Kadant Inc (KAI) 2007 Q3 法說會逐字稿

Good afternoon. My name is Lenny and I will be your conference operator today. At this time I would like to welcome everyone to the Kadant Incorporated earnings teleconference call. (OPERATOR INSTRUCTIONS) Thank you. It is now my pleasure to turn the conference over to your host, Mr. Thomas O'Brien, Chief Financial Officer of Kadant. Sir, you may begin your conference.

Thank you, Lenny. And good morning, everyone. Welcome to Kadant's third 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 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 period ended June 30, 2007, 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 third 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, and thank you for joining us today as we recap our third quarter 2007 results. I'm pleased to report record results for our Company in a number of key areas.

Before I discuss our results, I would like to note that the folks at Forbes Magazine have recognized something that I have known for a long time when they listed Kadant as one of the 200 best small companies in America.

Now let's begin with a review of the financial highlights of our continuing operations as compared to our third quarter last year. Our revenues for Q3 were a record $92.7 million, an increase of 2% from the prior record for revenue in Q3 of last year. Both our stock preparation and food handling business had record revenues this quarter. The food handling business saw revenue growth of 15% over strong Q3 performance last year. In addition, our accessories business grew their revenue 9%. Operating income grew 7% to $9.9 million as compared to the 2006 with our core paper making business up 16%. Operating income was 11% of revenue in the quarter.

You may recall that at the beginning of the year, I talked about several programs we plan to undertake in '07 to improve our operating margins including shifting production to lower cost regions, increasing after market sales, and increasing sales of accessories, and water management products in China. The improvements we see in our margins as a result of those programs as well as better overall execution at our business units. Other financial highlights include our EBITDA which was up 6% from Q3 '06, $11.7 million, or 12.7% of revenue. Our diluted EPS was $0.49, exceeding the high end of our guidance by $0.10. This is the highest quarterly EPS we have had since our spin off from Thermo Electron in 2001.

We also had a record bookings quarter with orders totaling $106 million. We had exceptionally strong bookings in our stock preparation business of $58 million, a 66% increase over Q3 last year. As we have noted in the past, our stock preparation business is characterized by large system orders so the bookings pattern is somewhat variable from quarter to quarter. We were also pleased with bookings in our accessories business which recorded a 10.6% increase, $16.4 million. The strongest bookings in Q3 contributed to our record backlog of $103 million at the end of the quarter, beating our previous record set last quarter.

With very strong performance in the first three quarters of the year, we feel very good about 2007. Let's discuss the outlook for the remainder of the year. In general, market conditions are encouraging. Let me review the major regions.

The Asian market remains strong. We have seen good booking activity in our major product lines in that region including several large system orders. In the third quarter our stock preparation business received several important project orders from leading producers in Asia including a $13 million order for three banking and OCC stock prep systems in Vietnam which will be delivered in 2008. In addition, we received three order with a total value of $6.5 million and we also received pending orders for a total of $22 million for OCC systems for customers in Asia. We expect that most of the revenue associated with these projects will be recognized in '08. I want to remind you that we will record the $22 million of pending orders as orders when we receive the down payment. The timing of when we receive the down payments can be unpredictable.

We're also encouraged by unusually strong spare parts bookings in Q3 for stock prep equipment in China of $1.5 million. Developing a strong spare parts business in China is one of our major initiatives and we're glad to see good demands for our products. The key to increasing our spares business in China is local manufacturing of our parts and we hope to increase a number of locally produced spare parts throughout next year.

One area of success has been the sale of our wedge wire screen baskets produced at our screen basket facility in China. This facility is supplying baskets to our customers in Asia and around the world. I'm happy to report bookings for this product has been very strong in all of our major markets. In order to keep up with demand, we have increased our manufacturing capacity throughout this year and we expect to further increase capacity in '08. We're also making steady progress manufacturing components of our stock prep product line in China.

We have manufactured components for several of our products this year and we are beginning to do complete manufacturing and assembly of some equipment at our facility in June '08. We plan to increase the number of products we can produce in China over the next 12 months. Manufacturing these products in China will help us serve the growing Asian market and also improve our margins throughout the world. We are seeing margin improvement in our stock prep product line as a result of these actions and we expect this trend to continue.

We successfully fabricated and tested our first significant shower, doctor, and filter orders in our [wishi] facility in China. These products will be installed in three of China's premier paper mills, producing fine paper during the fourth quarter and providing a great platform from which to market our spare parts. Our efforts to sell accessory water management products in China continue to progress with new blade accounts being won and repeat blade orders being placed by some of the largest mills in China.

The North American market continues to impress us with its strength. Most of our U.S. based businesses experienced solid bookings in the quarter. The stock prep business received an $8 million order for evaporation systems from a major craft pulp mill in the southeast. The mill has the option to expand the order to include construction and installation which if exercised will increase the total order to approximately $19 million.

We're also actively pursuing other significant stock prep orders in North America. Our fluid handling business continues to benefit from high energy costs with strong demand for their energy efficient products. In addition, we believe the severe drought in the southeastern United States has created opportunities for our water management business as mills seek to minimize their use of fresh water. High oil prices and restriction on water usage makes our products more attractive to customers. Under the current conditions, the return on investment for our products can be compelling, making investment decisions very easy for our customers. We now are optimistic North America will continue to show modest growth with the market in Canada considerably weaker than the U.S. and Mexico.

We've also seen a noticeable increase in orders from South America for our food handling business as investment in the pulp paper industry in this region continues to grow. We expect to see good growth in South America as the region benefits from access to low cost fiber in an increasingly tight worldwide market for fiber.

Our western European market remains weaker than North America. Eastern Europe, however, has been a bright spot. We have booked over $10 million of orders for stock preparation in Russia this year, including a large order booked in the third quarter for a stock preparation system for a 120 per day tissue mill. Our fluid handling business in Europe had record revenues due in large part to several systems orders received earlier in the year from Eastern Europe. Older, less efficient machines are being upgraded and our products are critical to improving performance. We're optimistic this trend will continue.

We also continue to pursue growth opportunities outside the paper industry. For example, we recently received an order for $1.9 million for dewatering equipment in North America for processing corn. We have received orders for $3.8 million of dewatering equipment for the corn and ethanol industry so far this year. Sales of our food handling products outside the paper industry continue to be strong. Sales of these products are up over 30% in the first three quarters of this year when compared to 2006.

Finally, we continue to look for acquisition opportunities that complement our business. Our worldwide distribution capability as well as our low cost manufacturing base means that we can often add value to potential acquisition.

Now let's review our guidance. For the fourth quarter, we expect to report diluted EPS of $0.42 to $0.45 per share on revenues of $94 to $96 million. Our record EPS performance in the third quarter combined with solid bookings and backlog leads us to increase our annual EPS guidance for '07. For the full year we now expect diluted EPS of $1.66 to $1.69 in continuing operations, revised from our previous estimate of $1.49 to $1.59 per share. We also expect '07 revenues of $364 to $366 million, revised from our previous estimate of $360 to $370 million.

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 $92.7 million in the third quarter of 2007, 2% higher than last year, including a 3% favorable effect from foreign exchange. The 1% decline in internal growth was primarily due to the casting products business which we sold in April of this year. Reported revenues in our paper making systems segment were a record $91.1 million, 3% higher than the previous quarterly high set in the third quarter of 2006 and included a 3% favorable effect from foreign currency.

Looking at our revenue performance in general, we had very strong revenues in the fluid handling product line which also set a quarterly record in the third quarter of 2007. Encouragingly, we had another solid revenue performance in our accessories product line. Stock prep revenues were slightly higher than previous quarterly records set in the third quarter of 2006. Revenues in our water management product line were lower than last year where the comparison is to a very strong quarter and I will discuss this in more detail in a moment.

So that is the general overview. Let's now take a look at each of the revenue performances in these major products lines.

Stock prep revenues were a record $41.8 million in the third quarter of 2007, 1% higher than last year including a 2% favorable effect from foreign exchange. For the first time, both the 2006 and the 2007 periods include full quarterly results from our most recent acquisition, Kadant Jining, which we made in June of 2006. Stock prep revenues in our North American based operations increased 38% over the third quarter of 2006, entirely due to revenues recognized under the percentage of completion method related to the $8 million evaporation system order which we announced earlier in the quarter.

Continuing with stock prep, revenues in China, including Kadant Jining were $18.9 million, down 13% from last year's record level including a favorable effect of 2% from foreign exchange. We continue to be encouraged with the strength of the demand for our stock prep products in China where we have recorded revenues of over $52 million in the first nine months of 2007, slightly higher than the same period last year. If we obtain our revenue targets in the fourth quarter of 2007, we expect to achieve record stock prep revenues in China for the year, in excess of $65 million.

And finally, to finish the stock prep discussion, revenues in Europe were down 8% from the third quarter of 2006 including a favorable impact from foreign exchange of 8%. The decline in Europe is primarily due to the timing of a number of capital projects. I should note that we did have very strong stock prep booking in Europe in the third quarter of 2007, almost tripling from the third quarter of 2006.

Revenues in our water management product line were $7 million in the third quarter of 2007, a decrease of 21% compared to the prior year, including a favorable effect of 1% from foreign exchange. Revenues were lower in both North America and in Europe, primarily in the capital components of the business.

Of note is that we are comparing to a very solid quarter last year when we recognized $1.9 million in revenues from a large farming system order and that the bookings performance in this product line was more encouraging. Bookings of $7.6 million in the third quarter of 2007 were up 7% sequentially and were only slightly lower than the same period last year.

Continuing on with my discussion of revenues and our major product lines, the accessories product line had another solid performance in the third quarter of 2007. Revenues in this product line were $16.7 million in the third quarter of 2007, an increase of 9% over last year, including a 4% favorable impact from currency. The results here were led by a significant increase in the U.S. business which was up 14% compared to last year, due mainly to higher capital and parts revenues.

We continue to be impressed with our accessories team, has been able to grow the business in spite of a number of mill closures and machine shut downs in the U.S. In Europe, accessories revenues were up 11%, all of which was due to foreign exchange.

And to end my discussion of revenues on a most encouraging note, revenues in our fluid handling product line were a record $25.1 million the third quarter of 2007, up 15% over last year, including a 6% favorable effect from foreign exchange. Here we had solid revenue growth in each of the three largest businesses in this product line. Europe was up 32% including 10% from foreign currency, China increased 17% including 8% from foreign currency, and the U.S. was up 14%. This product line which you may recall we acquired in May 2005 continues to benefit from higher energy prices which have led to a number of steam system projects driven by energy efficiency requirements in many paper mills throughout the world. In addition, our fluid handling business in China is benefiting from higher capital sales and new paper machines.

Now turning to our product gross margins, consolidated product gross margins were 38.1% in the third quarter of 2007, up 250 basis points from last year. All of this improvement occurred in our paper making system segment where gross margins of 38.4% were 260 basis points higher than last year. The improvement in our paper making systems segment was due to higher margins in our capital and after market products which accounted for approximately 220 basis points of improvement and the remainder was due to a small favorable effect from product mix. Needless to say, we were quite pleased with the gross margin improvement in the third quarter and we were especially encouraged with another increase in our fluid handling gross margins.

Now let's look at our SG&A expenses for a moment. SG&A expenses were $24 million in the third quarter of 2007, up $2.5 million or 11% from last year. This increase includes approximately $800,000 or 4% from the unfavorable effect of foreign exchange. In addition, the 2007 period includes $500,000 or 2% of stock equity expense which we did not incur in the 2006 quarter. As a percentage of revenues, reported SG&A was 25.9% in the third quarter of 2007, up from 23.8% in the third quarter of 2006.

Our EPS results, we reports GAAP diluted earnings per share including the discontinued operation of $0.40 in both the third quarters of 2007 and 2006. Due to higher warranty claims, the discontinued operation incurred losses of $0.09 per diluted share in the 2007 quarter compared to $0.01 in the 2006 quarter. So excluding the discontinued results in both periods, income from continuing operations was $0.49 in the third quarter of 2007 compared to $0.41 in the third quarter of 2006, an improvement of $0.08 per diluted share. This improvement of $0.08 per diluted share includes an increase of $0.04 due to a lower effective tax rate and $0.02 due to the net favorable effects of foreign currency translation. Diluted EPS was lowered in the third quarter of 2007 by $0.02 due to an increase in non-cash employee equity compensation expense.

Now all these factors together account for a net increase of $0.04 and since I'm explaining an increase of $0.08 between the two periods, it leaves us with an increase of $0.04 attributable to better operating results in our paper making systems segment in the third quarter of 2007 compared to last year. I should add here that the reduction in the tax rate in the third quarter of 2007 consisted of a decrease in the recurring effective tax rate to 30% which had an impact of $0.02 per diluted share and several non-recurring decreases in tax expense which occurred in several tax jurisdictions, most notably the U.S. which also had an impact of $0.02. We expect that the recurring effective tax rate in the fourth quarter of 2007 will be approximately 30%.

Now let me conclude my remarks with a few comments on the balance sheet and our cash flows. We ended the third quarter with $40.4 million in cash and $47.6 million in debt leaving us with a net debt position, that is debt less cash, of $7.2 million. Our net debt has declined by approximately $7.1 million or 50% as compared to the balance at the end of 2006. Although cash flows are famously difficult to forecast, we believe that there is a reasonable probability that we will be net debt free within the next few quarters, possibly as soon as the end of 2007. Net debt as a percentage of our total capital was 2.7% at the end of the third quarter of 2007, down from 6.8% in the third quarter of 2006. The ratio of our net debt to our last 12 months EBITDA was less than 0.2.

Cash flows from continuing operations were $3.9 million in the third quarter of 2007, 5% lower than last year's $4.1 million. For the first nine months, cash flows from continuing operations were $7.7 million in 2007, more than doubling over the same period last year in spite of significant investments in working capital associated with several large system order, especially from China. In China, as you may know, the payment terms are traditionally and significantly less favorable to suppliers than in other parts of the world. With that in mind, our investment in working capital of our continuing operations, here defined as excluding cash and debt was 18.5% of our last 12 months' revenues in the third quarter of 2007, up from 14.8% a year ago. We do expect to improve upon this measure in the next several quarters.

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

Yes. Thank you. (OPERATOR INSTRUCTIONS) Your first question is coming from Mike Hutchison.

Good morning.

Good morning, Mike.

Do you guys think that the recent strength in North America is going to continue into 2008? It seems like there's been a big change here that now North America you're starting to see a lot of strength on both sides of the business -- parts and the larger orders.

Mike, I do think it's going to continue for the following reasons; I think that a lot of the capacity has been taken out -- has been taken on and I think our customers are starting to see better cash flows. You see selling of timberlands or in some cases going private such as GP. And I think that the focus on the high energy costs has really driven a lot of our product sales. It especially impacted very positively the fluid handling business, but also we see a lot of activity concerning water. We see basic upgrading and stock prep has benefited as well because they can afford now to put new systems in. And also just impacting energy such as the evaporator systems that we had to set up -- we announced. And that was really primarily driven by high energy costs again. So we do benefit from higher energy costs and basically just upgrading production machinery as well. More efficient.

So you think this order that you got in the U.S. for the evaporator system with Black Clawson, you think that's going to lead to other similar orders where they want to save on energy?

Potentially, it could. Yes. It could.

If I could ask one other question --

Certainly.

Based on your orders for 2008 because you've booked quite a bit here in the past couple books, where do you see margins going? I know with these larger orders they tend to have a little bit of a negative impact. Where do you see those going next year?

We do have a -- on the larger systems we don't enjoy the same margins as we do certainly on the parts and consumables piece of our business. On the other hand, we expect to see improved margins out of our stock prep systems, primarily due to more of a focus on manufacturing within China as well. So we look at that as a continuing margin opportunity that's not really going to help us on the orders going into Asia, but as well as orders going into North America and Europe as we supply more components from China. And as well as we see continued improvement in margins throughout most of our business units at this point, primarily because of what we have done over the past couple of years in shifting more of our manufacturing into lower cost regions such as Mexico as we shifted a lot of our capital orders from water management and the accessory business into Mexico. We expect that to continue.

So going forward net-net you see the margins maybe improving a bit despite the fact that you've got these large capital orders?

That is certainly our goal. Yes. And I think we've taken a lot of steps to help achieve that.

Okay. Thanks a lot.

Alright. Thanks, Mike.

(OPERATOR INSTRUCTIONS) Your next question is coming from [Tyler Oh].

Hi. Good morning. And congratulations on the strong quarter.

Good morning, Tyler. And thank you.

I was wondering if you could talk or go into a little bit more detail on mix this quarter, especially in the paper making equipment segment. If I look at EBIT margins there, they're certainly up a little bit more than I would've expected, especially given the larger proportion of the stock prep. Is there something going on there with mix or is more of this just shifting production off-shore?

I think it's a combination, Tyler. I think some of it is due to shifting production within China, a lot of big cap orders as well as certainly we've been focusing on the after market piece of that business too in parts and consumables. Now with our large install base that we've been putting into China for example, we should start the benefit as they require parts and some of the consumable business that we look at as well as the basket facility that we have going in China I think is going to help us a great deal in margin opportunity in the stock prep area.

Just on the wedge wire baskets in that facility, how much capacity is there? Are you running up against -- are you capacity constrained there?

Yes and we've been working on that. We have more machines on order that keep pace. Fortunately that doesn't require a great deal of capital investment on it but we thought we had enough capacity to take us for awhile but with all the business coming out of China and the big orders that are coming in, that's impacted deliveries into North America and into Europe. So we intend on continuing to increase capacity to meet the demand. But that's a great opportunity for us.

And then on one of your customer's conference calls this morning the company was talking a lot about continued upward pressure on fiber prices, especially OCC and I think must of us are of the view that high OCC costs are going to persist for the foreseeable future. What sort of opportunities are there from an innovation standpoint that could help with this?

Yes. Unlike our customers, we can benefit from higher OCC costs and because we've demonstrated that we will dig deeper into the waste stream that allows them to pay less for their waste, for their OCC as well as we can provide them with a better yield from it. In other words, there's less good fiber in the reject stream. And that's often when prices go up is when the existing mills, the more mature mills look at probably optimizing their stock prep system if they have a dated one and also that gives us an advantage on which -- this is one of the primary reasons we do so well in China because there they not only pay for the cost of OCC here, they need to ship it a long distance. So we look at that as an opportunity. And I think right now we are armed with the technology to benefit from that.

I guess the follow up is as corrugated recovery becomes more developed in Asia, is there an opportunity there for partnership or joint development given the technology that you possess with one of the larger waste collection companies over there.

One of our larger customers over there as you know is Nine Dragons which is involved in waste collection and that's been a big part of their business but we constantly look because I think the biggest opportunity comes from going deeper into the waste stream and getting more mixed waste. And again, we have developed and continue to develop technology to address that part of technology.

And then just switching gears a little bit, given the success that you've had with the Kadant Johnson acquisition and with the Jining acquisition now, pretty well positioned, what's the strategy going forward here in terms of growth and where do you see the most opportunities there?

I think we see -- certainly we see growth opportunities internally with the technologies we have by applying them to other industries. That is one that we continue to work on and we are getting good results on it as well as we see opportunities because the paper industry, as you know, it's forecasted to grow substantially throughout Asia as well as Eastern Europe. And there's also still the need I strongly believe to retool equipment in North America which provides us a great opportunity. So internally we see a lot of opportunities to continue to grow the business and we continue to grow new products as well as on the acquisition side.

I mean the fact that as Tom commented that we're going to be basically -- we could be debt free certainly in the next couple quarters and maybe by the end of this year. Because we generate great cash flows and we don't require a lot of cash to operate our businesses. We have an opportunity on acquisitions and we would look most within the paper industry. We add on the fiber line. We're in the paper machine side of the business. There's opportunities within those two regions but there are also opportunities we could look at in the converting side of the business. But we deal with the same customer base but also expand our addressed market.

And again, we continue to scout out opportunities outside the paper industry as well, industrial markets where we can take our products in and maybe if we could acquire someone with a good distribution and a product that would be complementary, that would be another source of growth for us.

Just lastly, since you said it about being net debt free perhaps by the end of the year and the Company's generating a lot of cash. How do you think about the capital structure here?

I'm going to let Tom get some comments on that, Tyler.

As we said before, Tyler, our target in terms of net debt to total capital would be in the range of 20% as an upper limit. We could go higher than that if the opportunity presented itself. So as Bill mentioned, if we do acquisitions, we still have repurchases that are on the plate and we'd be applying our cash towards internal growth, repurchases of the stock, and also acquisitions down the road. We're well armed in the balance sheet to do a lot of that and still stay within our targeted capital structure of 20% net debt to total cap.

Great. Thanks very much.

Thank you, Tyler. With that I understand there is no more questions in queue, so just a couple closing comments.

First off, thank you, operator, and in closing I'd like to say that I'm pleased with Kadant's performance so far this year. And I believe we are well positioned for continued growth in '07 and going through 2008. Market conditions are generally improving, as I commented, around the world and we believe we have several opportunities to improve our top and bottom lines.

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

Thank you. This concludes today's Kadant Incorporated Earning Call Teleconference. You may now disconnect.