Michael McKenney - Senior Vice President and CFO Jon Painter - President and CEO.

Rudy Hokanson - Barrington Research Walter Liptak - Seaport Global Dan Jacome - Sidoti.

Good day, ladies and gentlemen. And welcome to the Kadant Inc. Q1 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call maybe recorded.

I would now like to introduce your host for today’s conference, Michael McKenney, Senior Vice President and Chief Financial Officer. Please go ahead..

Thank you, Charlotte. Good afternoon, everyone. And welcome to Kadant’s first quarter 2017 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 December 31, 2016.

Our Form 10-K is on file with the SEC and is also available in 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 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 first quarter earnings press release issued today, 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’ll 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 first quarter results and our outlook for the rest of 2017. Overall, we had a great start to the year, with strong operating performance leading to big earnings per share beep, as well as record bookings and record parts and consumables revenue and booking.

Slide five contains the specifics of our first quarter financial results. Without question, one of the highlights of the first quarter was our record bookings of $119 million, up 23% versus Q1 of last year and following a strong bookings performance in Q4 of $114 million.

This was driven in large part by continued strong capital bookings in China, as well as record parts and consumables booking. Other key points I want to note include, first quarter revenue of $103 million, exceed the top end of our guidance of $100 million.

Gross margin of 47.6% was the third best in our history due largely to our high percentage of parts and consumables at 68% of revenues and solid pricing execution. Adjusted EBITDA was up 11% to $15 million, representing 15% of revenue.

We generated $0.80 of GAAP diluted earnings per share, handily beating the top end of our guidance of $0.66 and were up 11% compared to last year's adjusted earnings per share. For the first time in quite a while FX had a relatively minor impact on our results.

Our revenue growth in Q1 however was due to the contribution from PAAL which we acquired in the second quarter of 2016. As you can see on slide six, our internal revenue growth in the first quarter without the impact of PAAL was a negative 6%, while internal growth and adjusted earnings per share was up 4%. Internal growth in bookings was a solid 11%.

I'm also pleased to report our internal revenue growth for parts and consumables in Q1 was up 5%, while bookings were up 14%. On slide seven, you can see a nice trend in bookings over the last three quarters, culminating in a record $119 million in bookings in the first quarter of 2017.

More encouraging, we could -- we continue to see an active pipeline of projects. The major contributors to our bookings performance were stock-prep product line, we saw strong increases in China, as was the case last quarter and our wood processing and fluid handling product lines also up 26% and 16%, respectively, versus last year.

Q1 revenue increased 7% to $103 million, due largely to the contribution of PAAL. All of our product lines saw revenue growth in the first quarter compared to the same period last year. Another bright spot of quarter was the performance of our parts and consumables business.

Revenue from parts and consumables in the first quarter increased 11% to a record $70 million and represented 68% of our total Q1 revenue. This solid revenue increase included internal growth in our wood processing and fluid handling product lines.

We pay a lot of attention to our parts and consumables business, so it's satisfying to see the strong performance. Parts and consumables bookings were also outstanding, up 20% to a record $75 million. All major regions experienced increased parts and consumables bookings compared to Q1 of last year.

Next, I’d like to review our performance in the major geographic regions where we operate and we start with North America. The pulp and paper market in North America is solid and stable, while the U.S. housing market continues its recovery leading to strong growth in our wood processing product line.

As you can see on slide nine, revenue increased for the second consecutive quarter to $50 million, but was down 8% compared to the first quarter of 2016. Bookings in North America were $57 million, up 16% sequentially and 5% compared to Q1 of last year.

Increases in bookings for our wood processing and fiber-based product lines offset reductions in our stock-prep product line compared to a very strong Q1 of last year.

We had a decent level of larger orders in North America in the first quarter, including 10 rebuilt orders for our wood processing products valued at nearly $4 million and orders for a recycling system and a chemical pulping product with a combined value of approximately $7.5 million. On slide 10 we show our revenue and bookings performance in Europe.

First quarter revenue was up 56% year-over-year. Thanks largely to PAAL and was up 11% sequentially. Bookings in Europe were down 2% sequentially from the near record performance in Q4 of 2016 and remained strong at $32 million. Overall, the market in Europe is pretty good and Russia continues to be a bright spot for capital projects.

We booked nearly $4 million in Russia in Q1 and there are still projects in the pipeline, which we hope to secure this year. Turning now to Asia. Revenue was down 9% from last year due largely to the slower bookings levels we had in the middle of 2016.

The overall business in China capital project activity in mid-2016 constraint revenues in the second half of 2016 and the first quarter of 2017. That said, the strong bookings performance from China in the last two quarters will have a positive impact on revenues going forward in 2017.

The high level of capital bookings we had in Q4 of last year continued in the first quarter of 2017 contributing to a 19% increase in overall booking versus the same period in 2016. All of our product lines had double-digit growth in booking. In China we booked three large OCC system order during Q1.

This combined value of approximately $11 million and numerous orders for our drying systems and fabric cleaning equipment with a combined value for approximately $2 million. Moreover, after the first quarter closed, we booked an order with a value of more than $6 million from containerboard producer for two OCC recycling system.

We continue to have an active pipeline of projects in the works which looks promising for later this year. Although, we know the capital equipment market in China can be volatile. Finally, a few comments on the rest of the world results.

Our revenue in the rest of the world was $8 million in Q1, up 4% compared to the same period last year and up 35% on a sequential basis. Bookings were also up sequentially and year-over-year due to a number of smaller projects including equipment for pulp drying at a major pulp and paper producer in Brazil.

That said, there's still a lot of political uncertainty in Brazil which continues to have an adverse impact on the economy. I would like to conclude my remarks with a few comments on our guidance for Q2 and the full year 2017. We are encouraged by the bookings trends we are seeing in the past two quarters and a strong start to 2017.

Based on our Q1 results and our outlook for the remainder of 2017 we are raising our full year revenue and earnings per share guidance. For 2017 we now expect to achieve GAAP diluted earnings per share of $3.27 to $3.37 on revenues of $427 million to $437 million.

For the second quarter of 2017 we expect to achieve GAAP diluted earnings per share of $0.87 to $0.91 on revenues of $107 million to $110 million. I will now pass the call over to Mike for additional details on our financial performance in Q1.

Mike?.

Thank you, Jon. I'll start with our gross margin performance. Consolidated gross margins were 47.6% in the first quarter of 2017, up 200 basis points compared to 45.6% in the first quarter of 2016.

The increase in gross margins from last year's first quarter was principally due to higher margins in parts and consumables business, as well as a favorable product mix. Our higher margin parts and consumables revenue represented 68% of total revenue in the first quarter of 2017, compared to 65% in the first quarter of 2016.

Now let's turn to slide 16 and our quarterly SG&A expenses. SG&A expenses were $34.8 million in the first quarter of 2017, up $2.3 million from the first quarter of 2016. This included an increase of $3.1 million resulting from our acquisition of PAAL and a favorable foreign currency translation effect of $0.4 million.

SG&A expenses in the first quarter of 2016 included $1.4 million of acquisition costs associated with the PAAL acquisition. Excluding PAAL’s G&A and foreign currency translation effect in the first quarter of 2017 and excluding the acquisition costs in the first quarter of 2016 SG&A was up $4 million.

SG&A expenses as a percentage of revenue was 33.8% in the first quarter of 2017 compared to 33.7% in the first quarter of 2016. Let me turn next to our EPS results for the quarter. In the first quarter of 2017 GAAP diluted earnings per share was $0.80 and there were no adjustments to EPS.

In the first quarter of 2016, GAAP diluted EPS was $0.62 and our adjusted diluted EPS was $0.72. The $0.10 difference relates to acquisition costs that gain on the sale of the facility.

The increase of $0.08 in GAAP diluted EPS in the first quarter of ‘17 compared to adjusted diluted EPS in the first quarter of ‘16 consist of the following; $0.23 due to higher gross margin percentages; $0.07 due to inclusion of the operating results from PAAL; and $0.03 due to a lower effective tax rate.

These increases were partially offset by $0.21 due to lower revenue and $0.04 due to higher operating costs. Collectively, included in all categories I just mentioned was an unfavorable foreign currency translation effect of $0.02 in the first quarter of 2017 compared to last year's quarter due to the strengthening of U.S. dollar.

Let me also take a moment to compare our diluted EPS results in the first quarter to the guidance we issued during our February 2017 earnings call. Our GAAP diluted EPS guidance for the first quarter of ‘17 was $0.62 to $0.66. We reported GAAP diluted earnings per share of $0.80 in the first quarter of ’17.

This $0.14 increase over the high-end of our guidance range was principally the result of better than expected operating results from our stock-preparation product line in all regions.

I would also like to point out that in our February call I noted that our tax rate for the first quarter of ‘17 would likely be lower than the remaining quarters of ‘17 due to unanticipated tax benefit associated with the vesting of equity awards in March.

The tax rate for the first quarter of ‘17 was 23% and as anticipated in our guidance, first quarter 2017 GAAP diluted EPS include a tax benefit of $0.04 related to the vesting of equity awards. As we guided in February, we still expect our effective tax rate will be approximately 27% to 28% in 2017.

Now let's turn to our cash flows and working capital metrics starting on slide 18. Cash flow from operations were $1.7 million first quarter of 2017, down from $5.5 million in the first quarter 2016.

As you can see on the chart, the major factor contributing to this performance in the first quarter 2017 was a $12.2 million use related to working capital, primarily due to a $6.2 million increase in accounts receivable and unbilled costs and fees and a $4 million increase in inventory.

The inventory increase is related to projects that are scheduled for delivery later this year and we expect the cash flows will be positively affected in future quarters as we complete and shipped these projects. Receivables increase was principally driven by shipments in the last month of the first quarter which is still in accounts receivable.

As we have noted in the past, historically, the first quarter has been a week quarter for operating cash flows, partly due to the payment of performance incentive compensation. We had several notable non-operating uses of cash in the first quarter of 2017.

We paid $2.2 million for tax withholding payments related to the vesting of stock awards, paid a dividend of $2.1 million and also paid $0.7 million in debt issuance costs related to our new credit facility. We also expanded $1.7 million for capital expenditures. I'd like to update our guidance on CapEx spending for 2017.

In addition to our normal CapEx of $7 million to $8 million, we have a facility project underway. We anticipate funding for this project to be approximately $12 million in 2017 and $4 million in 2018. Let's now look at our key working capital metrics on slide 19.

Overall, our days in inventory and payables have remained fairly consistent from the first quarter of 2016 through the first quarter of 2017. Days and receivables increased to 67 days from 62 days at the end of the fourth quarter of 2016 as a result of the timing of shipments as I noted when discussing cash flows.

Looking at our overall working capital position our cash conversion days measure calculated by taking days and receivables plus days in inventory and subtracting days in accounts payable was 120 at the end of the first quarter of 2017, up two days from the first quarter of 2016.

Working capital as a percentage of revenue was 14.1% in the first quarter of ’17, compared to 11% in the fourth quarter of ‘16 and 15.1% in the first quarter of 16. Net cash that is cash less debt at the end of the first quarter of 2017 was $2.5 million, down from net cash of $7.2 million in the fourth quarter of 2016.

As you can see on slide 22, our leverage ratio calculated as defined in our updated credit facility was 0.53 at the end of the first quarter 2017. Under the credit facility this ratio must be less than 3.5. As a final note, in March we completed the process of renewing our credit facility.

The new credit facility is a five-year unsecured multicurrency revolving credit facility primarily with our existing bank group includes a committed aggregate principal amount of $200 million, an increase from $100 million in the old facility.

In addition, there is an uncommitted unsecured facility of an additional $100 million, up from $50 million in the old facility. That concludes my review of the financials and I'll now turn the call back over to the operator for our Q&A session.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of Rudy Hokanson from Barrington Research. Your line is now open..

Thank you. Nice quarter. Hi, everyone. Good afternoon. I have a question, it sounds like so much right now is focused on China and you went into some detail on that.

But could you tell us little bit more about what's going on with Carmanah and your outlook on the housing market and what we can expect out of that in 2017?.

Sure. So, as you know the housing market has had a sort of steady -- slow and steady increase from the recession in kind of the ’07, ‘0 period. So, and it's probably been a little slower than we expected, but I think that means it last a little longer than we expected. And the price of OCC is nice and high, they are making good money.

So a lot of the growth Carmanah had a fantastic. Wood processing business had a fantastic quarter and in North America we are definitely driving that. So the mills in the Southeast are making very, very good money at this point. And it looks fairly promising going forward I would say. Certainly the mills impact there, they are ordering a lot..

Okay. So you would expect that business to outperform last year on a relative basis….

They are certainly off to the -- they are off to a hell of a start..

Yeah..

And they had -- it’s fair to say, I would say, they had an extremely strong parts booking. I talked about of the 10 rebuilds that's a little unusual. I don't think that's going to be happening every quarter going forward. But they are definitely out of the blocks very, very strong..

And could you just focus little bit more on the strength in Europe, is that a particular region, is it country or it give -- it seems fairly broad..

So I would say, as I kind of mentioned in my remarks, Russia definitely stands out. As you know the ruble has weakened. It’s down like 40% or so from just a few years ago. And the mills that are making a lot of money in Russia right now are ones where their costs are in rubles and they are selling either in the China in U.S.

dollars or in the Europe in euro. So that is a nice formula. You can look at the IP, because they had a joint venture with [ph] LM (22:32) is pretty open about how that mill in Russia is doing and it’s really been doing very well. So I think that is definitely one of the stronger regions right now in Russia.

Frankly the industrial market has been excellent in Europe this year as well. So it’s -- I would say, we actually had our management meeting in Barcelona three weeks ago and the mood was decidedly more upbeat than this time last year I would say..

Okay.

And could you make any comments in regard to China as to where you think the transition is in the industry of the capacity utilization with the mills that you service and the closing of the less efficient mills that the government was trying to take out of the market?.

Sure. So, a little -- couple of comments I guess on China. You can see the bookings in Q4 and Q1 are quite strong. And probably, they -- the capital bookings are stronger than the underlying demand for paper liner in particular. So other things are happening.

One is, you do have the government closing down mills and that is moving demand towards people who are customers of bigger mills. Secondly, the market in China in Q4 had tightened up, prices had moved up pretty strong.

Now kind of a little choppy I would say in Q1, but the -- in general mills in China are particularly in liner those are making quite a good profit right now. I think they are also more aggressive about building, because they'll put another, not necessarily mill that the government is closing, but just the lesser inefficient mill out of business.

So they are more aggressive I would say in terms of building new modern mills and they figured they'll just put some kind of business..

Okay. Thank you. Those are my questions..

Thank you. Our next question comes from the line of Walter Liptak from Seaport Global. Your line is now open..

Hi. Thanks. Nice quarter guys..

Hey, Walt..

Thanks, Walter..

I want to ask a question on the guidance, you did this quarter pretty nicely, but it looks like you only took numbers up for -- you beat to the first quarter.

I wonder -- and the tone seemed a little bit cautious especially on China, I wonder if you could kind of address that for us?.

Okay. You're right. You are absolutely right that the increase in the guidance is pretty much equal to beep we had in Q1. I would say Q1 was quite strong. The tax rate was quite low. We had a high percentage of sales.

As we move into the year we expect to see some of this capital moving through, so even though the revenue will be higher the gross margins will be lower..

Especially, I think, in the second half..

Yeah. Pretty much in the second half, for sure. Well, I think, we will have kind of strong capital shipments in Q2 and Q3..

Okay..

But higher tax rates. That said, to be honest with you, I -- we are pretty conservative and cautious as you figured out from the tone, the -- we have been through volatility in China before, so I don't expect this will continue forever. But it does look like it’s not done, I also say that..

I would say, we had anticipated a good first quarter….

Yes..

… level of bookings, so that was baked into the forecast that we gave..

Excellent point. You might remember, Walt, we started talking about strong capital activity in China in Q3 of last year..

Yeah. Yeah. I remember. Yeah..

Yeah. That’s kind of in I think if you will..

Okay.

How -- what’s the -- what was the customer makeup in China, is it still the large papermaking companies or is it more diversified group of customers?.

It certainly more diversified. If you go back, I will talk to you in the past about in the kind of ’07, ’08, ’06 period, you had two or three mills doing all this -- two or three big groups not driving fleet and you have people like that making up a big part of the activity there. It is much broader now..

Okay. So that -- so the orders are….

The big guys are definitely, yeah, the big guys are definitely participating, but it is a much more diverse customer base, for sure..

Okay. That’s good. Okay. Yeah. That’s look better..

Yeah. Definitely better..

What about the cadence during the quarter, was it stronger in the first part of quarter, weaker in the second part of quarter?.

Well, I mean, the thing I would say on that is, okay. We booked around -- let’s talk prep, we booked about $11 million in the stock-prep, about $2 million in fluid handling business. But in April we booked $6 million, so that’s a….

Okay..

… April might be our strongest month of the last four months..

Okay. Great. Okay. And then on the parts strength that you saw, a few quarters ago the head scratcher we couldn't understand why parts were slowing down and now they are picking back up again. Is there anything you can point to and say, okay, now it’s the wood what’s been happening? Why do you think the….

Good -- that’s a good question, Walt. I would say, you often with parts, you have this kind of reversion to the mean type of things. So when you have a couple quarters that are weak, it does -- you often try to catch up and incidentally vice versa. So that I think is part of it. The increased capital activity is part of it.

Sometimes, fair beat, let say, fair parts gets sold with capital. And the other thing and I don't want to -- I want to kind of emphasizes our wood processing business had extremely strong capital. So North America was largely driven on the parts side by our wood processing business..

Yeah. Very good start to the year..

Yeah..

Okay..

Okay. Great. Thank you, guys..

All right. Thank you, Walt..

Thank you. [Operator Instructions] Our next question comes from the line of Dan Jacome from Sidoti. Your line is now open..

How are you doing?.

Good, Dan.

How are you doing?.

Good..

Good. I have to say nice job. Obviously, this quarter was a poker hand. I think you kind of hit the royal flush here..

Yeah. Actually it was one of those things, everything seems to turn out right. So you are right..

Yeah. And I know it won’t happen every quarter, but definitely encouraging, the year is off to a good start.

Just two really quick ones, I think, you called out the strong pulp market in North Am were helping you out, is that correct?.

Could you say that again, Dan?.

I think you called out the pulp market -- pulp..

Pulp market..

We think we -- the -- we did book some chemical pulping stuff in North America in the first quarter, like the virgin pulp market in U.S. has been pretty good..

Yeah. That was my question….

It’s been pretty good for a couple years, yeah..

Okay. I mean, but I am seeing -- in fluff pulp seems to be the area that I have….

Oh! Fluff, I am sorry, fluff pulp, yes..

I am hoping like you know..

Yeah. The -- in general the fluff pulp market has been good to us. We have a pretty strong market share in certain pieces of equipment for that..

Okay..

So it's a -- it’s relatively good..

Okay.

And then on just M&A pipeline obviously, any update there, I know, you think about the strategy over the next couple years has been important, but just is there any update there?.

Sure, I mean, I think, I said in last quarter and we increase our facility and the prime function of that facility, frankly, is M&A. We have good cash flow on our own. You might remember from our Investor Day in December that that the bulk of our growth for the next five years I expect will be related to acquisitions.

So we are actively looking at companies. Obviously, there never done till they are done things, go off the rails or don't happen for all kinds of reasons. But we -- I would say we are out there looking around pretty actively. I think I said earlier that we are seeing somewhat higher prices then we certainly had over the last five years.

But I think that we can probably make all those work. But it won't be the -- it won't be sort of the five times EBITDA we are saying in 2013 and ’14..

Okay. Great. Thanks a lot..

Thank you..

Thank you. our next question comes from the line of Rudy Hokanson from Barrington Research. Your line is now open..

Thank you. I just want to check on the few things..

Yeah..

And I just want to make sure I'm reading it correctly in the press release and also in the comments.

When you talked about the active pipeline of projects was that related to China?.

It is related to China and Russia, I would say. I referred to an active pipeline of projects for both those areas..

Okay.

And the $6 million that you recycled stock-prep systems was those specifically China?.

They were China, yes, yeah..

Okay..

I guess, what I'm saying, Rudy is, we had a pretty strong bookings in Q1, I called out that $6 million in Q2 and I -- we still have stuff in the pipeline. Obviously, you never know if you're going to get it, now there's a lot of things that could happen, but it's not like, we have captured everything we are going to capture, I think..

Okay.

So is it general business conditions are very positive, but you are highlighting some specifics that were in China or China and Russia, would that be the way to say it?.

Yeah. I think the capital side of our business is more heavily weighted to China in particular and secondly Russia. More than North America and Europe proper, if you will.

Okay. Thank you. And then in terms of the guidance, after this first quarter, I know you said that you expect the gross margin to come down.

You expect for the year that will still be roughly equal to what it was in ‘16 around 45.5% or will be little bit higher?.

No. Rudy, we are maintaining our guidance, so approximately same, possibly slightly higher than ’16..

Okay.

And the SG&A also at about 31.5% to 32.5%, even though you were almost 33% in this quarter?.

Yes. Correct. We will get some leverage going forward here when -- as this -- the capital shipments our revenue increases. So, yes, we are going to maintain guidance on the SG&A also..

Okay.

And then when you gave guidance on the interest expense that was before I think you had finalized the terms of your new agreement and would the net interest expense for the year still be about $800,000 fairly evenly distributed or will it be a little bit lower?.

I think actually, Rudy, it will be a little bit higher, maybe $250 million a quarter..

Okay. $250 million a quarter..

Yeah..

Okay.

And then the adjusted rate for the year would be 27% to 28%?.

Correct. Yeah..

Okay.

And what was the adjusted rate has been for this quarter?.

About 27....

Okay..

We had a -- yeah..

Okay. Thank you. That’s were my questions..

All right, [ph] Rowdy (35:35), I mean, Rudy, sorry..

Yeah..

Thank you. At this time, I am not showing any further questions. I would like to turn the call back over to Jonathan Painter for any closing remarks..

Okay. Thank you, Charlotte. Before I let everyone go, I thought I summarize what I think of the key takeaways from the quarter. First, we had excellent performance in Q1 with record bookings, record revenue and bookings for parts and consumables and a strong earnings per share beep.

Secondly, as we mentioned, we are seeing strong demand for our capital projects in product in China and Russia. And finally, we are raising our full year guidance with the expectation of achieving record revenue and record earnings per share in 2017. Thanks for joining the call today. I look forward to updating you next quarter. Thanks very much..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day..