Kadant Inc (KAI) 2003 Q2 法說會逐字稿

Ladies and gentlemen, welcome to Kadant Incorporated Second Quarter 2003 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following the presentation.

It's now my pleasure to hand the floor over to your host, Thomas O'Brien, CFO. Sir, you may begin.

Thank you, operator, and good morning everyone. Welcome to Kadant's second quarter 2003 earnings conference call. With us in the call today are Bill Rainville, our Chairman and Chief Executive Officer; and Jonathan Painter, Executive Vice President of Kadant's and the Head of our Composite and Fiber-Based Products segment.

Before we begin, let me read the 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 discussed in our Quarterly Report on Form 10-Q for the fiscal quarter, ended March 29th 2003, which is on file with the SEC and is also available in the "Investors" section of our website, at www.kadant.com, under the heading "SEC Filings".

In addition, any forward-looking statements, we make on this call, represent our views only as of today. While we may elect to up date forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. You should not rely on these forward-looking statements.

During this call, 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 News Releases.

With that, I'll turn the call over to Bill Rainville who'll give an update on Kadant's business and future prospects. Following Bill's remarks, I'll give an overview of our financial results for the quarter, and will that have a Q&A session. Bill?

All right. Thank you, Tom, and good morning everyone. Welcome to Kadant's earning call. Kadant completed what turned out to be a very solid first half of the year. Our second quarter results came in strong, in fact slightly ahead of our guidance. What is especially pleasing is our performance in line with the continuing economic pressures that we see in many parts of the world, and this certainly reflected in the continuing weakness in pulp and paper marketplace in North America which has also spread into Europe.

Fortunately for Kadant, one of our key assets is the global distribution, which is very strong. So we can benefit on our opportunities as they occur. China is an example that has remained a key contributor to top and bottom line growth. We will report to that continuing.

Let me give a brief review of our financial results, as Tom is going to give in more details a little later. Everything I refer to you as well will be in GAAP measurements. Our quarterly net income for the quarter was more than 50% compared to second quarter of '02, to $3.09m or 28 cents per diluted share. Our revenues were up 20% to nearly $56m including the $3.3m benefit from currency translation. Resulting the 7% percent of increase that was from the currency translation, we still have a 13% internal growth for the quarter. In China, the present market conditions were pretty good.

Now I'd like to give a brief overview of our businesses starting off with our core business in the pulp and papermaking systems. As the market needs change in different parts of the world, our goal and price will continue to be a key advantage for Kadant. Let's take a look at where our market opportunities lie geographically.

As I commented, China continues to be an important market for Kadant. And China continues to be a strong economy. It's growing at a rate of 8% despite the SARS epidemic which is now under control. As China's economy grows, the basic infrastructure needs to be put in place. Then an infrastructure requires a very solid growth in the pulp and paper industry, as they ship our products and exports products every quarter Fagazine [ph], Boxin [ph] instruction manuals and they have targeted in our investing heavily to supply their need. This is reflected in the orders we received in the first six months where Kadant had $17m in orders from China.

Almost all of the orders have been for large recycling systems, which are highly capital incentive as mills undergo capacity expansion from the ground up. It's certainly great for Kadant, not only for this year, but in pieces in installed base, which can provide us an opportunity for an annuity in parts and components for future years. We expect this activity to continue in China, but not at the same level for the rest of the year.

We'll be booking orders in China, but again, not as the same level as we experienced in the first part of the year. We expect this activity to continue on for a number of years, however. We also plan to protect the aftermarket value of our brand sold ever increasing install base in China. We are committing to, as planned, put up a small manufactured facility to provide us an opportunity to mind the installed base on parts and components for our recycling system, as well as, to take advantage of a strong market presence in China, introduce our accessory environment management products as well. This plan should be up and running by next year at this time.

Now in the North America, and increasingly Europe, where we continue to be affected by recapital spending in the phase of economic pressures. Here, the focus is on cost saving, and quality improvements that can add value for our customers. Within these markets, we do see pockets of opportunity. For example, we have recently seen increased activity in Eastern Europe. And have recently as well had orders form Poland.

Poland targeting the tissue business is one that they need to invest in and we've already been relatively strong in providing technology as tissue producers. We also have pockets of opportunity in the share markets such as Western Europe. We have our three product segments, accessories, stock-prep and water management.

In some of those countries, we have stronger market presence in one or two of the product lines and not in the others. We're going to be very aggressively focusing on those pockets of opportunity, increase our market shares to more acceptable level for Kadant that presents an opportunity for us. And also take an advantage of our market strength globally. We also hope to see opportunities in introducing new products and services that trade more quick predictable businesses to take advantage of our install base and market presence.

Now let's rely on capital spending. I've talked a number of times about the Corcrate [ph], which is very key blade that's used in the crapping process for tissue. We've been successfully introducing that product to market mill-by-mill. In fact, our bookings in this second quarter were up 65% over the first quarter, just to give you an example. But also other products groups as well have opportunities.

So we begin to focus on that, for example, in stock preparations where we have a great opportunity to upgrade our existing install base with events, parts and components that can provide our customers a tremendous return on their investments, as well as, give up Kadant a great opportunity. A specific example is on focus. We have a large install base to focus, which is the first piece of major equipment in the stock-preparation systems.

These focus have parts, which have to be replaced relatively frequently router and extraction plates, for an example. Our recent design group came up with a router and extraction plates that provide much longer life which minimizes downtime for mill which is a very critical for them, as well as it can operate at 30% less power so that they can get a nice pay back there. They could pay back on these new designs.

We just recently introduced a very successful in the marketplace as well as to expanding the non-stoppage we've adapted some of these routers and extraction plates for another [indiscernible] which now we are looking at a much larger market as well. Those are the opportunities that we see to take advantage of market conditions that are somewhat weak at this point.

Now I want to talk in a moment about our bookings. Our bookings from quarter to quarter comparison in the same quarter of '03 were down 10% from the same quarter in '02. I have to remind you that a big part of the orders that we got from China deferred in the first quarter. So for the first six months, the paper making systems bookings were up 12% over the last year. I also need to tell you that each one of our product lines had increases in bookings levels over that period of time.

Now, a few comments on our guidance. In our current booking levels and the timing of large orders from China in the first half, we expect to earn on a GAAP basis from 17 to 19 cents in the third quarter. On revenues, a $44m to $46m, and this will keep us inline with our previous guidance of 84 to 92 cents for the year and revenues of $195m to $200m.

Now, we're going to talk about the next part of our businesses and that's on the composite building products. The decking market continues to be strong and this is evidenced by our revenue performance. In the second quarter, revenues grew more than 50%over last year to $3.4m. Our operating performance was roughly breakeven. There is more profit of $26,000 versus $700,000 loss a year ago.

We also identified ways to improve profitability and we're focusing on that. I'll speak more about that in a minute.

Now what is happening in the building industry? Well, Northeast, Midwest had large delays this year due to the very unusual wet springs that we've experienced. On the other hand, the building industry is going to catch up after slow start due to the bad weather. However, most of our distributors have worked through with inventories and are now in the process of reordering.

Bookings in the second quarter increased to 2.8b from a relatively low level in the first quarter. We've also built inventory in the second quarter, as we are able to ramp up production in Green Bay [ph] extremely well and at the same time, the sales in Q2 were affected somewhat by delayed start of the building season. We're continuing to expand our distributor networks of sales well those aligned with capacity. They will also allow us to delay and postpone our capacity expansion until 2004. This is primarily due to the optimization of the Green Bay facility.

Now, we have two factors that affect the profitability of the composites in the quarter. One, it is encouraged we have higher warranty expenses in the second quarter. And these were claims that were associated with a small percentage of decks installed, mostly last fall for the spring. We estimate between 1% to 2% of the decks had some warranty issues. It typically occurred on large decks using long boards. However, we've identified the problem and have modified our installations instruction and offering our production process to correct it. We believe we can put this issue behind us.

The other issue that impacted price of our profitability was plastic prices. We commented on that in the last call that there was a slide up in plastic prices early in the year at the same time when we were required to purchase plastic for production. And the good news is that the plastic prices as we expected and as we indicated that return to more traditional lower levels.

Another action that we have taken is that we've installed laving equipment. So we can now incorporate different grades of plastics, which could have minimized impact of slides in the future. Unfortunately, the higher cost material is where we'll be shipping in Q3, which will affect the profitability during the third quarter.

Now, our third quarter profitability in composites will be affected by two short-term issues, a combination of reduced production in the camphor [ph] inventory level which was created by a small start at a building season and the high plastic cost material which we now have in inventory. So we expect the composite business to report a loss in Q3 in the range of $300,000 to $400,000 resulting in a loss of about the same amount for the year.

Revenues are still on track with $3m to $4m for the third quarter, and $13m to $15m for the year as we stated previously. As with any new product, we've had some hurdles to overcome. But we're confident in overall growth prospects for composites. We're continuing to expand distribution and most distributors sign on in the fall during the off-season after they had a chance to see and compare the various industry trade shows and I can tell you that the comments we get from whether they are builders, dealers, distributors have all been very favorable as the quality of our product is very [indiscernible]. So it is comparable with other alternatives.

The $13m to $15m revenue target for the year would also yield us a growth a better than 50% of the pervious year. So, we still remain with our expectations as composites, there's a great opportunity to provide some real growth pertained.

With that, I will turn the call over to Tom. Tom?

Thank you, Will. I am going to start by filling in some details in our P&L performance in the second quarter, and then I'll make some comments in our balance sheet and our cash flows. We'll start with revenues. Consolidated revenues were $55.8m in the second quarter of 2003, an increase of 20% over last year and $3.3m through the favorable effect of foreign currency translation. Most of these translation gains occurred in our Europe based businesses with smaller gains resulting from the US dollars weakening versus the British pound and the Canadian dollar.

Our revenue performance slightly exceeded our guidance of $53m to $55m. Revenues were up significantly in both of our recording segments compared to last year. Let's take a look at those now, starting with our core business, the papermaking equipment segment. Revenues in our papermaking equipment segment were $50.7m, 21% higher than the second quarter of 2002. Due to increases of 8% from currency translation and 13% from internal growth. This internal growth was achieved and there continues to be weak conditions in many of our markets.

Our stock-prep product line accounted perpetually all of the revenue increase in this segment. Increasing 42% over last year including 11% from the favorable effect the foreign currency. The remaining increase of 31% from stock-prep revenues was entirely due to higher sales in China, where revenues of $9.6m tripled over last year. Stock-prep revenues were up slightly in North America and declined in Europe excluding exchange.

Finally, in this segment, combined revenues and our accessories in water management product lines were up 3% compared to last year. Entirely due to a 5% increase from foreign currency net translation. These new product lines continue to hampered by sluggish industry condition in both North America and Europe.

Now turning to our other recording segments, the composite fiber based product segment. This recording segment, which includes both our fiber based granular products business and our composite building product business had revenues of 5.1m in the second quarter 2003 up 15% over last year. Revenues in our composite building product business, which is grown to be largest product lines in this segment where up 53% compared to last year, a $3.4m versus $2.2m. Importantly, we achieved this revenue growth of the late start to the building season caused by weather in much of the country.

Now, let's turn to product gross margins for a moment. Consolidated product gross margin in the second quarter of 2003 was 37.1%, down a 117 basis points from last year's 38.8%. As we look at the segments, the entire decline is due to lower product gross margins in our papermaking equipment segment.

Product gross margins in this segment was 37.1% in the second quarter of 2003, compared to 39.6% last year or decrease of 250 basis points. The lower margins were caused mainly by a higher proportion of lower margin capital business to our total revenues compared to last year. This trend was largely due to the increase in stock-prep sales in China. Encouragingly, we did see in the second quarter in a row, it increased in our product and considerable margins as compared to the prior year period.

Product gross margins continued to improve in our composite and fiber-based product segment, increasing to 37.4% in the second quarter of 2003 and 31.8% in the second quarter last year. Although margins were down slightly in our fiber-based granular and products business, they were more than offset by higher product gross margins in our composite building products business. Higher margins here were due to the efficiency associated with higher levels of the production and better net prices attained during the quarter offset somewhat by higher launching provisions and plastic prices.

Now before talking about our operating income, I'd like to spend a few minutes on our selling, general and administrative expenses and also on a small net gain that we recorded in the quarter. Our SG&A expenses were $13.4m in the second quarter of 2003 or $800,000 higher than last year. Now remember that during the period of a weakening US dollars such as we have been in and we experienced in the second quarter, expenses incurred in local currencies will translate into higher US dollars denominated expenses on our consolidated P&L.

That said, included in SG&A this quarter is an increase of approximately $650,000 due to this unfavorable foreign currency asset. Within an increase of only a $150,000 due to internal SG&A expense growth over the last year. This smaller growth in SG&A compared to a higher revenue growth demonstrate that we are continuing to tightly control our spending level throughout the company in this challenging market environment. The comparison also illustrates the operating and financial average we have, once the paper industry recovers, in North America and Europe.

Also on the P&L, you've noticed that we recorded a small net gain of $180,000 in the second quarter of 2003. This item actually consists of two offsetting amounts, the first being a gain of approximately $650,000 from the sale of fixed assets in one of our European businesses, offset by approximately $470,000 of restructuring charges in that same business. As we said in last quarter, we do not to expect any material net restructuring and unusual items, for the remainder of the year.

Let's turn to our operating income results, higher revenues coupled with constraint spending levels contributed to a strong operating income performance in the second quarter of 2003. On a GAAP basis, operating income was $6.2m in 2Q '03, compared to $4.3m last year, an increase of 45%, excluding the small net gains from the 2Q '03 performance, which I just discussed.

Adjusted operating income was $6.0m compared to last year's $4.3m, an increase of 41%. You can see both the GAAP and the adjusted operating income results at the bottom of the schedule attached in the press release. As a percentage of revenues, GAAP consolidated operating income was 11.1% in 2Q '03 up a 190 basis points over the last year's 9.2% which represents the highest operating income profitability performance since the fourth quarter of 1999. We had solid operating income results in both of our reported segments.

Operating income in the paper making equipment segment, on a GAAP basis was $6.7m up 33% over the last year. GAAP operating income profitability was 13.2% in the second quarter of 2003 compared to 12% last year, and is the highest profitability performance in this segment, since the fourth quarter of 2000.

Quarterly operating income in our composite and fiber-based products business was the highest achieved in this segment, ever. Operating income yield with a little under $600,000 in 2Q '03 compared to approximately $100,000 last year. And the increase was entirely the result of the significant improvement and profitability in our composite building products business. Last year, we got an operating loss of almost $700,000 in this product line. In the 2003-quarter, we achieved quite the even results. Improvement of $700,000 year-over-year in operating income was slightly offset by small reduction in our fiber-based granular products business.

Now working away down the P&L, finally, let's turn to our second quarter diluted EPS results. We recovered an EPS of 28 cents in the second quarter of 2003 compared to 20 cents in the second quarter of 2002. Included in these results are unusual net gains of 1 cent in the 2003 period, which I've already discussed, and 2 cents in the 2002 period, a letter, which was due to the repurchase of our convertible debentures.

Excluding these net gains from both periods, the comparison now becomes 27 cents in 2003 versus 18 cents in 2002 or increase in EPS of 9 cents. You can a reconciliation of the GAAP EPS to the adjusted EPS in the table in the middle of the schedule attached to the press release.

So lets go back to that increase, 27 cents in 2003, 18 cents in 2002, increase of 9 cents. 4 cents of this 9 cents increase in EPS is due to the shift from net interest expense in 2002 to net interest income in 2003 and that, of course, was due to the repurchase of our convertible debentures in 2002, 1 cent is due to foreign currency transaction gains, and 7 cents is due to improved operating results in 2003 over 2002. Now, those combined improvements of 12 cents were offset slightly by EPS dilution of 3 cents due to an increase in shares outstanding arising from our June 2002 public stock offering.

If anyone would like me to go through that again, I'll be happy to do that in the Q&A session.

Finally, on EPS, the composite product business had no material effect on our consolidated EPS in second quarter 2003 compared to a loss of 3 cents in the second quarter of 2002. So I'll conclude my review with a few remarks on the balance sheet. We ended the second quarter with over $52.5m in cash and 600,000 in total debt giving us a net cash position of $51.9m.

Our net cash position improved by $7.9m in the second quarter of 2003, including a favorable effect of $3m due to foreign exchange. It does spin-off from Thermoelectron [ph] almost two year for ago. We have increased our net cash position by approximately $57m, $17m of which was the consequence of our public offering in June 2002. Despite the strong revenue performance, we invested only $500,000 in working capital in the second quarter.

This combined with net sources of cash from other operating activities generated $4.1m in cash flows from operations. Although cash flows from operation were lower from last year's very strong $9.4m, it did improve by $5.1m over the first quarter of 2003. We expected third quarter cash flows will benefit from collections of much of the China revenue that was recognized in the second quarter. In fact, we have already collected $4.5m from these China shipments at the end of the second quarter.

We remain focused on working capital management throughout the company. Working capital as a percentage of last 12 months revenues was 19% in the second quarter 2003 equals to both the first quarter of 2003 and the second quarter of last year. Our day sales and receivables increased by six days in the first quarter of 2003 largely due to the high level of China revenues. Encouragingly, our inventory trying to improve for the second quarter on a row to 4.4 times in second quarter of 2003 up from 4.2 in the first quarter of '03 and 3.7 last year. That concludes my review on the financials.

Now, I'll turn the conference back to the operator for Q&A session. Operator?

Thank you ladies and gentlemen. The floor is now open for questions. If you do have a question, you can press, "1" followed by "4" on your touch-tone phone to start. If at any point your question has been answered, you may remove yourself from the queue by pressing the "#" key. Once again, ladies and gentlemen its "1" followed by "4" to ask a question at this time.

Our first question comes from Michael Hutchinson of Barrington Research.

Hi, guys.

Good morning, Mike

Hi, Mike.

Congratulations on the quarter.

Thank you.

Right now, we've been seeing pockets of strength in your core business. But when do you expect that you will see a more sustained upswing in this business?

That's a good question I wish I could give you that the answer today. We've been looking at that market for a longtime and one of the things I couldn't tell you, Mike, is that with our product development segment we've been focusing on the material markets as well as, taking advantage of what we see capacity expansion. I can tell you that we're well positioned for an eventual recovery and certainly in the technology of the products that we have, but we do see is that have also taken -- or looking these mature markets and they are like I commented earlier.

Some geographic examples were -- we may not have the market share that we enjoy in other parts. And primarily we - I would say because we have not focus on [indiscernible] we are looking harder at those areas. So we still see why we're waiting for the recovery in the material market. We're still seeing opportunity. The other thing I would comment on is that they've been operating at a long time with lower budgets on capital expenditures and they can only do that for so as well. I mean the equipment wears off. It becomes worn out. We've seen some of that in some cases. We benefited out of that -

So it is a combination of things, but eventual pick up I think in - for example, North America is going to more [indiscernible] now to pick up on the economy in general. It is what I would say because it seems like their capacity has been taken down to the level that when the economy starts to pickup. We'll start seeing the benefit.

See, if you think at earliest, maybe we're looking at next year?

Yes. That's what I would I say.

Okay. Could I ask you a follow-up?

Sure.

Any pipeline delays that you're seeing from SARS, I know that that issue. It looks like is essentially eliminated. But are you seeing any pipeline delays there?

No. In fact, I was thinking that we were lucky that we probably did have, but we received a bulk of our orders early in the year, when it was really committed to us. We have a real team on the ground there. We're pulling like 25 people in China -- Chinese. Where the Europeans had people over there, we were pulling people off during that period of time. And we cautioned our people, but they stayed on the ground. So if anything we had a slight benefit of that and this is why we continue to pick up additional business and see opportunities. So there is no real delay that impacted us.

Okay. Thanks.

Okay, Mike. Thank you.

Thank you. Our next question comes from Claudia Shank of JP Morgan Chase.

Hi. Good morning, Claudia.

Hi. How are you guys?

Hi, Claudia.

Fine. Thanks.

I just had a question, I guess, you mentioned that the facility at Green Bay had its optimization. You might postpone the capital expansion plans there and if that's the case then what are you thinking about, for all that cash?

That's a good question. We keep our eye on that constantly, because we have -- as Tom would tell you and he has said before --competing needs for the cash. And one; we like to do is put it to work to grow the business, that's our primary reason, and there is option for that one assuming the internal growth, such as, we see other composite.

The other one would be acquisitions, which we really looking at very hard at this point in the core business, as well as looking very hard in the building industry as well to get us some growth. But as you know, we also have available to us stock buyback, which at the right time would compete for that cash, as well. But primary objective is to put it to work in growing the business.

I think the fact that we have accumulated the cash, it should give some confidence to our patience and discipline and not just going out and acquiring something we have some high standard that we've look at on an acquisition, but -- and also for internal growth. But our objective is to grow the business.

Okay.

Okay.

And then just sort of shifting gears little bit to the fiber and composite side of the business. And I actually just wonder, if you could comment a little bit on the fiber-based granule at that business? And I think - if I remember right, this is sort of your seasonally strongest period and just sort of talk a little bit about that and what you're seeing in that business?

Okay. Thank you, Claudia. I'm going to have John respond to that, as you know, he is the closer to that. John?

You're right, Claudia. The second quarter is our strongest quarter tied with the planting season. We have a product that we sell to [indiscernible] called Grubecks [ph]. It sells very well and actually benefits from the less rainy weather we've had. So that was a strong performance for us this quarter in that sector.

Does that answer your questions, Claudia?

Yes. That's good.

All right. Thank you.

Once again, ladies and gentlemen, as a reminder, if you do have a question, that's "1" followed by "4" on your touchtone phones at this time.

We do have a follow up question coming from Michael Hutchinson.

Okay.

Hi. In the roofing tiles business, what you believe the market size is; and what kind of margins longer-term do you think that will generate? The other thing I wanted to know is -- what are your plans for distribution of that product?

Okay. Those are good questions, Mike. I'm going to turn this over to Jon, again, to respond.

Sure. The roofing market in total in North America is around 9b. Now, obviously -- and about a half of that or a little more than half of that is [indiscernible]. And we were pressured to be the only addressing part of that. We, kind of, see margins from that one, when the business is up and going similar to what we would expect to see in the composites, in general, high 30s.

And what about...

Does that answer your question?

Yes. And then what about in terms of distribution?

Sure. Right now, we're working with a unit called, Vandal High Reilly [ph], which is a subsidiary of ABC; and ABC Supply is the largest supplier of roofing material in the country there with 200 and something stores. So what we're doing now in terms of our own products development is getting our production up to speed and modifying them also. It can do more production as well as getting the necessary buildings certifications, ICBI or that sort of things. So once we do that, ABC should be a strong distributor for us.

Okay. Thanks.

Okay. Thank you, Mike.

Ladies and gentlemen, as a final reminder, that's "1" followed by "4" to register a question at this time.

Well, if there are no further questions, Operator, we should close the meeting. I just got to say that we're innovative. We are pleased with our performance overall in what continues to be, obviously, a challenging business environment. I think we put the right strategies in place to optimize the environment, both where we see softness in markets as well as where we see capacity expansion and growth opportunities. We maintained our global presence in the paper industry; and we'll continue to benefit from the geographic opportunities, as they occur relatively wherever they're on the marketplace.

Then, also, we've focused our product development, I think, on the right areas in the mature markets where we're going to starting to reap the benefit of that even in a soft market. When the market recovers, we're really going to get a pickup by the introduction of those components and products.

On the composite side, I do want to say that, on the topline, we're very pleased with the performance; and that's very encouraging to us. We are committed to growing the business, and we're improving the bottomline.

I'd like to thank everyone for joining us today and look forward to having you join us on the next conference call. Thank you.

Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.