Good day ladies and gentlemen and welcome to the Q3 2018 Kadant Inc. Earnings Conference Call. At this time all participants in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. [Operator Instructions] I would now like to turn the conference over to Mr. Michael McKenney, Executive Vice President and Chief Financial Officer. Sir you may begin.

Thank you Lisa. Good morning everyone and welcome to Kadant's third 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 cadence future expectations financial and operating results and 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 31st 2017 and subsequent filings with the Securities and Exchange Commission. In addition any forward-looking statements we make during this webcast represent our views and statement estimates only as 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 views or estimates change. During this webcast 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 non-GAAP financial measures to the most directly comparable GAAP measures is contained in our third quarter earnings press release and the slides presented on the webcast and discussed in the conference call which are available in the Investor section of our website at www.kadant.com under the heading Investor News. With that, I'll turn the call over to Jon Painter who 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. Thank you for joining us this morning to review our third quarter results and to discuss our outlook for the remainder of the year. Overall, we had another outstanding quarter with record performance and revenue, operating income, adjusted EBITDA and earnings per share. I'll start with the financial highlights of the quarter. Bookings were up 22% nearly all from internal growth. Revenue is a record and up 8%. Gross margin was a solid 44% despite a relatively high level of capital projects. Adjusted operating income was also a record up 13%. Adjusted EBITDA was a record at $34 million or 20% of revenue which was also a record and a milestone we're very proud to achieve. GAAP diluted earnings per share of $1.64 was a record and our adjusted earnings per share was also a record at $1.53. A lot of records. Finally, cash flow from operations was $17 million bringing our net debt at the end of the third quarter to $136 million and our leverage ratio to 1.37. If you take a look at slide six you can see the stronger dollar had a modest negative impact on our foreign currency translation while acquisitions played a really minor role as this quarter represents the one-year anniversary of the two major acquisitions we completed in 2017. Our internal revenue growth which excludes FX and acquisitions was 10% and internal growth and bookings was 24%. Similarly our internal revenue growth for parts and consumables was 12% while bookings were up 13%. Needless to say our internal bookings growth rates of 13% in 2017 and 16% the first nine months of this year are well above our long-term projections for internal growth. Well, I don't expect to sustain this level of internal growth over the long term,…

Thank you Jon. I'll start with our gross margin performance. Consolidated gross margins were 44.1% in the third quarter of 2018, up 180 basis points compared to 42.3% in the third quarter of 2017. The consolidated gross margins in the third quarter of 2017 were negatively affected by the amortization of acquired profit and inventory which lower consolidated gross margins by 220 basis points. Excluding the impact of the amortization of acquired profit in inventory consolidated gross margins were 44.5% in the third quarter of 2017. Our consolidated gross margins in both periods were negatively affected by a lower percentage of parts and consumables products. Our parts and consumables revenue represented 56% of total revenue in the third quarter of 2018 down from 64% and 61% in the first and second quarters of 2018 respectively. Our parts and consumables revenue as a percentage of total revenue was also lower in the third quarter of 2017 at 55% of total revenue compared to 61% of total revenue for the full year of 2017. Now let's turn to slide 16, on our quarterly SG&A expenses. SG&A expenses were $42.9 million in the third quarter of 2018, up $0.5 million from the third quarter of 2017. This included a decrease of $0.7 million from a favorable foreign currency translation effect. SG&A expenses as a percentage of revenue decreased to $25.9 million in the third quarter of 2018 compared to 27.7% in the third quarter of 2017. Let me backtrack on that and I think I said million there. The SG&A expenses as percentage of revenue decreased to 25.9% in the third quarter of 2018 compared to 27.7% in the third quarter of 2017. Let me turn to our EPS results for the quarter. In the third quarter of 2018 GAAP diluted EPS was…

Thank you sir. [Operator Instructions] First question is coming from Chris Howe with Barrington Research. Your line is open.

Jon and Mike.

Hey Chris.

Hi Chris.

I have a few questions here. The first one is in regard to margin expectations and kind of what your expectations for margin, for the mix for 2018 and heading into 2019 and if you could add some additional color on how the 80/20 initiatives are progressing currently?

Okay Chris I'll tackle that one. For the fourth quarter again we're going to have a fairly significant capital shipments. So I think we'll see some pressure on margins in the fourth quarter. We are a little over 44% in the third. We might come in a little under that in the fourth quarter. We guided two for the year 43.5% -- 44.5% and I think we'll probably end up right in the middle of that for the year when we're all set and done.

Okay.

I guess I just give a couple comments on 80/20. We have a couple of units who are doing that they are more or less started at the end of last year, the beginning of this I would say we're at the point we've kind of yielded what I would call the low-hanging fruit which is right raising prices and on your smaller customers and your smaller products the real benefit of 80/20 actually is getting additional revenue as you transfer resources towards your best customers and your best products and that takes a little longer. I wouldn't say we're seeing that roll in yet but every indication are that it we expect it to.

Okay, and then one other question – a couple other questions before I jump back in the queue. The M&A environment. How would you characterize where it is now versus maybe what you were seeing at the beginning of this year? Has there been any change or shift in pricing with some of the candidates that you are looking at?

So I would actually say it's a little more active as the years gone on. There we see more deal flow as they say. A lot of companies that look pretty interesting. The pricing is still I would say too high and often the bigger the company the higher the price but the tax rules help in effect that you're going to get a higher after-tax return with with U.S. companies anyways because the lower rates but it's, I would say healthy but whether we find something at a price that we can live with I can't be sure but I would say the overall environment is pretty healthy.

Okay and then if I may sneak one more in. Just based on what you're seeing with the bookings growth reaching the near record backlog, I assume that orders booked after the tariff announcement have been pretty receptive to price increases and those have more or less pass through.

Yes. We have – so I would say different product lines are in different positions but in general we are certainly seeking to raise prices. I would say for a lot of our product lines it's an excellent price environment. Customers are expecting this and they understand that. Other product lines where we compete particularly for spare parts with local people it's a little longer slog and it'll probably be a take a little longer to fully pass those prices on.

Okay, thank you for taking my questions. I'll hop back in queue.

Our pleasure.

Next question is from Walter Liptak with Seaport Global.

Hi, good morning guys.

Hey Walt.

Good morning Walt.

Good morning. So my first question I want to talk about the guidance. We went back and looked at the last three quarters and you guys always guide lower than where we are for the quarter out and then you end up beating our number like you did this quarter and I wonder how much is the fourth quarter guide is these shipment delays that are firm versus just you guys being conservative on what you might be able to get out the door in the quarter.

I mean it's always, I tell you it's I will comment and Michael will have some comments but it's always a challenge when you have big systems that are not on percent complete and they're shipping in December. So a lot of times we'll say okay we've got five that are going to ship it's possible three will be delayed and we don't assume all five are going to ship sometimes all five end up shipping and we beat the number. So there is I'm not going to lie that there's a little bit of conservativism in our methodology but that's pretty much the extent of it to a lot of time I would largely.

I think Jon's characterized it correctly. We do have a lot of capital shipping in the fourth quarter and there's a good chunk that is going in December. So we're cautious in that regard but as a backdrop for that Walt you heard me mention in my closing comments we did have about $10 million in orders/shipment delays that stuff that was pushed in to 2019. So that, at the end of the day that really did impact where we decided to guide for the quarter.

I will also add – I will kind of add another little color Walt. I would say if these kind of robust times we're often a little bit surprised that how well our divisions are executing and what their margins are. So we have a little bit of catching up to do to fully appreciate the level they are performing at.

Okay. All right. I will move on from there. Just want to ask about the OSB markets in China and are you currently seeing the kind of growth rates that you're seeing in rest of the world's especially in North America?

No. No. China is much, in terms of capital in China I would say much stronger than the current growth rates of OSB in North America or Europe. So obviously North America is a much more mature market. There's many more standards but and China is just essentially getting started but no it's a multiple of what we have for strand orders in North America.

Okay got it. And then thinking about the comments that you made about China offering putting restrictions on waste paper by 2020. Are your customers thinking that regulations going to come to fruition? Are they planning to add more capacity outside of China?

I would I would say they are acting and talking like they expect this will happen. They of course don't have a crystal ball either but they are sounding like that they expect it to happen whether it's January 1, 2020 or phased in but I think they think that this is definitely the direction that the China is going.

Okay and I think you mentioned that there were 25 to 30 tons that was taken out that was inundated 11 new OCC systems. What's the capacity I mean to meet the 2020 regulation how many OCC systems need to go in?

Well, I mean I think I said we have 11 and that was 4 million tons so they are not always all the same size. So it's a little but you can use that as a rough measure. Not all of the 25 million tons is OCC. There's newsprint. There's printing and writing in there and it ends of course mixed waste. So I wouldn't – we are capturing I would say a substantial and that's an understatement portion of the orders for this expansion on OCC. I wouldn't necessary expect that would be the same for some of the other grades.

Okay. All right and then just switching over to the other regulation that you mentioned in Europe the removals and single-use plastics. Have you heard anything from customers yet what the market could look like as cellulose single-use products start going into the market? Is there any enforcement that's going on here is this a law or is this something that's 2019 at the end?

So how the EU is the Brussels adopt something and in Venice up to the states to adopt. France has already adopted something. The EU law is rather vague but that is definitely a trend I would say not only in Europe but even I think The Wall Street Journal today talked about that plastic cups and styrofoam cups of Dunkin Donuts and stuff are coming out of favor and got to be replaced with paper. So I couldn't tell you how big it is. I think it's actually pretty big particularly cups. So we'll see. I would say we are – we have actually done a lot of work on the recycling side to process kind of plastic a lot of these cups have kind of a coding on them and they can be recycled so long as you do it properly and we're one of the companies that have that kind of technology to be able to recycle some of these paper products that have a coating of some type.

Okay. All right. Got it. Okay. Thanks guys.

Thank you.

Next question is coming from Dan Jacome from Sidoti.

Good morning.

Hey Dan.

Good morning Dan.

How's it going? A couple questions just two. First on Nine dragons can you give us some more color on their plans specifically here in North America? I'm assuming it's mostly going to be recycled liner board but can you confirm that and then if it's not going to be just a liner board are you agnostic as to what type of packaging they may pursue here in North American and how might it impact your business?

Okay, so it's not all recycled. They've actually bought some integrated, an integrated mill. They've said they're going to convert this, a lot of these are in the white grades and they're going to convert these to the browns grades. I think the $64 million question is are they going to ship pulp back to China which they have to fully; dry are they going to ship liner board back to China and are they actually going to sell liner board in the U.S. So I don't know what the – they haven't really talked about what the answer there is. The only thing that really said is that they do intend to convert these mills to brown grade packaging mills.

We have a great relationship with Brown Nine Dragons of course in China. I would, we will certainly if they have a project in the U.S. we will hope to participate in it.

Right. So the incremental gain longer-term could be on the stock per upside I imagine or?

Yes. As the machine converts it's kind of good for all of our product lines but stock prep is definitely the biggest to benefit from that.

Okay and then one last one I think when you did the acquisition of FPG last summer part of the business was a timber extracting product line? Can you talk a little bit about that if it's material at all and you I'm just curious what trends you're seeing on that end?

It's also got demand. So they're booking well, well towards the end of next year if you want to order, anyone want to order some timber harvesting equipment. So it's still relatively small but we are seeing very, very strong demand.

Okay. Where's that like in the southeast of North America I imagine or –?

They're more actually – I would say they're more specialized in stuff on steep slopes so not as much the Southeast as the Northwest.

Got it. Okay. Thank you.

Okay thank you.

[Operator Instructions] Next question is coming from Bill Hyler from WDH Capital. Your line is open.

Thank you guys.

Hey Bill.

Hey. I guess I think you answered most of my questions but maybe just a follow-up on the North American capacity growth, which another talking about 3 million to 3.5 million ton through 2021. How does the timing work on that and when it begins to hit your bookings backlog. And then you could talk over about that it's pretty fairly spread out another 2018 is probably already reflected but when do you get a better feel on how the 2019 impact and then the 2020, 21 is it 12 months of advance or –?

As a general rule and this is we're going to have some exceptions but typically when you talk -- when you hear about capacity announcements for next year we've of course had the booking and often made a lot of progress in terms of manufacturing it this year. So our bookings are well ahead of that obviously that capacity coming online. I would say – personally I'm talking about our stock prep businesses which I think you're asking about. Typically with this much capacity online I don't know that we're expecting a huge capital business next year. The wild card of course is what happens with China does this if China actually goes through with those wastepaper restrictions in 2020 there's going to be a lot of – the only way they can have their economy keep running is import a lot of liner board and probably North America would be right up there in terms of the people taking advantage. So if that happens that would have suck up a lot of this capacity going online and they may keep pushing forward with more.

Okay, I got you and then I guess a lag effect with the parts and consumables as the installed base growth rose that tends to come when you start to see that I would assume on the new capacity a year later or?

Yes. Nine months to a year later. It depends a little bit depends on the product line but yes something like that.

Got you. All right. Thanks.

Okay.

[Operator Instructions] At this time I would like to turn the call back to Mr. Jon Painter for further remarks. Sir go ahead.

Thanks Lisa. Before I let everyone go this morning I want to just summarize what I think of the key takeaways from the quarter. Number one of course we had a great quarter with record revenue, record adjusted EBITDA, record earnings per share, etc. Two, we had strong internal revenue bookings growth of 10% and 24%. Three the build-out on the public capacity in Southeast Asia and the OSB capacity in China which we talked about is providing a good growth opportunity for us and finally we're expecting to have a record 2018 for revenues bookings and earnings per share and of course [indiscernible] that's the other notable things of the quarter. Anyway, I look forward to updating you next quarter. Thanks very much.

Ladies and gentlemen thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.