Nordson Corporation (NDSN) Earnings Call Transcript & Summary

Good morning, everyone. My name is Allison Poliniak. I'm an analyst here at Wells Fargo covering the multi-industrials as well as transportation sectors. We're pleased to have Nordson kicking off our virtual day today. Naga, who took the helm as President and CEO of Nordson in August 2019, so certainly interesting times is, with us this morning. Before we jump in, I just want to remind folks that this is a closed line. So if you have any questions for Naga, please e-mail me at [email protected]. But first, Naga, I want to pass it over to you for some opening remarks.

Thank you, Allison, and thank you to the many current and interested investors who are listening in today. We hope that you and your families are healthy and safe. I want to thank our 7,500 colleagues around the world for their tireless efforts and creativity to staying safe and being responsive to our customers' needs in these challenging and uncertain times. Before I continue, I want to reference our safe harbor statement, which can be found in Nordson's past filings with the Securities and Exchange Commission. During this conference call, forward-looking statements may be made regarding our future performance based on Nordson's current expectations. We are in a very dynamic environment. So these statements may involve a number of risks, uncertainties and other factors that could cause actual results to differ. Nordson is a precision technology company focused largely on fluid dispensing and some adjacent technologies and processes. We have a direct sales presence in over 35 countries. We are differentiated by our customer-intimate business model with a global direct sales force and our commitment to innovation. Our high-tech customer relationships allow us to add value by solving problems, enabling innovation and driving efficiencies for our customers. Over the past 66 years, this model has delivered the growth of Nordson into a $2.2 billion manufacturer with leading margins. Another core strength of the company is the diversity of our geographies and end markets. Nearly 70% of our business is outside of the United States. We serve a variety of end markets, including consumer non-durables, medical, electronics, industrial and more. Approximately 54% of our business mix is recurring revenue. Historically, these attributes have made Nordson recession resilient. And even in the current environment, all our production facilities are producing product for essential critical infrastructure customers. Nordson also benefits from a strong balance sheet and liquidity position. In 2019, we entered into a $850 million credit facility with 15 banks. This credit facility is undrawn. Our balance sheet also remained strong with approximately $115 million in cash at the end of our fiscal first quarter. In addition, we have -- we had a net debt-to-EBITDA of 1.7x and our covenant is 3.7x. Now let's shift our focus to the current environment. As you would expect, we are actually managing the impact of COVID-19 on our businesses. Our executive management team is meeting regularly to assess new information and share lessons learned across our divisions and geographies. To ensure that we are taking the appropriate actions to keep our employees safe while we are reporting to work, we are monitoring the recommendations of WHO, the U.S. Centers for Disease Control and local governments. In some cases, we have adjusted schedules to allow the proper amount of social distancing between workstations. Some employees are rotating days when they come into the office. Everybody who can work from home is working from home. They're also maintaining a rigorous cleaning schedule in our facilities. As we continue our operations, our focus is on maintaining health and safety of our employees, who continue to report to work through social distance, regular cleaning, temperature checks and masks as appropriate. We are grateful for the commitment and responsiveness of our employees to the needs of our customers. While we remain focused on managing this dynamic short-term environment, I'm equally committed to moving this organization forward and making progress towards our long-term objectives. The greatest opportunity for Nordson is profitable growth, which we will achieve by accelerating organic growth, diversifying through acquisitions, leveraging the Nordson Business System and building our talent pipeline. Allison, with that, I know you have a lot of questions, so we'll get into much more detail on this topic. So let me turn it back to you.

Great. So you did talk to the diversity of Nordson's portfolio. We've seen a trend though across multi-industrials really to lessen that diversification and become more focused. Just your thoughts on the diversified model. What does that really bring to Nordson and for you?

Yes. As I mentioned in my opening remarks, Nordson's greatest opportunity is profitable growth. And this growth, we will drive through organic means as well as through acquisitions. The key to our acquisitions and a diversified model is to stay true to what makes Nordson really special. It is our precision technology and our high-quality growth-focused businesses. This proprietary technology and high percentage of revenue -- recurring revenue is really key to our diversification. This is what makes Nordson special. And as we stay true to what makes it special for us, we certainly are quite successful. A good example is our medical businesses and our test and inspection businesses. These are great examples of our diversification. As we continue to acquire, our Nordson Business System will ensure we'll stay focused and disciplined. We're not going to grow for growth's sake. It is really going to be based on what the acquisition and diversification will bring to Nordson that is true to what makes Nordson special.

Great. And then as we think broadly about Nordson, obviously, quite an unusual time. But what level of growth should Nordson achieve and maybe see a more normalized environment here as you look forward?

Yes. Through the cycle, think of Nordson as a 1.5 to 2x GDP grower. Really, there are lots of different growth drivers for us in many of our markets. But broadly speaking, the growth drivers in all of our segments is really penetration into emerging markets, so this is like following our customers as they support their expansion into emerging markets like Africa, Southeast Asia or Middle East or think of the expanding middle class, who have growing demands for consumer non-durables such as diapers or packaged beverages. Another growth driver for Nordson really is our new applications. The company has been really creative and innovative in finding new applications for existing precision technologies. A great example is the fabric bonding application to replace stitching in athletic wear and feminine undergarments. This is a great opportunity for our traditional adhesive business that have been mostly focused on packaging. Think about product tiering as a third lever for us. We are really, really good at the high end of the market, where we have done a wonderful job of really moving into the mid-tier. We will never play in the bottom tier of the applications, but product tiering is a great growth lever. New products. This is really the heartbeat of the company. We are very focused on critical applications. We are always the go-to innovation partner, as our customers bring new technology to market. We're always solving problems for our customers. Think about this, every time we make, there is a change. It is an opportunity for us to be able to innovate for our customers. Certainly, the last bit is, I would tell you, we have a large installed base and recapping that installed base is a huge opportunity. So we have multiple growth levers to be able to deliver on this potential of 1.5 to 2x GDP growth.

Great. And then onshoring, we're getting a lot of questions about that. Just -- it's been a growing theme in the midst of this pandemic. Investors are interested in hearing your thoughts on companies potentially nearshoring after this and what kind of impact would you see on consumer durable brands as a result?

Most of our consumer non-durable customers are very global customers. They have been in many geographies. That is really one of our core strength, is our global sales and service infrastructure that helps our customers to be able to support them in faraway places. As they consider nearshoring, Allison, what I would typically expect is that we will definitely benefit from onetime when they build a new factory in Vietnam or they build a new factory in Mexico or in South America. But after that, you're really replacing the revenues that you would have enjoyed in another geography. So for us, we look at nearshoring as an opportunity that will benefit us onetime. And after that, it's pretty much the same as what we have enjoyed in the past.

Perfect. And Nordson just recently announced a resegmentation. And along with that, some changes in leadership. Can you just review with us why you're consolidating ICS and ATS into a single segment? And what should investors be looking for to know that the consolidation is achieving what your objectives were set out to be?

Yes. It's a great question, Allison. Really, what we're -- our thoughts are really around this realignment is to build a simpler organization that allows us to stay focused and be more agile in accomplishing our long-term strategic priorities of accelerating organic growth, diversifying through acquisitions, leveraging the Nordson Business Systems and focusing on talent development. Think about this macro environment. As we're in a very dynamic environment, it is really important for us to stay agile, and we believe a simpler organization will allow us to do that. Furthermore, this simpler organization would allow us to begin to build a division-centric enterprise, an enterprise that is recommitting to Nordson's entrepreneurial spirit. And also, it gives an opportunity for us to grow talent. Think about Greg Merk, who's leading our IPS business. He started with us in 1994. And he has been leading our adhesive business. Now this expands his scope and responsibility. Jeff Pembroke, who runs our ATS business, has been able to -- he joined us in 2005, and now will have an opportunity to run our entire ATS business. He has led our medical acquisition strategy and really gives him an opportunity to contribute to the further growth of the company. So this resegmentation, the way to think about this is this will enable us to implement and execute against NBS next. So the success of our realignment is really will be measured by our ability to implement NBS next throughout the company in a very rigorous way and our ability to continue to build a division-centric enterprise.

Great. Would you also discuss your approach to growth investments, particularly in light of the current environment? Does it change how you allocate R&D? Do you ramp up investments, just given some of the success that you've seen over the years? Just any thoughts around that.

Yes. For a company like Nordson, what makes us really special is our precision technology and customer passion. That is really the foundation of how the company wins in the marketplace. So our priorities in this environment is no different than what it has been in the past, which is innovation remains our top priority. We invest approximately 3% of our sales into R&D, total company-wide. In certain segments like in our electronic business, is significantly higher, many more times than that. In addition, we have a very savvy team of application engineers who work closely with our customers and deliver on solutions. So we're going to stay invested in our customer intimacy as well as in our innovation capabilities. The other thing to really remember is that we need to protect our investments in the direct sales model that makes the company truly, truly unique. It provides us: a, incredibly differentiated customer value proposition; b, it comes with a large fixed cost structure, but this direct sales model is really important for our innovation. It's also very important to protect our 54% recurring revenue stream, which really is all about being in the customer's business, solving the customers' problems and being able to help them improve efficiencies and reduce waste, which is particularly important in times like this.

Great. And we had a question come in related to your comments around recurring revenue as it relates to parts and consumables. Trying to understand what's the gross margin difference, if anything, between that and the OEM systems? Also what's consumables versus service? Any color around that, that you could provide?

Yes. The -- as I mentioned, 54% of our revenue is recurring revenues and you have both parts and consumables in it. Our consumables really come from our medical side of the business. So you could easily say 60-40 mix between the two. In terms of margins, clearly, as you would expect, our margins on the parts are significantly higher than our system revenue -- system margins.

Got it. And then any concern about, I guess, getting into sites at this point just given the COVID issue?

Allison, it's a great question. It really varies from region to region. In China, we're beginning to see a significant amount of customer activity, albeit with some restrictions around face coverings and things like that. But we have been able to stay engaged with our customers through virtual means. During that period of time in China, we're beginning to visit customers. In Europe, it is just getting started. I think in U.S., I would say, in the coming weeks, we would be in a better place. But now it is mostly helping our customers through virtual means.

Perfect. And you touched on medical as an end market certainly becoming a bigger part of your portfolio over the past few years. What's your strategy to grow that business in the short and long term? How do you decide what areas to emphasize? Clearly we've seen some pressure on elective-type surgeries. Any color on that side?

Yes. The medical is a very interesting part of our portfolio. It really is the growing part of the company. Today, there's about 17% of the portfolio. A number of growth drivers are very exciting for us is that the aging population, certainly, the complexity and relatively very high-value devices are very interesting areas. What is also neat about this particular part of our business is that as you think about infection rates, hospitals were really moving away from sterilized components to single-use disposable plastic components. And after what we've gone through, we expect that part of it -- that trend will continue to accelerate. And finally, think about it is really favorable for our customers to reduce their total cost in terms of less hospital stays and lower infection rates. That's really where we're focused on. Our primary focus in the medical business has been building a core component that make up the delivery mechanism of critical medical devices. So let me give you an example. Think about stents or aortic valve replacements or lung therapies. What we participate in is helping our med device customers move the devices to the right place in the patients where the therapy needs to happen. So we would provide catheters, balloons, connectors, would allow our med device customers to safely and effectively deliver these medical devices at the point of therapy. So in terms of growth levers, the base market itself is growing about 5% to 6%. It's really a very nice part. The second is product innovation. There is continuous rapid innovation cycle in med devices. And through the mentioned acquisitions, we were able to bring in design and development capability into the company and that really positions us in a place of strength to help our medical device customers. And finally, our medical device customers really want to focus their R&D and manufacturing resources on developing, designing and manufacturing medical devices. So they would look to people like Nordson, who have strong product capability and a track record of performance to be able to help them with these core components that are so critical in delivery. So that's really where we are evolving. We're evolving into a very trusted partner for this med device customers and be able to provide them a critical delivery component. That's sort of how we're doing. If I could, Allison, one more thing I would add is that we have -- this is a very fragmented space. It still has a lot of smaller properties. We have a ability to acquire. We have a design and development capability that really helps us. And this provides us a real strong set of multicomponent capability. But to remember, in all of this, we are focused on what makes Nordson special and that is really focused on precision technologies that are used to help our customers in their critical applications. So we're going to stay true to that. So you won't see us get into things that are commoditized. And there are commoditized parts of the medical business, but you wouldn't see Nordson getting into it. We're going to stay true to what makes us special, what we are good at, which is really precision technologies that are helping our customers and building a very strong customer relationships that solves problems for them.

That's helpful. And obviously, can't let you walk away without talking about 5G. A lot of interest there. Would you kind of walk us through how Nordson could benefit and how you see that technology evolving today?

Yes. When we think about 5G, Allison, we think about it as a key growth driver across multiple electronic devices. Everybody knows one of the greatest attractiveness of 5G is really it is significantly faster than current technologies. The 5G opportunity is spread across not only mobile phones but in auto electronics and consumer electronics and in industrial applications such as IoT devices. And one thing to note, which is particularly different beyond the devices, is that 5G is a much weaker signal. And hence, there is a significant amount of infrastructure that is needed. So infrastructure building is also an important opportunity for us. The rollout of the technology has been slow. It's primarily because we've had some issues around supply chain related to trade barriers and number of things like that. But there are also competing technologies like millimeter wave that are starting to come out. The penetration of 5G in mobile phones is still fairly limited. Although there is a lot of discussion about it, it has still been fairly limited. We expect over the next 3 years or so, this technology is going to roll out. It is going to be a significant opportunity for Nordson. In terms of where we are working on, we're working on multiple fronts. We're working on a number of applications, all the way from chip packages to RF components, to switches, filters, antennas, base station. So we're working on a number of different applications in these many different components. In terms of application, primarily where we are involved in is we're involved in dispensing thermal paste, which have thermal interface materials. We're definitely working on conformal coating of large boats in the base station. And also another exciting part for us is our test and inspection capability. This is a capability we have built over the last few years and that one is really becoming a huge asset for us as 5G rolls out. And so lots of different applications. The best way to think about the company's opportunity is, it is across the supply chain. Think about Nordson being able to help our semicon customers make the chip packages. Think about those chip packages getting put into components at our many electronic component manufacturers. And then think about those components getting assembled on a PCB board at an EMS assembly manufacturer, and then finally, in the end product. So we would benefit on 5G across the supply chain in multiple different applications. It has been slow, but I think it's an important driver of our electronic business growth.

Great. And then Nordson consolidated some of its production facilities and opened a new centralized shared service center. How have these initiatives improved your capacity and lead times?

Yes. Let's take the two of them. In general, both of them have been very effective for us. The production consolidation is almost complete. The benefits of them have already shown up in the businesses. Our shared service model is continuing to -- being implemented in our businesses in the regions is doing fairly well. What I would tell you is that for us, really staying focused on what our customers need and being in the right geographies at the right time is the critical part of our manufacturing strategy. And so both of those items that you mentioned have been effective. They continue to roll out, and many of those benefits have shown up in our performance already.

Great. And then just want to touch on capital allocation M&A. What does your M&A strategy look like as you look over the next, say, 3 to 5 years? Are we adding another leg to the stool? Or are they sort of focused on those 2 segments that you've talked to?

Yes. Our capital deployment priorities remain consistent, Allison. And really, they start with funding our organic growth initiatives, and this is something we've done really well on. Second is really making sure we continue to maintain our dividend streak, something we've done fairly well. And then acquisition is going to be an important part of our growth. And so for us, continuing to be focused around what makes Nordson special is going to be the most important thing we can do on acquisitions. That is really staying focused on precision technologies that help our customers in their critical application and adds value. So in the current environment, would we be a little bit more thoughtful as to how we think about these? Yes. But we are focused on the long term and we're focused on these two segments that we've talked -- the two businesses we've talked about, which is medical and test and inspection, two areas. We really like these businesses, and we do believe we have significant opportunity to expand. You'll see us stay focused there. And if we should ever run out of work to do there, we have a growth and innovation team inside the company that is always looking for new areas that sort of have a strong strategic fit with Nordson's business model of being customer-centric and precision technology oriented. So we're always looking for new opportunities. But the two areas we're going to be focused are medical and test and inspection.

Okay. And last, as it looks like we're running out of time here. As we head into an eventual recovery, would you talk to Nordson's positioning in light of what could be a new and very unique normal at this point?

Yes. And I think I'll draw you back to three things. So I'll start with what makes Nordson really special, which is the foundation of the company and core of what makes Nordson a differentiated profitable and growth-focused industrial technology company. That is really our customer passion and our precision technologies. Three things to note about Nordson really is, it's a highly customer-intimate-driven business model, which is based on a global direct sales force. This allows us to be in our customers' business all the time; helps us understand our customers' needs; creates innovation that enables them to be running their manufacturing lines faster, bringing new technology to market. So we're really seen as a problem-solver and an innovation technology partner. It's also a great defense for our 50% recurring revenues. So really, the first important core element of our success is really our customer-intimate business model. Clearly, our global infrastructure of sales and service will also enable Nordson to continue to grow. The second and probably the most important critical ingredient in the company's success is our diversified position. We're diversified by geographies. I talked about it earlier in our -- in the opening statement that 65% of our revenues come from international locations. Clearly, we have consumer nondurable and medical end markets that are very resilient in recessions. Our electronic business is also very interesting because it is highly diversified in many applications and the cycle of which -- it mirrors a tech cycle, which is sort of, in many ways, disconnected from the GDP cycle. Clearly, our -- if you think of about Nordson, most of our products and components are very low in the cost stack for the customer, but yet play a very important critical role, be it in a manufacturing line or in their product performance. So it's less susceptible to cost pressures from the customer because we provide a unique value. And third, I will tell you, Allison, really is the strength of the company's balance sheet and our liquidity positions. We're mostly light assembly business, less CapEx required to run the business, 2% to 3% of our revenue. Very good conversion of cash, 100% of net income converted into cash. Pretty solid balance sheet. All of this really helps us to be a very strong attractive growth company.

Great. Well, thanks so much for your time this morning. It looks like our time's up. Everyone stays safe. Thanks again.

Thank you, Allison. Appreciate the opportunity and you stay safe as well.