ESAB Corporation (NYSE:ESAB) Q4 2022 Earnings Call Transcript

ESAB Corporation (NYSE:ESAB) Q4 2022 Earnings Call Transcript March 7, 2023

Operator: Good morning and welcome to the ESAB’s Fourth Quarter 2022 Earnings Conference Call. Thank you. Mark Barbalato, Vice President of Investor Relations, you may begin your conference.

Mark Barbalato: Thanks, operator. Welcome to ESAB’s fourth quarter 2022 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.

Shyam Kambeyanda: Thank you, Mark. Good morning, everyone and thank you all for joining us today. 2022 was the beginning of a new era in ESAB’s 118-year rich history. We had a strong finish to 2022 and are entering 2023 with positive momentum as we continue to shape ESAB for the future. Let me take a moment to highlight a few accomplishments. We successfully launched as an independent company. We are well positioned to compound value for our shareholders. We again demonstrated our innovation leadership by introducing several exciting new products, like Renegade VOLT, battery-powered welder and our new heavy industrial product, the Warrior Edge. We took our business system, EBX, up a notch. Our EBX process helped drive price and working capital improvements in a challenging environment.

Our strengthened balance sheet and robust cash flow funded 3 acquisitions that moved our strategy forward. We continue our progress on ESG initiatives and I’ll share more on this later. Before I highlight the fourth quarter, let me take a moment to acknowledge the hard work and commitment of our associates. They embody our purpose and values and have been relentless in their focus on our customers and key stakeholders. Moving to Slide 3 and our performance in the fourth quarter. As I said before, we had a strong finish to 2022. Organic sales increased 11%, adjusted EBITDA rose 10% and margins expanded to 17.4% as our EBX initiative drove margin and working capital improvement. We made 2 acquisitions in the fourth quarter that further strengthened our enterprise, shaping ESAB towards higher growth, lower cyclicality, higher margins and higher cash flow.

Moving to Slide 4. We met all of our key financial metrics, reflecting strong execution despite a challenging operating environment. Full year organic revenue grew 13%, all of our regions contributed to our growth. India and the Middle East were standout performers. We achieved $417 million of EBITDA which was $7 million higher than the midpoint of our guidance. And we delivered $4.21 of EPS which was $0.16 higher than the midpoint of our guidance. To appreciate the team’s EBITDA performance, I would like to highlight that we absorbed approximately $10 million of unfavorable currency pressure or roughly $0.12 a share compared to our original guidance. And on free cash flow, we generated $219 million of cash with a strong finish in the fourth quarter.

The key takeaway on this slide is ESAB delivered on all of its commitments. And we’re on a clear, continuous improvement path towards our long-term strategic goals of 20% EBITDA and 100% free cash flow conversion. Moving to Slide 5. Over the last 6 years, we worked hard to reshape our company. And with the recent acquisitions of Swift-Cut and Therapy Gas Equipment, we continue our journey to compound value. Therapy Gas Equipment strengthened our gas control business by broadening our product offering and extending our geographic reach. Like our Ohio Medical acquisition, Therapy Equipment Is immediately accretive to our margins. Swift-Cut is a leader in light industrial automated cutting and provides us with an opportunity to extend our process leadership as well as grow our aftermarket.

Additionally, there’s an opportunity to accelerate growth and expand margins by plugging in Swift-Cut’s innovative products and solutions into our global distribution network. Turning to Slide 6. Let me share an example of EBX at work. We’re all aware of the supply chain issues at the start of 2022. We felt this was a perfect situation to use our powerful EBX tools to drive improvement. We use product line simplification, AI forecasting, enhanced standard work, improved shop floor gemba and glass boards to systematically optimize and improve our inventory levels. As the chart indicates, we were able to reduce inventory by $60 million over the course of the second half of 2022. In 2023, expect us to raise the bar and continue to reduce our inventory days.

Photo by Russ Ward on Unsplash

Moving to our fourth quarter financials on Slide 7. As I mentioned before, fourth quarter sales grew 11% organically. Our markets remained resilient with particular strength in our emerging markets. Acquisitions added 2 points of growth and are performing as expected. Our integration and synergy plans are off to a good start. I recently had the opportunity to visit with our team at Ohio Medical for our 100-day integration plan review. This includes implementation of our strategic vision as a global leader in gas control equipment as well as leveraging EBX across the business to drive growth, margins and cash flow. It was evident that there was great energy in the room, Ohio Medical has fit right in and the team is excited about our future opportunities together.

Similarly, I’ll be visiting both Swift-Cut and Therapy Equipment for their 100-day reviews in the second quarter. Continuing with the impact of EBX, we’re pushing price to offset inflation and our cadence of innovative new product introductions are driving excitement within our sales team and our customers. I’m encouraged by the strength of our sales funnels and the activities that will drive both an increased share of wallet as well as bring new customers to ESAB. Strong price and cost-saving execution helped offset both inflation and currency headwinds in the quarter. As a result, EBITDA margins expanded 40 basis points year-over-year and 80 basis points sequentially. Moving to Slide 8. Americas had a solid quarter and performed as expected.

Sales rose 5% organically as the team executed on price. Volume in the Americas reflected a tough year-over-year comparison. We made strong progress on penetrating new channels, accelerating our product line rationalization and improving our operational efficiency. Acquisitions added 4 points of growth. As a result, adjusted EBITDA increased 9%, margins expanded by 20 basis points and 100 basis points on a sequential basis. Turning to Slide 9 and our EMEA and APAC segments, they had a strong quarter again. Our fourth quarter sales rose 15% organically, reflecting 8 points of price and 7 points of volume. Acquisitions added another 100 basis points. We saw particular strength in India and the Middle East. In the quarter, both regions made significant progress on equipment, digital solutions and automation sales.

Adjusted EBITDA improved 10%. Margins expanded 60 basis points year-over-year, reflecting strong execution and despite being impacted by a strong U.S. dollar . With that, let me turn it over to Kevin for Slide 10.

Kevin Johnson: Thanks, Shyam and good morning, everyone. ESAB had another strong quarter for free cash flow, $35 million higher than the prior year and a cash conversion greater than 100%. I’m proud of the work the ESAB team has completed during the year, particularly on inventory which we reduced by a further $30 million in the fourth quarter. We funded our new acquisitions with our strong free cash flow and ended the year with net leverage of 2.7x, 0.1x better than we expected last time we spoke. As we look forward to 2023, new technology is being implemented that will further improve our cash generation. We are confident of delivering on our long-term goal of cash conversion greater than 100% in the next few years. Turning to Slide 11.

We provide our 2023 guidance. Our guidance numbers exclude our Russian business for the full year 2022 and 2023. Total sales growth is expected to be 2% to 4%, with sales seasonality similar to 2022. Organic growth of 3% to 5% includes 1 to 2 points of volume and the rest from price. We expect 2.5% from acquisitions and a 3.5% FX headwind due to a stronger U.S. dollar, impacting the first half of 2023. We expect a year-on-year incremental in the mid-20s with an adjusted EBITDA guidance of $420 million to $440 million. This includes $15 million of investment we are making to drive growth for our gas control and equipment products. As we discussed last year, we successfully fixed half of our debt at a 4% interest rate and we are assuming the Fed will increase the cash rate to around 5% by the end of Q2.

Our interest expense is guided to $70 million to $72 million. 2023 adjusted tax rate is expected to be 24% to 25% with 50 basis point improvement at the midpoint versus 2022. We expect to consistently lower our adjusted tax rate over the next few years. Overall, 2023 adjusted EPS guidance is $3.80 to $4. Finally, our cash flow conversion guide is greater than 90%, as we continue to generate strong free cash flow with a similar quarterly seasonality to 2022. To assist with modeling, we have included a more detailed guidance slide in the appendix. With that, let me hand back to Shyam on Slide 12 to discuss our ESG progress.

Shyam Kambeyanda: Thank you, Kevin. Let me highlight some of the exciting things we’ve been doing with ESG. At ESAB, we’ve established 5 work streams that are aligned to our purpose of shaping the world we imagine. We’ve reduced our footprint by 30%, as a result, reduced our energy, waste and water usage by the same proportion. We’ve improved our safety performance and our performance is in the 90th percentile amongst industrials. Every voice is valued at ESAB and diversity is a big part of it. As part of our design process, all of our new products meet ecostandard designs. We use over 20% recycled steel in our consumables business and are making great progress on sustainable packaging for our products. Lastly, the communities we’re part of, ESAB believes in participating and growing the communities we live in.

As a result, our associates have volunteered and ESAB has funded several initiatives globally to ensure shared success. We are using ESG to make ESAB a better business for our customers, our associates and our communities. Turning to Slide 13 and to wrap up. I’m very proud of our team. ESAB delivered a strong year of performance in a challenging environment. There is more to come from EBX as we drive growth, expand margins and generate cash. We have a healthy funnel of bolt-on acquisitions as we continue our compounded journey. We have made strong progress on our ESG initiatives and we’ll be doing much more in this field. ESAB has had a solid start to the year. And as I’ve said in the past, our best is yet to come. Thank you again for joining us.

Operator, please open the line for questions.

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Q&A Session

Operator: Your first question comes from the line of Tami Zakaria from JPMorgan.

Tami Zakaria: So my first question is, it seems like volume in the Americas was down in the quarter, about 3%. Could you expand on that a little bit? What drove that? And what are you seeing now quarter-to-date?

Shyam Kambeyanda: Tami, thank you for the question. So the first aspect to answer your question is we actually performed as we expected in the Americas. We felt that we had a really strong performance in the quarter from a margin perspective. We made great progress with some of the initiatives that I spoke about which was around creating new channels, driving better equipment sales, continue to win our share of wallet with our existing customers going forward. We did have a year-over-year comparable issues. If you remember from my call last year, the Americas business actually grew 31% in Q4 of last year. And we’re also running the playbook around our product line rationalization which is really the 80/20 strategy. And so for us, what we find in North America and South America that we’re right where we want to be, we’re positioning the business to be less cyclical, better margin and a better profile for long-term growth.

I’m really thrilled about the work the team is doing to set ourselves up to sell more equipment, a better process automation in the market. And we’re off to a good start in Q1 and so looking forward to how the business performs in the year.

Tami Zakaria: Got it. And one more from me. Can you remind us which of your key end markets you still see sort of volumes below pre-COVID levels and enhance you expect some sort of recovery in the next couple of years?

Shyam Kambeyanda: Yes. We were really encouraged by how the emerging markets performed. I sort of highlighted in my commentary that we really — we’re thrilled with how the business in India which, as you know, is a public company and is doing quite well, along with the Middle East business performed. So we really saw some really emerging shoots with a broad-based recovery and sort of activity above sort of COVID — pre-COVID levels in the emerging markets. We’re seeing the auto market recover in Europe, giving us a bit of tailwind as we finished out Q4 and we’ve started off nicely also in Q1. And in the North America market, we’ve seen sort of ag and general industry continue to be strong, where we are seeing — and we’ve been reading about the same is that the retail space is seeing a bit of a weakness on that particular front.

But as I have mentioned before in some of my commentary that we’re new to that space, so that every dollar of sales that we get is actually accretive to us. And so really excited about what that drives for ESAB in 2023.

Operator: Your next question comes from the line of Nathan Jones from Stifel.

Nathan Jones: I’d just like to pick up on part of your answer to one of those questions, Shyam. You talked about product rationalization through the use of 80/20. Maybe you could give us a bit more color around what’s going on there? I know 80/20 is somewhat of a new initiative for ESAB. What kind of impact that could have to the sales number and what kind of impact that could have to the margins over the next few years?