Nordson Corporation (NASDAQ:NDSN) Q3 2023 Earnings Call Transcript

Nordson Corporation (NASDAQ:NDSN) Q3 2023 Earnings Call Transcript August 22, 2023

Operator: Hello, and welcome to the Nordson Corporation’s Third Quarter Fiscal Year 2023 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to Lara Mahoney. Please go ahead.

Lara Mahoney: Thank you. Good morning. This is Lara Mahoney, Vice President of Investor Relations and Corporate Communications. I’m here with Sundaram Nagarajan, our President and CEO; and Joseph Kelley, Executive Vice President and CFO. We welcome you to our conference call today, Tuesday, August 22 to report Nordson’s fiscal 2023 third quarter results. You can find both our press release as well as our webcast slide presentation that we will refer to during today’s call on our website at www.nordson.com/investors. This conference call is being broadcast live on our investor website and will be available there for 14 days. There will be a telephone replay of the conference call available until Tuesday, August 29, 2023. During this conference call, references to non-GAAP financial metrics will be made.

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A reconciliation of these metrics to the most comparable GAAP metric was provided in the press release issued yesterday. Before we begin, please refer to Slide 2 of our presentation, where we note that certain statements regarding our future performance that are made during this call may be forward-looking based upon Nordson’s current expectations. These statements may involve a number of risks, uncertainties and other factors as discussed in the company’s filings with the Securities and Exchange Commission that could cause actual results to differ. Moving to today’s agenda on Slide 3, Naga will discuss third quarter highlights. He will then turn the call over to Joe to review sales and earnings performance for the total company and the three business segments.

Joe will also discuss the balance sheet and cash flow. Naga will then share a high-level commentary about our enterprise performance. He will conclude with an update on the fiscal 2023 full-year and fourth quarter guidance. We will then be happy to take your questions. With that, I’ll turn to Slide 4 and hand the call over to Naga.

Sundaram Nagarajan: Good morning, everyone. Thank you for joining Nordson’s fiscal 2023 third quarter conference call. While sales were at the low-end of our expected guidance range for the quarter, I would like to recognize the dedicated Nordson team who has actively controlled cost in divisions where it was necessary and leverage the NBS Next growth framework to deliver strong growth in divisions where the market demand was strong. This resulted in adjusted earnings per share of $2.35, which was at the high-end of our third quarter EPS guidance. Going into the third quarter, we expected to be pressured by the ongoing weakness in our electronics and biopharma product lines. We understand the macro factors impacting these end markets and we have line of sight to returning to growth.

This quarter’s electronics end-market softness is particularly visible when looking at our results in Asia Pacific, which declined 20%. This reflects decreased demand from semiconductor customers in our ATS segment and electronics assembly customers in our MFS segment. These markets are cyclical, and we anticipate them turning in the middle of 2024. The diversification of our business offset some of this pressure. From a product perspective, we continue to experience double-digit organic growth in medical interventional solutions and polymer processing product lines, as well as high-single-digit growth in the test and inspection business. Regionally, we experienced mid-single-digit organic growth in both Americas and Europe, as our customers in both these regions are rebalancing their supply chains to be closer to the markets they serve.

I’ll speak more about the enterprise and our exciting new acquisition of ARAG in few moments, but first, I’ll turn the call over to Joe to provide a detailed perspective on our financial results of the quarter.

Joseph Kelley: Thank you, Naga, and good morning to everyone. On Slide number 5, you’ll see third quarter fiscal 2023 sales were $649 million, a decrease of 2% compared to the prior year’s third quarter sales of $662 million. This was driven by an organic decrease of 5%, partially offset by the favorable benefit of the CyberOptics acquisition. During the quarter, sales were negatively impacted by the end-market pressures that Naga referenced. Gross profit for the third quarter of fiscal 2023 totaled $360 million. Excluding severance cost, gross profit totaled $362 million or 56% of sales, which is comparable to the prior year third quarter. SG&A in the third quarter was elevated to a $189 million above the $181 million we have been averaging for the last six quarters.

Third quarter SG&A was impacted by notable non-recurring items that I’d like to highlight. Our teams advanced two separate $1 billion global acquisition targets through the comprehensive due diligence process all the way to the final stages. As a result of these two significant and strategic projects, we incurred $7 million in non-recurring cost from third-party service providers. We ultimately chose to move forward only with ARAG, which included an additional $1 million for the fairness opinion. In total, we incurred $8 million in non-recurring cost for acquisition-related activity in the third quarter. Operating profit, excluding these non-recurring items, was $181 million in the quarter or 28% of sales, 4% below the prior year adjusted operating profit of $188 million.

Despite the lower sales volume, we held on to decremental margins on adjusted operating profit of 56%, reflective of our cost controls and improved pricing, which can be attributed to our team’s dedication to the NBS Next framework. As we execute the Ascend strategy and scale through strategic acquisitions, EBITDA remains the key profitability metric. EBITDA for the third quarter was $208 million or 32% of sales, which is above our long-term profitability target, however, $5 million or 2% below the prior year EBITDA of $213 million. The decrease was primarily driven by lower sales volume in the quarter. Looking at non-operating expenses, interest expense increased $6 million associated with higher borrowings and increase interest rates. Other net expense decreased $2 million related to a combination of changes in pension and deferred compensation plans, as well as foreign exchange gains and losses.

Tax expense was $34 million for an effective tax rate of 21% in the quarter, which is in line with the prior year third quarter rate and the forecasted full-year rate for 2023. Net income in the quarter totaled $128 million or $2.22 per share. Adjusted earnings per share excluding non-recurring acquisition and severance cost totaled $2.35 per share, a 6% decrease from the prior year adjusted earnings. The decrease was primarily driven by higher interest expense and lower operating profit. Now let’s turn to Slide 6 through 8 to review the third quarter 2023 segment performance. Industrial Precision Solutions sales of $338 million decreased 1% compared to the prior year third quarter, driven by softness in our product assembly and nonwovens product lines in Asia.

This was partially offset by continued strength in polymer processing product lines and growth in the Americas and Europe. Year-to-date, the IPS segments has delivered 3% organic sales growth following two consecutive years of double-digit growth. EBITDA for the quarter was $122 million or 36% of sales, which is a decrease of 3% compared to the prior year EBITDA of $126 million. The biggest driver of the decrease is lower sales volume and unfavorable sales mix due to the higher sales volume and polymer processing product lines. EBITDA in the current quarter has improved compared to the prior two quarters of the current year and year-to-date is $4 million higher than the prior year. On Slide 7, you’ll see Medical and Fluid Solutions sales of $171 million decreased 4% compared to the prior year’s third quarter.

The decrease was driven by continued softness in the medical fluid components division related to destocking in single-use plastic components for biopharma applications and fluid solutions product lines specifically for electronics assembly primarily in Asia Pacific. This pressure was partially offset by double-digit growth in our medical interventional solutions product lines. Third quarter EBITDA was $68 million or 40% of sales, which is a decrease of $8 million compared to the prior year EBITDA of $76 million. EBITDA continued to be impacted by meaningful sales mix changes within medical product lines. It is noteworthy that the segment EBITDA margin sequentially improved 200 basis points over the second quarter of 2023 and back to the profitability levels this segment delivered in 2021 and 2022.

Turning to Slide 8, you’ll see Advanced Technology Solutions sales were $140 million, a 3% decrease compared to the prior year third quarter. During the quarter, the CyberOptics acquisition contributed 11% growth. Organic sales volume was down 13%. The organic decrease was driven by electronics dispense product line, serving the semiconductor end markets, predominantly in Asia Pacific, slightly offset by continued growth in test and inspection products. The cyclical downturn of demand in the semiconductor market will anniversary in the second quarter of fiscal 2024, which aligns with the historic downcycles lasting approximately four to five quarters. Structural cost reduction actions were taken during the third quarter of fiscal 2023 to address the volume decrease in electronics dispense products.

For example, they’ve chosen to outsource their fabrication shop to focus on more value-added precision dispense technology, resulting in a $2 million of non-recurring severance cost. Third quarter EBITDA was $33 million or 24% of sales, which was an improvement compared to the prior year third quarter EBITDA of $30 million. The improvement in EBITDA during the quarter was driven by favorable sales mix and continued realization of cost savings actions. Despite the double-digit organic sales volume decrease, this segment is delivering quarterly profitability only 100 basis points below 2022 levels. Finally, turning to the balance sheet and cash flow on Slide 9. We had a very strong cash flow quarter, generating $181 million in free cash flow, bringing our year-to-date cash conversion rate on net income to 126%.

Cash ended the quarter at $143 million and net debt was $695 million, resulting in a 0.9 times leverage ratio based on the trailing 12 months EBITDA. We continue to have significant available borrowing capacity to pursue organic and inorganic growth opportunities such as our upcoming acquisition of ARAG. We expect to close the ARAG acquisition by the end of August and exit the year with a net debt to EBITDA leverage ratio of approximately 2 times. During the third quarter, we repaid $111 million of debt, paid $37 million in dividends and spent $23 million on repurchasing approximately 107,000 shares of company stock at an average price of $217 per share. Our Board approved a 5% increase in our annual dividend, effective in the fourth quarter of fiscal 2023.

This marks the 60th consecutive year the company has increased its dividend, an impressive accomplishment only enabled by maintaining a truly differentiated precision technology portfolio and serving diverse end markets. For modeling purposes, in fiscal 2023, assume an estimated effective tax rate of 20% to 22% and capital expenditures of approximately $35 million to $40 million, as several of our investment timelines have pushed out. With our upcoming acquisition of ARAG, I want to provide you with some assumptions for modeling purposes. For revenue, assume approximately $20 million to $30 million in fiscal ’23. EBITDA margins are expected in the high-30% range. We expect ARAG to be slightly dilutive to GAAP EPS in Q4 2023 due to increased amortization of acquisition-related intangibles and interest expense associated with the acquisition.

Excluding acquisition costs and related intangible amortization, EPS should be neutral for the fourth quarter. Due to the expeditious nature of the close, the acquisition will initially be financed with a short-term loan and revolver borrowings. We anticipate following up with a bond issuance in the public markets later this year, and we are currently working through the ratings process. Based on current market conditions, assume a weighted average interest rate of approximately 5.5% for total Nordson debt in 2024. We will now turn to Slide 10, and I’ll turn the call back to Naga.

Sundaram Nagarajan: Thanks, Joe. Our team continues to execute the Ascend strategy, which is clear in the strong profitability delivered in this quarter. While we are managing the short-term sales weakness related to the biopharma end-market and electronic cycle, we’re getting closer to anniversarying that pressure in fiscal 2024. Related to the biopharma product lines in our medical fluid components division, we believe we have seen the bottom of the customers’ unique supply chain destocking trend and will anniversary this pressure in the first quarter of fiscal 2024. Following this period, we cautiously expect the medical fluid components business to return to its historical mid to high single-digit growth rate over time. Moving onto electronics end markets.

I visited our Electronics Processing Solutions leadership team in Carlsbad, California earlier this month. Our team’s expectation is that electronics CapEx spend cycle will begin to turn in the second half of the calendar 2024. We expect to benefit from customer investments in automation, memory, AI and electronics new product innovation. In the meantime, this division is successfully managing costs, while staying invested in profitable growth opportunities identified through the NBS Next growth framework. In fact, the EPS division exceeded its targeted decremental margins during this low-volume period. We also continued to be pleased with the growth of our test and inspection division, which mutes the volatility of the electronic cycle. Geographically, we are closely monitoring the pressure in Asia Pacific region, specifically in China.

The regional sales weakness was largely related to the electronics exposure, though there was weakness in demand across all three segments, some of which was due to the timing of large system orders. Nordson has a well-established footprint in China with long-tenured and knowledgeable employees. We will remain close to our customers and support them appropriately. Simultaneously, Nordson’s business model positions us well to support customers, if they decide to diversify their supply chain to other regions of Asia or into the Americas and Europe. Our customer intimate business model ensures we are prepared to fully participate as global supply chains rebalance. Finally, I’d like to share an update on the Ascend strategy. Acquisitions are a very important part of our goal to achieve $3 billion in revenue by 2025.

Of the $500 million acquired revenue target we set at our 2021 Investor Day, we are now nearly 80% of the way there. In June, we announced the acquisition of ARAG, a global market and innovation leader in precision spraying technology. Precision dispense technology is core to Nordson. Over nearly 70 years, we have expanded that expertise beyond our beginnings in industrial applications into dispense for packaging, product assembly, non-wovens, electronics, medical and more. Through it all, we adhered to disciplined strategic acquisition criteria, differentiated technology generated Nordson-like gross margins, high-growth end-market applications and the customer-centric business model. The acquisition of ARAG meets all of these criteria and expands our technology expertise into the high-growth end-market of precision agriculture, and is the largest single acquisition in our history.

Today, ARAG is the market leader in precision agriculture technology in Europe and South America. ARAG fluid components are sold to implement manufacturers, who in turn sell to the tractor manufacturers or OEMs. ARAG closely works with all of the customers within these channels to ensure its innovation pipeline, supports the customers’ goals of improving crop yields and minimizing the use of expensive fertilizers and chemicals. It is also important to note that over 40% of ARAG’s revenue is recurring aftermarket sales sold through distributors. We were attracted to the continued growth opportunity in ARAG’s existing geographic markets. The opportunity to invest and grow ARAG’s technology in North America presents an attractive proposition beyond the existing core market growth, upon which we valued the company.

I’m very excited about the ARAG acquisition and the long-term profitable growth opportunities in our business. We have a winning team, who is focused on the customer and managing through unique market headwinds, while delivering solid profitability and cash flow. Turning to the outlook for the remainder of the year on Slide 12. We are narrowing our previously provided 2023 revenue guidance to 0% to 2% growth over record fiscal 2022 and narrowing our adjusted earnings guidance to $8.90 to $9.05. Looking specifically at the quarterly sales and earnings split on Slide 13, we expect fourth quarter sales to be the strongest of the year, increasing low to mid-single-digits over the prior year fourth quarter at the midpoint. This guidance includes approximately $20 million to $30 million of sales from the ARAG acquisition that we expect to close in late August.

Fourth quarter earnings are forecasted in the range of $2.34 to $2.49 per share. Embedded in our forecast is strong profitability and cash conversion performance, which is a result of Nordson’s operational excellence, a clear competitive advantage created through the execution of the Ascend strategy by winning teams with an owner mindset. As always, I want to thank our customers, shareholders and the Nordson team for your continued support. With that, we will pause and take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] One moment for your first question. Your first question comes from the line of Jeff Hammond of KeyBanc Capital Markets. Your line is open.

Jeff Hammond: Hey. Good morning, everyone.

Sundaram Nagarajan: Good morning, Jeff.

Joseph Kelley: Good morning, Jeff.

Jeff Hammond: So, just really want to unpack the guidance change. I mean, I hear kind of Asia Pac and electronics kind of weaker and then the ARAG impact. So maybe just unpack kind of what drives the lower-end. And it seemed like the revenue was lighter in 3Q, but 4Q seems kind of in line, but maybe just a little more help on the moving pieces. Thanks.

Joseph Kelley: Yes. So let me take a start with that Jeff, if I could. So at the midpoint of the guide, it’s roughly 3.5% growth. And so, when you think about that for Q4, the acquisition should contribute about 6%, FX will be favorable, about 2.5% and from an organic standpoint, it’s negative 5%, which is consistent with what we just delivered here in Q3. And then when you think about the range, I appreciate on the ARAG acquisition, the timing of the actual close will contribute to that. And the first two months post-acquisition, we have that range there of $20 million (ph) to $30 million. So that drive some volatility, I would say, or flex expands the range on the revenue guidance a little bit there. The other is — as I would tell you is the timing of some large system shipments.

Q4 last year was our strongest quarter of the year as you recall, and Q4 this year is forecasted to be the same. And so, there are large system deliveries in there. And so, sometimes those get pushed and pulled out, so that contributes to little bit to the how wide the range is on revenue. And from an end-market standpoint, Naga, you can comment.

Sundaram Nagarajan: Yeah. From an end-market perspective, if you think about the three segments, IPS, we feel pretty good about where we are at in comparison to our long-term, as well as sequentially. We expect this system to continue to be at or above our long-term growth rate. So that’s what is embedded in the growth. Suddenly, electronics and biopharma continuing at the levels they are today, we don’t expect them to recover here in the fourth quarter. They certainly are our expectation, and we’ll talk a little bit more about it later. In that electronics, we expect sometime in middle of calendar 2024 is when we expect that to turn and biopharma sometime in the first quarter of 2024 is when we anniversary, but the growth on biopharma is going to be, as I indicated in my initial comments, that is going to be — we’re going to be cautious here as to when that fully recovers to its high single-digits kind of growth rate.

But nothing in biopharma long-term secular trends have been impacted. So we fully expect we will get to it. It is just a matter of how long it takes for us to get back to it. And then if you think about our medical IS business, that is growing double-digits. We fully expect that in the fourth quarter, we continue to do so. Our polymer processing businesses are doing incredibly well, and they are expected to do well in the next quarter. And we’ve got a couple of system businesses that are — that have strong backlog we expect to do well as well.

Jeff Hammond: Okay. And then just some housekeeping questions on the ARAG deal one. So I think you said high-30s EBITDA margins. Just wondering what — if you’ve done the purchase accounting, what the D&A component is that would kind of get you to — to an kind of ongoing operating margin for that business in — at least in year-one. And then just a clarification on the interest expense at 5.5% is weighted for the total company, or is that for the ARAG deal and if so, just kind of how to think about the interest cost associated with funding ARAG would be? Thanks.

Joseph Kelley: Yeah. So let me take a stab at that, Jeff. First of all, on the purchase accounting, we’ll hold off and I’ll give some clear guidance on that when we do our full-year 2024. And so, right now, the guide with the amortization just is really looking at historical trends for acquisitions of this nature and a percentage of the purchase price, but we will firm that up, when we issue the 2024 guide for Nordson, which will include purchase accounting assumptions on ARAG. On the interest expense, given the current market conditions, depending on where the bonds will price later this year, our estimate currently is that total Nordson interest expense will be roughly 5% to 5.5% based on current market conditions. And that’s for our weighted basket of debt.

Jeff Hammond: And what would — what would that have been kind of pre the bond offering, or pre-ARAG?

Joseph Kelley: If you look from a year-to-date standpoint, we’re slightly below 5% in terms of our weighted average interest cost.

Jeff Hammond: Okay. Appreciate it. I’ll get back in queue.

Joseph Kelley: Thanks, Jeff.

Operator: Your next question comes from the line of Allison Poliniak of Wells Fargo. Your line is open.

Allison Poliniak: Hi. Good morning.

Sundaram Nagarajan: Good morning.

Joseph Kelley: Good morning.

Allison Poliniak: I want to go back to your comments on China. Is there any way that — I know there are some cyclical aspects to it, but you did talk to sort of maybe potentially structural. Are you starting to see some, I would say, industry minimizing that region because you did talk about maybe the offsets in other regions for you? Just — I don’t know if there’s any way to decide or what you’re seeing in terms of the cyclical versus structural over there at this point.