Kadant Inc. (NYSE:KAI) Q3 2023 Earnings Call Transcript

Kadant Inc. (NYSE:KAI) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good day and thank you for standing by. Welcome to the Kadant Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead.

Michael McKenney: Thank you, Amy. Good morning everyone and welcome to Kadant’s Third Quarter 2023 Earnings Call. With me on the call today is Jeff Powell, our President and Chief Executive Officer. Before we begin, let me read our Safe Harbor statement. Various remarks that we may make today, like Kadant’s future plans and expectations, financial and operating results and prospects are forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks and uncertainties that may cause our actual results to 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 December 31, 2022, and subsequent filings with the Securities and Exchange Commission.

In addition, any forward-looking statements we make during this webcast represent our views and estimates 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 views or estimates change. 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 and the slides presented on the webcast and discussed in the conference call, which are available in the Investors section of our website at www.kadant.com.

Finally, I want to note that when we refer to GAAP earnings per share or EPS and adjusted EPS on this call, we are referring to each of these measures as calculated on a diluted basis. With that, I’ll turn the call over to Jeff Powell, who will give you an update on Kadant’s business and future prospects. Following Jeff’s remarks, I’ll give an overview of our financial results for the quarter and we will then have a Q&A session. Jeff?

Jeffrey Powell: Thanks, Mike. Hello everyone. Thank you for joining us this morning to review our third quarter results and discuss our outlook for the remainder of the year. I’ll begin by reviewing our operational highlights. The third quarter was another record-setting performance, benefiting from a combination of excellent execution across our operating segments and stronger-than-expected aftermarket parts revenue. This will add to near-record revenue and record adjusted EBITDA, record adjusted EBITDA margin and record adjusted EPS in the third quarter. As has been the case throughout 2023, our operations teams around the globe delivered exceptional value for our customers in the most recent quarter, leading to excellent performance across our key financial metrics.

I want to thank them for their outstanding work and the results they generated, not only in the third quarter, but throughout the year. Turning next to Slide 6, I’d like to review our Q3 financial performance. As you can see on the slide, our Q3 performance was notably higher across most key metrics compared to Q3 of last year. Revenue was up 9% compared to the third quarter of 2022 to $244 million and benefited from record capital shipments and strong aftermarket parts business. Solid execution contributed to our record adjusted EBITDA of $53 million and a record EBITDA margin of 21.6%. All our operating segments delivered excellent adjusted EBITDA margin performance. Cash flows from operations and free cash flow were outstanding in the third quarter at $47 million and $38 million respectively, demonstrating the strength of our business model.

As anticipated, bookings softened from the record-setting pace earlier this year and were essentially flat compared to the prior period. I’ll review the performance of our operating segments next beginning with our Flow Control segment. Capital project activity and solid aftermarket demand contributed revenue growth in our Flow Control segment, up 5% compared to Q3 of last year. Bookings were $83 million, down 2% due to weaker capital bookings compared to the prior period. Aftermarket parts bookings were up slightly in the third quarter and represented 71% of total revenue in this segment. Excellent execution in both the commercial and operational areas of the business led to solid adjusted EBITDA, adjusted EBITDA margin of 29.7%. Many end markets in our Flow Control segment remained strong despite the general sluggishness found in the manufacturing sector.

We continue to see good levels of project activity and are well-positioned to win new business as these projects move forward, although the timing is somewhat uncertain. In our Industrial Processing segment, revenues were up 9% to $94 million, led by record aftermarket parts business, which made up 60% of our total revenue in Q3. Adjusted EBITDA was up 9% and our adjusted EBITDA margin was excellent at 23.8%. As anticipated, demand slowed in Q3 in response to producers taking market-related downtime. As was the case in our Flow Control segment, capital project activity and interest remained high across all product lines despite the economic headwinds. In our Material Handling segment, we experienced strong demand for both capital equipment and aftermarket parts.

Revenue was up 15% to $59 million due to a record capital revenue in the third quarter. All product lines in this segment contributed to this performance. Bookings in this segment were up 17% compared to the same period last year to $56 million. This growth was largely due to increased demand for our high-performance balers used to prepare recycled materials and post-consumer waste for secondary processing. Solid execution helped boost adjusted EBITDA by 33% and adjusted EBITDA margin by 300 basis points compared to the same period last year. While we expect demand to moderate in the near term, we continue to see growing business activity for our bulk material handling equipment and our balers, particularly in North America. As we look ahead to the remainder of 2023, we expect to finish the year with record results.

We ended the third quarter with a large backlog and expect fourth quarter demand to be consistent with the prior quarter. Although we are seeing a lot of activity around capital projects, the timing of these projects is uncertain due to macroeconomic headwinds. And finally, our healthy balance sheet and strong cash flow have us well-positioned to pursue new opportunities. With that, I’ll pass the call over to Mike for his review of our Q3 financial performance.

Michael McKenney: Thank you, Jeff. I’ll start with some key financial metrics from our third quarter. Consolidated gross margins were 43.3% in the third quarter of 2023, up 80 basis points compared to 42.5% in the third quarter of 2022. All our segments contributed to the higher gross margins, especially our Material Handling segment, which was up 340 basis points compared to the third quarter of 2022. Parts and consumables revenue represented 61% of revenue in the third quarter of 2023 compared to 63% in the prior year. SG&A expenses were $57.9 million in the third quarter of 2023, an increase of $4.7 million compared to $53.2 million in the third quarter 2022 and included a $1.1 million increase from the unfavorable effect of foreign currency translation.

The remaining increase in SG&A expense is primarily associated with increased compensation expense and outside consulting fees. As a percentage of revenue, SG&A expenses were 23.7% in the third quarters of 2023 and 2022. Our effective tax rate of 25.8% in the third quarter of 2023 was lower than we anticipated, due to discrete tax items. Our GAAP EPS increased 12% to $2.63 in the third quarter compared to $2.35 in the third quarter of 2022, and our adjusted EPS increased 13% to a record $2.69. Our third quarter 2023 adjusted EPS exceeded the high end of our guidance range by $0.40, due primarily to higher revenue in our stock preparation and material handling product lines. In addition, lower selling-related costs and a lower tax rate also contributed to the guidance beat.

Adjusted EBITDA increased 10% to a record $52.7 million compared to $47.8 million in the third quarter of 2022, due to strong performance in all our segments, most notably in our Material Handling segment which had near-record revenue and adjusted EBITDA in the quarter. Adjusted EBITDA as a percentage of revenue was a record 21.6% in the third quarter of 2023 compared to 21.3% in the third quarter of 2022. We had our highest quarterly operating cash flow since the fourth quarter of 2021 at $47 million in the third quarter of 2023, up 89% compared to $24.9 million in the third quarter of 2022. We had cash outflows in the first half of the year related to working capital to support our record backlog. In the third quarter, projects were completed and shipped, resulting in a sequential decrease in inventory of $12 million.

Overall, working capital was a $5.8 million source of cash in the third quarter of 2023. Free cash flow increased 106% to $38.1 million in the third quarter of 2023 compared to $18.5 million in the third quarter of 2022. We had several notable non-operating uses of cash in the third quarter of 2023. Paid down debt by $25.7 million in the quarter, paid $8.8 million for capital expenditures and paid a $3.4 million dividend on our common stock. I would also note that $2.5 million of the $8.8 million in capital expenditures related to the facility project in China. The facility move has been essentially completed with the remaining capital expenditure of approximately $2 million to $3 million. Let me turn next to our EPS results for the quarter.

In the third quarter of 2023, our GAAP EPS was $2.63, and after adding back $0.03 of relocation costs and $0.03 of restructuring and impairment costs, our adjusted EPS was $2.69. The relocation costs relate to the facility project in China and the restructuring and impairment costs relate to the consolidation of one of our smaller manufacturing facilities into a larger facility, both in Europe. In the third quarter of 2022, our GAAP EPS was $2.35, and after adding back $0.02 of acquisition costs and $0.01 of restructuring costs, our adjusted EPS was $2.38. As shown in the chart, the increase of $0.31 in adjusted EPS in the third quarter of 2023 compared to the third quarter of 2022 consists of the following. $0.53 due to higher revenue, $0.13 due to higher gross margins, and $0.01 due to lower tax rate.

These increases were partially offset by $0.33 due to higher operating expenses, $0.02 from higher interest expense, and $0.01 from higher weighted average shares outstanding. Collectively included in all the categories I just mentioned was a favorable foreign currency translation effect of $0.03 in the third quarter of 2023 compared to the third quarter of last year. Looking at our liquidity metrics on Slide 15. Our cash conversion days, which we calculate by taking days in receivables plus days in inventory and subtracting days in accounts payable were 138 at the end of the third quarter of 2023, unchanged from the prior quarter. Working capital as a percentage of revenue decreased to 15.4% in the third quarter of 2023 from 16.7% in the second quarter of 2023.

Our net debt, that is debt less cash, decreased $36 million or 42% sequentially to $50 million at the end of the third quarter of 2023. We’ve paid down $70 million of our revolving credit facility debt in 2023, helping to lower our leverage ratio calculated in accordance with our credit agreement to 0.38 at the end of the third quarter of 2023, compared to 0.74 at the end of 2022. Our net interest expense increased $0.2 million to $1.7 million in the third quarter 2023 compared to $1.5 million in the third quarter 2022. We have a strong balance sheet and are well-positioned to take advantage of investment opportunities with our current net debt position of $50 million, current borrowing capacity of $285 million available under our revolving credit facility, and an additional $200 million of uncommitted borrowing capacity.

Now turning to our guidance for the fourth quarter and full year 2023. Due to our strong third quarter performance, we are increasing our full-year revenue guidance to $941 million to $949 million, from $925 million to $940 million, and we are increasing our adjusted EPS guidance for the full year to $9.65 to $9.75 from $9.15 to $9.35. The adjusted EPS guidance excludes $0.03 of relocation costs and $0.03 of restructuring and impairment costs. Our revenue guidance for the fourth quarter of 2023 is $222 million to $230 million and our adjusted EPS guidance is $2.02 to $2.12. As always, I’ll caution here, there could be some variability in our quarterly results due to several factors, including the variability of order flow and the timing of capital shipments.

In addition, other risks that could impact our guidance include Central Bank’s policy responses to inflation, geopolitical tensions and softening markets. We continue to anticipate gross margins for 2023 will be 43% to 43.5% with fourth quarter margins projected to be in the mid-42% range as the mix is expected to be more heavily weighted towards capital. We expect our tax rate for the fourth quarter will be approximately 27%. We hope these guidance comments are helpful. And that concludes my review of the financials and I will now turn the call back over to Amy for our Q&A session. Amy?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Gary Prestopino with Barrington Research. Your line is open.

Gary Prestopino: Hey, good morning, Jeff and Mike.

Jeffrey Powell: Good morning, Gary.

Gary Prestopino: Could you maybe — I was trying to write this down as quickly as possible. Could you maybe dwell a little bit into the strength that you saw in Material Handling? And I think you said you were going to see maybe a step-down in demand in Q4. Could you help me out there?

Michael McKenney: Sure. Well, we had very — we’ve had very strong performance on the Material Handling front on the — in regards to bookings and that continued in the third quarter. And I would say, I’d remind you that in the first quarter we had a large order that we booked for that conveying system, the 42-mile-long conveying system, and view — that is — you’re seeing some of that in revenue in the third quarter, and you’re going to see a good portion of that revenue in the fourth quarter. So think on the revenue front, Material Handling performance will be pretty strong. But on the bookings front, I’d say, I’ll just — let me just take a sneak peak here for the fourth quarter. We usually don’t get too granular on forecasting bookings, but when I look back to our performance in the fourth quarter of 2022, we had quite a strong quarter on capital bookings and I would anticipate that we’ll see that pull back a little bit.

So that may cause — overall that may make Material Handling kind of flattish or down a little bit on the bookings front.

Gary Prestopino: You also, as I wrote down demand for balers that was pretty strong too [Multiple Speakers].

Michael McKenney: Yes, we had a very good strength in the baler business.

Gary Prestopino: Okay. And then the Flow Control, you mentioned good levels of project activity within various segments of the business. Could you maybe elaborate on that a little bit?

Jeffrey Powell: Yeah. So, of course, we’re particularly strong — we are particularly strong in the packaging and paper, but they’ve also done a great job. That product line Probably has more applications through the general industry than almost any other product we have, and they’ve grown that side — that industrial side nicely. So they’re particularly strong in the metals. They have — they are particularly strong in food and tissue, which is a subset of paper, but a lot more stable. And then just general industry. It’s amazing how many industries that are out there that use our fluid handling products from solar fields, to windmills, to just all kinds of applications out there. So there is quite a mix of general industry that — and they are continuing to make good progress in taking their products to new markets.

And so, in fact, I’d say that’s true through all of Kadant where our largest segment now is what we call general industry. It’s our — biggest of all of our segments. So everybody works hard to try to take their products in new markets, and the fluid handling in particular has a lot of broad applications there.

Gary Prestopino: Okay, thank you.

Operator: One moment for our next question. Our next question comes from Lawrence De Maria with William Blair. Your line is open.

Lawrence De Maria: Hi thanks. Good morning everybody. Hey, first question, you said you expect, I believe, flat backlog for the end of the year. Obviously, you gave your sales guide, implies orders pick up sequentially to 2.20 to 2.30 range. So, I guess, first, what’s driving that uptick sequentially, especially if the MH is maybe down a little bit, I guess the other two have to be up. Is there anything specific driving that, because that’s good visibility as we move into next year?