Kadant Inc (KAI) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quarter Three 2011 Kadant Inc. earnings conference call. My name is Kelly and I will be your coordinator for today. (Operator Instructions).

I will now turn the presentation over to your host for today's conference, Mr. Tom O'Brien, Chief Financial Officer. Please proceed, sir.

Thank you, operator, and good morning, everyone, and welcome to Kadant's third-quarter 2011 earnings call. With me on the call today is Jon Painter, our President 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 the 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 outlined at the beginning of our slide presentation and those discussed under the heading risk factors in our quarterly report on Form 10-Q for the fiscal quarter ended July 2, 2011.

Our Form 10-Q is on file with the SEC and is also available in the investor section of our website at www.Kadant.com under the heading SEC filings.

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

During this webcast, we may 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 investor news.

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

Thanks, Tom. Hello, everyone. It's my pleasure to brief you on our third-quarter results and our outlook for the remainder of the year.

If you are viewing our webcast presentation, you should have the slide titled business review on your computer screen. If you don't have the presentation on your computer screen, you can find it in the investor section of our website.

As we've done before, prior to the Q&A session we will provide the call-in number for questions.

Overall, we had another excellent quarter all around, I would say. Let me start with the highlights. The strong revenue performance that we saw during the first half of the year has continued into the third quarter. Revenues for the third quarter were $84 million, a 27% increase compared to the same period last year.

Gross margin performance was 43%, which is down slightly compared to last year and lower than the first half. As you may remember, we projected lower gross margins in the second half of the year as we began to ship some of the larger stock prep systems.

We generated diluted earnings per share of $0.80 in the third quarter, which is a record for Kadant, and on an adjusted basis, our earnings per share increased over 50% to $0.47, which beat our guidance of $0.40 to $0.42.

Our adjusted EBITDA margin for the third quarter also increased, from 11.2% last year to 12.6% of revenues this year.

Other highlights, the third quarter was one of our best booking quarters at $95 million. The strong booking performance also led to a record backlog of the company of $128 million. This puts us in a very good position as we wrap up 2011 and begin 2012.

In addition, we had strong cash flows of more than $12 million during the quarter and we ended the quarter in a net cash position of $31 million. We also took advantage of our lower stock price and repurchased approximately 430,000 shares of our stock for $9.4 million.

Finally, I want to comment briefly on our recently-filed class-action settlement with respect to our discontinued composite building products business. We essentially have settled this because it's really more expensive to litigate it than to settle it. We continue to think that the plaintiff's allegations are without merit and we really want to get this time-consuming, expensive litigation behind us.

Under the terms of the settlement, the original deck owners who had damage and can prove that they bought the product from our composite subsidiary, and they do this typically by producing a receipt, will receive up to $1.00 per foot or the right to purchase replacement decking at a discount. The settlement is subject to a $5 million aggregate cap, and is, of course, contingent upon court approval.

Our total possible exposure to the settlement is the $5 million limit on the payments to the deck owners, plus approximately $1 million for the plaintiffs' legal fees and other administrative expenses.

As many of you know, one benefit of a nationwide class-action settlement, and there aren't many, is that it does provide finality in that it bars further warranty claims for defective composite decking material by members of the class. I can tell you we will be happy to put this matter behind us.

Turning back to our continuing operations, and looking at revenues, if you look at our revenue performance in the third quarter, we had a 27% increase in revenues, and it was broad-based with all of our products up double digits over last year.

Our water management and stock prep product lines had particularly strong results, with revenues of 44% and 38%, respectively. Our recently-acquired Kadant M-Clean business contributed about half of the increase in our water management product line. Our fluid handling product line also had a good quarter, both in percentage and absolute terms, with revenues up 17% over a pretty strong Q3 of 2010.

All of our product lines also had sequential revenue increases, resulting in a 2.3% sequential revenue increase for the Company overall from, again, a pretty strong Q2.

Turning now to bookings. As we look at bookings in Q3, we had $95 million in bookings, which is a 63% increase over Q3 of last year. As you can see on the table on slide nine, we had nice breadth in the increases with all our product lines increasing bookings over last year by double digits, except for our fiber-based products business.

The standout in the quarter again was our stock prep product line, which more than doubled its bookings compared to the same period last year. This performance was really attributed to the larger orders that we secured for chemical pulping and recycling equipment from customers in the U.S. and Latin America that we announced in our press release issued in August. It also includes the pending orders from Russia announced in the same release, which were booked in Q3, for a combined value of $11.4 million.

Also coming in strong for the quarter with a 57% increase was our water management product line, which did benefit from the additional bookings from Kadant M-Clean, but also from good demand of our water filtration equipment, particularly in southeast Asia.

Now looking at trends, which is -- there we are. The booking and revenue trend on slide 10 shows our quarterly revenue, which is the red line, and our bookings for quarters, which is the blue bars. Our quarterly revenues continued to trend upward over the past two years. In Q3, we had the highest quarterly revenue really since Q2 of 2008.

Given our strong bookings in Q3 and our record backlog, we actually expect to have even higher revenues in Q4. Bookings in the third quarter were the strongest of the year and really one of our best quarters ever. We achieved the bookings performance despite having only $5 million of bookings from China. I will say one of the benefits of our global reach is the increased stability you get as when one region is weak, often another is strong.

Turning now to parts and consumables, as many of you know, parts and consumables is a major focus of ours. Typically, it's about 50% of our business. Both bookings and revenues in Q3 were up from the same period last year. Overall, our revenues for spares and consumables were $45 million, which is an 11% increase from Q3 of last year, although down 3% on a sequential basis.

And this was really due primarily to weaker sequential revenues in North America compared with a pretty strong Q2. All of our geographic regions, except China, had revenue increases in parts and consumables compared to Q3 of last year, with Europe leading the way with a 27% increase compared to the same period last year.

Turning now to bookings, which are the blue bars, our parts and consumables bookings were up 5% over Q3 of last year, although they were down 10% compared to a fairly strong Q2. On a year-to-date basis, our year-to-date bookings for parts and consumables were up 10% over the first three quarters of last year.

I'm also pleased to announce that we are now producing our new Fibrewall screen basket in China for global distribution. This screen basket incorporates the technology we acquired from Filtration Fibrewall last year. I can tell you we're excited about this really important addition to our stock prep consumable business.

Finally, turning to backlog, we set a new record with $128 million in backlog. As you can see from this slide, our backlog has been increasing fairly steadily since the second quarter of 2009. We do expect to see this order backlog decline over the next two quarters as we ship some of the larger capital equipment that we booked earlier this year.

I would now like to take a few minutes and review our business activities in each of the major geographic regions of the world. Let me start with North America. Like the U.S. economy, the paper industry in North America has had some general sluggishness. Paper and board production in 2011 is down 1.4% through August, and no surprise, there is weaker demand for many grades, particularly printing and writing.

However, containerboard and tissue producers, which I will remind you make up a substantial portion of our customers, do remain relatively healthy. The operating rates for containerboard were strong at 95% year to date, and in fact was at 98% in the month of September.

Our Q3 revenues in North America were $35 million, which is up 10% compared to the same period last year, but down 9% compared to Q2. Bookings in North America saw an increase of 90% in Q3 compared to the same period last year. The increase over last year was led by our stock prep and fluid handling product lines, which had increases of 244% and 45%, respectively.

An order for an evaporator system with a value of nearly $8 million from a pulp mill in the U.S., which we announced in August, as well as a $2 million order for a dryer system rebuild, contributed to our strong bookings performance.

We also importantly booked an order for a Kadant M-Clean multi-jet cleaning system for a mill in the U.S. This is notable because you may remember that utilizing our North American sales force to help introduce the Kadant M-Clean products to this market is an important synergy related to the acquisition.

I will also say that we continue to have active projects in the pipeline in North America, some of which we actually hope to book by the end of the year. I would say that the strong bookings performance in North America in Q3 is certainly one of the headlines of the quarter.

Turning now to Europe, the difficult market conditions are well known. I guess they are a little less difficult as of yesterday. But they do, in fact, impact the paper industry.

On the whole, however, European paper makers, I'd say, have done a good job balancing supply and demand, and this has really supported pricing levels in most grades.

Turning to us, as you can see from the chart on slide 15, our European business has had an excellent quarter, both in terms of bookings and revenues, despite the weaker macroenvironment. Revenues from customers in western Europe were solid, while regions outside of western Europe, which are also covered by our European businesses, were quite strong. So let me point out that our European businesses, they cover areas outside of western Europe, including Russia, the Middle East, India, southeast Asia, and parts of South America. They had more strength here than they did in western Europe proper. In Q3, just to give you a sense, 29% of the revenues of our European businesses were from outside of western Europe.

Our revenues increased 35% over Q3 of last year, really making Europe one of our stronger markets for this quarter. This performance was due in part to strong growth of our fluid handling product line, which was up 54% compared to Q3 of 2010.

Bookings from our European businesses were also excellent, with an increase of nearly 60% compared to the same period last year. And I would say the outstanding booking for us was led by our stock prep and water management product lines, which were both up more than double from the same period last year.

Bookings at our European businesses benefited from a large stock prep system for a tissue producer in Latin America, which we announced in August. And our water management product line also saw continued success with its Petax refined filtration systems, particularly in southeast Asia.

Turning to China, China over the next few years is going to be a great source of growth for Kadant. China is projected to have GDP growth in the 8% to 10% range for several years, and we see projected demand for paper products will increase 6% per year, or approximately 7 million tons per year.

This capacity growth, however, has been uneven and lumpy, and as we've seen before during times when significant capacity additions are coming online, paper producers often defer further investments until the market absorbs the new production. We are seeing this happen now. Large producers such as Lee & Mann and Nine Dragons have announced delays in new capacity startups in reaction to softer market conditions.

That said, we do still see a lot of project activities, particularly in mid-sized producers, and this is for the short run and the medium term. This is not all long-term stuff.

Revenues from our China operations were up significantly, thanks largely to the stock prep capital orders that we booked in Q4 of 2010 and Q1 of 2011. Our stock prep revenues in Q3 were double the same period last year, while our doctoring product line also saw good growth.

Bookings in China are reflective of the macroenvironment I talked about and have continued to weaken in 2011. Our bookings in Q3 decreased by approximately 14% compared to Q3 of last year and declined 56% sequentially. The sequential decline was seen in all of our product lines.

We continue to see good activity in our spares and consumables business in China with bookings up 19% over Q3 of 2010, as well as positive momentum continuing with our water management product offering in China.

The good news about China is that it still has very strong growth. And as they absorb this capacity that's come online, and the balance between supply and demand works itself out, we do expect our bookings in China will pick up again.

The other point I'd make about China is that although it is definitely our most important market, it is not our only growth market. I think our bookings performance over the last few quarters has demonstrated this. We've had very strong bookings due to growth in areas like Russia, South America, and southeast Asia, despite relatively weak bookings from China.

Turning now to our guidance, and I'll make a few remarks about our guidance for the fourth quarter and the rest of the year. For the fourth quarter, we expect to generate $0.56 to $0.58 of diluted earnings per share on revenues of $92 million to $94 million. For the full year, we expect to achieve a record adjusted earnings per share of $2.09 to $2.11.

In this updated guidance, we've actually increased the revenue guidance slightly, but lowered our earnings-per-share guidance. And there are really three main reasons for this. First, as we finalize our shipment schedule for the large stock prep systems in China, we've had a situation where some of the lower-margin orders are shipping in the fourth quarter while some of the higher-margin orders have slipped to next year, really essentially a timing issue.

Secondly, the chemical pulping equipment orders received in Q3, which we take a percent complete, are largely outsourced for manufacturing and, as a result, have lower margins and bring margins down a bit in the fourth quarter.

And finally, the stronger U.S. dollar is expected to adversely impact our earnings per share by $0.03 versus our earlier forecasts.

If the fourth quarter turns out as we forecast, we'll have one of the best earnings-per-share performances in our Company's history and we'll have a record earnings-per-share performance for the year. I will say our employees have put a lot of hard work into achieving this result and I'm really glad to see their hard work paying off.

I'll now pass the call over to Tom for some additional details on our financial performance. Tom?

Thank you, Jon. I'll start with a review of gross margin performance.

Consolidated product gross margins were 42.7% in the third quarter of 2011, decreasing 140 basis points from last year and, as we had expected, lower than the record levels recorded in the first two quarters of 2011. In our paper-making systems segment, gross margins of 42.8% decreased 160 basis points compared to the third quarter of 2010, due to lower gross margins in our stock prep product line and to an unfavorable product mix. Stock prep margins were up in China compared to last year, but were down in both North America and in our Europe-based operations.

Looking at the margins on a sequential basis, the 250 basis-point decline in the third quarter of 2011, compared to the second quarter of 2011, was largely due to lower margins in our capital products. A relatively minor portion of the sequential decline was due to product mix.

Product gross margins in our fiber-based products business were 36.5% in the third quarter of 2011, 820 basis points higher than last year, largely due to better cost absorption resulting from higher revenue volumes.

Now, let's turn to slide 20 and our SG&A expenses. SG&A expenses were $26.1 million in the third quarter of 2011, up $3.6 million, or 16%, from last year and included the following increases -- $1 million from the unfavorable effect of foreign-exchange translation; $900,000 of operating expenses from M-Clean, which was acquired in the second quarter of 2011; and $600,000 of bad debt expense associated with a customer bankruptcy during the third quarter. Despite these increases, our operating leverage improved 290 basis points compared to the third quarter of 2010.

Looking forward, we expect SG&A expenses to be between 30% and 31% of revenues for the full year.

Now let me turn to our EPS results for the quarter, which is on slide 21. We reported record GAAP diluted earnings per share from continuing operations of $0.80 in the third quarter of 2011, compared to $0.36 in the third quarter of 2010, an improvement of $0.44. This increase of $0.44 in diluted EPS consists of the following -- increases of $0.44 associated with higher volumes in the third quarter of 2011, compared to the third quarter of 2010; $0.10 of incremental gains from the sale of assets; $0.01 from lower net interest expense; and $0.17 from discrete nonrecurring tax items, the most important of which was the favorable resolution upon audit of an uncertain tax position in one of our European subsidiaries.

These increases were partly offset by decreases of $0.13 due to higher operating expenses, $0.06 from lower gross margin percentages, $0.04 due to a slightly higher recurring effective tax rate, $0.03 from the customer bankruptcy, and $0.02 arising from the operating results of M-Clean.

Selectively included in all the categories I just mentioned was a favorable foreign-exchange translation effect of $0.05 in the third quarter of 2011 compared to last year. This was an unusually high translation effect and was caused partly by discrete tax items and the sale of a building, both of which occurred overseas and in currencies which strengthened versus the dollar compared to last year.

Our recurring effective tax rate, that is the tax rate excluding all the discrete tax effects recorded in the third quarter of 2011, was approximately 27% and was in line with our expectations. For the full year, we believe that our recurring effective tax rate will be approximately 27% to 28%.

Now let me conclude my remarks by turning to our cash flows, working capital, and debt leverage starting on slide 22. Operating cash flows from continuing operations were $12.3 million in the third quarter of 2011, doubling over last year's $6 million. As you can see on slide 22, the results included a $2.5 million reduction in working capital, which in turn reflected an $800,000 decrease in inventory.

We do expect that operating cash flows will be positively and significantly affected in future quarters as we ship several large system orders in China later this year and into the first half of 2012. For the year, we have invested almost $10 million in working capital, including over $14 million in inventory.

Let's also look at some of the major nonrecurring sources and uses of cash during the third quarter of 2011. We received $2.3 million in cash from the sale of a building in China and we used cash of $1.5 million for CapEx. We also purchased $9.4 million of our common stock, which represented approximately 430,000 shares, for an average price per share of slightly below $22.

Looking at our key working capital metrics on slide 23, you can see that we had slight improvements in both our number of days in receivables and in inventory compared to the second quarter of 2011. Despite the unfavorable effect of the decrease in AP days, our overall working capital performance, as measured by working capital compared to the last 12 month's revenues, was 10.8%, one of the lowest -- that is, best performances -- we have ever achieved. Working capital here is defined as current assets less current liabilities, excluding cash, debt, and the discontinued operation.

Our net cash position, that is cash less debt, at the end of the third quarter of 2011 was $30.7 million, an increase of $2.1 million compared to the second quarter of 2011. Significantly, our net cash position has increased $4.1 million when compared with the third quarter of 2010, even as we acquired M-Clean for approximately $16 million and we purchased over $9 million in stock during that 12 months. As you may recall, during the second quarter of 2011, we purchased M-Clean for approximately $16 million, including $900,000 of acquired cash and $500,000 of acquired debt.

Finally, on slide 25, you can see that our leverage ratio declined for the seventh consecutive quarter and now stands at 0.36 at the end of third quarter of 2011. This ratio represents our total indebtedness, divided by our consolidated EBITDA, as defined in our credit agreement.

That concludes my review of the financials, and I will now turn the call back to the operator for our Q&A session. Operator?

(Operator Instructions). Eric Prouty, Canaccord.

Good job on the quarter. First, a couple questions on Q4. The -- maybe you could get into just a little more detail on gross-margin expectations with what you're seeing out there on what you're going to deliver. What kind of sequential decrease or year-over-year decrease can we be expecting?

I think you might remember, Eric, in an earlier call, we said we expected for the year that our gross margins would probably end up averaging around 44% overall. So, that obviously means the fourth quarter is going to have the highest amount of shipments of these large stock prep systems and really lower margins than we have right now. You can probably deduce it, I think.

Yes, I mean, the margins in the fourth quarter will be around 40%. That will get you to a number, as Jon was saying, which will be slightly under 44% for the year.

Okay, and then, I guess just to carry on with that, when you look at the backlog that you have, without getting into too much detail, given some of these are also larger -- some large equipment orders that are going to ship in the March and the June quarter, are we going to have margins more like the second half of 2011 in the first half of 2012 or more like the first half of 2011?

It's really -- obviously, the other component of that is the shorter booking cycle stuff. It's true, Eric, that our backlog, which is the longer lead items, in many cases, had somewhat lower margins, so the extent that that stuff is in our backlog now will have the impact of dragging overall margins down in the first part of the year.

What we really don't know is the activity in the spares and consumables, fluid handling, some of the stuff that has a much shorter cycles.

Okay, but where things stand right now, would you be looking for margins kind of in that low 40% range or the mid to high 40% range?

No, I would say 40% to 41%.

Yes, I think (multiple speakers) the first half margins of 2011 were extraordinary. We had record margins in the first quarter. It was almost 48%. So I don't think we're going to see that in the (multiple speakers) quarters.

That's not typical, yes, as we said at the time.

(Multiple speakers). So we haven't really compiled all this yet, but I would say it will be in the lower 40s would be my guess.

Eric, I think you might remember we kind of said at one point we think that the new normal for us in terms of the margins is around 42%.

That's right, okay. So we would see a sequential increase, at least, from the December quarter -- would be your expectation?

Yes, it's hard to say. It all depends on the mix. When we have a bigger percentage of capital going through there, it will be lower than 42% and a bigger percentage of spares, consumables, and some of our not big capital product lines, it will be a little bit over 42%.

Yes, okay, great. And then, Tom, just to clarify from a modeling standpoint, it sounds like you're pretty active buying back stock. One, did that continue post-quarter? And if we looked right now, where does kind of that diluted share count stand or do you have kind of a guess-timate on where it will play out for the December quarter?

I think the share count, the diluted share count to use in the model, will be around 12 million shares in the fourth quarter. I think that would be a good estimate to use.

Okay, great. And then, finally, and you touched on this a bit in your prepared comments, but both from a China and from a European standpoint, has there been any, especially over the last two or three weeks, month, any changes from previously in the quarter? Has it remained a cautious market or have things gotten incrementally better or worse?

I would say it's remained cautious. But in both those markets, and I would say in particular China, we continue to have projects and high-value projects, often with these mid-tier producers, I would say, but we do continue to see active projects that would be in the short term, medium term -- they're not all talking about doing stuff three years from now.

So, that really hasn't changed. And I think that's what we said at the end of the second quarter, too, that we still have active projects that are out there and people are talking, although you can see our bookings did come down significantly in Q3 -- in China. Obviously Europe has been quite good, and I don't know if I was clear in my comments, but our European businesses don't just do western Europe, and it was outside of western Europe where a lot of the strength came in Q3.

(Operator Instructions). Gentlemen, you have no other questions in the queue at this time.

Thanks very much, Operator. You know what, before we end the call, I'd kind of maybe make three wrap-up sort of takeaway points. First, to me, we had an excellent quarter, both in revenues and earnings per share, up 50% in earnings per share. You can see we had good bookings globally, despite relatively weak bookings in China. We have a record backlog and we are forecasting a very strong Q4 and really a record year for earnings per share.

So I'm looking forward to updating you on the fourth quarter for next call. Thanks very much. Bye bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a good day.