Q4 2019 Earnings Call
Good morning, everyone. My name is Jamie and I would be your conference operator today.
At this time I would like to welcome everyone to virtues fourth quarter and full year 2019 earnings conference call.
All lines have been placed on mute to prevent any background noise.
Please also note today's event is being recorded.
At this time I like to turn the conference call over to your host for today's conference call when Mac Signer, Vice President of Investor Relations.
Great. Thank you Jamie good morning, welcome tempered and fourth quarter and full year 2019 earnings Conference call. Joining me today are burdens executive Chairman, David Cody Chief Executive Officer, Rob Johnson, Chief Financial Officer, David Cohen, and Chief strategy and.
And then officer dairy need or proof.
Before we begin I'd like to point out that during the course of this call. We will make forward looking statements regarding future events, including the future financial and operating performance Humberto.
These forward looking statements are subject to material risks and uncertainties that could cause actual results could differ materially from those in the forward looking statements.
We refer you to the cautionary language included in today's earnings release, and you can learn more about these risk in our registration statement, a proxy statement and other filings with the FCC.
Any forward looking statements that we make today are based on assumptions that we believed to be reasonable as of this date.
We undertake no obligation to update these statements as a result of new information or future events.
During the call. We will also present, both GAAP and non-GAAP financial measures, our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and ended the investor Slide deck found on our website at Investor stopped bird of Dot com with that I'll turn the call over to executive Chairman David.
Okay.
Thank you Lynn and.
And it's great to be on me.
Yeah.
Mr call to announce our Q4.
Fiscal year 2019 result, so before I turn it over to Rob Johnson our CEO.
I want to begin with a few remarks about.
My level of excitement regarding the transaction.
Many of you know I was fortunate to be able to lead Honeywell for both 16 years.
Those who invested with US made a great return and that performance was marked by consistent annual improvements in the people processes and portfolio.
Businesses that comprise Honeywell.
We were able to do this [noise].
Missing a reference on businesses with great positions and good industries.
[noise] differentiating with technology.
We implemented H class or the Honeywell operating system.
We drove functional transformation.
We invested in new products and services, we built their software capability, we had a rigorous process for capital deployment.
We steadily planted seeds for long term and importantly, we consistently delivered on our commitments.
Now on slide three the earnings deck.
You see that many of the attributes that drew me divert of initially.
He is truly checks all the boxes. It has a great position a good industry able to differentiate with technology and has great potential upside for growth and margin expansion.
As you could probably tell them pretty excited by this opportunity and as I've gotten even closer to Rob and the team and the overall business.
Even more excited today than I was even a few months ago I've been very impressed with Rob's knowledge of the industry is customer relationships and we've gone on some customer visits together and have seen it firsthand and.
And is drive to make bird of the first choice for our customers.
So now I'll turn the call over to Rob can take you through the business in some more detail Rob.
Thanks, Dave and thanks for the great intro and before I, even began I just want to say what a pleasure it's been working with Dave. These past few months he's been a great coach and mentor for me and he's provided invaluable guidance to the team as well, it's really just spend a great start to our partnership.
I would like to thank all the investors on the phone today and thank you for your support over the last several months.
Additionally, I want to thank all that sort of employees, who have helped us get through our transformation over the last three and a half years.
Well our journey is nowhere near complete I'm very proud of the transformation efforts and our ability to deliver a very solid 2019 results.
Moving to slide for.
As you know we closed the deal with Goldman Sachs acquisition Holdings on February seven and followed up with a great ceremonial day on Friday February 28 by ringing the Bell on the New York Stock Exchange.
Those events were fantastic and continued to help the exposure of our burden brand to the marketplace.
Now on the financial side, we exceeded expectations for organic sales by growing 5.6%.
And for adjusted EBITDA by finishing at 542 million for the full year of 2019.
Additionally, we had strong orders quarter in Q4 by booking over 1.170 billion.
And between January and February of 2020, our orders are up 8% for the same time period last year.
Well, that's the meant that the corona virus could negatively impact the first.
Net sales quarter by 70 to 90 million in first quarter adjusted EBITDA by 28 to 36 million.
Based on what we know today, we're confirming our previously communicated full year guidance of 4.5% to 5% organic sales growth and adjusted EBITDA of 595 million.
Due to our expectations to partial recovery of these first quarter sales and earnings are conservative planning process and additional cost actions put in place.
Well the impact of the virus is dynamic based on what we know today, we do believe that our first quarter shortfall can be made up by the end of the year.
Finally, I'm happy to report, we completed our refinancing efforts on recently on our term loan, which will provide us a 100 basis points reduction on the current term loan rate.
So between our debt pay down, but this back proceeds and the refinancing we have significantly improved our balance sheet and on a pro forma run rate basis expects to generate over 285 million into free cash flow.
Turning to slide five.
Some of these events I mentioned on the prior side, but I think it's important to highlight the major milestones we've guided the business through over the past few months.
Since early December when we first announced the transaction the entire team has been hard at work to close the deal restructure our balance sheet and increase our visibility in the financial markets.
VR T was officially lifted February seven and Dave officially became our executive chairman.
With the pros be boost the proceeds from this back transition we were able to significantly reduce our debt levels as an average level leverage decreased from six and a half times to 3.7 times on a pro forma basis.
With that leverage reduction, we were able to improve our credit rating with both agencies with Moody's we increased three levels and with S&P, we bettered our position by one level.
As a result of all these moves we will lower our annual interest payments by almost $160 million, which is great for us.
Lastly, hopefully many of you saw it Dave David Gary MISO and the rest of the management team ring. The Bell on February 28 on New York stock from staying.
It was a great morning for a company and those types of efforts coupled with all the analyst interactions, we pad will lead to greater visibility for this great company of ours.
Now I'll turn it over to David for a few slot discuss a few slides on our segment results.
Thanks, Rob turning to slide six this page summarizes our full year financial results for 2019 versus prior year, starting at the left and moving right net sales increased 3% and organic sales adjusted for a 98 million dollar foreign exchange headwind.
Increased almost 6% from 2018.
Adjusted EBITDA increased $40 million or 8%, primarily on the strength of higher sales and a 50 basis point improvement in adjusted EBITDA margin to 12.2% as lower adjusted EPS DNA as a percentage of sales was partially offset by a reduction in adjusted gross profit percentage.
Okay.
Finally.
On this slide free cash flow improved over $300 million from 2018, primarily driven by improved working capital and lower investments in restructuring initiatives and the digital project as detailed on page 19 of this presentation.
Next moving to slide seven.
This pace summarizes our 2019 financial performance for our regional segments.
The solid topline organic growth in 2019 in each region led by 8% in EMEA was strongly supported by continued penetration of Hyperscale and co location markets.
Year over year adjusted EBITDA also increased in all three regions, 6% in Americas, 7% in APAC and an impressive 14% in EMEA.
And with adjusted EBITDA growing faster than net sales in each region. Adjusted EBITDA margin also increased the call across all three segments.
Americans is our most profitable region as you can see at 23.5% adjusted EBITDA and EMEA is lowest at 13.4%.
However, we believe there is still significant opportunity for margin expansion in EMEA as their fixed cost as a percentage of sales is much higher than the other two regions.
We've addressed some of these higher fixed costs over the last three years through restructuring efforts, but we see significantly more opportunity.
From the benefits of implementing divert of operating system in EMEA as well as other regions.
Next turning to slide eight this page summarizes our fourth quarter financial performance.
Once again, starting on the left and moving right our fourth quarter net sales equaled the record high in last year's fourth quarter and grew 1% on an organic basis, despite the challenging comp.
Fourth quarter, adjusted EBITDA declined $8 million and adjusted EBITDA margin declined 70 basis points as a 130 basis point improvement in gross margin percentage was more than offset.
By 200 basis point increase in adjusted EPS DNA as a percentage of sales.
Lower SGN a in last year's fourth quarter was partially driven by lower incentive compensation expense as we fail to meet internal targets last year and several favorable discrete SG SGN any adjustment.
That did not repeat in this year's fourth quarter.
Free cash flow increased $74 million, primarily driven by a 50 million dollar reduction in working capital and a $17 million reduction in cash interest payments due to timing.
Next on slide nine.
This page summarizes our fourth quarter results versus 2018 for our regional segments.
The overall, 1% increase in consolidated organic sales was driven by a 9%.
Increase in organic sales in Asia Pac offset by a 7% decline in EMEA Americas was relatively flat.
Solid growth in Asia Pac was due to strong shipments in the telecom space.
And lower organic sales in EMEA was in part due to record quarterly sales in last year's fourth quarter.
Supported by several large projects.
Adjusted EBITDA margin in Americas expanded 350 basis points, despite flat sales.
As a result of productivity gains pricing and fixed cost control.
470 basis points decline in adjusted EBITDA margin in EMEA was primarily driven by lower sales and the associated fixed cost leverage.
And in addition to the negative impact of a larger low margin project.
Moving to slide 10.
We provide the components of our full year 302 million dollar increase in free cash flow.
From 2018.
Although each major category of cash flow generation improved from last year. The two primary sources of higher cash flow.
Were a 135 million dollar reduction in investment in restructuring initiatives and the digital project and we detail that on page 19 of this presentation.
And also a $74 million improvement in cash flow from working capital as we focused heavily last year on both inventory optimization and the collection of past due to accounts receivable.
Despite the significant year over year improvement in free cash flow was still slightly below breakeven at a negative $8 million. However, as we will discuss in a little bit more detail on a short bit.
We expect 2020 free cash flow to be both improved and significantly positive.
So with that said I turn it back over to Rob.
Thanks, David as we look at Slide 11. These are some there is a day Cody I itself and the rest of the management team are focused on.
As I mentioned earlier, Dave is brought another level of coaching and guidance for the entire leadership team.
Given us great advice and counsel on many business topics over the past few months.
I will walk through each one of the bullet, but I would like to comment on a few specific ones.
First we are really focused on increasing our R&D efforts to allow us to differentiate the technology, we have a great position in almost all of our product and service areas.
But we know there's plenty of opportunity to do more.
We have already begun with this effort in several areas where projects have been scope resourcing people being hired and plans are being executed.
While most of these programs will not come to market till 2021. This effort has really fired up our product managers and our engineers to know that we are investing and we'll continue to add those investments over the next few years.
On the margin side, we're already working to hold fixed cost constant now why tell you. The concept is very easy in theory, but it's not easy in practice, but we are developing that muscle and are using this principle as one of our core foundational pieces as we move forward.
Lastly, I want to touch on the vertical operating system.
As we call moving forward boss.
We took the team of over 25 people, including my direct reports to Honeywell for full week to understand their operating system.
I want to thank all the Honeywell associates, who hosted us during that week and it was one of the most ethical educational week in my professional career.
I will get into more details on approach to rolling out the operating system over the next few quarters, but needless to say it will be one of the most powerful tools will add to our tool kit the concept of boss and everything that comes with it certainly will help US bridge, the 500 basis points Delta in the margin between ourselves and our peers.
So between our top line and our bottom line initiatives, we have a lot of new areas to explore to drive growth that we know we can achieve.
Now turning to slide 12.
We feel good about how we closed out 2019 with organic sales growth of five 5.6%.
We achieved an all time high in orders during Q4, and our pipeline continues to grow.
Where we sit right now we expect sales growth to be between four and a half and 5%.
With most of that growth bias in the second half of this year.
As I stated in my opening comments the impact of the Corona virus is still dynamic, but based on what we know today. We believe we can still grow organically between four and a half and 5% range for the full year.
Due to our expectations to partially recovered the lower first quarter sales and overall conservative planning process.
We are certainly monitoring the entire situation very closely interstate in constant contact with our customers and believe based on all of that that we can maintain full year guidance.
Now in terms of long term trends, we believe the market to be fundamentally solid and the data growth and the edge development will be our primary drivers that will always be ebbs and flows to our business, but through the cycle. We expect the macro backdrop, we'd be very positive.
Engineering and contracting activity is continuing to pick up and our record order rate in Q4 and from what we've seen in the first part of Q1 provide solid proof point.
The edge is it is in its early stages with key critical verticals, such as retail and education, where we're beginning to see really good traction.
Finally on the communication side Fiveg Rollouts will continue to increase over the next few years there are pockets of rollouts in parts of the us in Asia.
But the really big bulk of deployments are expected to start later part of 2020.
And we'll go for a few years, depending on the regional Rollouts.
Now as it relates to grown a virus, let's turn to slide 13.
Before I, even comment on the business impact and what we've been doing about it I want to reiterate that our employees health and safety is our top priority.
China is a great market for us and it's important we are leader in following the safety and precautions.
We have made sure we work closely with the government provide the safest workplace possible and to date, it's been working.
Almost all of our employees are back to work at our facilities in China and had been ramping up for Johnston production. Since then.
We jumped aggressively on this issue not only from a safety perspective, but also from a supply chain and logistics perspective in many instances, we helped our suppliers with masks and other Ivan items to help them open up.
And from a logistics standpoint, we have bought ahead to make sure we have the freight lanes available when the recovery begins.
While we generally manufacture any region or region similar to most multinational companies, we have a global supply chain with several components in sub components. The do come from China. So between the supply chain, our manufacturing facilities and some of the China demand side, we're projecting between 70 and $90 million topline.
For Q1.
Please realize that the situation continues to be very dynamic globally and this is our current testament of the impact.
We are monitoring and actively managing the situation on a daily basis. So this has the highest visibility in our company.
With that I'll turn it back over to David for the next few slides.
Great. Thanks, Rob.
Turning to slide 14, we ended earlier of our expected improved and significantly positive free cash flow for 2020, a certainly a big driver of this improved cash flow is significantly lower cash interest from two things one to 1.5 billion debt pay down from.
Spec proceeds.
And the recently restructured debt composition of our capital structure through the pay down of three high interest rate notes through the proceeds from a new term loan that we just closed last week priced at LIBOR plus 3%.
100 basis points lower than our former term loan.
In addition, and not reflected on this slide we will also benefit from a seven year floating to fixed interest rate swap associated with the new term loan and that will lock in a fixed 4.1% rate on 1.2 billion notional.
Over the first 12 months and $1 billion per year thereafter.
In the end the spec transaction was truly transformational for our capital structure as we lowered our net leverage from 6.2 times to 3.7 times.
And we improve both our Moody's.
In S&P credit ratings.
And we reduced our annual run rate cash interest.
By almost a $160 million has reflected at the bottom this slide.
And with the strong free cash flow characteristics of our business. We certainly have a have a clear pathway for continued deleveraging going forward.
Next moving to slide 15.
This page summarizes our 2020 financial guidance.
We expect organic sales growth of 4.5% to 5% and adjusted EBITDA of $595 million and both those figures are consistent with the projections. We provided in our roadshow presentation late last year.
We estimate.
Adjusted EPS of 89 cents.
And we do provide a detailed reconciliation from GAAP to adjusted EPS.
On page 22. This presentation and that's also included in the earnings release.
We expect 2020 free cash flow on a GAAP basis.
As reflected on the slide of 130 million to $150 million.
And let's turn to slide 16 as well.
Yes. This 2020 free cash flow estimate at the midpoint is almost $150 million higher.
Then in 2019 free cash flow, but if we adjust this free cash flow projection for items, we do not expect to repeat going forward.
Such as transaction costs associated with the spec merger Thats, the $21 million Green bar to the right.
And also adjusted for the timing of our debt refinancing we illustrate here a 2020 pro forma annual run rate free cash flow of approximately $285 million.
So we call. This the money slide in the presentation and it really demonstrates the strong cash flow generation potential of our business going forward. So with that said I turn it back over to Rob for final thoughts prior to opening up for Q Annette.
Thanks, David.
In closing we are pleased on how we executed in the fourth quarter as we finished out a very strong year with organic top line growth of almost 6% and bottom line growth of around 8%.
Additionally, we are excited to have Dave CODI as our executive chairman to provide is inside perspective and good advice.
The Corona virus outbreak will dampen the Q1 results, but we will continue to attack. This talk a topic aggressively while also balancing the safety of our employees, which is paramount.
We anticipate our growth painted planned coupled with our restructured balance sheet will lead to good cash generation.
We see good demand drivers and are excited to execute our 2020 plans.
Thank you for your support I will now turn the call over the operator to open up line for questions.
We will now begin the question answer session in order to ask your question. Please press star and the number one on your telephone keypad.
Pause for just a moment to compile the acuity.
And our first question today comes from Lance Vitanza from Cowen. Please go ahead with your question.
Hi, Thanks for taking the other question and great job on the quarter.
Two we start with the revenue target that you set for yourselves at one and a half times industrywide revenue growth could you help help us think through that opportunity. There is that taking share and if so is it mostly from the the half to two thirds of the market Thats fragmented still.
Or do you have or do you perceive a pricing opportunity I guess any sort of granularity on how you get to that premium revenue growth would be helpful.
Sure Hi, this is Rob Johnson, Thank you for the question.
What we would say is it's a combination of the things that you are pretty good straight man on answering what what's driving it.
Taking share and Colo and Hyperscale as many of you recall over the last three years that was not initial area that was focused on under previous ownership, so taking share that be aggressive with.
What I call joint development and collaboration the second part of our growth area is coming from what we call the white space and more edge devices, we've expanded our product lines over the last year year and a half two years to have a complete set of products. So we expect to take share and also participate in that in that.
Ads growth and finally, you mentioned pricing, we were able to get price in 2019, and we will continue to exercise that muscle as we go forward and were Rob we're excited about that in our ability to get price. So I think it's a combination of market share taking some more that gray space and eliminating some of the smaller competitors globally.
And then driving hard on the edge in white space.
Thanks, if I have time for a second question I wanted to ask you a little bit more about China, and the Corona buyers and back and I thought slide 13 was really helpful. But could you talk about your direct exposure to China in a little bit more detail.
Perhaps the total number of facilities the percent of product that is supplied from China.
Is that product being served is it going just to your China revenue base or is it going worldwide to other revenue areas et cetera.
Yes, I'll give some color and then let David David kind of fill and first of all we have two facilities in China, John Man and men Yang not none in the who Bay Providence.
So thats why were at a backup and running from from an exposure perspective, what I'd say as China made up in 2019 about $669 million are 15% of our net sales as a company.
The impact that we're seeing as I mentioned earlier, while we're pretty much in region for region for final Assembly and test like most global multinational companies, we get a lot of components.
Sub component from the China region.
As far as the breakout of of how much is local versus global David I don't know if you have a few comments on that yes, just very broadly.
Our direct material purchases in any given year are about 1.8 billion and I'd say less than a third of that come.
From China, whether it is.
Source sort through external suppliers are internally from our plan sourcing.
The other two region. So there is certainly a supply chain impact.
In both the Americas and AMEA.
Related to the the situation in China.
That's really helpful. Thanks, guys.
Thank you.
Again, if you would like to ask your question. Please press the number one on your telephone keypad.
Our next question comes from Mark Delaney from Goldman Sachs. Please go ahead with your question.
Yes. Good morning, thanks, very much for taking the questions.
First question was on the current a virus and trying to better understand the supply chain ramifications.
The one handheld you're talking about having its employees back to work in your facilities and you've you've been able to pre purchase components, but you're also talking about some potential supply chain disruptions or I mean, it better reconcile some of those comments and understand our you're already seeing inability to ship some product.
Is it more just conservatism just any kind of reconciliation on some of those those comments and then just better understanding your ability to manufacture.
Yes. So this is Rob I'll start off an Dave can drive a little bit David can drive a little bit further into this what we did even a we're back to work. We do we do rely on a supply chain base for PCB boards discrete components and things like that and while we're pretty much back to full strength.
Other suppliers or not and we're working with them to help get back online. So thats really kind of where I would say the suffered sufferings coming from there's not really our ability to get things done, but it's to sub component suppliers that just arent fully back to speed.
Yeah, I would just echo what.
Rob is mentioning the larger components the MMS power modules.
Yes, we feel pretty good shape at this point, what we know today with that supply it's really those smaller suppliers that are having.
At this point a pass through effect.
In Americas into the lesser extent with EMEA.
Got it is helpful and my follow up question or second question was on the order strength that the company reported which was a very nice to see.
Can you talk about the breadth of those orders I know, there's a time is where the company has some tomorrow projects until it was this was broad based order strength of that vertical was seen in the fourth quarter or was it.
More specific to a large project for two or any color you can give on the orders in terms of what markets maybe driving it. Thank you.
Sure. This is Rob I'll start off and then get let Gary follow through I'd say in general.
It was just kind of broad base across all the segments that we participate and we just saw strength in whether its telecom consumer and industrial and our AR.
Hyperscale and even traditional enterprise an edge. So that was not I wouldn't say one big area that stood out as we go forward as you know and we've talked about it a lot of bar Rob.
Hi business is traditionally been really kind of project base and that ebbs and flows over time.
We are working and driving the channel to make it more of a consistent flow business. So we'll continue to do that but we saw pretty much shrink.
Around kind of around the globe and in all the vertical.
Europe certainly stands out is probably one of the stronger areas for us from a order perspective coming out of the gate this year.
And ladies and gentlemen, with that will conclude today's question and answer session I'd like to turn the conference call back over to Rob Johnson for any closing remarks.
Thank you operator.
To close the call by saying how excited I am about being a public company and the great path ahead perverted I'd also like to thank our 20000 employees around the world for working hard every day to take care of our customers.
We appreciate everyone's time today and we we look forward to speaking to you soon again.
Thank you.
Ladies and gentlemen, the conference has now concluded we do thank you for attending today's presentation. You may now disconnect your lines.
[laughter].