Kadant Inc (KAI) 2015 Q3 法說會逐字稿

Hello and welcome to the Third Quarter 2015 Kadant Incorporations Earnings Conference Call. (Operator Instructions) And as a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Chief Financial Officer, Mike McKenney.

Thank you, operator. Good morning, everyone, and welcome to Kadant's Third Quarter 2015 Earnings Call. With me on the call today is Jon Painter, our President and Chief Executive Officer.

Before we begin, let me read 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 annual report on Form 10-K for the fiscal year ended January 3, 2015, and subsequent filings with the Securities and Exchange Commission. Our Form 10-K is on file with the SEC and is also available on 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 the most directly comparable GAAP measures is contained in our third 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, Mike. Hello, everyone. It's my pleasure to brief you on our third quarter results and our outlook for the remainder of the year.

Overall, despite significant currency headwinds, we had another strong quarter with excellent cash flow, operating margins and better-than-expected earnings per share performance. I'll begin today's business review with the financial highlights of the quarter.

We finished the third quarter with revenue of $92 million, down 7% compared to the third quarter of 2014. Foreign currency translation had a large impact on Q3 revenue, and excluding the effect of FX, our revenue in Q3 was up 2%. Gross margins in the third quarter continued to be very strong at 48%. Operating income was up 25% to $13 million or 14% of sales, which is the highest operating margin since our spinoff in 2001.

Our adjusted EBITDA was $15 million or 17% of the sales, up 14% compared to Q3 of last year. Our GAAP diluted earnings per share was up 30% to $0.78 in the third quarter, despite an $0.11 negative impact from foreign currency translation. Our adjusted earnings per share was up 24% to $0.78. Excluding the impact of FX, our adjusted earnings per share increased 41%.

Our bookings of $99 million were down 2% compared to Q3 of 2014. However, our bookings performance was masked by the impact of the strong dollar as our bookings were up 8% when excluding the impact of FX.

Cash flow for the third quarter was excellent at $16 million, and we ended the quarter with net cash of $27 million. During the quarter, we repurchased approximately 118,000 shares for $5 million at an average price of $41.27.

As you can see from Slide 6, FX continues to have a significant effect on our results when compared to Q3 of last year. Our internal growth for Q3, which excludes acquisitions and FX, was up 6% for bookings and essentially flat for revenues. Our internal growth for Q3 in Parts and Consumables revenue was up 6%, while bookings growth was up 8%.

Earlier this year, I talked about how FX versus, affects us versus how it may affect other companies, but it bears repeating. We have operations all over the world, which for the most part, have revenues and costs denominated in the same currencies. This reduces the impact of changes in currency on the financial results of our domestic and foreign subsidiaries, although we do have translation exposure associated with converting revenue and profit of our foreign subs into U.S. dollars for reporting purposes.

It's far better to have a business that's doing well and growing in local currency, even if it translates into less U.S. dollars due to FX, than to have a business that's declining in local currency and benefiting from favorable FX. And it's much better than having a business whose margins are squeezed by FX because costs and revenues are in different currencies. The strength of our gross margins this year, in this year of currency volatility, is a testament to this.

Turning to our bookings and revenue trends slide. Bookings and revenues are relatively strong in Q3 despite the strong dollar. Our third quarter revenue of $92 million was down 7% year-over-year, entirely due to FX translation. Excluding the impact from FX, our growth was 2% compared to Q3 of last year.

Strong performance in our Stock-Prep and Wood Processing product lines, particularly in North America, was largely responsible for this growth. Our Stock-Prep product line in North America is benefiting from investments in pulp mills, and our Wood Processing product line is benefiting from strength in the housing market and growth in Parts and Consumables.

Our bookings of $99 million in Q3 were down 2% from the third quarter of last year. Excluding the impact of FX, our Q3 bookings were up 8%. Project activity in our Stock-Prep business in both North America and Europe were the primary drivers of our solid bookings performance in Q3.

Turning now to our Parts and Consumables business. Our revenue for Parts and Consumables in the third quarter was essentially flat compared to Q3 of last year and represented 69% of our total revenue. Excluding the impact of FX and acquisitions, our internal growth was 6%. Our strong Parts revenue performance in Q3 was driven by our Stock-Prep product line in North America, which had an exceptionally strong quarter.

Growing our Parts and Consumables business continues to be a strategic focus of ours, and we're seeing solid results from both our internal initiatives as well as from acquisitions. Parts and Consumables bookings were up 3% compared to Q3 of last year to $61 million. This increase was tempered by the strong dollar, and when excluding the impact of FX, bookings were up 12%.

Next, I'd like to take a few minutes to provide an overview of our business activities and our performance in each of the major geographic regions of the world. Let me start with North America.

The North American market is our largest and continues to be the strongest in the world for us. Overall, paper industry producers, particularly those in containerboard, are enjoying excellent profitability, and this makes for a good environment for investment.

In addition, housing starts in the first nine months of 2015 are up 12% compared to last year, and we are on track to finish the year at the highest level since the recession.

Our revenues in North America were up 1% compared to the third quarter of 2014 to $55 million. Our Stock-Prep product line led the growth in this region, up 62% compared to Q3 of last year, driven by strong demand for our Stock-Prep parts as well as several large capital orders for virgin-pulp mill upgrades.

Our Wood Processing product line was also up 8% despite considerable FX headwinds, and I'm pleased to announce that we were recently awarded Supplier of the Year from the Engineered Wood Association, a group consisting of producers of OSB and other engineered wood products.

On the other hand, our Doctoring, Cleaning, & Filtration product line had a 24% revenue decline compared to a very strong Q3 of 2014, which included a very large capital order. The majority of this revenue decline was in our capital business, which tends to be more volatile.

As I noted last quarter, weakness in the printing and writing grades also has negatively affected this product line. Q3 bookings in North America were $54 million, up 17% compared to a relatively weak Q3 of last year, led by our Stock-Prep and Fluid Handling product lines. During the quarter, we booked several large orders for the rebuild of the dryer sections for two large containerboard machines in the Southeast and a large order for an OCC recycling system.

Outside paper, we're seeing growing market penetration of our industrial steam systems offers offerings. During the quarter, we booked a $0.5 million order for a steam system using our advanced control technologies for a new corrugating line going into Canada, and we continue to see good project activity in this adjacent market.

In addition, in the fourth quarter, we received an order from a major producer of carbon fiber in the U.S. for 66 VeriLite doctoring assemblies to be installed in five of its manufacturing lines. Both of these orders are examples of expanding our technology into new industrial markets, which is one of our growth initiatives.

Between internal growth initiatives and acquisitions, our growth rate outside the paper industry has been faster than our growth rate inside the paper industry. At the rate we're going, there will be a time when the majority of our business will be the customers outside the paper industry.

In summary, 2015 is shaping up to be the best year in our history for our North American businesses for revenue and income. And this region has been a major driver of growth for Kadant this year. As I look to 2016, I expect another good year, although I will say 2015 will be a tough act to follow.

In Europe, we're increasingly encouraged by the positive trend in bookings over the past 4 quarters, and the upward trend in revenues despite FX headwinds. As I had mentioned in earlier calls, we're seeing increased project activity in Southern Europe, and some of that activity was converted to orders in Q3. Our Q3 revenue in Europe was $18 million, down 12% from Q3 of last year, but when excluding the impact of FX, our revenue was up 4%.

Q3 bookings of $23 million were up 22% compared to Q3 of last year, due entirely to our Stock-Prep product line, which saw a 63% increase in bookings. Excluding the impact of FX, we had an even larger increase of 46%. The increase in bookings was led by an approximately $7 million order for recycled fiber processing equipment, which we announced several weeks ago to be used in the conversion of a mill in Southern Europe from printing and writing to packaging.

There continues to be reasonable project activity in Europe, and I'm pleased to announce that we booked an order in early Q4 for a turnkey dryer system rebuild for a board machine in Eastern Europe with an approximate value of $1.1 million. These orders and other project activity are indicating a positive trend emerging in Europe as the region begins to recover. As I look ahead to 2016, the booking, the building bookings and backlog momentum in Europe should lead to a stronger revenue and income performance in 2016.

Next, let's take a look at Asia. In contrast to North America and Europe, Asia is continuing to experience an overall sluggishness that has resulted in delayed projects and creating financing challenges for some producers. Our Q3 revenue in Asia was $12 million, down 18% compared to Q3 of last year.

Our Q3 bookings in Asia were $15 million, down 41% from a very strong third quarter of last year, which included several large Stock-Prep capital orders. While new system activity was somewhat restrained in Q3, we are seeing increased demand for upgrades of existing equipment to improve mill efficiency, and we booked several smaller OCC system rebuild orders with a combined value of just over $1 million.

This is a pattern we're seeing in -- this is the pattern we see in the more mature and stable markets such as Europe and North America, where supply, where smaller projects are implemented to improve operating efficiencies rather than increases capacity. The nice thing about these types of orders, they do not depend on capacity expansion and as a result, they can provide a more stable revenue stream.

China is the dominant market in Asia, and China's overcapacity conditions and its recent forecast of containerboard demand growth slowing to 2% per year for the next few years suggests new capacity, new capital activity will remain at reduced levels in the coming year. For the last several years, we've sought to minimize the volatility of large capital swings in China by growing our spare Parts and Consumables business. And I'm pleased to report that we've made good progress on this initiative. For the first nine months of 2015, our Parts and Consumables revenue made up 58% of our total revenue in China compared to 35% in 2010.

As I look into 2016 in Asia, we have several advantages that we expect will mitigate the soft market conditions in China. The first I just mentioned is the growth of our Parts and Consumables business in China, which tend to be more stable as it's tied to operating rates rather than capacity expansion. The second is a very strong backlog of $57 million, a good portion of which will be shipped in 2016. And the other positive factor we're seeing is the relative strength of other parts of Southeast Asia such as Vietnam and Taiwan.

Finally, let me take a look at -- make a few comments about the rest of the world. As a reminder, this region includes South America, Africa, Australia and the Middle East. Our revenue in the rest of the world was $7 million in Q3, down 25% compared to the same period last year, due entirely to FX. Excluding the impact of FX, revenue was essentially flat.

Rest of the world bookings were down 29% to $7 million in Q3 of 2015 from a very -- from a strong Q3 of 2014. FX translation also had a major impact on our results, and excluding FX, rest of the world bookings were down 6% compared to the same period last year. This region continues to be weak overall, largely due to the relatively severe recession in Brazil. But I can tell you that there still is some project activity.

Let me close my remarks with a few comments on our guidance for Q4 and the full year 2015. The first three quarters of 2015 have positioned us well for a record year in a number of categories, including gross margin, EBITDA, operating income, and earnings per share. Our outlook for Q4, however, has been impacted by reduced revenue expectations in our Doctoring, Cleaning, & Filtration and Fluid Handling product lines due to delays in capital bookings and shipments.

In addition, the strong U.S. dollar has reduced our full year revenue and earnings per share expectations by $3 million and $0.05, respectively, since our last call. For the fourth quarter of 2015, we expect to achieve GAAP diluted earnings per share of $0.79 to $0.82 on revenues of $105 million to $107 million.

We're lowering our full year revenue guidance to $388 million to $390 million and our full year guidance for GAAP diluted earnings per share to $2.95 to $2.98. As I mentioned in the past, FX has had a significant impact on our expected growth rate versus 2014, reducing revenue by $31 million and adjusted earnings per share by $0.33. Excluding the negative currency impact, we expect our revenue to grow 4% to 5% and our adjusted earnings per share to grow 19% to 20% over 2014.

I'll now pass the call over to Mike for additional details on our financial performance in Q3. Mike?

Thank you, Jon. I'll start with our gross margin performance. Consolidated product gross margins were 47.5% in the third quarter of 2015, up 280 basis points compared to the third quarter of 2014. The increase in gross margins from last year's third quarter was due to higher margins in our capital business as well as a favorable product mix.

Our higher-margin Parts and Consumables revenue represented 69% of total revenue in the third quarter of 2015 compared to 64% in the third quarter of 2014. Looking ahead, we expect that full year 2015 consolidated gross margins will be approximately 46%.

Now let's turn to Slide 17 and our quarterly SG&A expenses. SG&A expenses were $29.2 million in the third quarter of 2015, down $2.7 million from last year's third quarter, and included a favorable foreign currency translation effect of $2.5 million. Excluding the translation effect of $2.5 million and the SG&A from acquisitions, as well as the transaction expenses of acquisitions, SG&A expenses were down $600,000 or 2% compared to the third quarter of 2014. SG&A as a percentage of revenue was 31.8% in the third quarter of 2015 compared to 32.3% in last year's third quarter. Looking ahead, we expect that SG&A spending in 2015 as a percentage of revenue will be approximately 31.5% compared to 32.2% in 2014.

Now let's turn to Slide 18, adjusted operating income. Our adjusted operating income, which excludes restructuring costs and expenses related to acquired inventory and backlog, was $12.7 million or 13.8% of revenue for the third quarter of 2015 compared to $10.7 million or 10.8% of revenue in the third quarter of 2014. Adjusted operating income was up $2 million or 19%, principally due to improved gross margins as well as a modest 50 basis point improvement in SG&A expenses as a percentage of the revenues. As Jon mentioned, our third quarter operating margin is the highest we have achieved since our spinoff in 2001. We've worked hard at continuing to improve the profitability of the business, and I think this chart shows we have made good progress.

Let me turn to our EPS results for the quarter. We reported GAAP diluted earnings per share from continuing operations of $0.78 in the third quarter of 2015 compared to $0.60 in the third quarter of 2014 or an increase of $0.18. This increase of $0.18 in diluted EPS consists of the following -- $0.18 due to higher gross margin percentages, $0.17 due to lower operating expenses, $0.03 due to a lower effective tax rate, $0.03 due to the absence of restructuring cost in the third quarter of 2015, and $0.02 associated with acquisition operating results. These increases were partially offset by a decrease of $0.25 from lower revenue. Collectively, included in all the categories I just mentioned was an unfavorable foreign currency translation effect of $0.11 in the third quarter of 2015 compared to last year's third quarter due to the strengthening of the U.S. dollar.

Now let's turn to our cash flows and working capital metrics, starting on Slide 20. We had strong operating cash flows from continuing operations of $15.9 million in the third quarter of 2015, up $700,000 compared to the third quarter of 2014. Free cash flow, defined as cash flows from continuing operations less CapEx, was $14.5 million in the third quarter of 2015, up from last year's $13.5 million. We had several notable nonoperating uses of cash during the third quarter of 2015. We purchased $4.9 million of our common stock. We paid a dividend of $1.9 million and we expended $1.4 million in CapEx.

Over the past 12 months, we've returned $17.9 million of capital to our shareholders, $10.9 million from share repurchases and $7 million from dividends. This represents approximately 54% of our net income during that period.

Now let's look at our key working capital metrics on Slide 21. Days in inventory were 123 in the third quarter of 2015 compared to 97 in the third quarter of 2014 and 107 in the second quarter of 2015. We have several large capital orders scheduled to ship in the fourth quarter of 2015 and in the first half of 2016. Once these orders are shipped, the days in inventory should return to historical levels.

Our days in receivables measure was 63 days in the third quarter of 2015 and compares to 66 days in the third quarter of 2014 and 57 days in the second quarter of 2015. Our AP days were 51 in the third quarter of 2015 compared to 46 in the third quarter of 2014 and 49 in the second quarter of 2015.

Looking at our overall working capital position. Our cash conversion days measure, calculated by taking days in receivables plus days in inventory and subtracting days in accounts payable, was 135 at the end of the third quarter of 2015, up 20 days from the second quarter of 2015, up 18 days from the third quarter of 2014. Working capital as a percentage of revenue was 14.7% in the third quarter of 2015 compared to 14% in the third quarter of 2014 and 15.8% in the third quarter, excuse me, in the second quarter of 2015.

Our strong cash flows in the third quarter led to an increase in our net cash position of $7.4 million compared to the second quarter of 2015. Net cash, that is cash less debt, at the end of the third quarter of 2015 was $27.5 million compared to $20.1 million in the second quarter of 2015 and $18.7 million in the third quarter of 2014.

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

(Operator Instructions)

Do you have any -- I am told they're coming.

Our first question comes from the line of Walter Liptak from Seaport Global.

Hey, Walt.

Hey, guys, it's [Steven], and I'm on for Walt today.

Hey, Steve, how are you?

Not too bad. How is it going?

Very well. Thank you.

Just a couple of quick questions here. First, with regard to the guidance. You guys mentioned larger delays in capital bookings and shipments. I was just wondering if you could provide a little bit more color on the expectations there.

Sure. We've had -- over the years, we've had delays in capital before. And typically -- the typical pattern of those delays, it's a large stock-prep order in China. I would say that's probably happened to us many times over the years. This is a little different in that these projects delays are more related to our Doctoring, Cleaning, & Filtration and our Fluid Handling Line. So they're smaller projects. These are kind of in the $1 million and under range.

So there's more of them and they're not all in China. I would say probably Europe, North America, China, maybe even probably a little heavier in Europe. Nothing particularly special in terms of the reasons for the delays. I would say, the typical types of delays you see, they're usually part of a larger project so other things can often cause it to delay. There is some -- in the projects in China, there is some projects which have, I would call, financing delay. But nothing like that in North America and Europe.

Okay. Yes, it's definitely helpful there. So -- and then, just kind of switching gears, talking about North America a little bit. Obviously, parts sales continue to be strong. Could you just talk a little bit about your guys' expectations? Obviously, you've continuously said that it's continued to be a priority. Can you talk a little bit about just your expectations for that? And where you see those going? Will they maintain the levels they're currently at? And then on the other side of that, could you also just provide a little color on system sales in North America, just kind of what kind of quote activity? It sounds like, Jonathan, in your prepared comments, like, it seems to be kind of a healthy environment. If you could just provide a little more color on the system sales in North America as well.

Sure. I mean, in my remarks, I said North America is having an outstanding year, driven largely by our Stock-Prep business. I mean, they are really, both in capital and parts, doing incredibly well. And I would say the other one that's doing quite well is our Wood Processing business. And frankly, when I also said that I think 2015 will be a tough act to follow, I was largely talking about our Stock-Prep business in North America. They -- it'll -- they had a number of capital projects this year, which will be hard, frankly, to repeat in terms of revenue and income for that product line next year. The other part of -- what was the other parts of your question?

Just kind of about system sales, the environment. And -- yes, well and then -- that and then -- sorry, just talking about -- I think I kind of got what you mean (multiple speakers).

Yes. I mean it continues to be a good environment in North America. It continues to be a good environment. It just -- there's always a little bit to sort of timing of capital orders that can make one year -- like frankly, our Doctoring, Cleaning, & Filtration product line, they had a very, very strong '14. So they had some tough comparisons this year because last year, '14 was so good. So that kind of comes and goes. I actually take it is a little bit of a positive that those two product lines tend to cycle a little differently. I would say our Fluid Handling and our Doctoring, Cleaning, & Filtration product line cycle more similarly and then our -- but our -- and our fluid -- our Stock-Prep product lines and maybe cycles a little different than those other 2.

Okay, thank you. That's very helpful. Thanks, guys.

You're welcome.

Next question comes from the line of Dan Jacome from Sidoti.

How are you?

Hi, Dan.

Very well, Dan.

Hey, Just a couple here. Well, I guess, ceramic blades, any update on that? Just -- I'm just curious about the response rates or what traction you're seeing in that product line as we enter the new year.

Sure. I mean, so just to kind of update you, we're -- we did this acquisition in the beginning of last year. And we spent much of the time here really building a production facility here in the U.S. And I'm hoping that, that will be done first quarter next year. The -- we've -- in the meantime, we're sort of taking the blades out for trials. They're all going extremely well. I mean they're performing technically quite well, so we couldn't be more pleased with that. Quite understandably, our customers want to see the production facility up and running before they're really going to commit, and so that's kind of I would say where we are.

Got you. Okay. I'll be on the look-out for that. And then just turning to North America. Obviously, very strong containerboard, robust. I was just curious what your initial thoughts were when you saw -- when we saw WestRock idle, I guess, over 1 million tons of capacity last week. Just curious what you were thinking when you saw that.

This happens all the time. It's -- I'm frankly as interested in anything in sort of overall containerboard demand and how they're doing. And I would say, not just limiting to containerboard. So we're really interested in kind of overall tons produced. And sometimes if they can maintain their profitability or improve it by closing some mills down, that's life. I'd rather there were more mills, but ultimately we need them to be very profitable, which they are.

Okay. I agree. And then lastly, I hate to sound like a nag, but you're sitting here on record backlog, looks like highest cash earning margins ever, stock's kind of been lagging. I was wondering if there's anything you might be doing next year to maybe get the story a little bit more out there next year, and if you guys have ever considered possibly holding an Analyst Day.

That's a good question. And it is a little bit frustrating. I think a lot of that blame probably falls on me in terms of, if you will, getting the story out on the stock. And we are -- that is something that we're looking at, to have kind of an Analyst Day either in New York or maybe out here, and maybe have people come to our facility out here in Massachusetts.

Okay, that's good. New York would be good. I think everyone in Boston already knows the story, but just my two cents.

Yes.

All right, nice job. Thank you.

Okay, thank you.

Next question comes from the line of Anthony Young from Macquarie.

Good morning, guys. Thanks for taking the question.

Hi, Anthony.

Just a -- Jonathan, on the -- you mentioned possibly having the majority of your business outside of the paper industry at some point. What sort of time frame were you talking about when you made this comment?

I quite purposely didn't give one. But all I'm saying, the fact of the matter is that a lot of the acquisitions that we're looking at are outside of the paper industry, and that's not a -- and that -- what it's not, it's not because we are down on the paper industry. I would actually prefer to do an acquisition inside the paper industry because we got better synergies. But in just in terms of good businesses available, there's more outside than in. That said, it could go the other way. If we had a good acquisition inside of the paper industry, we would happily do that. But as I look forward, particularly driven by acquisitions, I wouldn't be surprised that the majority of acquisitions are outside the paper industry. That's really what that was driving towards. And I wasn't -- again, I'm definitely not signaling any kind of plan to get outside the paper industry or desire to get outside the paper industry. It's more just the nature of what's available in terms of acquisitions.

Okay, that's helpful. And then, I guess, just to feed into that, I mean, you guys reported last, beginning of August, and we obviously had a sharp correction mid to late August and at different points during September. Previously, you talked about multiples and prices being somewhat elevated, I guess, for things that you're looking at. I mean have you seen things come in or are people still sticking to those --

To be honest with you, I haven't really seen a change in terms of the private company market. It's still an issue that when the companies are larger, they tend to have kind of more high pricing and the smaller ones are still more reasonable.

Okay.

So I have -- I think it probably takes a more sustained correction to work its way into M&A from the stock market.

Okay, that's helpful. Thanks for the questions, guys.

You're welcome.

I would now like to turn the call back over to Mike McKenney for closing remarks.

Actually, it'll be me. And let me thank you all for listening, and I'll conclude it really with what I think are the key takeaways for the quarter. The first one is that we grew our earnings per share 30% despite this $0.11 FX headwind. Secondly, our Parts and Consumable business is continuing to grow strong, up 9% excluding the impact of FX. And finally, although we reduced our outlook for 2015, we still expect it to be an excellent year with record earnings-per-share performance. I look forward to updating you on the next -- on our progress in future calls. Thanks very much. Bye.