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Good day. My name is Jack, and I will be your conference operator today. At this time, I would like to welcome everyone to the nVent Q2 Earnings Conference Call. [Operator instructions].
J.C. Weigelt, Vice President of Investor Relations, you may begin your conference.
Thank you, Jack, and thank you, and welcome to nVent's second quarter 2018 earnings call. We're glad you could join us. I'm J.C. Weigelt, Vice President of Investor Relations, and with me today are Beth Wozniak, our chief executive officer, and Stacy McMahan, our chief financial officer. On today's call, we will provide details on our second quarter performance, as well as our third quarter and full year 2018 outlook.
Before we begin, let me remind you that any statements made about the company's anticipated financial results are forward-looking statements subject to future risks and uncertainties. This is the risk outlined in today's press release and nVent's filings with the Securities and Exchange Commission. Forward-looking statements included here are made as of today, and the company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances. Actual results could differ materially from anticipated results. Today's webcast is accompanied by a presentation which can be found in the investor section of nVent's website. Any references to non-GAAP financials are reconciled in the appendix of this presentation.
We'll have time for questions after our prepared remarks, and now I will turn the call over to Beth.
Thank you, J.C. Good morning, and thank you for joining us. The second quarter marks our first as a public company, and we delivered on all three of our top priorities: To stand up nVent, to deliver organic growth, and to expand Enclosures margin. I'm pleased with our second quarter results, and I'm proud of our team. We became a public company less than three months ago, and our team put forth tremendous effort to make it successful, all while serving our customers and delivering on our second quarter commitments. Both organic sales and adjusted segment income, excluding corporate and other costs, grew 4% in the quarter. In addition, I hope you saw our announcement on Monday that our board approved our first regular quarterly dividend of $0.175 per share, or $0.70 annualized. We also announced a $500 million share repurchase program over three years. These two items are important components of a broader capital allocation strategy focused on investing in growth and returning excess cash to shareholders. Stacy will touch on this later on the call. Turning to Page 4 of the presentation, this morning we reported second quarter revenue of $543 million, representing organic sales growth of 4%, which is at the high end of the guidance we provided in April. Sales were driven by strong results from both Enclosures and Electrical and Fastening Solutions, which we call EFS. Return on sales was 19.7%, also at the high end of our previously issued guidance range for the quarter.
Specifically, looking at Enclosures, sequential margin was up 270 basis points, as we continue to make progress toward margin recovery with optimization in our new manufacturing and distribution facilities. Second quarter adjusted earnings per share was $0.44, which was at the high end of our guidance. Turning to Slide 5, organic growth of 4% was driven by volume and strong price realization, which helped offset increased inflation. Organic growth was broad based, led by the industrial and commercial verticals. Although early, we are already beginning to see benefits from our enterprise-wide growth strategy. Segment income of $107 million grew 1%, in line with our guidance for the quarter. Adjusted segment income, excluding corporate and other costs, grew 4% during the quarter. We believe this is the best way of assessing year-over-year profitability trends throughout the first year, as we are comping allocated corporate and other costs in 2017. We anticipate this to even out by the end of the fourth quarter. During the quarter, we made significant progress in Enclosures margin, and we still expect margin expansion in the second half of the year. Our price cost improved from the first quarter, with better price realizing $9 million in the second quarter. Year-to-date, we delivered approximately $69 million in free cash flow, which includes $40 million of one-time separation and related costs. We target converting 100% of adjusted net income to free cash flow.
Now let's turn to Slide 6 for an overview of our Enclosures segment. During the first half of the year, I had the opportunity to meet with many of you and discuss our strategy to grow nVent and generate value for our shareholders. I learned during these conversations that it is helpful to review the value proposition for each of our segments, so I'm going to take a couple of minutes to discuss the Enclosure segment in particular. Our value proposition in Enclosures is simple: We connect and protect critical components and electronics that help to ensure equipment is always running, while also keeping workers safe. We have one of the broadest and most diverse product offerings in this industry that is tailored to meet specific customer needs. Our products meet global regulatory standards and have obtained stringent certifications. We provide both standard products as well as highly engineered solutions to meet a variety of customer requirements, like resistance to tough environmental conditions, size, material type, panel cutouts, cooling capabilities, color, and so much more. Our customers can purchase our products from more than 3,000 distribution points in North America alone, and we are a top 20 supplier to electrical distributors globally.
Within our Enclosures business, we also provide leading thermal management solutions, from air conditioners to high-density liquid cooling solutions that support customers' applications from hazardous plants or environments, to clean data centers. Our global manufacturing presence allows us to meet the demands of many global customers and OEMs that require product and support where they need it. I hope these insights give you a better understanding of our offerings from HOFFMAN and SCHROFF, and how we provide a clear value proposition to the end user. Now let's turn to Slide 7 for a discussion of second-quarter segment performance, starting with Enclosures. This segment grew approximately 9%, or 7% organically, in the second quarter. We saw broad-based growth that we believe outpaced industry growth of roughly 5%. We continue to see strong growth within our largest vertical, industrial, and are encouraged by a wide range of other verticals contributing to growth. Our previous outlook for the year was for this business to grow 3% to 5% organically. We now expect this business to deliver organic sales growth at the high end of this range for full year 2018. Importantly, we continue to make progress on Enclosures margin. Although return on sales was down 80 basis points year-over-year, we remain on track to see year-over-year improvements during the second half. Turning to Thermal Management, sales were more or less flat. While organic sales declined 3%, as our longer-cycle energy business continues to lag behind our initial expectations. This was somewhat offset by strong growth in industrial MRO and commercial vertical sales. Our longer-cycle energy business is experiencing strong quoting activity. We believe this business will rebound in the near term, though this is more likely to occur in the fourth quarter. Our Thermal team is launching new products and technology in the back half of this year that should provide additional innovative solutions for our customers. Like the first quarter, Thermal margin was especially strong at 21.9 percent, driven by a heavier mix towards the industrial MRO and commercial sides of the business. While sales have been muted in the first half, it is important to point out that Thermal has delivered strong year-over-year income growth.
Turning to EFS, sales increased 6%, or approximately 5% on an organic basis, with steady, broad-based growth throughout the quarter across multiple verticals. With a couple of price increases this year, the second quarter included a strong contribution from price, which offset inflation. Still, second quarter return on sales contracted 210 basis points, partially driven by a mix shift during the quarter. Our margin did improve sequentially, and we will continue to call for margin expansion for the full year. That concludes my remarks on the segments, and now I would like to move on to the topic of tariffs, which we have been following closely. Similar to when I spoke about this in April, the situation remains very fluid. We have a team focused on all the developments, and my leadership and I receive regular updates. Specifically on tariffs and counter-tariffs, we analyze the impact based on what we know today and expect it to be roughly $5 million on an annualized basis. This is point-in-time estimate, and we executing on a number of mitigating actions to help offset this impact, such as steel locks, pricing strategies, and identifiable actions within our supply chain.
These indirect impact from these tariff headlines remains in the form of increased inflationary pressure. As you know, steel prices appreciated earlier this year and have remained at elevated levels. We are executing on our mitigation plans, such as the recent price increases in Enclosures and EFS. The situation remains very fluid, but I can tell you we are aggressively reviewing it on an ongoing basis, taking the information and adapting to help alleviate some of this increased inflationary pressure. During the second half of the year, we believe we have a good line of sight to continue to drive organic sales and expand margins in Enclosures. We also have a keen focus on growth in Thermal, as we believe the longer-cycle energy business can rebound. We have a plan in place to execute on our growth initiatives within key verticals, which we expect to yield more and more to the top line. Our strategy is taking shape, and we are gaining traction in many areas I discussed with you at our February analyst day, including our One nVent vertical and channel growth, geographic, and geographic expansion initiatives. I would now like to turn the call over to Stacy.
Thank you, Beth, and good morning everyone. Please turn to Slide 8 titled Third Quarter 2018 nVent Outlook. We expect organic sales for the third quarter to increase 2% to 4%, and return on sales to be between 19% and 21%. We also introduced adjusted earnings per share guidance for the third quarter of $0.44 to $0.48. The recent move in exchange rates have created an approximate $10 million to $15 million negative impact to sales in the third quarter alone versus our April currency assumptions. As a general rule of thumb, about 10% of the currency impact to the top line will fall through to our segment income reporting line. Overall, we see our third quarter performance as being consistent with the second quarter. We anticipate similar organic sales in segment income growth, as we see strong volume, price, and improving productivity as the main offsets to tariffs, increased inflation, and currency headwinds. Turning to Slide 9 titled Full-Year 2018 nVent Pro Forma Outlook, we are holding our 2018 guidance for sales and margin, consistent with the guidance we issued in February. By segment, there are a couple moving parts I wish to call out. First, we point to the high end of our full-year Enclosures guidance of 3% to 5% organic sales growth, due to the strong start to the year. Second, we see our Thermal business closer to the low end of our full-year sales guidance of flat to up 2% organically, as our longer-cycle energy business recovered later than expected.
We continue to believe Thermal will return to growth later in 2018, given what we are seeing in quote activity and the continued industrial MRO and commercial strength. Halfway through the year, we believe we have greater visibility into our adjusted earnings per share, and therefore, we are tightening the range by $0.02 on each end to $1.72 to $1.78, which keeps the midpoint consistent at $1.75. Turning to Slide 10, I want to share with you our capital allocation framework. It begins with maintaining investment-grade metrics. This gives us good and competitive access to capital. Our top priority remains reinvesting in our business to drive growth through new initiatives such as One nVent and Digital, and we would look to augment growth with a targeted bolt-on M&A strategy. In addition, we plan to return excess cash to shareholders through dividends and share repurchases, as you saw with our press release on Monday. The dividend represents an approximate 40% payout ratio, which we see as being competitive amongst our peers. The share repurchase authorization for $500 million over a three-year period gives us the flexibility to offset dilutions and return excess cash to shareholders. We expect this framework to position us well as we target top-tier shareholder returns.
As Beth stated, we delivered on our commitments during the quarter and understand what we need to do in order to deliver the remainder of the year. I will now turn the call over to the operator for Q&A, after which Beth will have a few closing remarks. Jack, please open the line for questions. Thank you.
You're welcome. [Operator Instructions] Your first question comes from the line of Deane Dray with RBC Capital Markets.
Beth and Stacy, congratulations to you and the team for the smooth first-quarter earnings for nVent. So, we like seeing all that and also like seeing the dividend and buyback announcement. First question is kind of big picture, is where are you today on the right size being of the organization? One of the reasons we're particularly interested is you are not following the path of some spinouts that turn into these serial restructurers, and so the quality of earnings perception is very high with the idea that you're going to be doing pay-as-you-go restructuring. But just want to know what inning are you in in right-sizing the organization, how much of your focus is on this versus, let's say, the individual businesses. But, if we could start there, that would be helpful.
You know, when I think of right-sizing the organization, we did a lot of that work back in 2017. So as you're aware, we had significant restructuring, so as we go forward, one of the things were very pleased with is our portfolio with our three segments. All three of them are very profitable and have good positions in the industries where we focus. So I think you will see as we go forward that we'll continue to have some opportunities as we look at some of our ERP implementations, as we look to position ourselves to support fast growth regions. So, you know, I would say there's always more that you can do, but we're probably in the latter half of the innings. We don't see any real significant restructuring, but we're going to do things to continue to optimize our cost structure.
That's really good to hear. And then, my follow-up is I appreciate the color on the tariffs, because you anticipated that question. The two points in price was better than what we were looking for, so it looks like a lot of good work is happening there. But maybe, how does this translate into price cost for the year? The tariff headwind of $5 million annualized, how does that net against the 2 points, I think you said $9 million in pricing for the quarter? But how does that net out in expectations on price cost?
So as we look at the back half of the year, what we are driving toward is that our price, plus productivity, will offset inflation.
Does that include any of the potential indirect cost that is likely coming out of the tariff pressures today?
Yes, we've incorporated that, as I shared with you, into our forecast, as we know today. Things could change.
I got it.
Your next question comes from the line of Jeff Hammond with KeyBanc Capital.
Just on Enclosures, it sounds like obviously the top line coming in better. You know, clearly, you've kind of been below first half year-over-year and you're calling for flat margins. Just walk me through the confidence that you get the margin lift in the second half, and what are the big drivers to get there?
Okay, as you know, you know, we shared that we did some significant changes to our supply chain last year, and as we started to see demand come up, we were inefficient in terms of just how we were bringing up our new factory and just managing capacity. So I think we have a lot of confidence as we go into the back half of the year because of the performance that you've seen through the first half. So sequentially, from Q4 to Q1 and Q1 to Q2, we've improved margins, and we're able to see that we're getting more productive. We're able to see that the different focus areas that we have in optimizing both our manufacturing and distribution and logistics are improving. So we do expect in Q3 and Q4, you're going to see year-over-year margin expansion in Enclosures.
Great. And then, seasonally, you have much stronger cash flows in the second half, and you know, you did lay out the dividend and buybacks. But just give me a sense of what the best use of cash here is, as you start to generate, you know, more meaningful cash. Do we pay down debt for a while, or can we jump right in to M&A and buybacks? Thanks.
Jeff, we like the flexibility that we've set up within our capital allocation framework. We have said our priorities are to reinvest in nVent's growth strategy, and then to add to it some bolt-on M&A opportunities. But we do produce much cash, and we want to return excess cash to shareholders. The dividend is positioned competitively, and our cash flow is well supportive of it. In addition, if we have the room to be able to return excess cash through a share buyback, we will, depending on M&A opportunities. The other option we have is to reduce debt, and again, the optionality in our capital framework, given our strong cash flow generation capability, is good for us.
Your next question comes from the line of Scott Graham with BMO Capital Markets.
Can you hear me?
Yes.
Awesome, thank you. I had a little trouble this morning, technically. You were kind enough to say what price cost was in EFS. When you said the price cost price exceeded inflation, you meant purely price, not price and productivity?
In EFS business, yes, that is correct.
Could you kind of give us the same framework for the quarter for the other two segments? I'm assuming below, yes?
Yes. Enclosures, for instance, had a slightly less price realization. It has a little bit more of a lag as it increased its price through the pre-notification required with distributors, and there's not a full quarter of price realization for their second quarter price increase yet. So, just wanted to call that out, so there is a bit of a lag, so it does not fully offset inflation. And similarly, Thermal is in a similar position.
Yeah, Thermal I'm assuming you didn't get much price there at all because of the market conditions.
Yes, and because we had a small price increase very early in the year in Q1, and not one in Q2.
But as we start to see inflation in resins, for example, we have a price increase that we're going to execute in Q3 in Thermal.
Now, sort of the same question, tiger with different stripes though. We heard this yesterday from your sister company, I guess no longer, but we've heard this before as well, that there seems to be a movement afoot here to be very customer-friendly on pricing and not to do too much too fast, make sure that we announce it, the whole thing. I'm just wondering, we are in a very unique inflation environment, something truthfully, I haven't seen for a while; I don't want to tell you how long that is. But it seems to me that customers are almost kind of getting a little bit of a pass here, and I'm just kind of wondering on your view there, the need to [ GAAP] out the price because we have to notify, because 60 days and all this. Is there a way to get around that? Because it just seems like, you know, we're kind of allowing customers a benefit that--you know, and putting that perk on us. You're not the only company, and that's what I'm implying here. Is there a way to get around this?
Well, I think, you know, the way we think about it is you're absolutely right; with this high inflationary environment, I think our channel partners expect it, I think end users expect it. And what we're trying to do is continue to be on top of what we see going on with inflation and introduce these price increases as soon as we anticipate that there is going to be some inflation. So I think we're trying to manage it very real-time, and so we're definitely not delaying decisions. As you can imagine, there's a lot of work, just to implement these price increases through multiple channels, and so that's part of the reason that there's a delay to when all that goes out, but we're trying to manage it as actively as we can and not delaying.
That's really all I have. Thank you for you--and congratulations on your first independent earnings call.
Your next question comes from the line of Julian Mitchell with Barclays.
This is Ronnie Weiss on for Julian. I was wondering if you could help me walk through the margin ramp from Q3 to Q4. You know, with the margins guided down 110 basis points after being down in the first half, full year held at flat. I was wondering if you could just walk us through the big buckets of items that kind of swing from Q3 to Q4 to kind of get to that margin.
Yes, that's a great question, Julian. You will see that we have a unusually difficult comp in the Thermal business in Q3, and so that will cause sort of Q3 to be a more moderate position, and that maybe will help you with the math into Q4. The other thing in Q4 to remember, again, these are events of last year, both the unusually high Thermal margin in Q3 of 2017, and in Q4 of 2017 is when we saw the largest challenge in our productivity in our Enclosures business as we moved the factories and opened a new distribution center.
So as we go forward, you know, productivity we expect to be stronger in the second half of the year, and we also expect to continue to see strong price realization.
From a sequential performance, I think you'll see Q3 and Q4 looking pretty good and pretty consistent. Year on year hopefully is where the blip is, and it's based on 2017 events.
Got it. And then, on that productivity point, you know, the first half was still down combined minus one. I think the guide originally was for that to be $50 million for the year. Is that still the expectation? And kind of, what's the visibility on getting to that number for the year?
Yes, a great question. Yes, the guide was around $50 million at--I think we set that forth at investor day. And essentially, that $50 million did not have the growth investment netted out of it, so really, it would be around $40 million, because the growth investment's around $11 million, and it should have said $40 million. We're still saying it's a little more challenging. We're going to get to the same bottom line of about $430 million of segment income, but just a little different path. We have stronger price and stronger growth that offsets the lower currency benefit and increased inflation. So the equation is slightly different, but we still get to the same endpoint.
Understood. Thanks for the color.
[Operator instructions] Your next question comes from the line of Erik Karlsson with Industrial Equity.
In Enclosures, could you help us understand how much of the productivity improvement you expect to have achieved by year end and whether there's any flow-through in 2019?
So we expect the Enclosures margin, again, to year-on-year expand in the back half, and we will not get back to the full, you know, historical levels of Enclosures margin until the end of 2018, beginning of 2019. Productivity improvements will continue throughout the rest of this year, and it's an ongoing--it's an ongoing challenge for us to continue to maintain productivity every day.
Very good. So if I understand that correctly, as a follow-up, by the end of this year or early 2019, as a run rate, you'll be back to prior peak?
Not peak, but--no, back to prior general levels in that sort of 19%, 20% range.
Very good, and maybe one more follow-up, if I may, just on M&A, and you talked about capital allocation; already very helpful. But do you think--are you actually looking for bolt-on acquisitions already this year, potentially?
You know, one of the things that we set as our priority was to ensure that we were operating as a new public company successfully. So it is not in our near-term focus, because we think it's important to show that we can drive organic growth, to show that we can execute on our growth strategy and deliver results. So, that was not our near-term priority, and I think as we start to execute and get a track record, we have lots of opportunity for M&A, but it just won't be near term.
Very clear. Thank you very much.
There are no further questions at this time. I would now like to turn the call back over to Beth Wozniak for closing remarks.
Well thank you for joining us today, and your interest in nVent. I'm proud of the work we put forth to ready ourselves for the spin on April 30th, and we're on track with the priorities we laid out earlier in the year. And that was to do three things, you know, to stand up nVent, where we've made tremendous progress; two, to drive organic growth, with second quarter sales being evidence that we can do just that; and three, improve Enclosures margin, where we've demonstrated sequential improvement in the first and second quarters, and we expect to show year-over-year improvement during the second half of the year. We've had a good first half. We're aligned on our strategy to grow this business organically, and we have the team to execute. Thank you for your interest, and Jack, you can now conclude the call.
This concludes the conference call for today. We thank you for your participation. You may now disconnect.