Ladies and gentlemen, thank you for standing by and welcome to the Q1 2020 Kadant Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker for today, Michael McKenney, Executive Vice President and CFO. Sir, you may begin.

Thank you, Towanda. Good morning everyone and welcome to Kadant's first quarter 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 28th, 2019, 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 the non-GAAP financial measures to the most directly comparable GAAP measures is contained in our first quarter earnings press release and 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. Finally, I wanted to note that when we refer to GAAP earnings per share or EPS and adjusted EPS on this call, we are referring to each of these measures as calculated on a diluted basis. With that, I'll 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 will give an overview of our financial results for the quarter, and we will then have a Q&A session. Jeff?

Thanks Mike. Hello, everyone. Thank you for joining us this morning to review our first quarter results and discuss our business outlook for 2020. We had a strong start to the first quarter, but as the global pandemic took hold, we saw a deterioration in the general economic environment. Before getting into the details of our Q1 performance, I'd like to take a few minutes to update you on our operational response to COVID-19. The rapid spread of COVID from Asia to Europe and then to North America led to an incredible change in our operating environment and the global economy. We, like everyone else, have been affected in many ways by this pandemic. Like other critical infrastructure industry partners, we worked first to provide a safe work environment for our employees and then adapted our operations to continue serving our customers who are making life-sustaining goods available to people around the world. We are grateful for all of the essential workers who continue to perform their duties to help get us through this pandemic. Specifically, I'm grateful for our committed and resilient workforce of 2,800 employees who have performed exceptionally well under extremely challenging circumstances. Thank you all for the work you have done and you continue to do. We have only had one employee who has tested positive for COVID virus, and I am pleased to report that person has now recovered. As of today, no other employees in any of our locations have tested positive for the virus, and all 20 of our manufacturing locations around the world are fully operational. Our strong footing in China gave us an early insight of this outbreak, allowing us to better prepare our manufacturing facilities and supply chains in other regions. We continue to take precautions to not only protect…

Thank you, Jeff. I'll start with some key financial metrics from our first quarter. Slide 14 is a summary of some of the key financial metrics that I'll comment on over the next few slides. Our diluted EPS was $1.09 in the first quarter, up 14% compared to the first quarter of 2019, which included $0.28 of acquisition-related expenses. Diluted EPS of $1.09 in the first quarter exceeded the high end of our guidance range of $0.80 to $1.08. We provided this large guidance range in February due to uncertainties surrounding the impact of COVID-19 on our business. We did experience shipping delays and some operational inefficiencies during the quarter due to COVID-19, which started with the government-mandated shutdowns at our Chinese operations. Additionally, travel restrictions at times prevented us from connecting with customers and made servicing our customers challenging. Consolidated margins were 42.9% in the first quarter of 2020, up 170 basis points compared to 41.2% in the first quarter of 2019. 130 basis points of this increase was due to the negative effect from the amortization of acquired profit and inventory in the first quarter of 2019. Consolidated gross profit margin increased 200 basis points sequentially in the first quarter of 2020 due to a higher overall percentage of Parts & Consumables revenue, which represented 66% of revenue in the first quarter of 2020 compared to 60% last quarter. The increase was also driven by higher margins achieved on Parts & Consumables in the first quarter this year. SG&A expenses were $45.6 million or 28.7% of revenue in the first quarter of 2020 compared to $49.3 million or 28.8% of revenue in the first quarter of 2019. The decrease in SG&A expense included a $0.7 million decrease from a favorable foreign currency translation effect and a $1.8 million…

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

Good morning Jeff and good morning Mike.

Hi Chris.

Good morning Chris.

Good morning. Lots of areas of interest here based on your comments thus far, but I'll try to stick to a few key points here. First, starting with what you saw in Parts & Consumables in the first quarter, I know guidance was withdrawn on a quarterly and on a yearly basis, but perhaps there's a little bit greater visibility into the growth that you're seeing within Parts & Consumables. Perhaps you can speak to what your outlook is on this, generally speaking, and some different positive drivers that you're seeing within Parts & Consumables on a segment level basis.

Well, I think, as you might imagine, Chris, there are certain sectors that are experiencing a surge in demand and, therefore, are using more consumables and generating more need for replacement parts. In particular, our customers that are serving the tissue market, in particular, the at-home tissue market, which is quite different from the away-from-home tissue market, as well as our customers that are providing packaging that goes into the e-commerce sector and also in the food sector as people shift from eating out to eating at home, they buy food in small packages that are designed for home use, and so that demand is up where restaurants tend to get their products in bulk. So, we're seeing some customers that are having near-record demand for their products. And their consumables and parts are increasing for them. One of the issues you often have is they really can't take downtime as they normally would to do some maintenance work. So, there's always a little bit of a question on timing. But eventually, they will have to. They're consuming more of our parts and, at some point in time, will have to take some downtime to do some maintenance and repairs. And then we have other sectors that are going to experience a slowdown. So, of course, they will consume less in the parts side. So it really is very, very specific, I think, to our particular customers. And that's pretty much the case, I think, across all of our geographic markets. Everybody -- there's been a big, of course, kind of shift, right, in living as everybody's kind of stayed at home. And so the consumption has picked up for the at-home products and has declined for the away-from-home products.

Is it appropriate to think that once we, hopefully sooner than later, get on our path towards a recovery from this economic environment, with these customers running at full capacity for an extended period of time, that the recovery will be accelerated or led by perhaps a snapback in Parts & Consumables as they service these machines?

Yes, I mean I think -- we've always said that our Parts & Consumables pretty much are a function of operating rates. And all of our customers are operating now. So, to the extent they continue to operate, we think that will be the more stable of our business, of course. But there'll be two things that will probably happen. People who are delaying maintenance work and repair work right now will, well, at some point, have to perform that work. And then people who are just running at a lower production level as that economies recover and that production level increases, their consumption of parts will increase also. So, we would expect to see kind of two effects there: one being, as you said, kind of a snapback from the delays that are taking place now for the customers that are busy and then just an increased consumption as people start to ramp back up production.

Thank you. That's very helpful. And one last question here just as it relates to what Mike discussed about the different methods of cash preservation that are being implemented for this fiscal year, perhaps some color on that as it relates to how you might see that going into next year. A lot of that depends on the pace of the recovery but just thinking of that in light of your ongoing strategic objectives for potential candidates within the M&A opportunities.

Yes. So, as is prudent right now, we, like most others, have put measures in place to conserve capital. I would say assuming that things kind of, over time, start to open back up again, we'll probably start to increase our capital expenditures as they were originally planned for production increases and operations improvements. On the M&A side, that's an ongoing kind of a long-term, if you will, process. And we really haven't put, really, any constraints on our people as far as looking at opportunities. If we find the right opportunity and it's a good strategic fit for us, we will -- I think we will continue to pursue that. These tend to be a long-term process. And so we really are really kind of going to full speed right now in sourcing and discussing strategic fits within our company. And right now, I don't envision us changing that, unless this thing was to get substantially worse for a very, very long duration.

That's very helpful. Thank you. That's all I have for now and I'll hop back in queue.

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

Hi, good morning guys.

Hi.

Good morning Walt.

I wanted to ask about the comments, Jeff, that you made about the deterioration that happened. And obviously, we're all trying to deal with the same thing. But just maybe trying to get a little bit better understanding of the backlog. What percentage of the backlog or the projects in backlog got delayed? And what are customers saying? Like, the problems are obvious, but are they saying, hey, hold off indefinitely or hold off until the third quarter, check back with us in a month? Like, what are the conversations like?

Yes. So, we had -- there was a little over $6 million, Walt, that was---

Revenue.

Revenue, so within backlog, that was delayed, that we're aware that was delayed. And those delays are really -- have just been to -- largely been to quarters within 2020, so second quarter, third quarter. Some of them were delays caused by the COVID issue in terms of logistics and some were delays just on the ability of the company purchasing the goods to put them in place and utilize them currently. So, I think on the booking side, I think some of the customers, of course, just as we have started to be a little more cautious and prudent in capital expenditures, our customers have, too. So, I think on new capital projects, we are seeing some caution there. We've seen some announced reductions in planned capital expenditures for the year. And that will somewhat be a function of the particular market and the geography. So, we're seeing some stronger activity in some areas and weaker activity in others. So that will be probably based on the markets and the geography as to how quickly we see capital projects starting to spool back up.

Okay, great. And I didn't hear too much about any kind of special cost cutting or trying to reduce levels of spending. I wonder if you could just talk about that, what you're doing to mitigate this, the pause that's going on in the business.

Yes. Sure. So, obviously, Mike mentioned that we've reduced our planned capital expenditures by quite a bit. We also are trying to control costs. And as you might imagine, we are not spending a lot on traveling now, so that's down. Mike, I think you had a list of things that--

Yes, I would say on the, as Jeff mentioned, any discretionary, so nonessential travel, meetings, of course, we're pulling back on that. The other thing I would mention, Walt, is we try to staff our operations for kind of a -- I wouldn't say for the peak but more for an even flow. So, when we -- when demand increases, we outsource components, and we outsource some of the labor also. So, when things get soft, we pull components back in, we can manufacture in-house. And if you will, that outside labor that we've contracted, that's more of a flex labor pool that we can remove.

Yes, I mean as of right now, Walt, our business activity level is still strong enough that we don't envision mass furloughs or layoffs or anything like that. I mean most of our customers are operating. We're operating under -- albeit challenging circumstances in some areas, but we're still in full operation. And so as of today, we don't have plans for major personnel reductions. Those are -- our people are our most critical asset. As you know, they are very long tenured. Our people have been with us a long time. They're very hard to find. And the business conditions right now certainly would not warrant us having any significant layoffs.

Okay, that's great. Other companies that we follow are not in that boat, so that sounds great. Maybe as a last one for me, I wonder with the new segments, if you could just update us on the long-term growth rates for each one. Are they all about equal or do you expect that maybe one of the three new segments could grow faster? And then in terms of M&A opportunities within the three segments, which have the best opportunities?

One of the things that we like about our segments is that it gives us pretty broad diversity. And so you will notice that, right now, the industrial processing side was down a little more than the others. But of course, the prior couple of years, they were quite strong. In fact, the wood processing was very strong. And so we think we have some nice diversification, which -- actually, not only geographically but within the markets we serve, which we like. That was kind of -- that's by plan. As far as growth opportunities, again, they vary somewhat. I think the acquisition side; we're looking at acquisitions in all three segments. I would say we have opportunities we're following and discussions with companies in all three areas. The industrial side, of course, which consists of our stock prep and our wood processing, that's a side that has very, very high market share. And so by definition, there's probably less acquisition opportunities and growth opportunities there, not that there aren't any, there are, but it probably has lower -- has less opportunity because they have such very high market share to start with. The other two segments, Flow Control, which is a very, very broad industry, of course, and the Material Handling sector, I think, although we have nice market share, it's not quite as high. They're big industries. And so there's probably more growth opportunities in Flow Control than Material Handling just because of the size of the markets and our market share in those.

Okay, great. Thank you.

Thank you. [Operator Instructions] I'm not showing any further questions at this time. I would now like to turn the call over to Jeffrey Powell, CEO, for closing remarks.

Thank you, operator. Before wrapping up the call today, I just want to leave you with a few takeaways that give me comfort in these uncertain times. First, Kadant has a proven track record of cash flow generation. And even during the worst of times, we continue to meet the needs of our customers and employees, and we are prepared to meet this present challenge head on. Second, our Parts & Consumables business provides a relatively stable and profitable revenue stream that benefits from our large installed base around the world. And third, our liquidity position is solid and further enhanced by our strong cash flow generation. I want to thank you for joining the call today. We look forward to updating you next quarter and please stay safe.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.