UL Solutions Inc. (ULS) Earnings Call Transcript & Summary

Greetings. Welcome to the UL Solutions Second Quarter 2024 Earnings Call. [Operator Instructions] I will now turn the conference over to your host, Mitchell Ji, Senior Vice President of Corporate Finance. You may begin.

Thank you. Welcome, everyone, to our second quarter 2024 earnings call. Joining me today are Jenny Scanlon, our Chief Executive Officer; and Ryan Robinson, our Chief Financial Officer. During the discussion today, we will be referring to our earnings presentation, which is available on the Investor Relations section of our website at ul.com. Our earnings release is also available on the IR section of our website. I would like to remind everyone that on today's call, we may discuss forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may include, among other things statements about UL Solutions results of operations and estimates and prospects that involve substantial risks, uncertainties and other factors that could cause actual results to differ in a material way from those expressed or implied in the forward-looking statements. Please see the disclosure statement on Slide 2 of the earnings presentation as well as the disclaimers in our earnings release concerning forward-looking statements and the risk factors that are described in our quarterly report on Form 10-Q for the period ending March 31, 2024. We assume no obligation to update any forward-looking statements to reflect events or circumstances after the date hereof, except as required by law. Today's presentation also includes references to non-GAAP financial measures. A reconciliation to the most comparable GAAP financial measure can be found in the appendix to the earnings presentation. With that, I will now turn the call over to Jenny.

Good morning, everyone, and thanks for joining us. This is our second quarterly report as a public company, and I'm really pleased to say we had another strong quarter. We reported meaningful growth across all of our segments and geographies, improved margins and generated solid cash flow that has been a hallmark of our business. These results reflect outstanding execution and a keen focus on our core business. Safety science underpins important mega trends that we expect will continue to drive demand for our industry-leading services for years to come. Innovation without safety results in failure. I have 3 key topics I'll cover on today's call. First, I'll highlight key elements contributing to our strong second quarter performance. Second, I'll highlight some key growth achievements and customer activities from the quarter. Finally, I'll touch on our strong financial position and capital allocation actions. Let me start by sharing my thoughts on our strong second quarter results. I'd like to say that while we are newly public, we are not newly for profit, and this mantra is echoed in our ability to once again deliver profitable growth. We could not have achieved these results without focused execution led by our experienced and technically accomplished team for whom I am truly grateful. Our employees' relentless emphasis on safety, science and customer centricity shapes our culture and enhances our business. In the second quarter, our team achieved organic growth of 8.4%, resulting in $730 million of revenue. We continue to experience stamina in our Industrial segment. We benefited from improving trends in our consumer segment, and we posted a solid quarter for Software & Advisory. Importantly, our results were well balanced with growth in all 3 segments across all geographic regions and service lines. Adjusted EBITDA grew 11.6% and adjusted EBITDA margin expanded by 120 basis points. Adjusted net income increased by 5.6%. And in the first 6 months of the year, we delivered $131 million of free cash flow. Now let me highlight a few key achievements from the quarter. In our Industrial segment, our Korean advanced battery lab that came fully online last quarter is experiencing a rapid ramp-up in activity, serving Korean automotive customers with the latest large battery safety technology. Construction of our Auburn Hills, North American battery lab is progressing on schedule and we expect to open in August with a strong backlog of work ready to go. And I want to emphasize a key point battery testing at UL solutions is so much more than EV and hybrid automotive batteries. The electrification of everything spans a broad spectrum of energy transfer and storage needs from small consumer to large-scale industrial batteries used to power heavy equipment. These 2 new facilities expand our already impressive suite of offerings across the full set of industrial and automotive battery testing. We were active on the M&A front in the Industrial segment with 2 acquisitions, 1 in the quarter and 1 subsequent. In May, we acquired German battery testing and simulation company Batterieingenieure who has expertise in specialized cell, small modules and battery system performance testing. This acquisition expanded our global battery testing footprint adding opportunities in the European market to our already impressive portfolio. And in July, we acquired another company based in Germany called TesTneT Engineering, a leader in hydrogen component and system testing. This acquisition deepens our expertise in clean energy testing and enhances our ability to impact global decarbonization efforts. We believe hydrogen technology will play a significant role in the transition to lower global emissions from transportation and energy systems. We are excited to expand our capabilities in this important area. In our consumer segment, as the HVAC industry continues to drive towards sustainable solutions through the transition to more environmentally friendly refrigerants, we have focused on strategic initiatives and capital investments to support our customers' needs. Our foundational research for the safe transition to the next generation of refrigerants helped solidify our thought leadership position in the future of HVAC safety and performance. We planned for an expected surge in demand for our services, and we completed a capacity expansion of our HVAC Performance Center of Excellence in Plano, Texas in the second half of last year. Customer reception to the new chambers has been overwhelmingly positive, and we are seeing strong and durable demand. In our Software & Advisory segment, we are making good progress with balanced growth. Sustainability continues to be a key driver of demand, while the energy transition was also a contributor. Finally, let me comment on our capital allocation activities. Our hard work and focused business model put us in an enviable position with regard to our investment-grade balance sheet, robust cash flow generation and disciplined approach to capital allocation. During the quarter and subsequent to its end, we were active on multiple fronts. First, we completed a divestiture as well as the 2 acquisitions I just mentioned. Second, organically, we announced plans to construct an advanced automotive and battery testing center in Korea to further serve the automotive industry. The new lab when complete, will expand our current battery testing capacity in the region and add EV charger testing and other capabilities to our suite of offerings. It leverages the technology used in our Korea Advanced Battery Lab, which we opened last year. This new lab is expected to open in the second half of 2025. Third, we returned cash to shareholders in the form of our first regular quarterly dividend as a public company of $0.125 per share in June. We are committed to maintaining a strong balance sheet with conservative leverage and investment grade ratings. We expect to continue to return excess capital to shareholders. Now I'm going to turn the call over to Ryan, who will provide greater detail on our results and our outlook.

Thank you, Jenny, and hello, everyone. I also want to thank all of our team members for delivering another strong quarter. I'll first provide more detail on our financial results, then discuss our segment's performance before closing with some comments on our full year outlook. We are proud to report in our second earnings release a continuation of strong top line growth, adjusted EBITDA margin expansion and solid cash generation. As Jenny mentioned, it's encouraging to see that organic growth once again occurred across all of our segments, geographies and service lines. Now let me dive into the details of the quarter. Consolidated revenues of $730 million were up 6% over the prior year quarter, including organic growth of 8.4%. The increase reflected particular strength in the industrial segment, which delivered 11.6% organic growth. Adjusted EBITDA for the quarter was $173 million, an improvement of 11.6% year-over-year on strength across all 3 segments. Adjusted EBITDA margin was 23.7%, up 120 basis points from the same period a year ago on strength in both consumer and the software and advisory segments. Adjusted net income for the second quarter was $94 million or $0.44 per adjusted diluted share, up 5.6% from $89 million or $0.42 per adjusted diluted share in the second quarter of 2023 despite $5 million of additional pretax interest expense. As a reminder, our IPO occurred in the second quarter and then affected 2 income statement items, in particular, these items are not adjusted for in our non-GAAP financials. First, virtually all our cash-settled appreciation rights, or CSARs, have either matured or were converted as stock settled depreciation rates. As a result of the value at the IPO closing, we recorded a $9 million pretax expense in Q2 '24, which reduced adjusted EBITDA by $9 million. These awards have historically created mark-to-market expense volatility, which will no longer occur as the value of these converted awards was established upon the closing of the IPO, they will no longer have mark-to-market volatility. Second, since public companies have a limitation on the tax deductibility of executive compensation, we reduced the value of some deferred tax assets post IPO, which resulted in an increase in the Q2 provision for income taxes of $5 million. Now let me turn to our performance by segment, starting with Industrial. The megatrends of energy transition and the electrification of everything are driving tremendous innovation and demand for our services. While the Internet of Things is spreading across the industrial infrastructure, these factors help the Industrial segment deliver the strongest growth of the 3 segments for the quarter. Revenues in this segment rose 7.5% to $314 million or 11.6% on an organic basis as compared to the second quarter of 2023. Those impressive gains were driven by robust demand for ongoing certification services and certification testing for engineered materials, energy and automation and building products. This was partially offset by the sale of our payments testing business which closed May 1 as well as some FX impacts. Adjusted EBITDA for the Industrial segment increased 6.6% to $97 million in the quarter while adjusted EBITDA margin declined 30 basis points to 30.9%, driven by increases in compensation costs, including $4 million of the IPO CSAR conversion expense as well as higher M&A diligence expenses. Now turning to the Consumer segment. Revenues in Consumer were $322 million, up 4.2% from the 2023 quarter or 6.1% on an organic basis. The improvement was driven by strong demand for non-certification testing and other services for consumer technology, particularly higher electromagnetic compatibility or EMC testing for automotive and connected devices as well as improved retail products demand. In addition, strength in HVAC led to improvements in certification testing. Adjusted EBITDA for the quarter in Consumer was $61 million, an increase of 17.3% versus the second quarter of last year. Adjusted EBITDA margin for the quarter was 18.9% an increase of 210 basis points year-over-year, driven by higher revenues and expense management actions taken in 2023 to improve our cost structure. As we detailed on the last call, Consumer completed several cost structure improvements in the past year, including relocating 2 large laboratories into larger, more cost-efficient locations, which contributed to the improvements in margin. This more than offset $4 million of the CSAR conversion cost within Consumer. Our third segment is Software and Advisory. Revenues for that segment were $94 million, an increase year-over-year of 6.8%, including a 5.7% increase on an organic basis. The improvement was driven by higher demand for both software and advisory services. Adjusted EBITDA for the quarter for Software & Advisory was $15 million, an improvement of 25% as compared to the second quarter of last year. Adjusted EBITDA margin for the quarter was 16%, an increase of 240 basis points year-over-year, driven by higher revenues and cost structure improvement actions. Turning to our cash generation in the first 6 months. We delivered $244 million of cash generated from operating activities compared to $220 million in the first half of 2023. Capital expenditures were $113 million in each of the first half of this year and last year and were primarily geared towards higher return growth investments in both periods. We continue to make important investments in energy transition opportunities, a focus area for UL Solutions. Free cash flow was $131 million compared to $107 million in the first half of 2023, in part reflecting lower cash incentive payments. We finished the quarter with $295 million of cash and cash equivalents on the balance sheet and net leverage of 0.9x net debt to trailing 12-month adjusted EBITDA. The strength of our balance sheet is reflected in our investment grade ratings. We believe our robust balance sheet and cash flow generation give us great flexibility to invest in organic initiatives, accretive acquisitions and to pursue a number of value-enhancing ways to produce best-in-class shareholder returns. Now turning to our full year outlook. On a constant currency basis, we continue to expect organic growth to be in the mid-single-digit range. We expect organic growth in the second half to also be in the mid-single-digit range. This is driven by continuing strong tailwinds from the electrification of everything along with digitalization and sustainability megatrends. In addition, for modeling purposes, we expect the revenue impact of the 2 acquisitions Jenny discussed DI and TesTneT to be less than $10 million in 2024. In addition to this incremental revenue, these 2 companies give us expanded capabilities and a broader footprint around battery and alternative fuel technologies. We expect to drive full year adjusted EBITDA margin improvement in 2024 and beyond through a combination of key focus areas for the company. First is delivering top line organic growth, where we look for the electric market to grow mid-single digits and expect our market share to expand as our investments take scale and the business grows. Second, we are driving increased productivity to the automation and digitization of work through higher utilization of our people and our facilities and by streamlining and standardizing our processes and our metrics. Finally, as we look at M&A, we will continue in strategic areas of focus with an eye towards margin and earnings accretion. We will continue to evaluate our pipeline of acquisition opportunities. We now expect capital expenditures to be in the range of 7.5% to 8.5% of revenue in 2024. This is up slightly, reflecting CapEx in the 2 acquisitions we have closed and our plan to continue to pursue high-return growth investment opportunities. In summary, I'm proud of the strong results we delivered in the second quarter and in the first half of 2024, which position us well to deliver on our goals for the full year and beyond. We believe we are growing our business faster than the market, gaining share while improving profitability and enhancing our already strong cash-generating profile. This positions us to be active yet selective in our deployment of capital. We are creating and delivering shareholder value on our path to being our customers' most trusted science-based safety, security and sustainability partner. Now let me turn the call back to Jenny for her closing remarks.

Thanks, Ryan. In summary, we are proud of how our team performed in the second quarter, delivering strong top line growth and solid margin improvement, which we believe sets us up to deliver impressive full year results in our first year as a public company and beyond. We are a leader in a highly fragmented industry, focused on product markets that we believe will be driven by long-term mega trends that favor our unique suite of offerings. Our focused execution and targeted M&A strategy position us to share -- to gain share and help accelerate our ability to ensure safety, compliance and sustainability. We believe we have the strong investment-grade balance sheet and robust cash flow profile to deliver outsized long-term returns for all shareholders. As we continue on this journey of being a public company, occasionally, I will highlight for you some important awards or notable events because it helps bring to life some of the amazing work and technical expertise we have in so many areas of safety science. So today, I'm going to talk about the environmental impact of refrigerants, those used in everything from drinking fountains to industrial chillers. This has been a growing concern for decades. As major transformations for refrigerants within the industry emerge, phasing down outdated and climate damaging refrigerants will be a continuous challenge in years to come. In March, Brian Rogers, UL Solutions principal engineer for HVAC was invited to the White House to discuss this important safety concern. UL Solutions has been working hard on this issue since the late 1980s and the knowledge that we can offer to solve these safety challenges are extremely deep. This is just one of many examples in which our experts are invited to meetings at the highest levels to help shape the needed safety outcomes for consumers and indeed, for our entire society. With that, I will wrap up by saying we are thrilled to be building on the momentum we had leading up to our April IPO and I'm excited for what the future holds for UL Solutions. Operator, let's please open the call for questions.

[Operator Instructions] Our first question comes from the line of Stephanie Yee with JPMorgan.

Congrats on a strong quarter.

Thanks, Stephanie.

So when I look at organic revenue growth in the first half, it was 8%, which I would consider to be high single digits. You maintained your full year guide at mid-single digits growth. Could you -- is that for conservative reasons? Are you expecting some deceleration in growth in the back half because the back half is expected to be mid-single digits? Or is there like a tough year-over-year comparison issue in any particular segment that you can kind of highlight.

Well, absolutely, Stephanie. As you highlighted, we are pleased with the 8% first half growth organically. And if you look at the back half of last year, our second half comps are a bit more challenging because we saw some growth drivers begin to accelerate in the second half of last year. Our organic growth in Q3 last year was 7.5% and Q4 was 8.3%. So we're comfortable giving realistic guidance that we expect to deliver.

Okay. That's helpful. And you mentioned some improving trends within consumer, especially retail. It seems like EMC trends are still strong. Do you expect those improving trends to continue in the back half of the year?

We are seeing some confidence in consumer in our customers' reinvesting in R&D and innovation. And we -- as I mentioned, those global warming potential type of test that we talked about in the HVAC business continues to be that type of driver for the consumer business. So we think that our customers see confidence in the consumer space and that they're making investments in R&D and innovation.

Our next question comes from the line of George Tong with Goldman Sachs.

Organic revenue growth in the Industrial segment accelerated to around 11.5% in the quarter despite the comps in the prior year period becoming considerably more difficult. Can you elaborate on some of the tailwinds you're seeing on the industrial side and the extent to which they should persist into the second half of the year?

Absolutely, George. And there is tremendous stamina in industrial. It's driven by those megatrends that we talk about, the electrification of everything. We see great demand in power and controls. I mentioned the Korea battery lab that came online and we've seen great market demand from that. In the built environment, we're seeing an increase in demand around things like warehouse solutions and fire suppression and fire-resistives and containment products. So there's a lot of different pieces in industrial that really flow through this demand that is reflected by the electrification of everything and those trends that are -- those megatrends that are out there.

And George, just to add on that, you're right. We are lapping a period where we had double-digit organic growth in the second quarter of last year. The 5 consecutive quarters of double-digit organic growth for Industrial.

Great. That's helpful. And then turning to the consumer business, the margins -- EBITDA margins expanded 210 bps on a year-over-year basis. Can you talk about whether that pace of margin expansion is sustainable and some of the efficiency initiatives that you're undertaking to continue to unlock margin expansion going forward.

Indeed, we are seeing improved cost structure in the segment. We had a number of expense management actions in 2023. And when you look across occupancy, new labs, better efficiencies, IT costs, we continue to believe that there are -- the consumer margins are durable, and there's additional margin expansion opportunities.

Our next question comes from the line of Andrew Nicholas with William Blair.

I wanted to ask first on Software and Advisory. You talked last quarter and again this quarter about some of the momentum with ULTRUS in particular. I'm just curious, how much of the improved growth in that segment would you attribute to that product versus sales force execution or any other strategic shifts that you've made over the past several quarters.

Well, I think the sales force execution is tied to the growth in Software & Advisory. We mentioned in the past that we're undergoing a commercial transformation there. And we did see equally balanced growth this quarter between both the software and the advisory side of the business. But ULTRUS, we believe is really helping propel what we're seeing in the pipeline. 2/3 of our top 500 customers purchased both TIC and software and advisory and we've been very focused in using ULTRUS to help extend the value proposition of those modules that are within that ULTRUS umbrella. We've had a number of additional releases within ULTRUS, particularly in the sustainability software, and we continue to see favorable results or favorable indications, I should say, from the marketplace about the value of those products.

Great. And then for my follow-up, maybe on a different topic. Throughout your prepared remarks, you talked about maybe new labs, whether it's the HVAC center in Texas or the advanced battery lab in Korea experiencing pretty quick ramp-up in activity. And I'm just wondering if that is consistent with what you have historically seen with new labs and if it affects your kind of willingness to invest in similar initiatives going forward, just feels like the uptick is more immediate than maybe I would have otherwise expected. So any context there would be great.

Andrew, I really appreciate you calling that out because it reflects a philosophy that we have around capital investment is that we really want to see potential demand before we even start breaking ground on a lab. And so many of these, our customers come to us and we'll ask us if we're willing to extend our footprint, our capacity to accommodate their growth. And we saw that in a number of cases. So like the Korea lab that we talked about that came online last year, I think it was pretty close to capacity within that first quarter. We're excited about the backlog that we're seeing for the North American battery lab that will come online in August. So it is reflective of our philosophy and the ways in which we deploy capital. So when we talk about that growth capital, we are grounding that growth capital in market-based research and facts based on our customer conversations.

Yes. And I would just build on that, in particular, related to batteries, which large capacity batteries are a relatively new technology. And we've made investments in China, in Korea, in North America and then the surrounding technologies in many other locations for things like charging and the plastics and casings that are used in batteries. So the revenue growth we saw in the customer demand, particularly in Korea, gave us the confidence to make that additional investment. It's definitely early days in North America and we don't have that battery open yet but we'll -- that lab open yet but we'll continue to evaluate.

Our next question comes from the line of Heather Balsky with Bank of America.

This is Emily Marzo on for Heather Balsky. Wondering if you could give us an update on your pricing initiatives, what you're seeing in the market, if you're getting any pushback on pricing?

We continue to be focused on the configuration price quote software that we've implemented and deploying that across our entire set of commercial teams and our pipeline remains strong. The evidence that we look to is really our Net Promoter Scores, which we keep a close eye on, conduct that quarterly. And our response rate continue to be strong, and we continue to trend upward. And the data point that I look most closely at is perceived value and our customers continue to express that they perceive value from the services that we offer. So that leads me to continue to believe that pricing is holding in a really strong way.

Okay. And I guess the next question, you had 2 German acquisitions in the quarter. Could you talk to us a little bit about your M&A opportunities, what you're seeing? Is it a geographic approach? Is it a capacity or capabilities approach? Like what are you seeing in the market?

It's a great question because we are active in M&A globally. We've got a number of prospects and a number of opportunities that we evaluate all over the world. So it's a bit coincidental that we closed 2 in Germany this quarter. That said, our M&A philosophy is to be the acquirer of choice. We've been in business for 130 years. So many of these entrepreneurs and founders know us. Some of them even started as UL employees and then launched their own business, and it's a great opportunity for them to return. So our M&A philosophy is where we can gain intellectual property that we otherwise don't have or where we can gain access to a set of customers or a set of capabilities that would be harder for us to build organically, we pursue it.

We prioritize each of our businesses, and we seek to establish and maintain leadership in all of our businesses. And sometimes, we have portfolio components that don't fit those objectives. And in the last roughly a year, we've divested 2 businesses. So it goes both ways.

Our next question comes from the line of Stephanie Moore with Jefferies.

I wanted to take maybe a high-level question here. Obviously, it's an election year, and there is a potential we could see a new President who might take a harder stance on tariffs versus the current administration on what we've seen in the last couple of years. So with this potential change, I'd love to get your thoughts on what your customers are saying in terms of contingency plans, preparation, potentially maybe moving manufacturing to different locations. How this could potentially impact you guys if you think it's neutral, positive or negative implications? So any color there?