Enerpac Tool Group Corp

NYSE:EPAC

Earnings Call Transcript 2022-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Enerpac Tool Group's Fourth Quarter Earnings Conference Call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, September 29, 2022.

It's now my pleasure to turn the conference over to Bobbi Belstner, Senior Director of Investor Relations and Strategy. Please go ahead Ms. Belstner.

[Bobbi Belstner, Senior Director, IR and Strategy]

Thank you, Operator. Good morning and thank you for joining us for Enerpac Tool Group's fourth quarter of fiscal '22 earnings conference call. On the call today to present the company's results are Paul Sternlieb, President and Chief Executive Officer; and Tony Colucci, Chief Financial Officer. Also with us is Barb Bolens, Chief Strategy Officer and Bryan Johnson, VP of Finance and Chief Accounting Officer.

Our earnings release and slide presentation for today's call are available on our website at enerpactoolgroup.com in the Investors section. We are also recording this call and will archive it on our website.

During today's call, we will reference non-GAAP measures such as adjusted profit margins and adjusted earnings. You can find a reconciliation of non-GAAP to GAAP measures in the schedules to this morning's release. We also would like to remind you that we will be making statements in today's call and presentation that are not historical facts and are considered forward-looking statements. We are making those statements pursuant to the Safe Harbor provisions of federal securities laws. Please see our SEC filings for the risks and other factors that may cause actual results to differ materially from forecasts, anticipated results or other forward-looking statements.

Now I will turn it over to Paul.

[Paul Sternlieb, President and CEO]

Thanks, Bobbi and good morning, everyone. Thank you for joining our Q4 earnings call. I am glad to have the opportunity to discuss our fiscal 2022 fourth quarter results with you and provide an update on the progress of our ASCEND transformation program.

Before we get started, I want to first welcome Markus Limberger to Enerpac Tool Group. Markus joined us as Executive Vice President of Operations on September 01 and we're very excited to have him as a member of our leadership team. His background includes a strong focus on operational excellence and proven success in developing and executing operation strategies to achieve sustained improvements and performance with extensive experience in lean and continuous improvement. Markus will be instrumental as we execute on our global operational excellence initiatives here at Enerpac.

Now to touch on the quarter as we wrapped up the fiscal year, we experienced nice momentum heading into the last several weeks of the quarter. I'm very pleased with our results, which were driven by continued solid demand in both our product and service businesses in two regions, and we achieved a quarterly adjusted EBITDA margin of 21.1%, which is a record high following the EC&S divestiture in 2019.

Tony will provide additional commentary on the fourth quarter financial results in a moment, but before I move on, I want to thank our global team for the solid execution throughout the fiscal year and their dedication to serving our customers. Overall, with the exception of the additional receivable reserve in the third quarter, it was a strong fiscal year, which we'll continue to build on here in fiscal 2023.

Now moving on to Slide 3; as we announced on our Q2 earnings call, we launched our ASCEND transformation program focused on driving organic growth, operational excellence improvement and greater efficiency and productivity in SG&A to enhance shareholder value.

In the fourth quarter, we moved from the design stage to the implementation phase of the program and we continue to work diligently on hundreds of individual initiatives across the company to position the business to achieve its full potential. I sincerely appreciate the extra efforts from all levels of the organization to make this transformation a success. Without our dedicated and driven team members, none of this progress would be possible.

The work done to date continues to support our view that we expect ASCEND will deliver between $40 million to $50 million of incremental adjusted EBITDA, which will be in our run rate as we exit fiscal 2024. We anticipate the investment to achieve the incremental EBITDA will be between $60 million and $65 million, and we recorded $9.8 million of ASCEND related expenses in Q4 with the first benefits of the transformation program to be realized in fiscal 2023.

Turning the Slide 4, I want to take a minute to give a brief update regarding the progress we have made on just a few of our ASCEND initiatives. On the commercial side, we have started to implement strategic pricing adjustments based on our analysis of our price position in our key product categories.

In addition, through continued implementation of 80/20 frameworks, we have been focused on skew rationalization to simplify our product offering and reduce complexity in our business. We have also reviewed our sales coverage model and as a result, we have increased territory management support in key territories where we believe we are under penetrated.

On the operational side, we are implementing warehouse digital scheduling and capacity planning tools along with optimization initiatives to improve picking accuracy and receiving throughput. These are just a sample of some of the exciting initiatives within ASCEND, which demonstrates the broad reach of the program and the level of engagement across and throughout the organization.

As it relates to our expectations on the impact of ASCEND for fiscal 2023, we currently anticipate that we will see $12 million to $18 million of EBITDA benefit, which is included in the guidance that we will cover at the end of today's call.

Again, I want to reiterate that ASCEND is much more than a restructuring program. There is a high degree of focus and discipline associated not only with our cost structure, but also organic growth and operational efficiency and productivity. We very much view ASCEND as a transformation program, not a restructuring program, and we will provide further details on the ASCEND transformation program at our Investor Day, which I'm excited to announce will be held on November 16 in New York City. We will be sending out details and registration information in early October, so please watch for that and we hope to see you there.

Now moving on to Slide 5, an important aspect of our balanced capital allocation strategy includes returning capital to shareholders through opportunistic share repurchases. As we announced on our in our Q2 earnings call, the Board of Directors approved a new share repurchase program of up to 10 million shares of the company's common stock.

In the fourth quarter, we repurchase an additional two million shares for a total of $39 million. So combined with our activity in the third quarter, this amounts to a total share repurchase under the new authorization of $75 million since March 2022. This share repurchase program reflects the confidence our board has in our strategy and in our ability to create shareholder value.

Turning to Slide 6, I'll provide a market update based on what we experienced across our business in the quarter. I'm pleased that we continue to see strong core growth in two of our four regions with another strong quarter in the Americas and a nice recovery in our MENAC or Middle East region. While some pricing and availability has started to stabilize, supply chain challenges remain throughout the quarter, which Tony will cover in more detail.

Our global supply chain operations team members continue to work tirelessly to manage these day-to-day challenges, and while our past back -- past due backlog did increase slightly, I am encouraged that we were able to ship some of our past due backlog from the third quarter and keep inventory levels flat quarter-over-quarter, excluding the impact of foreign currency, thanks to their hard work.

We also took additional pricing actions to cover increasing costs and preserve margin, and I'm glad to say that COVID-related challenges had less of an impact on our business in the quarter. While Enerpac Tool Group does not have a material top line exposure in Russia or Ukraine, the conflict there has had ancillary impacts to our business that we continue to manage in the fourth quarter, including supply chain challenges, foreign currency impacts, and delayed maintenance as refineries continue to run to reduce dependency on Russian oil, particularly in Europe.

Moving on to the regions, the Americas experienced solid core sales growth in the mid-teens percent in the fourth quarter. This was driven by both product and service with service having strong year-over-year improvement. Overall, the improvement in the quarter was broad based with rail being positive due to investments and maintenance activities, we continue to see solid performance from our OEM and national accounts, reflecting steady underlying industrial growth and demand and inquiries for our Heavy Lift Business or HLT was also strong in the quarter.

In South America, mining continues to be favorable, driven by copper and iron ore. The ongoing recovery within the service business was driven by strong demand for field machining work related to ship building and power gen decommissioning work offset by delays as many refineries stayed online to support national and global demand for petroleum and chemical products. While demand was steady within the channel, distributor sentiment was cautious, driven by inflationary pressures.

Moving on to Europe, this region experienced a slight core decline year-over-year, primarily driven by a large service project that did not repeat and a decrease in service due to delayed maintenance work as pipelines continue to operate due to high oil prices and to reduce dependency in oil and gas coming from Russia.

From a vertical market perspective, the region experienced strong demand within power generation and particularly wind, driven by the need to become independent from Russian oil and gas, and while oil and gas exploration activities increased due to high oil and gas prices, big shutdowns are being postponed impacting our service business.

Infrastructure was flat in the quarter after growth in the first half of 2022 due to inflation, labor shortages and the Russia-Ukraine conflict. In general, manufacturing industries in Europe have been impacted by a combination of supply chain issues, high energy prices, labor shortages and inflation, while there are increasing concerns about a recession in some countries in the region. Overall distributor sentiment is cautious due to the current macroeconomic environment.

Moving on to Asia Pacific, the region was flat from a core growth perspective year-over-year, while the region continues to experience some COVID-related lockdowns and closures, COVID had much less of an impact on the business in the fourth quarter. From a vertical perspective, mining continued to be favorable in the fourth quarter, driven by demand across the region for raw materials.

Ship building and infrastructure were also positive, with infrastructure primarily driven by government spending on capital projects, particularly in Australia.

And turning to the MENAC or Middle East region, MENAC delivered solid year-over-year core growth in the mid-30%. As we've seen the last few quarters, overall spending on oil and gas activity in the region continue to ramp up. Energy produces are making large investments into downstream activity; however, maintenance work on some facilities continues to be pushed out a few months to leverage the high oil prices.

Travel restrictions related to COVID have been lifted and while each country has its own COVID protocols, it did not limit our work scopes in the fourth quarter. From a vertical market perspective, oil and gas continues to be favorable and the region continues to make investments in new projects related to power generation, including renewable energy and infrastructure.

Now moving on to Cortland, our Cortland business experienced core growth of 14% year-over-year in the fourth quarter. On the medical side of the business, demand continues to improve for commercial products above historical levels in diagnostics, robotic surgery and orthopedics. We transferred another orthopedic product from development to production and also produced several new design and development samples for potential new orthopedic and cardiovascular products in the quarter.

Moving on to the industrial side of the Cortland business, oil and gas, aerospace and defense and industrial were favorable in the fourth quarter while marine was challenged due to the high fuel prices and operating costs. Lead times and supply chain challenges improved sequentially in the fourth quarter.

I'll now turn it over to Tony to walk us through the Q4 financial results as well as an update on supply chain and operations. Tony?

[Anthony Colucci, EVP and CFO]

Thanks Paul and good morning, everyone. Now turning to Slide 9, let's review the adjusted fourth quarter results. Net sales were $152 million, which is a 10% increase in core sales when compared to the fourth quarter of fiscal 2021. Tool product core sales were up 12%. Service core sales were up 3% and Cortland core sales were up 14%. Adjusted EBITDA margin was 21% in the quarter, representing a post EC&S divestiture high and reflected currency-neutral incremental profitability of 67%, well above our previously communicated range of 35% to 45%.

The tax rate for the quarter was 17% compared to 36% in the prior year. This resulted in an adjusted EPS of $0.37 up from $0.19 in the prior year.

Turning to Slide 10 for details on our sales performance#; reported year-over-year net sales were up 4% including the FX headwind of $7.5 million, driven by the strengthening of the US dollar primarily related to the Euro and GBP. Product core sales increased 12% with approximately 90% of the increase from our tools products and the remainder to Cortland. All regions experienced year-over-year double-digit product core sales growth except APAC, which was in the high single digits, which reflects continued strong demand for our products.

Service growth continued in the Americas and MENAC with MENAC driven by strong oil and gas opportunities, but was partially offset by the clients at APAC in Europe where the latter is largely due to the non-repeat of a significant North Sea service project in the prior year. Lastly, pricing actions contributed roughly $9 million to the top line.

While we do expect our ASCEND transformation program to contribute to our sales growth, given that we are still in the early stages of implementation, there was minimal impact to the top line in the quarter.

Turning to Slide 11, reflecting a consistent trend with the third quarter, IT&S has product net sales exceeded the peak range of the five years prior to COVID, driven by strong demand and new product launches.

Transitioning to Slide 12, I'd like to spend some time discussing the year-over-year change in adjusted EBITDA. Just like sales, the stronger US dollar had an unfavorable impact to profitability, reducing EBITDA by $1.4 million versus the prior year. Higher product sales volumes contributed roughly $2 million of growth to EBITDA. Pricing actions resulted in net price cost realization in the quarter, increasing margin by $5.5 million, along with the mix of Courtland medical sales and improved industrial profitability, which contributed an additional $2 million of EBITDA improvement in the quarter.

Excluding the favorable impact to largely European costs resulting from the stronger US dollar, SG&A was up approximately $2 million when compared to the prior year. The increase was primarily driven from higher short term incentive compensation, incremental travel and entertainment, which was linked primarily to our commercial leadership teams and increased advertising costs. This was partially offset by lower salary and rate wages, resulting from benefits tied to restructuring actions taken earlier in the year and selective reorganization and SG&A functions to capture early productivity and efficiency improvement.

While we did incur approximately $3 million in restructuring charges in the quarter associated with our ASCEND transformation program, the associated savings from those actions will largely be recognized throughout fiscal 2023. More to come on the anticipated impact of ASCEND for fiscal 2023 shortly.

Moving now to operations, as mentioned during our third quarter call, we started to see some easing of the high freight and commodity costs coming out of the COVID pandemic, specifically in China. That easing continued into the fourth quarter and we now see freight rates down roughly 50% from the April rates.

Additionally, commodity softening resulted in some price reductions from some of our Chinese suppliers. Also sticking with the freight side of things, the port strike concerns on the US West Coast did not come to fruition in the fourth quarter, which was great news for the execution in the quarter. An agreement has not been reached yet, so we continue to maintain a watchful eye on the potential risk this could have on our future results.

Port strikes in Europe were announced for September, which will put pressure on the other European ports and could have a slight impact on our operations.

Finally, there continues to be roughly $2 million of our inventory waiting at the Shanghai ports to be shipped, which we had anticipated alleviating during our fourth quarter after the COVID shutdowns in Shanghai, but that has not yet occurred. We expect that borrowing any additional COVID shutdowns, this inventory hang up will subside in our fiscal first quarter. We have seen some easing in commodity pricing during the quarter, albeit at a slower pace, which is promising news and we will continue to monitor.

Our biggest concern like many other companies, is the steep increase in energy prices that are taking effect in Europe where we've seen electricity increase 500% in natural gas prices increase over 1100%. We estimate that barring any other mitigating factors, these increases would result in an annual cost increase of roughly $700,000 in our Europe utility costs, not including potential energy surcharges from our direct material suppliers. Our supply chain and operations teams are working collectively to identify opportunities to mitigate this anticipated impact.

Shifting to US supply, availability of labor is improving and still prices are stable. Lead times however, in the US continue to remain very long, especially for castings, forgings and electrical components. Electrical component tree is probably the biggest challenge for us with some lead times as high as 80 weeks to receive supply and ultimately being the primary driver behind our higher than typical pass due backlog.

Shifting to backlog, we see continued -- we saw continued strong demand for our products, which resulted in order rates greater than pre-COVID levels and monthly shipments continue to set high water marks versus the previous five years, consistent with our third quarter. The combination of strong orders and the continuation of global supply chain challenges continues to add pressure on our past due backlog, which increased slightly from the end of our third quarter to be roughly $10 million to $11 million at the end of Q4.

Despite the aforementioned softening of certain commodity and freight costs, the headwinds tied to substantially higher energy costs, particularly in Europe, leads us to believe that this inflationary environment is not over and will continue through at least the remainder of the calendar year, albeit at perhaps a slower pace than earlier in the calendar year.

As a result, and as discussed during our last earnings call, we implemented additional pricing actions in response to the continued inflationary environment. As anticipated, we saw the impact of the incremental pricing outpace the cost increases. We will continue to monitor inflationary pressures going forward and react with additional pricing actions as necessary.

So I will wrap it up with liquidity on Slide 14. We generated $43 million in free cash flow during the quarter versus $27 million in the fourth quarter of fiscal 2021. Excluded the impact from foreign currency translation, working capital decreased by $16 million in the fourth quarter, primarily on $7 million of lower receivables due to strong collections performance and $8 million of incremental payables.

Inventory remained flat sequentially. Capital expenditures were approximately $1.5 million in the quarter. Our leverage ratio is at 0.9 times remaining well below our target range of 1.5 times to 2.5 times as was the case for the entire fiscal year. As Paul mentioned earlier, during the quarter, we purchased roughly two million shares for approximately $39 million. In fiscal 2022, we acquired roughly 3.8 million shares for a total of $75 million.

Finally, I am pleased that we were able to execute the refinancing of our Credit Facility Agreement, which was completed on September 9. The agreement provides for a $400 million revolving credit facility and a $200 million term loan. The proceeds from the term loan were used to pay down the outstanding borrowing that we had under our previous credit agreement. Additional details on the new credit agreement are available in the Form 8-K filed with the SEC on September 15.

Our current liquidity as of Q4, in addition to future cash flow generation positions us well to support our balanced capital allocation priorities, which includes our ASCEND transformation program, along with other internal investments, returns to shareholders and select M&A. We will remain disciplined stewards of our capital to ensure we create long-term value for our shareholders.

With that, I will turn the call back to Paul.

[Paul Sternlieb, President and CEO]

Thanks, Tony. In the first four weeks of the fiscal first quarter, demand remained strong and we have not seen a change in order trends from the fourth quarter. However, we are cautiously optimistic as it relates to fiscal 2023. Due to the uncertain macroeconomic environment and particularly the impact of the stronger US dollar, we are setting our full year fiscal 2023 net sales range of $565 million to $585 million, which based on current foreign exchange rates, is approximately a 3.5% headwind from fiscal 2022 and assumes that there is not a global recession.

The guidance range represents organic growth of approximately 3% to 6%, and while we continue to have potential tailwinds that could help support growth, we remain cautious. We anticipate our normal seasonality trends where our second half is stronger than the first half of our fiscal year. We expect an adjusted EBITDA range of $113 million to $123 million, which includes an ASCEND EBITDA benefit of between $12 million to $18 million with improvement in our typical adjusted EBITDA incremental margins as ASCEND progresses.

Before we open the line for questions, I want to share that while we are cautious as we enter fiscal 2023, I am extremely proud of the work that we have accomplished as an organization over the past 12 months. We are well on our way to transforming the business, and we look forward to sharing more details regarding our strategic plan, ASCEND and capital allocation strategy with you at our Investor Day in November. Our strong balance sheet and the work we have done with ASCEND thus far has us well positioned to unlock the full potential of this business.

As always, I would like to thank our Enerpac Tool Group employees around the world for their hard work and dedication to serving our customers and for their efforts in driving ASCEND transformation

[Bobbi Belstner, Senior Director, IR and Strategy]

Operator, that concludes today's prepared remarks. Please open the line for questions.

[Operator]

Certainly. We'll now be conducting a question-and-answer session. [Operator instructions] Our first question today is coming from Jeff Hammond from KeyBank Capital Markets. Your line is now live.

[Jeff Hammond, KeyBank Capital Markets]

So just down to 3% to 6% organic growth, can you just, I guess one, talk about the price component within that carryover additional actions and then two, just any drag anticipated from any 80/20 actions, product line simplification, etcetera?

[Paul Sternlieb, President and CEO]

Yeah, I'll let Tony address first on the kind of thinking behind the framework and then we can talk a little bit on H1 as well.

[Anthony Colucci, EVP and CFO]

Yeah, the 3% to 6% is going to be more heavily weighted towards pricing than growth as we're -- than volume that as we're being cautious here with the low one here in particular, but it is a mix is what I would say.

[Paul Sternlieb, President and CEO]

Yeah, and I would add to that. There certainly is a fair amount of pricing carryover that we kind of built into that top line guidance, Jeff, and we do have some additional pricing actions that we're anticipating in the fiscal and of course we'll react as necessary further for inflation. But we also talked about some of the strategic pricing actions that we took towards the tail end of fiscal 2022, which will have certainly carry-over effect in fiscal '23.

I think with regards to the 80/20 work, which is progressing well, we don't anticipate any significant drag on revenue from that, just in the sense that we do have a fairly extensive product catalog. So we believe that we have ample substitute products available, that we can point customers to if not the exact one that they would be requesting, but I think the top line does reflect just a bit of cautious outlook and particularly with regards to the European region where obviously the macro environment is more challenging.

[Jeff Hammond, KeyBank Capital Markets]

Okay, great. And then just on I guess the $10 million of spend this quarter, kind of where are the big buckets and then just on the savings, what kind of -- what are the big factors that swing kind of towards the lower, the higher end of that 12% to 18% range?

[Paul Sternlieb, President and CEO]

Yeah, on the spend here in the quarter, again a mix of restructuring and mainly service fees that went into the program here as well, that's the primary amount that we see here in the quarter and then sorry, the second question?

[Jeff Hammond, KeyBank Capital Markets]

Just the band is pretty big, $12 million to $18 million, just what kind of pushes you to the higher, the lower end and maybe just speak to some of the bigger opportunities. I know you mentioned strategic pricing, but within kind of the early stage, some of the big buckets.

[Anthony Colucci, EVP and CFO]

Yeah, I would say some of that is volume dependent and within the range share as well, but the $12 million to $18 million really does cover all three categories of our ASCEND program that we have. Again, I would say lower and on the low end, taking down some of the volume on the low end, but it really does cover all three of the categories that we have and looking to gain traction on all three.

[Paul Sternlieb, President and CEO]

Yeah, and I would just echo that and say, if you remember on our three serve ASCEND pillars, there are organic growth elements that are more near term. There are operational efficiency improvements we're making. We referenced some of those in warehousing, for example, and the third bucket around SG&A. I think we feel very confident around particularly cost related actions and our ability to execute those and the fiscal. As Tony said on the first bucket, there are some that are the growth related pieces that are somewhat volume dependent. So we're just being a bit cautious on that.

[Jeff Hammond, KeyBank Capital Markets]

Okay, great. I'll get back with you. Thanks.

[Operator]

[Operator instructions] We've reached the end of our question-and-answer session. I'd like to turn the floor back over for any further and closing comments.

[Paul Sternlieb, President and CEO]

Okay. Well, thank you all for joining our Q4 earnings call. Have a great day, and we look forward to seeing you at our Investor Day in New York City on November 16. Thank you.

[Operator]

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.