ESAB Corp (ESAB) 2023 Q2 法說會逐字稿

Good morning, and welcome to the ESAB Second Quarter 2023 Earnings Release and Conference Call. (Operator Instructions) Mark Barbalato, Vice President of Investor Relations. You may begin your conference.

Thanks, operator. Welcome to ESAB's Second Quarter 2023 Earnings Call. This morning, I'm joined by our President and CEO, Shyam Kambeyanda; and CFO, Kevin Johnson. Please keep in mind that some of the statements we are making are forward-looking and are subject to risks, including those set forth in our SEC filings and today's earnings release. Actual results may differ and we do not assume any obligation or intend to update these forward-looking statements, except as required by law.

With respect to any non-GAAP financial measures mentioned during the call today, the accompanying reconciliation information related to those measures can be found in our earnings press release and today's slide presentation.

With that, I'd like to turn the call over to our President and CEO, Shyam Kambeyanda.

Thank you, Mark. Good morning, everyone, and thank you all for joining us today. I'm very proud of the ESAB team. Our first half results are a testament of our team's focus on executing our strategic vision. These efforts have yielded expected results and strengthened our conviction in our strategy. We're creating a narrowly diversified premier industrial that is less cyclical, focused on growth, expanding margins and delivering impressive cash flow.

One of the key drivers of our success has been harnessing the transformative power of EBX, which has propelled ESAB to new heights of efficiency and effectiveness. Our commitment to streamlining our product line has not only fueled growth, but also boosted profitability.

In addition, our Kaizen activities at manufacturing sites continue to improve our productivity and create opportunities to consolidate our footprint. But that's not all, we're making significant progress on our ESG journey. Workplace safety is a top priority, and our team's efforts have yielded excellent results. We are equally dedicated to making a positive impact in our communities.

Lastly, we've entered into partnerships to accelerate our commitment to green energy and the possibilities ahead are truly exciting. Moving to Slide 3, we talk about the second quarter, in particular. ESAB achieved record sales and margins, reflecting the dedication and hard work of our global teams. Total sales grew 8% and organic sales in the second quarter rose an impressive 600 basis points, driven by robust demand and solid execution by both regions.

I was happy to see our Automation business grow above 20%, an indication of our innovative solutions. Adjusted EBITDA margins expanded 200 basis points to 18.6%. Our EBX initiatives have improved our operational efficiency and cash flow generation. As a result of our positive momentum and strong performance, we're raising our full year 2023 guidance.

Turning to Slide 4. Let me share a bit more on how we're shaping ESAB into our narrowly diversified premier industrial company. We have strategically built our Gas Control business into a global leader, complementing our FABTECH business. With the recent acquisitions of Ohio and therapy equipment, our Gas Control business is now around $450 million in revenue with gross margins greater than 40%. We are in our early innings. We see plenty of potential to grow this business and expand margins over the coming years.

Second, we've been shaping our Automation business into a less cyclical, faster-growing, process-focused and higher-margin product line. As I've mentioned before, Automation today is approximately 10% of ESAB's revenue. In the second quarter, we saw 23% growth in our Automation business. Automation, along with our Digital Solutions and our Cobot Solutions have been met with great enthusiasm at our customers.

As a result, we anticipate double-digit growth in our Automation business over the next few years as customers reshore and address the ongoing shortage of skilled welders. Today, Gas Control and Automation contribute 26% of ESAB's total sales. This percentage will continue to increase in the years ahead.

Moving to Slide 5 and sharing a bit more on our automation strategy. We are focused on creating a differentiated Automation business. Over the last few years, we've been on a journey collaborating with integrators, acquiring companies that give us an edge in programming and data management. As a result, allowing ESAB to provide our customers with a complete workflow process solution. Today, I'm pleased that these initiatives and acquisitions have started to yield dividends reflected in our strong growth we experienced in the second quarter.

Talking specifically about our Cobot Solution, our customers love the fact that our solution is easy to use, reduces programming time. In fact, with our solution, one can use their smartphone or smart tablet to program the robotic arm. Additionally, ESAB has the capability to provide real-time analytics, providing customers with a unique value proposition. Our offering has been a game changer for customers looking to simplify programming and boost their shop floor productivity. Our Cobot product line saw a triple-digit percentage sales growth in the second quarter. There's more to come in the years ahead.

Turning to Slide 6. In the second quarter, I had a chance to visit our Czech manufacturing sites. It is clear our teams in Bamberg and [Schöderberg] have taken lean activities up a notch. The teams have done a fantastic job of connecting capital investment and lean activities to deliver a step function improvement in efficiency and productivity. What was more impressive was a list of ideas of additional improvements at our sites.

Talking specifically about our Kaizens for the second quarter, we saw 51 Kaizens completed globally. The example on the right of the slide is our health care valve line in Schöderberg . We automated our click washer production line using a Cobot. This Kaizen delivered 30% improvement in throughput, a 40% reduction in lubricant usage, also an important ESG initiative for us and most importantly, created a reliable, repeatable process, ensuring quality to our customers while also enhancing safety of our associates.

Moving to Slide 7 and briefly updating you on our ESG efforts. I'm particularly proud of our health and safety efforts. The second quarter's total recordable incident rate was a remarkable 0.33% surpassing industry benchmarks. Our commitment to giving back to our communities is steadfast. Recently, we collaborated with our customer Northern Tools to donate ESAB equipment to a trade school training the next generation of welders. And on my visit to our Hanover, Pennsylvania plant, I was able to drive by the local Little League baseball fields where the scoreboard is now sponsored by ESAB.

These are small contributions, but they are creating a great sense of pride and belonging for our teams in the communities we live in. Lastly, our partnership with GRI Renewable Industries. This highlights our focus on green energy projects and deepens our commitment to shaping a better world together.

Turning to Slide 8 and our financial performance. Sales for the quarter was $680 million, up 8% in total. Organic sales grew 600 basis points. Our end markets continue to perform as expected and remain resilient, acquisitions added 300 basis points of growth and are performing better than expected. Adjusted EBITDA margins expanded 200 basis points and reached a record 18.6%. I would like to point out that we modestly benefited from $2 million of growth investments being pushed into the third quarter. All in all, a fantastic quarter for ESAB in which we delivered record sales and profit.

Moving to Slide 9. Another solid quarter for our Americas region. They continue to perform in line with our expectations. Total sales grew 7% and organic sales was up 400 basis points. Acquisitions added another 500 basis points of growth. The region continues to drive our product line simplification strategy, excluding our PLS-related activities, volume grew low single digits.

We continue our progress on changing the mix of our business at the core of our success is our commitment to innovation. The team's relentless efforts have brought new products and solutions like the battery-powered VOLT and the Warrior Edge heavy industrial product for automation and robotics, creating additional growth opportunities.

Turning to Slide 10. Another impressive quarter for our EMEA and APAC regions. With total sales growing 9%, organic sales up 700 basis points and acquisitions added 200 basis points of growth. We continue to see a resilient end market buoyed by investment in renewable energy, agriculture, infrastructure and oil and gas; liquefied natural gas, in particular.

I'm very proud of our team in Europe, Middle East, Africa and Asia. They are using EBX and our product line simplification initiative to drive growth and expand margins. Our team in Europe has enhanced our product line simplification process and have identified a unique way to stratify target growth customers. Adjusted EBITDA in the region expanded 180 basis points to a record 18.4%.

On that high note, let me hand it over to Kevin to talk about Slide 11.

Thanks, Shyam. We delivered another strong quarter of free cash flow, which was up 61% versus 2022 and allowed us to pay down debt and further reduce our net leverage to 2.4 turns. Excluding recent acquisitions, which were funded with our free cash flow, our leverage is closer to 3 turns. We are continuing to leverage our EBX business system and work with AI partners to identify opportunities for working capital improvement.

This work is delivering strong results with our working capital turns, improving by 0.3 turns. In the third quarter, we also increased our dividend payment by 20% to $0.06. You can expect us to continue to increase this in future years. We are on track to drive even higher cash flow in the second half of this year.

Turning to Slide 12. As Shyam mentioned earlier, with a strong first half and increased confidence in our second half performance, we have significantly raised our full year 2023 guidance. Our business continues to benefit from resilient end markets and improved FX outlook and recent acquisitions performing ahead of plan.

As a result, we are increasing our full year sales guidance to $2.56 billion to $2.61 billion, for a total growth of 6% to 7.5% and an organic growth of 4% to 5.5%. Our guidance for the remainder of the year continues to assume low single-digit volume and price growth and FX turning to a tailwind.

Adjusted EBITDA guidance increased to $450 million to $465 million, which includes $5 million from improved FX and continued progress on margins from further manufacturing consolidation, product line simplification initiatives and automation in our factories and back office. We are continuing to invest in our business and our second half guidance assumes $4 million of added investment on initiatives to fuel long-term growth, $2 million of this deferred from the second quarter. Interest expense guidance has been increased to $74 million to $76 million, which accounts for one additional Fed rate hike.

Tax rate guidance is unchanged and adjusted EPS guidance has been raised by $0.25. Our cash flow conversion remains on track. I am pleased to let you know that we are scheduling our Investor Day for the 5th of December in New York City, and we will be issuing details shortly. We have had a strong first half and expect to continue our momentum into the second half of this year.

With that, let me hand back to Shyam on Slide 13 to wrap up.

Thank you, Kevin. In summary, we're focused on driving our strategy forward. Product line simplification is taking root, delivering both growth and margin expansion. Our acquisitions are performing above expectations, and we're seeing great progress on our automation strategy. We continue to drive EBX within our enterprise, and I'm pleased with our team's energy and commitment towards continuous improvement. As a result of our first half performance and confidence in our team's ability to execute, we have significantly raised our full year guidance.

We're on track to deliver another year of significant progress towards our strategic goals. As a team, we're focused on creating significant value for our associates and shareholders. Thank you again for joining us. Operator, please open the line for questions.

(Operator Instructions) Your first question comes from the line of Tami Zakaria from JPMorgan.

So my first question is just to clarify, you expect both price and volume to be up low single digit in the back half. So both pricing and volume up?

Tami. Yes, that's accurate. Obviously, we've had a strong first half. We started off the third quarter well as well. And so our current estimates are that the second half of the year will have low single-digit price and volume.

Does that mean pricing will be positive in both markets? Because I saw -- I think EMEA and APAC pricing was flat in the second quarter. So do you expect that to reaccelerate in the back half?

No. I think the view is that we see pricing in the rest of the world to kind of stay where it's at and then the North America pricing to start to lap and then sort of that's the estimate that we have or the assumption that we have into the second half.

Got it. If I can ask 1 more question. The 3% volume -- negative volume in the Americas, could you give us a sense how much of that is attributable to the PLS initiative and when you expect that to dissipate?

Yes. I think first, it's important to sort of reiterate that we had a really strong quarter overall at ESAB and you saw our global volumes sort of be very strong. We also saw our American volumes be good and positive in the low single digits when you took out our PLS activities. But that being said, I think I've mentioned several times before that we have a complex business that we continue to work on in North America and execute our PLS strategy.

Our view is that it takes the rest of this year to get through that. Now it may happen earlier, but we're committed to the process. We're committed to driving our margins to a good spot, making sure that we have a business that's sustainable. But we're very happy with the results when you exclude PLS and you saw a slight volume growth in the Americas.

And your next question comes from the line of Nathan Jones from Stifel.

I'll just follow up on Tami's question there. There's obviously an impact from PLS on the volume numbers, but I assume that there's also an impact from PLS on the margin profile of the business. So any commentary you can give us on kind of the improvement that you're seeing in the margin profile directly from these PLS actions?

Well, the first piece is that I think I was very proud of the team and the way we executed in the second quarter. Multiple things went right from our team's perspective. We delivered well on price, we grew the accounts that we wanted to grow, we improved the mix in the business and then obviously, PLS and EBX. And so one could sort of take a look at this and say, EBX and PRS delivering half of it and the rest of it coming from execution on the growth accounts along with price.

I guess a follow-up to that, I mean, the comment there was a lot of things went right in the second quarter. Do you think you can maintain those kinds of margins in the back half? I mean 4Q is probably going to be a strong volume quarter, which should result in good margins. So just any commentary on whether there's some good guys in the second quarter that maybe don't repeat in the back half?

Yes. I think the intention of this leadership team and the entire enterprise for us is obviously to hit a watermark and then continue to go from that particular point. There's a couple of things that we want to sort of add in it. We had about $2 million of operating expense that sort of got pushed into the third quarter that is a growth investment for the rest of the year and into 2024.

So that was a good guy in the second quarter. But what I can also say is that our teams are focused on driving growth, maintaining where we are today. We see the similar seasonality kind of playing out. And I know Kevin has given you some numbers on the seasonality. And we expect our business to perform in that seasonality with us kind of gaining momentum as we go into 2024.

Just a quick one on innovation. You guys released a bunch of new products last year, and you have EDGE and VOLT coming out in the second half. Can you talk about customer reaction to the new products, kind of what kind of traction you're seeing on those? And what kind of revenue or growth contribution you're looking at from EDGE and VOLT as we get into the back half of the year or if that's more '24?

Yes. Thank you for that question. I think clearly, we have been really excited about our equipment line. We sort of call our light industrial line now the ultimate lineup. We're seeing a significant amount of growth in that product line. The Renegade VOLT launch is actually in the third quarter. We're going to actually talk about it in a big way at FABTECH and also at Essent, and then at the same time, launch also that Warrior Edge product line.

The initial reaction from the customer has been very positive. In fact, I was in Europe a few weeks back. I had a chance to interact with a couple of our large customers and distributors, and they were very impressed with the performance of the Warrior Edge.

Similarly, in North America, we've had a few customers come in and look at that particular product line and now truly feel that we will be in play on the heavy industrial line of category of product lines. And so really looking forward to what the second half brings from that category.

But that being said, we -- that hasn't prevented us from sort of gaining momentum. The Automation part of our business was a great story. The solution sets that we're bringing in, in terms of programming, in terms of our data analytics and creating a workflow solution was very well received.

In fact, in one of the customers that I met with, when we showcased them the combination of our power unit, our data analytics and also a piece of adaptive welding, they were thoroughly impressed to the extent that we got a pretty large order from them in the wind sector as a result of our technology and our innovation.

So really thrilled about the progress. We've also realigned our teams to be focused on automation. So all of that is now paying dividends. So looking forward to us gaining more traction and talking more about this, especially during Investor Day.

Your next question comes from the line of Mig Dobre from Baird.

So sticking with the Automation discussion, I'm wondering if you can maybe remind me how big is this business for you and your -- when you're talking about this 23% year-over-year growth, can you delineate a little bit as to what you're seeing in Americas, Europe versus other regions?

Yes. So we've talked about our Automation business being about 10% of our total revenue within the business, and so you can do the math to that, 23%. What we had been working on, if you remember, Mig, was to really create a business that was a more differentiated solution around automation, where we were less focused on large material handling but focused on process-based automation.

I've really spent the last couple of years building out that solution set, adding programming capability, adding digital analytics capability, along with the workflow solution that we are talking to integrators about and end users. That's gained some traction. We actually saw growth of similar volumes, both in North America and in the rest of the world. So really excited about that category.

And then also in that space comes our automated cutting business as well and so, that also did extraordinarily well, and we shared a brief on our Cobot product line, which obviously comes off a really small base, but we've really seen tremendous amount of excitement on that front. Last time I shared with you a Canadian customer that had improved that throughput, almost tripled that throughput as a result of our Cobot applications and held on to our equipment until we actually got them our new products.

So really thrilled about what all 3 are doing for us in the marketplace, and we see growth actually quite balanced, both in the Americas and the rest of the world.

And you say rest of the world, but I'm presuming that Europe is where most of this demand is occurring or maybe I'm wrong about that. Are you seeing it in emerging markets as well, demand for...

Yes. Yes. Actually, we are seeing India adapt a lot of automation. We're seeing places in the Middle East adapt a lot of automation. And then obviously, Europe is a big piece of it as well.

Understood. You already got asked the margin question a couple of times, but I'll try it as well. When I look at incremental margins in the quarter, they were considerably better than what I was expecting. And I'm sort of curious if there's anything that's unique about Q2 that potentially you might not have going forward? And if not, then how do you frame the margin opportunity, because we're not that far from that 20% goal that you've outlined before. And I'm curious as to kind of how you see the path going forward?

Yes. Obviously, we were very thrilled with the execution from our teams in the second quarter. We felt that both the regions performed very well and executed through the opportunities that we had to drive the business forward. Apart from the amount that I spoke about, which was the $2 million that sort of got pushed out to the third quarter, we didn't see any onetime benefits in the quarter.

But that being said, there is a seasonality to our business. And I think the way that we have forecasted the rest of the year, (inaudible) that. Kevin, do you want to add something?

Yes. I think, Mig, our expectation is sequential incrementals, decrementals in that sort of 30% range as we progress through the rest of this year.

I'm sorry, just to clarify here, when you talk sequential incrementals. I mean, I guess the way I think about it is on a year-over-year basis to (inaudible) typical seasonality?

Yes. Year-over-year will be in the mid- to high 20s as we go through the rest of the year.

Yes. Remember, Mig, we are planning to invest a bit into our business. We have talked about that earlier with the launch of some of the new products that are coming in the third quarter and the activities that we have planned for the fourth quarter that we believe will set us up really well for 2024. We've got some additional investments coming our way in the second half of this year.

Yes, there's around $4 million of audit investment we've put in, Mig, as well as the half of the $10 million that we have already communicated that we were going to spend additional for this year.

Last question for me. Maybe a comment on your M&A pipeline and sort of how aggressive you think you want to be over the next, call it, 18 to 24 months? Maybe that's a question from the Investor Day later in the year, I don't know.

Yes. No, we're obviously happy to take the questions on that front. One, I would say that our funnel is very strong. I think our team has done a really nice job identifying what we call bolt-on and tuck-in acquisitions that continue to move our strategy forward meaningfully. Thrilled about the 3 acquisitions that we've made thus far, and all of them are performing above expectations, and we're thrilled about the value that they've added to our business and the opportunities for growth that they're providing in different geographies.

We expect our acquisition strategy say, very similar to that. You saw on the slide that Kevin presented. Our leverage now is down to close to 2.4x. And if we had done none of the acquisitions, we would haven been down to 2.0x, 2.1x. We expect to stay within that 2x range as we do our acquisitions. We're obviously generating as we had mentioned to all of you in the past, we're a great generator of cash where we expect the second half to continue that trend. And so we expect to generate cash and acquire companies, keeping our debt rates to where they are today or in that 2x range.

(Operator Instructions) And your next question comes from the line of Chris Dankert from Loop Capital.

Really appreciate all the color you've given us around just the margin moving parts here and there, not particularly around product line simplification here. I'm just curious for you if I missed it, but on the price cost side, can you just kind of give us a sense for how big of a benefit that was in the quarter and kind of what we can expect in the back half from a price cost perspective?

Yes. So we've always said that on a price cost side, we expect to be neutral. And so our view on price cost, that is our strategy. Now we've got other activities underway, whether it be value pricing whether it be price related to product line simplification, that we think will continue to add a tailwind to our sales.

But that being said, our intention with pricing is always threefold, and we've talked about this before. One is related to inflation, and we expect if we do see inflation, we will go to market. The second one was related to value pricing and the third one now is around product line simplification. And so we expect to do all 3 inflation-based pricing. Obviously, we don't see as much inflation now towards the second half of the year.

We did see some inflation in North America. As a result, you see that pricing number be a bit higher. But otherwise, we continue to expect to play those second and the third play around that value pricing and PLS as we move into the second half of the year and into 2024.

Understood. That's really helpful. And then I guess to zoom out a little bit here. Obviously, maybe you talk about Gas Control and some of the opportunities there, obviously nice growth in the quarter. But when you're looking at Gas Control more specifically, what gets you the most excited whether we're -- is it the core industrial applications? Or is it more like the diverse markets in terms of medical and that type of thing?

Yes. The great part about that business as we sort of began to focus on it back in 2017 and 2018, we saw that the industrial side of that business actually has better characteristics than the broader industrial business that ESAB had. So we like the characteristics of the industrial side of the business. And then when you map it over to Med and Specialty, we then see lesser cyclicality, greater growth, higher margin and then the possibility is obviously to acquire and stack up businesses in that category. So we're actually happy about the entire breadth of that product line.

We like the performance of the industrial side of that business, and we've talked about it being accretive to the gross margins of ESAB. And then you pick the spec gas and the medical side of that business and that continues that journey further north for us.

And there are no further questions at this time. Mr. Mark Barbalato, I'd like to turn the call back over to you for some final closing remarks.

Thank you for joining us today, and we look forward to speaking to you on our next call.

This concludes today's conference call. Thank you for your participation. You may now disconnect.