Enerpac Tool Group Corp: Form 10-Q for the period ended Nov 30, 2023

Enerpac Tool Group Corp. is a premier industrial tools, services, technology, and solutions company serving a broad and diverse set of customers in more than 100 countries. The Company's businesses are global leaders of high pressure hydraulic tools, controlled force products and solutions for precise positioning of heavy loads that help customers around the world safely, reliably and efficiently tackle some of the most challenging, complex, and often hazardous jobs. The Company was founded in 1910 and is headquartered in Menomonee Falls, Wisconsin. The Company has one reportable segment, the Industrial Tools & Services Segment ("IT&S"). The IT&S segment is primarily engaged in the design, manufacture and distribution of branded hydraulic and mechanical tools and in providing services and tool rental to the oil & gas/petrochemical; general industrial; industrial MRO, machining & manufacturing; power generation, infrastructure, mining and other markets. Financial information related to the Company's reportable segment is included in Note 13, "Segment Information" in the notes to the condensed consolidated financial statements. The Company has an Other operating segment, which does not meet the criteria to be considered a reportable segment.

Our businesses provide an array of products and services across multiple markets and geographies, which results in significant diversification. The IT&S segment and the Company are well-positioned to drive shareholder value through a sustainable business strategy built on well-established brands, broad global distribution and end markets, clear focus on the core tools and services business and disciplined capital deployment.

Our Business Model

Our long-term goal is to create sustainable returns for our shareholders through above-market growth in our core business, expanding our margins, generating strong cash flow, and being disciplined in the deployment of our capital. We intend to grow through execution of our organic growth strategy, focused on key vertical markets that benefit from long-term macro trends, driving customer driven innovation, expansion of our digital ecosystem to acquire and engage customers, and an expansion in emerging markets such as Asia Pacific. In addition to organic growth, we also focus on margin expansion through operational efficiency techniques, including lean, continuous improvement and 80/20, to drive productivity and lower costs, as well as optimizing our selling, general and administrative expenses through consolidation and shared service implementation. We also apply these techniques and pricing actions to offset commodity increases and inflationary pricing. Finally, cash flow generation is critical to achieving our financial and long-term strategic objectives. We believe driving profitable growth and margin expansion will result in cash flow generation, which we seek to supplement through minimizing primary working capital. We intend to allocate the cash flow that results from the execution of our strategy in a disciplined way toward investment in our businesses, maintaining our strong balance sheet, disciplined M&A and opportunistically returning capital to shareholders. We anticipate the compounding effect of reinvesting in our business will fuel further growth and profitable returns.

General Business Update

In March 2022, the Company announced the start of its ASCEND transformation program (“ASCEND”). ASCEND’s key initiatives include accelerating organic growth strategies, improving operational excellence and production efficiency by utilizing a Lean approach, and driving greater efficiency and productivity in selling, general and administrative expense by better leveraging resources to create a more efficient and agile organization. In support of the ASCEND initiatives, the Company anticipates investing

approximately $70 to $75 million over the life of the program, which is expected to be fully implemented by the end of the fourth quarter of fiscal 2024, with an expected annual operating profit improvement from the program in the range of $50 to $60 million. Through the end of fiscal 2023, the Company had realized approximately $54 million of annual operating profit and had invested approximately $60 million as part of the program.

In June 2022, the Company approved a restructuring plan in connection with the initiatives identified as part of the ASCEND transformation program (see Note 3, “ASCEND Transformation Program” in the notes to the consolidated financial statements) to drive greater efficiency and productivity in global selling, general and administrative resources. The total costs of this plan were then estimated at $6 to $10 million, constituting predominately severance and other employee-related costs to be incurred as cash expenditures and impacting both IT&S and Corporate. On September 23, 2022, the Company approved an updated restructuring plan. The restructuring costs of this updated plan (which includes the amounts for the plan approved in June 2022) are estimated at $10 to $15 million. These costs are expected to be incurred over the expected duration of the transformation program, ending in the fourth quarter of fiscal 2024. For fiscal 2024, we expect to incur $10 to $15 million of ASCEND transformation program costs, which is inclusive of $3 to $5 million of restructuring costs.

Results of Operations

The following table sets forth our results of continuing operations (dollars in millions, except per share amounts):

(1) Results are from continuing operations and exclude the financial results of previously divested businesses reported as discontinued operations. The summation of the individual components may not equal the total due to rounding.

Consolidated net sales for the first quarter of fiscal 2024 were $142 million, an increase of $3 million or 2% compared to the prior-year comparable period. The impact of weakening U.S. dollar on foreign currency rates compared to the first quarter of fiscal 2023 favorably impacted sales by approximately $2 million or 2% and the divestiture of the Cortland Industrial business during the fourth quarter of fiscal 2023 unfavorably impacted sales by approximately $7 million or 5%. Management refers to sales adjusted to exclude the impact of these items (foreign currency changes and recent acquisitions and divestitures) as "organic sales" (which we formerly referred to as "core sales"). Compared to the prior-year period, in the first quarter of fiscal 2024, product sales declined 1% with foreign currency favorably impacting sales by $1 million or 2%, and the divestiture of Cortland Industrial unfavorably impacting sales by $7 million or 7% resulting in product organic sales growth of 4%. The product organic sales growth is attributed to carryover price increases and favorable sales mix in IT&S product. Service sales increased 13% compared to the prior-year period, favorably impacted by foreign currency rates of approximately $1 million or 3% resulting in 10% organic sales growth year over year.

Gross profit as a percentage of sales was approximately 52% for the first quarter fiscal 2024 compared to 49% in the first quarter of fiscal 2023. The increase in gross profit as a percentage of sales was driven by operational improvements related to ASCEND, favorable sales mix, carryover price increases from fiscal 2023, and the disposition of the Cortland Industrial business.

Operating profit for first quarter of fiscal year 2024 was $29 million, an increase of $16 million compared to first quarter fiscal 2023. The increase in operating profit was driven by the aforementioned benefits in gross profit, as well as the decrease in Selling, general & administrative expense ("SG&A") by approximately $10 million year over year. SG&A decreases were a result of $8 million in lower ASCEND transformation program expenses and decreases in personnel cost and indirect spend from the actions taken in the ASCEND transformation program.

Segment Results

IT&S Segment

The IT&S segment is a global supplier of branded hydraulic and mechanical tools and services to a broad array of end markets, including oil & gas/petrochemical; general industrial; industrial MRO, machining & manufacturing; power generation, infrastructure, mining and other markets. Its primary products include branded tools, cylinders, pumps, hydraulic torque wrenches, highly engineered heavy lifting technology solutions and other tools (Product product line). The segment provides maintenance and manpower services to meet customer-specific needs and rental capabilities for certain of our products (Service & Rental product line). The following table sets forth the results of operations for the IT&S segment (dollars in millions):

IT&S segment net sales for the first quarter of fiscal 2024 increased by $10 million or 8%, compared to the first quarter of fiscal 2023. The weakening of the U.S. dollar favorably impacted sales by $2 million or 2%, resulting in organic sales growth of 6%. Organic sales growth was driven by carryover pricing actions from fiscal 2023 and favorable sales mix. Operating profit was $36 million compared to $27 million in the first quarter of fiscal 2023 and increased due to pricing actions, favorable sales mix and reductions in SG&A.

Corporate

Corporate expenses were $9 million and $16 million in the three months ended November 30, 2023 and 2022, respectively. The approximately $7 million decrease for the three months ended November 30, 2023 was driven by lower ASCEND transformation program charges.

Financing Costs, net

Net financing costs were $4 million and $3 million for the three months ended November 30, 2023 and 2022, respectively. Financing costs increased due to higher debt balances and higher interest rates.

Income Tax Expense

The Company's global operations, acquisition activity (as applicable) and specific tax attributes provide opportunities for continuous global tax planning initiatives to maximize tax credits and deductions. Comparative earnings before income taxes, income tax expense and effective income tax rates from continuing operations are as follows (dollars in millions):

The Company’s earnings from continuing operations before income taxes include earnings from both U.S. and foreign jurisdictions. As several foreign tax rates are higher than the U.S. tax rate of 21%, the annual effective tax rate is impacted by foreign rate differentials, withholding taxes, losses in jurisdictions where no benefit can be realized, and various aspects of the U.S. Tax Cuts and Jobs Act, such as the Global Intangible Low-Taxed Income and Foreign-Derived Intangible Income provisions.

The effective tax rate for the three months ended November 30, 2023 was 23.6%, compared to 27.1% for the comparable prior-year period. The effective tax rate in each time period was impacted by year-to-date losses and deductions in jurisdictions where no tax benefit can be realized. The lower effective tax rate for the three months ended November 30, 2023 was primarily driven by the more favorable tax impact of stock compensation in comparison to the prior period. Both the current and prior-year effective income tax rates include the impact of non-recurring items.

Cash Flows and Liquidity

At November 30, 2023, we had $148 million of cash and cash equivalents, of which $135 million was held by our foreign subsidiaries and $13 million was held domestically. The following table summarizes our cash flows provided by operating, investing and financing activities (dollars in millions):

Net cash used by operating activities was $7 million for the three months ended November 30, 2023 as compared to $18 million of cash provided by operating activities for the three months ended November 30, 2022 . The approximately $25 million decrease in cash from operating activities is primarily due to annual incentive compensation payment made in the first quarter fiscal 2024, while the prior-year payment was made in the second quarter, and payments made for ASCEND transformation program charges.

Net cash used in investing activities was $3 million for both the three months ended November 30, 2023 and 2022. The cash used in investing activities for both fiscal years primarily related to capital expenditures.

Net cash provided by financing activities was $2 million for the three months ended November 30, 2023 compared to $6 million cash used by financing activities for the three months ended November 30, 2022. The net cash provided by financing activities for the three months ended November 30, 2023 consisted of $30 million increase in total borrowings, offset by $26 million of payments to acquire treasury shares and payment of the annual cash dividend of $2 million. Net cash used in financing activities for the three months ended November 30, 2023 consisted of $1 million decrease in total borrowings, $2 million in debt issuance costs and $2 million payment of the annual cash dividend.

On September 9, 2022, the Company refinanced its previous senior credit facility with a $600 million senior credit facility, comprised of a $400 million revolving line of credit and a $200 million term loan, which will mature in September 2027. The Company has the option to request up to $300 million of additional revolving commitments and/or term loans under the new facility, subject to customary conditions, including the commitment of the participating lenders. The senior credit facility contains restrictive covenants and financial covenants. See Note 8, "Debt" in the notes to the condensed consolidated financial statements for further details regarding the senior credit facility.

At November 30, 2023, there were $47 million of borrowings and $352 million available under the revolving line of credit facility after reduction for $1 million of outstanding letters of credit issued under the new facility. The Company was in compliance with all covenants under the senior credit facility at November 30, 2023.

We believe that the revolving credit line, combined with our existing cash on hand and anticipated operating cash flows, will be adequate to meet operating, debt service, acquisition and capital expenditure funding requirements for the foreseeable future.

Primary Working Capital Management

We use primary working capital as a percentage of sales (PWC %) as a key metric of working capital management. We define this metric as the sum of net accounts receivable and net inventory less accounts payable, divided by the past three months sales annualized. The following table shows a comparison of primary working capital (dollars in millions):

Commitments and Contingencies

Given our desire to allocate cash flow and revolver availability to fund growth initiatives, we have historically leased most of our facilities and some operating equipment. We lease certain facilities, computers, equipment and vehicles under various operating lease agreements, generally over periods ranging from one to twenty years. Under most arrangements, we pay the property taxes, insurance, maintenance and expenses related to the leased property. Many of our leases include provisions that enable us to renew the

leases at contractually agreed rates or, less commonly, based upon market rental rates on the date of expiration of the initial leases.

We had outstanding letters of credit totaling $7 million and $9 million at November 30, 2023 and August 31, 2023, respectively, the majority of which relate to commercial contracts and self-insured workers' compensation programs.

We are also subject to certain contingencies with respect to legal proceedings and regulatory matters which are described in Note 14, "Commitments and Contingencies" in the notes to the condensed consolidated financial statements. While there can be no assurance of the ultimate outcome of these matters, the Company believes that there will be no material adverse effect on the Company's results of operations, financial position or cash flows.

Contractual Obligations

Our contractual obligations have not materially changed at November 30, 2023 from what was previously disclosed in Part 1, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Contractual Obligations” in our fiscal 2023 Annual Report on Form 10-K.

Critical Accounting Estimates

Management has evaluated the accounting estimates used in the preparation of the Company's condensed consolidated financial statements and related notes and believe those estimates to be reasonable and appropriate. Certain of these accounting estimates are considered by management to be the most critical in understanding judgments involved in the preparation of our condensed consolidated financial statements and uncertainties that could impact our results of operations, financial position and cash flow. For information about more of the Company’s policies, methodology and assumptions related to critical accounting policies refer to the Critical Accounting Policies in Part 1, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our fiscal 2023 Annual Report on Form 10-K.

The diverse nature of our business activities necessitates the management of various financial and market risks, including those related to changes in interest rates, foreign currency exchange rates and commodity costs.

Interest Rate Risk: As of November 30, 2023, long-term debt consisted of $47 million of borrowing under the revolving line of credit (variable rate debt) and $198 million of term loan debt bearing interest based on SOFR (variable rate). An interest-rate swap effectively converts the SOFR-based rate of $60 million of term borrowings under our credit facility to a fixed rate. A ten percent increase in the average costs of our variable rate debt would have resulted in less than $1 million of an increase in financing costs for the three months ended November 30, 2023.

Foreign Currency Risk: We maintain operations in the U.S. and various foreign countries. Our more significant non-U.S. operations are located in Australia, the Netherlands, the United Kingdom, United Arab Emirates and China, and we have foreign currency risk relating to receipts from customers, payments to suppliers and intercompany transactions denominated in foreign currencies. Under certain conditions, we enter into hedging transactions (primarily foreign currency exchange contracts) that enable us to mitigate the potential adverse impact of foreign currency exchange rate risk (see Note 10, “Derivatives” in the notes to the consolidated financial statements for further information). We do not engage in trading or other speculative activities with these transactions, as established policies require that these hedging transactions relate to specific currency exposures.

The strengthening of the U.S. dollar against most currencies can have an unfavorable impact on our results of operations and financial position as foreign denominated operating results are translated into U.S. dollars. To illustrate the potential impact of changes in foreign currency exchange rates on the translation of our results of operations, quarterly sales and operating profit were remeasured assuming a ten percent decrease in all foreign exchange rates compared with the U.S. dollar. Using this assumption, quarterly sales would have been lower by $2 million and operating profit would have been lower by approximately $1 million, respectively, for the three months ended November 30, 2023. This sensitivity analysis assumes that each exchange rate would change in the same direction relative to the U.S. dollar and excludes the potential effects that changes in foreign currency exchange rates may have on sales levels or local currency prices. Similarly, a ten percent decline in foreign currency exchange rates versus the U.S. dollar would result in a $35 million reduction to equity (accumulated other comprehensive loss) as of November 30, 2023, as a result of non-U.S. dollar denominated assets and liabilities being translated into U.S. dollars, our reporting currency.

Commodity Cost Risk: We source a wide variety of materials and components from a network of global suppliers. While such materials are typically available from numerous suppliers, commodity raw materials, such as steel and plastic resin, are subject to price fluctuations, which could have a negative impact on our results. We strive to pass along such commodity price increases to customers to avoid profit margin erosion.

Evaluation of Disclosure Controls and Procedures.

Under the supervision and with the participation of our senior management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). There have been no changes in our internal control over financial reporting that occurred during the quarter ended November 30, 2023 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.