Earnings Call Transcript - ESAB Q1 2022

Operator, Operator

Good morning, ladies and gentlemen. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the ESAB Corporation's First Quarter 2022 Earnings Conference Call. Today's conference is being recorded. Thank you.

Mark Barbalato, Vice President of Investor Relations

Thanks, operator. Welcome to ESAB's First Quarter 2022 Earnings Call. This morning, I am 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 might 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 made during the call today, the company reconciliation information relating to those measures can be found in our earnings press release in today's slide presentation. With that, I would like to turn the call over to our President and CEO, Shyam Kambeyanda.

Shyam Kambeyanda, President and CEO

Thank you, Mark, and good morning, everyone. Thank you for joining us today. Let me start by reminiscing a bit. April 5 was a fantastic day for ESAB as being listed on the New York Stock Exchange was a source of profound pride for all of our global associates. Over the last five years, we've made solid progress and have confidence in our strategic direction moving forward. As a team, we're focused on taking our ESAB business system, which we call EBX, up a notch to continue to drive innovation, growth, margin expansion, better cash flow, and breakthrough strategies to deliver long-term shareholder value. Turning to Slide 3, I'm pleased to report another quarter of strong results. We extended our outperformance on volume growth and improved our margins year over year. I am very proud of our team's focus and determination as we navigated headwinds due to COVID restrictions in China and the war in Ukraine. In terms of financials, in the first quarter, we delivered a record of $648 million in sales, an 18% year-over-year organic growth, which reflected strong price realization and broad-based demand for innovative solutions. EBITDA climbed to $109 million, a 16% increase year over year. Our margins expanded 30 basis points to 16.9%. We continue to introduce exciting new products and as I mentioned before, we have taken our EBX efforts up a notch, and I will share more on both these topics in the next two slides. Now moving to Slide 4, we launched 28 new products in Q1 and continue to prioritize investment in R&D. Our open innovation process has allowed ESAB to accelerate the pace of innovation. For the full year, we are on target to launch approximately 110 new products. I want to highlight some of them. RobustFeed, this is an award-winning feeder that is used in heavy industrial applications. During the quarter, we redesigned the unit so that it can connect to any power source, helping us expand the market for this product. The fabricator has new and upgraded technology that simplifies our product line and provides a competitive offering to our customers. I have mentioned product line rationalization in the past. This accelerates our efforts to rationalize our SKUs and improve margins going forward. Our gas control bus business also launched some exciting new products in the first quarter, like druvaPUR, High Purity, and MediVital which are great examples of us designing best-in-class technology and expanding into new geographies. Moving to Slide 5, I'm really excited about the next phase of EBX. As we completed in the first quarter, we continued our EBX journey to improve safety and productivity while reducing our footprint. We completed 10 major Kaizen initiatives in North America in the first quarter, resulting in $3 million in productivity savings. These Kaizens also freed up over 5,000 square feet of manufacturing and assembly space. The main tenant of our Kaizen is to improve quality, productivity, and safety with minimal capital investments. At our Denton facility, one of our key product lines increased sales per month by over 40% and improved productivity by 42%, gaining manufacturing space and improving safety. I will be visiting the Denton facility later this month to celebrate with our team. Moving to Slide 6, first quarter 2022 sales rose to a record $648 million, a 14% increase year-over-year and 18% organically. This reflected a volume increase of 4%, a price increase of 14%, and a 400 basis point currency impact. We continue to experience healthy demand across most geographies. A highlight of this quarter was record equipment sales at ESA. Regions where we experienced lower sales were expected in Russia and China due to COVID lockdowns. Our teams continue to manage pricing to offset the impact of inflation. Successfully focusing on margin expansion, EBITDA increased to $109 million up 16% with a strong year-over-year performance from our Americas unit. Moving to Slide 7, talking specifically about our Amercian segments, the Americas segment performed well as sales climbed to $272 million, a 21% growth organically. This reflected increases in volume of 3% and a price increase of 18% with a slight currency headwind. We continue to make good progress with our new and improved product offerings driving growth in the channel. EBITDA increased by 32%, and margins expanded by 150 basis points, reflecting strong execution as our team successfully navigated inflation and supply chain constraints. Earlier, I shared our lean activities, and I am very proud of our team and what we are building together. We have a multitude of exciting new products under development, which will drive future growth and margin expansion. Moving to Slide 8, our EMEA and APAC segments performed well despite headwinds from COVID in China and the war in Ukraine. First quarter sales increased by 10% and climbed 16% organically. This reflected a volume increase of 4% and a price increase of 12%, with a 600 basis point currency headwind. This region also saw record equipment sales. Another highlight in the quarter was the momentum in robotics and cloud solutions, driving growth in both our funnel and auto backlog, with EBITDA increasing by 7% in the quarter, reaching 17.4%. This included approximately $4 million provision related to Russia, without which margins would have increased 50 basis points year over year. I am very proud of our teams in Europe, the Middle East, and Asia during these challenging times; they have performed extraordinarily well and built great momentum. Now let me turn it over to Kevin.

Kevin Johnson, CFO

Thanks, Shyam. On today's call, we are confirming our 2022 guidance. This guidance has been updated to reflect the impact on our Russian business. In the first quarter, Russia contributed around 6% of sales as we had expected; our guidance for the rest of the year has removed any further sales and profit from Russia. Our business excluding Russia is performing really well, and we continue to expect organic growth of 9% to 12%. We did have some pressure in China in the first quarter, as Shyam mentioned, sales down approximately a hundred basis points due to the recent wave of COVID lockdowns. However, our main manufacturing facility in China is now open, and we expect things to improve in the second quarter. We are still operating in a highly inflationary environment and are closely monitoring this. If further inflation occurs, we will respond quickly with price increases. Our team has made good progress on our manufacturing consolidation and transformation project in the first quarter and remains on target to deliver around $20 million in savings this year. EBITDA is guided to $400 million to $420 million, which includes approximately $35 million in additional public company expenses, around $6 million of which we incurred during the first quarter. Our adjusted EPS remains in line with our previous guidance at $3.85 to $4.05. We continue to be on target to deliver free cash flow of greater than $210 million. In the first quarter, free cash flow at $22 million was in line with expectations, lower than the prior year due to additional investments made in working capital to support growth and mitigate supply chain risk. We expect to see free cash flow improve as we progress through the rest of this year. In the near term, our priorities are focused on paying down debt, and we are considering initiating a modest quarterly dividend. To assist with modeling, we have included some additional slides in the appendix, a more detailed guidance slide, and additional quarterly historical financials by segment. Let me now hand back to Shyam on Slide 10 to wrap up.

Shyam Kambeyanda, President and CEO

Thank you, Kevin. We're off to a great start as a public company. Our team continues to manage pricing to offset inflation and successfully mitigate supply chain risks. EBX is in our DNA. The planned activities in lean manufacturing, coupled with our business process improvements, provide a clear path to growth, margin expansion, and improved cash flow. The team is in place, and we are on target to deliver our long-term strategic goals. With that, I want to thank you again for joining us. Operator, can we please open the line for questions?

Operator, Operator

And we will take our first question from Chris Dankert with Loop Capital.

Christopher Dankert, Analyst

I guess first off, congrats on all the hard work that got you here. So I guess first question here, kind of looking at everything, speaking to Europe specifically, maybe you can kind of just tell us the lay of the land, what you're seeing in terms of order rates and demand. Just kind of give us an update on what you're seeing there kind of in the context of the conflict and kind of economic concerns there.

Shyam Kambeyanda, President and CEO

Chris, thank you for the question. The momentum that we had in the first quarter continues into the second quarter. That being said, we are closely monitoring our daily sales rates and our order rates. As of now, we are not seeing anything that changes our outlook or anything to our forecast that we have issued in the press release and in the presentation.

Christopher Dankert, Analyst

Got it. Okay. Glad to hear. You are kind of comfortable in that market. That may be kind of a bigger picture question. I mean, roughly half the markets historically have been lower labor cost regions. Thinking with that backdrop, how do we think about automation solutions within the ESAB portfolio, and maybe kind of what is the mix of automation sales today and where that's headed?

Shyam Kambeyanda, President and CEO

Yes. I don't think we have given out specific numbers related to automation or as a percent of our sales, Chris, but what I would say to you is that we see, even in emerging markets, the adaptation of sorts, as you see the labor market in terms of welders minimized. We do see adoption for automation and especially with the solution that we're looking at. I've talked about this many times before with the Octopus acquisition; we have the ability to program robots within hours on an offline basis. On that particular front, we see a strong trajectory for growth within our business, in both the emerging markets and the developed markets. Countries like Brazil and India have already made a significant foray into automation, accelerating the adoption of that particular technology.

Operator, Operator

And our next question comes from Walter Liptak with Seaport.

Walter Liptak, Analyst

And Mike, congratulations too, and all the hard work to get here. Want to ask about the gross margins and how you're feeling about the inflation rates that you're seeing right now and selling price increases. What do you think about the latter half of this year and where your margins might be?

Shyam Kambeyanda, President and CEO

Yes. To answer that question in full, what I would say is that we're confident about our pricing process. We've mentioned before that we have three strong processes: one to deal with inflation, two to deal with new innovative products and their value pricing, and the third being product line lifecycle management. We're executing across all three processes and feel confident that going forward we can continue to move prices based on inflation while also optimizing our product lines. In terms of gross margins, we anticipate about a 200 basis points compression due to the price-cost balance affected by inflation. Going forward, we may see inflationary headwinds ease into next year, but we are working diligently with EBX to streamline our factories and improve our footprint.

Walter Liptak, Analyst

Okay. Great. That kind of leads into maybe on the cost side, more of the overhead SG&A costs. How are you feeling about your corporate expense and your SG&A this quarter, and as a public company, are there more adds that you have to do to have the right people to run the company?

Shyam Kambeyanda, President and CEO

The short answer is that we have our full team in place; we do not need any more resources to run a public company. Kevin mentioned earlier that the assumption we have made on an annual basis is around $35 million, of which $6 million was already included in our Q1 results. You can expect the remaining portion in the following quarters, while we continue to work on business process improvements as discussed in EBX.

Operator, Operator

And we will take our next question from Vlad Bystricky with Citigroup.

Vladimir Bystricky, Analyst

So Kevin, I think you mentioned about a hundred basis points headwind in China in the quarter related to the lockdowns but that your facility is back online now. Did I hear that right?

Kevin Johnson, CFO

Yes. Just a hundred basis points, not 100 million.

Vladimir Bystricky, Analyst

Okay. That's great. That makes more sense. So a hundred basis points. Can you just give us more color on what you're actually seeing on the ground in China? I know you said your facility is back up, but what are the broader supply chain impacts and how do you expect recovery to unfold over the quarter?

Shyam Kambeyanda, President and CEO

Yes. What we observed towards the end of the quarter was that Shanghai and several other cities were shut down. However, we are now seeing signs of recovery into May with businesses reopening, and factories and ports continuing to function. We anticipate a return to some amount of normalcy throughout the quarter. China's announced plans to stimulate their economy as they emerge from COVID, leading us to expect a strong recovery by the end of Q2, continuing into Q3, and then reaching normal levels by Q4 and Q1 of the following year.

Vladimir Bystricky, Analyst

Okay. That's really helpful color. Appreciate it. And then just a follow-up. Now that you've separated, any updates or considerations regarding your balance sheet leverage in the current environment going forward?

Shyam Kambeyanda, President and CEO

We aim to maintain our leverage ratio between 2 and 3, starting off at around 2.75. Our current focus is to reduce that debt while generating strong cash flow and preparing for potential acquisition opportunities.

Operator, Operator

We will take a follow-up question from Chris Dankert with Loop Capital Markets.

Christopher Dankert, Analyst

I just wanted to circle back on Russia. It's been removed from the guidance, but can you provide any insights on how you're considering that moving forward? Are you exploring strategic options, or is it more of a matter of riding it out?

Shyam Kambeyanda, President and CEO

The best way to think about our Russia business is that we have fully transitioned out. No further capital investments will be made; our primary focus is the safety and security of our associates while determining the most appropriate exit strategy for the region. This perspective is reflected in our guidance, indicating we do not expect profits from that region going forward. If anything changes, we will let you know.

Christopher Dankert, Analyst

I appreciate that. Lastly, as we think about data capabilities, whether it’s related to understanding customer purchasing habits or inventory management, can you comment on the current state of data analytics within the company?

Shyam Kambeyanda, President and CEO

Yes. I feel strongly about our data capability. We've engaged with data mining experts to enhance our real-time data gathering, looking at customer perspectives and material flow in our business. This represents a strong opportunity for ESAB as we aim for margin expansion and improving cash flows.

Operator, Operator

We will take a follow-up question from Walter Liptak with Seaport.

Walter Liptak, Analyst

I wanted to ask about the guidance and the organic revenue growth of 4% to 7%. You're at 18% in the first quarter, so that implies some tough comps in the second half. Are you expecting to remain volume positive throughout the year across the regions? What assumptions are driving that organic growth of 4% to 7%?

Shyam Kambeyanda, President and CEO

The best way to frame that is to recognize that our guidance was presented at our investor day recently. We are cautiously monitoring the rest of the year to evaluate where we stand, emphasizing that while we feel confident in our forecast, we wanted to maintain conservatism in our guidance. We are off to a strong start in Q2 and will see how the next few months unfold.

Operator, Operator

And ladies and gentlemen, there are no further questions at this time. I will now turn the call back to Mark Barbalato for closing remarks.

Mark Barbalato, Vice President of Investor Relations

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

Operator, Operator

Ladies and gentlemen, this concludes today's call. We thank you for your participation, and you may now disconnect.