Kadant Inc. (KAI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Kadant Inc. acquisition of Joh. Clouth conference call. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Alexander. Good afternoon, everyone, and welcome to Kadant's conference call to discuss its pending acquisition of Clouth Group of Companies. 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, including the expected benefits of the proposed acquisition of Clouth and the related timing considerations, 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 January 2, 2021 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. With that, I'll turn the call over to Jeff Powell, who will discuss the acquisition. Following Jeff's remarks, we will then have a Q&A session. Jeff?

Thanks, Mike. Hello, everyone, and thank you for joining the call today. We announced earlier today that we have entered into an agreement to purchase the Clouth Group of Companies. As many of you know, we have specific attributes we look for in an acquisition, namely: strong market position, high revenue percentage in parts and consumables and asset-light operating model and long-standing customer relationships. Clouth has all of these attributes, and we are very excited to welcome them to the Kadant family. Let me start with an overview of the company and the transaction. Clouth is a 150-year-old supplier of doctor and creping and cleaning blades, with a strong global presence in packaging, tissue and paper as well as metals, fiber and food. They have highly automated manufacturing facilities in Poland and Germany and sales throughout Europe, Asia and North America. Their revenue in 2020 was approximately EUR 41 million and 92% of that was in parts and consumables. It's challenging to find a business with nearly all of its revenue in consumables. This attribute makes acquiring the company very exciting. The purchase price is approximately EUR 78 million, and we expect to close the deal early in the third quarter. Their adjusted 2020 EBITDA margin was approximately 19%, which translates to an EBITDA multiple of 9.9x. Clouth is our primary competitor around the world in blades and systems. The blade business is one of our most stable and profitable products, and acquiring them doubles our revenue in these markets. Additionally, they have made significant investments in ceramic blade production for the tissue market and are the #2 global player. They have state-of-the-art ceramic blade manufacturing facilities with additional production capacity to serve the fastest-growing sector of the blade market. This acquisition greatly expands our offering in ceramic blades. As you can see in the slide, approximately 92% of revenue last year was in parts and consumables and service. They supply around the world and are particularly strong in Europe and Asia. One of the things that attracted us to Clouth was the complementary market share we have around the world. As you see, we tend to be stronger where they have less market share, and they are stronger in markets where we are weaker. We each have unique technologies and technical expertise, and we will now be able to offer the market a much broader range of products and services worldwide. As I mentioned earlier, as the #2 global player, they are particularly strong in ceramic blade business, an area where we have been making investments but are still a relatively small player. As part of our decentralized operating model, we will maintain separate R&D centers that specialize in different areas, but the teams will jointly plan the strategic investments and our future technology development. Consistent with our decentralized operating model and past practices, we will maintain a multi-brand strategy with the Clouth Companies continuing to operate as stand alone businesses. We each have specialized manufacturing operations and sales organizations that complement each other geographically. We often find that acquired companies have some best practices that we can share with our other Kadant companies, and we are confident this will be the case with Clouth. In addition, the team at Clouth has shown interest in our 80/20 initiatives. And with that, we'll open the call up for questions.

[Operator Instructions] We have your first question from John Franzreb from Sidoti.

My first question is, you point out that they did EUR 41 million in 2020. What does that number look like in 2019 pre-COVID?

That was essentially flat.

Okay. And is there any customer constitution that showed the geographic mix, but what's the customer concentration?

So we all call on -- as you would imagine, as competitors, we all call on the same market. And what you normally find is that they have their client base and we have ours. So it's fairly complementary. I mean there's certainly some overlap, but I would say for the vast -- for the most part, it's a complementary combination between the 2.

Got it. And it sounds like the ceramic blade is one of the drivers -- one of the things that appealed to you with this merger. Can you talk a little bit about that market more? And who are the largest players in that market?

Sure. So the ceramic blades, in particular, are used in the tissue production. And that's a market where traditionally they had used non-ceramic blades and they're migrating over. There's varying estimates on what percentage of the tissue market is converted to ceramic at this point. It's the fastest-growing in the blade market. But it could be in some markets as low as 25% of converted. So there's still a lot left to convert over, particularly in places like Asia. So that's a business that we've made a big investment in over the last several years, but it was essentially a new development for us where they have been in the business for quite a while. And as I said, it grew to become the #2 player. The #1 player is a company called BTG out of Europe.

We have your next question from Kurt Yinger with D.A. Davidson.

Yes. Great. Just the first one, you mentioned that sales were pretty much flat in 2020. I'm just curious as you think about the business in a couple of years prior to that, were they growing quicker than you guys? Do you kind of consider them share-takers? And how would you kind of characterize their growth profile relative to what you guys have seen in Flow Control in general?

Yes. Kurt, so prior to that, for the few years running up to the pandemic in 2020, they were growing at a little under 5%. And that would be a little bit higher than our growth rate.

Got it. Okay. Great. And I guess, just on kind of funding and sources of funding you're looking at? And then any initial thoughts on accretion here maybe in the back half or annualized for 2022?

Well, on the funding front, Kurt, we're -- as we said in the -- in our first quarter earnings call, at that point in time, we had about $193 million available on the revolver. So we'll just use the revolver to fund this. We'll probably tap into some cash also on hand to fund it. And what was your -- the second part of your question?

Just any kind of initial bracketing thoughts on possible accretion?

I would -- yes. Well, I'm going to hold off until our second quarter earnings call to kind of reguide on everything. But I would say broadly for 2021, the second half of 2021, we expect it to be accretive. Of course, that would be excluding any of the onetime intangible write-ups, specifically the inventory and backlog because those will turn through relatively quickly.

Okay. Okay. Makes sense. And then just last one on the consumables percentage, 92% last year. I mean was that a high year for them, just given maybe less kind of project activity? Or would you say that's pretty representative of what they've done year in, year out?

Yes. That's pretty representative. They very much focus on that particular market where we're stronger and have a business on the system side. They focused most of their effort and development and growth on the blade side. So that's a fairly representative breakdown for them.

[Operator Instructions] We have your next question from Chris Howe with Barrington Research.

Congrats on this acquisition. Just to follow-up on some of the other questions, the manufacturing operations of this acquisition in combination with your operations, any opportunity there? Perhaps you could talk about their capacity utilization, how the combined footprint now looks in serving your customers and theirs?

Yes. So they've got newer facilities -- much, much newer facilities than us that are more modernized and automated. But where this is really going to help us is we were looking at having to make sizable investments on the ceramic side going forward to increase our capacity there. And they have quite a bit of additional capacity available on the ceramic blade side. So we'll be able to utilize them to increase our ceramic blade production without having to make any investments. So that was a big plus for us, something that we were quite -- that we are quite happy of. The other parts of the business, it's kind of a regional business. We sell around the world, and we're strong in our respective areas. So there's -- there'll be certain opportunities there. But I would say that really, the big ones for us is not having to make future investments on the ceramic side.

That's great. And my next question, just for context, perhaps you could talk about the evolution of this deal, how long it's been in the pipeline. I'm sure it's opened your eyes for some time with its high mix of parts and consumables at 92%. You just don't typically find that. And perhaps following up on that, perhaps you could talk about the doctor blade market as a whole. With your combined power with the #2 global player now in your pocket, does this open up opportunity to further deepen your penetration of market share?

So answering your first question, it's funny, Bill Rainville, who some of you remember, was the founding CEO of Kadant for 30 years, called me this morning when we made the announcement and congratulated me. He said that he tried for 20 years to buy this company, and we've been in discussions with them since first meeting -- since first meetings in the '80s. So this is literally one that we've -- this is obviously the 150 years old, it's a multigenerational business. And we've had discussions with them and have been interested in them for literally 40 years. And we're fortunate enough to be in a position where the current generation made the decision that they were ready to kind of place this into a new home, a new set of hands, so to speak. And we spent a lot of time working with them and demonstrating to them that we would be the best home for their people. As you can imagine, they're quite sensitive to where these people end up. This has been -- these employees have been with them forever. It's got a tremendous legacy. So they went -- I would say they went to great lengths to make sure that they found what they thought was the best home for the business. And I would tell you, they did that even over maximizing the sell price. And so they -- the owner very much has looked out for his employees and said, this is the best home out there for you globally. And so sell price wasn't the ultimate and only decision that he considered. So it was a very -- we've known them for a very long time, admired them and was interested in them for a long time, and he went through a thorough process and ultimately decided that Kadant was the best home for his employees. You got another question. We can't remember if there was a second question [indiscernible]

[indiscernible]

Yes. As you can imagine, when you take the -- depending on which market we're talking about, the 2 biggest players in the market or #1 and #2 in markets, when you combine them, there's tremendous opportunities for economies of scale, for synergies. And so we think that we'll be able to offer better value to our customers going forward. And it broadens our offering from a technology standpoint and from a geographic standpoint. So we think that will enable us to get deeper and deeper into the market in all geographic areas.

Okay. In combination, what percentage of the market do you now have for doctor blades?

I don't know that we -- I have the exact number for that. It's -- you can look at the chart -- if you look at the chart, you can see that it's quite high. I mean, I think we're looking at probably -- in regular doctor blades, we're probably looking at 65%. In the ceramic blades, which is a new and emerging market, we're probably going to be at 20%.

Okay. All right.

They're approximate numbers.

Okay, 25%.

[Operator Instructions] We have your next question from Bobby Eubank with Chevy Chase Trust.

Congratulations on a long sought for deal. Happy to see finally closed. I know this has been a little bit of an overhang for you guys. A question on every earnings call is when's the next deal. I think many of us expected it to happen in the Material Handling segment. So maybe if you could just comment on still field capacity, obviously, integrating is the #1 priority, but further deal opportunities that are out there in the market would be a wonderful update on that as well. And congratulations again.

So as Mike mentioned, we had a fair amount of debt capacity. And this is -- this obviously isn't going to consume all that up. So we have -- from a financing standpoint, we have still a fair amount of capacity out there in our revolver and accordion and then some additional debt we have with -- potential with PRU. So financially, we're not -- debt-wise, we're not constrained at this point. And as I think we've mentioned on our earnings calls, the M&A activity, the deal flow is as strong as it's been in a very long time. And our people are very hard at work, trying to find the next good deal. And so we're not capital-constrained, and we're working hard to try to find deals where we can create the value. And so I think that's -- nothing's really changed there.

Yes. Great. And if I could squeeze in one last question. Can you just walk us through one more time why Clouth decided now is the time to sell the business?

Yes. I really can't -- I don't know all the underlying reasons. I know it was -- as I said, it's been a multi-generational family and more and more members of the family, with each passing generation, are not involved in the business. So I don't know whether that had -- if that had something to do with it or not. I do think the current owner, I think, very much wanted before he retired to make sure that it was in good hands going forward. And I don't know that there was a next generation there to do that, to manage the business. And so I think he felt one of his primary objectives was to make sure that this business continue to thrive and grow and prosper, and he wanted to control where that occurred, if there wasn't a follow-on generation within the family to do that. And I think that's -- there's a little bit of speculation there, but in talking to them, I think that was a big part of the motivation was making sure that it was in very good hands, considering there wasn't another generation to take over.

[Operator Instructions] I am showing no further questions at this time. I would now like to turn the conference back to Mr. Jeff Powell, CEO and President, for any closing remarks.

Thank you. So in closing, Clouth is a company that, as I just mentioned, we have followed and admired for a very long time, and we're very excited to have them join Kadant, the combination of the company that can serve all of our customers' needs globally and there are many synergistic opportunities to explore as we go forward. So we thank you for joining us today, and we look forward to updating you on the progress in the future.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.