Good day and thank you for standing by. Welcome to the Kadant's Second Quarter 2023 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] 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, Abigail. Good morning, everyone, and welcome to Kadant's Second 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 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. Reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is contained in our second 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, and thank you for joining us this morning to review our second quarter results and discuss our business outlook for the second half of 2023. I'll begin by reviewing our operational highlights for the second quarter. I'm pleased to report, we had another well-executed quarter with solid aftermarket demand for parts, combined with strong capital business, leading to record revenue, record adjusted EBITDA and record adjusted EPS. Our operations teams around the globe continued to deliver exceptional value for our customers and perform at a high level as shown by our strong financial performance. They have done a great job of meeting our customers' needs in a challenging environment, and I want to thank them for their outstanding work and the results they generated. Turning next to Slide 6. I'd like to review our Q2 financial performance. We achieved a number of new financial records in the second quarter driven by large capital shipments along with strong contribution from aftermarket parts. Revenue increased 11% to a record $245 million with solid growth across all regions and all operating segments. Strong execution contributed to a record adjusted EBITDA of $52 million, up 12% compared to last year and representing 21% of revenue in the second quarter. Our adjusted EPS was also a record at $2.54 a share. As economic headwinds strengthen, second quarter bookings declined from the record set in the first quarter of this year. Capital project activity remains healthy, but as the scope of these projects is refined, the execution time line has, in some cases, been pushed out to a later date. While the general slowdown in industrial activity over the past few months is reflected in our second quarter new order activity, we have a strong backlog and expect bookings in the second…

Thank you, Jeff. I'll start with some key financial metrics from our second quarter. Consolidated gross margins were 43.5% in the second quarter of 2023, up 20 basis points compared to 43.3% in the second quarter of 2022. This increase was principally due to higher margins achieved on capital projects, especially in our Industrial Processing segment, offset in part by a lower proportion of parts and consumables revenue, which represented 62% of revenue in the second quarter of 2023 compared to 66% in the prior year. SG&A expenses increased $4.7 million to $60 million in the second quarter of 2023 compared to $55.3 million in the second quarter of 2022 due to wage increases and incremental costs related to trade shows and travel. As a percentage of revenue, SG&A expense decreased to 24.5% in the second quarter 2023 compared to 25% in the prior year period. Our GAAP EPS increased 13% to $2.54 in the second quarter compared to $2.24 in the second quarter of 2022, principally due to higher revenues. Our adjusted EPS was a record $2.54 in the second quarter 2023, exceeding the prior record of $2.40 achieved in the first quarter of 2023. The second quarter 2023 adjusted EPS exceeded the high end of our guidance range by $0.39 due to higher revenue and better gross margins than forecasted. We had record revenue in the second quarter of 2023 driven by our highest quarterly parts and consumable revenue. Both our Material Handling and Industrial Processing segments exceeded their parts and consumables revenue forecast due in part to fulfilling additional orders from backlog. Adjusted EBITDA increased 12% to a record $51.6 million compared to $46 million in the second quarter of 2022 due to strong performance in our Flow Control and Material Handling segments. As a percentage of…

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

Hi. Good morning, Mike and Jeff. Could you just go -- for my purposes, as a new analyst following the company, could we just -- maybe just go into some of the puts and takes on the year-over-year bookings? They're down somewhat dramatically, I’d suppose. So could -- is that just really a function of what you're seeing economically a slowdown? Or was last year just a big year in terms of bookings due to catch-up from the pandemic?

Yes. So I think it's really a combination of two things. Last year, at the time that was $266 million was a record for us, quite strong. And so -- and of course, the first quarter of this year was $275 million, a new record. So we kind of look at -- when we look at our bookings, some of maybe what we thought would come in the second quarter moved in the first quarter. So we had the very strong $275 million in the first quarter. But there is -- I think there's no question there is a little bit of an industrial slowdown. If you look at the overall economy, what we're seeing is that the service side of the economy is doing quite well and the industrial side is slowing down some. So I think a little bit of it is -- comparing to a record at the time last year, a little bit of it is having such a phenomenal first quarter at the $275 million combined with a little slowdown in industrial production. It tends to be our capital equipment that shifts around. Our parts are pretty stable, and they're pretty flat actually. So it's really the timing of capital from one quarter to the next and a little bit of a slowdown. I think people are just taking a little more of a wait-and-see approach, trying to see what the Fed is going to do. Interest rates have gone up, of course, which increases the cost of borrowing money. And so, I think it's a combination of all those factors.

Okay. Thank you.

One moment for our next question. Our next question comes from the line of Lawrence De Maria with William Blair. Your line is open.

Thanks and good morning, Jeff and Mike. Just as a follow-up on the earnings -- sorry, the orders question, can you just give an idea of how much worse were orders compared to your expectations in the quarter? And what gives you confidence that those second half bookings will come through at the levels you said they were? Do you have the pipeline and the conversations and good visibility on that? That's the first part.

Yes, Larry. The orders came in on forecast. That was the forecast for the quarter. So, no disappointment there. That is what we anticipated. Again, as Jeff mentioned, we had an extraordinarily strong first quarter bookings performance as we noted. So it's -- you're looking at first quarter bookings, which were extraordinarily strong and also second quarter of last year at $266 million. We also indicated it was a phenomenally strong order quarter for us, especially in both periods on the capital front.

Okay. And then the pipeline into the second half that gives you that confidence?

Yes. I think as Jeff said, our parts and consumables business is very stable. We are seeing a little -- some softness on the capital bookings front, and that's what folks have forecast.

Okay. And then -- now we start to think about long term again through the second half and kind of low orders that we are starting -- that we're having kind of now. Give us some high-level thoughts, if you can and are willing to do it, what it means into 2024 if we're looking at, is this a trough year? Is it -- do we sort of start off soft based on the orders and then look for reacceleration in industrial from [IIJA] (ph) and other things? Or can you actually think about even growing margin earnings next year because of 80:20 and positive price? Any kind of high-level puts and takes on how to start to frame next year based on where the orders are now would be really helpful.

Yes. Of course, as you know, it's always -- when you sit here just closing the second quarter, it's a little challenging to know exactly what's going to happen next year and particularly because the Fed is still on a campaign to try to get control of inflation. But I think we're encouraged by the fact that the -- in particular, our wood group, the builders are starting to see improved demand. The -- a lot of the forest product companies have released earnings and had strong earnings and are somewhat optimistic. So I think that sector, I think they're hoping that might come back a little bit next year. Our Material Handling side, in particular, the bulk equipment handling side, that's been ramping up with this infrastructure bill that really is just now starting to be spent. It takes a while for the government to start spending that. So our customers kind of try to get ahead of that and make some investments in their business, so they're prepared when that money starts to flow, but it really is just -- it hasn't really hit the market yet. But it's -- I would say that it's still a bit early for us to predict. What the experts are saying is, they expect maybe things will be slow in the first half of the year and that in the second half things will start to pick back up. There might even be -- some people even predict there might be some rate cuts in the second half of the year. I have no idea whether that will be the case or not. But I think we believe that there will be some improvements as the year progresses. I think -- we think that it's going to be kind of flat and stable the rest of this year with last year, probably start out that way, the first of the year, then we would expect to see investments start to be made as the year progresses and our customers get a little more visibility on exactly where interest rates top out at and kind of what the Fed's action might be. But it's -- I would say these are more uncertain times because you do have these central banks. I mean, in China, the bankers are actually trying to spur growth because they're growing. They're worried about disinflation not inflation. So they're trying to increase demand. Europe, of course, is just essentially flat this quarter, up maybe [0.001 or 0.002] (ph) of a percent. So there a fair amount of variability around the world right now and what the different bankers are doing to impact their economies. But we think, generally speaking, that things should improve as the year goes on next year.

Okay. That makes sense, and I appreciate. Obviously, it's difficult to make those calls right now. Last question, you talked about, obviously, M&A capacity center in the balance sheet. At some point, do you ever considered share repurchases? And is -- are we at the point where we're getting closer to actionable M&A? Or is it just a good pipeline and still waiting for things to align?

So I would say, Larry, on the share repurchase, yes, we have a $50 million authorization outstanding. We always have an authorization available to utilize. So that is always in the mix for capital deployment. And I would also say, for us currently right now, there is a lot of activity on the M&A front. We're seeing a lot of companies come out. So that is certainly always in play for us also.

Yes. I would say our deal flow, we talk about -- we have a corporate development group that focuses on that. I would say the deal flow was surprisingly weak last year, but it has bounced back nicely this year. So there's a lot of activity, a lot of discussions, a lot of companies out there that are interested in being acquired. So our group is quite busy right now looking to try to find companies that are good strategic fits for us at the proper value.

Okay. Thank you very much and good luck.

Thank you.

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

Hey, good morning, everyone. And filling in for Kurt Yinger today. And just a couple of quick questions for me. So could you give us more color on the backlog? And like how would you characterize it? When does it extend out into the cancellation rate or anything else we should know about it?

Well, Adi, our back -- we ended the quarter with a backlog of $363 million. So as you know, we ended the first quarter with a record backlog of $393 million. And just as a benchmark, that $363 million would be a very high backlog for us. It would be our third highest backlog, only eclipsed by the first quarter of 2024, and then mid-2022, we had a higher backlog in the second quarter of 2022. So we have a very strong backlog. And in regards to your question, I think you were saying about cancellations, that's very rare for us. We -- it does happen on occasion. But a good chunk of the backlog is capital. It kind of breaks out 70-30, 70% of the backlog is capital. So majority, far and away, in backlog is capital. And our customer base, when they commit to a capital project, they tend not to back off of that. So it does happen on occasion, cancellations, but not much.

Got it. Got it. Yes, that makes sense. And then you talked about your wood clients. And so when it comes to mill taking downtime over the quarter, how did that trend? And how do you expect that to be going forward, maybe for the full year? Also, if you could talk about it more broadly?

Yes. The first quarter, the mills on the wood side were slow and demand was down, but it surprisingly picked up quite a bit in the second quarter. Prices firmed up. And our parts business was quite strong, which tends to be an indicator of operating rates. So I would say on the wood side, things seem to be improving. Now it's very much a function of interest rates. And I think everybody is trying to adjust to the new rates. But there's almost no kind of used inventory coming on the market. Everybody's locked into these very low-interest-rate loans. They don't want to trade out a 3% mortgage for 7%. And so almost all of the home purchases now are new construction because of that. And so of course, that drives a lot of our customers' demand. So I think if you look at the underlying fundamentals of demand in the housing sector, you look at the millennials, which are going to peak around 2030 as far as prime house buying. And then also, the average age of homes on the 20 to 40 year, which is when major remodeling takes place, that's at a quite high rate, too. So the underlying fundamentals for wood were actually quite good for the next several years. And I think there's been this momentary challenge with the Fed raising rates to try to crush inflation. But as rates start to come down, whether it's middle of next year or the end of next year, I think you're going to see the wood sector come back very strongly because there's just so much underlying demand. And these millennials aren't going to live in their parent's basement forever. They want to get out. And so there's just a lot of demand, and we've underbuilt for 10 years now or more. So I think you're starting to see some improvements now, and we expect that will absolutely continue and will accelerate as soon as rates top out and start to come down some.

Great. Thank you for that. And then just going back to capital allocation from your comments, is it fair to say you're leaning more towards like sticking with the dividend and increasing the dividend relative to M&A?

I would say, no. That wouldn't be true. We have a dividend and although we can't promise, our goal is always to -- we strive to try to increase it every year. So in all likelihood, we'll be continuing with the dividend. But that really, I would say, is not impacting what we choose to do on M&A at all.

Okay. Got it. Thank you so much and good luck for the next quarter.

Thank you.

Thank you.

[Operator Instructions] That concludes the question-and-answer session. At this time, I would like to turn it back to Jeff Powell for closing remarks.

Thank you, Abigail. And before wrapping up the call today, I just want to leave you with a few takeaways. Despite the slowing economies, the second quarter was another record-setting quarter, and our operations teams deserve a lot of credit for producing these results. We have strong market positions and expect stable demand during the second half of the year. And finally, our balance sheet continues to strengthen, and we are actively pursuing new growth opportunities. And with that, I want to thank you for joining the call today, and we look forward to updating you next quarter.

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