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Executives

Thomas O’Brien – EVP and CFO

Jon Painter – President and CEO

Analysts

Walter Liptak – Global Hunter Securities

Lawrence Stavitski – Sidoti & Company

Kadant Inc. (KAI) Q3 2013 Earnings Call November 5, 2013 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the Q3 2013 Kadant Inc. Earnings Conference Call. My name is Jasmine and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Thomas O’Brien, Chief Financial Officer, Kadant. Please proceed, sir.

Thomas O’Brien

Thank you, operator and good morning everyone and welcome to Kadant’s third quarter 2013 earnings call. With me on the call today is Jon Painter, our President and Chief Executive Officer.

Let me begin by encouraging all participants in our business review today to participate via our webcast. You may access the live webcast by going to www.kadant.com, select the Investors tab and then select the listen live option for the webcast. To participate in the question-and-answer session at the end of our prepared remarks, you will need to dial into the teleconference. The dial-in number is available in our press release issued yesterday. It will also be shown at the end of our presentation.

Let me now remind everyone of our Safe Harbor statement. Various remarks that we may make today about Kadant’s future expectations, plans and prospects, our forward-looking statements, the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Our actual results may 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 report on Form 10-Q for the fiscal quarter ended June 29, 2013. Our Form 10-Q is on file with the SEC and is also available in the Investors section of our website at www.kadant.com under the heading SEC filings.

In addition, any forward-looking statements we make during this webcast represents our views 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 estimates change and you should not rely on these forward-looking statements as representing our views on any date after today.

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 third quarter earnings press release issued yesterday, which is available in the Investors section of our website at www.kadant.com under the heading Investor News.

And with that, I will turn the call over to Jon Painter, who will give you an update on Kadant’s business and future prospects. Following Jon’s remarks, I will give an overview of our financial results for the quarter and we will then have a Q&A session. Jon?

Jon Painter

Thanks, Tom. Hello, everyone. It’s my pleasure to brief you on our third quarter results. Overall, we had a solid quarter with strong cash flows, gross margin and better than expected earnings per share performance.

I will begin today’s review with the financial – a review of the financial highlights of the quarter. We finished the third quarter with revenues of $91 million, which were up 5% compared to the third quarter of 2012 and 11% sequentially. Gross margins in the third quarter remained strong at 44%. We generated GAAP diluted earnings per share of $0.57, down 14% compared to the same period last year due to higher tax rates. This exceeded our guidance of $0.47 to $0.49 which included $0.01 of restructuring costs. Our Q3 2013 earnings per share also included $0.05 of acquisition expenses.

Operating income was $10 million in both the third quarter of 2012 and 2013. Our bookings in the third quarter increased 18% to $82 million compared to the same period last year. Cash flows continue to be strong at $13 million and allowed us to end the quarter in a net cash position of $59 million. We generated over $30 million of operating cash flow over the last nine months.

And finally, I am happy to announce that after the quarter closed, we signed an agreement to acquire Carmanah Design and Manufacturing, a leading supplier of process equipment for the production of oriented strand board, or OSB. I will be talking about, more about this company later in my remarks. You can see from Slide 6, our revenues which include $7 million from acquisition were up 5% compared to Q3 of last year. Our bookings of $82 million were up 18% compared to a relatively weak Q3 of last year.

Our bookings of $82 million were up 18% compared to a relatively weak Q3 of last year. Our recent acquisitions contributed $5.2 million to our bookings. Excluding acquisitions, our bookings were up 10% compared to the same period last year. Although we reported bookings of $82 million, we actually booked $86 million in new business during the quarter. The difference was due to the reversal in Q3 of an order we originally booked from Russia in 2012 for $3.8 million. Due to an extended delay in the customer’s ability to get financing, we thought it’s prudent to remove the booking from our backlog although we are still hopeful that the project will go forward once the financing is in place.

Slide 8 illustrates our bookings and revenue trends with bookings shown by the blue bars and revenues shown by the solid line. Revenue in 2013 continues to trend up nicely reflecting the improved bookings this year and the additional revenue from acquisitions. Bookings were down 6% in Q2, but were essentially flat if you exclude the booking reversal I mentioned earlier. We are seeing some good activity on the number of capital projects, so I expect we will have a meaningful sequential increase in bookings in Q4. Our Q3 parts and consumables bookings were $54 million, up more than 20% compared to Q3 of 2012.

Our businesses in all geographic regions had double digit growth in parts booking led by strong performance in our stock-prep product line. Our revenues from products and consumables of $52 million in the third quarter were also up 20% with solid performance in all regions. As many of you know increasing our parts and consumables business has been a focus of ours and I am very pleased with the progress we have made. Before I talk to you about the performance of each of our major markets, I would like to brief you on Carmanah Design and Manufacturing which as I noted earlier we signed an agreement to acquire last Friday for approximately CAD54 million or $52 million. Carmanah is based outside Vancouver, British Colombia. For its fiscal year ended March 31, 2013, Carmanah had sales of CAD29 million and EBITDA of CAD7 million which included CAD1 million of non-recurring expenses. This acquisition is significant that will expand our presence in the forest products industry outside of pulp and paper.

Carmanah’s principal product line is stranding equipment which is used to break down trees into the thin strands of wood that are used in the production of oriented strand board or OSB. For those of you who don’t know OSB is an engineered environmentally friendly product that performs functions similar to plywood but at a lower cost. Carmanah’s equipment and systems are used to de-bark the trees and strand the logs into the – in the OSB manufacturing process which is shown here in the colored photos.

Although Carmanah has different end markets than we do, it is similar to Kadant in many ways. Similar to our products, Carmanah’s products are critical, high impact components that are used in a large process mill which are in Carmanah’s cases an OSB mill. Similar to a paper mill an OSB mill is a significant capital investment with a cost of over $300 million. Customers choose Carmanah’s strands for the same reason they buy our equipment reliability, fiber and energy savings and safety as the strand goes down the entire OSB.

Just as we are impacted by the overall health of the pulp and paper industry, Carmanah is impacted by the overall health of the OSB industry and indirectly the housing market as 70% of OSB is used in new home construction or remodeling. Needless to say the U.S. housing industry was severely impacted by the housing prices as you can see on Slide 12. While the housing market is recovering, it is nowhere in the near pre-crisis levels. We have taken a close look at the housing market and there is reason to be optimistic about the growth in housing over the next several years.

The dotted line on Slide 13 shows the average annual household information from 1980 to 2007 at just under 1.3 million households per year. The bars show the change in occupied housing, what is notable on the chart is not the overbuilding in the years building up to the crisis but the dramatic underbuilding after the crisis. Industry analysts expect it will take several years of growth for new home construction meets current demand never mind pent-up demand for five years along their building. In the end, I would say we can expect more volatility in the OSB market than we have in paper, but it does not have the structural headwinds we see in certain grades of paper. In fact industry analysts expect annual growth of just under 10% per year for the next five years in North America.

Another thing we like about Carmanah which is also similar to us is leading market position it has particularly in the large North American market. Carmanah strands are installed in more than 80% of the OSB mills in North America and 70% globally. We also watch Carmanah’s strong parts and consumables business. As you can appreciate breaking down trees into the thin strands of wood used to produce OSB is extremely abrasive and the equipment suffers a lot of ware. The cutting knives, in particular, need to be replaced once or twice per day, and a ring strander can have up to 44 sets of knives on a machine. On average each rings strander in operation can generate 150,000 to 200,000 parts and consumables per year. As you can imagine this large and stable parts and consumables business was highly attractive to us. Finally and perhaps most importantly Carmanah has a great management team and they are staying on the operative business. They have been together a long time and they have managed to grow the business while increasing profitability over the last several years.

As I mentioned earlier Carmanah is seeing good growth in OSB production and we expect the business will have revenues of $35 million to $40 million in 2014 and adjusted EBITDA margins of 25% to 27% depending on mix. I should point out that Carmanah is a low-asset intensive business with over 70% of its manufacturing outsourced. In general, we like the lowest and intense businesses, but it does mean that we will have significant annual non-cash amortization of intangible assets. In addition we’ll have a number of purchased accounting investment in Q4 and the first part of 2014 which will negatively impact earnings, so the earnings per share accretion from Carmanah in 2014 will likely be in the ballpark of $0.25.

In summary, Carmanah will benefit Kadant by expanding our presence into a faster growing part of the forest products industry and advancing our strategy to increase our parts and consumables business. In addition with over 70% of their manufacturing outsourced, we expect we will have opportunities to manufacture some of their products at our facilities in China.

Getting back to our third quarter performance, I would like to take the next few minutes to provide a brief review of our business activities in each of the major geographic regions in the world let me start with North America. Our revenues in North America were up 5% compared to the third quarter of 2012, the $37 million was down 8% sequentially. Bookings in North America in Q3 of $38 million, up 17% compared to the same period last year and 4% sequentially. Overall, I would characterize the North American market as slow but steady. We see a lot of activity in the market but our customers still have some uncertainty regarding the global economy.

Turning to Europe, the market continues to be weak but it’s showing some signs of improvement. Our Q3 revenues in Europe were relatively strong at $26 million, up 43% over Q3 of last year and 56% sequentially. The strong revenue performance in Europe is driven primarily on the timing of capital sales of our stock-prep product line. Q3 bookings were $19 million, were up over 30% compared to a fairly weak Q3 of last year and 4% sequentially. Our fluid-handling and doctoring cleaning and filtration business took a number our capital orders in Q3 including a driver system we build and a fabric cleaning system with a combined value of approximately $4.4 million. Despite a general weakness in Europe upgrades in paper making equipment are continuing albeit at a modest pace. Germany, the UK and Eastern Europe are stronger while the Western – rest of the Western Europe is somewhat weaker.

Financing continues to be a serious issue in Russia and we have seen several pending orders they have pushed out due to customer difficulties on obtaining financing. Additionally, we reported a booking from our backlog that I have discussed earlier which we had hoped to shift in Q4.

Next, let’s take a look at China. Although the time in China has been a slight increase in Q3 to 7.9% annualized growth, there continues to be an overcapacity situation that creates a drag on investments in new capacity. Even on a relatively strong tissue section sector overcapacity continues to threaten mill profitability and are seeing a shift in customer focus towards machine optimization projects rather than capacity of this. Although we like capacity addition, the new file focused on optimization proved an excellent opportunity for us to demonstrate for our customers how we can help them maximize the performance of other equipment. Our consultative approach has led to significant increase in our aftermarket sales in China, particularly in our stock-prep product line. Our Q3 revenues in China declined 17% from a fairly strong Q3 of last year by increasing 19% sequentially.

Our bookings in China are $14 million were up 12% compared to Q3 of last year. Despite the soft capital activity, we booked several OCC recycling system orders as well as five system upgrades in Q3 with a combined value of more than $5 million. In addition, we booked several orders for our new multi-jet cleaning system with a combined value of just under $1 million. While China is working through its capacity issues and general economic slowdown, we continue to introduce new products to our customers in China. This is creating new products to grow due to our relatively low market share in these newly introduced products, such as our forming equipment and filtration systems.

Turning to South America, in Slide 20, you can see the impact of our CBTI acquisition, which contributed $3 million to bookings and $2 million to revenues in Q3. We have completed the move of our fluid handling business, which is based in Sao Paulo, which is CBTI’s existing facility located near Campinas and integrated the two businesses into a single operating entity that we are calling Kadant South America. Revenues in South America were $8 million in Q3, up 37% compared to the same period last year and up 3% from Q2. Bookings in Q3 more than doubled to $6.9 million although they were down nearly 40% sequentially due to a large stock-prep system that was booked in Q2 of this year. The Brazilian economy has slowed in recent quarters as demand for commodities has declined due to the global slowdown. Recent economic forecast predict Brazil’s annual growth rate in 2013 will be a relatively modest 2.5%. So far the slowdown in the market has not had a significant impact on paper and packaging. Tissue and containerboard demand, for example, is expected to grow at a rate of 46% per year for the next five years.

I’d like to close my remarks with a few comments on our guidance for Q4 in the full year 2013. The third quarter was stronger than we expected and the fourth quarter will be weaker than we thought last quarter due in part to the removal of the Russian project from our fourth quarter forecast I mentioned earlier. That said, we expect to generate $0.47 to $0.49 of GAAP diluted earnings per share on revenues of $86 million to $88 million in the fourth quarter of 2013, including $0.01 of acquisition-related restructuring charges.

From the full year, we expect to achieve GAAP diluted earnings per share of $2.02 to $2.04 on revenues of $336 million to $338 million. I should mention that our guidance does not include any results from the pending acquisition of Carmanah. Although we expect Carmanah to maintain its historical EBITDA margins, the purchase accounting adjustment I mentioned earlier will cause the acquisition to be dilutive in the fourth quarter.

I’ll now pass the call over to Tom for additional details on our financial performance in Q3. Tom?

Thomas O’Brien

Thank you, Jon. I will begin with an overview of our gross margin performance. Consolidated product gross margins were 43.9% in the third quarter of 2013, up slightly 50 basis points from 43.4% in the third quarter of 2012. This increase in gross margins from last year’s third quarter was due to a favorable product mix of approximately 170 basis points offset partly by lower margins in our capital products, especially stock-prep.

Regarding the product mix, our higher margin parts and consumables revenues represented 57% of total revenues in the third quarter of 2013 compared to 50% in the third quarter of 2012. As we expected, gross margins in the third quarter of 2013 were notably lower than the margins recorded in the first half of 2013, in this case largely due to an unfavorable product mix as the third quarter margins include relatively lower margins of several larger system orders shipped in the quarter. Looking ahead and excluding the effect of the Carmanah acquisition, we now expect that full year 2013 consolidated product gross margins will be over 45%, which if achieved will exceed the record 43.9% annual margin in 2012.

Now, let’s turn to Slide 24 in our SG&A expenses. SG&A expenses were $28.6 million in the third quarter of 2013, up $2.4 million or 9% from last year’s third quarter and included an unfavorable foreign currency translation effect of $400,000. Excluding the translation effect, SG&A expenses were up $2 million over last year’s third quarter, including a $3.2 million increase associated with the operating, due diligence and other expenses of acquisitions. SG&A expenses, as a percentage of revenues, were 31.3% in the third quarter of 2013 compared to 30.2% in last year’s quarter. The sequential decline you are seeing on the chart reflects improved operating leverage, the higher revenues and slightly lower expenses in the third quarter of 2013 compared to the second quarter of 2013. Looking forward and again excluding the effect of Carmanah, we expect that SG&A spending as the percentage of revenues for the full year will be approximately 33% to 34% compared to last year’s 31%.

Let me turn to our EPS results for the quarter, Slide 25. We reported GAAP diluted earnings per share from continuing operations of $0.57 in the third quarter of 2013 compared to $0.66 in the third quarter of 2012. This decrease of $0.09 in diluted EPS consists of the following; decreases of $0.10 resulting from a higher effective tax rate in the third quarter of 2013 compared to the third quarter of 2012; $0.07 associated with lower revenues, excluding the revenues of the acquisitions; and $0.02 from the combined effects of the operating results of the acquisitions and acquisition-related expenses. These decreases were partially offset by increases of $0.05 due to lower operating expenses, $0.03 from higher gross margin percentages, $0.01 from lower net interest expense and $0.01 from lower weighted average shares outstanding. Collectively included in all the categories I just mentioned with the favorable foreign exchange translation effect of $0.01 for third quarter of 2013 compared to last year.

Now, let’s turn to our cash flows, working capital and debt leverage starting on Slide 26. Operating cash flows from continuing operations were $12.6 million in the third quarter of 2013 only slightly lower and a very strong performance of $13.2 million in the third quarter of 2012. As we have noted in previous earnings calls, we are having an excellent year in operating cash. For the first nine months of 2013, we have generated $30.7 million in operating cash flows compared to $17.7 million in the same period of last year, an increase of $13 million or 73%. We had several relatively small non-operating uses of the cash during the third quarter of 2013. We spent $1.6 million in CapEx. We repaid debt of $1.5 million. We paid a dividend of $0.125 per share or $1.4 million. And we purchased 25,000 shares of our common stock for $766,000 or approximately $30.63 per share.

Let’s now look at our key working capital metrics on Slide 27. As you can see, we had an excellent performance in our working capital management in the third quarter of 2013. Days and inventory declined from 103 days in the second quarter of 2013 to 92 days in the third quarter of 2013 and DSO declined six days in the same period. There was an unfavorable sequential decline of 10 days in our accounts payable days measure, although this had a relatively minor effect on our overall working capital position.

Looking at that overall working capital position, our cash conversion days calculated by taking days and receivables plus days and inventory and subtracting days in accounts payable were 110 at the end of the third quarter of 2013 down seven days from the second quarter of 2013 and improved three days compared to the third quarter of 2012. Also working capital as a percentage over the last 12 months revenues was 14.4% in the third quarter of 2013, down slightly from 15.1% in the second quarter of 2013 and up slightly from last year’s 13.4%. Impressively, our net cash position increased by $10.2 million in the third quarter of 2013 compared to the second quarter of 2013 and attained its highest level since the first quarter of 2005.

Net cash that is cash less debt, at the end of the third quarter of 2013, was $58.7 million compared to $48.5 million in the second quarter of 2013 and $41.5 million in the third quarter of 2012. Looking forward, our net cash position will decline significantly in the fourth quarter of 2013 of course with the Carmanah transaction, which is expected to close in the fourth quarter of 2013. We currently plan to finance the purchase with approximately $19 million source from our existing cash balances and the remainder from borrowing under our revolving credit facility.

As you can see on Slide 30, our leverage ratio calculated as defined in our credit facility was 0.22 at the end of the third quarter of 2013. Under the credit facility, this ratio must be less than 3.5. With respect to our credit facility in conjunction with the acquisition of Carmanah, we amended the facility on November 1, 2013. The amendment extends the maturity date of the revolving credit facility to November 1, 2018 eliminates the financial covenant limiting our capital expenditures and provides the borrowings in Canadian dollars indexed to the Canadian dollar bankers’ acceptance rate.

That concludes my review of the financials. And I will now turn the call back to the operator for our Q&A session. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Walter Liptak from Global Hunter. Please proceed.

Jon Painter

Hey Walt?

Operator

Mr. Liptak, would you please check your mute feature on our phone?

Walter Liptak – Global Hunter Securities

Hi. Yes, thanks. Good morning guys.

Jon Painter

Hey, Walt.

Thomas O’Brien

Good morning Walt.

Walter Liptak – Global Hunter Securities

Hi good morning. Congratulations on the acquisition and nice quarter. I want to ask first about the booking that was pushed out and just see if we can get a little bit more color on it, was this a new customer, what dates are you getting on the timing of the financing etcetera?

Jon Painter

It’s a customer in Russia who we have run business with before. We booked today with third or fourth – yes, towards the end of 2012. We have got a deposit in, but it’s been long delays in getting the sort of interim payment. And he is having – he was having trouble getting a letter of credit from the banks in Russia. And I was kind of like said in my remarks, this is – we have seen this in a number of – with a number of customers, I mean, in Russia where financing is an issue. So he has got enough skin on the game, he has got other expenditures besides expenditures on us, but I suspect that they will try to find a way to get it done, but we really can’t say for certain when that will happen. So we have to – the thing to do was take it out of our backlog.

Walter Liptak – Global Hunter Securities

Okay. Yes. We have seen this kind of thing before in other parts of the world and talked about it on these calls, but is there anything different about this one, because typically it’s just like a one quarter or two quarter push-out?

Jon Painter

I would say that that you are right. And over the years we have talked about financing in various regions being an issue, but this seems a little more widespread the situation in Russia, I would say. I am not saying it’s permanent or anything like that, but it does seem like it’s more pervasive.

Walter Liptak – Global Hunter Securities

Okay. Does that mean that we may see other orders that come out of Russia that come up with the same problem?

Jon Painter

No, I didn’t say that. I mean, not every customer need financing and so forth, but immediately possible.

Thomas O’Brien

Yes, you said on that well, but I don’t think there are any other orders in the backlog that you are concerned about recycling, Jon is there other orders being delayed for financing or pending orders. We haven’t actually booked. So fairly unusual for us to take an order out of the backlog and I think we did it this time, because of the extended delays associated with this one, but there are no other booked orders in the backlog of any significance that we are aware of that, that are in this situation, but there are some pending orders throughout some other operations, especially in Europe where we do business from Russia that we are awaiting financing. Well, we haven’t actually booked those orders yet.

Jon Painter

We might have a signed contract, but we don’t book it, so we get a deposit and we may have been involved in finance.

Walter Liptak – Global Hunter Securities

Okay, good. And if we can switch over to the Carmanah acquisition and yes, congratulations it’s a very good acquisition. Just want to clarify a couple of things, one, so your 2014 accretion number I think you said it was $0.25, is that right?

Jon Painter

Yes, I would say, Walt, the operating word being in the ballpark. There is a lot of purchase accounting in that kind of thing and valuations. So we really don’t have a good hand on exactly on what it’s going to be, but I did want to give people some kind of a sense. I don’t know if you look into that as well.

Thomas O’Brien

No, I think that’s exactly right. I think we are trying to give a sense of 2014. The EBITDA here is very high. So it implies good cash flows in this acquisition. But the first full year 2014 we will have a lot of a purchase accounting adjustments going through the P&L. Now having said that, in 2015 a lot of that will go away, not all, but we will still have some significant amortization of intangible, but a lot of this will go away. And I think to see all the things being equal, much more accretion in ‘15 than in ‘14 from this acquisition.

Jon Painter

I think that’s a good point about the cash flow. I think it’s going to be a case even for 10 years, where the cash flow is going to be much more impactful even after we flush through the purchase account, because of this intangible amortization, the impact on earnings per share will be less than the cash to cash impact?

Walter Liptak – Global Hunter Securities

Okay. I wonder if I could just ask the steps like you mentioned that gets you out of traditional markets, is there something that we should imply by that, in that, you don’t think there aren’t as many acquisitions in core markets of paper and packaging or you are just being opportunistic here?

Jon Painter

So, kind of Walter as we said in the past, we love doing acquisitions in pulp and paper if we can find the right company, because frankly we have better opportunity for synergies, but in this case that there isn’t a tremendous wealth of companies like us particularly we are going to be saying, hey, we want to have a nice parts business, we wanted to have technology. And as you remember even following us a while we often describe if we were to get outside of pulp and paper what would the acquisition look like. And we would say it would probably be in an adjacent space, I would say, Carmanah fits a very good management, because we know – we don’t know that market very well. Carmanah has excellent management and a nice parts business, something to give it some stability and Carmanah has that for sure. So it really met all the characteristics that we are looking for in a business, in a move outside of our core markets. And I would say a business it’s in the market it’s growing close to 10% is a real plus too.

Walter Liptak – Global Hunter Securities

Yes, okay, great. I will just ask one more and I get back in queue. On Carmanah, are there margin improvement opportunities if you look over the next couple of years? And I wonder if you could talk about the competition in OSB?

Jon Painter

So the principle margin opportunities are really related to – are doing some manufacturing for them in China. And as I said in my remarks, 70% of their – the work that they do is outsourced primarily in the Vancouver area. So I think we are going to take a hard look at whether we can increase their margins or by manufacturing something for them in China.

From a competitive point of view, there is not a lot of players. There is another Germany player that competes with them throughout the globe. Carmanah does extremely well in North America in particular, I would say, the competitor does a little bit better in Europe. And but North American market is much bigger part of the world market. So Carmanah’s market share was probably in the 70% world market share range. The other thing I would say is that one of the things that Carmanah is doing in terms of internationally is a lot of times, a customer particularly abroad or in a developing country, where they will kind of do a – they will work with a supplier of the whole OSB now. So we actually have a marketing business relationship with the largest producer of the press, which is kind of the center of that OSB system. And so they have a preference for using Carmanah standards and vice-versa. So we are hoping that, that relationship was going to bear some good fruit going forward. Well, did that answered your question?

Walter Liptak – Global Hunter Securities

Yes, it does. Thank you.

Jon Painter

Alright.

Operator

(Operator Instructions) And I do see where Mr. Liptak has queued for another follow-up question from Global Hunter. Please proceed.

Walter Liptak – Global Hunter Securities

(Technical Difficulty)

Jon Painter

Hey, Walt, you are going to have to – we are having a little trouble, moved towards the window or something, we can’t hear you.

Walter Liptak – Global Hunter Securities

(Technical Difficulty)

Jon Painter

Walter, I am sorry to say we have no clue what you are talking about, we can’t hear you at all.

Walter Liptak – Global Hunter Securities

(Technical Difficulty)

Jon Painter

Okay. I will take it offline. Alright, well operator any other questions?

Operator

Yes. Your next question comes from the line of Lawrence Stavitski from Sidoti & Company. Please proceed.

Lawrence Stavitski – Sidoti & Company

Hi, good morning guys. Thanks for taking my question. You gave your gross margin guidance for ‘13 as you mentioned is kind of fluctuated a little bit in the last couple of quarters, what do you think are sustainable margins looking past ‘13?

Thomas O’Brien

Well, it’s a very interesting question. Jon and I sometimes think back and forth, but I think this year we once again exceeded what we thought we could do. We thought we will be over 45% as I mentioned, which is quite remarkable. And I think going forward we have to factor into our calculus the fact that we will probably have better parts and consumables percentages in the total of the – of the total revenues, particularly with the Carmanah acquisition with 70% of the business isn’t fierce [ph] and we also added the Noss acquisition, a few months ago. And then they are very heavily dominated series as well. So we are continually exceeding what we thought we could do, I think on the margin side. And I would say – I would say we are somewhere in the 45% range, but frankly where we – the mix of business that we have right now, that will fluctuate quarter-to-quarter, because as you know we will get a large systems order or several of them and they go out at lot lower percentages, still good margin dollars with lower percentages. So it will fluctuate, but we seem to have been settling in, in this 44%, 45% plus range. And I think as you look forward, most of the factors I see would be favorable on that front. And the unfavorable factors would be competitors coming in or owing to that nature.

Lawrence Stavitski – Sidoti & Company

Or big capital orders?

Thomas O’Brien

Or a big capital order, but we seem to be in and around that 45% range. That’s what I would say the sustainable level is at the moment.

Lawrence Stavitski – Sidoti & Company

Okay, great. Thank you. I guess, building on Walt’s question in terms of the Russian project, is that basically the primary – the sole reason for lowering the fourth quarter guidance, EPS guidance?

Jon Painter

No, it’s not it was one of the factors. In every quarter, there are sort of puts and takes, but it was certainly one of largest reasons.

Lawrence Stavitski – Sidoti & Company

Can you amplify on any other reasons or is it means, I guess the question remain the orders fluctuation of orders that you are seeing or is there another component that you could…

Jon Painter

I don’t know if I could – you can put your finger on any specific thing. But forecast change all the time and particularly the timing of where revenues fall between forecasts happens regularly. So I would say, the Russian order is a little unusual in the sense when you expected to ship that entire order more or less in Q4, but you always have a little move and customer wanting to delay this or you didn’t get better order or got something you didn’t expect is quite common.

Lawrence Stavitski – Sidoti & Company

Okay, got you. I guess shifting gears to the Carmanah acquisition, can you actually breakdown, I guess the revenues by geography or I mean, I guess kind of give us a ballpark estimate of North America versus the world?

Jon Painter

Well, I guess what I would say is the North American is by far the bulk of their revenue. OSB is tied to housing made of wood. So Europe is not a big market. They don’t have typically wood houses. From an international point of view going forward, there is a lot of talk about Russia even though we have – this is our financing, but they have a lot of treat and the government has announced some sort of impetus to build new housing made of wood obviously and using OSB. China is another market. Even though they don’t have wood houses, they do, do things like betting, the poor betting for shipping containers things like that. They would have need for panels. And another one of the nice things about OSB kind of unlike plywood is it can actually use the smaller trees. And the other big market which is not a big market for Carmanah for wood housing is Japan and that is primarily a plywood market, not an OSB market. I can’t predict whether that would change over to OSB or not, whereas North America, OSB is probably 70%, 80% of the panel market versus plywood.

Lawrence Stavitski – Sidoti & Company

Okay, got you. Yes, I was kind of doing a little bit reading up on the divide between plywood and OSB, you kind of alluded to some of the other uses for OSB, but I guess what’s the remaining 30% of some of the uses for it outside I guess outside of homebuilding?

Jon Painter

Yes. So it’s homebuilding and then remodeling which is different than homebuilding and not quite as different to have their cycle that their homebuilding has, but other uses are there is actually a – they are doing a very interesting kind of a new project using it for furniture making kind of a very, very thin strand for a major – for a European furniture maker and that would use in furniture, a little place is I would say, industrial uses, things like that.

Lawrence Stavitski – Sidoti & Company

Okay, great. Is there a way to quantify the synergies or I guess what would be the synergies between with the acquisition between you guys?

Jon Painter

Well, we haven’t really quantified it. I would say the synergies as I mentioned that, the biggest one is probably are manufacturing some of the products that they outsourced in China. Another area which is a little softer is much of the future growth of OSB – new OSB mills that’s probably going to be outside of North America, because in North America there is actually quite a number of idle mills just from the pre-crisis there as you know. So you can expect that those mills will start up in the next several years, but they won’t necessarily building new mills, at least until 2017, 2018.

Lawrence Stavitski – Sidoti & Company

Okay.

Jon Painter

Offshore, internationally, well we are not going to have sales from Carmanah as big customers rising like that. We can offer some infrastructure, Carmanah specifically located in North America and we can maybe help them be a little more European or a little more South American or a little more Chinese just really with infrastructure as opposed to sales in (indiscernible).

Lawrence Stavitski – Sidoti & Company

Okay, okay, got you. And I guess the last one, but for you return on the horizon you guys close on or will close on two or three acquisitions in the year looking forward has that – I guess what will be the priorities for capital going forward, any further expectations on the forefront or have you guys kind of called off for a while?

Jon Painter

Our thinking on capital allocation is very much the same. We are always compared with buying, we had a dividend of course and we will compare buying our stock back to doing acquisition and what’s going to benefit the shareholders in the long run. It’s been a fairly active year, if we complete Carmanah it will certainly be a fairly active year for us in acquisitions. I wouldn’t say we are signaling some new big strong push to do more and more acquisitions or anything like that. That said, there is still several in the pipeline and it’s not like we are going (indiscernible) either.

Lawrence Stavitski – Sidoti & Company

Got you, okay. Thanks a lot guys, I appreciate it.

Jon Painter

Thanks a lot.

Operator

There are no remaining questions at this time. Now I would like to turn the call back over to Mr. Jon Painter for final remarks. Please proceed.

Jon Painter

Thanks operator. Let me conclude today’s call with what I think there are three takeaway points. First, we had a solid EPS performance of $0.57 versus our guidance of $0.47 to $0.49. Second, our cash flows remain strong at $13 million in the third quarter and $31 million in the first nine months of 2013 leaving us a net cash position of $59 million at the end of Q3. And finally the addition of Carmanah to the Kadant family once completed is expected to adjust our aftermarket revenues strategy, while getting us into faster growth market. I look forward to updating in next quarter on our progress. Thank you very much.

Operator

This concludes today’s conference. Thank you for your participation. You may now disconnect. So you all have a great day.

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