Ladies and gentlemen, thank you for standing by, and welcome to the Kadant Third Quarter 2019 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you Wes. Good morning everyone and welcome to Kadant's Third Quarter 2019 Earnings Call. With me on the call today is, Jeff Powell, 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 plans and expectations, financial and operating results 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 29, 2018 and subsequent filings with the Securities and Exchange Commission. In addition, any forward-looking statements we make during this webcast represent our views and estimates 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 views or estimates change. 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 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 will turn the call over to Jeff Powell, who will give you an update on Kadant's business and future prospects. Following Jeff's remarks, I'll give an overview of our financial results for the quarter, and we will then have a Q&A session.

Thanks Wes, 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 performed well and achieved a solid EPS beat and are on our way to another record year of financial performance. I'll begin with our financial highlights for the quarter. Our Q3 bookings increased 4% to $171 million and revenue was up 5% to $174 million, led by our Material Handling business. Our gross margins were 43% and adjusted EBITDA was $32 million or 18.6% of revenue. Adjusted EBITDA was down 4% from a record third quarter of last year. Adjusted EPS was $1.41, well above the top-end of our guidance of $1.20 to $1.26. Cash flow from operations was strong at $26 million, up 51%, compared to third quarter of last year. And finally, we finished the quarter with net debt of $267 million and a leverage ratio of 2.07. As you can see on slide 6, the stronger dollar had a significant impact on our foreign currency translation. Also of note was the strong contribution from our Material Handling acquisition completed earlier this year. Excluding FX and acquisitions, both our internal revenue growth and internal growth in bookings were down 5%. For Parts and Consumables, our internal revenue growth decreased 1% while bookings decreased 3%. On Slide 7, you can see our Q3 bookings were up 4% and revenue was up 5%, compared to the third quarter of last year and down slightly sequentially from last quarter's record revenue. We benefited from solid bookings in our Stock Prep and Fluid Handling product lines in North America, Europe and South America. However, these were more than offset by declines in China, and in our Wood Processing segment, which…

Thank you Jeff. I'll start with our gross margin performance. Consolidated gross margins were 42.8% in the third quarter of 2019, down 130 basis points, compared to 44.1% in the third quarter of 2018 due to the inclusion of the lower gross margin profile of our Material Handling business, acquired in the first quarter of 2019. Our Parts and Consumable revenue represented 61% of total revenue in the third quarter of 2019, compared to 56% in the third quarter of 2018. Now, let's turn to Slide 16 and our quarterly SG&A expenses. SG&A expenses were $47.1 million in the third quarter of 2019, up $4.2 million from the third quarter of 2018. This included an increase of $4.7 million from our acquisition and a decrease of $0.8 million from a favorable foreign currency translation effect. SG&A expense, as a percentage of revenue increased to 27.1% in the third quarter of 2019, compared to 25.9% in the third quarter of 2018. Let me next turn to our EPS results for the quarter. In the third quarter of 2019, GAAP and adjusted diluted EPS were both $1.41. In the third quarter of 2018, GAAP diluted EPS was $1.64 and our adjusted diluted EPS was $1.53. The $0.11 difference relates to $0.03 of restructuring costs, and a $0.14 discrete tax benefit that related to the reversal of tax reserves associated with uncertain tax position, covering multiple tax years. The decrease of $0.12 in adjusted diluted EPS in the third quarter of 2019, compared to adjusted diluted EPS in the third quarter of 2018 consists of the following: $0.13 due to a lower effective tax rate, $0.03 from lower interest expense, after allocating a portion of interest expense to the acquisition; $0.03 due to lower operating expenses; $0.01 due to higher gross margins and…

[Operator Instructions] Our first question comes from the line of Chris Howe with Barrington Research. Your line is now open.

Good morning, Jeff and Mike.

Good morning, Chris.

Good morning, Chris.

Hey, just going over some of the comments that you've mentioned, just as we think about Parts and Consumables, you mentioned on an organic basis, it was down, but your expectations are for the year for it still to be up for it still to be up. On a geographic basis, can you comment on the performance of Parts and Consumables, and - in the quarter? and what you're seeing there as far as we look forward?

Yes, I would say that our Parts and Consumables actually are holding up quite well, generally speaking, which is an indication of the operating rates that our customers are currently experiencing. The one area where our Parts and Consumables is down is in China and that's because of course there has been a reduction in the runrates there and there has been a reduction in the amount of recycled material that they are processing. And we are in the process of building these new processing facilities over there in Southeast Asia, but, most of them, the vast majority have not come online yet. So, they are not generating parts yet. So, we definitely have seen a reduction in our parts in China associated with this transfer of the initial fiber processing from Mainland China to Southeast Asia, as well as U.S. I would say, parts in Europe actually have been quite good for us. Some areas surprisingly strong. And in the US is holding its own, I'd say with the exception of the Wood Processing, which is down a little bit because the operating rates are down some on the Wood Processing side. But generally speaking, I would say, the Parts and Consumables globally are holding up quite well. We are kind of flat with the last year, up slightly from last year when you kind of take out FX and everything else. So, we're actually pleased with that and we think that indicates that our customers are still operating at a healthy rate from an operations – from a run rate standpoint.

Yes, that's great. And then that leads me to my next question. Just about Asia, more specifically, China. The success that you're having in capital equipment orders outside of China, can you give an update, where are we, as far as the timeline and where are we in regard to offsetting the current fiber shortage with the 18 coming on? And what are some key inflections or bookmarks that we should pay attention to as we monitor the environment there?

So, let me give you a couple of data points. In 2016, before the waste import ban was implemented and the cleanliness standard was implemented, China imported about 30.4 million tons of wastepaper. In 2017, that was down to 25.7 million tons as the cleanliness standard started to be applied. In 2018, that dropped down to 18.7 million tons and in 2019, through October there is 11 million tons that have been permitted. So, that gives you a sense that this year, we are looking at possibly a third as much imported waste, as they had in 2016. Now, I was over in China few weeks ago and actually had dinner with the Head of the China Paper Association and he tells us that in fact this ban will go forward. They'll continue to reduce the import permits next year and that will be completely eliminated in 2021. So, if you look at the 30 million tons that they were importing in 2016, you can say okay, they've got to somehow replace 30 million tons of fiber. Today, the 18 systems that we've received orders for, which I think is the vast majority of all the orders have been placed, it only represents about 4 million tons replacement. So, you can see that, if in fact, they've got to replace 25 million tons to 30 million tons, we're in the early stages. I think in the last call, I said, we were kind of in the second inning – first or second inning of this and I would say that's still the case. What they are doing is, they are starting up these systems and they are making sure that this works, because they have to shift this processed fiber into China and get it into the machine before it…

Great, that's helpful and my last question. Thanks Jeff. My last question is for Mike, your SG&A came in ahead of my expectations. You're at $47.1 million. I was around $48 million. Can you talk about the different expense line items, as we look forward to the fourth quarter? And more specifically, further out, what type of leverage opportunities that you see here?

Well, so Chris you had modeled it at $48 million and we came in at $47.1 million?

For SG&A? Yes.

Yes, yes.

Yes.

I think for the fourth quarter, we'll probably be around that level. So, I think that's a pretty good marker for the fourth quarter activity. In terms of operating leverage, at this point, it's very much contingent on sales volumes.

Okay. That's all I have for right now. Thank you.

[Operator Instructions] Our next question comes from the line of Walter Liptak with Seaport Global. Your line is now open.

Hi. Thanks. Good morning guys.

Good morning, Walt.

I wanted to ask a follow-on about the southeast Asia processing plants. So – and just to clarify, so these 18 systems that you called out, you've already booked those orders or are those – or that are…

And I would say, Walt, roughly half of those have been delivered already.

Okay. Okay, great. And the other half, I guess, finish up over the next 12 months, that was what you're comment was?

Yes.

Okay. But, it sounds like, there is potentially significant more orders behind those 18 to get enough wet fiber into China over the next couple of years. Is that - so that's what you guys are talking about?

Yes, I mean, like I said, they've seen a little bit of a slowdown in their economy and as well as their exports. So, their demand probably isn't where it was in 2016 when they brought in 30 million tons and of course, they continue to try to increase their recovery rate within China although they are kind of, I think starting to bounce up against the top of the limit of that. But, there is still substantial fiber requirements that they are going to have to replace. And so, we expect that we'll have to get that somewhere bringing in pulp doesn't really work for them in the long run. So, we expect that there is going to be, as I said earlier, a fairly significant investment requirements somewhere to offset this loss of imported fiber.

Okay, great. What was the value of the 18 systems that you've already booked orders on?

It is roughly $14 million-ish

Okay, great. And how many tons do you think that that helped bring back online into China?

Somewhere between 3 million tons and 4 million tons.

Oh I see, what you're saying, so, there is a long way to go to fill the 30 million?

Yes.

Okay, great. Okay. And any visibility on the next slug of orders of orders that might start coming in from China? I heard the concern about the economic issues. But – or is this something where we can start seeing orders next quarters or is it an unknown kind of event for the next round of orders?

Obviously, we are constantly engaging our customers over there, discussing projects. I don't know that we are ready to forecast exactly when and if they may occur. But there is ongoing discussions in activity.

Okay. All right. Fair enough. I wanted to ask…

Walt, I wanted to mention now, because I was looking at a schedule here. That $14 million that I referenced, that's actually what's left to be delivered. You were asking what the aggregate value was I would say it's roughly twice that.

Oh, wow. Okay.

Yes.

All right, great. So $28 million for 18 systems. Okay. I wanted to ask on the Material Handling order. Congratulations on that - those orders starting to come in. How is the margin coming through for these? Are these going to be, I guess, a normal profitability or because of where we are in the market, is there pricing pressure?

Well, they have – they have quite a mix of products and as is the case with many of our other businesses, the margins vary a fair amount from product-to-product. But, I think it's fair to say on the – when you might imagine on really large projects like this multi-million dollar projects, there is always more competition and more price pressure. So I would say generally speaking, they are really big systems and lower margin and of course the parts in the smaller systems are higher margin.

Okay. Great. And then, I just want to ask about Europe, the bookings excluding foreign currency, up 9% looked pretty good. But, everything we hear about Europe is bad, slowing down, we see ISM is going down. I wondered, if you'd comment about, like the sustainability of the bookings or the visibility on other projects in the EU.

Yes. So, I think I mentioned this a little bit in the last call that, the activity level that we are seeing tends to be in the developing parts of Europe – Eastern Europe, Russia, Belarus, Romania, kind of the developing world is as the standard of living increases there, they have more and more demand for our products. And so, I would say, kind of the historical Western Europe, definitely is a little slower, right now. The export market clearly has slowed down in Germany. But we are very active in all of Europe and in Eastern Europe, Turkey and places like that. There is still decent activity. So, I would say that our project activity level has been quite high this year in kind of the, what we would call the developing portions of Europe.

Okay. Okay, great. And then last one for me, for Mike. Thinking about the pension, is there going to be a lower expense level in 2020 as a result of the change in the pension or is this is – maybe of what that will be?

Well, it had been running at about $1.6 million a year, roughly let's say $0.10 or $0.11 cost.

Okay, great. So that goes away in 2020?

Right. That will go away in 2020. Yes.

Okay, great. All right. Thanks guys.

You're welcome.

[Operator Instructions] We have a follow-up question from the line of Chris Howe with Barrington Research. Your line is now open.

Hey, it's me again. Just following up on Walt's question about the Material Handling order, can you comment on the size of this deal? How does this compare to other customers that are in the market? And at the time of the acquisition, you have mentioned about potential synergistic acquisition opportunities, related to Kadant/Syntron. How does that environment look? And what are you seeing as far as the overall pricing environment for M&A?

Yes. So, on the order, it's a larger – it's on the larger side of orders. Certainly, there are projects out there that we are aware of that could be larger than this. But this would be considered a large project – a large order. As far as the acquisitions, our business development group actually has been spending a fair amount of time with the company, just developing a strategic plan for that and as you mentioned, when we bought the company, we had indicated that one of the things we really liked was the size and the diversity of their markets and the opportunities that that would present. And I think we are still excited about that. We still see that is the case. And so, we are – obviously, we have known these guys now for ten months. So we're still early in the planning process. But we are working closely with them to develop a plan to grow that business and expand it. Valuations have been high for the last few years and they continued to be high, which makes it more challenging for us because we have a very specific discipline that we adhere to and that we try not to deviate from. So, it's always a challenge for us because of that. But we have been – if you look at us over the years, we have been successful in identifying opportunities and been able to buy companies that what we think are a reasonable return and I expect that, that will be the case going forward, although clearly it's more difficult now, because prices are quite high.

Thanks so much for the color, Jeff. Appreciate it.

I am showing no further questions in queue at this time. I'd like to turn the call back to Mr. Powell for closing remarks.

Thank you, operator. Before I let you go, I would like to summarize what I think are the key takeaways from the quarter. First, we had good operating performance in Q3 with a strong EPS beat and excellent cash flow. Second China's economic headwinds and the slowdown in our Wood Processing segment are impacting our business activity. And finally, we are maintaining the high-end of our full-year adjusted EPS guidance range and expect to achieve record revenue and adjusted EBITDA in 2019. We want to thank you for joining us today and we look forward to updating you next quarter.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.