Michael McKenney – Executive Vice President and Chief Financial Officer Jon Painter – President and Chief Executive Officer

Walter Liptak – Seaport Global Chris Howe – Barrington Research Bill Hyler – WDH Capital Dan Jacome – Sidoti

Good day, ladies and gentlemen, and welcome to Second Quarter Kadant Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at that time. [Operator Instructions] I would now like to turn the conference over to your host Michael McKenney, Executive Vice President and Chief Financial Officer. You may begin, sir.

Thank you, Nicole. Good morning everyone, and welcome to Kadant's second quarter 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 expectations, plans and prospects are forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks and uncertainties that may cause our actual results to differ materially from these forward-looking statements as a result of various important factors, including those outlined at the beginning of our slide presentation, and those discussed under the heading Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and subsequent filings with the Securities and Exchange Commission. Our Form 10-K is on file with the SEC and is also available in the 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 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 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. Hello everyone. Thank you for joining us this morning to review our second quarter results and discuss our outlook for the second half of the year. Overall, we had another terrific quarter with strong growth in bookings and revenue and a solid earnings per share beat. Let me begin with the financial highlights of the quarter. We had near record bookings of $176 million, up 47%. The contribution from our recent acquisitions as well as strong capital bookings in all our major markets led to this growth. Q2 revenue was up 41% to a record $155 million. Gross margin came in at 44% due to the inclusion of recent acquisitions and the larger percentage of capital orders we shipped in the second quarter. Adjusted EBITDA was up 37% to $26 million or 17% of revenue. GAAP diluted earnings per share was up 50% to $1.08, while our adjusted earnings per share was up 3% to $1.07. Cash flow from operations which was definitely one of the highlights of the quarter at $28 million left us in a net debt position of $146 million and a leverage ratio of 1.56 at the end of the quarter. As you can see on Slide 6, foreign currency translation had a favorable effect in the second quarter and the newly acquired businesses also made a significant contribution to our financial performance. Our internal revenue growth which excludes FX and acquisitions was 10% continuing the strength we've seen in the last few quarters. Internal growth and bookings was also very healthy at 11%, and I'm pleased to report that our internal revenue growth of parts and consumables is 6% while booking for parts was up 7%. Turning to Slide 7. Following our record bookings levels set in Q1 of this year, we had our second best booking performance in Q2. Second quarter bookings of $176 million, benefited from excellent capital bookings in our Stock-Prep product line in Asia, as well as our Fluid-Handling product line in North America and Europe. I'll provide more details on this when I discuss our regional performance. Our book-to-bill ratio for the first half of 2018 was 1.18. Q2 revenues set a new record at $155 million with growth in all our product lines in all regions. We had excellent internal growth in our Stock-Prep and Fluid-Handling product lines of 22% and 20%, respectively, while acquisitions contributed 26% to our revenue growth. The first half of the year has also been excellent in our parts and consumables business with record revenue in Q1 and near record revenue in Q2. Revenue from parts and consumables in the second quarter increased 35% to $95 million and represented 61% of our total Q2 revenue. Parts and consumables booking were up 40% to $95 million. North America and Europe led the strong performance of 44% and 42%, respectively. Bookings for parts and consumables however were down 7% on a sequential basis from the record Q1 particularly – due to particularly strong booking for our wood processing parts in Q1. In additional, seasonal influences in North America affected the decline as Q1 is historically a stronger quarter for parts as mills prepare for spring maintenance outages. Next, I'd like to review our performance in the major geographic regions where we operate. Let me start with North America. The packaging market in North America continues to be quite healthy and industry conditions are favorable from producers with high containerboard prices and decade low OCC prices. The low OCC prices are primarily the result of China's restricting imports of waste paper, which I'll discuss later in my remarks. The packaging industry has always benefited from the stability of food and beverage segment, but it now has an added boost from strong growth in e-commerce shipments. As a result, industry analysts are projecting solid corrugated packaging demand in both the near and medium term. Containerboard machine operating rates during the second quarter reached 99% and analyst expect operating rates to remain strong in the second half of the year. While demand for housing remains strong, land and labor shortages are constraining housing starts which were down 12% in June. As many of you know, monthly statistics can be quite volatile. If we instead compare the residential housing starts for the first six months of 2018 to the first six months of 2017, we see a 7% increase. Despite the softer monthly housing statistics, our lumber and OSB customers are doing quite well. Both lumber and OSB prices remain high and producers are running flat out with limited downtime being taken for maintenance. This has resulted in continued strong demand for our products from our wood processing customers. As you can see on Slide 9, revenue was up 46% in the second quarter to $75 million, second only to our record-setting performance last quarter. Contributions from our recent acquisitions as well as strong performance by our Fluid-Handling product line drove this growth. Bookings in North America were up 67% to $80 million with strong contributions from our acquisitions and growth in our Fluid-Handling product line which more than doubled compared to last year. Several Fluid-handling capital orders from paperboard and box producers with a combined value of $5 million were booked in Q2. We're having good success penetrating the corrugated packaging industry, where we had extended our papermaking expertise and steam systems to the converting segment where corrugated boxes are produced. Our R&D efforts in this segment began over five years ago and we're now seeing strong demand for this segment as box plants are reaching their operating limits in production and they need our products to increase output from their equipment. Before leaving North America I want to comment on the tariff situation and the general increases we're seeing in input costs. As most of you know, the trade tariffs went into effect July 6 and include pulp and paper equipment. Last quarter, I noted that the trade tariffs – that had the trade tariffs been in place in 2017, the impact on Kadant would have been about $2 million assuming we did not pass on the cost through price increases. Due to the exceptionally strong second half in 2018 in North America, we expect to have a $1.4 million margin impact due to the tariffs. Since nearly all of our second half capital shipments relate to order booked before the tariffs were announced, we're not able to adjust prices for the vast majority of capital orders to be shipped in 2018. We are in the process of adjusting prices which will start to impact parts and consumables margins in the fourth quarter and capital margins as we move into 2019. I should note that while we're working to mitigate the impact of the tariffs through pricing and sourcing strategies, we can't be certain of how our customers and competitors will react to the actions we take. Finally, the strong economy in North America has led to upward pressure on input costs particularly material cost, however over time, we expect to offset most of these higher costs through price adjustments and sourcing strategies. Turning the Europe. As in North America, European packaging producers are facing a favorable environment with low fiber costs coupled with solid demand and stable prices. Slide 10 shows our revenue and bookings performance in Europe. Second quarter revenue was up 33% to $45 million led by our forest products acquisition and double digit revenue growth from our existing businesses. Bookings in Europe were up 22% to $48 million. The capital project activity consisted of many smaller orders for our fiber processing systems, balers, paper drying systems and debarking equipment. Bookings from all of our major product lines were up compared to last year except for our Doctoring, Cleaning, and Filtration product line which had tough comparison against record bookings into Q2 of last year. As has been the case for the last several quarters, the Russian market has been particularly strong. Turning now to Asia, you can see the bookings and revenues chart on Slide 11. Our second quarter bookings were up 40% and revenue was up 54% from last year led by a high volume of capital shipments during the quarter and solid growth in parts and consumables revenue. The market in Asia has been extremely strong. It's also undergoing major changes stemming from China's decision to severely restrict the import of recovered paper. So far in 2018, recovered paper imports to China are half of what they were last year. The resulting fiber shortage is causing big disruptions in China with up to 40 mills announcing down time related to the lack of available fiber. China has also announced its intention to ban all imports of recovered paper by 2020. These actions are creating havoc in the global fiber balance which is driving Chinese producers to make huge investments to rapidly increase pulping capacity outside China. Once they are in place, these facilities are expected to process imported waste paper outside of China and then ship the pulp to mills in China. The capacity build-out presents a big opportunity for us and we're capturing the bulk of these new systems and we're encouraged by our customer's demand for our products. During the second quarter we booked eight pulping system orders in Asia with the combined value of approximately $14 million, of which nearly half was for mills outside of China. We also expect Q3 will be a strong bookings quarter. So, far in the third quarter we've secured approximately $3 million in order for pulping systems to be located outside of China. We're also putting plans in place to expand our service capability in Southeast Asia to support this new wave of capacity. In addition to Start-Prep, our start wood processing product line also contributed to our strong bookings performance in Q2. During the quarter we booked two OSB processing equipment orders with a combined value of approximately $4 million. One project is destined for China, while the other is for a new mill in Thailand. The outlook for Q3 bookings for our OSB equipment is also promising, but we do expect bookings level to pause and moderate after Q3 as the market absorbs this new capacity. Finally a few comments on the rest of the world results. As you can tell from my remarks, we're seeing healthy market conditions in most regions of the world. As has been the case in the past, the exception of South America and in particular Brazil, which has shown some sign of improvement, but that has reversed in the second quarter with labor actions such as the trucker's strike. Our revenue in the rest of the world which is largely South America was $9 million in Q2, up 10% compared to the same period last year. However, on a sequential basis revenue was down nearly 10%. Bookings in Q2 were $11 million up 76% from the same period last year, but down sequentially after a strong performance in the three preceding quarters. Despite this decline, we have several notable capital bookings during the quarter including one from a tissue producer for an upgrade to an existing Stock-Prep system in Chile and a capital order for a rotary debarker for a plant in Brazil. We believe the increasing uncertainty resulting from the upcoming Presidential election has been a large driver of the general slowdown in Brazil that began in April. The high level of optimism that we saw at the start of the year has all but fizzled and it's led to a rather weak economic outlook until after the elections in the fall. Despite this, there are several capital projects under consideration that may move forward in the coming months. I like to conclude my remarks with a few comments on our guidance for Q3 and the full year 2018. The strong starts the first half of 2018 has positioned us well for another record year of financial performance. The strong economy in North America, the capital build out in Asia and our acquisitions have all contributed to our record bookings in the first half of the year. While our markets in general are doing well, there are two negatives impacting our guidance; the first is the impact of the stronger U.S. dollar which negatively affects our foreign earnings when translated to U.S. dollars; and the second is the impact of the trade tariffs that I mentioned earlier. For 2018, we are increasing our revenue guidance to $630 million to $638 million. However, due to the expected negative impact of FX and the trade tariff were lowering our GAAP diluted earnings per share guidance to $4.89 to $4.99, our earnings per share guidance includes a negative impact of $0.19 from the strengthening of the U.S. dollar since our last call and $0.09 from tariffs. We expect our adjusted diluted earnings per share which excludes restructuring costs and other items to the $5 to $5.10. I think it's important to understand that our business on the ground are doing quite well and in fact have strengthened since our last call. If we did not have the FX and tariff headwinds, we would have been raising our earnings per share guidance which makes sense given our earnings per share beat in the second quarter and our strong bookings performance. For the third quarter of 2018, we expect to achieve GAAP diluted earnings per share of a $1.35 to $1.40 on revenue of $162 million to $166 million. I'll now pass the call over to Mike for additional details on our financial performance. Mike?

Thank you, Jon. I'll start with our gross margin performance. Consolidated gross margins were 44% in the second quarter of 2018, down 390 basis points compared to 47.9% in the second quarter of 2017. Our second quarter 2017 gross margins were one of the best quarterly performances ever and were influenced by a high percentage of parts and consumables in our overall product mix. Our parts and consumables revenue represented 61% of total revenue in the second quarter of 2018 compared to 64% in the second quarter of 2017. In addition to the lower percentage of parts and consumables in 2018, the most significant factor reducing gross margins in the second quarter is the inclusion of the lower margins from businesses we acquired last year, which includes some product lines that have lower margins in our legacy business. I should also note that they have lower SG&A costs as well. The remainder of the change is due to lower gross margins achieved on capital equipment sales. Margins on capital equipment sales are very order specific, and as a result can fluctuate between periods. The gross margins on our legacy parts and consumables were essentially the same in both periods. Now let's turn to Slide 16 in our quarterly SG&A expenses. SG&A expenses were $45.1 million in the second quarter of 2018, up $6.2 million from the second quarter of 2017. This included an increase of $6.9 million from our acquisitions and $1.1 million from an unfavorable foreign currency translation effect. SG&A expenses in the second quarter of 2017 included $4.1 million of acquisition costs. SG&A expenses as a percentage of revenue decreased to 29.1% in the second quarter of 2018 compared to 31.6% in the second quarter of 2017, when acquisition related costs are excluded in the prior year period. We expect continued improvement in this metric in the second half of 2018. Let me turn next to our EPS results for the quarter. In the second quarter of 2018 GAAP diluted EPS was $1.08 and our adjusted diluted EPS was $1.07. The $0.01 difference relates to $0.04 of restructuring costs and a $0.05 discrete tax benefit. In the second quarter of 2017, GAAP diluted EPS was $0.72 and our adjusted diluted EPS was $1.04. The $0.32 difference relates to acquisition cost. The increase of $0.03 in adjusted diluted EPS in the second quarter of 2018 compared to the second quarter of 2017 consists of the following; $0.49 due to higher revenue, a $0.19 from the operating results of our acquisitions. These increases were partially offset by $0.21 due to higher operating costs, $0.17 due to lower gross margin percentages, $0.15 due to higher recurring tax rate, and $0.11 due to higher net interest expense, almost entirely related to our prior year acquisitions, and $0.01 due to higher weighted average shares outstanding. The increase in our recurring tax rate can largely be attributed to two items. The primary cause of the increase in our tax rate is how the new U.S. law taxes foreign earnings. This accounts for more than half of the rate increase. As I mentioned last quarter, we believe there is a flaw and how that law was written related to the utilization of foreign tax credits and we hope it will be corrected. If it is corrected, as we believe it should be, the impact would reduce our tax rate by roughly 200 basis points. The second item is that we are now providing for repatriating earnings from certain locations as we move cash to pay down debt. This accounts for approximately one-third of the rate increase. Collectively included in all the categories I just mentioned was a favorable foreign currency translation effect of $0.05 in the second quarter of 2018 compared to the second quarter of last year due to weaker U.S. dollar. Let me also take a moment to compare our adjusted diluted EPS results in the second quarter to the guidance we issued during our May 2018 earnings call. Our adjusted diluted EPS guidance for the second quarter of 2018 was $0.95 to $1, which excludes $0.06 of restructuring cost. We reported adjusted diluted earnings per share of $1.07, which excludes a $0.05 discrete tax benefit and $0.04 of restricting cost in the second quarter of 2018. This $0.07 increase over the high-end of our guidance range was principally the result of better than expected results primarily from our Stock-Prep product line in China. Our adjusted EBITDA was $26.1 million or 16.9% of revenue in the second quarter of 2018, compared to last year's quarter adjusted EBITDA increased $7.1 million or 37%. We are anticipating stronger adjusted EBITDA margins for the remainder of 2018. Now let's turn to our cash flows and working capital metrics starting on Slide 19. Cash flow from operations was $28.4 million in the second quarter of 2018 compared to $23.7 million in the second quarter of 2017. On an year-to-date basis, cash from operations was $35.6 million in 2018 compared to $25.4 million in 2017, an increase of $10.2 million or 40%. We had several notable non-operating uses of cash in the second quarter of 2018. We paid down debt $29.5 million, paid $5.1 million for capital expenditures which includes $2.1 million for the facility project, and paid a $2.4 million dividend on our common stock. We anticipate spending approximately $700,000 on the facility project in the third quarter, which will complete the capital expenditure for this project. Let's now take a look at our key working capital metrics on Slide 20. Our days in receivables was 52 days and in payables was 36 days, both decreasing from the first quarter of 2018. Days in inventory increased to 100 days from 98 days in the first quarter of 2018 as we increased inventory related to projects which will ship in the second half of 2018. Looking at our overall working capital position, our cash conversion days measure calculated by taking days in receivables plus days in inventory and subtracting days and accounts payable was 116 at the end of the second quarter of 2018. Working capital as a percentage of revenue was 10.2% in the second quarter of 2018 compared to 13% in the first quarter of 2018 and 11.6% in the second quarter of 2017. Net debt that is debt less cash at the end of the second quarter of 2018 was $145.7 million, down $21.5 million from the first quarter of 2018 as a result of the strong cash flows in the second quarter. As you can see on Slide 23 our leverage ratio calculated in accordance with our credit facility was 1.56 at the end of the second quarter of 2018, down from 1.93 at the end of the first quarter of 2018. Under the credit facility this ratio must be less than 3.5. Before concluding my remarks, I'd like to update some guidance numbers that we gave in our last call. As Jon mentioned, we have increased our revenue guidance to $630 million to $638 million from $625 million to $635 million, despite a significant FX headwind of $50 million due to the U.S. dollar strengthening from our April forecast to our July forecast. We were able to increase revenues – our revenue guidance as a result of our strong bookings performance in the first half of 2018. Our first half book-to-bill rate was 1.18. However, regarding our EPS guidance, we have lowered our adjusted diluted EPS guidance by $0.15 to $5.10 from $5.15 to $5.25. The strength of the U.S. dollar reduced our forecasted EPS by $0.19. In addition, we have included a $0.09 impact related to recently implemented tariffs and the guidance we are providing today. Although these two items have impacted EPS by $0.28, we have only reduced our adjusted diluted EPS by $0.15, as a result of our improved outlook for the second half of 2018. In addition, we now expect that full year 2018 consolidated product gross margins will be approximately 43.5% to 44.5%, down 50 basis points from our previous guides. We also now expect that SG&A spending in 2018 as a percentage of revenue will be approximately 27.5% to 28.5%, down 50 basis points from our previous guidance. I would also like to add that at the beginning of third quarter, we closed on a 10-year real-estate loan for $21 million at a fixed rate of 4.45%. The loan has a provision that allows us to prepay with no penalty after three years. This loan frees up $21 million of additional borrowing capacity under our revolver agreement. With this new debt agreement and our outstanding interest rate swaps, we have fixed interest – we have fixed the interest rate at slightly over 4% based on our current borrowing margin of 1.25% and $46 million of the $117 million of U.S. denominated debt that was outstanding at quarter end. That concludes my review of the financials. And I will now turn the call back over to Nicole for our Q&A session. Nicole?

[Operator Instructions] And our first question comes from Walter Liptak from Seaport Global. Your line is now open.

Congratulations on the good quarter. It looks like all the fundamentals are going really well for you. I wanted to ask about the $0.19 FX headwind in the guidance. And I wondered what assumptions did you make about the U.S. dollar for the back half? Did you take the dollar where it is right now and project it forward, or was there some assumption that you made?

Yeah, it's a good question, Walt. We're essentially using the spot rate at the end of the second quarter. So, we're really not making any assumption on the dollar weakening or strengthening. We're just looking at the spot rate at the end of the second quarter.

Okay. Are there any – so, it just looks like, the $0.19 looks like a big number. You know in the second quarter, was there headwind from foreign currency? Or is it just in the forward?

Yeah. Yes, it was about $2.5 million looking at the guidance we gave back in April.

$2.5 million on revenue. How about on EPS?

That was about $0.02, just for the second quarter. And so, yes, of course there was an impact in the second quarter.

Okay, and so it ramps up, because of comps, I guess?

Yeah.

Okay. Are there any other assumptions in that 2018 guidance that we should know about that are headwind you called out the tariffs, obviously is there anything else that we should know about.

No, I mean we're assuming, as I kind of said in my remarks that you know we – our plan is to mitigate the tariffs through sourcing and pricing, but it will be – you know have relatively little impact in 2018, and in 2019 will sort of be continuing stuffing it up. I think our goal is eventually you know to mitigate it a 100%, but I don't know that we would do that in 2019, and we certainly are having minimal impact in 2018.

Okay. And the reason that you don't take up prices, because these are contracts that you've already signed prior to the tariffs?

Exactly. You saw our big backlog building up. Much of that was done before the tariffs were really in place. So, in the end it's not that huge of an impact on us, so it's not the kind of thing you can go back and renegotiate a contract you've signed.

Okay good. If I can switch gears to Asia, I guess that was a nice surprise in the quarter, you know for I think at least six months, you guys have been talking about China orders that are going to slow because of the U.S. waste paper restrictions. But I guess the pickup in orders outside of China are you know – are obviously extremely strong. And so, I wonder about the investment funnel I guess, so as you look into 2019 and 2020, you kind of alluded to big projects that are out there. Can you give us an idea of what the order could look like, what the opportunity is for Asia ex-China?

That's a great question Walt. You know, I would say also that is the – to me the most important thing that we're talking about on this call, is this build-out of pulping capacity outside China. We had you know, as you know Walt, for a while we were saying that we expected the Stock-Prep capital orders within China to dissipate in the second half, nothing to do with the waste paper. It was more just the fact that they've done a lot of building. And I think that's still the case, but it is well, well more than offset by this need to build out pulping capacity outside of China. And, to put it a little bit in perspective, China right now exports around 20 million tons of fiber every year in the form of boxes to the U.S. and Europe, primarily the U.S. and they've imported about 25 million tons. You know they've just OCC and mixed office waste is cut in half from what it was, they were importing about 7 million tons so far this year. Last year they had about 14 million tons. So, big, these are huge changes and of course if they ban all imported waste paper, they are going to have to – they're going to have to figure a way to get fiber into that market to the tune of 20 million tons, or 25 million tons. So, we are we – the bookings we talked about are you know less than – sort of less than 5 million tons. They're probably in the 3 million to 4 million tons. So, I don't know exactly how this is all going to play out, but if China is serious that they are going to ban all waste paper by 2020, that way they're going to have to figure some stuff out in terms of how to get pulp in. And of course if they process the – the restrictions are because the waste paper has these contaminants in it, by pulping it outside of China, you get around that, because you essentially are removing the contaminants in Vietnam or Thailand or wherever they do that and then they send relatively clean pulp into China.

Okay. Alright great. Well, it's not like the sector in Asia will be very strong for…

We don't – we can see Q3 looks pretty good. I can tell you that. And I would say this is kind of unchartered territory for how this is going to go, but if China is serious about this, that will force of investment.

Okay. If I could just switch gears but stay around the same line, thinking about the sector, you mentioned North American packaging is healthy for the medium term, so, I wondered if you could just clarify what do you mean by medium term, is it this year, is it into next year, and I guess I'm thinking about what do you think about North America packaging in 2019. Are there still project that are building in the – in your funnel? Do you expect steady growth in 2019?

Right. And I – when I talk about the medium and short-term, I am not saying in any way the long-term is worst. As I've talked about before, I absolutely think this structural change with the e-commerce and Amazon impact and what that drives to boxing is got, that's a long-term structural change, so I am totally optimistic in long, medium, short and long-term. I can tell you that the analysts were forecasting capacity additions in North America are talking 3.5% increases for the next couple of years.

Thank you. And our next question comes from Chris Howe from Barrington Research

Good morning, gentlemen. Good quarter.

Hi Chris, how are you doing?

Hi, Chris.

I am going great. I just wanted to see if there is been any update as in regard to the acquisition environment. Are you still seeing kind of the same things that you've echoed before as far as things being a little bit expensive or just kind of what you are seeing there in the quarter and right now I guess?

Sure. So I am actually very happy. We have a business development person whose is doing an excellent job and we are seeing a lot of stuff. That said, it's been a little on the expensive side. So we found a number of things we actually like quite a bit, but we just couldn't get there and price. So I would say it's active, but a little on the pricey side for our taste at this point.

Okay. Then another thing, previously you mentioned a five year goal while back of 2% to 3% organic revenue growth. And is there going to be an Investor Day coming up or is that something that's a little bit archived right now?

Well, so another good question, Chris. With that I am almost a little embarrassed about that forecast for 2021 because we are basically kind of bumping against it in 2018. So yes, we need to re-do. We are going to have another Investor Day towards the end of this year or possibly the beginning of next year and we'll probably update that. We had our internal revenue growth of 2% to 3%. Last year we did around 6%, this year we are probably going to do around 10%. So, we are well ahead of that. That said, I don't think this is a five year growth rate. So, we'll have to come up with something that's maybe not as conservative as we were before, but certainly not as aggressive as we are experiencing right now. And we'll update the acquisition model and so forth. I wouldn't be surprised if we have a little more on the internal side and little less on the acquisition side, but we have to work all that through.

I think you mentioned before the oriented strand board and how that's a growth opportunity moving forward in Asia? How should we think about that? How material could that be within the next 12 months or so?

Let's start with – it's a very big opportunity, right. A lot of furniture built in China. I have heard and these are not – I am going to caution, these are not sort of my estimates, but the people who we work with in that area say that, if this thing really takes off over the next sort of 5 to 10 years, you could be looking at another 50-60 OSB mills. So, that would be a lot. My guess is with missionary, this is a missionary product, it will probably take longer, but to put it in perspective, we've booked so far two OSB mills that we have some optimism, we'll book some more in Q3. Prior to that there were was only really three western OSB mills in the whole country. So, this is a big influx of a new product line. So we kind of see a pausing, I would say not stopping, but pausing as they work to introduce this product and then if it's successful you should see a sort of pick up again at some point.

Thank you. And our next question comes from Bill Hyler from WDH Capital. Your line is now open.

Hi. Good morning guys.

Hi Bill, how are you?

I'd like to delve a little more into this containerboard expansions. First in North America, it looks like there is another round of significant expansions that have been announced this year. A lot of them are expansions, a lot of them are conversions from paper plants to containerboard. Can you walk us through your relative exposure to a paper plant versus the OCC recycle containerboard plant? And what the relative – given your exposure would be between the two type of plants because you'll probably lose a little bit on the paper side as these other plants are built out?

Right. So I would say that, let's talk about, when there is a conversion, right, that's often, they are modifying a paper machine. They are often adding new Stock-Prep and significant modifications to the paper machine. So, we do quite well in that kind of set up. The area we probably do a little less well is a greenfield paper mill, where they are actually building the whole thing including the paper machine, because our competitors in the Stock-Prep side and frankly in the – the stuff that goes on the paper machine, they make the whole paper machine and they'll bundle that. So, I would say when we come to expansions, our favorite is conversions. We also like that they do a lot of debottlenecking that kind of stuff. We like that. And of course, even when there is a greenfield mill, we fight quite hard to get the customer, they insist on our stuff.

Right. Okay. I guess to say, that's true with virgin plants too, you don't make as much. You don't have as much exposure to a…..

We don't have much exposure to virgin, right. I mean one of the things that's happening, right, so adding virgin capacity in North America because they can increase a little, but we haven't had a new virgin mill in North America in like 30 years probably, it's a long time. It's very difficult to add – truly add a plant that tends to go in South America. But when they do these sorts of small capital improvements, we will get some of that. The other thing I would say is, with the other side of the paper shortage that's created in China with these restrictions on imports is that OCC prices have plunged here. So, there is a lot of favoritism to doing recycle, which we also like.

Right. The economics I think are now favoring that in a big way. Let me just – also I have a question on China. I've been reading some of these expansions they've announced pulp plant in Vietnam I think is an area they've been targeting. So what you are saying is, what they'll do is you'll process the waste paper say in Vietnam, produce clean pulp, and then ship that back to the OCC plant in China.

That's exactly right.

To produce the containerboard. Now, have the OCC plant in China been idle. Have many been idle or running at lower capacity than they normally would be because of this problem?

Absolutely. As I said in my remarks that 40 mills have announced downtime in July and August and these are big players, you know Nine Dragon, people like this. So yeah, it's a real problem I would say.

So, there should be a double of positive effect for you I guess long-term here, you'll do some business in Vietnam but also the traditional Chinese plant should start ramping up again in the next five years.

I think it's going to shift, right. So we are doing quite well I would say capturing market share in this build out in Southeast Asia in particular. But a cleaner pulp will be going to China than just a regular waste paper. So, I think – I expect it will have a slight or maybe some modest negative impact on our parts business in China because they're going to be processing already semi-cleaned pulp, right. So it won't be as much wear and tear. And I don't know – we don't know exactly know how this is all going to fall. They are even talking about doing some build outs in North America where the waste paper is, in that case they have to dry it, because you can't ship pretty wet. When it's in Vietnam, they'll ship what they call wet lap, so they don't spend a lot of energy drying it and they just put it back in the pulper, but if you are shipping it from North America, you really got a fully dry it because it's on a boat for a month.

Okay. All right. I'll appreciate it. Thank you.

Thank you.

[Operator Instructions] And our next question comes from Dan Jacome with Sidoti. Your line is now open.

Just a quick housekeeping question. I couldn't find it in the K, how – what of your COGS, production cost, how much is comprised of just stainless steel and I guess aluminum and what else is into the chest maybe ductile iron?

No. You won't really find that there.

Just maybe like a high level thought on that, I mean…

I'll give you the broadest comment. It is easily our largest cost. It's hard to say it's this much because you know sometimes you buy raw steel and we process it, sometimes you buy a casting made of steel, you are – your steel, the price of steel impact that casting, but there is a lot of labor into the thing you bought. So, it's kind of little bit kind of hard to quantify. But you know it's far away our largest 30%-ish, would you say?

Material

Okay. There is a number, alright, that's kind of what I was going at 30% to 40%. Just well, maybe one more on the, you said that containerboard capacity expansions during the next couple of years they are pretty solid. I agree, I've seen similar things in my reading, but what – all of that's going to be recycled linerboard do you think? Is that what you are saying about the conversions and the lack of virgin?

It depends on what region you know the – when production – when box usage ticks up, you need to add more fiber into the system. So, somewhere in the world, virgin capacity has to be added, because you – there is loss every time you recycle right, so you got to add fiber, so that will mean, somewhere in the world – my guess is, it won't be so much in North America.

Okay.

It will be in Russia – Russia and Brazil will be my two leading candidates for that.

Thank you. I'm showing no further question at this time. I would now like to turn the call back to Jonathan Painter for closing remarks.

Thanks Nicole. Before I let you go, I'd like to summarize what I think are the key takeaways for the quarter. First, we have a solid performance in Q2, with strong internal growth of 10% and 11% in revenue and bookings respectively. Second, China's recovered paper import restrictions have created a big opportunity for us as producers scramble to build pulping capacity in Southeast Asia. Third, cash flow from operations is a healthy $28 million and finally despite the negative impact of FX and the tariffs, we're expecting to have a record 2018 with revenue and earnings per share. Thanks for joining us on the call today. And I look forward to updating you next quarter.

Ladies and gentlemen, thank you for your participation in today's conference call. This concludes today's program. You may all disconnect. Everyone have a great day.