Good day, and thank you for standing by. Welcome to Kadant First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Norma. Good morning, everyone, and welcome to Kadant's First Quarter 2024 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 30, 2023, 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're 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 2024. Q1 was a solid start to 2024. Our acquisitions Key Knife and KWS completed at the beginning of the year performed very well and contributed direct revenue in the first quarter. Solid execution by our operations teams around the globe contributed to excellent adjusted EBITDA. As expected, demand in the first quarter moderated from the unprecedented record-setting first quarter of last year as economic headwinds tempered manufacturing activity, particularly in Europe and Asia. As you can see on Slide 6, our Q1 revenue increased 8% to a record $249 million. Our recent acquisitions and strong performance in our Industrial Processing segment are the drivers of this record revenue. Our aftermarket parts revenue made up 69% of Q1 revenue and was up 13% to a record $171 million. Solid operating performance led to an adjusted EPS of $2.38 and adjusted EBITDA of $52 million, representing 21% 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 decreased 38% to $23 million compared to last year's record cash flow for the first quarter, while free cash flow was $17 million. As expected, bookings softened in the first quarter primarily due to reduced capital project activity. I'll provide more details about this when I discuss each of our operating segments, beginning with our Flow Control segment. Our Flow Control segment experienced solid demand in the first quarter for both parts and capital equipment, particularly in North America. Bookings of $95 million were strong. However, they were down 9% compared to the record performance of Q1 last year. Q1 revenue declined 3% to $87 million…

Thank you, Jeff. I'll start with some key financial metrics from our first quarter. Gross margin was 44.6% in the first quarter '24, up 20 basis points compared to 44.4% in the first quarter of '23. The gross margin in the first quarter '24 was negatively affected by the amortization of acquired profit and inventory related to our recent acquisitions, which lowered gross margin by 90 basis points. Excluding the impact of the amortization of acquired profit and inventory, gross margin in the first quarter of '24 was 45.5%, up 110 basis points compared to the first quarter of '23. This is one of the highest gross margins in our recent history due in part to higher margins achieved in our Industrial Processing segment on parts and consumables as well as the mix of capital projects in the quarter. Also contributing to the improved gross margin was a higher overall percentage of parts and consumables revenue, which represented 69% of revenue in the first quarter of '24 compared to 66% in the prior year. SG&A expenses as a percentage of revenue increased to 28.2% in the first quarter '24, compared to 25.5% in the prior year period. Higher percentage in the first quarter '24 is due in part to the nonrecurring acquisition-related costs. In addition, the first quarter revenue represents the lowest quarterly revenue we expect for the year. SG&A expenses were $70.3 million in the first quarter '24, an increase of $11.7 million compared to $58.6 million in the first quarter '23. This included an increase of $7.3 million from our acquisitions, $1.9 million from acquisition-related costs and a $0.2 million unfavorable foreign currency translation effect. Excluding these items, SG&A expenses were up $2.3 million or 4% compared to the first quarter of '23, primarily due to annual wage…

[Operator Instructions] Our first question comes from the line of Ross Sparenblek with William Blair.

Surprising strength in the aftermarket, particularly given the concerns coming into the year that there was maybe a pull forward late last year. Can you just help parse out some of the drivers here during the quarter? And how are we thinking about price and volume for aftermarket for 2024? I know there seems to be a continuation of customer mothballing across the key markets and just trying to engaging at what point does a broader capacity reduction begin to outweigh volume growth?

I think in general, Ross, as you know, our parts consumables kind of a function of operating rates. And the operating rates really vary quite a bit around the world right now. North America, they're holding up, I think, reasonably well. I would say the lowest operating rates are in China right now, which is still struggling to kind of recover from their pandemic policies and coming out of that. And then Europe, it varies, but some of the major economies in Europe, Germany and the U.K. are certainly very slow and maybe technically in recession. So the rates very fair amount around the world. I do think that for a while, a lot of our customers were operating off of existing inventory. There was certainly some pull forward in some areas, but I think a lot of people also were running their stores lean. And so they're starting to replenish those. And so I think we're benefiting from that. And then some of the markets -- there are some markets we have, OSB, in particular, it's still running very strong, surprisingly strong. So it's -- there's kind of a fair amount of, I'd say, disparity around the globe. But all in all, they're hanging in there. And as you know, that's a big focus of ours. So we're constantly working to pick up market share and the spares and consumable piece.

Yes. No, that's very helpful. Can you maybe just also help frame the sensitivity of your equipment sales on your guidance? I know you kind of previously specified that in the comments. But any updated color from customer conversations as we think about a potential second half recovery, and then maybe any nuances that we should be thinking about in regards to strength in maintenance and rebuilds versus greenfields?

Well, so there's a couple of things. First of all, as you know, many of our customers were quite busy during the pandemic and really ran their equipment very hard. And then also, a lot of our equipment as we analyze the average age of our equipment and a lot of our markets, the equipment is getting quite old. So there is an awful lot of discussions and activity. And I would say, quotes going on. The issue is, I think everybody is in the same boat. They're all waiting to get more visibility and clarity on when things are going to start to turn around and strengthen. And it's very much driven by interest rates. And obviously, in the U.S., in particular, the economy doesn't seem to be responding or acting the way the Fed had expected. And so rates are holding maybe higher longer than I think a lot of people had sought. But I do think that at some point, they will start to reduce rates, and I think there's a fair amount of pent-up demand in many of our markets as well as kind of old tired equipment that will need to be upgraded. And so we think that the underlying fundamentals are still quite strong. It's just a question of timing as to when people get confident enough that things have bottomed out and are starting to turn around to start making those investments.

Yes. I mean it looks like you have the backlog for the guidance this year. But when we think about the magnitude of these projects, I mean, is the expectation that we could see still sustained growth in 2025? I know it's still very early, but that's where the investor interest is right now?

Well, it's a function of when the orders get booked, Ross, for sure on that. I think we are looking at the -- we are cautiously optimistic that in the back half of the year here, we're going to start to see capital bookings really start to firm up.

Okay. So it's a meaningful pipeline here on the project side? That you're speaking to.

Yes. There's a lot of projects on the board.

Next question comes from the line of Kurt Yinger with D.A. Davidson.

It sounded like perhaps the commentary around industrial processing and Material Handling pointed to maybe an expectation for improved booking trends, particularly on capital in the coming quarters, I guess, am I interpreting that correctly? Or is the expectation still that's more of a back half type phenomenon?

No, you're right on there, Kurt. The Industrial Processing has some -- there -- I think we may see things that will be the earliest and they're also some good projects in Material Handling. But I think Industrial Processing is the one that really stands out to me as having some projects coming up earlier.

Got you, okay. Makes sense. And in terms of the strong gross margin, it sounded like industrial processing was kind of a standout there. Anything really noteworthy to call out there? I mean maybe the strength in OFC you referenced was beneficial from a mix perspective? And is that something that can kind of prove sustainable, do you think?

Kurt, I mean I gave a lot of credit. I thought the Industrial Processing segment performance was just outstanding. But our gross margins improved across the board for us in all 3 segments. So I was very, very happy to see that. And we -- it was very good in parts and consumables, but we also had broadly amongst the segments, favorable mix in capital projects that went through. So good gross margins also on our capital projects.

Got it. Okay, and I'm not sure if I missed it, I apologize if I did, but was kind of the full year outlook for gross margins I guess, maintained on that 43.5% to 44.5% range. And I guess if we were to think about coming down from Q1, is that primarily a mix factor just in shifting more back towards capital or anything else that, I guess, could dampen us from the elevated Q1 level that we just saw?

You're correct, Kurt. It's really a function of just having more capital in the mix. And I also wanted to point out that, that guidance range of 43.5% to 44.5%, that has the inventory write-up in it, the impact of that in there, which is about probably 25 basis points for the year or something like that.

Got you. So that would be, I guess, the GAAP gross margin, not the adjustment?

Correct. It's a -- it's the GAAP gross margin. I thought that would be the most useful to put out.

Got it. Okay. That makes sense. And then in terms -- it looked like Key Knife and KWS order of magnitude contributed maybe $24 million to $25 million in bookings and sales this quarter. Any way to think about kind of the split of that between aftermarkets, parts and consumables versus capital?

Well, Key Knife is essentially all parts and consumables and the split on KWS is about 60-40, with 60-40 being parts. So however you're building your model, you can use that as the way to parse it.

Okay. Makes sense. And then just lastly, there are 2 big deals in the containerboard space, the consolidation of some European and U.S. players. How do you think about any potential impacts to your business from that? And I guess, longer term, any thoughts around kind of the implications of just continued consolidation in some of your key forest product customer base?

Yes. As you obviously know, Kurt, there's been a fair amount of consolidation for -- actually going on for quite some time. The overall global demand continues to grow. But I actually think it's a positive thing for us. I think it's positive for the industry because they do a better job in balancing supply and demand, they do a better job in, I think, in controlling pricing and improving their profitability. And from our perspective, we always want our customers to be as profitable as possible because then they have the capital to invest in their business. And so for us, I think, generally speaking, consolidation is good because it increases the profitability of the industry and increases their opportunities to invest, to continue to drive efficiencies in the business. And the other big customer of ours; obviously, if you're talking about IP and WestRock, both of them are quite big customers of ours. So I actually look at it as ultimately as a positive thing because it will improve the overall health of the industry.

Our next question comes from the line of Gary Prestopino with Barrington Research.

A couple of questions here. First of all, Mike, the D&A for this quarter did not reflect, I believe, a full quarter run rate from the acquisitions. Can you give us an idea of what the D&A would be on an annual basis or even a quarterly basis with the full effect of these acquisitions?

Yes. The -- I would -- well, the most important piece of it to me is on the recurring amortization. And right now, we have that at about $7.2 million annually. So you can -- and we maintained our guidance range on the D&A, but that will hopefully help you in terms of -- the valuations are still open, but I think we're closing in on finalizing.

Okay. That's great. And then given the environment that you're operating in right now, especially with the capital projects being choppy, and with the acquisitions that you've made here this year, do you think you can keep your parts and consumable revenues as a percentage of revenues in the high 60s, low 70s throughout the year?

Well, as we go through the year, we're looking at capital increasing. So I would say, we'll probably be in the kind of 62% to 65% range as we go through the remainder of the year by quarter.

Okay. And then lastly, just on adjusted EBITDA because that's how I look at your company. And you may have mentioned this in the guidance. Did you give an adjusted EBITDA margin number for this year in terms of what is part of your guidance?

No, I haven't. I usually do not do that because well, one, Gary, would be with the guidance I've given out, you can back into it, right? You have all the pieces to back into it. But I will say very broadly that the guidance range that we've given out would -- when you calculate that, you'll find we're about 21%-ish.

[Operator Instructions] And it looks like I'm currently showing no further questions at this time. I'll hand the conference back over to Mr. Powell for any closing remarks.

Thank you, Norma. So before wrapping up the call today, I just want to leave you with a few takeaways. The first quarter was a solid start to 2024. Despite continued economic uncertainty, our employees around the globe continue to focus on meeting our customers' needs and finding new ways to 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 quickly pay down the debt associated with our recent acquisitions. We look forward to delivering exceptional value for all our stakeholders again in '24, and we want to thank you for joining us today, and we look forward to updating you on our progress next quarter.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.