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Kadant Inc. (NYSE:KAI) Q1 2024 Earnings Call Transcript

Kadant Inc. (NYSE:KAI) Q1 2024 Earnings Call Transcript May 1, 2024

Kadant Inc. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and thank you for standing by. Welcome to Kadant First Quarter 2024 Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Michael McKenney: Thank you, Norma. Good morning, everyone, and welcome to Kadant's first quarter 2024 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 about Kadant's future plans and expectations, financial and operating results and prospects are forward-looking statements for 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 30, 2023, 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 first 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

Finally, I wanted to note that when we refer to GAAP earnings per share or EPS and adjusted EPS on this call, we're 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 first quarter results and discuss our business outlook for 2024. Q1 was a solid start to 2024. Our acquisitions Key Knife and KWS completed at the beginning of the year performed very well and contributed direct revenue in the first quarter. Solid execution by our operations teams around the globe contributed to excellent adjusted EBITDA. As expected, demand in the first quarter moderated from the unprecedented record-setting first quarter of last year as economic headwinds tempered manufacturing activity, particularly in Europe and Asia. As you can see on Slide 6, our Q1 revenue increased 8% to a record $249 million, our recent acquisitions and strong performance in our Industrial Processing segment are the drivers of this record revenue.

Our aftermarket parts revenue made up 69% of Q1 revenue and was up 13% to a record $171 million. Solid operating performance led to an adjusted EPS of $2.38 and adjusted EBITDA of $52 million, representing 21% of revenue. All our operating segments delivered excellent adjusted EBITDA margin performance despite inflationary pressures. Cash flow in Q1, which is historically a weaker quarter decreased 38% to $23 million compared to last year's record cash flow for the first quarter, while free cash flow was $17 million. As expected, bookings softened in the first quarter primarily due to reduced capital project activity. I'll provide more details about this when I discuss each of our operating segments, beginning with our Flow Control segment.

Our Flow Control segment experienced solid demand in the first quarter for both parts and capital equipment, particularly in North America. Bookings of $95 million were strong. However, they were down 9% compared to the record performance of Q1 last year. Q1 revenue declined 3% to $87 million partly due to fewer capital shipments in the first quarter compared to the same period in the prior year. Aftermarket parts revenue made up 74% of Q1 revenue and is expected to remain stable as the year progresses. Adjusted EBITDA declined 9%, our adjusted EBITDA margin of 27.8% was down due to lower operating leverage. As many of the first quarter of the year is often our strongest quarter for our Flow Control segment in terms of bookings as our customers prepare for annual spring maintenance shutdowns.

That said, we do expect to deliver a strong performance again this year in our Flow Control segment. Turning now to our Industrial Processing segment on Slide 8, we can see the positive effect from our recent acquisition of Key Knife, which became a key part of this segment beginning in the first quarter. Q1 revenue was up 27% to a record $106 million and aftermarket parts revenue made up 69% of total revenue in the segment. Excluding the impact of FX and the acquisition, revenue was up 7% compared to the same period last year. Q1 bookings were down 7% compared to the prior year period, reflecting the recent moderation of capital orders in this segment. However, there is significant capital project activity developing in this segment and we expect to convert a good portion of those active projects into orders as the year progresses.

Improved operating leverage and contributions from our recent acquisition led to record adjusted EBITDA of $27 million and adjusted EBITDA margin of 25.5%. Overall, we had a good start to the year, expect to see solid performance from this segment in the months ahead. In our Material Handling segment, we experienced solid demand for aftermarket parts and benefited from our acquisition of KWS Manufacturing completed at the end of January. Revenue of $56 million was flat compared to the prior year period and was negatively impacted by some customer delays in shipments as well as softness in capital equipment revenue. Demand for capital equipment was down from the record performance set in the prior year period, which included an unusually large capital order.

However, we believe the weaker capital order activity in the quarter was largely due to timing as project activities remains relatively strong. Adjusted EBITDA margin of 20.3% of revenue was down 170 basis points from the same period last year due to largely to reduced operating leverage associated with lower organic revenue. The outlook for this segment remains positive as the end markets we serve are fundamentally strong. As we look to the second quarter of 2024 and the full year, our healthy balance sheet and ability to generate robust cash flows have us well positioned to fund growth as the year unfolds. We expect industrial demand to strengthen in certain regions and remain stable in others as the year progresses. We remain focused on accelerating profitable growth in our core markets and expect to deliver strong financial performance again this year.

Mike will discuss this in more detail. And with that, I'll turn the call over to Mike.

An aerial view of a large manufacturing facility, conveying the scale of the industrial processing.
An aerial view of a large manufacturing facility, conveying the scale of the industrial processing.

Michael McKenney: Thank you, Jeff. I'll start with some key financial metrics from our first quarter. Gross margin was 44.6% in the first quarter '24, up 20 basis points compared to 44.4% in the first quarter of '23. The gross margin in the first quarter '24 was negatively affected by the amortization of acquired profit and inventory related to our recent acquisitions, which lowered gross margin by 90 basis points. Excluding the impact of the amortization of acquired profit and inventory, gross margin in the first quarter of '24 was 45.5%, up 110 basis points compared to the first quarter of '23. This is one of the highest gross margins in our recent history due in part to higher margins achieved in our Industrial Processing segment on parts and consumables as well as the mix of capital projects in the quarter.

Also contributing to the improved gross margin was a higher overall percentage of parts and consumables revenue, which represented 69% of revenue in the first quarter of '24 compared to 66% in the prior year. SG&A expenses as a percentage of revenue increased to 28.2% in the first quarter '24, compared to 25.5% in the prior year period. Higher percentage in the first quarter '24 is due in part to the non-recurring acquisition related costs. In addition, the first quarter revenue represents the lowest quarterly revenue we expect for the year. SG&A expenses were $70.3 million in the first quarter '24, an increase of $11.7 million compared to $58.6 million in the first quarter '23. This included an increase of $7.3 million from our acquisitions, $1.9 million from acquisition-related costs and a $0.2 million unfavorable foreign currency translation effect.

Excluding these items, SG&A expenses were up $2.3 million or 4% compared to the first quarter of '23, primarily due to annual wage and incentive increases. Our effective tax rate in the first quarter was 23.9% and included tax benefits related to the vesting of equity awards, which lowered the effective tax rate by 1.5%. Our GAAP EPS decreased 13% to $2.10 in the first quarter compared to $2.40 in the first quarter '23, due to acquisition-related costs in the current period. Our adjusted EPS decreased 1% to $2.38, which exceeded the high end of our guidance range by $0.38 due to several factors. Gross margin was stronger than anticipated and we had higher-than-anticipated revenue, especially for our aftermarket products in our Industrial Processing segment.

In addition, the operating results for our acquisitions were better than expected. We closed our Key Knife acquisition at the beginning of the first quarter and our KWS acquisition in late January and the integrations are going well, as Jeff mentioned earlier. Adjusted EBITDA increased 8% to $52.2 million compared to $48.6 million in the first quarter '23 driven by strong performance in our Industrial Processing segment. This segment had record adjusted EBITDA due to contributions from its recent acquisition and improved performance at our other wood processing businesses. As a percentage of revenue, adjusted EBITDA was 21% compared to 21.1% in the first quarter '23. Operating cash flow at $22.8 million was lower than the prior two quarters due to an increase in working capital requirements and down 38% compared to the first quarter '23.

Free cash flow was $16.6 million in the first quarter of '24, down 49% compared to the first quarter '23, which was a record for first quarter cash flows, both in operating and free cash flow. We expect higher cash flows for the remaining quarters of the year and overall anticipate strong cash flows for '24. We paid $232.3 million net of cash acquired for our acquisitions of Key Knife and KWS in the first quarter. We borrowed $234 million, mainly to fund our acquisitions and we also repaid $33 million of our debt in the first quarter of '24. Other non-operating uses of cash in the first quarter '24 included $6.3 million for capital expenditures, $3.4 million for dividends on our common stock and $5.9 million for tax withholding payments related to the vesting of stock awards.

Let me turn next to our EPS results for the quarter. In the first quarter, '24, GAAP EPS was $2.10 and after adding back $0.28 of acquisition related costs, adjusted EPS was $2.38. In the first quarter of '23, GAAP and adjusted EPS were $2.40. A decrease of $0.02 in adjusted EPS in the first quarter '24 compared to the first quarter '23 includes increases of $0.21 from our acquisitions, $0.18 due to higher gross margins, $0.05 due to a lower tax rate. These increases were offset by $0.18 due to higher operating expenses, $0.14 due to lower organic revenue, $0.13 due to higher interest expense and $0.01 due to higher weighted average shares outstanding. Collectively, included in all the categories I just mentioned, was a favorable foreign currency translation effect of $0.01 in the first quarter '24 compared to the first quarter last year due to the weakening of the US dollar.

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, decreased to $128 at the end of the first quarter '24, compared to $136 at the end of the first quarter of '23 due to a lower number of days in inventory. Working capital as a percentage of revenue was 15.7% in the first quarter '24, compared to 15.6% in the first quarter of '23. Our net debt, that is debt less cash, increased $223 million sequentially to $227 million at the end of the first quarter '24 due to borrowings from the 2 acquisitions. Our leverage ratio calculated in accordance with our credit agreement increased to 1.12% at the end of the first quarter '24 compared to 0.27% at the end of '23.

At the end of the first quarter '24, we had $102 million of borrowing capacity available under our revolving credit facility and an additional $200 million of uncommitted borrowing capacity. Now I'll update our guidance for '24. We are maintaining our full year revenue guidance of $1.040 billion to $1.065 billion and our adjusted EPS guidance of $9.75 to $10.05, which excludes $0.36 of acquisition-related costs. We now expect GAAP EPS of $9.39 to $9.69 revised from our previous guidance of $9.55 to $9.85, which had assumed acquisition-related costs of $0.20. 2024 guidance includes an unfavorable foreign currency translation impact of approximately $0.9 million on revenue and $0.01 on adjusted EPS. This represents a reduction of $0.16 from our prior forecast due to the strengthening of the US dollar against other currencies.

Our revenue guidance for the second quarter '24 is $258 million to $266 million, and our adjusted EPS guidance is $2.40 to $2.50, which excludes $0.04 of amortization expense associated with acquired profit and inventory and $0.02 related to acquired backlog. Our 2024 guidance assumes amortization expense related to acquired profit and inventory will be completed in the second quarter and an additional $0.02 of amortization expense associated with acquired backlog in the third quarter. Excluding acquired backlog, the 2024 intangible amortization expense associated with the acquisition is $0.46. Both GAAP and adjusted EPS guidance include our initial estimates of purchase accounting adjustments, which are subject to change as we review and finalize the valuation work for these acquisitions.

While we are maintaining our revenue and adjusted EPS guidance for '24, we remain cautious and continue to monitor risk to our guidance. Requests for capital project proposals are high, but the timing for finalizing orders is uncertain, especially in certain regions like China where securing financing can be a challenge. As a result, the timing for large capital projects can shift by quarter with some potentially moving to next year. In addition, Central Bank's policy response to inflation and the impact on the U.S. dollar and other currencies can have a significant impact on our guidance. Our '24 guidance currently includes a $0.01 unfavorable foreign currency translation effect, which represented a $0.16 decrease from our previous guidance, further strengthening or weakening of the US dollar will impact this estimate.

We continue to anticipate gross margins for '24 will be 43.5% to 44.5%. As a percent of revenue, we still anticipate SG&A will be approximately 25.5% to 26.2% and R&D expense will be approximately 1.3% to 1.4% of revenue. We now expect net interest expense of approximately $17 million to $17.5 million, down from our previous guidance of $18 million to $18.5 million as a result of faster debt pay-downs than originally forecast. We continue to expect our recurring tax rate will be approximately 26.5% to 27.5% in '24. And we continue to expect depreciation and amortization will be approximately $46 million to $48 million, and we are maintaining our CapEx guidance spending of $29 million to $31 million. That concludes my review of the financials, and I will now turn the call back over to the operator for our Q&A session.


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