[Call Starts Abruptly] At this time, I would like to instruct all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Gerald. Good morning, everyone, and welcome to Kadant's First Quarter 2023 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 31, 2022, 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 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. 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'll 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 2023. Q1 was an excellent start to 2023 with strong demand for aftermarket parts, which contributed to record bookings and a record adjusted EPS in the first quarter. Business activity was strong in most regions of the world, and new order activity was led by our Material Handling operating segment, along with solid growth in our Flow Control segment. As a result of new order activity, we ended the first quarter with record backlog. I'll provide more details on that when I review our operating segments. Overall, our healthy balance sheet and strong cash flow positions us well to capitalize on growth opportunities in 2023. Despite the dampening effect of foreign currency translation, we had solid increases across most financial metrics compared to Q1 of last year. As you can see on Slide 6, a notable highlight for the quarter was our record bookings performance. Bookings were $275 million, up 3% compared to our previous record in the same period last year. Excluding the negative impact of FX, organic bookings were up 7%. Q1 revenue increased 1% to $230 million compared to the same period last year. Excluding FX, organic revenue was up 5%. Our aftermarket parts revenue made up two-thirds of Q1 revenue and was up 4% to a record $152 million. Improved operating performance led to record adjusted EPS of $2.40 and adjusted EBITDA of $49 million, representing 21.1% of revenue. All our operating segments delivered excellent adjusted EBITDA margin performance despite inflationary pressures. Cash flow in Q1, which is historically a weaker quarter, increased 55% compared to the same period last year to $37 million, while free cash flow was $32 million. Next, I'd…

Thank you, Jeff. I'll start with some key financial metrics from our first quarter. Gross margins were 44.4% in the first quarter 2023, up 100 basis points compared to 43.4% in the first quarter 2022. This increase was principally due to higher margins achieved on the mix of capital projects, especially in our Industrial Processing segment. Also contributing to the improved gross margin was a higher overall percentage of parts and consumables revenue, which represented 66% of revenue in the first quarter 2023 compared to 65% in the prior year. SG&A expenses were $58.6 million in the first quarter 2023, a decrease of $0.6 million compared to $59.2 million in the first quarter 2022. We had a favorable foreign currency translation effect of $1.8 million, which lowered SG&A expenses in the first quarter 2023. In the first quarter of 2022, we had $0.8 million in acquisition-related costs and a $0.6 million indemnification asset reversal. Excluding these items, SG&A expenses were up $2.6 million or 4% compared to the first quarter 2022, primarily due to increased compensation expense as well as travel-related costs. As a percentage of revenue, SG&A expense decreased to 25.5% in the first quarter 2023 compared to 26.1% in the prior year period. Our effective tax rate in the first quarter was 25.7%, which included tax benefits related to the vesting of equity awards, which lowered the effective tax rate by 90 basis points. Our GAAP EPS decreased 32% to $2.40 in the first quarter compared to $3.53 in the first quarter 2022, which included $1.30 gain on the sale of one of our Chinese facilities related to a relocation plan. Our adjusted EPS was up 5% to a record $2.40, which exceeded the high end of our guidance range by $0.20, predominantly due to higher-than-anticipated revenue, especially…

Thank you. At this time we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from the line of Gary Prestopino from Barrington Research. Your line is now open.

Hey. Good morning, everyone.

Good morning.

Quick question here. On the Flow Control, you said 73% of revenue was aftermarket parts. Is that correct in this quarter?

Yes.

And how did that compare to last year? Do you have that handy?

See here. I think I have that rate in front of me, Gary. I'll come back to you on that one. I'll find it.

Okay. And I'd also – and you said it was 65% for industrial. I just would like to see where that was last year at that time too – at this time, too?

Last year, it was 72% for flow. And industrial, this year, we were 65%. Last year, it was 60%.

Okay. And then in the Industrial Processing side, was the majority of that revenue decrease really due to what you do on the wood products side versus recycling paper and paperboard?

Yes, it was. But I'd also note there, Gary, I mean, we did – first, a couple of things. It's a tough comp for us. I think we're going to have that frequently, especially in wood for 2023. But the other thing that happened, which is why I made that mention in my call notes about capital, the variability of when capital ships, is we had some projects that were scheduled to ship in the first quarter, and those who were moved to later quarters in the year. So had those shipped in the quarter, we really – we would have been flat organically on revenue.

You still have them?

Yes, still have them. This is normal course of things, especially – most especially, of course, on capital projects. They can get pulled in or moved out.

What often happens, Gary, is the site, there's a lot of civil construction work on the site that has to be completed before they can install our equipment. And the customers will often get behind their projects, and so they're not ready for the equipment to be installed. So that kind of dictates the delivery schedule.

Okay. And then lastly, in the Material Handling segment, you had some pretty good growth there. You said you booked a large capital order for a 42-mile conveyor. That's a huge conveyor. But I mean, was there any revenue in the quarter from that? Or was it all – was all the revenue – was the majority – well, was there any revenue in the quarter from that?

No, no, Gary. No revenue in the first quarter related to that.

Okay. Thank you.

[Operator Instructions] Our next question comes from the line of Adi Madan from D.A. Davidson. Your line is now open.

Hi. Good morning.

Good morning.

Good morning. You have Adi here filling in for Kurt Yinger today.

Hi, Adi.

Hey. And so first off, congrats on a great quarter in this environment. And I actually have three questions for you today, and the first one being in terms of the outlook for moderation in activity in the second half of the year, are you seeing tangible signs in terms of commentary from your customers? Or is it – or more recent booking activities to lead you that view? Or is it just more of a potentially conservative stance of given the current environment?

Yes. Well, as you can see, the bookings in the first quarter were incredibly strong. There was even a big FX impact to that, so the bookings were even stronger than the $275 million in reality. So we experienced great activity, but we do – I think we do have concerns in the back half of the year because, as you know, these – the Central Banks and in particular the Federal Reserve Bank is working very hard to try to crush demand. And so I think we're being particularly cautious in the back half of the year because we don't have good visibility, and there's just a lot of noise and a lot of uncertainty out there. And so we're – we tend to be, as you know, a conservative organization anyway. And so we're just being cautious. But through the first quarter, of course, demand was exceptionally strong and really all of our businesses, all our segments across the world. So it's more just being cautious because of the unknown, I would say, at this point.

Okay. Yes. That makes sense. And another question about gross margin. So gross margins were quite strong relative to the full-year guide in Q1. Could you talk to how you expect that to trend over the balance of the year? And is some compression there primarily just related to your mix expectations around higher capital going forward?

Yes. Hi, Adi. You're exactly right. The first quarter for us, you will tend to see gross margins be pretty strong because it tends to be more – our first quarter tends to be more heavily weighted towards parts and consumables. As you saw for first quarter of this year, it was 66%. And you're exactly right. As we go through the year, that mix is going to shift towards more capital. So this will be our strongest quarter for parts and consumables as a percent of revenue. And then that percentage will start to decrease as we ship more capital, and that is what's creating the pressure on gross margins. And that's why I was careful to call that out in the call to say, Hey, we started out with very strong gross margins. We anticipated that, and it fits the guidance that we gave of 42% to 43%. And as a result, on the go-forward quarters, you'll see margins kind of in that 42% range.

Okay. Yes. That makes sense. And just lastly on capital allocation. For the remainder of the year, how are you thinking about share repurchases versus dividends? And specifically, maybe if you could talk more about M&A, what kind of opportunity you're seeing out there. Are you more or less willing to be active on that front? Thank you. And good luck for next quarter.

Thank you. Yes. So as you know, we pay a dividend. Our goal is to try to increase it every year. But it tends to be something that the Board looks at every – kind of every quarter. As far as stock buybacks, while we have authorized buyback, we haven't purchased any shares for several years. We found that there have been good acquisition opportunities out there that we thought were better returns for us. And I would say that from an acquisition activity standpoint, last year was quite slow. I think many of the bankers would say their business was off about 50% last year. We certainly saw that. But this year, I think there's a lot more activity. There's a lot more discussions going on. So it does seem like deal flow is picking up this year. It's still early in the year, of course, but at least through the first quarter, I would say the activity level, the discussions, the number of deals coming to the market is up quite a bit from last year. So as you know, we tend to be opportunistic. We don't buy companies every year, but if we find good strategic fits, we will move on them. And of course, we've got the balance sheet and the debt capacity to do that. Gerald, I think that was the last of his questions. I don't know if there's another questioner.

We have one more question. [Operator Instructions] Our next question comes from Walter Liptak from Seaport Research. Your line is now open.

Hey. Good morning, guys. How are you doing?

Good. Walter, how are you?

Good. Thanks. I wanted to ask about – a little bit more about the second quarter and maybe the mix of business in the second quarter. The number – the guidance on the EPS line was a little bit below where the consensus had you. I just wonder if you could just clarify. I think you touched on it a little bit, but maybe what's the mix looking like for the second quarter?

Yes. One second here, Walt. The second quarter, we're projecting that the capital will be about 40% of the mix. So parts and consumables, 60%. So as you can see, as we're – and that's as we move through the year, we're going to have – that's kind of how it's going to play out. We had our – I think this will be our best quarter in terms of parts and consumable mix at 66%. And then you'll see second, third and fourth, it will be much heavier on the capital side.

Okay. And then another question for maybe later in the year and kind of the cautiousness because of the monetary policy. We've seen some OCC prices, lumber, OSB coming down. And I wonder what the project funnel from your customers is looking like. What kind of discussions are you having with them about future capacity adds?

So I don't know if you saw the article in The Journal this morning, but it was talking about how housing has bounced back up a little bit. What we've experienced, certainly what we experienced in the first quarter, I would say, was that for the last couple of years, a lot of the mills – a lot of our customers were running full out and really didn't take their traditional downtimes to do maintenance, upgrades, refurbishments. And so in the first quarter, we saw a fair amount of activity around that where they're now taking the opportunity because things aren't running at 100% of utilization the way they were the last couple of years. There has been some softness, I would say, a little bit on the packaging side. We've seen some mill downtime announced not only in the U.S. but in China as well. So I think they're kind of in the same position we're in. Everybody is trying to discern what the back half of the year is going to look like and what interest rates are going to do and what the bankers are going to do. So I think it's a little unclear, although I do think most people are expecting some moderation. They've made a lot of money, a lot of money in the last couple of years. And so they're using that money to upgrade their facilities, to get more production, to become more efficient, and we benefited from that in the first quarter. And there could still be more of that as the year goes on. But I do think the overall economic activity level is forecasted to slow down some. And as you know, when you've got two-thirds of your business being parts and consumables, they're a function of the operating rates. So if operating rates slow down a little bit, we'll see a corresponding slowdown in our activity. And that's really the question. That's why we're being somewhat cautious for the back half of the year.

Okay. Got it. And then maybe a last one for me, just about pricing strategies. I know that you guys have handled the supply chains and price/cost, from my perspective, pretty well. But I wonder if you could just maybe refresh us on pricing last year and what you're thinking about for pricing to offset any inflation for 2023?

Well, first and foremost, we always work very hard to try to lower our cost so that we manage those cost increases. Our customers, of course, don't like us having to pass those on to them, just like we don't like our vendors passing cost on to us. So we're always working hard to come up with ways to lower our input cost so that we can maintain our competitive position in the marketplace. But there are instances where you just can't – you can't get any more savings. And in those cases, we're sometimes required to pass those on to our customers. This year, I think you're going to see less by increases across the board in all industries because demand is going to be down a little bit. And to be quite frank, last year, people were more concerned about whether they could get something delivered to them than they were about the price. And the supply chain logistics has improved substantially, so you don't have kind of that mentality where, first and foremost, I need to deliver. I'll worry about the products later. That's not the case anymore. And so I think there's a lot of scrutiny on pricing. And therefore, we're working hard to contain our cost to make sure we maintain our competitive position.

Okay. Makes sense. Thanks very much.

[Operator Instructions] Looks like there's no further questions. So at this time, I would like to turn it back to Jeff Powell for closing remarks.

Thank you, Gerald. Before wrapping up the call today, I just wanted to leave you with a few takeaways. First quarter was an excellent start to 2023 with high demand for our parts and good project activity, which led to record bookings and record backlog. Although there are continuing economic headwinds, our employees around the globe continue to focus on meeting our customers' needs with innovative technologies and solutions that deliver long-term value to our stakeholders. Our financial health is excellent, and our ability to generate strong free cash flow has us well positioned to capitalize on growth opportunities. And we look forward to delivering exceptional value to our stakeholders again in 2023. With that, I want to thank you for joining the call today, and we look forward to updating you again next quarter.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.