Michael McKenney - SVP and CFO Jon Painter - President and CEO

Walter Liptak - Seaport Global Securities Rudy Hokanson - Barrington Research Daniel Jacome - Sidoti & Company

Good day, ladies and gentlemen. Welcome to the Kadant Incorporated Q4 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference call is being recorded. I would now like to disperse this conference call over to Michael McKenney. You may begin sir.

Thank you, Kevin. Good afternoon, everyone, and welcome to Kadant’s fourth quarter 2016 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 expectations, plans and prospects are forward-looking statements for 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 Annual Report on Form 10-K for the fiscal year ended January 2nd, 2016 and subsequent filings with the Securities and Exchange Commission. Our Form 10-K is on file with the SEC and is also available in Investor section of our website at www.kadant.com, under the heading SEC Filings. In addition, any forward-looking statements we make during this webcast represent 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 second 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. 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’ll give an overview of our financial results for the quarter and we will then have a Q&A session. Jon?

Thanks, Mike. And thank you for all for joining us this afternoon to review our fourth quarter and full year 2016 results and discuss our business outlook for 2017. The fourth quarter represented a solid finish to a year with record revenue and adjusted EBITDA and provide positive momentum as we move into 2017. Our operating units executed very well leaving better than expected profitability in Q4 and the integration of our PAAL acquisition continues according to plan. A few highlights of the quarter. First, we had strong bookings performance, the third highest in our history. Particularly notable was the recovery in bookings for parts and consumables in North America and strong capital equipment bookings in China. Second, we had excellent operating cash flows and free cash flows. We pay a lot of attention to cash flows since that's the fuel that feeds our growth and both the quarter and the year were great in that regard. And finally, we introduced PAAL balers to the U.S. market and received an order for our first installation. The next slide contains the specifics of our fourth quarter financial results. We're comparing against an exceptionally strong fourth quarter and 2015, which we said at the time is going to make for some difficult comparison this year. Our fourth quarter 2016 revenue came in right in the midpoint of the guidance at $100 million. Gross margin was strong at 46%, thanks to a favorable product mix of 64% parts and consumables. Adjusted EBITDA was $14 million, equating to adjusted EBITDA margin of 14%. Diluted earnings per share was $0.69, comfortably exceeding our guidance, thanks to good execution by our operations and a lower tax rate, which Mike will speak to a little later. Without question, the highlight of the quarter was our bookings of $114 million, which is the third highest in our history. As we noted in our press release, the 50% booking increase compared to 2015 benefited from the reversal of a $60 million booking we had in China last year and our PAAL acquisition, which anniversaries after the first quarter of this year. Without those two impacts, fourth quarter booking still would have been up 11% and if you exclude the impact of the strong dollar, our bookings were up 13%. When you look at booking trends on a sequential basis, fourth quarter bookings were up 20% from Q3 of this year, reversing the software booking levels we experienced in the second and third quarters of 2016. Finally, fourth quarter operating cash flow number stands out at $16 million, 32% higher than last year's fourth quarter. Slide seven provides our full year 2016 results. As was the case with Q4, the full year 2015 was a record year for Kadant in many categories and as a result, we're facing difficult comparison. Despite the high bar of 2015, we did achieve some records in 2016, including revenue which was up 6% to $414 million. We're pleased to see gross margin coming only 70 basis points below last year's record as parts and consumables accounted for 62% of revenue compared to 65% last year. The shift in mix was a result of our PAAL acquisition, whose sales are more capital equipment related. Adjusted EBITDA was also a record at $62 million for the year with an adjusted EBITDA margin of just shy of 15%. We reported $2.88 in diluted earnings per share for 2016, which on an adjusted basis was the equivalent of $3.10 per share. Adjusted return on invested capital was 12.5%, down from the 15% performance we had in 2015. The reduced return reflects the impact of the acquisition of PAAL in mid-2016. As you know acquisitions tend to weigh on ROIC results in the early years. Excluding the impact of PAAL, our adjusted ROIC was 15% after-tax for both 2015 and 2016, which is really excellent. Finally, cash flows from operations for the year were outstanding and $51 million and we ended the year with $7 million of net cash. Free cash flows were another record at $45 million. On slide eight, we show the internal growth of our business, which we define as our performance excluding the impact of acquisitions and foreign currency translation. As I mentioned earlier, both Q4 and the full year 2015 were outstanding and therefore, makes a difficult comparisons. As you can see, internal revenue growth in the fourth quarter was negative16% reflecting the high level of capital equipment shipments in China in Q4 of 2015. Parts and consumables revenue on the other hand was up 5%. Also we’re pleased by the internal growth of bookings were up 37%. Stating the book reversal in China in Q4 of ‘15, the bookings were up 13%. For the full-year 2016, our internal revenue growth was negative 2% for revenue and negative 4% for earnings per share. Bookings were relatively flat and down 5% and excluding booking reversal in Q4 of last year. Our revenue and bookings were parts and consumables were basically flat. As I said in our Investor meeting in December, our objective is to achieve organic growth of 2 to 3% on average over the long-term, as expected we are below the score in 2016, but in 2017 the top end of our guidance assumes organic revenue growth excluding effect of acquisitions of over 3%. Looking at bookings trends on slide nine, you can see the significant sequential on year-on-year pickup we had in the fourth quarter. The major increase came in our stock prep product line were we saw healthy sequential increases in all major geographically regions. China was particularly strong and had one of the best quarters for capital bookings. Also bookings in our wood processing product line were up 30% sequentially. Q4 revenues decline 5% due to weaker bookings in the second and third quarters. For the year, revenue increased 6% and bookings were up just over 7%. On a constant currency basis, this is equivalent to increases of 8 and 10% respectively. Last quarter, we said that we're cautiously optimistic that bookings will turn up in the fourth quarter and we are pleased with the magnitude of the increase. Revenue from parts and consumables increased 4% sequentially in the fourth quarter and bookings were up 6%. The sequential growth in parts and consumables revenue was due strong performance in North America and China. The sequential bookings increase is largely due to a strong rebound in North America which was up 11%. On slide 11, we show our breakdown of our revenue by end market for 2015 and 2016. As you continue -- as you can see we continue to slowly diversify our end and markets, approximately 26% of our 2016 revenue came from non-paper industries which is up 2 percentage points from 2015. Within the paper industry, end market about 63% of our businesses is in growing grade such as packaging and tissue. Only 11% of our revenues related to the trouble printing and writing in the newsprint race which was down 1 percentage points from last year. Looking at North America, this chart tracks revenues and bookings trends over the last five years. As you can see the uptick in Q4 revenue and bookings for our two relatively soft quarters in which economic uncertainty among industrial companies took its toll on for orders for both capital and equipment’s and parts and consumables. Fourth quarter revenue and bookings in North America were still below 2015 level improved sequentially with revenue up 1% and bookings up 5% from the third quarter. More importantly parts and consumables bookings from our operations in North America were up 11% sequentially. Last quarter, I mentioned the opportunity to leverage PAAL's number one market share position in Europe with Kadant presence in North America to enter the North American market for balers. In January of this year, we announced the appointment of Bulk Handling Systems as the exclusive U.S. distributor of our high performance balers to the material recycling facilities in the U.S. and Canada. We also received our first U.S. order for Channel Baler to be installed at a world-class waste recovery facility in Monterey California. This will be a multi-facility one of the nation’s leading operators and will be an excellent reference site for us. BHS is a well-respected global leader in the manufacture of large-scale sorting systems used in recycling facilities, so we’re quite pleased to be partnering with them in this market. Overall, we ended the year with a nice improvement project activity in bookings in North America and a healthy level of project activity has continued into the New Year. In general, we are pretty optimistic about 2017. On slide 13, we show our revenue and booking performance for Europe. Fourth quarter revenue was up 43% year-over-year thanks to PAAL, but declined 7% sequentially primarily reflecting lower capital revenues. Fortunately, bookings in Europe were up 7% sequentially driven by an order for stock prep system for machine conversion project in Spain with investment value of €6 million. Overall, the market in Europe continues to slowly strengthen, Brexit doesn’t see much of an issue with our customers either in the U.K. or in EU. I should note that Russia is emerging as a bright spot with several active projects in the works which is nice to see as that market has been extremely slow over the last several years. Our business in Russia is off to a good start this year. In January, we received an order for €2 million for stock prep system for recycled linerboard mill, in February received a €500,000 order for a dryer section rebuilt project from one of Russia's largest packaging producers. Turning now to Asia. Fourth quarter revenue was down considerably from last year's record quarter bring full-year 2016 revenue from Asia 5% below 2015 levels. Without question one of the highlights of the fourth quarter was a strong booking in China driven by a high level of capital equipment projects. I mentioned on last quarter's call, the market was getting active and [indiscernible] did resulting in strong in Q4. On a sequential basis, fourth quarter bookings in China were up almost threefold due strong capital shipment order all of which are destined for the Chinese market. Overall, the market in China has picked up considerably with linerboard and OCC seeing big price increases in the latter part of 2016. Producers are doing well and the pipeline of projects in the works looks promising for the rest of the year. Finally, a look at the rest of the world, were revenue trended down in the fourth quarter but was up 24% for the full-year primarily due to shipment of a large stock prep system in middle of 2016. This region accounted for about 8% of global 2016 revenue with the largest contributing been South America which remains relatively weak despite the sequential pickup in booking in the fourth quarter. Those economy and improving economy in 2017 for Brazil would be a welcome change in the last few years. A few comments on our guidance. We are pleased by the booking trends we saw in the fourth quarter indicating a good start 2017. We expected record performance for revenue and earnings per share in 2017 with full year revenue in the range of $423 million to $433 million and GAAP diluted earnings per share of $3.13 to $3.23. Once again FX of the headwind versus 2016 reducing revenue by 7 million and earnings per share by $0.10. On constant currency basis, revenue would be up 46% and earnings per share would be up 47%. In the first quarter of 2017, we expect revenue of 97 to $100 million and diluted earnings per share $0.62 to $0.66. This includes an unfavorable effects impact of nearly 1 million on revenue and $0.02 on diluted earnings per share. Before I turn the call over to Michael I want to say a few words about acquisitions which is a key pillar in our growth strategy. We continue to look for acquisitions that meet our criteria and I would say the pipeline is fairly active. That said, we are disciplined in our approach and therefore the timing of finding and acquiring good businesses is difficult to predict. We are in the process of renewing and expanding our credit facility which Mike described, so we will have plenty of dry powder should the right opportunity appear. I would now like to turn the call over to Mike for the financial review. Mike?

Thank you, Jon. I will start with our gross margin performance. Consolidated product gross margin were 46% in the fourth quarter 2016, up 290 basis points compared to 43.1% in the fourth quarter 2015. The increase in gross margins from last year's fourth quarter was principally due to a favorable product mix. Our higher margin parts and consumables revenue presented 64% of total revenue in the fourth quarter of 2016 compared to 54% in the fourth quarter of 2015 which included large capital shipments in China. For the full year 2016, product gross margins of 45.5% were 70 basis points lower than the gross margins achieved 2015. The inclusion of PAAL's results, which has lower gross margins and a lower mix of parts and consumables, lowered our overall margin by approximately 120 points for the year. Excluding PAAL's results, Kadant beat last year's record gross margins of 46.2% by approximately 50 basis points. Looking ahead, we expect that full year 2017 consolidated product gross margins will be approximately equal to or slightly higher than 2016. As is typically the case there is likely to be some variability by quarter due impart product mix as well as the timing and profitability of larger systems. Now, let's turn to slide 20, and our quarterly SG&A expenses. SG&A expenses were $33.7 million in the fourth quarter of 2016, up $3.3 million from the fourth quarter of 2015 and included an increase of $2.9 million from our recent acquisition of PAAL and a favorable foreign currency translation effect of $0.5 million. SG&A expenses as a percentage of revenue was 33.6% in the fourth quarter of 2016 compared to 28.2% in the fourth quarter of 2015, which benefited from a higher revenue level. For the full year 2016, SG&A expenses were $135.8 million, an increase of $12.9 compared to 2015. This increase includes $12.6 million from our PAAL acquisition, both operating SG&A and related acquisition cost. In addition there was a favorable foreign currency translation effect of $2.3 million. Excluding PAAL's SG&A, related acquisition costs and the translation effect, SG&A expenses were up $2.7 million or 2.2% compared to 2015. This increase includes approximately $1 million in increased compliance-related costs as well as one-time costs of $0.7 million related to ERP conversions at certain of our subsidiaries. As a percentage of revenue, SG&A expenses were 32.8% in 2016 compared to 31.5% in 2015, or an increase of 130 basis points. Looking forward, we expect that SG&A spending in 2017 as a percentage of revenue will be approximately 31.5% to 32.5%. I should note that one of our goals is to continue to work on finding ways to better leverage our SG&A going forward. Let me turn to our EPS results for the quarter. In the fourth quarter of 2016, GAAP diluted earnings per share was $0.69 and there were no adjustments to EPS. In the fourth quarter of 2015, GAAP diluted EPS was $0.94 and our adjusted diluted EPS was a record $0.95, the $0.01 difference relates to a restructuring charge. The decrease of $0.26 in adjusted diluted EPS in the fourth quarter of 2016 compared to the fourth quarter of 2015 consists of the following. $0.56 due to a lower -- due to lower revenue and $0.03 due to higher operating cost. These decreases were partially offset by $0.27 due to higher gross margin percentages, $0.04 due to the operating results of PAAL and $0.02 due to lower effective tax rate. Collectively included in all the categories I just mentioned was an unfavorable foreign currency translation effect of $0.04 in the fourth quarter of 2016 compared to last year's quarter due to the strengthening of the U.S. dollar. Let me also take a moment to compare our diluted EPS results in the fourth quarter to the guidance we issued during our November 2016 earnings call. Our GAAP diluted EPS guidance for the fourth quarter of 2016 was $0.57 to $0.63. We reported GAAP diluted earnings per share from continuing operations of $0.69 in the fourth quarter of 2016. This $0.06 increase over the high end of our guidance range was principally the result of better than expected operating results from our stock preparation product line in all regions and our doctoring, cleaning, and filtration and fluid handling product lines in China. In addition, our tax rate was lower than projected due to the geographic distribution of our earnings and a $0.02 benefit derived from the expiration of uncertain tax positions. Now, turning to our EPS results for the full year on slide 23. We reported GAAP diluted earnings per share of $2.88 in 2016 and our adjusted diluted EPS was $3.10. Adjusted diluted EPS excludes acquisition costs of $0.15, a $0.12 charge for the amortization of acquired profit in inventory and backlog, $0.02 gain on the sale of assets and a $0.02 benefit from a discreet tax item. We reported GAAP diluted earnings per share from continuing operations of $3.09 in 2015 and our adjusted diluted EPS was $3.13. Adjusted diluted EPS excludes restructuring costs of $0.03 and a $0.01 charge for the amortization of acquired profit in inventory and backlog. This decrease of $0.03 in adjusted diluted EPS from 2015 to 2016 consist of the following; decreases of $0.49 due to lower revenues, $0.01 due to higher operating expenses, and $0.01 due to higher shares outstanding. These decreases were partially offset by increases of $0.26 due to the operating results of PAAL, $0.11 due to higher gross margin percentages and $0.11 due to a lower effective tax rate. Collectively included in all the categories I just mentioned was an unfavorable foreign currency translation effect of $0.16 in 2016 compared to 2015 due to the strengthening of the U.S. dollars. Now, let's turn to our cash flows and working capital metrics starting on slide 24. Our cash flows and continuing operations were excellent at $16.3 million in the fourth quarter of 2016, up $4 million from $12.3 million in the fourth quarter of 2015. For the full year 2016, operating cash flows were $51 million, an increase of $10.6 million from 2015. As I noted in our third quarter call, we anticipated finishing the year strong. The $51 million in operating cash flow is the second strongest performance in our company's history, surpassed only by $51.1 million in 2014. We had several notable non-operating uses of cash during 2016. We paid $56.6 million for the acquisition of PAAL net of cash acquired, $8 million for dividends, and $5.8 million for capital expenditures. In addition, in 2016, we borrowed $32.6 million, principally related to the PAAL acquisition. There were no share repurchases in 2016. Slide 25 shows our free cash flow for the past eight years. As you can see the strong operating cash flows for 2016 led to a record at $45.2 million in free cash flows. Let's now look at our key working capital metrics on slide 26. Overall, our days in inventory, receivables, and payables have remained fairly consistent from the fourth quarter of 2015 through the fourth quarter of 2016. Looking at our overall working capital position, our cash conversion day's measure calculated by taking days in receivables plus days in inventory and subtracting days in accounts payable was 117 at the end of the fourth quarter of 2016, up three days from the fourth quarter of 2015. Working capital as a percentage of revenue was again excellent at 11% in the fourth quarter of 2016 compared to 11.6% in the third quarter of 2016 and 12% in the fourth quarter of 2015. Strong cash flows from operations in the fourth quarter contributed to a sequential increase in our net cash position. Net cash that is cash less debt at the end of the fourth quarter of 2016 was $7.2 million, up from net debt of $3.3 million in the third quarter 2016. I should note that these numbers now include capital lease obligations assumed in the PAAL acquisition. As you can see on slide 29, our leverage ratio calculated as defined in our credit facility was 0.93 at the end of the fourth quarter of 2016. Under the credit facility, this ratio must be less than 3.5. As Jon mentioned, we are in the process of renewing our credit facility. We anticipate this will be completed in the next couple of weeks. Our current facility is scheduled to expire in November of 2018, we wanted [ph] a new facility prior to being inside one year of the expiration date. In addition the new facility will support our growth plans over the next several years. The new credit facility will be a five-year unsecured multi-currency revolving credit facility, primarily with our existing bank group and is expected be include a committed, aggregate principal amount of $200 million, an increase from the $100 million we have in place today as well as an uncommitted unsecured facility of additional $100 million, up from the $50 million we have today. Before concluding my remarks, I'd like to give you little more caller on EPS guidance that Jon gave for 2017. Looking at our quarterly EPS performance in 2017, we expect that the first quarter will be the weakest quarter the year and the second half of the year will be modestly stronger than the first half. As always, I should caution here, but there could be some choppiness and variability in our quarterly results due to a number of factors including the variability of order flow and the shipment of capital projects. We expect our effective tax rate will be approximately 27% to 28% in 2017 compared to our 2016 tax rate that came in slightly over 27%. The first quarter tax rate may be lower than the remaining quarters as we anticipate receiving a tax benefit from the vesting of equity awards in March. We anticipate CapEx spending in 2017 will be approximately $7 million to $8 million. In addition, we expect depreciation and amortization will be approximately $13.5 million in 2017. That concludes my review of the financials. Now, I'll turn the call back over to Jon before we move to our Q&A session. Jon?

Thanks Mike. Before I turn the call over the operator for questions, I thought I would what I think are the five key takeaways from the quarter and the year. Number one, we have excellent financial and operating performance in 2016 with record revenue and adjusted EBITDA. Number two, we ended the year with strong Q4 bookings. Number three, we maintained high gross margin and expect to maintain these levels in 2017. Number four, we had record free cash flow in 2016. And most importantly, number five, we expect record revenue and earnings per share in 2017. With that I'd like to open the call up to question. Kevin?

[Operator Instructions] Our first question comes from Walter Liptak with Seaport Global.

Hi, good afternoon guys.

Hey Walt. How are you doing?

Good. I want to ask first, great to see the bookings pick up, especially the parts. I wonder if you can talk a little bit about the trend -- anything that might have picked up after the election or how you closed the year. And then we're already now into -- well into the quarter -- into the first quarter, just any trends in January and February on both equipment and consumables?

Sure. Okay. I'm going to talk a little bit regionally. In North America, I would say that the trend picked up probably after the election -- I mean I don't know whether it was election, but certainly the latter part of the fourth quarter continuing onto now, we've seen a pick-up in activity including project activity in North America, which was pretty slow most of 2016. So, I would say definite pickup -- I'd say parts and consumables holding steady kind of that. They will be picked up pretty well in Q4 as we mentioned, but we definitely see some capital activity that we haven't seen certainly in the middle part of 2016. China was kind of booming along, I would say, most of the fourth quarter and that spirit if you will is continuing into 2017 -- fair amount of projects. As I mentioned on the call, pricing in China has really shot up for both recovered paper and liner. The producers, they are making a lot of money. So, there might be some animal spirits I would say in China. In Europe, certainly a pick-up in Russia that had been almost dead for the last couple of years and we have some -- as I mentioned nice capital order in Spain, so I would say Europe also picking up, probably the strongest region right now is Russia. South America not any big particular change, but it's relatively small for us.

Okay, great. Anything in particular about the North American consumables. Can you pinpoint any reason why that ticked-up, is it continuing?

Well, you might remember when in the third quarter call when we were talking about what's puzzling that they were down as much as they were in Q2 and Q3 and I kind of said these things do tend to avert to mean, the drop in Q2 and Q3 was too much. We didn't correspond to production and that kind of stuff. So, I think there's an element of that who knows all the uncertainty running up to the election may be had some pent-up demand that kind of freed up in Q4. But I don't have any reason to think that that North American parts market is in any kind of trouble if you will.

Okay, great. And then you now -- you mentioned China -- yes, you mentioned China continues here in the beginning of the year because of approaching it. Has anything changed with the way their cadent is doing business out there and I guess what I'm thinking about is just any -- as you issue credit and look at different projects, our -- has anything changed in your process?

We tend to ship -- they pay first and then ship. We do have certain customers we issue credit too, but our payment history in China is excellent. And people like Nine Dragon, [Indiscernible] there are some big well-established players that we're comfortable with from a credit perspective.

Okay.

But no, I wouldn’t say meaningful change in our credit policy in China.

Okay, great. And then material costs have been -- have moved out over the last six months. I wonder -- have you instituted price increases for either equipment or consumables for 2017 and expect to recoup the material cost increases?

So, you might remember, Walt, on our pricing for parts, we do it in a different way now. It's much more market-based, I would say much more sophisticated and it is much more real-time. It's not like in January, we have a price increase particularly, it's kind of throughout the year. So, that kind of thing happens I would say automatically. The other area and frankly where there's more steel, which is the principal raw material we deal with is in capital and that is priced into the job at the time that the quotes are made and so forth. So, I guess that's a [Indiscernible].

Longer than I thought.

Okay, good. All right. Thank you.

Our next question comes from Rudy Hokanson with Barrington Research.

Hey Rudy.

Hi Rudy.

Hi Jon, hi Mike. A couple of questions. As you talk about your guidance on gross profit margin and SG&A, are you finding that with PAAL that where you might give up some on the gross margin given the intensity on the capital equipment you're making it up as you expected on the SG&A line?

Yes, that is basically true. So, PAAL has been -- has hurt us a little bit on the gross profit. Their margins incidentally are just what they -- we had planned, what they expected, they are fine. And their SG&A is also basically what they said, but it is helpful to our ratios if you will. Most of the work we have do on SG&A is really on our own house.

Okay. And then you didn't really talk much about OSB, how is that business right now? And especially with what -- not that any of us know where the economy is going in the next 12 months, although there's a lot of speculation. But recent indications are -- and recent forecast for the housing market have been very positive for North America and I was wondering what your assumptions are and your guidance that you are giving for 2017?

Sure. As when I talked about the growth in Q4 bookings which is if you look at the chart for that -- it's pretty -- we had a nice uptick in our bookings in Q4. The OSB or Wood Processing Group is definitely a part of that. They were up 30% sequentially. So, they are steadily increasing I think that if I looked at what our expectations were for the housing market versus what they turned out it's a slower and steadier and based on longer housing recovery which is totally fine with me. So, I think the outlook for housing is still quite excellent in North America going forward. And frankly, they are coming up with more uses and in places like Asia where it’s a relatively new product that the things -- I would say things are pretty bright for our OSB business. And the other part for the people who attended the Investor Day you were introducing a new kind -- it's called integrated scoring knife that has a nice payback the mills and as that thing gets kicked-off we'll -- we expect to see some of revenue and income benefits from that.

Okay. What should we think of -- as you're working on your negotiations, I realized they are not done yet. On your line what you do have factored in for interest expense given your guidance? And how should we look at again acquisitions been important part of growth. I mean your forecast on revenue doesn't assume any acquisitions. Yet at your Investor Day it almost seemed like you had -- and I think you mentioned you had a strong pipeline. These are going to start clicking off, so it's like -- this is an organic forecast from what I see, but I mean the strategy is to be doing acquisitions. How should we look at interest expense and the variability of what interest expense could be as you know that you add acquisitions as you debt. In other words, what's going to be your cost of interest and what you have factored into this organic model?

Okay. So, let me make a couple of comments, I'm going to pass it onto Mike. Absolutely correct Walt that the forecast and the interest expense and everything we're looking at when we're talking about 2017 is organic, no additional acquisitions. That said we are -- we do hope to do acquisitions and over time, those will add up and we hope to borrow money from this line we're putting in place and maybe Mike, you can comment a little bit on how you step up in the -- in some of the expenses you can figure borrowing?

Well, I would say Rudy first on to the organic, I think just we're looking at your -- working on your model may configure net interest cost approximately $800,000-ish for the year, so about $200,000 a quarter. And in terms of the pricing, the pricing grid for this is the same as the current agreement. And if you wanted just factor off the organic Rudy, we have about $27 million euro-base debt. So, it's about €26 million, about $27 million euro-base debt. That's under one and then the remainder is you U.S. based about $34 million and you can factor in the Fed talking about increases of 25 basis points, what that's going to do, but it's not going to move our debt cost much.

Okay. And I think I had -- on in terms of execution with PAAL, the announcement of a sale into North America is a little earlier than you had wanted to indicate before or have people think about, you were talking more about 2018 and integrating operations in some plant in the U.S. But do you have anything to say about how fast North American sales for PAAL could be maybe not what you have built in your model, but maybe what the constraints are as well as what the other opportunities are?

Sure.

And then the second one is just how things work in Europe because in some signs are that strengthening in Europe usually when economy strengthen and you even raised this at the Investor Day that means there's more waste it's got to get bundled?

Exactly, so let me kind of start with North America. You may remember one of the things that we like about the products with PAAL has -- being there was is kind of mission critical if they fail the recycling centers go down so that I would say the case for all of our products more or less and it helps us get the pricing that we get. But so one of the -- one of the questions customers have they want to make sure you can support these mission-critical products and they are course looking to score some sort of manufacturing the faith. By partnering with BHS we really helped ourselves to make they can help us with that number one and there often kind of the EPC for these large systems in effect in Monterey they are the EPC.

Actually, what is EPC?

EPC, equipment, procurement and construct so they are in charge of the entire project that you work.

Okay. Thank you.

So when I was talking back in last year maybe talking about a little bit of a longer timeline I didn't necessarily know we are going to partner with a company like BHS. That was a possibility, but you can't be sure that I would say when you do partner with someone like that it definitely accelerates them.

Thanks.

Now that said if you look going forward the hardest thing together that first reference, frankly no one wants to be first with these things and so I think it's a fabulous reference is that really a one of the leading always facility operators in country, cutting edge also is public so it’s available as a reference. So we couldn't have asked for a better first installation. That said, the second guy often wants to see the first one in place he want to see a running a while so that that there's often a bit of a lag, where you want to see the new facility done. So this thing will be kind of put in place in spring, early summer maybe I don’t know what the timing is the whole facility is up and operational, but it will be sort of late summer and then if someone wants to look at it could take a while. That said we are certainly out there pounding the pavement and talking to people and BHS has been a big help with that, so you may get someone who is comfortable with us without waiting for that reference.

So you don't have anything really built into your forecast right now, correct?

I would say in our forecast for North American revenue, we have really just one facility at this point, yes. So the one we have – we don’t have others. I still think just missionary work in any market is a long slow growth so that it’s typically the way it -- the way it goes. I'm pleased that this went a little faster than that may be I had anticipated, but it typically takes a long time despite the fact that the first ones out there. Your comments about Europe. Yes, as economies pickup in general the people will spend more on nondurable goods those things are in boxes, so the boxes get the recycle and those recycles they are veiled in our equipment more or less. So in general anytime you have a little bit of a pickup in activity it is helpful for both linerboard as well as the balers.

Do you have any particular trends on PAAL in Europe that you can share right now?

I would say it’s basically coming in like we have I mean frankly they were little stronger in the middle part of the year, but they knew that they were quite open about that right from the beginning it just kind of normal been flow of orders, but I would say steady stable those kind of words probably as more describing their business in Europe.

Okay. Thank you. Those are my questions.

Okay. Thanks, Rudy.

Our next question comes from Daniel Jacome from Sidoti & Company.

Hi, how are you?

Hi, Daniel.

Great. Nice job, impressive bookings. Just wanted to stay on the balers in the North American topic, I can’t remembered you guys may have talked about this at Analyst Day, but what exactly is the addressable market and if you can't answer that may be you can reminded us kind of what was the markets share of PAAL was in Europe and then may be the size of the market in North America versus Europe how much bigger or smaller maybe I can sort of…

Sure. PAAL’s market share in Europe for a horizontal baler, they make horizontal and vertical is around 45%.

Great.

Roughly, the market in the U.S. is similar to Europe; let’s call it all in 75 million that kind of ballpark.

,:

Yes, I kind of went through on the Analyst day, one of the characteristics we like in the company and one of them is the policy, we like this where the product has a high impact on big asset like a big piece of process equipment, like a paper machine, like a recycling center an OBS mill. My opinion that makes sticky customers and decent pricing. Now the other things you like of courses is stable earnings, high market share, high percentage of spare parts.

Right now, so your ideal thought would be profit technology with a good mix of aftermarket, right? Is that correct?

Correct. The key I like to see, when I think about aftermarket is it tends to lead to higher margins and more stable revenue.

Yes. Annuity with pricing power make sense. Just wanted to make sure we are still on the--

Yes.

…same page from Analyst Day. And then on the last one on SG&A and I know historically you guys had high SG&A very high gross margin for now, maybe Martin more or all just a little bit we can have some offset as clinical. Reminded as kind of where exactly it's going to come from given what you said about your forecast for internal growth on topline, kind off maybe you could just give us a real flavor of what buckets or how are you going to drive that?

On the SG&A side?

Yes. I don’t know if it's already been asked I apologize if it's asked.

I mean I will say a couple words and then hand it over to Mike. But we are – it's definitely an area of focus for you us. One of the things that we are doing some of our divisions is so-called 8020 program which ITW I think is probably a pioneer and you really look at your business and how you're allocating your resources and making sure you're allocating resources to your best customers and your best products not your last ones. So I'm hopeful that’s going yield some results some of these initiatives frankly that I talked about in the Analyst Day have kind of an upfront SG&A hit that we have expense, but not a lot of revenue. We are getting into new markets like carbon, fiber insight so forth, so of those start to do better job generating revenue that will help our ratios as well. I don’t know Mike if you have something you want to add to that.

I would Jon. Just from our past experience, we can do tuck-in acquisition, it can be very powerful. So, we're getting topline growth, but we're able to leverage our existing infrastructure and the other thing that we’re currently actively working on beside the is 8020. We have some meaningful compliance costs for stocks and COSO and we’re actively working on trying to streamline that take some cost out of it.

No one, really talked about the Trump thing, but the lessening of regulation for a little company like ours will help a lot.

Very helpful.

Yes, he has been pretty busy. See what happens to the business. Just last one now that I remember in China, the pocket of strength we're seeing there. You said that -- is that mostly liner board, is there any other vertical. Are you seeing some strength overall?

The market in China is about 75% liner. Just like the rest of the world, they are printing and writing and newsprint is not very good. And frankly we're not big players. They are doing quite well in tissue, but we're not huge players. They don't do recycled tissue. So, that kind of hurts the stock prep and just the nature of rotary joints tissue [Indiscernible]. So, it's just -- it’s a technical reason that we're not big player on the rotary joint side.

Actually one last one since you talked about capacity, here in North America, do you have any line of sight on back, because everything I've hearing from North America whether its [Indiscernible] or line of border, private label tissue, there's a lot of capacity swing for the upside. I'm just trying to figure kind of tie that in with maybe where you must be selling into, do you have comments on that or just want to keep the data to China?

So, a couple of moving parts I would say. The liner, again, the biggest piece in North America as well. Most producers put about $40 or $50 a ton price increase through in the fall, October timeframe. They are doing partly because OCC prices have been going up and that's partly because the Chinese are driving that prices up. So, I would say a general tightening. There has also been a few facilities -- IP had a prominent one of their facilities in Florida and you got a little bit of supply constraints that would be helpful for pricing as well.

Okay. [Indiscernible] damage it seems like that. It's been a really impact to you guys, too much. When you see that sort of stuff?

What IP says is they're going to make up for that with the rest of their production. So, we largely care about tons produced. It hurts us a little bit because I'm sure we get a spares business out of that, but can be less good now.

No, I was just curious. All right. Well, nice job on the bookings again. I'll talk to you guys. Thank you again.

Okay. All right. Yes, thanks Dan.

Thanks Dan.

[Operator Instructions] Our next question comes from Walter Liptak from Seaport Global.

Hey Walt, back on the call.

Just wanted to ask an easy one. Just capital allocation, I think on the share repurchase, you guys have showed that recently in your thoughts what the balance sheet cash flow and well, how much is left in your share repurchase, how do you feel about that versus acquisitions?

So, we didn’t buy any shares back last year. So, it was all potentially--

$20 million.

$20 million. I kind of said it before that in terms of capital allocation, share buyback compete with acquisitions compete with CapEx and other internal growth opportunities. So, everything kind of competes with everything else. I'm hopeful that we'll -- I'd like to like to spend the money on stuff and in fact I'd like to get a little leverage. But acquisitions are I would say looking promising right now.

Okay. That's great. Thank you.

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host.

Okay. Thank you all for joining us on the call. And I look forward to updating you in future quarters. Thanks very much.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.