Kadant Inc. (NYSE:KAI) Q4 2023 Earnings Call Transcript
Kadant Inc. (NYSE:KAI) Q4 2023 Earnings Call Transcript February 15, 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 the Fourth Quarter 2023 Kadant Earnings Conference Call. [Operator Instructions] Again, please be advised that today's conference is being recorded. I will now turn the conference over to your first speaker today, Michael McKenney, Executive Vice President and CFO. Please go ahead.
Michael McKenney: Thank you, Victor. Good morning, everyone, and welcome to Kadant's fourth quarter and full year 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 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 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 fourth quarter and full year 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 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 Kadant's business and future prospects. Following Jeff's remarks, I'll give an overview of our financial results for the quarter and the year, 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 fourth quarter and full year results and discuss our business outlook for 2024. I'm pleased to report the fourth quarter was a solid finish to a record-setting year for Kadant. Despite the slowdown in overall manufacturing activity and continued macroeconomic headwinds in many regions, we had another well-executed quarter. This led to solid adjusted EBITDA performance and excellent cash flow in the fourth quarter. Organic bookings were steady in the fourth quarter with solid demand, as we delivered on our mission to provide technologies and engineered solutions that help our customers operate more efficiently. At the end of 2023, we were honored to, once again, be named by Newsweek Magazine as one of America's most responsible companies.
This marks the fourth consecutive year of being included on this list, and it is rewarding to be recognized for our efforts in this area. With that, I would like to review our Q4 financial performance. Fourth quarter performance overall was solid and better than expected in several areas. Q4 revenue and adjusted EPS were both up 3% compared to the same period last year, while bookings were comparable with the prior year period. Although a large portion of our Q4 revenue was from capital shipments, excellent execution resulted in an adjusted EBITDA margin of 20.3%. I'm particularly pleased with our operating cash flow, which was the second highest in our company history at $59 million. Our fourth quarter earnings performance contributed to exceptional full year financial results, which I will review next on Slide 7.
The record demand we experienced in the first quarter of 2023 provides an excellent start to the year and contributing to our record-setting revenue performance for the full year. Adjusted EPS increased 9% to a record $10.04, exceeding the prior record set last year at $9.24 per share. Our full year adjusted EBITDA was a record $201 million and a record 21% of revenue. Our strategic focus on improving our margin performance continues to deliver results, and we are pleased with the progress of ongoing initiatives to grow our businesses. Our workforce around the globe deserve tremendous credit for these results as they performed exceptionally well throughout the year. I'm extremely proud of our employees for the innovative work they have done and continue to do to serve our customers.
Next, I'd like to review our performance in our three operating segments. I'll begin with our Flow Control segment. Q4 revenue declined 4% to $87 million compared to the then record fourth quarter of 2022. Aftermarket parts revenue was up slightly compared to the prior period and made up 68% of total revenue. Product mix within both parts and capital negatively affected gross margin, and this led to an adjusted EBITDA margin of 27% in the fourth quarter. Bookings were up 8% compared to the same period last year. This strong finish to the year positions us well entering 2024. We believe the fundamental drivers of end markets remain healthy, though business activity continues to be influenced by geopolitical and macroeconomic challenges around the globe.
Turning now to our Industrial Processing segment. Our performance in the fourth quarter was solid, despite the softening in some of our core end markets. Revenue declined 3% compared to the same period last year, due largely to fewer capital shipments of our stock prep equipment used to process recycled fiber. Aftermarket parts revenue, however, was up 5% and represented 64% of total revenue in the fourth quarter. Adjusted EBITDA margin declined 110 basis points compared to the prior year, but remained strong at 23.8% of revenue. This decline was largely attributed to a decrease in operating leverage associated with lower capital revenue. Looking ahead to 2024, we expect demand in this segment to shift towards aftermarket parts versus capital, particularly with the addition of our recently announced acquisition of Key Knife.
Key Knife is a manufacturer of engineered knife systems used in various wood processing applications. More than 90% of its revenue is aftermarket parts. And addition of Key Knife to our Industrial Processing segment is expected to further strengthen our aftermarket position in this segment. In our Material Handling segment, revenue increased 27% in the fourth quarter to a record $64 million. Strong bookings in the first half of the year contributed to this record-setting performance. Capital equipment revenue was exceptionally strong and represented 55% of total revenue in the quarter, led by our conveying product line. Despite the large portion of revenue attributed to capital business, we achieved excellent operating leverage and adjusted EBITDA margin increased 350 basis points to 22.1% in the fourth quarter.
The integration of KWS Manufacturing acquired a few weeks ago is underway and progressing well. We are pleased to have this leading manufacturer of screw conveyors and related equipment in part of Kadant. Looking ahead to 2024, we believe this segment will continue to see good business activity, particularly as new infrastructure projects are executed and demand for Kadant-made equipment remained strong. As we look ahead to the first quarter of 2024 and the full year, ongoing project activity is healthy, and demand has been solid as we entered the year. That said, we are seeing continuing economic uncertainty around the globe and expect demand in 2024 to be similar to 2023. Our strong backlog and ability to generate robust cash flows have us well positioned to capitalize on opportunities that may emerge as the year unfolds, and we expect to deliver a solid financial performance again this year.
I'd now like to pass the call over to Mike for his review of our financial performance and outlook for 2024.
Michael McKenney: Thank you, Jeff. I'll start with some key financial metrics from our fourth quarter. Gross margin decreased 40 basis points to 42.7% in the fourth quarter '23 compared to 43.1% in the fourth quarter '22, due primarily to lower margins achieved on capital projects at our Industrial Processing and Flow Control segments. Our overall percentage of parts and consumables revenue was 60% of total revenue in both the fourth quarters of '23 and '22. As a percentage of revenue, SG&A expenses increased to 25.1% in the fourth quarter of '23 compared to 24.5% in the prior year period. SG&A expenses were $59.8 million in the fourth quarter of '23, increasing $3 million or 5% compared to $56.8 million in the fourth quarter of '22.
The fourth quarter of '23 included a $0.9 million unfavorable foreign currency translation effect and an increase of $1.3 million of acquisition costs and a decrease of $0.8 million in indemnification asset reversals compared to the fourth quarter of '22. Excluding these items, SG&A expense increased $1.6 million or 3%, primarily due to increased selling-related costs. Our GAAP EPS increased 4% to $2.33 in the fourth quarter compared to $2.23 in the fourth quarter '22, and our adjusted EPS was up 3% to $2.41 from $2.33. Our fourth quarter '23 adjusted EPS of $2.41 exceeded the high end of our guidance range by $0.29 due to higher-than-anticipated aftermarket revenue, especially at our Industrial Processing and Flow Control segments. We had record operating cash flow and adjusted EBITDA in '23, which I will cover on the next slide.
For the full year '23, gross margins increased 40 basis points to 43.5% compared to 43.1% in '22, due to higher margins achieved on our aftermarket products, especially at our Material Handling segment. Our percentage of parts and consumables revenue was 62% in '23 compared to 63% in '22. As a percentage of revenue, SG&A expenses decreased to 24.7% in '23 compared to 24.8% in '22. SG&A expenses were $236.3 million in '23, increasing $11.9 million or 5%, compared to $224 million in '22. Excluding a decrease of $1.2 million of expense from indemnification asset reversals, SG&A expenses were up $13.1 million or 6% compared to '22, primarily due to annual wage increases as well as incremental travel and consulting costs. Our GAAP EPS was $9.90 in '23, down 4% compared to $10.35 in '22, which included $1.30 gain on the sale of the Chinese facility.
Our adjusted EPS was a record $10.04, up 9% compared to $9.24 last year. Aside from being a record, our adjusted EPS also exceeded the 5-year target of $8 to $9 a share we set back at the beginning of 2019. In the fourth quarter of '23, adjusted EBITDA decreased 2% to $48.5 million or 20.3% of revenue compared to $49.5 million or 21.3% of revenue in the fourth quarter '22. Our Material Handling segment had a record adjusted EBITDA in the fourth quarter '23 and a notable 350-basis-point improvement in adjusted EBITDA margins compared to the prior year. This was offset by the performance in our other segments. As you can see on the slide, our annual adjusted EBITDA has grown significantly compared to 2019, up 58%. For the full year, adjusted EBITDA was a record $201.3 million and a record 21% of revenue in '23 compared to adjusted EBITDA of $189.1 million or 20.9% of revenue in '22.
Our Material Handling segment had record adjusted EBITDA of $53.6 million in '23 and a 210-basis-point improvement in adjusted EBITDA margins compared to the prior year. Our Flow Control segment also had record adjusted EBITDA of $105 million in '23 and a record 28.9% adjusted EBITDA margin. Adjusted EBITDA is an important metric for us. We set a 5-year target for adjusted EBITDA margin of 20% back at the beginning of 2019, and I'm happy to see that we've exceeded this target with a record 21% in '23. Our adjusted EBITDA margin has increased 300 basis points since 2019, due in large part to contributions from subsidiaries participating in our 80/20 program. This program provides revenue growth through a highly focused sales approach and profitability improvements as a result of dynamic pricing and streamlining product offerings.
Once adopted, subsidiaries continue to follow the 80/20 program yielding incremental benefits the longer they have followed the tenets of the program. Average adjusted EBITDA margin for subsidiaries under the program have consistently exceeded our other subsidiaries. Over 50% of our revenue is from subsidiaries currently under or starting our 80/20 program. One of the highlights for the fourth quarter and full year was our operating cash flow, which increased 68% to $59.2 million in the fourth quarter of '23 compared to $35.2 million in the fourth quarter '22. For the full year, operating cash flow was a record $165.5 million, up $62.9 million or 61% from '22. We also had strong free cash flow, increasing 114% to $49.5 million in the fourth quarter '23 and increasing 80% to $133.7 million for full year '23.
We had several notable nonoperating uses of cash in the fourth quarter of '23. We repaid $22.1 million of debt and paid $9.8 million for capital expenditures and a $3.4 million dividend on our common stock. For the full year, we repaid $94 million of our debt and paid $31.9 million for capital expenditures, which included a $7.4 million for our facility project in China. Let me turn to our EPS results for the quarter. In the fourth quarter of '23, GAAP earnings per share was $2.33 and adjusted EPS was $2.41. The $0.08 difference relates to $0.10 of acquisition costs, $0.05 of other income and $0.01 of relocation costs, both related to the facility project in China and $0.02 of restructuring costs. $0.05 of other income is associated with cash received for remaining assets of the old facility.
In the fourth quarter of '22, GAAP earnings per share was $2.23 and adjusted EPS was $2.33. The $0.10 difference relates to $0.09 of impairment and restructuring costs and $0.01 of acquisition costs. The increase of $0.08 in adjusted EPS in the fourth quarter '23 compared to the fourth quarter '22 consists of the following: $0.17 due to higher revenue, $0.09 due to a lower recurring tax rate and $0.05 due to lower interest expense. These increases were partially offset by $0.17 in higher operating expenses, $0.05 due to lower gross margin and $0.01 due to higher weighted average shares outstanding. The $0.09 impact from the lower recurring tax rate was due to a slightly higher tax rate in '22 related to the timing of certain incentive compensation payments.
Collectively, including all the categories I just mentioned, was a favorable foreign currency translation effect of $0.03 in the fourth quarter '23 compared to the fourth quarter of last year due to the weakening of the U.S. dollar. Now turning to our EPS results for the full year on Slide 17. We reported GAAP earnings per share of $9.90 in '23 and our adjusted EPS was $10.04. The $0.14 difference relates to $0.10 of acquisition costs, $0.05 of other income and $0.05 of relocation costs, both related to the facility project in China and $0.04 of restructuring costs. We reported GAAP earnings per share of $10.35 in '22, and our adjusted EPS was $9.24. The $1.11 difference relates to $1.30 gain on sale related to one of our Chinese facilities, impairment and restructuring costs of $0.11 and acquisition-related costs of $0.08.
The increase of $0.80 in adjusted EPS from '22 to '23 consists of the following: $1.41 from higher revenue, $0.26 from higher gross margins, $0.08 from a lower recurring tax rate and $0.01 from lower noncontrolling interest. These increases were partially offset by $0.86 from higher operating expenses, $0.07 from higher interest expense and $0.03 due to higher weighted average shares outstanding. Collectively, including all the categories I just mentioned, was an unfavorable foreign currency translation effect of $0.09 in '23 compared to '22. Now let's turn to our liquidity metrics on Slide 18. Our cash conversion days, calculated by taking days in receivables plus days in inventory and subtracting days in accounts payable, was 130 at the end of the fourth quarter '23, down from 138 at the end of the third quarter of '23, but up from 126 days at the end of '22.
The sequential decrease in cash conversion days was principally driven by a lower number of days in inventory. Working capital as a percentage of revenue decreased to 12.8% in the fourth quarter '23 compared to 15.4% in the third quarter '23 and 13.9% in the fourth quarter '22. Net debt, that is debt less cash, at the end of '23 was $4.4 million, the lowest level since 2017, representing a decrease of $117 million compared to net debt of $121.4 million at the end of '22. Our interest expense increased 30% to $8.4 million in '23 compared to $6.5 million in '22 due to an increase in borrowing rates. Our leverage ratio, calculated as defined in our credit agreement, decreased to a very low 0.27 at the end of '23 compared to 0.74 at the end of '22.
After our recent acquisitions, our borrowing capacity is $71 million available under our revolving credit facility and an additional $200 million of uncommitted borrowing capacity. Now I'll review our guidance for '24. We expect to achieve records in a number of key metrics in '24, including revenue, cash flow and adjusted EBITDA. Our earnings performance in '24 will be affected by increased borrowing costs and noncash intangible amortization expense associated with our recently announced acquisitions. As we look beyond '24, the increased borrowing costs will continue to decrease as we have demonstrated our proven track record of paying down debt. For the full year, our revenue guidance is $1.04 billion to $1.065 billion, that is $1.04 billion to $1.065 billion, and our adjusted diluted EPS guidance is $9.75 to $10.05, which excludes $0.20 related to the amortization of acquired profit and inventory and backlog.
Looking at our quarterly revenue and EPS performance for '24, we expect the first quarter will be the weakest quarter of the year due to the timing of capital projects, and the second half of the year will be stronger than the first half as a result. Our revenue guidance for the first quarter of '24 is $238 million to $246 million and our adjusted diluted EPS guidance for the first quarter is $1.90 to $2, which excludes $0.14 related to the amortization of acquired profit and inventory and backlog. I should 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. Guidance includes our acquisitions of Key Knife and KWS, which we completed in January.
Aside from the impact of intangible amortization, there is a negative impact in the initial post-acquisition period associated with the amortization of profit in inventory and acquired backlog as these amounts are reflected in the income statement when the underlying order is fulfilled and inventory shipped to the customer. Our 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. I'd like to give some additional metrics on our EPS guidance. We borrowed $230 million in January for the acquisitions of Key Knife and KWS. We'll work diligently throughout '24 to pay down that debt. As a result of the borrowings, we project our interest expense will increase by approximately $0.70 over '23.
In addition, Key Knife and KWS transactions have significant amounts of recurring noncash intangible amortization expense, which is reducing our EPS guidance by approximately $0.50 in '24. While the noncash intangible amortization does have a significant impact on EPS, it will not impact our cash flow or EBITDA for '24. '24 guidance includes a favorable foreign currency translation impact of approximately $11.6 million on revenue and $0.15 on adjusted EPS due to the weakening of the U.S. dollar. We anticipate gross margins for '24 will be approximately 43.5% to 44.5%. As a percentage of revenue, we 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 in '24. We anticipate net interest expense of approximately $18 million to $18.5 million, and we expect our recurring tax rate will be approximately 26.5% to 27.5% in '24.
We expect depreciation and amortization will be approximately $46 million to $48 million in '24, and we anticipate CapEx spending in '24 will be approximately $29 million to $31 million, which includes $2 million related to the final payments on our facility project in China. Approximately 15% of the CapEx spending in '24 relates to final payments for CapEx projects approved in '23. We were a little bit above our normal CapEx as a percent of revenue metric as we continue to invest in automation projects and upgrades to our manufacturing capabilities. That concludes my review of the financials, and I will now turn the call back over to Victor for our Q&A session. Victor?
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