Kadant Inc

Good day, and thank you for standing by. Welcome to the CADENT second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone, and you will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Michael McKinney, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Abigail. Good morning, everyone, and welcome to CADEN's second 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 about CADEN's future plans and expectations financial and operating results, and prospects are forward-looking statements for purposes of 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 our annual report on Form 10-K for the fiscal year ended December 31st, 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 most directly comparable GAAP measures is contained in our second quarter earnings press release and the slides presented on the webcast and discussed in the conference call, which are available in the investor section of our website at www.cadent.com. Finally, I wanted 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 Cadence business and future prospects. Following Jeff's remarks, I will give an overview of our financial results for the quarter, and we will then have a Q&A session. Jeff?

Thanks, Mike. Hello, everyone. Thank you for joining us this morning to review our second quarter results and discuss our business outlook for the second half of 2023. I'll begin by reviewing our operational highlights for the second quarter. I'm pleased to report we had another well-executed quarter with solid aftermarket demand for parts, combined with strong capital business leading to record revenue, record-adjusted EBITDA, and record-adjusted EPS. Our operations teams around the globe continue to deliver value for our customers and perform at a high level as shown by our strong financial performance. They have done a great job in meeting our customers' needs in a challenging environment, and I want to thank them for their outstanding work and the results they've generated. Turning next to slide six, I'd like to review our Q2 financial performance. We achieved a number of new financial records in the second quarter, driven by large capital shipments along with strong contribution from aftermarket parts. Revenue increased 11% to a record $245 million with solid growth across all regions and all operating segments. Strong execution contributed to a record adjusted EBITDA of $52 million, up 12% compared to last year, and representing 21% of revenue in the second quarter. Our adjusted EPS was also a record at $2.54 a share. As economic headwinds strengthen, second quarter bookings decline, from the record set in the first quarter of this year. Capital project activity remains healthy, but as the scope of these projects is refined, the execution timeline has, in some cases, been pushed out to a later date. While the general slowdown in industrial activity over the past few months is reflected in our second quarter new order activity, we have a strong backlog and expect bookings in the second half of 2023 to be similar to the second half of last year. I'll provide more details on that when I review our operating segments. Next, I'd like to discuss our three operating segments beginning with flow control. As you can see on slide seven, our flow control segment had solid bookings coming off of a record first quarter in 2023. Revenue in the second quarter increased 12% to a record $96 million with a strong contribution from capital projects. Our after markets parts revenue remained robust in the second quarter and made up 68% of total revenue. Excellent operating performance led to record adjusted EBITDA and an adjusted EBITDA margin of 29.3%. Our flow control segments bookings performance in the first half of 2023 provided a good start to the year. We expect business to moderate in the second half, reflecting the overall softening in industrial production. That said, the fundamentals of our end markets remain healthy and we are well positioned to capitalize on new projects and opportunities. Our industrial processes segments revenue in the second quarter grew 7% compared to the same period last year. Relative to our other operating segments, our industrial processing segment was more impacted by foreign currency translation in the second quarter, and when excluding the impact of FX, our revenue was up 9%. Strong operating leverage boosted EBITDA margin 40 basis points to 22.2%. As you can see on slide 8, our year-over-year bookings comparison is challenging for the second quarter as we had historic demand in the prior year period. The decline in capital business was largely in our wood processing product line, while demand for parts in this segment was comparable to the same period last year. In our material handling segment, we achieved our best revenue performance since creating this segment, with strong contributions from our bulk material handling equipment leading to record revenue of $59 million in the quarter. Aftermarket parts demand for our high-performance bailing systems, particularly in Europe, was also notable. Bookings in our material handling segment were down 19% compared to the same period last year, largely due to reduced capital project activity in our bailing product line. The record-setting revenue volume, combined with solid execution by our businesses in this segment, helped boost adjusted EBITDA margin to a record 22.9% in the quarter. We are encouraged by the number of infrastructure projects already underway and the additional projects being planned since the passage of the infrastructure bill in the U.S. Inquiries for our material handling equipment continue to increase as infrastructure projects gain traction, and we are well positioned to take advantage of this growing demand. As we look ahead to the second half of 2023, the ongoing economic challenges lead us to believe demand for our products will be similar to that of the second half of last year. Our operations teams around the globe are executing well on their strategic initiatives and making positive strides to create and capture more value. Our robust backlog and ability to generate strong cash flows continue to have us well positioned to capitalize on opportunities that may emerge as the year unfolds. We expect to deliver record financial performance again this year and are raising our full year 23 revenue and EPS guidance. With that, I'll turn the call over to Mike for a review of our financial performance in Q2 and our guidance outlook for the remainder of the year. Mike. Thank you, Jeff.

I'll start with some key financial metrics from our second quarter. Consolidated gross margins were 43.5% in the second quarter of 23, up 20 basis points compared to 43.3% in the second quarter of 22. This increase was principally due to higher margins achieved on capital projects, especially in our industrial processing segment, all set in part by a lower proportion of parts and consumables revenue, which represented 62% of revenue in the second quarter of 23 compared to 66% in the prior year. SG&A expenses increased $4.7 million to $60 million in the second quarter of 23 compared to $55.3 million in the second quarter of 22 due to wage increases and incremental costs related to trade shows and travel. As a percentage of revenue, SG&A expense decreased to 24.5% in the second quarter of 23 compared to 25% in the prior year period. Our GAAP EPS increased 13% to $2.54 in the second quarter, compared to $2.24 in the second quarter of 22, principally due to higher revenue. Our adjusted EPS was a record $2.54 in the second quarter of 23, exceeding the prior record of $2.40 achieved in the first quarter of 23. The second quarter of 23 adjusted EPS the high end of our guidance range by 39 cents due to higher revenue and better gross margins than forecasted. We had record revenue in the second quarter of 23, driven by our highest quarterly parts and consumable revenue. Both our material handling and industrial processing segments exceeded their parts and consumables revenue forecast due in part to fulfilling additional orders from backlogs. Adjusted EBITDA increased 12% to a record $51.6 million compared to $46 million in the second quarter of 2022 due to strong performance in our flow control and material handling segments. As a percentage of revenue, adjusted EBITDA was 21% compared to 20.7% in the second quarter of 2022. Operating cash flow increased 20% to 22.5 million in the second quarter of 23, compared to 18.8 million in the second quarter of 22. Free cash flow was up 16% to 13.7 million in the second quarter of 23, compared to 11.9 million in the second quarter of 22. We had several notable non-operating uses of cash in the second quarter of 23. paid down debt by 25.1 million, paid 8.8 million for capital expenditures, and paid a 3.4 million dividend on our common stock. I would also note that 3.1 million of the 8.8 million capital expenditure amount related to the facility project in China. The facility move has started and is expected to be completed in the third quarter with the remaining capital expenditure of approximately $5 million to be paid over the next two quarters. Let me turn next to our EPS results for the quarter. Our gap in adjusted earnings per share were $2.54 in the second quarter of 23 compared to $2.24 in the second quarter of 22. As shown in the chart, the increase of 30 cents in adjusted EPS in the second quarter of 23 compared to the second quarter of 22 consists of the following. 63 cents due to higher revenue, 2 cents due to a higher gross margin percentage, and 1 cent due to a lower tax rate. These increases were partially offset by 30 cents due to higher operating expenses, 5 cents due to higher interest expense, and 1 cent due to higher weighted average shares outstanding. collectively included in all the categories I just mentioned, was an unfavorable foreign currency translation effect of six cents in the second quarter of 23 compared to the second quarter of last year due to the strengthening of the U.S. 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, was 138 at the end of the second quarter of 23 compared to 136 last year. Working capital as a percentage of revenue was 16.7% in the second quarter of 23 compared to 15.6% last quarter. Our net debt, that is debt less cash, decreased 10 million or 10% sequentially to 87 million. This is the lowest net debt position we've had since 2017. We were able to pay down $25 million revolving credit facility debt in the second quarter of 23, and as a result, our leverage ratio, calculated in accordance with our credit agreement, decreased to 0.51 at the end of the second quarter of 23 from 0.64 at the end of the first quarter of 23. We have a strong balance sheet and are well positioned to take advantage of investment opportunities with our current net debt position, current borrowing capacity of $257 million available under our revolving credit facility, and an additional $200 million of uncommitted borrowing capacity. Now I'll update our guidance for 23. We are increasing our full-year revenue guidance to $925 to $940 million from $910 to $935 million, and we are increasing our adjusted EPS guidance for the full year to $9.15 to $9.35 from $8.90 to $9.15. The adjusted EPS guidance excludes $0.04 in estimated relocation costs associated with one of our facilities in China. Our revenue guidance for the third quarter of 23 is $229 to $236 million, and our adjusted EPS guidance is $2.19 to $2.29, which excludes 4 cents of estimated relocation costs. As always, I'll caution here that 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. We now anticipate gross margins for 23 will be 43% to 43.5%. This implies gross margins in the remaining quarters will be slightly below 43% as the mix is expected to be more heavily weighted towards capital in the second half of 23. As a percentage of revenue, we now anticipate SG&A will be approximately 25%. We continue to anticipate our tax rate for the remaining quarters in 23 will be approximately 27%, and we now anticipate CapEx spending in 23 will be approximately $38 to $40 million, up from $32 to $34 million, as we were able to accelerate some investments originally planned for 24. Our CapEx For 2023, CapEx funding includes approximately $9 million related to our facility project in China. That concludes my review of the financials, and I will now turn the call back over to Abigail for our Q&A session. Abigail?

Thank you. At this time, we will conduct the question and answer session. As a reminder, to ask a question, you will need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. One moment while we compile the Q&A roster. Our first question comes from the line of Gary Prestopino with Barrington Research. Your line is open.

Hey, good morning, Mike and Jeff. Good morning, Gary. Can we just go, for my purposes, as a new analyst following the company, could we just maybe just go into some of the... puts and takes on the year-over-year bookings? I mean, they're down somewhat dramatically, I suppose. So is that just really a function of what you're seeing economically, a slowdown? Or was last year just a big year in terms of bookings due to catch-up from the pandemic?

Yeah, so I think it's really a combination of two things. Last year at the time, that was, you know, 266 was a record for us, quite strong. And so, and of course, the first quarter of this year was 275, a new record. So, you know, we kind of look at, when we look at our booking, some of, you know, maybe what we thought would come in the second quarter moved in the first quarter. So we had the very strong 275 in the first quarter. But there is, I think, there's no question that there is a little bit of an industrial slowdown. If you look at the overall economy, you know, what we're seeing is that the service side of the economy is, you know, doing quite well, and the industrial side is slowing down some. So I think a little bit of it is comparing to a record at the time last year, a little bit of it is having such a phenomenal first quarter at the 275, combined with, you know, a little slowdown in industrial production. You know, it tends to be our capital equipment that shifts around. Our parts are pretty stable, and they're pretty flat, actually, you know, so it's really the timing of capital from one quarter to the next, and a little bit of a slowdown. You know, I think people are just taking a little more of a wait and see approach, trying to see what the Fed's going to do. Interest rates have gone up, of course, which, you know, increases the cost of borrowing money. And so I think it's a combination of all those factors.

Okay. Thank you.

One moment for our next question. Our next question comes from the line of Laurence Dumerio with William Blair. Your line is open.

Thanks. Good morning, Jeff and Mike. I just, as a follow-up on the earnings, sorry, the orders question, can you just give an idea of, you know, how much worse were orders compared to your expectations in the quarter? And what gives you confidence that those second half bookings, you know, will come through at the levels you said they were? Do you have the pipeline and the conversations? and good visibility on that. That's the first part.

Yeah. Yeah, Larry. You know, the orders came in on forecast. That was the forecast for the quarter. So, no disappointment there. That is what we anticipated. Again, as, you know, Jeff mentioned, you know, we had an extraordinarily strong first quarter bookings performance, as we noted. So, you're looking at Um, first quarter bookings, which were extraordinarily strong and also second quarter of last year at two 66, we also indicated was a phenomenally strong, uh, order quarter for us, especially in both periods on the capital front.

Okay. And then the pipeline into the second half that gives you that confidence.

Yes. I think, uh, you know, uh, as Jeff said, our parts and consumable business is very stable. We are seeing a little – some softness on the capital bookings front, and that's what folks have forecast.

Okay. And then now we start to think about long-term again through the second half and kind of lower orders that we're starting that we're having to kind of now. Give us some high-level thoughts, if you can, and are willing to do it, on what it means into 2024. If we're looking at, you know, is this a trough year? Do we sort of start off soft based on the orders and then look for reacceleration in industrial from IIJA and other things? Or can you actually think about even growing margin earnings next year because of 80-20 and positive price? Any kind of high-level puts and takes on how to start to frame next year based on where the orders are now would be real helpful.

Yeah, of course, as you know, it's always, when you're sitting here, you know, just closing the second quarter, it's a little challenging to know exactly what's going to happen next year, and particularly because the Fed is still, you know, still on a campaign to try to get control of inflation. But I think we're encouraged by the fact that the, in particular, our wood group, you know, the builders are starting to see, you know, improved demand. The A lot of the forest product companies have released earnings and had strong earnings and are somewhat optimistic. So I think that sector, you know, I think they're hoping that might come back a little bit next year. Our material handling side, in particular the bulk equipment handling side, that's been ramping up with this infrastructure bill that really is just now, you know, starting to be spent. You know, it takes a while for the government to start spending that. So our customers kind of tried to get ahead of that. and make some investments in their business so they're prepared when that money starts to flow. But it really is just, you know, it hasn't really hit the market yet. But it's, you know, I would say that it's still a bit early for us to predict. You know, what the experts are saying is they expect maybe things will, you know, will be slow the first half of the year and that in the second half things will start to pick back up. There might even be, some people even predict there might be some rate cuts the second half of the year. I have no idea whether that will be the case or not. But I think we believe that there will be some improvements as the year progresses. I think we think that it's going to be kind of flat and stable the rest of this year with last year, probably start out that way the first of the year. Then we would expect to see investments start to be made as the year progresses and our customers get a little more visibility on exactly where interest rates top out at. and kind of what the Fed's action might be. But I would say these are more uncertain times because you do have these central banks. I mean, in China, the bankers are actually trying to spur growth because they're growing. They're worried about disinflation, not inflation, so they're trying to increase demand. Europe, of course, is just essentially flat this quarter, up maybe one or two-tenths of a percent. So there is a fair amount of variability around the world right now in what the different bankers are doing to impact their economies. But we think, generally speaking, that things should improve as the year goes on next year.

Okay. That makes sense. I appreciate it. Obviously, it's difficult to make those calls right now. Last question. You talked about, obviously, M&A capacity, et cetera, and balance sheet. At some point, would we consider share repurchases? And are we at the point where we're getting closer to actionable M&A, or is it just a good pipeline and you know, still waiting for things to align.

So I would say, Larry, on the share repurchase, yes, we have a $50 million authorization. Outstanding. We always have an authorization available to utilize. So that is always in the mix for capital deployment. And I would also say for us currently right now, there is a lot of activity on the M&A front. We're seeing a lot of companies come out. So, you know, that is certainly always in play for us also.

Yeah, I would say our deal flow, we talk about, you know, we have a corporate development group that focuses on that. I would say the deal flow was surprisingly weak last year, but it's bounced back nicely this year. So there's a lot of activity, a lot of discussions, a lot of companies out there that are, you know, interested in being acquired. So our group's quite busy right now looking to try to find, you know, companies that are good strategic fits for us at the proper value.

Okay. Thank you very much and good luck. Thank you.

As a reminder, to ask a question, you will need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. One moment for our next question. And our next question comes from the line of Addie Madden with DA Davidson. Your line is open.

Hey, good morning, everyone, and filling in for Kurt Ginger today. And just a couple of quick questions for me. So could you give us more color on the backlog and like, how would you characterize it? When does it extend out into the cancellation rate or anything else we should know about it?

Well, uh, Eddie, our, our, our back, we ended the quarter with a backlog of 363 million. So, as you know, we ended the first quarter with a record backlog of 393. And just as a benchmark, that 363 would be a very high backlog for us. It would be our third highest backlog, only eclipsed by the first quarter of 24. And then mid-22, we had a higher backlog the second quarter of 22. So, we have a very a strong backlog. And in regards to your question, I think you were saying about cancellations. That's very rare for us. It does happen on occasion, but a good chunk of the backlog is capital. It kind of breaks out 70, 30, 70% of the backlog is capital. So the majority far and away in the backlog is capital. And our customer base, when they commit to a capital project, they tend not to back off of that. So it does happen on occasion, cancellations, but not much.

Got it, got it. Yeah, that makes sense. And then you talked about your work clients. And so when it comes to mills taking downtime over the quarter, how did that trend, and how do you expect that to be going forward, maybe for the full year also, if you could talk about it more broadly?

Yeah, you know, the first quarter, the mills on the wood side were slow and demand was down, but it surprisingly picked up quite a bit in the second quarter. Prices firmed up, and our parts business was quite strong, which tends to be an indicator of operating rates. So I would say on the wood side, things seem to be improving. Now, it's very much a function of interest rates, you know, and I think, you know, Everybody's trying to adjust to the new rates. But there's almost no kind of used inventory coming on the market. Everybody's locked into these very low interest rate loans. They don't want to trade out a 3% mortgage for a 7%. And so almost all of the home purchases now are new construction because of that. And so, of course, that drives a lot of our customers' demand. So I think if you look at the underlying fundamentals, demand in the housing sector. You look at the millennials, which they're going to peak around 2030 as far as prime house buying. And then also the average age of homes in the 20 to 40 year, which is when major remodeling takes place, that's at a quite high rate too. So the underlying fundamentals for wood are actually quite good for the next several years. And I think there's been this momentary challenge with the Fed raising rates to try to crush inflation. But as rates start to come down, whether it's middle of next year or the end of next year, I think you're going to see the wood sector come back very strongly because there's just so much underlying demand. And these millennials aren't going to live in their parents' basements forever. They want to get out of that. And so there's just a lot of demand, and we've underbuilt for 10 years now or more. So I think you're starting to see some improvements now, and we expect that we'll absolutely continue and will accelerate as soon as rates top out and start to come down some.

Right. All right. Yep. Thank you for that. And then just going back to capital allocation from your comments, is it fair to say you're leaning more towards sticking with the dividend and increasing the dividend relative to M&A?

I would say, no, that wouldn't be true. You know, we have a dividend, and although we can't promise, our goal is always to, we strive to try to increase it every year. So in all likelihood, we'll be continuing with the dividend, but that really, I would say, is not impacting what we choose to do on M&A at all.

Okay. Thank you so much, and good luck to the next quarter. Thank you.

Thank you.

As a reminder, to ask a question, you will need to press star 11 on your telephone and wait for your name to be announced. That concludes the question and answer session. At this time, I would like to turn it back to Jeff Powell for closing remarks.

Thank you, Abigail. And before wrapping up the call today, I just wanted to leave you with a few takeaways. Despite the slowing economies, the second quarter was another record-setting quarter, and our operations teams deserve a lot of credit for producing these results. We have strong market positions and expect stable demand during the second half of the year. And finally, our balance sheet continues to strengthen, and we are actively pursuing new growth opportunities. With that, I want to thank you for joining the call today, and we look forward to updating you next quarter.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.