Kadant Inc

NYSE:KAI

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Kadant Inc. Fourth Quarter 2018 Earnings Conference Call. At this time all participants in a listen-only mode. Later there will be a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Michael McKenney, Executive Vice President and Chief Financial Officer. Sir, you may begin.

[Michael McKenney, Executive VP & CFO]

Thank you, Shannon. Good morning, everyone, and welcome to Kadant's Fourth Quarter and Full Year 2018 Earnings Call. With me on the call today is Jon Painter, 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 operational results and prospects are forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks and uncertainties that may cause our actual results to differ materially from these forward-looking statements as a result of various important factors, including those outlined at the beginning of our slide presentation and those discussed under the heading, Risk Factors, in our annual report on Form 10-K for the fiscal year ended December 30, 2017, 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 may change.

During this webcast, we'll 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 under the heading Investor News.

With that, I'll 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'll give an overview of our financial results for the quarter and the year, and we will then have a Q&A session. Jon?

[Jonathan Painter, President, CEO]

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 2019.

The fourth quarter was an extraordinary finish to a record-setting year with solid execution and record adjusted diluted earnings per share. We also had record performance for the full year 2018 in bookings, revenue, adjusted EBITDA as well as GAAP and adjusted diluted earnings per share. I'll begin my review with the financial highlights of the quarter.

As you can see on Slide 5, our financial performance in Q4 was extremely strong. Revenue was up 10% to $164 million. Gross margin remained healthy at 43%. Adjusted EBITDA was up 20%, just $32 million or just under 20% of revenue.

GAAP diluted earnings per share was a strong beat at $1.61. On an adjusted basis, EPS was up 46% to a record $1.66. There are several factors contributing to our strong earnings per share performance, which Mike will review in his remarks.

Cash flow from operation was $10 million, leaving us with net debt at the end of the quarter of $130 million and our leverage ratio, as defined in our credit facility, was 1.2.

Of course, this does not include the $180 million of borrowings we made in early Q1 of this year to finance the Syntron acquisition. Including the Syntron acquisition, we expect our leverage ratio under our credit facility to be approximately 2.4%.

Now let me turn to our full year results. Our full year 2018 financial performance exceeded our record setting 2017 performance as a result of excellent execution of our existing businesses, strong contributions from our prior year acquisitions and favorable market conditions.

Bookings were outstanding, up 29% to a record $670 million. Revenue was up 23% to a record $634 million. Gross margin was 44%. Adjusted EBITDA was a record $115 million with adjusted EBITDA margin of 18%, which was also a record.

GAAP diluted earnings per share and adjusted diluted earnings per share were both records at $5.30 and $5.34, respectively. Adjusted return on invested capital for the full year 2018 was 12.1%.

Acquisitions tend to weigh on ROIC results in the early years. Excluding the impact of our acquisitions that were completed in the second half of 2017, our return on invested capital was approximately 17%.

Adjusted return on equity was 16.2% and cash flow from operations for the year was $63 million, while free cash flow was $46 million. Overall, an outstanding year.

As you can see on Slide 7, the strong dollar had a negative impact on our foreign currency translation in the fourth quarter. We had no adjustments for acquisitions in the fourth quarter as all of our 2017 acquisitions occurred prior to Q4.

Our internal revenue growth, which excludes FX and acquisitions, was 13% in the fourth quarter, which is outstanding. Internal growth in bookings was 3%.

For the full year 2018, our internal revenue growth was 10%, which is more than three times our targeted growth rate, and our internal growth in bookings was even better at 12%.

With internal revenue growth of 10% in 2018 and 7% in 2017, we've had two strong years of internal growth. While I don't believe that this level of internal growth is the new normal, I do think on average, we can expect modest internal growth for the coming years.

On Slide 8, you can see our quarterly bookings and revenue trends over the last 5 years. As you can see from the chart, our quarterly bookings started the year extremely strong and returned to more typical levels as the year went on.

Significantly, weaker bookings in Asia and South America were the principal reasons for the sequential decline in Q4. On a year-over-year basis, the weakness in Asia and South America was more than offset by booking gains of 16% and 77%, respectively in Europe and North America.

Our Doctoring, Cleaning, & Filtration product line had the strongest bookings performance, up 23% versus Q4 of last year, followed by our Wood Processing product line, which was up 11%.

Q4 revenue was up 10% compared to the fourth quarter of 2017 with all major product lines up compared to Q4 of last year, led by our Wood Processing product line, which was up 24% to a record $42 million.

Parts & Consumables revenue bookings in the fourth quarter followed a similar pattern as our total revenue and bookings. Both metrics were down slightly compared to the same period last year, but still relatively strong when compared to the prior run rate.

For the full year 2018, Parts & Consumables revenue was up 18% and reached a new record of $374 million and represented 59% of total revenue compared to 61% in 2017. Bookings were also a record at $379 million and up 21% compared to last year.

Before I move on to the regional market reviews, I want to say a few words about our recent acquisition of Syntron, which we completed last month. This business, like other Kadant businesses, has earned a reputation of offering premium products that add high-value to critical production processes.

The company is a leader in its markets with a history of stable earnings and a strong aftermarket business. The integration of Syntron is moving forward as planned and we're pleased to have this company as part of Kadant. Syntron was once part of a public company and the management team is excellent. So we don't anticipate many issues integrating them into Kadant.

2019 is shaping up better than we thought at the time of our last call. We now expect this acquisition will have a modestly positive impact on our 2019 adjusted earnings per share and a more significant positive impact on our free cash flow. Overall, we have high expectations for Syntron and look forward to reporting on our progress during the year.

Incidentally, the Forest Products business of NII, the other large acquisition, which we made in 2017, has completed its first calendar year as part of Kadant. I'm pleased to report that it also has exceeded our expectations with strong internal growth and improved operating margins.

Next I'd like to review our performance in the major geographic regions where we operate. Let me start with North America. Healthy demand for containerboard supported by the relatively large amount of capacity that came online in 2018.

Demand for corrugated packaging and carton board led to packaging mills operating at a 97% average rate in 2018. With packaging making up the largest portion of our revenue in 2018, we benefited from strong demand driven in part by e-commerce shipments and the healthy financial position of our customers.

That said, we've seen some sizes slowing as the year ended with operating rates dropping to 94% for the month of December, due largely to reduced export demand in the fourth quarter.

This combined with announced capacity additions coming online in 2019 and 2020 should lead to a more modest capital booking environment in 2019, although still at a healthy level.

The big question for North American linerboard producers is what role Fibre Star of China will play in absorbing some of the additional capacity that comes online in North America.

On the housing front, U.S. housing starts continue to be under some pressure with affordability being noted by industry analysts as a headwind. More recently, interest rates have come down a bit, which would moderate this headwind.

Our Wood Processing equipment is used by producers of OSB and lumber, and we saw a strong demand in 2018 with record revenues, although we have seen somewhat weaker booking conditions as the year came to close and in early 2019. Despite this, we expect the solid year in revenue and earnings from our Wood Processing product line, due in part to our strong backlog.

As you can see on Slide 11, our revenue in North America in Q4 was up 15% to a record $79 million. All major product lines contributed to this growth with the largest contributors being our Wood Processing Stock-Prep and Fluid-Handling product lines, all of which were up 20% and more compared to the same period last year.

Bookings in North America were $75 million, up 7% compared to Q4 of last year. Increases in bookings for Stock-Prep, Doctoring, Cleaning, & Filtration and Fluid-Handling product lines were partially offset by a reduction in bookings at our Wood Processing equipment. Overall, we believe, North America, particularly with the addition of Syntron will have solid growth in 2019.

Slide 12 shows a revenue and bookings performance in Europe. Europe's economy continued to show strength in Q4 with bookings increasing both year-over-year and sequentially.

However, in some areas like Germany and Italy were weaker, while other areas such as Eastern Europe and Russia were stronger. The Brexit situation is a damper on investment, which is affecting some of our European customers.

Fourth quarter bookings were up 28% sequentially and 16% year-over-year to $49 million. This near-record booking performance was led by our Wood Processing product line, which was up 68% compared to last year.

We booked several large orders for capital equipment for customers in Europe for chemical pulping equipment and our debarking equipment with a combined value of approximately $11 million.

The chemical pulping equipment is used to process virgin fiber at a paper producer in Russia, while the debarkers are used by sawmills in Northern and Central Europe to produce lumber and other wood products.

Revenue in Europe was down 4% compared to Q4 of 2017 at $43 million due to the negative impact of foreign currency translation. Excluding FX, revenue was flat. The market in Asia, which is dominated by China saw a significant reduction in Q4 bookings as capacity additions were slowed and project activity diminished.

While the trade issues between China and the U.S. are being resolved, uncertainty in future demand for packaging as well as fiber shortage due to wastepaper import restrictions have impacted new capacity additions.

The build-out in Southeast Asia has also slowed as there is uncertainty regarding the willingness of these countries to accept the imported waste paper and questions as to how well this semi-finished product will ship to mills in China.

Although, lack of clarity has impacted the more recent investment levels, assuming China goes through with its announced plans to ban all wastepaper imports by 2020 or 2021, it will need to get fiber from somewhere to supply its huge demand for boxes.

This means it will either need to build a lot more mills in Southeast Asia to process imported wastepaper or it will need to import linerboard from North America and Europe.

Our Q4 revenue in Asia was up 26% from last year, primarily due to shipments of large capital orders booked in the second and third quarters of this year -- of 2018. This strong revenue growth was driven by our Wood Processing and Doctoring, Cleaning, & Filtration product lines.

Bookings in Asia saw a decline of 28% compared to Q4 of 2017. We expected this weaker market for pulp and paper related capital projects in China in the second half of 2018.

That said, we are off to a good start in 2019 with 3 large orders for OCC recycling systems for customers in China with a combined value of approximately $9 million, which should lead to a sequential bookings improvement in Asia in Q1.

In addition, there continues to be strong interest in OSB projects in China, which bodes well for our Wood Processing business. During the quarter, we booked a large order from a furniture manufacturer in China for a new strander.

As I had mentioned on previous calls, OSB is a relatively new product in China, and due to its cost advantages, it's well positioned to displace a lot of plywood used in furniture, and crates and subflooring. We're currently seeing healthy project activity for new OSB capacity, which should offset some of the weakness we're seeing in pulp and paper.

2018 was a record year for Asia for bookings and revenues. However, for the reasons I discussed, we do expect weaker market conditions in 2019. Fortunately, we're heading into 2019 with a healthy backlog, and consequently, we expect reasonably good revenue and income in the year ahead.

Finally, a few comments on our rest of the world results. As you can see on Slide 14, our revenues in the rest of the world was down 1% to $11 million. Excluding FX, revenues increased 7% compared to Q4 of 2017.

Likewise, bookings were down sequentially in year-over-year. We continue to see the largest economies in this region, specifically Brazil struggling to gain positive momentum. That said, we do see some green shoots and expect some improvement this year.

During the fourth quarter, we booked several capital orders for drying system equipment from one of the largest packaging producers in South America and another large order to rebuild pulping equipment used in tissue production.

Let me conclude my remarks with a few comments on our guidance for Q1 and the full year 2019. We are encouraged by the relatively healthy economic conditions in North America and Europe and expect business activity to remain reasonably healthy throughout 2019.

OSB project activity is another -- in China is another tailwind that we expect will continue throughout the year. We do see, however, headwinds emerging in China, uncertainty in China-U. S. trade relations, the fiber shortage in China and Chinese overcapacity leaves us to be cautious as we look into 2019.

Another potential headwind is the softening U.S. housing market, which could present fewer opportunities for our Wood Processing segment in North America as OSB and lumber producers potentially delay future investment and capacity additions.

Finally, the stronger U.S. dollar will negatively impact our revenue and earnings by $16 million and $0.21, respectively, in 2019 compared to 2018.

For 2019, we expect to achieve GAAP diluted earnings per share of $4.75 to $4.90 on revenue of $700 million to $710 million. We expect that our adjusted diluted earnings per share, which excludes acquisition-related expenses to be $5.20 to $5.35.

Adjusted EBITDA is expected to be $128 million to $131 million in 2019, and assuming no change in working capital, free cash flow is expected to be approximately $80 million.

Given our high level of non-cash amortization of intangibles associated with our recent acquisitions, I believe, that adjusted EBITDA and free cash flow are important metrics to use in valuing Kadant.

For the first quarter of 2019, we expect to achieve GAAP diluted earnings per share of $0.77 to $0.83 and revenues of $1.60 to $1.65. On an adjusted basis, we expect diluted earnings per share of $1.11 to $1.17.

Before I pass the call over to Mike, I want to remind you about our upcoming Investor Day taking place at 2:00 p.m. on March 7 at the Grand Hyatt, New York. We plan to discuss our strategy and expectations for the next 5 years at that event.

I'll now pass the call over to Mike for additional details on our financial performance. Mike?

[Michael McKenney, Executive VP & CFO]

Thank you, Jon. I'll start with our gross margin performance. Consolidated product gross margins were 43.3% both the fourth quarter of 2018 and 2017. The consolidated gross margin in the fourth quarter of 2017 were negatively affected by the amortization of acquired profit in inventory related to acquisitions, which lowered consolidated gross margins by 120 basis points.

Adjusting for this amortization, our gross margins were 44.5% in the fourth quarter of 2017. Comparing the fourth quarter of 2018 to the adjusted fourth quarter of 2017, gross margins were down 120 basis points.

This decrease was primarily due to lower overall percentage of Parts & Consumables revenue, which represented 55% of total revenue in the fourth quarter of 2018 compared to 62% in the fourth quarter of 2017.

For the full year 2018, product gross margins were 43.9% compared to 44.9% in 2017. Excluding the amortization of profit in inventory in 2017, gross margins were 45.9%.

The 200-basis-point decrease from 2017 to 2018 is due to the inclusion of a full year from the businesses acquired in 2017 and the 2018 mix being more heavily weighted to capital.

Looking ahead, we expect that full year 2019 consolidated product gross margins will be approximately 41.5% to 42.5%. The 190-basis-point decrease from 2018 compared to the middle of the guidance range is due to Syntron having a lower gross margin profile than Kadant and 60 basis points due to the estimated amortization of acquired profit in inventory related to the Syntron acquisition. In the first quarter of 2019, we expect approximately 175-basis-point reduction in gross margins due to the estimated amortization of acquired profit in inventory.

Now let's turn to Slide 19 and our quarterly SG&A expenses. SG&A expenses were $43.6 million in the fourth quarter of 2018, down $0.2 million from the fourth quarter of 2017. We incurred $1.3 million of acquisition costs in the fourth quarter of 2018 compared to $0.9 million of acquisition-related cost in the fourth quarter of 2017.

In addition, there was a favorable foreign currency translation effect of $1.2 million. SG&A expense as a percentage of revenue was 26.6% in the fourth quarter of 2018 compared to 29.4% in the fourth quarter of 2017.

For the full year 2018, SG&A expenses were $177.4 million, an increase of $17.7 million compared to 2017, including $14.1 million in SG&A from our acquisitions. We incurred approximately $0.3 million and $1.4 million of acquired backlog amortization in 2018 and 2017, respectively.

We also incurred acquisition costs of $1.3 million and $5.4 million in 2018 and 2017, respectively. In addition, there was an unfavorable foreign currency translation effect of $1.2 million.

Excluding SG&A from our acquisitions, related acquisition costs and the impact of translation, SG&A expenses were up $7.6 million or 4.9% compared to 2017. As a percentage of revenue, SG&A expenses were 28% in 2018 compared to 31% in 2017 or a decrease of 300 basis points.

Excluding acquisition revenue and SG&A and acquisition-related costs, SG&A as a percentage of revenue was 28.4% in 2018 compared to 29.7% in 2017, down 130 basis points.

The improvement in our SG&A leverage is principally because our 2017 acquisitions have lower SG&A expenses as a percentage of revenue and Kadant as a whole, and the additional revenue helps leverage our corporate SG&A expenses. Looking forward, we expect that SG&A spending in 2019 as a percentage of revenue will be approximately 26.5% to 27.5%.

Let me turn to our EPS results for the quarter. In the fourth quarter 2018, GAAP diluted earnings per share was $1.61 and adjusted diluted EPS was $1.66. The $0.05 difference relates to a $0.14 benefit from discrete tax items offset by $0.10 of acquisition costs associated with our recent acquisition and a curtailment loss of $0.09.

In the fourth quarter of 2017, GAAP diluted earnings per share was $0.07 and adjusted diluted EPS was $1.14. The $1.07 difference relates to $0.90 of discrete tax items associated with the U.S. Tax Law enacted in December of 2017, $0.17 of acquisition-related costs and a $0.01 restructuring charge.

The increase of $0.52 in adjusted diluted EPS in the fourth quarter of 2018 compared to the fourth quarter of 2017 consists of the following: $0.39 due to higher revenue, $0.23 from a lower recurring tax rate and $0.04 due to lower operating expenses.

These increases were partially offset by $0.12 due to lower gross margin percentages and $0.02 related to higher interest expense. Collectively, included in all the categories I just mentioned was an unfavorable foreign currency translation effect of $0.07 in the fourth quarter of 2018 compared to last year's fourth quarter due to the strengthening of the U.S. dollar.

Let me take a moment to compare our adjusted diluted EPS results in the fourth quarter to the guidance we issued during our October 2018 earnings call. Our adjusted diluted EPS guidance for the fourth quarter of 2018 was $1.33 to $1.38, which excluded a curtailment loss of $0.09.

We reported adjusted diluted EPS of $1.66, which excluded the curtailment loss of $0.09 as projected. Our reported adjusted diluted EPS also excludes $0.10 of acquisition costs related to the Syntron transaction, which closed during the first week of 2019 and a discrete tax benefit of $0.14 related to the true up of the provisional amount recorded in the fourth quarter of 2017 due to the U.S. Tax Reform Act.

The $0.28 increase over the high-end of the guidance range was principally the result of a lower tax rate. Several items impacted our tax rate in the quarter, the most significant was additional guidance and clarification issued during the quarter related to the rules around how the new U.S. law taxes foreign earnings.

You may recall, I had mentioned this issue on calls during 2018. The flaw in the original methodology issued has now been corrected as we had hoped. We are particularly pleased about this clarification because it will favorably impact our tax rate going forward as well.

In addition, we had a favorable adjustment to provisions related to uncertain tax provisions. We also had better-than-expected revenue performance, principally due to our Wood Processing product line that contributed to the guidance speed.

Now turning to our EPS results for the full year on Slide 22. We reported GAAP diluted earnings per share of $5.30 in 2018 and our adjusted diluted EPS was $5.34.

Adjusted diluted EPS excludes a $0.29 benefit from discrete tax items, an $0.11 restructuring charge, $0.10 from acquisition costs, $0.09 from a curtailment loss and $0.02 of amortization expense associated with acquired backlog.

We reported GAAP diluted earnings per share of $2.75 in 2017 and our adjusted diluted EPS was $4.49. Adjusted diluted EPS excludes $0.90 of expense from discrete tax items, a $0.43 charge for the amortization of acquired profit in inventory and backlog, acquisition cost of $0.39 and $0.01 of restructuring cost.

The increase of $0.85 in adjusted diluted EPS from 2017 to 2018 consists of the following: $1.59 due to higher revenues and $0.53 from the operating results of our acquisitions.

These increases were partially offset by a decrease of $0.56 due to higher operating expenses, $0.40 due to lower gross margin percentages, $0.24 due to higher interest expense, $0.04 due to higher weighted average shares outstanding and $0.03 due to a higher recurring tax rate.

Collectively, included in all the categories I just mentioned, was an unfavorable foreign currency translation effect of $0.02 in 2018 compared to 2017.

Slide 23 presents our quarterly adjusted EBITDA performance over the last 5 years. Quarterly adjusted EBITDA was $32 million or 19.5% of revenue in the fourth quarter of 2018 compared to $26.7 million or 17.9% of revenue in the fourth quarter 2017.

As you can see on Slide 24, our adjusted EBITDA for 2018 was a record $115.2 million, up $23.5 million or 26% from 2017 and was 18.2% of revenue compared to 17.8% in 2017. Looking forward, we expect adjusted EBITDA in 2019 of $128 million to $131 million or approximately 18.3% to 18.5% of revenue.

Now let's turn to our cash flows and working capital metrics, starting on Slide 25. Cash flows from continuing operations were $10.4 million in the fourth quarter of 2018 compared to $32.8 million in the fourth quarter of 2017.

There was a negative impact of approximately $20 million on cash flows in the fourth quarter of 2018 associated with changes in working capital. We had an $8.8 million decrease in customer deposits in the fourth quarter of 2018 due to the shipment of several large capital projects.

We had a $7.4 million increase in unbilled revenues, which will be collected in fiscal 2019 and a $5.8 million decrease in advanced billings associated with revenue recognized in the fourth quarter 2018 and an over time basis, formerly referred to as percentage of completion.

For the full year 2018, operating cash flows were $63 million compared to a record $65.2 million in 2017. There was a negative impact of approximately $30 million on cash flows related to changes in working capital for the full year of 2018.

Our strong bookings performance in the first half of 2018 resulted in a large number of capital projects either in progress or completed and shipped in the latter half of the year.

This led to an increase in accounts receivable and unbilled revenues of $18.4 million, which will be collected in fiscal 2019. In addition, inventory increased $7 million. We had several notable non-operating uses of cash during 2018.

We paid down debt by $59.6 million. We paid $16.6 million for capital expenditures, including $6.4 million for our manufacturing facility in Ohio and paid $9.6 million for dividends. In addition, we paid $3.9 million for taxes related to vesting of equity awards.

Slide 26 shows our free cash flow for the past 8 years. Free cash flows for 2018 were $46.4 million. Looking forward, with the decrease in capital expenditures projected now the facility project has been completed and assuming working capital requirements are neutral, we anticipate free cash flows in 2019 will be approximately $80 million.

Again, this assumes working capital requirements are neutral. I would note that our first quarter free cash flows have historically been the weakest quarter of the year, due in part to the payment of management incentives.

Let's now look at our key working capital metrics on Slide 27. Overall, our days in receivables and payables have remained fairly consistent from the fourth quarter of '17 through the fourth quarter of '18. We have seen a nice improvement in days in inventory, which is now at 86 days, down from 93 days at year-end 2017.

Looking at our overall working capital position, our cash conversion measure calculated as taking days in receivables plus days in inventory and subtracting days in accounts payable was 110 at the end of the fourth quarter of 2018, essentially the same as the fourth quarter of '17. Working capital as a percentage of revenue was 12.5% in the fourth quarter of 2018 compared to 11.2% in the fourth quarter of 2017.

Net debt, that is debt less cash at the end of 2018, decreased $35.5 million to $129.7 million from $165.2 million at the end of 2017. Our interest expense increased to $7 million in 2018 compared to $3.5 million in 2017 due to the additional debt incurred to finance the NII and Unaflex acquisitions in the third quarter of 2017. We forecast our net interest expense for 2019 to be approximately $15 million to $15.5 million with forecasted average interest rates of approximately 4.5%.

As you can see on Slide 30, our leverage ratio calculated as defined in our credit facility was 1.19 at the end of the fourth quarter of 2018, down from 1.37 in the third quarter of 2018 as we continue to make good progress on paying down debt. Under our amended credit facility, this ratio must be less than 3.75.

With the new debt we raised to acquire Syntron at the beginning of 2019, we anticipate that our leverage ratio will increase to approximately 2.4 as defined in our credit facility to start 2019. As mentioned earlier, we anticipate free cash flows will improve in 2019 and we'll continue our strategy of paying down debt as we progress through 2019.

Before concluding my remarks, I'd like to give you a little more color on the EPS guidance that Jon gave for 2019. Looking at our quarterly EPS performance in 2019, we expect that the first quarter will be the weakest quarter of the year and the second half of the year will be stronger than the first half as a result.

Our adjusted diluted EPS guidance for the first quarter of $1.11 to $1.17 excludes $0.27 related to the amortization of profit in inventory and acquired backlog and $0.07 of acquisition costs.

Our adjusted diluted EPS of $5.20 to $5.35 for the year excludes $0.38 of adjustments related to the amortization of profit in inventory and acquired backlog and $0.07 of acquisition costs.

The 2019 guidance includes an unfavorable foreign currency translation impact of approximately $16 million on revenue and $0.21 on adjusted diluted EPS due to the strengthening of the U.S. dollar. I should caution here, there could be some choppiness in variability in our quarterly results due to a number of factors, including the variability of order flow and capital shipments.

During the fourth quarter, we took a charge related to freezing and terminating a defined benefit pension plan and a supplemental benefit plan at one of our U.S. operations. These plans have cost on average of approximately $1.6 million or $0.10 per diluted share annually over the last several years.

We anticipate that the final settlement related to terminating these plans will occur during late 2019 or early 2020, and we currently have not included any impact in our guidance as the timing and amount of the final settlement have not been determined.

The guidance includes our acquisition of Syntron completed at the beginning of fiscal 2019. Aside from the impact of intangible amortization, there was 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.

Both 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 this acquisition.

We expect our recurring tax rate, which excludes discrete tax expense, will be approximately 29% to 30% in 2019 compared to our recurring tax rate of 27.3% in 2018. The rate increase is due to several factors.

An estimated lower benefit from the vesting of equity awards, an increase in state income taxes and an increase in non-deductible compensation expense related to the 2017 tax law changes in the U.S. Our recurring tax rate in the first quarter of 2018 maybe lower than the remaining quarters as we anticipate receiving a tax benefit from the vesting of equity awards.

We anticipate CapEx spending in 2019 will be approximately $12 million to $14 million or 1.7% to 2% of revenue. In addition, we expect depreciation and amortization will be approximately $29 million to $30 million in 2019, which includes $1.2 million associated with the amortization of acquired backlog.

That concludes my review of the financials. And I will now turn the call back over to John for a few comments, and after that, we will have our Q&A session. Jon?

[Jonathan Painter, President, CEO]

Thanks, Mike. Before I turn the call over for questions, I just want to make a few remarks about the other press release we issued yesterday regarding my upcoming retirement and the appointment of Jeff Powell as my successor.

I'm delighted that the Board has selected Jeff as the new CEO. Jeff and I have known each other for over 30 years and worked together at Kadant for over 10. Jeff's run Material Processing group, which is about 60% of our business and includes our Stock-Preparation and Wood Processing product lines.

Under Jeff's leadership, the Material Processing group has grown four-fold through a combination of strong internal growth and acquisitions, while improving operating margins.

In addition, Jeff has led our largest and most successful acquisitions, including Carmanah in 2013, PAAL in 2016, the Forest Products business of NII in 2017 and Syntron in 2019.

Jeff and I think very much the same about what makes a good acquisition, what it should cost and how it should be integrated into Kadant. I feel Kadant is as strong and stable as it's ever been and well positioned to prosper in the coming years under Jeff's leadership.

Let me now open the call up to the operator for questions. Operator?

[Operator]

Thank you. [Operator Instructions] Our first question comes from Chris Howe with Barrington Research. Your line is open.

[Chris Howe, Barrington Research]

Good morning, everyone.

[Jonathan Painter, President, CEO]

Hey, Chris.

A - Michael McKenney

Morning, Chris.

[Chris Howe, Barrington Research]

Hey, good morning. I have a few questions here just to start off. The first in regard to Syntron, can you give us some more granular detail into their performance in 2018 and what your expectations are for its performance in 2019 within your guidance?

[Jonathan Painter, President, CEO]

So what - you might recall that on the last call, we said they did $89 million and a little under $19 million of EBITDA for the 12 months ended October. Like a lot of acquisitions that we do relative to us, they have lower gross margins, I would say kind of in the sort of lower 30s, but better SG&A leverage, and hence they have EBITDA margins in the 20%, 21% range versus us - we're aspiring to the 20% range.

Their CapEx is similar to us. It's an asset-light business. I think you can expect CapEx in the $1.5 million to $2 million range, good cash flow characteristics. And of course, they have this - probably because they're 100% U.S. based and probably because of the structure, they have really terrific tax attributes, if you will, their tax rate.

[Michael McKenney, Executive VP & CFO]

Essentially, cash taxes will likely be zero in the short term.

[Jonathan Painter, President, CEO]

So that's - we're not - how's that?

[Chris Howe, Barrington Research]

Next question, it was mentioned on the last call about Nine Dragons and their plan within the U.S. in regard to linerboard. Any update to their strategic plans for linerboard that will go to China or it's still wait and see basis?

[Jonathan Painter, President, CEO]

We haven't heard - no change has been announced for what they're doing. They're still moving forward. I haven't heard anything about whether they're going to make pulp and ship it to China or make linerboard. It probably makes more sense to make linerboard, would be my guess. But I don't - there's really nothing to update on that.

[Chris Howe, Barrington Research]

Okay. And then my last question is just a follow-up to your comments on Jeff Powell, who will be the new CEO. You mentioned, he comes from Material Processing with a good background in acquisitions. Who will be running Material Processing once Jeff assumes his new role?

[Jonathan Painter, President, CEO]

So we have - and actually it's one of the things I'm most proud about Kadant. There are two - the person who is running the U.S. Stock-Preparation business, our Black Clawson subsidiary is taking over the Stock-Preparation aspect of this business. And Michael Colwell, who was running our strander business, our OSB business, is taking over the Woodside of his business. So we're essentially – two people are taking over his job, well, only one is taking over mine.

But anyway, yes, so we have all internal people and they were the presidents of their operations. They have kind of long tenure running the larger operations within their sector and people are stepping up sort of behind them. So it's good to do it internally. I think it speaks well of our -- of the depth of our group.

[Chris Howe, Barrington Research]

That’s all I have for now. I’ll hop in the queue and thanks for your comments.

[Jonathan Painter, President, CEO]

Okay. Thank you, Chris.

[Operator]

Thank you. Our next question comes from Dan Jacome with Sidoti. Your line is open.

[Dan Jacome, Sidoti]

Good morning.

[Jonathan Painter, President, CEO]

Hey, Dan.

[Michael McKenney, Executive VP & CFO]

Good morning, Dan.

[Dan Jacome, Sidoti]

First congrats, Jon, Jeff, on the announced transition. Excited to see how that unfolds the next couple of years. Just wanted to learn a little bit more about Syntron assets. They look - it looks like third of the revenue is coming from the mining minerals industry. And I wanted to see if you can give us a little bit more color on some of their end markets, how much is going to the coal, copper and potash market?

Seeing - and just wondering if you've seen any industry-wide maybe projects on the copper side, the potash projects, that could potentially help the company? I'm only asking because like it's mostly U.S.-based revenue, and then for example, with the potash markets, I think, a lot of the production is outside of the U.S. I'm just wondering a little bit about that? That was my first question.

[Jonathan Painter, President, CEO]

Sure. One of the things - a good question, Dan. One of the things, I would say, we like about Syntron is they have a pretty diverse end market mix. So you can - even a descent hump, let's say a third is mining related, there's a big difference in the end markets whether you're mining copper, potash or met coal. So they all have kind of, I would say, different drivers.

Something around 15% of their business is in the aggregates. And that is - there is a fair degree of optimism. They're actually having a showdown at Atlanta right now, and people are pretty optimistic. One, about a potential infrastructure build, but also states are also moving forward on infrastructure type projects. So that's, I would say, fairly positive.

The mining as a generalization, it's had a couple of years of strong growth. People are expecting it to be pretty much flattish in 2019 as far as production, but we actually think in terms of investment in the minds, we're going to have some good years going forward, primarily because they are under invested in that - in those facilities for a number of years and you sort of expect to catch up.

The other side of their business, the - what I call the Syntron, the vibratory feeder side, that there's a light industry part of that, which is involved in things like food packaging, that kind of stuff, quite healthy, good - all these are, I would say, stable growth areas.

[Dan Jacome, Sidoti]

Okay. But the aggregate part is definitely interesting - is that - how does that work?

[Jonathan Painter, President, CEO]

I would put the aggregates as probably that the 1 - in the short term, I would say, we're most optimistic about and food is also right up there, food and packaging, generally.

[Dan Jacome, Sidoti]

Okay. How do the aggregates exposure work exactly? Do they have - is there like linked belt conveying some sort of ready mix concrete or something like that? I'm not an expert in that...

[Jonathan Painter, President, CEO]

No. It's just big sand and gravel pit, for example. They got to move the sand and gravel out from the ground back to local facilities.

[Dan Jacome, Sidoti]

Okay. And another question maybe - you called out the internal growth going forward would be modest and maybe I'd be lucky enough to get a little bit more color on that, how do you define modest - would it be modestly closer to mid-singles or can - look, I know on a couple of calls ago, you said 10% was unreasonable, but then looking at your underlying business, strong in so many aspects, 3% is too conservative. So I'm just seeing where you guys sit on that?

[Jonathan Painter, President, CEO]

Well, we - on our last Investor Call in 2016, we kind of said, we expected internal growth of 2% to 3%. And with the benefit of hindsight, that certainly has proved conservative.

That said, I think the 2017 and 2018 were extraordinarily strong years, and I don't expect to have that level of internal growth; whether something along the lines of global growth, which people are putting in 2% to 3% range, I think, it's probably a reasonable number.

We're going to put in our Investor Meeting that we're going to have on March 7, we will give another look at what's coming up in 5 years and give you -- in fact, Jeff will give you his 5 year thoughts about internal growth and acquisition growth going forward.

[Dan Jacome, Sidoti]

Okay, terrific. I’ll see you there.

[Jonathan Painter, President, CEO]

That’s great.

[Operator]

Thank you. [Operator Instructions] Our next question comes from Walter Liptak with Seaport Global. Your line is open.

[Walter Liptak, Seaport Global]

Hi, thanks. Good morning, guys.

[Jonathan Painter, President, CEO]

Hey, Walt.

[Michael McKenney, Executive VP & CFO]

Good morning, Walt.

[Walter Liptak, Seaport Global]

Morning. So I wanted to ask, I think you guys gave an EBITDA range of $128 million to $131 million, is that right compared to $115 million?

[Michael McKenney, Executive VP & CFO]

Yes.

[Walter Liptak, Seaport Global]

Okay. And the Syntron deal looks like it will add $15 million or $16 million in EBITDA. I wonder if you could help us with the math on organic core growth to EBITDA versus acquisition growth?

[Michael McKenney, Executive VP & CFO]

Well, Walt, are you talking the margin -- the margin growth?

[Walter Liptak, Seaport Global]

No, just in dollars. I mean, to get to the $128 million to $131 million, that's $15 million, $16 million of EBITDA. And it looks like from M&A alone, that will get you there. So I'm wonder what you're thinking about for EBITDA growth for the core business?

[Jonathan Painter, President, CEO]

We are losing some EBITDA in China for sure. So that's a drag on EBITDA. I think it speaks a little bit of the resilience of the company that other regions kind of offset that. But I would say, EBITDA out of China, we have lower, definitely lower expectations for 2018, I mean, 2019. So that factors in there as well.

[Walter Liptak, Seaport Global]

Okay. Kind of along those lines, last year, I think, we are looking for China to slowdown, which again, but then there was a step up, I think, in the second quarter with some orders coming in.

I wonder how concerned should we be about China for this year? And is there a chance that this is just lumpiness that typically happens and that we could ever repeat in 2019 with orders coming in later in the year?

[Jonathan Painter, President, CEO]

So that's a great question, which I can muse on, but I don't think we have a crystal ball on that. But we've been saying for a while now, going on two years, that we expected on the pulp and paper capital side that the second half of '18 would be slower because - just because of the capacity that they're adding and generally the economy there is slowing for sure.

You're absolutely right, Walt, that the orders in Southeast Asia in response to this wastepaper thing offset that, and also the OSB activity was new. As I look forward into 2019, I guess, I have two comments. One is, if you looked at that chart on Asia, it looked like we obviously had a pretty significant drop in bookings in Q4, and my comments about getting $9 million of orders in Q1, I think, should make it seem less dramatic than that chart might have set. I think that frankly, we expect again a little higher bookings in Q4 that I think, some of that slipped into Q1. I'll say that's number one.

Number two, I do think we will get some -- have some OSB activity in '19 for sure. And number three, which is the one that's a total wildcard is what is going to happen with this wastepaper situation. They're either - if they go through at then, they're going to have to either build a lot of sort of the smaller mills in China to process that wastepaper - and around China to process that wastepaper or it would have another positive for us in the sense that there will be more demand for exports coming out of the U.S. primarily, but also Europe.

So that - I would say that's a $64-question. It's - that burst of activity that we saw in building mills around China, I would say, has paused a little bit. And it doesn't mean that won't restart, I would say, we don't know.

[Walter Liptak, Seaport Global]

Okay. Is China is getting any linerboard shortages or they're pretty much in balance?

[Jonathan Painter, President, CEO]

They are, I think, right now importing linerboard. Certainly, I would say that the bigger mills tend to be getting the permits for wastepaper. So that's a little bit favoring our people. But they're also taking downtime for fiber shortages and just, I would say, slowing demand as the economy is slowing a bit for sure.

And then the other question, of course, on that is that what - if trade relations normalize with the U.S., what impact will that have on their general economy and sort of consumer demand, those kind of questions. So it's a bit of a - there was some uncertainty regarding it, but one way or another, I think, they're going to get -- they're going to make those boxes.

[Walter Liptak, Seaport Global]

Okay. What about the pension. It sounds like with the settlement in the fourth quarter, there's going to be some kind of an impact. Is it an income statement impact or is this a cash impact that we're talking about?

[Michael McKenney, Executive VP & CFO]

Both, it will be both, Walt. The timing is a little uncertain. And so just to be clear on the technical, this settlement is what's going to come. We froze and terminated the plan. The settlement is going to happen later in 2019.

So there maybe a cash impact, $0.5 million to $1.5 million. It's possible, there will be no cash impact. We're still working through that. But there will be some cleanup on the bookkeeping side, that will be non-cash.

[Walter Liptak, Seaport Global]

Okay. Great. Okay. And then the last one for me. Just congratulations on the change in CEO succession planning. I just want to make sure that as we're - in your comments, you were talking about kind of strategically that you guys think the same around M&A.

I just want to ask the question, is there any strategic changes to the company, whether on an operational bases or M&A or the way you're approaching the business with this change in the CEO role?

[Jonathan Painter, President, CEO]

So Jeff and I have worked together a long time, including at Thermo Electron. I do not expect that on acquisition since we've been - we've done a bunch together, our thinking is quite similar.

So don't expect much. He is frankly better operating guy than I am. So I would expect to see some - probably the only good things in terms of getting more profit out of the revenue that we got.

[Walter Liptak, Seaport Global]

Okay, great. All right. Thank you.

[Operator]

Thank you. [Operator Instructions] And I'm currently showing no further questions at this time. I'd like to turn the call back over to Jonathan Painter for closing remarks.

[Jonathan Painter, President, CEO]

Okay. Thanks, Shannon. Before I let you go this morning, let me summarize what I think are the key takeaways from the quarter and the year.

Number one, we are in excellent financial and operating performance in 2018 with record revenues, bookings, adjusted EBITDA and GAAP and adjusted diluted earnings per share.

Number two, although we do see weaker conditions in China and FX headwinds, we do expect a strong 2019 with record revenue and adjusted EBITDA. And finally, please join us for our Investor Day at the Grand Hyatt in New York on March 7. The event will be a good opportunity to meet Jeff and hear his thoughts about our goals for the next 5 years. You can RSVP for the event by contacting Joanne at the e-mail address shown on the slide.

Thanks for joining us on the call today. I look forward to updating you next quarter.

[Michael McKenney, Executive VP & CFO]

Thanks very much. Bye.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.