Kadant Inc (KAI) 2006 Q2 法說會逐字稿

Good morning. My name is Crystal and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Kadant Conference Call. [OPERATOR INSTRUCTIONS]

Thank you. It is now my pleasure to send the floor over to your host, Thomas O'Brien, CFO of Kadant.

Okay. Thank you.

Sir, you may begin your conference.

Okay. Thank you, Operator. And good morning everyone and welcome Kadant's Second Quarter 2006 Earnings Call. With me on the call today is Bill Rainville our Chairman and Chief Executive Officer.

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 statement for purposes of the Safe Harbor Provision 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 unfortunate factors, including those discussed in our quarterly report on Form 10Q for the fiscal period ended April 1st, 2006, which is on file with the SEC and is also available in the investor's 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 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 date after today.

During this call, we will refer to some non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted account principles. A reconciliation of the non-GAAP financial measures to most directly comparable GAAP measure is contained in our second quarter earnings press release issued yesterday, which is available in the investor's section of our website at www.kadant.com under the heading News Releases.

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

Bill?

Thanks, Tom. Good morning everyone. Thanks for joining us for a review of one of our best quarters yet. Our growth and momentum for Q1 apparently continued into the second quarter adding up to our strongest first half ever, with record revenues, bookings, and back logs.

Let me start with the financial highlights for our continuing operations during the quarter. As you saw in our press release, our revenues grew 38%, a record $89.6 million. Even without including revenues from acquisitions, which was almost all from Kadant Johnson, we had 26% revenue growth. Our operating income rose 76% to $8.7 million. Diluted EPS came in at $.40, which exceeded the high end of our guidance by $.04. An added note, our ESP and operating income were the highest we've reported since becoming an independent, public company five years ago.

Our EBITDA was 58% higher than Q2 last year at $10.6 million. The key contributor to that achievement was Kadant Johnson's food handling business, which had an EBITDA margin of 23%. You may recall when we acquired Kadant Johnson just over a year ago their EBITDA margin had been running at 15% to 17%, so we are especially pleased with this performance.

In addition, we generated very strong bookings again this quarter at $89 million. This was our second best bookings quarter, exceeded only by our record performance in Q1 of this year. As of the end of Q2 our backlog was at $87 million, more than double that of last year's quarter.

Our excellent performance in the second quarter was, for the most part, a continuation of what we saw in Q1 with two key drivers contributing to our growth. First, the focus on lowering energy costs in North America and Europe is resulting in strong demand for our food handling equipment, which can significantly improve energy efficiency during the drying process. Second, the continued capacity expansion by major producers of high quality recycled paper products in China is creating ongoing demand for our advanced stock press systems. Our continued investments to broaden our product lines and our market coverage have given us the ability to take advantage of these opportunities and strengthen our global market position.

Let me expand a bit on these key market drivers. First, North America and Europe, where customers are [inaudible] capital to invest in technologies that yield higher returns and a form of improved quality and productivity. In particular, our food handling equipment and controls can play a significant role in lowering energy costs, since drying is the most energy demanding stage of paper production. Sales of these products have increased every quarter since our acquisition of Kadant Johnson in May 2005. Orders totaled $23 million in the quarter and were the primary contributor to our strong bookings performance.

Our complete line of food handling products from rotary joints and siphons to dryer control software, called DMS, can increase dryer efficiency in a range of paper making applications. Just a few recent examples. In Wisconsin a major producer ordered DMS control packages for two or more machines after our system proved its ability to lower energy costs on an earlier machine installation. A mill in Texas has set new production and speed records after installing 50 of our PTX joints and stationary siphons. Machine build in the UK has installed our PTX joints on ten new [inaudible] machines, testing for Southeast Asia.

Although the potential for energy savings is greatest on the drying process, there are opportunities for improve productivity throughout paper making and that benefits all of our product lines. We saw increased bookings in every major product line during the quarter, which was very encouraging. We were especially pleased to see higher orders for our paper making accessories, primarily docking systems and blades, as well as showers and filtration systems in a lot of management product lines.

From the stock prep lines we have been focused on increasing sales of aftermarket products in North America and Europe. I'm pleased to report that aftermarket sales in Q2 were up 12% and 13% respectively in those markets, with higher revenues from parts, retrofit packages, and rebuilds.

The greatest demand for our stock prep systems continues to come from China, driven by ongoing capacity expansion in recycled paper production. We reported a record $21.3 million in stock prep revenues from China in Q2. What's more, we continue to see strong demand for these products in China. During the quarter we received orders totaling $16 million from two long-time customers, both leading producers of liner board and other packing materials. One was for an advanced stock prep system and will recover and process fiber for recycled corrugated containers. The other was for two complete systems that will be used for a similar application. These significant orders contributed to stock prep bookings from China totaling $20 million during the quarter.

In the first six months of 2006 we have booked $49 million in stock prep orders from China. That's more than double our bookings there in all of 2005. As we said before, orders from China can be choppy from quarter-to-quarter, so we don't expect them to continue at this pace. We believe, however, that China and Asian markets in general present a major, long-term opportunity and that Kadant's well position to benefit because of the number of steps we've taken. We've established leadership in stock prep and we believe our name and value recognition will help us to increase sales in our other product lines as well.

The significant [inaudible] equipment orders are expanding on an installed base throughout China in all leading mills, which we believe will present a major opportunity for higher margin aftermarket sales going forward and will minimize some of the volatility in orders we've seen in the past.

We've expanded our local presence in China, first with the addition of the food handling facility in Shanghai through Kadant Johnson and now with the addition of the stock prep operation in [Xianggang] through the YE acquisition, which we are now operating as Kadant Xianggang. Both of these facilities will serve as a base for market support throughout Asia, as well as supplying [inaudible] parts and components to our North American and European operations.

Although we've made a lot of headway and we are currently doing quite well, we continue to focus on improving in a number of areas that we believe will lead to long-term growth. First, we intend to leverage our growing installed base in China to increase aftermarket sales there. It's important that we capture a larger share of the parts and consumables stream generated from our installed base and I believe we can offer our customers the value to make that happen.

We're also working to increase sales of our paper machine accessories and water management products in China. Our market share for these products in China is far from the level of North America and Europe. Given our technology, our manufacturing base there, and our presence in stock prep, we should have some success here. We also need to source more components from our low cost manufacturing bases in China and in Mexico. We've made a lot of progress here, but there's still more to do. Increased sourcing from these regions will improve our margins throughout the world. Last, we continue to pursue applications for our products outside the paper industry, which we now have much greater access to through Kadant Johnson. This is more of a longer-term goal, but I believe there are uses for many of our technologies outside the paper industry. By capitalizing on these opportunities, we believe Kadant will be well positioned for growth in the long term.

As for 2006, our strong results in the first half should keep us on track to achieve a solid growth year. Following another quarter of excellent bookings, we anticipate a strong third quarter as well, as we stated in the press release. We expect to report GAAP diluted EPS of $.35 to $.37 from continuing operations in the third quarter on revenues of $88 million to $90 million, thus [inaudible] to raise our guidance for the full year. We now expect to report from $1.20 to $1.28 of GAAP diluted EPS from continuing operations, up from our earlier estimate of $1.18 to $1.25. We expect revenues to be in the range of $320 million to $330 million, which is $20 million higher than we originally forecasted and includes our Kadant Xianggang acquisition.

On that note, I will turn the call over to Tom for his review of the financials. Tom?

Thank you, Bill. I'll start with our revenues. Consolidated revenues were a record $89.6 million in the second quarter 2006, up 38% over last year's $65.1 million. Our results this quarter include incremental revenue of $10 million from Kadant Johnson, which was acquired roughly halfway through the second quarter of 2005 and $.7 million from our newest acquisition Kadant Xianggang acquired in June 2006. Including the increases from these two acquisitions and the immaterial effect from foreign exchange, revenues increased 26% compared to the second quarter of 2005. Kadant Johnson's revenues, which have increased each success quarter since the acquisition, were $21.1 million in the second quarter of '06.

Our guidance was $85 million to $87 million for the quarter and we exceeded this largely due to a second consecutive record revenue performance in our stock prep product line. Now, let's look at revenues in our major product lines, starting with stock prep. Revenues in our stock prep product line were $40.9 million, up 40% over last year, including 2% from Kadant Xianggang, whose results will be reported in our stock prep product line and a 2% unfavorable effect from foreign exchange. Stock prep revenues in China, including Kadant Xianggang, were a record $21.3 million in 2Q '06, more than triple the second quarter of 2005. Most of the revenue in China was derived from several large system orders, which we recognize as revenue on a percent complete method and which will be shipped to customers later this year.

The strong performance in China was partly offset by lower revenues at our North American and Europe based stock prep operations. Stock prep revenues in North American were down 16% from last year largely due to a very strong sales performance in our [chemi washer] product line last year. Encouragingly, aftermarket sales in this product line were up 12% in North America, compared to last year.

Stock prep sales in Europe were down 9% from 2Q of '05, including a 5% reduction from foreign exchange. Following the same pattern that was in North America, aftermarket sales in Europe increased 13% over last year.

Our water management product line also has solid revenue performance in the second quarter of 2006. Revenues here were $9.5 million, their highest level in five years, and increased 37% over the second quarter of 2005. North American based revenues were up 25% compared to last year and our European based revenues more than doubled, both led by robust sales of capital products. North American results include approximately $1.8 million of a $3.8 million order, which we announced in February for equipment used in the [foaming] section of a paper machine. The remainder of this order, which is the largest order we have ever taken for this kind of equipment, will be shipped and recognized as revenue in the third quarter of 2006. We are also quite pleased with the bookings performance of this product line in 2Q '06, up 15% over last year.

In our accessories product line revenues were $14.4 million in the second quarter of 2006, down 6% from last year. North American revenues were 3% lower than 2Q '05, including a 1% favorable effect from foreign exchange and European revenues were down 12%, including a 3% unfavorable impact from exchange. More so than in our other product lines, accessory revenues have been and continue to be adversely affected by mill consolidation and machine shutdown, both in North America and in Europe.

Nevertheless, we were quite encouraged by the improved bookings performance here in the second quarter of 2006. Accessories bookings were up 10% in 2Q '06 compared to last year and were higher in all of our operating units in North America and Europe.

Revenues in the food handling product line at Kadant Johnson increased for the fourth consecutive quarter since the acquisition of this business in May 2005. Revenues here were $20 million in 2Q '06, compared to $10.6 million recorded in the shorter period last year. This product line continues to benefit on a worldwide basis from our customers' increasing focus on improving energy efficiency in their manufacturing operations. On a sequential basis, revenues are higher in Europe, Latin America, and China.

[inaudible] quarterly revenues, which are included in the other category on the chart attached to the press release were $3.1 million in 2Q '06, an increase of 49% over last year. The increase was due mainly to higher volume and improved pricing in our family of Biodeck granular products, which are made from papermaking by-products and are used in various home, lawn and garden, and agricultural applications.

Turning to our product gross margins, consolidated product gross margins were 36.5% in the second quarter of 2006, down 150 basis points from last year's 38%. Most of this decline was due to lower margins in our papermaking systems segment, where product gross margins were 36.8% in 2Q '06, down 120 basis points from last year. As we noted during last quarter's earnings call, several of the larger systems orders we [inaudible] in the first half of the year were at lower than normal margin levels and this was especially the case in our stock prep product line.

In the longer term, of course, we should benefit from sales of higher margined aftermarket products, which will flow from these capital sales. In the short-term, however, we will see some deterioration in our margin percentages in this segment.

Product gross margins in the other category were 30.7% in 2Q '06, down from 37.2% last year, entirely due to the inclusion of the casting products operation of Kadant Johnson. The unfavorable performance in casting products more than offset higher product gross margins in [inaudible], where margins improved over 400 basis points in spite of higher cost of natural gas used in the manufacture of our [inaudible] products.

Now, let's look at our SG&A expenses for a moment. SG&A expenses were $22.5 million in the second quarter of 2006, up $4 million from last year. This increase includes $3.4 million of incremental SG&A from Kadant Johnson, which we owned for only a portion of the second quarter last year. It also includes $.03 million of SG&A from Kadant Xianggang. Excluding the impact from Kadant Johnson and Kadant Xianggang, as well as an immaterial effect from exchange, SG&A expenses were up $.04 million or 2% in the second quarter of 2006, compared to the second quarter of 2005. As a percentage of sales, SG&A was 25.1% in 2Q '06, down 330 basis points from last year due to the better leverage experience with a higher level of sales.

On to EPS, we reported GAAP diluted earnings per share, including the discontinued operation, of $.35 in the second quarter of 2006, compared to last year's reported EPS of $.24. The discontinued operation incurred a loss of $.05 in 2Q '06 due to higher product warranty expenses, compared to the income of $.02 in the second quarter of '05. Excluding the discontinued results in both periods, income from continuing operations was $.40 per diluted share in 2Q '06, compared to $.22 in 2Q '05, an increase of $.18 or 82%.

Now, included in the increase of $.18 was $.02 due to a reduction in the effective tax rate, $.06 from a return to profitability [inaudible], and an $.11 increase from the remainder of our operating units. Slightly offsetting these improvements, as we expected, was a small diluted impact of $.01 from Kadant Xianggang.

The effect on EPS from lower shares outstanding and foreign currency translation were all immaterial in the second quarter of '06, as compared to the same period last year.

Looking at EBITDA, consolidated EBITDA was $10.6 million in the second quarter of 2006, the highest since our spin-off from [inaudible] Electron five years ago and one of the highest levels ever achieved in our Company's history. Compared to last year's quarter, EBITDA increased $3.9 million or 58%. Our papermaking systems segment had EBITDA of $12.7 million in 2Q '06, up 65% or $5 million over last year.

Kadant Johnson's fluid handling business contributed a little over half or $2.7 million of this increase, posting an impressive EBITDA to sales performance in excess of 23% in 2Q '06. For this segment, EBITDA as a percentage of sales was 14.9% in the second quarter of 2006, up 260 basis points over last year.

In our corporate and other category, which includes the results of the casting products business, [inaudible], and our corporate expenses, we reported an EBITDA loss of $2.1 million, compared to last year's loss of $1 million largely due to higher corporate expenses and a loss in the casting products business.

Now, let me spend a few moments on the balance sheet and our cash flows. We ended the second quarter with $43.4 million cash and $58.3 million in debt, leaving us with a net debt position, that is debt less cash, of $14.8 million. Net debt as a percentage of our total capital was 6.2% at the end of 2Q '06, slightly higher than our position at the end of the first quarter of 2006.

During the quarter we made two significant changes in our outstanding bank debt. First, in May we entered into a $10 million commercial real estate loan in order to take advantage of long-term interest rates. We used most of the proceeds of this loan to pay down a portion of our floating rate debt. Secondly, as part of the acquisition of Kadant Xianggang, we borrowed the equivalent of $5 million in local currency in China. The effects of these changes net of our cash flows accounted for the small increase in our net debt in the quarter. Our weighted average interest rate on all of our bank debt, most of which is now fixed at attractive long-term rates, was 5.6% at the end of the quarter.

During the quarter we spent $5.4 million in connection with the acquisition of Kadant Xianggang and we expect to pay approximately another $9 million in cash in the third quarter for the purchase of the land rights, buildings, and a premium for the business. We expect to pay an additional $3.8 million over the next 19 months as certain hold back conditions are met by the seller. Also in the second quarter we purchased $.7 million of property, plant, and equipment.

Because we were conserving our available cash in the US for the acquisition of Kadant Xianggang, we did not purchase any of our common stock during the second quarter of 2006.

Our operating cash flows were at negative $2 million in the second quarter of 2006 and this was mainly due to an investment of $9.3 million in working capital most notably in accounts receivable, unbilled costs, and inventory associated with the large orders, which we've booked over the past two quarters. We expect our cash flows to improve in the second half of the year, as many of the large system sales are shipped and the payments are subsequently collected.

Now, before closing, I'd like to give you a few more details on our guidance. First, we expect the effective tax rate for the year and for the second half to be 32%. The lower rate in the second quarter was in effect truing up to this rate for the first half.

Secondly, as we have noted throughout the year and you can infer from quarterly and annual guidance, we expect a modest sequential decline in GAAP diluted EPS in the fourth quarter given the extraordinary booking performance, particularly in China, in the first half of the year, which is contributing to the record sale levels in the second to third quarters. As we have said in the past, orders from China can vary considerably from quarter to quarter.

And, finally, included in the guidance for 2006 is $.03 to $.04 of dilution from our Kadant Xianggang acquisition. We do expect this acquisition to be accretive beginning in 2007 and we will expand on that when we give our 2007 guidance.

And with that, I will conclude my review of the financials and turn the conference back to the operator for our Q and A session.

Operator?

Thank you. [OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile our Q and A roster. Our first question comes from Claudia Shank from JP Morgan.

Just a couple of questions. One on the fluid handling that's been a really good quarter and I know in the past you’ve talked about that business, seeing some opportunities there to ratchet down the SG&A expenses there. And I wondered if the margin improvement we're seeing there is reflective of SG&A or if there still is improvement you guys can make there going forward?

Certainly, I think the improvement we've seen out of Johnson is reflected basically on the increase in revenue that they've had. They've had some very -- you know, very strong bookings and sales results. And, you know, just like any of our operations, we constantly look at, you know, areas of which to cut and trim, and in that case there it would be more pruning than really anything else, but there's certainly could be some opportunities there [inaudible].

And then in terms of sort of the strategy for China and some of the growth of some of your other businesses there, is there much more capital that's sort of required for those? Do you need to hire more people? I mean, what sort of a strategy for attacking some of those measures?

Our capital needs over in China are relatively small at this point. I mean, we just acquired a, you know, very big facility in Xianggang and also when we acquired Johnson they were in the process of completing a doubling in size of their operation near Shanghai. And the additional capital would be relatively minor just to have a small, you know, doctor [inaudible] facility put in to take advantage of the market growth. But we don't see any substantial Cap Ex requirements at all in any of our operations.

And then just, finally, just on [Lamoure]. I guess, Tom you said it was $.06 positive to earnings, but how are things shaping up there following the restructuring?

Well, we continue to make progress. We're not where we want to be yet, but we're certainly headed in the right direction on it and we expect to continue to have that improvement throughout this year.

Thank you. The next question comes from [Stuart Bigeway] from Standard & Poor's.

Stuart Bigeway. I was just wondering, OCC prices have been rising and I was wondering if that has any affect on your business in terms of people looking for efficiencies or that kind of thing at all?

Yes. As the prices go up, they continue to look to optimize their operation and also one advantage that we can provide them is allow them to go deeper into the waste stream, which gives them some advantages as far as the cost of their raw material, so we look at that as a positive side. And this holds true globally for us, because, you know, right now this is a global market and that impacts certainly Asia, North America, and Europe. So that's an opportunity for us.

[OPERATOR INSTRUCTIONS] Your next question comes from [Brian Spygrove] from Wasatch Advisors.

just could you just remind us on stock prep? What's your market share again?

Our market share worldwide, you know, we consider ourselves one of the leaders in that and that varies from year to year, but it's roughly about a third, you know, 30% to 33% worldwide market share with a much stronger market share certainly in China, which has the growth market at this point. There we have a very, very strong market share due to the fact that we have the right equipment, especially taking a look at their thrust in the packaging material, as well as our Kadant Black Clawson operation have been involved in China now for about 25 years, so we've got a very strong market presence there.

Any emerging Chinese competitors?

Well, from -- you know, no. We don't see any Chinese competitors. We face really in a -- in the high end mills that we address in China, we basically have the same competitors worldwide. In fact, the acquisition we made, YE, which is now Kadant Xianggang was involved on stock prep systems, but this is for smaller, what I would call smaller non-world class mills, so -- and they were the -- outside of the -- what I'd call the western suppliers, they were probably the largest supplier of stock prep equipment for those types of mills in that area. So we've really expanded our address market at this point with that acquisition.

Thank you . And just your US side, kind of overall are you seeing any of the paper companies in the US interest sparking up?

Yes, we have. And this has been reflected in some of the bookings that we've had out of our water management and out of our accessories business, as well as our aftermarket channels in the stock prep are. And we're seeing their financial performance improving and especially if you take a look at even on the brown stock or liner board grade, corrugated grades, you know, and those heavy grades make up about half the tonnage in the US and we're seeing some more strength in that. Yeah. We're seeing some opportunities there and we believe that over the last number of years we've really addressed the right issues to help them optimize their operations. And also the Johnson acquisition, which was really a big part of their boost has come about by the high cost of energy and focusing on reducing energy costs.

And so are these just more kind of incremental orders or do you think anything kind of big might break loose here over the next year?

Well, we see incremental orders, but from time to time we also see opportunities to get bigger orders. And, again, it's the timing of those that are important. We don't see -- we're not going to see the same robust, big, huge capital orders that we do in China at this point, but we do see opportunities for modifying machines and upgrading our recycling systems that does represent some good sized orders for North America.

Thank you. [OPERATOR INSTRUCTIONS] We have a follow-up question from Claudia Shank from JP Morgan.

Just had one more question about China. You know, we're hearing all sorts of noise about Chinese newspaper capacity growth and I wondered have you seen much interest from the Chinese newspaper suppliers yet in some of your products?

Yeah. Well, we see -- what we see, Claudia, and that's a great question. What we see is that, you know, certainly as you know in North America and some parts of Western Europe there's been a lot of decline in newsprint and we do see opportunities to -- in China and throughout Asia. And we're certainly seeing more activity in terms of studies and as we look at projects going downstream, we see some opportunities there for us. They're starting to -- you know, should start to emerge.

Thank you. There appears to be no further questions at this time. I would now turn the floor over to management for any closing remarks.

Okay. Thank you very much. And just a brief closing comment is that, you know, we certainly have taken a number of steps during the past year and in previous years to position Kadant for growth. You know, we are pleased to see that they are paying off. We had a terrific first half and expect to finish with a growth year. I look forward to reporting on our progress next quarter. Thank you.

Thank you. This concludes today's Kadant Conference Call. Have a nice day. You may now disconnect.