GCP Applied Technologies Inc (GCP) 2017 Q2 法說會逐字稿

Good day, everyone, and welcome to the GCP Applied Technologies' Second Quarter 2017 Earnings Conference Call. (Operator Instructions) And please do note that today's event is being recorded.

I would now like to turn the conference over to Joe DeCristofaro, VP of Investor Relations. Please go ahead.

Thank you, William. Hello, everyone, and thank you for joining us on today's call. With us on the call are Greg Poling, President and Chief Executive Officer; and Dean Freeman, Vice President and Chief Financial Officer.

Our earnings release and corresponding presentation slides for our second quarter results are available on our website. To download copies, please go to gcpat.com and click on the Investors tab.

Some of our comments today will be forward-looking statements under U.S. Federal Securities Laws. Actual results may differ materially from those projected or implied due to a variety of factors. We will discuss certain non-GAAP financial measures, which are described in more detail in this morning's earnings release and on our website. Our comments on forward-looking statements and non-GAAP financial measures apply both to the prepared remarks and to the Q&A. References to EBIT refer to adjusted EBIT, and references to margin refer to adjusted gross margin or adjusted EBIT margin, as defined in our press release.

Greg will start us out today with a business update. Dean's commentary will include highlights of our second quarter financial results and 2017 guidance. We are discussing these results on a continuing operations basis to account for the sale of Darex Packaging Technologies. All revenue and associated growth rates in this discussion are stated on a comparable constant currency basis, which adjusts for the impact of foreign currency.

With that, I'll turn the call over to Greg.

Hi, good morning, everyone. Thank you for participating on the call. We're pleased with our accomplishments in the second quarter and we're well positioned for second half of 2017 as well as our future as a construction products technology company. We completed the sale of our Darex packaging business for over $1 billion. We have seen positive acceptance of our new product introductions. We completed the acquisition of Stirling Lloyd, which is a specialty waterproofing business, focused on infrastructure and commercial construction. We are also implementing a restructuring program and realigning our organization to reduce our cost and improve our effectiveness.

Sales in the quarter increased 5% due to growth in the cement additives and our acquisition of Stirling Lloyd and Halex earlier in the year. Our preapplied specialty waterproofing product line Preprufe saw a volume, which was consistent with a strong quarter last year, but our admixture business declined due to wet weather in North America and softness in our Asia Pacific business. Our in-transit concrete management system, Verifi, we saw install rates grow 25% and we opened a new state-of-the-art technology center to support this business here in Cambridge, Massachusetts. The 2 admixture products, which we launched in the first quarter, 1 for the control flow of concrete and the second to improve the quality of aggregates, each had their first commercial sale in the second quarter, and we have field trials underway with a number of customers and we're receiving positive feedback on these 2 new technologies. The Stirling Lloyd acquisition is off to an impressive start. We had some key infrastructure projects wins, which contributed to our results in the second quarter. And the Halex acquisition had good performance and we completed the sale of our low-margin tack strip product line that came along with that acquisition. We've initiated a company-wide restructuring and realignment program to reduce our expenses, eliminate stranded costs associated with the Darex divestiture and to delayer our organization to be closer to our customers. These initiatives are well underway. We've also reduced our debt and interest expense. We repaid our term loan and plan to pay down the amounts outstanding on our revolver by the end of 2017. We're reaffirming our 2017 guidance. We expect the second half to benefit from stronger project activity than we had in the first half of the year, the impact of our bolt-on acquisitions and savings associated with the restructuring activities and reduction of our debt.

Dean will provide you some details on how all of that adds up, and I'll come back at the end for a few comments.

Thanks, Greg, and good morning, everybody. Just a reminder, we're discussing the results on a continuing operations basis and all the revenues associated with the gross rate -- growth rates are on a constant currency basis.

GCP's consolidated revenues were up 5% to $297 million in the quarter. SCC sales were flat, and while we had growth in both cement additives and Verifi, our ready-mix business saw a slightly lower demand. We were pleased to see some recovery in Western Europe. However, we did have a lower project demand due to rainy weather in the U.S. and softness in Asia. SBM's revenue increased to 11% year-over-year, including the impact of Halex and the Stirling Lloyd acquisitions. Excluding the acquisitions, SBM was down about 4% compared to a strong second quarter of 2016.

In our preapplied waterproofing product line, project work, as expected, was flat compared to the prior year. We have major wins in North America, Europe and Latin America and the value of our second half project pipeline for building envelope is up more than 15% than it was last year, which supports our underlying expectations for second half revenue growth.

On a regional basis, North America revenues were up approximately 4%. SBM grew 8% in the region due to acquisitions and SCC was flat in North America as cement growth was offset by decline in concrete admixtures, as I mentioned, the wet weather impacted the seasonal construction activities. EMEA was up about 11% in the quarter, primarily due to the improved project activity for SBM as well as the acquisition of Stirling Lloyd. SCC decline about 1 point in the region due to strong cement growth, again, was offset by a decline in the ready-mix admixture, mainly in the Middle East. Most companies in Western Europe continue to improve, and Turkey grew on a year-over-year basis for the first time since the second quarter of 2016. In Latin America, growth in Argentina, Colombia and Peru helped to partially offset continued weakness in Brazil. Revenue in the region increased mainly due to price increases in Venezuela to offset the inflation there. In Asia Pacific, revenues declined about 7% in the quarter as growth in SBM was offset by a decline in SCC due to the infrastructure project delays and lower market volumes in Malaysia, Indonesia and Singapore. We also decided to maintain good price discipline and forego some low-margin business in SCC in the region.

Moving to GCP's adjusted EBIT, the decline in the quarter was primarily due to higher operating expenses, which will be reduced through our restructuring program and the negative impact of both raw material inflation and foreign exchange. The decline was partially offset by price and productivity improvements.

And turning to the margin performance for the segment, SCC's gross margins declined about 30 basis points due to lower-margin volumes as price and productivity offset the negative impact of raw material inflation. Segment operating margin for SCC increased 30 basis points in the second quarter. SBM's gross margins declined about 240 basis points to 45.6% due to the negative impact of raw material inflation, including a rise in butadiene-based rubbers, which was partially offset by price and productivity and comparatively stronger product margin mix in the second quarter of 2016.

SBM segment operating income declined about 1 point in the second quarter and segment operating margin was 27.5%. Rounding out the consolidated results for GCP in the quarter, net interest expense totaled about $17.5 million, adjusted EPS was $0.23 with diluted share count of $72.7 million and we invested about $9 million of CapEx. We generated positive adjusted free cash flow in the second quarter compared to a use of almost $39 million in the first quarter. So along with improved earnings, we will convert more working capital to cash in the second half of the year, which is consistent with the normal seasonality of the use of our cash in the business.

Looking at the rest of 2017 for the regional markets. The construction markets in North America continue to grow and market indicators suggest the outlook remains healthy across all segments. In Europe, we continue to expect moderate growth rates as recovery in Western Europe continues. And we're cautiously optimistic on Turkey, which has begun to improve. In Latin America, we are seeing growth in countries such as Argentina, Colombia and Peru, with stronger project work in Mexico. Brazil continues to face instability, which is negatively impacting the construction activity there. We expect a better second half in Asia Pacific as infrastructure projects positively impact our revenue. We are maintaining our guidance for the year with revenue growth of 5% to 8%, including acquisitions and adjusted EBIT in the range of $145 million to $160 million, which does include the impact of restructuring program savings in continuing operations. We expect our adjusted effective tax rate for 2017 to be between 32% and 33%, and capital investments are expected to be less than 5% of sales. And we're forecasting adjusted EPS range of $0.71 to $0.88 per share.

As Greg mentioned on Monday, July 31, we repaid $273 million outstanding balance of our term loan and we plan to pay down the amounts outstanding on our revolver by the end of the year, totaling about $125 million.

The annualized pretax interest expense savings as a result of these repayments is expected to be approximately $15 million or $0.15 of adjusted EPS. The estimated impact in 2017 is about $0.05 and that is included in our adjusted EPS guidance.

We continue to project about $40 million to $50 million of adjusted free cash from continuing operations for the second half of the year -- for the full year, excuse me. For the second half of the year, we expect the third and fourth quarter to be about evenly split for revenue and earnings.

As we've disclosed, we expect $22 million to $25 million of net cost reduction as a result of our restructuring plan, with $15 million of costs related to Darex eliminating in discontinued operations. $7 million to $10 million of net annualized savings will occur in continuing operations, including a planned reinvestment in sales and marketing activities. In 2017, we expect to achieve $5 million to $7 million of savings from restructuring and TSA cost recovery, which again is included in our guidance. In short, we've initiated a restructuring program that addresses all stranded costs related to that Darex divestiture.

So lastly, you should be aware though that on a continuing operations basis, we will continue to have -- sorry, to have -- lastly, you should be aware that we will continue to have discontinued operations for a period of time notwithstanding the close of Darex, as the Darex sale agreement provides for a series of delayed closings in certain non-U. S. locations in order to implement the legal transfer of the Darex business in those locations in accordance with the local law.

With that, I'll turn it over to Greg for closing comments.

Thanks, Dean. I'd just like to wrap up with a couple of comments. We did make significant progress in the quarter. We've included the divestiture of Darex, commercialization in new products, acquiring Stirling Lloyd and the initiation of our restructuring program. GCP is now a focused construction products technologies company. We've posted a presentation on our website that updates our strategy and outlines a number of our near-term initiatives. We currently participate in attractive $15 billion segments of the $10 trillion global construction market. We have leading market positions in concrete, cement additives, in-transit concrete management systems, high-performance waterproofing products and specialty systems. We're restructuring the company to effectively and efficiently deploy best-in-class selling capabilities, field service support, innovate products and technologies focused on these segments. We have the capital investment in technologies, plant and equipment as well as bolt-on acquisitions, while reducing the cost of our debt. The entire GCP is excited about the future and the focus on delivering value for our customers and shareholders.

And with that, we'll be happy to take some questions.

(Operator Instructions) And the first questioner today is maybe Laurence Alexander with Jefferies.

This is Jeff Schnell for Laurence. Is there a material fair value adjustment on Stirling Lloyd inventory? And if so, is it included in your EBIT outlook? And can you quantify the impact?

Yes, there was an inventory step up, but we adjust that out for guidance purposes.

Okay. And how do you think about the cadence of restructuring charges and cash outlays from here? How many quarters do you think before the noise starts to fade?

Well, I think, the cadence will be pretty significant in the second half of the year as we continue to support the TSA activity, but I think it starts to trail off in the early part of 2018.

Hey, Jeff, this is Greg, Let me sort of frame it for you. In '17, restructuring, realignment and the income on some of the Transocean Services agreements means our cost will be down (sic) [up] from $5 million to $7 million in '17. And what takes place is the restructuring flowing into '18 offset some of those service agreements. So the total next year is about $7 million to $10 million. So you're going to see an impact pretty much immediately going into the second half of the year, the way the activities are restructured to take costs out and some of the charges we have because of the services we're providing over the next few months. So you'll see it pretty quickly.

Great. If I can sneak one more in. On free cash flow conversion, it appears to be running about 25% of EBITDA. How much can you improve that conversion rate? And what do you need to do to get there?

Well, it's going to follow the seasonality of the business. So, I mean, as you look at the second half of the year, a good chunk of the improvement we see in the second half will come from earnings, improved earnings. And then we've got to convert the working capital that we built up to support the revenue and that will generate some of the cash. And then as we've kind of pointed out, we'll have interest payments in the second half as well, but it's largely going to come from the earnings profile and the generation of cash -- positive cash flow from the conversion of working capital.

We built a little working capital because we're putting in a new line for our Preprufe products. So that will work itself off now as that line comes in. That's being built now in the second half. So we'll get some working capital improvement. But as we see the volume, we get the revenue, that's the biggest driver for us on the cash, but we'll see that come with the revenue.

And the next questioner today is Mike Sison with KeyBanc.

I think you said, Dean, that the outlook for the second half would be similar in the third and the fourth...

Yes, about evenly split for earnings, yes.

Okay. And then when you think about that and you think about your backlogs, what gives you confidence that you're going to get -- that would imply a little bit of a step up from 2Q? It should be -- I don't know -- yes, decent pick up from 2Q. And any worries that things can slip, I mean, project-wise from 4Q to 1Q '18?

Yes, Mike, this is Greg. There are a couple of things. One, we're going to get the impact now on the restructuring activities that we didn't have in the first half. We had stranded costs in the second quarter in the first half and we're now eliminating that. So those actions are in place and being done. So from that perspective, we're just executing on plans that are well laid out and communicated. On the revenue side, our project activity is, we've been saying all year, picked up. And we're now seeing some of the projects: couple of airports came in, in the America as we've gotten some metro stations in Asia Pacific and the Middle East; we've got some bridge activity. So I mean, the project stuff, as you see come in the end of the year, your question is around how confident are we that stuff is going to get built in the time frame we have. And we acknowledge that risk is there, but that's a little bit why we have the range we have out there. The range incorporates in our mind some of the risks associated with timing. But on the SBM business, the project pipeline has been second-half loaded. We're seeing that come in. We've got the acquisitions on the full second half that we didn't have in the first half of the year and then we got the restructuring. Those are the 3 big drivers. We'd like to see the North America business on concrete pick up a little bit. We're hearing from our customers, very strong backlogs. I hate weather as an excuse, but it has been a bit rainy and as it dries out, we're seeing that business pick up. But we need a little bit of support there. But that's why we have the range.

All right. Would you say that the low end of the range gives you -- is it more driven by what you can control versus maybe some of the weather and external issues?

Yes, I mean, we had some inflation that hit us in the second quarter. Also, Mike, there was some dislocations on rubber, specifically raw materials. There were some butadiene shortages that came out of Asia. Those numbers went up quite significantly. That's dissipated. So you're right. There are pieces that we have good control over the restructuring. What we've bought on the raw materials, the projects we've landed and then the rest of it is how's the timing, I think it's a good way to think about it.

Okay. And just 1 quick follow-up. When you think about that corporate line item that has the stranded cost, what does that fall to in the third and the fourth quarter, if your cost savings programs sort of flow-through?

So if you kind of pick the midpoint of the savings we talked about, it's about $1 million that will come out of the corporate, the rest will be broadly distributed across G&A -- SG&A.

And the next questioner today is going to be Jim Barrett with SL King & Associates (sic) [CL King & Associates].

Dean, I think this may be a question for you. I'm looking at your strategy update and see that you -- in July, in the second half, you're going to be paying down $400 million worth of debt. That still leaves you with $400 million or more of cash. When I look forward, what's the likelihood that -- and it looks like you are going to refinance as opposed to retire your bonds due in '19. What's the likelihood of most of that cash going into acquisitions? Are there enough out there that you envision being potentially available over the next few years? Or do you envision that will be a difficult implementation of your cash proceeds?

Let me let Greg sort of answer that and I will follow up.

Jim, on the pipeline, the pipeline is pretty strong. And now with the Darex divestiture completed and the focus, it's building force, we'd like to put that money to work through the bolt-on acquisitions. If we sort of look at the pace we have, we have to be at a little greater pace than we've done since we had the company, but we've now got a focus. We think the pipeline will support it. But the fact of the matter is, they have to be available. They have to be available at a disciplined price that we like that fits into our business model. And if not, then we'll look for the best way to deploy that cash for value for the shareholders. But the fact of the matter is where we are today. The best thing we could do with our money is first invest in our ongoing base business. You know our CapEx number, it's not going to be much greater than 5% that takes in the growth on the Verifi and the installs. We want to get that done. We want get the bolt-on. We've given ourselves some time to plan that out and work it. And if there is cash at the end of the day, then we'll figure out the best way to make returns on that for the people who own our shares.

(Operator Instructions) And the next questioner today is going to be Chris Shaw with Monness, Crespi.

Can I get a little bit more color on the weakness in Asia this quarter? I think you said it was somewhat related to the project delay, but then there was a couple of countries you said it also that were weaker. Are those also sort of project based? And is Asia, in general, a more large project based sort of business?

There are big projects in Asia and on a comparative basis, we have some big ones that came off on SBM last year. But when infrastructure happens around the world, you get those bigger projects and they tend to be doing more of that in Asia. But our specific cases are sort of 3 things. I think Dean laid out a couple of countries where Malaysia and Indonesia and Singapore, those are markets that we've pretty nice positions on. Hong Kong was quite strong last year. They're not doing quite as much infrastructure. So that's where we have strong market position impacted us in the quarter. We're seeing some of that come back and we have some project work that's coming in, in the rest of Asia Pacific in the second half that we know we've got. There was a little bit of delay there. And then, frankly, there were a couple of customers that we don't have anymore, the margins just won't support of our business. We're confident on our recapture of that, but that hit us in the quarter as well, but we're going to be disciplined on our margins.

Okay. That's helpful. And then I was wondering for the second half of the year. Do you see -- I would think that FX would be a tailwind. Do you see that as well for you? I know the year was positive. Are there too many other ones offsetting it? Or should it also help the back half?

I mean, all things being equal, we should see a tailwind. But that our guidance is based on sort of the month-end foreign exchange at the end of June. But again, all things being equal versus our previous guidance, it should be a bit of a tailwind.

But you're right. It's been against us for quite a while now and sort of swinging our way a little bit. At least we've...

And then, I think, you referenced a bit about some raw material pressures. You said they were, I guess, subsiding. But did you also -- was there I guess, is there amount of pricing that you got in the quarter or over the first half of the year? Have you sort of made up for whatever raw material inflation you did see through the first half so far with pricing yet? Or is there still a little bit more to go on that?

Yes, if I step back and sort of look big picture, the price and inflation we anticipated, we pretty much offset the base inflation we saw in the business. We had some spike in rubbers and butadienes that came out of dislocation in Asia. Those things went up significantly. We're working off some of that inventory. Still there is a little bit of a tail on that in the third quarter as well, but they come back down. That we don't recover in price. You get a spike like that, you deal with it in either side. So our pricing inflation strategy was about right, ex that spike. And if you look at the comparatives on pricing, we felt pretty good about that. Where the markets are weaker, in some of the markets in Asia where the volumes aren't quite as good, it's a little tougher to pass some of that pricing through. That's just a reality when in some of those segments that aren't as strong. But overall on inflation, we just -- there was a dislocation. If you look out there, the rubber parts subsided. With our new acquisition, MMA, it's been a little tough and you're seeing some pricing. We've been able to offset that, but there's some raw material pressure there too.

And the next question is going to be a follow-up from Jim Barrett with SL King & Associates.

Greg, a question on Verifi. I know you have a customer in the U.K. Are there any organizational constraints to expanding that business internationally? And I'm thinking principally of continental Europe? Or is that beyond the U.K. multiyear eventuality?

The answer is, it will be multiyear, but there is no organizational constraints. For us, what we will do is put the infrastructure in from sort of the -- you've seen the system sort of technology back home, we're building that out. We have to have the European and other approvals to ship the systems. We're working those. Organizationally, we have the capability. One of the things that's happened to us, frankly, as we picked up and we did pick up some new customers also in the second quarter, we like our install rate. But some of those issues took us a little longer to get the units in because you had to get the right approval process. We're working our way through that. There is no structural reason. But as we add countries and customers, you got to put in the work in the infrastructure. So that's what's been happening in U.K. and our plans are, frankly, to over the next few years, is to take that product line to the markets that look for that kind of productivity. And we're getting some good -- we're talking to people around the world and getting some good discussions going. We're pretty happy with the response we're getting from Verifi, we could continue to and it's working out for us.

And in broad stroke, I believe, there are about 55,000 concrete trucks in the U.S. How large is the -- would the worldwide market be for Verifi, if I look at 5-plus years?

Yes. So, Jim, if you look at the strategy deck, I know people have been asking us and there's a lot of ways to frame it. We look at this as an early-stage technology. We frame now for everybody in that deck, a potential addressable market. And the way we got to that as we said where we know there's good usage from a technology, we can apply it. We have the organization. We think there'd be acceptance. We frame that at about $750 million. That's not the total potential, but as we sit today, we've sort of said early-stage technology, what's our addressable market target in terms of where we could go from a market standpoint, we frame that up at about $750 million.

And that's the current market size today as opposed to, well it's going to change obviously due to the cyclicality of the end markets, but -- and I take it that, that's largely U.S. at this point.

No, that would include U.S. market and other markets where the sophistication of the concrete methodology, the technology is available, strong enough Internet, web, all of that. So we would include Singapore in that market, for instance. We would improve some of the more mature Asia markets, parts of Europe. We could broaden that number. What we've just done is put a target and said let's give a framework to it. Given the size of the business in the early development, we sort of say that's big enough, let's go chase that.

And the next questioner today is Mike Harrison with Seaport Global Securities.

Greg, I was wondering if you can maybe give a little more detail on the restructuring. Exactly what it entails. I know you've mentioned that there was some delayering of the organization going on in order to get closer to customers. Can you just kind of walk through how much of it is headcount reduction? And kind of where exactly that's all coming from?

Yes, thanks, that's good. As we've said we've got a sort of total net reduction and when we say net reduction, we're including some reinvestment. That's why it's $22 million to $25 million. Dean made a statement in his prepared remarks that we've gotten the cost out associated with stranded cost of Darex. That number we pegged at about $25 million. $15 million of that is the cost that we are directly associated with Darex. It moved to discontinued op. So that's there. We have take it out. We have to manage that out. We've got the plans that's ongoing. And then the remaining $7 million to $10 million is a combination of delayering some management on a country structure, broadening the responsibilities at the top levels of the company and putting more people. This is some of the add-backs down at the customer tech service marketing level. We're trying to go through the company and say now that we're focused on construction, management can manage the people in our geographic regions at a more broad level rather than the specific product lines. But we want to be very strong at the sales level. So that's we've taken out some management layers. We've taken out some G&A layers, relative to the simplification of the business without Darex. And we've also, as you know, we had a President structure here. We now are going to add ACO to help with the operational management at the company. But we don't have the individual business product lines. We think it's going to make us more effective on big projects, put more people in the field. So total cost out about $25 million, $15 of that's with the Darex. There was also some stranded G&A that wasn't in discontinued ops. That comes out of that process. So that's where the money is coming from. And there's some add backs. And our add backs are all pretty much at the ground level. Sales, some marketing and we're continuing to add technical service and R&D. R&D spends up some. So that's how we're thinking about it.

And then is there any asset rationalization or manufacturing rationalization as part of the restructuring?

We have some asset restructuring that came with Darex. It's included in that number. It's a smaller piece of it. And there's also some activities going around on some other assets that, frankly, we'll be able to talk about probably in a quarter or so. As we look at it, we're looking for continued opportunities. This was the big chunk that came with the divestiture and we've taken care of that. But we think there might be a little more carving around the edges here on the assets.

But it's all within our guidance, right.

Anything there will be an addition.

Got it, okay. And then just going back to the butadiene spike that you saw, particularly in Asia. I was wondering if you saw that affect customer buying patterns during the quarter.

Yes.

If they couldn't get a hold of certain products or certain materials, where if you were trying to charge higher prices and they just delayed purchases?

No. I would tell you that and it's not in Asia. I didn't mean to portray it as an Asia market tissue. The cost spike was because of capacity constraints in Asia and there is a whole bunch of stuff that went on, when Chinese New Year fell, when the plants were running. But we saw a spike that we passed -- that we aid on the raw material side. I can't tell you that it impacted our business. Our pricing strategy was based on total raw materials. We think we've pretty much covered that. And part of the margin dislocation on SBM was that spike up, spike. It's flowing through the P&L now. Actually it was earlier in the year but the way our inventory works, it comes out second quarter or first month or so or third quarter. So it really didn't impact our business from a customer standpoint. It just took some margin.

All right. And then the last one from me is just regarding the capital structure. You addressed that you're going to be taking down the term loan and the revolver. In terms of those high-yield notes, is there a point in time when those get attracted to take out? Or is it just a matter of waiting until they're callable in 2019?

Yes, look, I think the short answer is when they're callable in February 2019 is probably the best point to start to think about repricing.

And continually run the number?

Yes.

Ladies and gentlemen, this will conclude the question-and-answer session and today's conference call. Thank you for attending today's presentation. And you may now disconnect.