Kadant Inc (KAI) Q4 2023 Earnings Call Transcript

Good day, and thank you for standing by. Welcome to the Fourth Quarter 2023 Kadant Earnings Conference Call. Please be advised that today's conference is being recorded. I will now turn the conference over to your first speaker today, Michael McKenney, Executive Vice President and CFO. Please go ahead.

Thank you, Victor. Good morning, everyone, and welcome to Kadant's fourth quarter and full year 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 fourth quarter and full year 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 the year, and we will then have a Q&A session. Jeff?

Thanks, Mike. Hello, everyone. Thank you for joining us this morning to review our fourth quarter and full year results and discuss our business outlook for 2024. I'm pleased to report the fourth quarter was a solid finish to a record-setting year for Kadant. Despite the slowdown in overall manufacturing activity and continued macroeconomic headwinds in many regions, we had another well-executed quarter. This led to solid adjusted EBITDA performance and excellent cash flow in the fourth quarter. Organic bookings were steady in the fourth quarter with solid demand, as we delivered on our mission to provide technologies and engineered solutions that help our customers operate more efficiently. At the end of 2023, we were honored to, once again, be named by Newsweek Magazine as one of America's most responsible companies. This marks the fourth consecutive year of being included on this list, and it is rewarding to be recognized for our efforts in this area. With that, I would like to review our Q4 financial performance. Fourth quarter performance overall was solid and better than expected in several areas. Q4 revenue and adjusted EPS were both up 3% compared to the same period last year, while bookings were comparable with the prior year period. Although a large portion of our Q4 revenue was from capital shipments, excellent execution resulted in an adjusted EBITDA margin of 20.3%. I'm particularly pleased with our operating cash flow, which was the second highest in our company history at $59 million. Our fourth quarter earnings performance contributed to exceptional full year financial results, which I will review next on Slide 7. The record demand we experienced in the first quarter of 2023 provides an excellent start to the year and contributing to our record-setting revenue performance for the full year. Adjusted EPS increased 9% to a record $10.04, exceeding the prior record set last year at $9.24 per share. Our full year adjusted EBITDA was a record $201 million and a record 21% of revenue. Our strategic focus on improving our margin performance continues to deliver results, and we are pleased with the progress of ongoing initiatives to grow our businesses. Our workforce around the globe deserve tremendous credit for these results as they performed exceptionally well throughout the year. I'm extremely proud of our employees for the innovative work they have done and continue to do to serve our customers. Next, I'd like to review our performance in our three operating segments. I'll begin with our Flow Control segment. Q4 revenue declined 4% to $87 million compared to the then record fourth quarter of 2022. Aftermarket parts revenue was up slightly compared to the prior period and made up 68% of total revenue. Product mix within both parts and capital negatively affected gross margin, and this led to an adjusted EBITDA margin of 27% in the fourth quarter. Bookings were up 8% compared to the same period last year. This strong finish to the year positions us well entering 2024. We believe the fundamental drivers of end markets remain healthy, though business activity continues to be influenced by geopolitical and macroeconomic challenges around the globe. Turning now to our Industrial Processing segment. Our performance in the fourth quarter was solid, despite the softening in some of our core end markets. Revenue declined 3% compared to the same period last year, due largely to fewer capital shipments of our stock prep equipment used to process recycled fiber. Aftermarket parts revenue, however, was up 5% and represented 64% of total revenue in the fourth quarter. Adjusted EBITDA margin declined 110 basis points compared to the prior year, but remained strong at 23.8% of revenue. This decline was largely attributed to a decrease in operating leverage associated with lower capital revenue. Looking ahead to 2024, we expect demand in this segment to shift towards aftermarket parts versus capital, particularly with the addition of our recently announced acquisition of Key Knife. Key Knife is a manufacturer of engineered knife systems used in various wood processing applications. More than 90% of its revenue is aftermarket parts. And addition of Key Knife to our Industrial Processing segment is expected to further strengthen our aftermarket position in this segment. In our Material Handling segment, revenue increased 27% in the fourth quarter to a record $64 million. Strong bookings in the first half of the year contributed to this record-setting performance. Capital equipment revenue was exceptionally strong and represented 55% of total revenue in the quarter, led by our conveying product line. Despite the large portion of revenue attributed to capital business, we achieved excellent operating leverage and adjusted EBITDA margin increased 350 basis points to 22.1% in the fourth quarter. The integration of KWS Manufacturing acquired a few weeks ago is underway and progressing well. We are pleased to have this leading manufacturer of screw conveyors and related equipment in part of Kadant. Looking ahead to 2024, we believe this segment will continue to see good business activity, particularly as new infrastructure projects are executed and demand for Kadant-made equipment remains strong. As we look ahead to the first quarter of 2024 and the full year, ongoing project activity is healthy, and demand has been solid as we entered the year. That said, we are seeing continuing economic uncertainty around the globe and expect demand in 2024 to be similar to 2023. Our strong backlog and ability to generate robust cash flows have us well positioned to capitalize on opportunities that may emerge as the year unfolds, and we expect to deliver a solid financial performance again this year. I'd now like to pass the call over to Mike for his review of our financial performance and outlook for 2024.

Thank you, Jeff. I'll start with some key financial metrics from our fourth quarter. Gross margin decreased 40 basis points to 42.7% in the fourth quarter '23 compared to 43.1% in the fourth quarter '22, due primarily to lower margins achieved on capital projects at our Industrial Processing and Flow Control segments. Our overall percentage of parts and consumables revenue was 60% of total revenue in both the fourth quarters of '23 and '22. As a percentage of revenue, SG&A expenses increased to 25.1% in the fourth quarter of '23 compared to 24.5% in the prior year period. SG&A expenses were $59.8 million in the fourth quarter of '23, increasing $3 million or 5% compared to $56.8 million in the fourth quarter of '22. The fourth quarter of '23 included a $0.9 million unfavorable foreign currency translation effect and an increase of $1.3 million of acquisition costs and a decrease of $0.8 million in indemnification asset reversals compared to the fourth quarter of '22. Excluding these items, SG&A expense increased $1.6 million or 3%, primarily due to increased selling-related costs. Our GAAP EPS increased 4% to $2.33 in the fourth quarter compared to $2.23 in the fourth quarter '22, and our adjusted EPS was up 3% to $2.41 from $2.33. Our fourth quarter '23 adjusted EPS of $2.41 exceeded the high end of our guidance range by $0.29 due to higher-than-anticipated aftermarket revenue, especially at our Industrial Processing and Flow Control segments. We had record operating cash flow and adjusted EBITDA in '23, which I will cover on the next slide. For the full year '23, gross margins increased 40 basis points to 43.5% compared to 43.1% in '22, due to higher margins achieved on our aftermarket products, especially at our Material Handling segment. Our percentage of parts and consumables revenue was 62% in '23 compared to 63% in '22. As a percentage of revenue, SG&A expenses decreased to 24.7% in '23 compared to 24.8% in '22. SG&A expenses were $236.3 million in '23, increasing $11.9 million or 5%, compared to $224 million in '22. Excluding a decrease of $1.2 million of expense from indemnification asset reversals, SG&A expenses were up $13.1 million or 6% compared to '22, primarily due to annual wage increases as well as incremental travel and consulting costs. Our GAAP EPS was $9.90 in '23, down 4% compared to $10.35 in '22, which included a $1.30 gain on the sale of the Chinese facility. Our adjusted EPS was a record $10.04, up 9% compared to $9.24 last year. Aside from being a record, our adjusted EPS also exceeded the 5-year target of $8 to $9 a share we set back at the beginning of 2019. In the fourth quarter of '23, adjusted EBITDA decreased 2% to $48.5 million or 20.3% of revenue compared to $49.5 million or 21.3% of revenue in the fourth quarter '22. Our Material Handling segment had a record adjusted EBITDA in the fourth quarter '23 and a notable 350-basis-point improvement in adjusted EBITDA margins compared to the prior year. This was offset by the performance in our other segments. As you can see on the slide, our annual adjusted EBITDA has grown significantly compared to 2019, up 58%. For the full year, adjusted EBITDA was a record $201.3 million and a record 21% of revenue in '23 compared to adjusted EBITDA of $189.1 million or 20.9% of revenue in '22. Our Material Handling segment had record adjusted EBITDA of $53.6 million in '23 and a 210-basis-point improvement in adjusted EBITDA margins compared to the prior year. Our Flow Control segment also had record adjusted EBITDA of $105 million in '23 and a record 28.9% adjusted EBITDA margin. Adjusted EBITDA is an important metric for us. We set a 5-year target for adjusted EBITDA margin of 20% back at the beginning of 2019, and I'm happy to see that we've exceeded this target with a record 21% in '23. Our adjusted EBITDA margin has increased 300 basis points since 2019, due in large part to contributions from subsidiaries participating in our 80/20 program. This program provides revenue growth through a highly focused sales approach and profitability improvements as a result of dynamic pricing and streamlining product offerings. Once adopted, subsidiaries continue to follow the 80/20 program yielding incremental benefits the longer they have followed the tenets of the program. Average adjusted EBITDA margin for subsidiaries under the program have consistently exceeded our other subsidiaries. Over 50% of our revenue is from subsidiaries currently under or starting our 80/20 program. One of the highlights for the fourth quarter and full year was our operating cash flow, which increased 68% to $59.2 million in the fourth quarter of '23 compared to $35.2 million in the fourth quarter '22. For the full year, operating cash flow was a record $165.5 million, up $62.9 million or 61% from '22. We also had strong free cash flow, increasing 114% to $49.5 million in the fourth quarter '23 and increasing 80% to $133.7 million for the full year '23. We had several notable nonoperating uses of cash in the fourth quarter of '23. We repaid $22.1 million of debt and paid $9.8 million for capital expenditures and a $3.4 million dividend on our common stock. For the full year, we repaid $94 million of our debt and paid $31.9 million for capital expenditures, which included a $7.4 million for our facility project in China. Let me turn to our EPS results for the quarter. In the fourth quarter of '23, GAAP earnings per share was $2.33 and adjusted EPS was $2.41. The $0.08 difference relates to $0.10 of acquisition costs, $0.05 of other income and $0.01 of relocation costs, both related to the facility project in China and $0.02 of restructuring costs. $0.05 of other income is associated with cash received for remaining assets of the old facility. In the fourth quarter of '22, GAAP earnings per share was $2.23 and adjusted EPS was $2.33. The $0.10 difference relates to $0.09 of impairment and restructuring costs and $0.01 of acquisition costs. The increase of $0.08 in adjusted EPS in the fourth quarter '23 compared to the fourth quarter '22 consists of the following: $0.17 due to higher revenue, $0.09 due to a lower recurring tax rate and $0.05 due to lower interest expense. These increases were partially offset by $0.17 in higher operating expenses, $0.05 due to lower gross margin and $0.01 due to higher weighted average shares outstanding. The $0.09 impact from the lower recurring tax rate was due to a slightly higher tax rate in '22 related to the timing of certain incentive compensation payments. Collectively, including all the categories I just mentioned, was a favorable foreign currency translation effect of $0.03 in the fourth quarter '23 compared to the fourth quarter of last year due to the weakening of the U.S. dollar. Now turning to our EPS results for the full year on Slide 17. We reported GAAP earnings per share of $9.90 in '23 and our adjusted EPS was $10.04. The $0.14 difference relates to $0.10 of acquisition costs, $0.05 of other income and $0.05 of relocation costs, both related to the facility project in China and $0.04 of restructuring costs. We reported GAAP earnings per share of $10.35 in '22, and our adjusted EPS was $9.24. The $1.11 difference relates to $1.30 gain on sale related to one of our Chinese facilities, impairment and restructuring costs of $0.11 and acquisition-related costs of $0.08. The increase of $0.80 in adjusted EPS from '22 to '23 consists of the following: $1.41 from higher revenue, $0.26 from higher gross margins, $0.08 from a lower recurring tax rate and $0.01 from lower noncontrolling interest. These increases were partially offset by $0.86 from higher operating expenses, $0.07 from higher interest expense and $0.03 due to higher weighted average shares outstanding. Collectively, including all the categories I just mentioned, was an unfavorable foreign currency translation effect of $0.09 in '23 compared to '22. Now let's turn to our liquidity metrics on Slide 18. Our cash conversion days, calculated by taking days in receivables plus days in inventory and subtracting days in accounts payable, was 130 at the end of the fourth quarter '23, down from 138 at the end of the third quarter of '23, but up from 126 days at the end of '22. The sequential decrease in cash conversion days was principally driven by a lower number of days in inventory. Working capital as a percentage of revenue decreased to 12.8% in the fourth quarter '23 compared to 15.4% in the third quarter '23 and 13.9% in the fourth quarter '22. Net debt, that is debt less cash, at the end of '23 was $4.4 million, the lowest level since 2017, representing a decrease of $117 million compared to net debt of $121.4 million at the end of '22. Our interest expense increased 30% to $8.4 million in '23 compared to $6.5 million in '22 due to an increase in borrowing rates. Our leverage ratio, calculated as defined in our credit agreement, decreased to a very low 0.27 at the end of '23 compared to 0.74 at the end of '22. After our recent acquisitions, our borrowing capacity is $71 million available under our revolving credit facility and an additional $200 million of uncommitted borrowing capacity. Now I'll review our guidance for '24. We expect to achieve records in a number of key metrics in '24, including revenue, cash flow and adjusted EBITDA. Our earnings performance in '24 will be affected by increased borrowing costs and noncash intangible amortization expense associated with our recently announced acquisitions. As we look beyond '24, the increased borrowing costs will continue to decrease as we have demonstrated our proven track record of paying down debt. For the full year, our revenue guidance is $1.04 billion to $1.065 billion, that is $1.04 billion to $1.065 billion, and our adjusted diluted EPS guidance is $9.75 to $10.05, which excludes $0.20 related to the amortization of acquired profit and inventory and backlog. Looking at our quarterly revenue and EPS performance for '24, we expect the first quarter will be the weakest quarter of the year due to the timing of capital projects, and the second half of the year will be stronger than the first half as a result. Our revenue guidance for the first quarter of '24 is $238 million to $246 million and our adjusted diluted EPS guidance for the first quarter is $1.90 to $2, which excludes $0.14 related to the amortization of acquired profit and inventory and backlog. I should caution here, there could be some variability in our quarterly results due to several factors, including the variability of order flow and the timing of capital shipments. Guidance includes our acquisitions of Key Knife and KWS, which we completed in January. Aside from the impact of intangible amortization, there is a negative impact in the initial post-acquisition period associated with the amortization of profit in inventory and acquired backlog as these amounts are reflected in the income statement when the underlying order is fulfilled and inventory shipped to the customer. Our GAAP and adjusted EPS guidance include our initial estimates of purchase accounting adjustments, which are subject to change as we review and finalize the valuation work for these acquisitions. I'd like to give some additional metrics on our EPS guidance. We borrowed $230 million in January for the acquisitions of Key Knife and KWS. We'll work diligently throughout '24 to pay down that debt. As a result of the borrowings, we project our interest expense will increase by approximately $0.70 over '23. In addition, Key Knife and KWS transactions have significant amounts of recurring noncash intangible amortization expense, which is reducing our EPS guidance by approximately $0.50 in '24. While the noncash intangible amortization does have a significant impact on EPS, it will not impact our cash flow or EBITDA for '24. '24 guidance includes a favorable foreign currency translation impact of approximately $11.6 million on revenue and $0.15 on adjusted EPS due to the weakening of the U.S. dollar. We anticipate gross margins for '24 will be approximately 43.5% to 44.5%. As a percentage of revenue, we anticipate SG&A will be approximately 25.5% to 26.2%, and R&D expense will be approximately 1.3% to 1.4% of revenue in '24. We anticipate net interest expense of approximately $18 million to $18.5 million, and we expect our recurring tax rate will be approximately 26.5% to 27.5% in '24. We expect depreciation and amortization will be approximately $46 million to $48 million in '24, and we anticipate CapEx spending in '24 will be approximately $29 million to $31 million, which includes $2 million related to the final payments on our facility project in China. Approximately 15% of the CapEx spending in '24 relates to final payments for CapEx projects approved in '23. We were a little bit above our normal CapEx as a percent of revenue metric as we continue to invest in automation projects and upgrades to our manufacturing capabilities. That concludes my review of the financials, and I will now turn the call back over to Victor for our Q&A session.

Hi, good morning, everyone. Just want to go over some of the puts and takes on your outlook in 2024. What you're basically saying is that the capital part of your business will be sluggish in the first half, and then you're anticipating that to come back in the second half. Is that a good read on...

Yes, Gary. Yes, that's a good read. We expect capital activity to pick up here in the second quarter and be stronger in the back half.

And what's driving that thought process? Or are you seeing any empirical evidence in terms of orders or anything that back half of the year, we're going to see that pick up?

Yes. I think there is quite a bit of activity, but these projects tend to take longer to develop. There's a lot of communication between our engineers and customers, leading to considerable discussion. The time from quote to booking the order is slightly longer than usual, primarily due to general economic uncertainties. People are trying to anticipate when the Federal Reserve will start reducing rates, and there is significant pent-up demand in many of our markets. Customers are preparing for that, but it's a bit uncertain as to how quickly they will begin investing in anticipation of increased demand. There is a lot of project activity and quoting happening, but people are taking a bit more time to actually place the orders as they assess the pace of the recovery.

Right. As I look at your guidance, I mean, the two acquisitions, I think what did they add about on an annualized basis, $110 million of sales? Is that about right if you get a full year run rate?

Yes, I believe that's a reasonable estimate, Gary. However, it's important to note that the KWS transaction didn't close until three weeks into the first quarter.

Right. No, I understand that, puts and takes there. But I mean, if you add that number into what you actually did, looking at rather de minimis growth in sales this year, and I just want to make sure I'm understanding this right, that that's really more or less a function on the capital side of the business?

Yes. That's correct. Yes, organically, when we take out the $11.6 million of FX and revenue, it would be down about 2% in revenue, organic.

Okay. And I'll just say real quick.

Sorry, go ahead, Jeff. I'm sorry.

I wanted to mention that we are facing challenges, especially at the beginning of the year, in forecasting what will happen as the quarters go by. This year is particularly tough due to a lot of uncertainty. Everyone, including the Fed, seems to change their view on the economy frequently. As you know, Gary, we are a fairly conservative organization, and at the start of the year, we aimed to be cautious. We are trying to gain better visibility on the timing of certain activities, but it is difficult coming out of a slower period.

No, I get that. I just wanted to make sure. I was confirming it. And then just some of the other figures that you guys talked about, especially Mike, you said $18 million to $18.5 million of net interest expense for this year?

Yes. Well, just interest expense, purely interest expense.

Okay. So that's $18 million to $18.5 million of interest. And then you said D&A is going to run to $46 million to $48 million, right?

Yes, that's correct, Gary.

What was your capital expenditure this year? I didn't see that mentioned in any of the releases, or maybe I overlooked it. Did you bring that up?

Yes, one second. We're at essentially $32 million.

Okay. Thank you very much. Appreciate it.

You're welcome.

Thank you. One moment for our next question. And our next question will come from the line of Kurt Yinger from D.A. Davidson. Your line is open.

Thank you, and good morning, everyone. I would like to follow up on a previous question regarding the strengthening in the second half of the year. Do you think you need to see better capital equipment bookings over the next few quarters for sales improvement to occur? Or, considering the booking activity in Q4 and your expectations for Q1, could any further improvements actually provide upside to your projections for the full year? How should we view those booking trends and their implications for performance in the second half?

Yes. You are right on your first assumption, Kurt. It really is predicated on us seeing strengthening in the capital bookings as we go forward.

Okay. Got it. And then one of kind of the bright spots this year, I think, has been parts and consumables. And it's had a steady performance despite some choppiness in some of the end markets, containerboard being kind of a big one. I mean we haven't yet seen a lot of those trends really improved very much. Is there any concern that that could catch up and start to weigh on parts and consumables going forward? Or do you expect the solid performance in 2023 sets you up pretty well for 2024 as well?

It's interesting to note that all of our businesses have some part in this. Specifically, we anticipate a significant recovery in the containerboard sector this year. Last year, containerboard demand was relatively flat and experienced a decline for the first time in a long while in 2022. However, forecasts predict a 4.3% increase in containerboard demand this year, with tissue expected to rise by 4%. In 2025, forecasts show a 3.8% increase in tissue and a 3.7% in containerboard. We expect to see substantial recovery in that area of the business. Additionally, while there has been a slowdown in wood processing, housing starts were around 1.46 last month and permits were approximately 1.5. This signals some improvement, and as interest rates begin to decrease, there's a significant pent-up demand for housing. We're engaging in numerous discussions with our customers, who are preparing for what they believe will be a strong uptick in market demand once interest rates go down. Our expectation is that the parts business could continue to gain strength throughout the year if conditions align with current economic forecasts.

Right. Okay. And I guess sticking with the wood piece, I mean there was a lot of capacity added. And to your point, I think there's a lot of optimism that demand is going to continue to improve. But at the same time, some of that new capacity is being absorbed. I guess as you think about your capital equipment, how important is new greenfield facilities and new capacity versus just better utilization at existing facilities in terms of the overall kind of sales and demand picture for wood processing?

Yes. I think there's both. And of course, because we're global, and we have an extremely high market share, globally, it varies. So if you look at North America, it may be more just upgrading tired equipment. The average age of a lot of the equipment out there is pretty old. And so there's just upgrading. But then there's a lot of new greenfields going on in Asia, in particular. Our stranding guys are very busy in Asia. A lot of projects, a lot of activity. We booked another order in China a few weeks ago. And then you've got the situation in Russia. A lot of product came out of Russia. And of course, that's got to be replaced now. So we're seeing activity in Europe and in particularly, in Scandinavia area as they start to invest to offset the lost supply out of Russia. So the wood side, it really depends on the region you're looking at. But I would say the activity level right now is as high as it was before the pandemic for us with the tired equipment out there. And frankly, more and more, in particular, on the stranding side, more and more products using stranded material. That's held up extremely well for us, and demand still looks quite good.

Got it. Thanks for that Jeff. And then just my last one, I guess, bigger picture. You're coming off two of kind of your strongest organic growth years in '21 and '22. This past year was still very solid as well. I mean where do you think the business is from kind of a cyclical standpoint entering '24? And I guess is there anything that's changed in terms of how you think about the organic growth profile of the business longer term relative to what you've kind of outlined in the past?

We experienced substantial organic growth starting around 2018 and 2019, reaching about 7.5% for several years, which significantly exceeded global GDP. While we wouldn't expect this to continue at the same rate over the next five years, I believe our Material Handling sector is well-positioned. The financial allocations from the infrastructure bill and the CHIPS Act are just beginning to be utilized, which we anticipate will benefit this sector. The billing aspect has shown strong performance in Europe and the U.S. in terms of recycling. In the paper sector, we noted that operating rates likely hit their lowest point in 2023, currently running around 79%, and are forecasted to recover to the mid-80s over the next couple of years, suggesting some growth in that market. The Flow Control division has been consistently stable, with the team effectively exploring new end markets. Presently, our largest sector is industrial, which surpasses all others, and there are numerous industrial markets that we are targeting with our products. Looking ahead, provided that no unexpected events occur, we anticipate solid growth over the next few years, but we need to begin seeing that take shape this year as it progresses.

Well, appreciate all the color guys. Thank you.

You're welcome.

Thank you. One moment for our next question. Our next question will come from the line of Larry De Maria from William Blair. Your line is open.

Thanks. Good morning, everybody. Just a few quick sort of clarifications. I know it's not unusual, but it was a little bit bigger for the second half than first half. Can you give us kind of order of magnitude second half versus first half? And secondly, maybe you could talk to the financial flexibilities you have after the recent deals. And just the M&A pipeline if we're out of the market for a while or if it's still relatively healthy?

On the split first half, second half, Larry, I'd say there's about a 5% delta there.

We're still very active on the activity side. Our corporate development team has indicated that there is still a significant amount of deal flow available. Despite taking on a bit of debt for our recent acquisitions, our balance sheet remains strong, and we believe we still have good capacity. We are moving forward at full speed and will not be slowing down after completing a couple of transactions. We are constantly on the lookout for opportunities that are strategically beneficial at a fair value, even though that can be difficult at times. Our corporate team is busy, and we do have the capacity. Moreover, our current debt agreements were established when we were smaller, so if necessary, we can adjust those at higher levels. We will take action on that if needed as we seek out new opportunities. We are fully committed to exploring these prospects.

Okay. Sounds good. Now, shifting gears a bit, I know you’ve mentioned this already, but I’m curious about the order expectations going forward and how we’ve performed so far. It seems a bit strange to discuss the strength in capital equipment while suggesting that orders will be restored in the fourth quarter along with solid demand, yet expressing some caution in the outlook feels overly conservative. Could you elaborate on why this perspective isn’t overly cautious, in light of your previous comments and recent results? Additionally, what areas of the end markets are indicating weakness and what are the expectations for orders from here? Is there a chance they could remain stable?

Yes. I would say, Gary.

I pointed to Mike and said you can handle this one, Mike.

The biggest thing that we're looking at is capital, capital order flow, and seeing that we get some traction and get some firmness there. That's the biggest thing that we're waiting to get some clarity on.

Our guys are very busy. As I mentioned, project discussions and activities are actually pretty strong. But the time to close is lengthened. I think as our customers are, again, trying to gauge how quickly rates come down and demand starts to pick up. And so because those discussions are taking longer than normal, it obviously introduces added degree of cost on our part.

And anything on the order expectations from here? And have we done so far this year? I assume, obviously, capital has been slow.

Yes. I mean I think right now, things are as expected. Right now as we look through last week, demand is kind of on track with where we would expect it to be.

Okay. So is it safe to say that given the comments on the pipeline and the time to close, it's a little longer, I mean those potential orders don't go away, right? They either hit in the second half or they get pushed out to next year. Is that fair to say? Or ultimately, it's the same timing.

It's very rare for a project to be canceled. We had one significant project that was canceled back in '22, but that's unusual. Typically, these projects are just delayed. Large projects take considerable time for board reviews, and once they reach that stage, they usually don't vanish completely. It's mainly a matter of timing. This uncertainty about timing contributes to the level of caution we have, as we are unsure when orders will materialize in the next quarter, third quarter, or fourth quarter, since customers are not quite certain yet.

Okay. Fair enough. Last quick question. Regarding parts and consumables and flow and industrial process, considering the mothballing we've seen, is it just about overall volume and parts and consumables? Are you expecting an increase in that area while capital is expected to decline? Is that a fair way to think about it?

Yes. I mean what happens is, as you know, we operate in almost every paper mill in the world. And I know some people get hung up when they hear about a closure. And we never like to hear about closures, but I just mentioned overall demand is forecasted. If you look at total paper demand, in '24, globally, it's supposed to be up 3.3%, and it grows every year. So what happens is they just shift that to other more efficient mills, and we're there, too. So we just picked the business up in one mill versus the other. And so we don't get nearly as hung up on a mill closure announcement here or there. As long as overall demand continues to grow, we're going to be there to get our fair share of that.

Hi, good morning, guys. Good end to your year. Wanted to try one on the Flow Control bookings, the plus 8.4%. I wonder if you could just give us some incremental color. Was that parts related? Was that capital projects? Maybe regionally, where the orders were coming from?

I'm checking my schedule for the specifics. In the fourth quarter, both capital and Flow Control performed well. In December, we secured several significant projects. Overall, the strong bookings were primarily driven by capital and Flow Control.

Okay. Great. Do you think that this could be the beginning of a trend? Is there any continuation? It seems like people are reducing their inventory and exercising caution as we approach the end of the year. However, it appears to be somewhat contrary to the trend.

Yes, it did, Walt, but I know that the projects from those capital initiatives were planned for 2024. So the orders came in a bit early.

Okay. Okay. That helps. And then I wonder, as you kind of alluded to this in some of the other questions. Last year, this time, you were getting that big 42-mile conveyor project in Material Handling. And that probably has already shipped now. That's probably already through your process. But I wonder if it's something you've got more in the funnel that are some of these bigger Material Handling projects. Is that right?

On the large project we booked in the first quarter, you're correct that most of the $12 million shift has occurred, with about $2 million remaining. A significant portion of that was recognized in the fourth quarter, which is why their revenue and other metrics, such as margin and EBITDA, performed so well. We achieved excellent operating leverage on the EBITDA front.

Okay. That's great. It seems there’s potential for more of these significant conveyor projects in the pipeline?

Yes, that was the second longest in the world. While there are discussions about projects, we don't anticipate anything of that scale happening soon as it's quite rare. Generally, the group has been improving over the last year and a half. If housing activity increases, it will positively impact them. The CHIPS Act represents significant construction efforts primarily focused on building plants, which is beneficial for them along with infrastructure. Additionally, the baler business in the U.S. remains very strong, as does its performance in Europe and other regions. Overall, other segments have experienced steady demand, and we expect them to continue to perform well throughout this year.

Okay. Great. I'd like to ask a couple of questions about the 80/20 initiative. Congratulations on the profit improvement you've been experiencing. I had initially thought you would be further along than 50% of the plants started. Could you update us on how many P&Ls you currently have? It seems like half of those P&Ls have started, but how many do you actually have? Additionally, for 2024, will there be more P&Ls starting the 80/20 process?

We have about 24 companies with profit and loss statements, and roughly half of them are currently involved. The challenge we’re facing is that it's not feasible to run an ERP project simultaneously with 80/20 since both require significant resources and effort. Presently, some of our 80/20 implementation is being held back by companies that are either in the middle of or preparing to start ERP projects. We've encountered situations where companies need to replace outdated ERP systems, which has consequently delayed the rollout of 80/20 in certain businesses. Over the past 18 months, we’ve been working on determining which ERP projects can be postponed until after 80/20 is implemented, and which 80/20 initiatives might need to be delayed. This has been influencing our progress. Additionally, we are actively enhancing our internal team and expertise, but there are still limitations regarding the available skills required for project implementation. I anticipate that it will take us another three to four years to fully transition, excluding any new acquisitions. Each new company we acquire leads to additional future projects. We've even added a couple of new projects this year, so the process will be ongoing. However, in about three to four years, most of our current businesses should be nearing the completion of these processes.

Okay. Maybe one last question for me, just regarding the pricing environment. I don't recall any issues related to pricing in your niche markets in 2020. Are you increasing prices again, and are you still experiencing inflation?

I would say that many of the inflationary pressures we experienced with raw materials have decreased. The situation has improved. Additionally, with demand somewhat lower, customers are quite hesitant to agree to significant price increases. As we noted before, in 2021 and 2022, the focus was on securing materials from the supply chain, with more emphasis on availability than cost. Now, the situation has stabilized, and we are returning to a more typical pricing environment. Our improvements have primarily been on the SG&A side, and our margins have remained steady, indicating our pricing stability. We have concentrated on reducing our operating costs, which is where we have seen the most improvement by cutting internal expenses.

Okay, great. Thank you.

Thank you. I'm not showing any further questions in the queue. I would now like to turn it back to Jeff Powell for any closing remarks.

Thank you, Victor. So before wrapping up the call today, I just want to leave you with a few takeaways. 2023 was another record-setting year for Kadant, and our employees deserve a lot of credit for achieving these results. I want to thank all our employees around the world for the commitment to serving our customers' needs. I also want to welcome our newest employees, from both Key Knife and KWS Manufacturing. We're excited about the value you add to Kadant and the opportunity to build upon the successes you have achieved. In 2024, we will continue to seek new opportunities to create value as we focus on meeting our customers' needs with innovative technologies and solutions that drive sustainable industrial processing. Lastly, our financial health is excellent, and our market positions remain strong. We look forward to delivering exceptional value for all our stakeholders again in 2024. With that, I want to thank you for joining the call today.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.