Michael McKenney - CFO Jon Painter - President and CEO.

Walter Liptak - Seaport Global.

Good day, ladies and gentlemen, and welcome to the Kadant Inc. Q1 2018 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] I would now like to introduce your host for this conference call, Mr.

Michael McKenney. You may begin sir..

Thank you, Kevin. Good morning everyone, and welcome to Kadant's first quarter 2018 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.

These forward-looking statements are subject to known and unknown risks and uncertainties that may cause our actual results to differ materially from these forward-looking statements as a result of various important factors, including those outlined at the beginning of our slide presentation, and those discussed under the heading Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and subsequent filings with the Securities and Exchange Commission.

Our Form 10-K is on file with the SEC and is available in the Investor section of our website at www.kadant.com, under the heading SEC Filings. In addition, any forward-looking statements that 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 and the slides presented on the webcast and discussed in the conference call, which are available in the Investors section of our website at www.kadant.com 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, and thank you all for joining us this morning to review our first quarter results and update our business outlook for 2018. Overall we had a great start to the year with solid operating performance leading to an earnings per share beat as well as record bookings. I'll begin with the Q1 financial highlights.

Without question the highlight of the first quarter was our record bookings of $182 million up 53% from Q1 of last year. This was driven in large part by strong capital bookings in North America and Europe and record parts and consumables bookings. Revenue was up 45% to $149 million. Gross margin remained healthy at 44%.

Adjusted EBITDA was up 49% to $24 million or 16% of revenues. We generated $0.96 of GAAP diluted earnings per share, handily beating the top end of our guidance of $0.81. Our adjusted earnings per share was up 30% to $1.07.

And finally cash flow in Q1 which is historically a weaker quarter increased significantly compared to the same period last year to $7 million. As was the case last quarter, FX had a modest impact on our results while we saw a large impact from the acquisitions we made in the second half of 2017.

Our internal revenue growth which excludes FX and acquisition was 5% in the first quarter. Internal revenue growth and adjusted earnings per share was down 7% compared to a very profitable Q1 of last year which had gross margin of nearly 48%. Internal growth in bookings increased 12% compared to a relatively strong first quarter of 2017.

Our internal revenue growth for parts and consumables in Q1 was modest while bookings were up 3%. While a big part of our revenue and booking success in the first quarter was the contribution of our acquisitions, internal revenue growth of our existing businesses played an important role as well.

Slide 7, is the first of what I think you will agree is a series of very pretty charts. On this slide you can see a nice trend of bookings over the past six quarters culminating in a record $182 million in bookings in the first quarter of 2018.

The major contributor to our first quarter booking performance was our Wood-Processing product line which includes our recent forest products acquisition. Our Fluid-Handling of Stock-Prep product lines also saw strong Q1 bookings up 52% and 17% respectively.

What's particularly notable about the bookings performance in Q1 was the breadth both in terms of product line and geographies. Q1 revenue increased 45% to $149 million due largely to the contributions of our recent acquisitions.

All of our product lines are good revenue growth with our Wood-Processing and Fluid-Handling product lines leading the growth. Another high point of the quarter was the performance of our parts and consumables business which had three consecutive quarters of double-digits sequential growth in bookings.

Parts and consumables bookings increased 38% to a record $103 million. All regions, except South America, experienced double-digit increases in parts bookings. Revenue from parts and consumables in the first quarter was also outstanding up 36% to a record $96 million and represented 64% of our total Q1 revenue.

This increase was driven by our Wood-Processing and Fluid-Handling product lines. As most of you know, we pay a lot of attention to parts and consumables, so these results are quite satisfying. Next I'd like to review our performance in the major geographic regions where we operate. Let me start with North America.

The packaging market in North America is in excellent shape with March containerboard production up nearly 4% and operating rates over 97%. Profits were also strong helped by a $50 a ton price increase that recently went into effect and continued low OCC cost due to China's restrictions on imports of wastepaper. The U.S.

housing market is also very healthy leading to strong growth in our Wood-Processing product line. You can see on Slide 9, revenues increased to a record $78 million up 55% compared to the first quarter of 2017 making North America one of the strongest regions in the world for us. Bookings in North America were up 64% to a record $93 million.

Increases in bookings in our Wood-Processing product line which includes our recent forest products acquisition and our Fluid-Handling and Stock-Prep product lines offset a modest decline in our doctoring, cleaning, and filtration product line.

During the quarter we had several notable capital bookings from our Stock-Prep and Fluid-Handling product lines with combined value of over $7 million. We received an order for a new OCC system for a machine conversion project in the U.S. and another for recycling system upgrade.

We also booked an order for a full line corrugator steam system for a new machine being installed later this year. This order was notable as it results from our strategy of leveraging our existing products and technologies to penetrate adjacent markets outside the traditional Pulp and Paper segment.

Before leaving North America, I do want to address two things that have been in the news lately. First, rising material costs, particularly steel and second, the potential impact of threatened trade tariffs by U.S. on China.

Although the tariff is one of the reasons for the recent increases in the steel prices, I think the main reason is a general tightening of the market conditions along the entire supply chain. Steel costs have been trending upward over the last several years as the economy has picked up which is no surprise and something we've seen many times.

In general we are able to pass on these cost increases. It is at times like these that our strategy of acquiring businesses with strong sticky customer relationships and pricing power pays off.

As to the tariffs, the Trump administration has listed pulp and paper machinery equipment as a potential target on its recent worst of $50 billion of threatened tariffs. We've analyzed this information with the limited data we have available and at this time we don't believe this will have a significant impact on us.

To put this tariff issues in perspective if 100% of our paper equipment and parts made in China and sold in the U.S. in 2017 were to be subject to the full 25% tariff and we were unable to pass on any of these added costs, both of which are highly unlikely, the impact on Kadant would be around $2 million.

In addition we don't believe tariffs or increases in commodity prices in general will change our competitive position as most of our competitors are in the situation as us. Most of us manufacture in many countries and have the flexibility to shift manufacturing locations as needed.

Before leaving North America I want to provide a quick update on our new facility in Ohio which we discussed in our last call. Most of the employees are now working out of the new facility and most of the machinery and associated equipment has been installed. All in all we're proceeding according to plan.

On Slide 10 we show our bookings and revenue performance in Europe. First quarter revenue was up 27% year-over-year, thanks largely to our forest products acquisition. The paper industry outlook in Europe is encouraging with capacity additions and packaging grades in the works.

I should note the market demand for our Wood-Processing products in Europe is significantly weaker than North America where a strong housing market is the primary demand driver. That said, we continue to see good project activity in Russia for this product line.

Bookings in Europe were up 55% to a record $50 million in Q1 and increased 18% sequentially. We booked a large number of small capital orders for various projects in Europe for fiber processing systems, balers, dryer section rebuilds, and our debarking equipment.

In fact capital bookings for all of our product lines except doctoring, cleaning and filtration, were up 1% compared to the same period last year. Overall, the market in Europe is pretty healthy and we expect market conditions continue to be good in 2018. Turning now to Asia, revenue was up 69% led by our Stock-Prep and Fluid-Handling product lines.

All of our major product lines were up double-digits. Bookings in Asia were up 18% led by strong project activity in China. We booked three OCC system orders with a combined value of approximately $4 million and several orders for our drawing systems and fabric cleaning equipment with a combined value of approximately $2 million.

Also during the quarter we booked two orders for our OSB would processing equipment with a combined value of approximately $5 million. These orders are noteworthy as the OSB produced by this equipment is expected to be used in export packaging and furniture, not just the traditional construction segment.

There are other OSB projects in the pipeline which if secured should help us to offset expected softer bookings for Stock-Prep capital in the second half of the year which I discussed last quarter. We are also seeing increased demand for our products in mills located in Asia, but outside of China.

After the quarter ended we booked four smaller OCC systems with a combined value of approximately $3 million for mills in Vietnam and Taiwan. Finally, a few comments on our rest of the world results. Our revenue in the rest of the world was $10 million dollars in Q1 up 24% compared to the same period last year, but down 11% on a sequential basis.

Bookings were up both sequentially and year-over-year due to several smaller project orders for Wood-Processing equipment in Chile and Brazil and a pulp drying machinery from a major containerboard producer in Brazil with a combined value of nearly $3 million.

Although project timing can be uncertain and the capital equipment market is volatile, I'm actually pleased with the upward trend that we've seen sin bookings over the past three quarters in these regions. I'd like to conclude my remarks with a few comments on our guidance for Q2 and the full year 2018.

We're encouraged by the booking trend we have seen and the strong start in 2018. Based on our Q1 results and our outlook for the remainder of 2018 we're raising our full year revenue and earnings per share guidance. For 2018 we expect to achieve GAAP diluted earnings per share of $4.98 to $5.08 on revenue of $625 million to $635 million.

We expect our adjusted earnings per share to be between $5.15 and $5.25 and our adjusted EBITDA to be between $116 million and $118 million. Mike will give you more details on our guidance in his remarks.

For the second quarter of 2018 we expect to achieve GAAP diluted earnings per share of $0.89 to $0.94 on revenues of $150 million to $154 million and adjusted EBITDA of $0.95 to $1. I will now pass the call over to Mike for additional details on our financial performance.

Mike?.

we now expect that SG&A spending in 2018 as a percentage of revenue will be approximate 28% to 29% down 50 basis points from our February guidance. We anticipate our net interest expense for 2018 to be approximately $6.5 million up from our guidance of approximately $6 million in February with forecasted average interest rates a little over 3%.

And as a final note, we expect our recurring tax rate which excludes discrete tax expense will be approximately 30% in 2018 from our February guidance of 27.5% to 28.5%. The primary driver of the increase in our tax rate is related to how the new U.S. law taxes foreign earnings.

This is an area where guidance and rules are still being developed and clarified and we hope that once this area in the tax code is clarified our rate will go down. That concludes my review of the financials and I will now turn the call back over to the operator for a Q&A session.

Operator?.

[Operator Instructions] Our first question comes from Walter Liptak with Seaport Global..

Hi thanks. Good morning guys. I want to ask first about the gross margin and I think in the prepared remarks you said that, the gross margin looked good kind of for a first quarter, but you mentioned that parts and consumables had a lower gross margin.

I wonder if that was a product mix issue or if there's a price cost issue with parts and consumables?.

It's a mix issue..

Okay, could you care to elaborate on what shifted was lower margin?.

Yes, well within the family of parts and consumables there is quite a wide range of margins and in this particular quarter that mix just lead to a lower overall gross margin and I will say last year's first quarter and actually the second quarter were, they were in the top three our performance of all time right..

Okay and based on your commentary it sounds like you've got a big enough moat around parts and consumables that you can increase prices for inflation?.

Yes, it’s not so much that. I mean sometimes you get a little catch up but it's mainly mix, occasionally will have some large parts that come in like in the quarter that have fabulous margins and they'll kind of skew it up a bit but it's nothing, I wouldn't say there's a trend here..

Okay and switching gears to North America you commented that the order activity is good, could you help us by breaking out the organic versus total bookings growth and the tone of the underlying market?.

Well, I would say, I said in my remarks one of the things I like and maybe I'll answer a little more broadly, but one of the good things was that the organic growth was pretty broad based both geographically and product lines, North America absolutely a major big part of that.

In North America both our forest products and our Stock-Prep-recycling business both had were strong in North America. If you think along product lines you've got the Stock-Prep recycling being a big one. In addition to North America of the Baylor business in Europe and also a little bit in North America is a contributor.

Our Fluid-Handling business was very strong in North America that’s organic and our OSB business, the stander business was strong in North America but also strong in China as we said on our call. So to me it's Stock-Prep, Fluid-Handling and OSB largely North America and OSB a bit in China as well..

Okay, is this the kind of year where the orders come in early in the year and then ship as time goes on or I wonder if you can address the pipeline or the funnel of projects that are in front of here?.

Right, a lot of you can tell from the guidance to that we're expecting a very strong second half, so we've got the bookings and I think we expect to have reasonable bookings in Q2, but that the shipments really will be in the second half..

Okay, is there a funnel that goes beyond the second quarter, are you, is there still more capacity projects or conversion projects?.

In terms of the outlook on bookings?.

Yes, on bookings..

Yes, I would say that the only area that I've kind of expressed some caution frankly in bookings trends is Stock-Prep second half of China. I actually expect pretty good booking Stock-Prep second quarter China, but I wouldn't say that we're projecting a softening in other regions in the world.

It's just that one product line in that one country and as we kind of noted there's other offsets; one is the strander business in China and two with bookings in Asia outside of China that I think will help offset that that decline in the Stock-Prep capital..

Okay, great and then speaking with North America, the Ohio factory that is being expanded how is there a ramp period to the production there and is there any disruption from that and after that the plant is expanded is there some kind of inefficiency or payback on the facility or just pure capacity?.

So, we do expect - there's a learning curve. It's a lot of new workers. We were lucky that a lot did come from Alabama but it's absolutely a lot of new hires and we've kind of assumed that we'll have a learning curve that we'll see in the second quarter and probably a little bit in the third quarter as well.

So that's kind of in our guidance if you will. I talked a little bit about the payback earlier, it was kind of in that 8% range. And that that's without taking really much to impact that what we need to do with the Baylor [ph] business there..

Okay, great thank you..

[Operator Instructions] We have a followup question from Walter Liptak with Seaport Global..

Hey, Walt..

Okay, yes I’m back..

You are, and by the way before you - I should say 8% after tax was the return we talked about before?.

Oh, that’s great. Okay. I wonder if we switched you to Europe and you talked about a good I guess pretty healthy was I think the comment that you mentioned.

Is there the same sort of dynamics that are going on there with OCC prices down and pricing good and you received, some of the same trends that are happening in North America with capacity ads are run conversions to paperboard that could happen in Europe?.

Yes, the short answer is yes, they also, China is restricting imports on OCC for cleanliness and they've obviously banned waste, so that has helped from a producer's point of view helps they have lower raw material cost in Europe just like North America.

The containerboard grades in Europe are the strongest grades and that's where we're seeing kind of projects in the works. There's a big conversion project in Spain that's just sort of starting up right now, but they've got others in the works as well. So it’s yes, I would say similar to the U.S., the U.S. is probably a little stronger frankly. The U.S.

is - the players it's much more fragmented market in Europe, so you don't necessarily have sort of big projects like you have in the U.S. but directionally it's the same. OSB in Europe as I said is much less of - there's not - the houses are made of wood so much there, so it's not as big a deal there whereas the U.S.

housing market is quite strong and so it's a big difference..

Okay.

Yes, with that said on the paperboard side, is it just timing of orders do you think or you are already expecting that the funnel is going to build as you get into 2019?.

Europe is good, I mean Europe is strong. And I wouldn't say it's a strong as the U.S. but it's relative to how Europe typically is, it's good. So I wouldn't want to lead you to believe that we're down on Europe in any way..

Okay..

Let’s say it looks good for the rest of the year..

Okay. And maybe a last one and then we can take the rest of them offline but you mentioned a number of times even with the last call about the Stock-Prep and you mentioned again on this call.

I wonder if you could just clarify for us why the second half will be weaker obviously the orders shipped I guess will be weaker in the second half, but can you talk to us about the supply demand in China and why stock prep would be weaker and maybe if we think about longer term 2019 and what that?.

Okay. So if you the pattern in China for the last 20 years is they are very aggressive at adding capacity and they often kind of overshoot a little bit, then the economy grows and then they need to add capacity again, but it kind of goes in waves.

So we've had really very strong bookings for our Stock-Prep capital in China since the fourth quarter of 2016, I think we've said right from the beginning that this is a little bit of a burst of activity that will slow down at some point.

The good news of course is, we've built up this is all building of a big installed base that gives us better spares. We don’t expect - it's just a question of that capacity gets a little bit ahead of demand and they'll slow down a little bit until the economy absorbs it..

Okay, all right, it makes sense.

And maybe one last one is, Mike, you mentioned in SG&A there was $300,000 of M&A costs, was that related to prior deals or was that - is there an M&A deal in the pipeline that you do indulge in?.

Nice try. That was the first quarter of 2017 that I was referencing. But to your point if you go back and look at the first quarter of 2017, you wouldn't see it. We didn't announce it until the second quarter of 2017 that we had incurred those costs, when we announced the transaction.

So to your point we couldn't tip our hand too early, so we had to wait and hold off..

Okay, got it. All right, thanks guys. Well may be one last one then. The tax rate you said that the U.S. taxes and foreign earnings are not clear yet, so just to understand you’ll be booking more taxes until there is some clarity around what the earnings are.

So there could be a drop in the tax rate in the back half of the year back to that 27.5% to 28% range..

Yes, correct. Well the issue is the rules aren’t clarified right now on how foreign earnings are going to be taxed.

So we have to go by the letter of the law, but there is a lot of discussion amongst the tax professionals that the law is going to be adjusted that there is a flaw in the calculation and that will get adjusted this year, so that's why I said hopefully want it to clarified our rate will go back down..

Okay, what’s the timing that your tax experts have given you for the clarification?.

Well, you're talking about yes, 2018 but this is the Government in action, so but we're hoping that it will be clarified in 2018. It's a pretty meaningful misstep we believe, most tax professionals believe, so we do think they will step up and correct it this year..

Okay, great. All right, thank you..

Okay, thanks a lot..

And I'm not showing any further questions at this time. I’d like to turn the call back over to our host..

Thanks. Before I let you go, let me summarize what I think of the three key takeaways from the quarter. First, we have excellent performance in Q1 with record booking of a $182 million.

Second, we had record parts and consumables bookings and revenue and finally we're raising our full year guidance with the expectation of record revenue and earnings per share in 2018. Thanks for joining us on the call today. I look forward to updating you next quarter..

Ladies and gentlemen that concludes today's presentation. You may now disconnect and have a wonderful day..