondering if there's anything you might be doing next year to maybe get the story a little bit more out there next year and if you guys have ever considered possibly holding an Analyst Day..

And you know it is a little bit frustrating I think a lot of that blame probably falls on me in terms of if you will getting the story out on the stock and we are that is something that we're looking at to have kind of Analyst Day either in New York or maybe out here and maybe have people come to our facility out here in Massachusetts..

Next question comes from the line of Anthony Young from Macquarie..

You mentioned possibly having the majority of your business outside of the paper industry at some point.

What sort of timeframe were you talking about when you made those comments?.

I quite purposely didn't give one, but all I'm saying, the fact of the matter is that a lot of the acquisitions that we're looking at are outside of the paper industry. And that what is not is not because we are down on the paper industry I'd actually prefer to do an acquisition inside the paper industry because we've got better synergies.

But in just in terms of good business is available there's more outside than in.

That said, it could go the other way if we had a good acquisition inside the paper industry we would happily do that but as I look forward particularly driven by acquisitions I wouldn't be surprised to know that the majority of acquisitions are outside the paper industry.

That's really what that was driving sorts and I wasn't -- again I'm definitely not signaling any kind of plan to get outside the paper industry or desire to get outside the paper industry, it's more just the nature of what's available in terms of acquisitions..

And then I guess just to feed into that, I mean you guys reported last beginning of August and you know we obviously had a sharp correction in mid to late August and from point during September.

Previously you talked about multiples and prices being somewhat elevated I guess for things that you are looking at and have you seen things come in or people still sticking to you know there's--.

To be honest with you, I haven't really seen a change in terms of the private company market. It's still an issue that when the companies are larger they tend to have kind of more of higher pricing and the smaller ones are still more reasonable.

I think it probably takes some more sustained correction to work its way into M&A in in terms of stock market..

I will now like to turn the call back over to Mike McKenney for closing remarks..

Let me thank you all for listening and I'll conclude with really what I think are the key takeaways for the quarter. The first one is that we grew our earnings per share 30% despite this $0.11 FX headwind.

Secondly, our parts and consumable business is continuing to go strong up 9% excluding the impact of FX and finally although we reduced our outlook for 2015 we still expected to be an excellent year with a record earnings per share performance. I look forward to updating you on the next on our progress in future calls. Thanks very much. Bye..