Kadant Inc (KAI) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2012 Kadant Incorporated earnings conference call. My name is Ann and I will be your coordinator for today's call. As a reminder, this conference is being recorded for replay purposes. At this time all participants are in listen-only mode. (Operator Instructions) We will be facilitating a question-and-answer session following the presentation.

I would now like to turn the presentation over to your host for today's call, Mr. Thomas O'Brien, Executive Vice President and CFO. Please proceed, sir.

Well, thank you, operator, and good morning, everyone, and welcome to Kadant's second-quarter 2012 earnings call. With me on the call today is Jon Painter, our President and Chief Executive Officer.

Let me begin by encouraging all participants in our business review today to participate via our webcast. You may access the live webcast by going to www.Kadant.com, select the Investors tab, and then select the Listen Live option for the webcast.

To participate in the question-and-answer session at the end of our prepared remarks, you will need to dial in to the teleconference. The dial-in number is available in our press release issued yesterday and will also be shown at the end of our presentation.

Let me now remind everyone of our 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 outlined at the beginning of our slide presentation and those discussed under the heading Risk Factors in our report on Form 10-Q for the fiscal quarter ended March 31, 2012. Our Form 10-Q is on file with the SEC; it is also available in the Investors section of our website at www.Kadant.com under the heading SEC Filings.

In addition, any forward-looking statements we make 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 representing our views on any date after today.

During this webcast 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 most directly comparable GAAP measures is contained in our second-quarter earnings press release issued yesterday, which is available in the Investors section of our website at www.Kadant.com under the heading Investor News.

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 second-quarter results. Overall, we had a good quarter despite the economic challenges that we found in various regions of the globe.

Let me begin my remarks with an overview of our financial performance in Q2. We finished the second quarter with revenues of $83 million, which was up slightly compared to the same period last year, while our gross margins at 44% was just a couple points below the near-record margin performance we had in Q2 of last year.

We generated GAAP diluted earnings per share of $0.56 in the second quarter, which beat our guidance of $0.50 to $0.52 and was once again one of our better earnings per share performances. Our EBITDA for the second quarter was $11.4 million or 14% of revenues versus $12.5 million in the second quarter of last year. Incidentally, our EBITDA for the last 12 months was $46.2 million.

Our cash flow from operations was $8.6 million, a 25% increase over Q2 of last year. We also repurchased 325,000 shares of our stock worth $7.3 million during the quarter. Finally, our cash less debt at the end of the quarter was $30 million.

Taking a closer look at our revenue performance in the second quarter, we had a slight increase over Q2 of last year. Revenue increases in our water-management product line, which benefited from the inclusion of revenues from Kadant M-Clean, were largely offset by declines in stock prep and fluid handling.

Excluding FX, revenues were up nearly 5%, and all of our major product lines except stock prep saw increases. The decline in stock prep revenues was primarily due to a decrease in capital revenues in China compared to a relatively strong Q2 of last year.

Turning to bookings, we generated $77 million in Q2, down 11% compared to Q2 of 2011 and flat compared to Q1 of this year. Our backlog at the end of Q2 was $94 million, which is down $8 million from the end of Q1 but still quite healthy.

The decline in bookings was due primarily to decreases in capital order bookings in Europe and China. Although we continue to see capital project activity in those regions, the general economic conditions have weakened, and we do not expect a significant turnaround for the coming months. Our parts and consumables business, on the other hand, has remained quite stable.

Looking at the bookings and revenue trend chart on slide 8, you can see our quarterly revenue, which is the red line, and our bookings, which are the blue bars. Revenues were down 1% sequentially and were impacted not only by the weaker economies in Europe and China but also by the strengthening US dollar. Likewise, bookings were flat sequentially in Q2 and have settled in at a rate of just under $80 million per quarter for the last three quarters.

Before I leave this slide I would like to use it to illustrate the difference between the economic crisis in 2008 and 2009 and the current global slowdown. As you can see from the quarters in the circle, the '08/'09 crisis resulted in an extreme decline in bookings and revenue that was completely unprecedented in our history.

Looking at our recent performance, although we have definitely experienced reduced bookings for the last three quarters, we don't see anything approaching the dramatic and continual declines that we saw in the '08 and '09 period. In addition, our aftermarket business has held up quite well, as we will see in the next slide.

Here again, you can see the sharp contrast between our parts and consumables bookings during the '08/'09 crisis, which dropped dramatically, and our more recent quarters where the trend is quite stable. Taking a closer look at our parts and consumables performance for Q2, we can see that revenues were up slightly from the relatively healthy parts and consumables revenue of Q2 of 2011, but were down 3% sequentially. Overall, our revenues for parts and consumables were $84 million and made up 57% of our revenues in the second quarter.

Looking at bookings, which are shown in the blue bars, you can see that bookings in Q2 declined both sequentially and compared to the same period last year. The sequential decrease of approximately 4% is not unusual, as the first quarter is typically our strongest quarter for parts and consumables bookings, as mills order parts in anticipation of planned maintenance shutdowns.

Our stock prep parts and consumables bookings in China is a particular bright spot. It's up over 30% from Q2 of last year and up 37% in the first six months of this year. This has been a major focus of ours because a larger spare parts business in China will help us moderate the more volatile capital business in that region.

I would like to take the next few minutes to provide a brief review of our business activities in each of the major geographic regions of the world, starting with North America. Despite a somewhat slower second quarter, the paper industry in North America is in fairly good shape and continues to be the strongest market in the world for us. Containerboard in particular showed some strength, with operating rates climbing to 96% in June and several major producers announcing a $50 per ton price increase to take effect in August.

Tissue is another strong grade, with operating rates remaining in the mid-90%s. As a reminder, containerboard and tissue are the most important grades to our business, and those two grades along with boxboard make up more than 60% of our customer base.

Our Q2 revenues in North America were $41 million, up 11% compared to the same period last year. This uptick was due in large part to revenue increases in our stock-prep and fluid-handling product lines.

Bookings in North America were up 3% in Q2 compared to the same period last year. The increase in bookings is led by our fluid-handling business, which was up more than 20% compared to the same period last year.

One notable order during the quarter was for three creping doctor systems. Creping doctors are used in production of tissue to add bulk and texture to the final product. These doctoring systems are notable for several reasons.

First, creping applications are demanding, and our doctors provide our customers higher machine uptime and improved run ability. Secondly, because of the nature of the application, creping doctors require more frequent blade replacement, and this can provide us with very nice aftermarket revenue stream going forward.

Taking a look at Europe, Europe's struggles with its sovereign debt issues continue to impact its economy and the demand for paper products. Containerboard consumption has been flat, while the market has been somewhat oversupplied. The weaker euro should help alleviate the situation, at least with regard to imports from regions outside of Europe.

Our revenues in Europe were down 4% compared to Q2 of last year and 1% sequentially. Bookings in Europe were down 30% in the second quarter compared to a fairly strong Q2 of last year and relatively flat on a sequential basis. As you can see from the chart, the bookings rate for the last three quarters in Europe seems to have stabilized at around $19 million a quarter.

Despite the uncertainty of the region, we do still see a good number of active projects. As was the case with North America, we booked several large orders for doctoring systems and showers for tissue producers and continue to see good activity in this particular grade.

In addition, we booked two large orders for drying equipment from papermakers in Finland and major steam system orders from customers in Germany and Italy. That said, the weak economy in Europe and the increasing uncertainty going forward make Europe the area in the world really of most concern to us.

Turning to China, we continue to see relatively weak market conditions as buyers absorb the large amount of capacity that has come online over the last year and the pace of economic growth slows. China's economy grew 7.6% in Q2 of 2012 versus a year earlier. This is really its slowest pace in three years.

Although slowing domestic consumption has been a drag on China's economic growth, we believe the longer-term outlook for China and our business is still quite promising. In addition, there are some indications, such as the recent improvement in the Manufacturers Purchasing Index, that the government stimulus programs are beginning to have some effect.

Our quarterly revenues in China declined to 29% in Q2 compared to a strong Q2 in 2011. The decline was due in large part to lower revenues from our stock-prep product line. Offsetting this revenue decline, our water-management and doctoring product lines saw relatively strong growth, albeit from a lower base.

Our bookings in Q2 were down 19% compared to the same period last year, but up 39% sequentially. The decline versus last year was found across all of our product lines.

As we have seen for most of 2012, the financial constraints placed on our customers as well as softer market demand have contributed to a fairly weak market for capital investment. That said, as I mentioned earlier, our stock-prep parts and consumables are increasing quite nicely as we work towards increasing the yield from the large installed base we have of stock-prep equipment.

The sequential bookings increase in Q1 was largely due to increased demand from our stock-prep and fluid-handling product lines, including orders for a stock-prep system for a coated whiteboard machine and two OCC recycled fiber systems for a linerboard machine, with a combined value of approximately $6 million. Our fluid-handling business, we picked up a major order for drying equipment for three linerboard machines, to be delivered later this year to one of China's larger paper producers.

Turning to South America, we saw nice rebound in business in Q2 following the traditional slower summer period in Brazil and Argentina and Chile. Revenues were up 17% in Q2 compared to the same period last year and down 1% sequentially.

Bookings, however, more than doubled from the previous quarter as we booked a major order for upgrades to two stock-prep systems for a major tissue producer with a value of more than $4 million. I should point out, we have a strong market position in China -- I mean, sorry, in South America for stock-prep equipment used in recycled tissue mills. As standards of living improve and the use of tissue products increase in South America, we are well positioned to win new orders for our equipment.

I'll conclude my remarks on the various regions we serve with a brief comment on emerging markets and the importance of those markets to our future growth. As shown on the pie chart on slide 17, revenues for the trailing 12 months coming from emerging economies contributed 40% to our total revenue. Annual growth in paper production in these markets is projected to grow at nearly 6% through 2016, which is significantly higher than the growth rates forecast for the US and Western Europe.

We have good market positions in many of the areas of the developing world, and we have several initiatives under way designed to capture an increased share of business in these regions. These efforts include establishing more regional sales offices, as well as using some of the new communications technology to engage with mill operators in remote regions as well as leverage our technical and applications expertise. Once fully implemented, we expect our ability to further penetrate these faster-growth markets will be enhanced and the portion of our revenues coming from the emerging markets will make up a larger portion of our total revenues.

I would like to close my remarks with a few comments on our guidance for the full-year 2012 and the third quarter. Our biggest concern going forward is the increased economic uncertainty in Europe. In addition, although there are some signs of improvements in the macro economy in China, the market for capital spending in the paper industry in China is still relatively weak.

These factors, combined with our recent bookings, have led us to decrease our guidance for the year. We now expect for the full year to achieve GAAP diluted earnings per share from continuing operations of $2.05 to $2.10 on revenues of $325 million to $330 million, which is down from our previous guidance of $2.10 to $2.20 on revenues of $335 million to $345 million.

I should note the FX impact of the stronger dollar reduced our EPS guidance for the second half by $0.03. For the third quarter, we expect to generate $0.49 to $0.51 of diluted earnings per share on revenue of $80 million to $82 million.

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

Thank you, Jon. I will start with a review of our gross margin performance. Consolidated product gross margins were 43.7% in the second quarter of 2012, declining 200 basis points from last year's second quarter and, as expected, were 190 basis points lower than the first quarter of 2012.

Margins were lower than last year in all our major product lines except the doctoring product line, where we saw solid increases in our operations in both North America and China. Despite these increases, consolidated margins declined mainly due to lower capital margins, most notably in the stock-prep product line. Product mix had a small favorable effect on gross margins in the second quarter of 2012 compared to the second quarter of 2011.

Looking ahead, we estimate that consolidated gross margins will be between 43% and 44% for the full-year 2012, which suggest slightly lower levels in the second half of 2012 compared to the first half.

Now let's turn to slide 21 and our SG&A expenses. SG&A expenses were $25.5 million in the second quarter of 2012, down $300,000 or 1% from last year, and included a favorable effect of $1 million or 4% from foreign exchange. As you can see on the chart, SG&A expenses have been relatively flat for the past several quarters.

Operating leverage improved 60 basis points in the quarter, with SG&A expenses as a percentage of revenues declining from 31.3% a year ago to 30.7% in the second quarter of 2012. Looking forward, we expect SG&A expenses to be approximately 31% of revenues for the full-year 2012.

Let me turn to our EPS results for the quarter on slide 22. We reported GAAP diluted earnings per share from continuing operations of $0.56 in the second quarter of 2012, compared to $0.59 in the second quarter of 2011, a decline of $0.03.

This decrease of $0.03 in diluted EPS consists of the following -- increases of $0.04 from lower weighted average shares outstanding; $0.02 from lower operating expenses; and $0.01 associated with higher volumes in the second quarter of 2012 compared to the second quarter of 2011. These increases were offset by decreases of $0.09 from a lower gross margin percentage and $0.01 due to a slightly higher effective tax rate.

Collectively included in all the categories I just mentioned was an unfavorable foreign exchange translation effect of $0.02 in the second quarter of 2012 compared to last year.

Now let's turn to our cash flows, working capital, and debt leverage, starting on slide 23. Operating cash flows from continuing operations were $8.6 million in the second quarter of 2012 compared to $6.8 million in the second quarter of 2011, an increase of 25%.

Despite this solid performance, as you can see on the chart, for the first half of 2012 we are still running behind the results for the comparable period last year, mainly due to a $15.7 million increase in working capital. This increase in working capital is partly due to an increase in our unbilled contract costs and fees, which can be thought of as the equivalent of accounts receivable for projects accounted for on the percentage-of-completion method.

An increase in this balance means that we have recognized more revenue on percentage-of-completion projects then we have collected in cash on those projects. We expect the cash flows will be positively affected in the second half of 2012 as we deliver these systems and receive additional progress payments from the customers.

As Jon mentioned, our major use of cash in the second quarter of 2012 was associated with our stock repurchase program, where we purchased $7.3 million of our common stock, representing approximately 325,000 shares, at an average purchase price slightly under $22.40 per share.

As you can see on slide 24, our key working capital metrics were largely unchanged from the first quarter of 2012. Days in inventory decreased by 4 days on a sequential basis and, encouragingly, were 16 days lower than in the second quarter of 2011.

Our AP days, on the other hand, were unfavorable -- that is, lower -- on both a sequential basis and compared to the second quarter of 2011; but the effect here on our overall working capital position was not significant. Days in receivables were essentially unchanged from the first quarter of 2012, but up 11 days from the second quarter of 2011.

Putting this all together, our overall working capital performance as measured by working capital compared to the last 12 months' revenues remained quite strong at 13.8%. This was only slightly higher than the first quarter of 2012 and last year's 13.4%. I should remind you hear that working capital is defined as current assets less current liabilities excluding cash, debt, and the discontinued operations.

Our net cash position -- that is, cash less debt -- at the end of the second quarter of 2012 was $30.1 million, an increase of $1.5 million compared to the second quarter of 2011 and down only $800,000 from the first quarter of 2012, in spite of the $7.3 million of stock repurchases in the second quarter of 2012.

On slide 27 you can see that our leverage ratio has declined significantly since the end of 2009 and now stands at 0.23 at the end of the second quarter of 2012. 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) Walt Liptak, Barrington Research.

Good morning, guys. I wanted to start out with the gross margin; and thanks, Tom, for the guidance on it. But I wondered what products you thought were going to be up in the quarter, which down, to come up with that mix?

You're talking about going forward?

Yes, on a going-forward basis.

Well, there will probably be a slightly better product mix in the second half than we had in the first half, by virtue of the fact that the capital (multiple speakers) will be somewhat slower. But on the other hand, we have somewhat lower revenues in the second half, so there may be a little less efficiency and underabsorption, etc.

So I don't know if we could actually target it to specific product lines. But I think in general it will be the fact that we will have a slightly better mix, offset with some less efficiencies due to the lower volumes.

Okay. I guess by better mix I meant is it a parts mix, or is it a program that's --?

Walt, typically the thing that is swinging more dramatically is the capital. The parts has been relatively stable. So when you have a quarter that's less revenue, the parts make up a bigger part, as Tom said, and that helps the margins.

Okay, got it. I wanted to ask about -- just switching gears to North America and your mentioned the $50 per ton containerboard increase. I wondered what impact, outside of the price increase, the consolidation is having on the business. And by that I mean sometimes you think about consolidation and it means rationalization of capacity. In this case, because that has been going on for so long, maybe it means North America will be putting more higher-efficiency capacity in.

There is -- you know, I would say on North America you have got some notable mergers, IP-RockTenn, that kind of thing; and there is some rationalization. A lot of that is taking place in their box plants, things like that, that don't affect us directly. I would say for our principal grades, containerboard and tissue, the balance is relatively good in North America.

Now, Europe is a little bit different story. They probably still have some rationalization they need to do.

The good news for the paper industry in North America is their input costs have moderated. You don't have the pressure, particularly on OCC, that you had two, three quarters ago. And it looks like this price increase, this $50 price increase is going to go through.

So, they are doing fairly well cash flow-wise. Top line, and what happens with the economy, and demand for boxes, that's something for the economists.

But I would say that the industry is pretty well positioned in North America. We view North America as our -- right now the strongest market in the world. Over time that will change, I'm sure; someone else will be stronger. But right now it's looking pretty good.

Okay. Is there a chance that we could see North America pick up even if the rest of the world is in this low stabilization rate?

Well, that is certainly the $64 question. It seems that North America is big enough and as an economy probably has less ties to Europe, that it is not quite as impacted by Europe as let's say somewhere like China is.

That said, the second quarter was certainly slower than the first, as you know. I think if you start to look ahead to next year, I would say -- this is just macroeconomic thinking, but I would expect North America to be somewhat similar to this year.

Okay. Okay, and then for a last one and then I will get back in queue. What in your -- I mean the order -- I mean the bookings are down year-over-year, but they were down last quarter too. Were you thinking that bookings were going to be picking up in the current quarter to provide a more of a lift to the back half, and that is why you changed the guidance? Or what is it about the outlook that made you take down the revenue targets for the year?

Okay, good question. Yes, the first quarter, as you know, things were looking brighter in the earlier part of the first half of the year. And yes, in fact we did expect to have some higher bookings in Q2 than in fact we had.

So, if I look at the guidance -- and really the guidance is going back to where we were with our initial guidance for 2012. It's basically somewhat softer bookings in the second quarter, and Europe being a little -- Europe and China too, both being a little slower than we anticipated.

Okay, okay. Thanks much.

Mark Tobin, ROTH Capital Partners.

Hi, Jon and Tom. Thanks for taking my questions. I guess following on Walter's questions, looking at the bookings that you had and the backlog you had, can you give us some indication of the duration of that backlog, and -- I guess looking in the crystal ball -- what 2013 would look like? Are we looking at a mirror image of 2012 where it would start out a little bit slow and then pick up in the back half?

All right. Let me take the first whack at that and then Tom will maybe have some additional comments. I would characterize the backlog at $94 million as still a pretty good backlog for us. You can see what we do in a quarter; that that is not a bad backlog. And that again is mostly capital.

That said, we've had three quarters of bookings under $80 million. So I would say it is a stable but reduced bookings rate.

One of the things -- you asked for some commentary on next year. I would say one of the advantages that we have as a Company is that we have pretty good diversified global exposure. So typically some place is picking up while someplace is slowing down.

And I wouldn't be surprised in 2013 that you saw the emerging economies -- the emerging economies, let's say, other than China, picking up first. They have all the demographics and stuff that we have talked about in the past.

China from a macro perspective, seems to be improving. Now, we lag that and they definitely have to work through the supply of linerboard that has gone on that has just come on. But if past is prologue at all, I wouldn't be surprised to see China start to pick up next year.

In North America as I said, I expect it to be fairly stable.

Europe is the big question. From a macro perspective, your guess is as good as mine in what goes on in Europe. I will tell you we were actually just in Europe at our division in France week before last, and they are in that unusual time where they have a project list that -- one of the longer ones we have seen.

We typically, when we review the business, we go through all their prospects, and they are extremely busy quoting and working on proposals, that kind of stuff. But those are not right now turning into bookings.

So we have seen that before. That is essentially pent-up demand. At some point those projects which make sense are going to get released. It is just a question of when the environment is such for that to happen.

Very different, I should point out, than the 08/09 period where we went through project lists and it took about a minute, because there was hardly anything on there. There is still good activity for projects in all our markets. But I would say particular our European operations have fairly long project lists.

And as you look at your backlog as well as the bids that you are working on, how do those margins compare to what you are recognizing in Q2, as an example?

Well, I will say as a general rule, our capital margins are lower than our spares margins. That said, our capital margins I think are quite respectable.

So it is not unusual that the margins in our backlog are lower than our flow business of spare parts, that comes in and goes out and doesn't spend a very long time in backlog. But there is nothing -- we are not at all unhappy with the margins that we see in our backlog.

I guess I was referring more on a common product type basis.

Not sure what you mean by common product.

Capital equipment versus capital equipment margins, as an example, or spares. Is there any change within those products from a margin perspective?

Actually pretty good. I would say that we don't have -- I don't see anything with -- maybe you are worried that with the slowing economy you start to see some erosion in pricing.

Right.

We don't really see that at this point.

Okay. Thank you. I will jump back in the queue.

Walt Liptak, Barrington Research.

Okay, I guess I am back. So I guess if I could characterize just what I am seeing from the environment, from what you have said, is that things have stepped down in terms of bookings and the level of business. And correct me if you look at it differently. But I wonder about any initiatives on the cost side to improve the leverage ratio or the manufacturing margins.

Good question, Walt, and that is something that we are looking at, starting to review, that kind of thing. As you know, earlier in the year we expected 2012 to build throughout the year; and in fact we don't think that at this point. So that is something that we are looking at.

Okay. The balance sheet is in great shape and cash flow has been good. I wonder if you could comment about the acquisition pipeline.

You know, the acquisition pipeline is pretty good. We see, I would say, a little more activity than we have seen -- we kind of see in the past.

I will tell you that we are trying to focus on acquisitions more in the paper industry or relating to products that we already sell outside the paper industry. So, if I look at the pipeline right now I would say it is more paper industry as opposed to outside; and it is smaller, tuck-in type acquisitions as opposed to some larger acquisition.

But, we do -- I think one of the things that has been frustrating in the past is that I didn't see valuations coming down or even availability of companies, let's say, during the last recession. No one wanted to sell in the last recession if they didn't have to.

I think now there is more realism, maybe, and you've got some potential sellers saying -- yes, it would be a good time to sell. And hopefully we will see some more reasonable valuations.

Okay, good. All right. Thanks very much.

(Operator Instructions) Ladies and gentlemen, with no further questions, this concludes today's question-and-answer session. I would now like to turn the call back to Mr. Jonathan Painter for closing remarks.

Thanks very much, operator. Before I make a few closing comments, I should point out one of our diligent fact-checkers noted that I inadvertently said that we have $84 million of spare parts; and I really meant $48 million of spare parts. So I want to correct that.

Also, in my mind, there's really three takeaways from the quarter. The first and foremost, of course, is that despite the economic environment we really had a very good quarter, strong gross margins, excellent earnings per share, and strong cash flow.

That said, there is definitely increasing uncertainty. We are a little more concerned than we were a quarter ago. And as everyone knows, we moderated our outlook for the second half.

The final point -- and we emphasized it during the call -- is that our outlook is very much not a situation we had in '08/09 where we had this dramatic decline. This is a much more modest change.

In fact, despite the challenging macroeconomic environment, we are still on track to have our second-best year in our history. I look forward to updating you on our progress in future calls. Thanks very much. Bye.

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