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Text: 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.
These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles.
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.
Since our last earnings call, the world has continued to be impacted by the COVID pandemic, which has led to an economic crisis in nearly every region of the world.
Most countries continue to deal with this pandemic and depressed economic activity.
I'll begin with a few comments about our operations and how the pandemic has continued to affect our business.
Like most other industrial companies, we have been affected in many ways by the pandemic.
The effect of COVID made the second quarter one of the more challenging quarters in the history of our company.
Our global workforce has adapted to a new way of work and performed exceptionally well under extremely challenging circumstances.
I'm very proud of our talented and dedicated employees around the world for the work they've done and continue to do to serve our customers and each other.
We are fully operational at all of our manufacturing facilities and continue to work under enhanced safety protocols designed to safeguard our workplaces and protect the health and safety of our employees.
These precautionary measures have served us well and allowed us to continue operating in every region of the world.
While some regions around the world are starting to reopen, it will take some time to see this increased economic activity reflected in new orders.
The early signs of the recovery are still fragile and could be appended by new surges in the virus.
Having said that, we believe we are well positioned to navigate through the pandemic and uncertainties in the economic environment.
Our balance sheet remains healthy and our liquidity position is solid.
Robust cash flows have always been a strength of Kadant, and we believe this will continue as economies begin to reopen around the world.
Performance in the second quarter was impacted by our customers' request to delay projects and postpone service work and curtail production.
Our cash flow from operations and our free cash flow were both strong.
Cash flow of $22 million was down 3% compared to Q2 of 2019, while free cash flow increased 2% to $21 million.
Our parts and consumables revenue made up 64% of total revenue comparable to the period -- to the prior year period.
This relative stability in our parts and consumables business is reflected in our strong cash flows and our focus on growing this area continues to be a key strategic initiative.
Overall, most of our customers are operating and adjusting to the new level of demand in the current environment.
After the initial surge in packaging and tissue demand early in the second quarter, these markets have returned to levels more indicative of the general economic environment.
The one sector that seems to be performing better than expected is wood, and specifically lumber.
I'll provide additional comments on that later in my remarks.
Also during the second quarter, we put into place various tough contingent measures and implemented selective reductions in our workforce via early retirement offers, furloughs and lay-offs at certain divisions.
While never something we look forward to, these adjustments were necessary to ensure our staffing levels reflect to the business environment.
We continue to assess the situation at each of our businesses and take actions where appropriate.
Before leaving this slide, I wanted to comment on our recent acquisition of Cogent Industrial Technologies announced yesterday.
This acquisition is an exciting addition to the Kadant family.
We believe this new platform greatly expands our ability to deliver automation and plantwide technology solutions to process industries.
It also allows us to play a bigger role in our customers' digital ecosystem by offering integration solutions across multiple processes, products and systems for enhanced productivity and increased operational agility.
Next, I'd like to review our performance in our three operating segments.
As shown on Slide 7, our Flow Control segment faced a challenging market environment with industrial production down across most sectors.
This was especially evident in non-critical infrastructure industries where manufacturers were forced to shut down operations, and those that did continue to operate, were doing so at much lower operating rates.
Capital project activity at most industrial companies was particularly impacted during the quarter.
While demand for our aftermarket parts was solid and made up 72% of total revenue in the quarter, customer delays in capital project execution, postponed service work and the inability of our employees to engage face-to-face with customers and prospects due to the pandemic negatively affected both our bookings and revenue performance.
Looking ahead to the third quarter, we expect Q3 to show some improvement, while we expect capital project orders to remain subdued.
Our Industrial Processing segment was also impacted by the global lockdown in Q2.
However, we are seeing encouraging signs in some of our market sectors, and particularly, in wood products.
Revenue in this segment declined 14% to $66 million year-over-year, but was up slightly compared to Q1 of this year.
This decline was largely due to a significant slowdown in capital projects, following two exceptional years of capital project activity.
Parts and consumables revenue, on the other hand, was solid and made up 62% of total revenue in the second quarter.
Encouragingly, U.S. housing starts in June were up 17% sequentially to $1.2 million, which followed a boost in May housing starts, up 14% compared to April.
The increase in housing construction coupled with homeowners forced to remain at home during the widespread shutdowns in April and May led to strong demand for lumber and other wood products.
As a result, lumber of prices for July delivery increased 8% above pre-pandemic high and demand is providing support for higher price levels.
This in turn has benefited our customers producing wood products.
We are experiencing an increase in capital project activity and expect capital bookings to strengthen as the second half of 2020 unfolds.
Turning now to our Material Handling segment.
We had solid results in the second quarter, due in part, to a healthy backlog.
This operating segment experienced depressed levels of bookings due to most customers being unable to receive visitors and others being shut down due to government-mandated closures associated with the pandemic.
Demand for our fiber-based products was in bright spot in the second quarter as homeowners used more lawn and garden products.
Adjusted EBITDA increased 8% to $6 million and our adjusted EBITDA margin was nearly 18% in the second quarter as a result of solid execution and product mix.
As in our other segments, we are seeing increasing capital project activity.
Looking beyond 2020, we continue to believe this segment has upside potential in its aggregates in market if there is increased infrastructure spending.
While the last several months have proven to be challenging with many unknowns, we remain confident in our ability to manage through these unprecedented times.
As we look ahead to the second half of 2020, the uncertainty in evolving environment limit our visibility to accurately forecast the timing of orders and the speed of economic recovery.
Therefore, we will not be providing guidance at this time.
We expect Q3 to be the weakest quarter of the year and are looking for some improvement in Q4 as we navigate through what we hope is the bottom of this pandemic-induced recession.
I'd like to pass the call over to Mike now for a review of our Q2 financial performance.
I'll start with some key financial metrics from our second quarter.
Slide 12 is a summary of some of the key financial metrics that I'll comment on over the next few slides.
Our GAAP diluted earnings per share was $1 in the second quarter, down 30% compared to $1.42 in the second quarter of 2019.
Our GAAP diluted earnings per share in the second quarter includes $0.03 of restructuring costs and $0.03 of acquisition costs associated with our acquisition of Cogent, which was completed in June.
In addition, our second quarter results include pre-tax income of $2.1 million or $0.14 net of tax attributable to government-sponsored employee retention programs related to the pandemic.
These programs were received by many of our subsidiaries around the world and enabled us to retain employees as we work our way back toward normal operating conditions.
Consolidated gross margins were 43.5% in the second quarter of 2020, up 150 basis points compared to 42% in the second quarter of 2019.
Approximately 80 basis points of the increase was due to the receipt of government-sponsored employee retention programs related to the pandemic and the remainder was due to the negative effect from the amortization of acquired profit in inventory that was included in the results for the second quarter of 2019.
Parts and consumables revenue, as a percentage of revenue, remained fairly consistent with the prior year at 64% in the second quarter of 2020 compared to 63% last year.
SG&A expenses were $45.1 million or 29.5% of revenue in the second quarter of 2020 compared to $48.5 million or 27.4% of revenue in the second quarter of 2019.
The $3.4 million decrease in SG&A expense included $1.1 million decrease from a favorable foreign currency translation effect and a $0.8 million benefit from government-sponsored employee retention programs.
The remainder of the decrease was essentially due to reduced travel-related costs.
Adjusted EBITDA decreased to $26.6 million or 17.4% of revenue compared to $32.7 million or 18.5% of revenue in the second quarter 2019 due to declines in profitability at our Flow Control segment, and to a lesser extent, our Industrial Processing segment.
Operating cash flows were $22 million in the second quarter 2020, which included a modest positive impact of $0.3 million from working capital compared to operating cash flows of $22.6 million in the second quarter of 2019.
We had several notable non-operating uses of cash in the second quarter of 2020.
We paid down debt by $13.8 million, paid $6.8 million for the acquisition of Cogent, paid a $2.8 million dividend on our common stock, and paid $0.9 million for capital expenditures.
Free cash flow increased significantly on a sequential basis to $21.1 million compared to $3.5 million in the first quarter of 2020 as our first quarter typically is the weakest of the year.
In addition, the second quarter of 2020 free cash flow was $0.5 million higher than the second quarter of 2019.
Let me turn next to our earnings per share results for the quarter.
In the second quarter of 2020, GAAP diluted earnings per share was $1 and our adjusted diluted earnings per share was $1.06.
The $0.06 difference was due to $0.03 of acquisition expenses and $0.03 of restructuring costs.
In comparison, the second quarter of 2019, both our GAAP and adjusted duty diluted earnings per share was $1.42.
We had $0.10 of acquisition-related expenses, which were fully offset by a discrete tax benefit.
As shown in the chart, the decrease of $0.36 in adjusted diluted earnings per share in the second quarter 2020 compared to the second quarter of 2019 consists of the following; $0.71 due to lower revenues and $0.08 due to a higher effective tax rate.
These decreases were partially offset by $0.24 due to lower operating costs, $0.11 due to lower interest expense, and $0.08 due to higher gross margin percentages.
Collectively included in all the categories I just mentioned, was an unfavorable foreign currency translation effect of $0.05 in the second quarter of 2020 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 128 at the end of the second quarter of 2020 compared to 117 at the end of the second quarter of 2019.
This increase was driven by higher number of days in inventory.
Working capital as a percentage of revenue was 14.8% in the second quarter of 2020 compared to 14.2% in the first quarter of 2020 and 15.4% in the second quarter of 2019.
Our net debt, that is debt less cash, decreased $11.1 million or 5% to $222 million at the end of the second quarter of 2020 compared to $233 million at the end of the first quarter of 2020.
We repaid $13.8 million of debt in the second quarter and have repaid $16.4 million of debt in the first six months of 2020.
After quarter end, we repaid our real estate loan, which had a remaining principal balance of $18.9 million by borrowing from our revolving credit facility.
This effectively swapped debt with an annual interest rate of 4.45% under the real estate loan for a revolver debt currently at 1.68%, which at current interest rates, would reduce interest expense by over $500,000 on an annual basis.
Our leverage ratio, calculated in accordance with our credit facility, decreased to 2.01 at the end of the second quarter 2020 compared to 2.03 at the end of 2019.
After repaying the real estate loan in July, we currently have over $130 million of borrowing capacity available under our revolving credit facility, which matures in December of 2023, and have access to an additional $150 million of uncommitted borrowing capacity under this agreement.
We also have access to $115 million of uncommitted borrowing capacity through the issuance of senior promissory notes under our note purchase agreement.
We do not have any mandatory principal payments on debt facilities until 2023.
We believe that our cash on hand, operating cash flows and access to available credit provide us with sufficient liquidity to meet our capital requirements and continue to navigate through this challenging environment.
Regarding guidance, the current environment has certainly made forecasting quite difficult.
While we have noticed an increase in inquiries related to capital projects, we have also experienced and continue to experience delays in anticipated bookings due to a reduction in capital expenditures and project delays by our customers.
In addition, we expect continued customer-requested delays related to certain capital projects in our backlog.
Given the current uncertainty, we will not be providing guidance for the third quarter or the full year 2020.
We will reevaluate providing guidance next quarter.
While we are not providing guidance, I would like to provide a few directional comments on our outlook for the year.
We anticipate the third quarter will likely be our weakest quarter of the year.
And as a result, sequential revenue could decrease approximately 5% to 9%.
Our revenue for the year could decrease roughly 11% to 14% compared to 2019.
Few other directional notes.
We anticipate that we will remain eligible for some government-sponsored employee retention programs in various locations.
However, as the year progresses, we expect these programs will diminish as our businesses return to more traditional operating levels.
During the second quarter, we recognized $0.5 million in restructuring costs related to reduction of employees across our businesses.
We expect these restructuring activities will reduce our cost structure by approximately $3.7 million annually.
We may incur additional restructuring costs in future periods as we continue to monitor the impact of the pandemic and the resulting global economic downturn on our businesses.
On a positive note, we now expect net interest expense for 2020 to be under $8 million compared to our last earnings call estimate of $9 million to $9.5 million.
Given the lack of visibility into what the future holds across our end markets and geographies, it's difficult to provide firm guidance at the moment.
However, we've given these directional comments to help provide insight into our current business environment as well as our belief that our healthy balance sheet, strong cash flows and recurring revenue streams, will help our business navigate through the current business cycle.
That concludes my review of the financials.

user
kadant q2 adjusted earnings per share $1.06.
q2 adjusted earnings per share $1.06.
q2 revenue $153 million versus refinitiv ibes estimate of $150 million.
will not be providing guidance at this time.
expect q3 will be our weakest quarter of year.
anticipating an improvement in business activity in q4.

assistant