Kadant Inc (KAI) 2007 Q2 法說會逐字稿

Good morning. My name is Showanna and I will be your conference operator today. At this time I would like to welcome everyone to the Kadant earnings conference call. (Operator instructions)

It is now my pleasure to turn the call over to your host, Mr. Thomas O'Brien, Chief Financial Officer. Sir, you may begin your conference.

Thank you, Operator, and good morning everyone, and welcome to Kadant's second quarter 2007 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 statements for purposes of the safe harbor provisions under the prior 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 period ended March 31, 2007 [sic], which 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 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 any 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 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 Investor 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&A session. Bill?

Thanks, Tom. Good morning, everyone. Thank you for joining us today as we recap our second quarter 2007 results. I'm happy to report another strong quarter in what is shaping up to be a very good year. Let's begin with a review of the financial highlights of our continuing operations as compared to our second quarter last year.

I remind you that Q2 of last year was an outstanding quarter for us, setting a record at the time for revenue. Revenues for Q2 were $89.1 million, which is down slightly from Q2 of last year, including a 3% favorable affect from foreign exchange. We exceeded the upper end of our revenue guidance by $3 million. We were pleased with the revenue growth in our accessories and food handling business, which grew 10% and 7%, respectively.

Our operating income grew 5% to $9.2 million, as compared to the '06 quarter, with our core paper making business up 11%. Operating income was 10.3% of revenue in the quarter.

Our EBITDA was up 9% from Q2 '06 to $11.5 million, or 12.9% of revenue. Diluted EPS was $0.42, exceeding the high end of our guidance by $0.04. Our EPS results include a loss of $0.02 per diluted share related to the sale of Kadant Johnson's casting business, and $0.01 for employee equity compensation expense.

We had another solid bookings quarter with orders totaling just under $92 million. Our food handling business had record bookings of $27 million, a 19% improvement over last year.

Finally, we ended the quarter with our highest backlog level ever, $87 million, which positions us well for the second half. With a solid first half under our belt, we look forward to yet another successful year.

Let's discuss the outlook for the remainder of '07. In general, market conditions are encouraging. Let me review the major reasons. The Chinese market continues to grow rapidly. We have seen strong booking activity in our major product lines in that region. Our food handling business in China received several important project orders from leading producers. Quote activity has also been strong so we're fairly optimistic about booking prospects in the second half of the year.

I'm happy to report that the blade line for accessories business in China is up and fully functional. We are now receiving and processing orders on a regular basis. Trials are also being run on many paper machines in China and we are beginning to see repeat orders.

In addition, our principle accessories and water management products are now being made in China. We are pleased to see the leading Chinese paper producers recognize the value of our products in maximizing the performance of their paper machines. These products provide enhanced value because of their after-market potential.

Bookings for stock prep in China exceeded $21 million for the second quarter and were just under $46 million for the year. Quoting activity has also been robust which should lead to strong bookings in the second half of the year. Many of the leading producers in China are planning significant capacity expansions and we are well positioned to supply stock prep equipment for many of them.

The North American market continues to be a mixed story with some grades such as tissue and non-quoted free sheet doing fairly well, while other grades such as newsprint are struggling. In general, orders for our North American based business were down slightly from Q2 of last year. We are also actively pursuing some significant orders. We expect North America to show modest growth with the market in Canada considerably weaker than the U.S. and Mexico.

On to Europe. The Western European market is undergoing consolidation similar to what had occurred in North America, resulting in that market being a bit weaker. Nevertheless, our European-based business saw slightly increased bookings in Q2 versus last year.

Eastern Europe has been a bright spot. We received a $2.4 million order during the second quarter for a condensate system for a paper producer in Russia. In addition, in early Q3 we secured a $2.1 million order for the inking system for a printing and writing mill in Russia. We also received good activity for other projects in Russia, making it potentially one of the more significant growth markets for our equipment. Russia offers significant growth opportunities in the paper industry due to its abundance of natural resources, growing internal demand, and proximity to rapidly growing markets like China. We have also seen strong bookings for doctor blades from the Czech Republic.

In addition to encouraging market conditions, we believe we have several opportunities to grow our business and improve our margins. We continue to shift manufacturing and procurement from high cost areas in North America and Europe, to lower cost regions such as China and Mexico.

I mentioned earlier the progress we have made in sourcing accessories and water management products in China. We also making steady progress manufacturing components of our stock prep product line in China as well. Manufacturing these products in China will continue to improve our margins and help us better serve the growing Asian market. We're beginning to see the benefits of these actions. We're also working to increase our spare parts business for stock prep in China. By providing parts for install base, we help our customers maximize their investment in our equipment while creating a profitable revenue stream in replacement parts and service for us.

We increased the capacity of our screen basket facility earlier this year and we are planning another significant capacity increase later this year. This facility is supplying baskets to our customers in China and around the world.

We also continue to pursue growth opportunities outside the paper industry. We recently received an order for $900,000 for evaporation equipment from a mining customer in China. In addition, we have sold over 1200 rotary joints in the second quarter for use in the steel industry in China. We believe our growing install base in the steel industry could lead to long term spare parts revenue.

In addition, we have received orders for $1.2 million of the watering equipment for the ethanol industry so far this year.

Now let's review our guidance. For the third quarter we expect to report diluted EPS of $0.37 to $0.39 per share on revenues of $90 to $92 million. For all of 2007 we expected diluted EPS of $1.49 to $1.59 per share from continuing operations on revenues of $360 to $370 million.

Our Board of Directors granted restricted stock units to certain key employees in May this year, and the guidance for the third quarter and full year now includes an expense of $0.02 and $0.05 per diluted share, respectively, for this compensation expense.

Now I'll turn the call over to Tom for a more detailed review of the financials. Tom?

Thank you, Bill. I'll start with an overview of our revenue performance. Consolidated revenues were $89.1 million in the second quarter of 2007, down slightly, 1%, compared to last year, including a 3% favorable effect from foreign exchange. Of the 4% decline in internal growth, approximately half is attributable to our fiber-based products and specialty casting businesses, the latter of which we sold in April.

Revenues in our paper making systems segment, which represent over 95% of our revenues, were the second highest quarterly result we've ever achieved in this segment. Revenues here were $86.6 million in the second quarter of 2007, up 1% compared to last year's second quarter, and included a 3% favorable effect from foreign currency.

In general we had solid revenue performances in our accessories and fluid-handling product lines, while revenues were slightly down in our stock prep product line, albeit comparing to a near record result in last year's second quarter. Revenues in our water management product line were down 10% from last year, again comparing to a very strong quarter in 2006.

Let's now take a look at each of our major product lines in more detail. Stock prep revenues were $40.3 million in the second quarter of 2007, 2% below last year, including a 2% favorable effect from foreign exchange. The 2007 period incorporates the full quarter results from Kadant Jining, whereas last year's second quarter included only one month revenues from the subsidiary, and this had the effect of increasing stock prep revenues by approximately 3%.

Stock prep revenues in our North American based operations increased 16% over the second quarter of 2006, mainly due to a strong performance in the capital portion of this business. As in the first quarter of 2007, the North American capital business is being helped by higher percentage of completion revenues derived from several large systems orders. After market revenues are also up, but only slightly compared to last year.

Stock prep revenues in China, including Kadant Jining were $19.7 million, down 7% from last years' near record level, including a favorable effect of 1% from foreign exchange. Our stock prep business in China remains robust with nearly $34 million in revenues and $46 million in bookings in the first half of 2007, although still predominantly consisting of very large capital systems with comparatively low gross margins.

Stock prep revenues in Europe were down 13% from the second quarter of 2006, including a favorable impact from foreign exchange of 9%. The decline in Europe is primarily in capital products and reflects somewhat weaker market conditions in Europe, along with the timing of larger orders.

Revenues in our water management product line were $8.6 million in the second quarter of 2007, a decrease of 10% compared to the second quarter of 2006, including a favorable effect of 2% from foreign exchange.

In North America, revenues declined $0.8 million from last year, although as I alluded to earlier, last year's strong results included $1.8 million from a large forming equipment order. Encouragingly, we did see a rebound in the market in our core competency products, such as showers and filtration equipment.

Revenues in Europe were down 6% from the second quarter of 2006, including a favorable effect of 8% from foreign exchange largely due to the timing of orders from OEMs.

Turning to accessories, revenues in this product line were $15.9 million in the second quarter of 2007. Compared to last year, revenues were up 10%, including a 4% favorable effect from currency. In North America, revenues increased 11% over last year, including a 1% favorable effect from foreign exchange. This proponent is actually quite noteworthy, given the number of mill closures and machine shutdowns in North America.

Among other strategies to combat these market headwinds, our accessories management team has been successful in taking blade positions from competitors by offering our newer blade materials, and by transitioning existing customers to more technologically advanced composite materials.

In Europe accessories revenues were up 9%, including an 11% favorable effect from foreign exchange.

Revenues in the food handling product line were $21.4 million in the second quarter of 2007, up 7% over last year, including a 5% favorable effect from foreign exchange. Here the revenue performance included increases in Canada, China, the U.S., and Europe, and a decline in Latin America. Compared to its sister companies, our food handling subsidiary in Latin America is more dependent on the capital portion of the business which has been weak so far this year.

In our fiber based product business, those revenues are included in the other category on the chart attached to the press release. Revenues were $2.2 million, down $0.8 million from last year. This decrease was attributable to lower sales of Biodac, offset slightly by increases in other product lines. As we've noted before, Biodac revenues have been, and will continue to be, affected in 2007 by increased competition.

Turning to our product gross margins, consolidated product gross margins were 38.3% in the second quarter of 2007, up 180 basis points from last year. Most of this improvement occurred in our paper making system segment, where gross margins of 38.4% were 160 basis points higher than last year.

The improvement in our paper making system segment was largely due to higher margins in our capital products, and to a lesser extent to a better product mix when compared to last year. Although it is difficult to precisely determine the effects of margins associated with pricing and costs, we believe that we are now starting to see the benefits of our strategy to move more manufacturing output to lower cost regions of the world.

Now let's look at our SG&A expenses for a moment. SG&A expenses were $23.1 million in the second quarter of 2007, up $0.6 million, or 3%, from last year. The increase is entirely due to the unfavorable effect of foreign exchange, which increased SG&A $0.7 million, or 3%, compared to the second quarter of 2006. As a percentage of revenues, reported SG&A was 25.9% in the second quarter of 2007, up slightly, 80 basis points, from last year. We expect that as we grow revenues from current levels, our operating margins will benefit from increased leverage in SG&A.

Now to our EPS results. We reported GAAP diluted earnings per share, including the discontinued operation, of $0.35 in both the second quarters of 2007 and 2006. Due primarily to higher warranty claims, the discontinued operation incurred losses of $0.07 per diluted share in the 2007 quarter, and $0.05 in the 2006 quarter. So excluding the discontinued result (inaudible), income from continuing operations was $0.42 in the second quarter of 2007, compared to $0.40 in the second quarter of 2006, an improvement of $0.02 per diluted share.

This improvement of $0.02 per diluted share includes an increase of $0.01 due to the net favorable effects of foreign currency translation, and decreases caused by the following, $0.04 from the reduction in profitability in our fiber based products business, $0.02 from the loss on the sale of the specialty castings business which took place in April 2007, and $0.01 from an increase in employee equity compensation expense. These factored together account for a net decrease of $0.06 and, with some explaining, an increase of $0.02 between the two periods, it leaves us with an increase of $0.08 attributable to better operating results in our paper making system segment in the second quarter of 2007 compared to last year.

I should note here that in May 2007 our Board of Directors awarded restricted stock units, both time-based and performance-based, to certain employees and officers of the company. The incremental effect of recognizing compensation expense associated with these RSUs in the P&L will be to reduce diluted EPS by approximately $0.02 in each of the remaining quarters of 2007.

A report, including my remarks will be to spend a few moments on the balance sheet and our cash flows. We ended the second quarter with $40.3 million in cash and $50.2 million in debt, leaving us with a net debt position that is debt less cash of $9.9 million. Our net debt has declined by approximately $4.4 million as compared to the balance at the end of 2006. Net debt as a percentage of our total capital was $3.8 percent at the end of the second quarter of 2007, down from 6.2% a year ago. The ratio of our net debt to our last 12 months EBITDA was approximately 0.2%.

We had negative cash flows from continuing operations of $2.7 million in the second quarter of 2007, slightly worse than last year's negative $2 million. As was the case last year, we made a significant investment in working capital during the quarter, associated with several large system orders, especially from China, which are scheduled to be paid later in the year and in some cases in early 2008. Nevertheless, for the first six months of 2007, our cash flows from continuing operations were $3.8 million, up $4.1 million over the same period last year.

Although we will likely continue to carry a larger than expected investment in working capital as are several large system orders move through the procurement and manufacturing processes, our working capital position remains solid. Working capital of our continuing operations, here defined as excluding cash and debt, was 16.1% of our last 12 months revenues in the second quarter of 2007, slightly lower than last year's 16.8%, and well within the average performance range for this measurement over the past three years.

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

(operator instructions) Our first question is coming from Michael Hutchison of Barrington Research. Please go ahead.

Good morning. Could you talk about the progress in the aftermarket business in China? I know that you had said that the blade line was up and running there. I guess what I'm trying to get at is what sort of run rate you're looking at for this year and next year.

That's a tough one for us, Mike, because we're really just getting started in that business. I will say this; I think we've been pleasantly surprised as to the acceptance of our technology and voyage into that marketplace. And right now, we're in the process, as I commented, where the number of mills -- are putting them in position, the new mills, and testing them; and the test results have been very encouraging, because we're really upgrading the blade technology in China.

We're offering blades that they've not seen before and some of our composite blades. So I would expect on the install base that we have that we're going to get considerable growth. It's just that it's difficult to quantify that at this point. But certainly throughout this year, we're going to continue to increase that business as well as throughout the next couple years. I see that as a great growth opportunity.

Okay. If I could ask one other question. Are you getting any better visibility with your North American paper customers on the large order side?

Yes, as a matter of fact, we are, Mike. We certainly have been encouraged in the first quarter with some of the order activity, as well as the prospects of perhaps coming in on the second half, because we have had some big increase, significant increase in proposals on capital equipment.

Are we're also seeing that a number of them that have sold, whether it be their lumber assets, whatever else, they're starting to really focus on optimizing paper production and reducing their cost, so I'm encouraged by that.

Okay, well thanks.

Thank you, Mike.

Thank you. Our next question is coming from Claudia Shank from JPMorgan. Please go ahead.

Thanks very much. Good morning.

Good morning, Claudia.

I was hoping you could talk a little bit about improvement in the operating margin in the core pulp and paper making equipment business. Was it more sort of mixed related, or was it more a reflection of some of the restructuring you've been doing that drove that margin higher? And how should we think about it here in the next couple of quarters?

I really think it was a combination of both of them. I think we're starting to get a benefit out of our low-cost sourcing into lower cost regions; as well as product mix. I think it was a combination of both of them which helped us increase the margin. And we expect that the operating margins, especially as we shift more into lower cost regions, to continue to improve.

Okay, thanks. And then just in terms of the capacity expansion you mentioned in the screen basket, will that have a material impact on the CapEx guidance you've given for the year?

No, not really, no. The expansion that we needed to make, it's not really going to have a major impact on our CapEx. On the other hand, it's going to really give us a tremendous amount of capacity to serve the growing market needs.

Okay, great. Thanks, guys.

Thank you, Claudia.

Thank you. Our next question is coming from Andrea Sharkey with Sidoti and Company. Please go ahead.

Hi, good morning. How's everyone doing?

Very good, Andrea. Good morning.

I just wanted to ask a little bit about the third quarter guidance. You're showing that sales -- or indicating that sales will be up year over year, but the bottom line, not so much; so I was just curious if there was something in there related to the margin, there's something going on, higher cost that you're expecting, or is it just the extra $0.02 from extra compensation expense, or is there something going on there?

I'm going to turn this over to Tom to answer.

Well, I think you're on part of it, there. It is an incremental $0.02 from the -- actually, it's an incremental $0.01 up, say, from the restricted stock awards. But it's also in the third quarter, our fiber-based products business will probably be down, say, a couple pennies as well from the second quarter. So there's probably $0.03 or $0.04 of just that from quarter to quarter, from second to third. And then the rest of it I would say would be the mix of different sales, obviously, in third versus the second; might be slightly more towards lower margin, higher systems sales.

Okay. And then, if you kind of take the guidance you gave and back into the fourth quarter guidance range, I get $0.37 to $0.47. It seems like a pretty wide range. I was just curious maybe if you could comment a little bit more on -- and also, it's a pretty nice jump in the fourth quarter from the fourth quarter of the prior year. So if you could just maybe talk a little bit about your expectations of the fourth quarter, what would get you to, say, the higher end of that range, versus the lower end? What gives you confidence in your seeing a pretty big jump in the fourth quarter?

Some of that would be, Andrea, the timing of some of the orders that we expect, some of the larger capital orders that -- difficult for us to time, especially those out of Asia; and so depending on how we would receive them, how much percent completion we would recognize.

I think also, Andrea, you're right. If you take the fourth quarter and you derive -- you take the guidance that we've given for the year and you derive the fourth quarter, there is a range in there; but I think the range is reasonable in terms of our outlook right now, what we can see into the fourth quarter. So if we do -- at the low end of the range in the third quarter, it's $0.37; another $0.37 would give us the low end of the range for the year. If we do the high end of the range in the third quarter, it's $0.39, and we could do $0.45 at the high end of the range of the year. So I think it's -- we'll start to narrow that down, obviously, when we give new guidance in November.

Sure. I guess also -- I was also looking at was that last year, you did $0.32. So even if you do the low end, $0.37, it's still an --

It's still an improvement over fourth quarter last year, that's exactly right.

Right, right. And so I guess I was just wondering if there was anything operational that we should be expecting to come through in the fourth quarter that maybe we're not seeing here or we're not going to see in the third quarter.

I don't think so, no.

Okay. That's about it. That's all I had. Thank you.

Okay. Thank you.

Thank you. Our next question is coming from Stewart Scharf from Standard and Poors. Please go ahead.

Good morning, Stewart.

Stewart, your line is live if you have a question. Our next question is coming from Mark McGrath with Kenmare. Please go ahead.

Hi there. Just to pick up on Claudia's question. Could you drill down a little bit and talk about margins and the Kadant Lamort European stock prep business and how that's tracking?

I think, Mark, we're certainly profitable at Lamort, but our margins are not where we want them to be. We still have room for improvement there. We want to get them back to levels that they had historically. So it's a work in progress, but we are making progress with it, and we're going to continue to do so. But also, what will help to some extent is when we get our operation is full swing in China, in Jining, to start serving some components into Lamort as well.

Okay. I think on prior calls you said that you thought that that business could get to a low double digit operating margin. Is that still your belief?

Yes, that's still our belief, because we've done that historically, yes.

Okay. Just -- what's been the holdup?

Well, I think the holdup has been simply -- it's a more difficult process within France than it would be in any of our other operations, and that's been the extent of it. But on the other hand, offsetting that, we certainly have been pleased with the level of revenues that they add. The technology is solid, and they're the ones that participate in the recycling activity within Russia, so they are faced with some nice opportunities.

But it's basic -- what we would look at as basic block-and-tackle issues in the business. This is why we're comfortable we're going to get there. It's just that we're not getting there as fast as we would like.

Yeah. The margin -- I think in Q4 you were saying that it was a low single digit operating margin. Has it improved from there, or is it still at that level?

It's still about that level. We haven't seen the improvement yet that we have, but believe me, that's getting a lot of attention, and we have -- it's a work in process to get us there.

Okay. And then just a second last question. Can you give us any color on your screen business, in terms of how that business is growing, what kind of market share you've got?

I think our market share is still relatively small, because in many cases, this is a relatively new entry for us. On the other hand, we are making good progress, both within North America and Europe, as well as in China; and Europe in particular. On the good news front is anytime we put the baskets in, and our customers had an opportunity to test them and compare them with what is available in the market today, we've had very favorable results on that, so we're encouraged. We expect to continue to grow market share in that. This is why we're going to be increasing capacity at that facility later on this year.

Okay. Thank you.

Thank you, Mark.

Thank you. (operator instructions)

Any other questions, operator?

I'm showing that there are no further questions.

All right, thank you, operator. Just a brief closing comment.

In closing, I'd like to say that Kadant is well positioned for continued growth; and as we were just talking about, we still have some margin opportunities that is going to enhance our value. I think we're doing fairly well in continuing to make improvements. We have things in our hands -- operations in our hands that will continue to enhance, I think, the value of Kadant. And our market conditions are generally improving around the world, and we believe we -- as I commented, several opportunities to improve not only our top line, but also our bottom line.

Thanks again for joining us today and supporting Kadant, and I look forward to reporting on our progress next quarter.

Thank you. This does conclude today's Kadant earnings call. You may all disconnect and have a great day.