GCP Applied Technologies Inc (GCP) 2018 Q2 法說會逐字稿

Good morning, and welcome to the GCP Applied Technologies Second Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Joe DeCristofaro, Vice President of Investor Relations. Please go ahead.

Thank you, Gary. 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 the quarter's 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 on 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 financial results and our outlook. We are discussing these results on a continuing operations basis to account for the sale of Darex Packaging Technologies. Additionally, we deconsolidated Venezuela as of July 3, 2017. 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.

Thanks, Joe, and good morning. GCP revenues grew 5% in the second quarter with our SCC business up 10% and SBM flat to prior year. Our earnings were negatively impacted by inflation and increased foreign exchange volatility in certain emerging markets. This impacted our costs, and our SCC business was disproportionately impacted by these factors. SBM revenues were flat in the quarter due to project delays and our decision to reduce customer discounts. This was especially in our residential underlayment business, which shifted June revenues into the third quarter.

Our bolt-on acquisitions are performing well and contributed about $25 million in second quarter sales with adjusted EBIT margins in the 20% range. We're continuing to pursue a strong pipeline of bolt-on acquisition opportunities. Our construction markets are healthy in North America, Western Europe and Asia. However, Latin America, Turkey and the Middle East are being impacted by geopolitical events, foreign exchange volatility and inflation pressures.

We are implementing a 3-point plan to improve the profitability of our SCC admixture business and to accelerate the penetration of high-margin technologies such as VERIFI.

First, we're raising prices significantly in low-profit, high-volatility admixture markets. We're also rationalizing business in a number of these volatile markets and in low-profit countries and with certain customers. This low-profit admixture business consumes a disproportionate share of our resources offers minimum near-term opportunities for our differentiated technologies.

Secondly, as a result, we are implementing a restructuring program that targets $25 million in annualized sales, with about 70% of the savings benefiting SCC business. The restructuring program consolidates facilities, reduces headcounts and lowers operating expenses.

Third, we are focusing on growth in approximately 25 to 30 core admixture countries where we are well positioned, generate strong margins by providing best-in-class product range and a level of service that customers value. We are also focusing additional resources on our growing VERIFI and integrated In-Transit Management admixture system as well as other differentiated admixture and cement technologies.

We estimate the addressable admixture market in our focused countries to be about $2.5 billion, with an additional $750 million to $1 billion in VERIFI opportunity. VERIFI continues to gain market acceptance by providing value to our customers who have placed over 45 million cubic yards of VERIFI concrete. We estimate ready-mix producers can capture $2 to $3 for every dollar spent once they implement the integrated VERIFI into their systems and mix designs. These savings come from reduced admixture and cement use, productivity improvements and the benefits of placing higher-quality concrete. VERIFI sales are growing at a rate of 60% over prior year. We're targeting VERIFI revenues of $50 million to $75 million by 2021, with adjusted EBIT margins equivalent to or greater than our SBM margins for this business. We also expect additional revenues as we gain penetration with our integrated In-Transit Management admixture system.

We've begun implementation on our 3-point plan to improve the admixture business in order to strengthen our competitive position, provide sustainable margins and accelerate opportunities for future growth built on our new technologies. As we announced in July, Randy Dearth will be joining us on September 1 as GCP's President and COO. And we look forward to working with Randy and our team to support the execution of our strategy across the company.

I'd now like to turn the call over to Dean for additional detail.

Thank you, Greg, and good morning, everybody. Just a reminder, all the revenue and associated growth rates in my comments are on a constant-currency basis. GCP's consolidated revenues grew 4% year-over-year to $299 million and were up 6% excluding Venezuela and the divested Halex tack strip business.

The second quarter began with strong sales with April and May averaging 11% growth. June, however, was down 3% due to a combination of project delays and our decision to reduce customer discounts in our residential business. As a result, revenue shifted into the third quarter. We now see July sales growing 13% year-over-year and we expect solid sales growth to continue in the third quarter, supported by strong construction market in our order pipeline.

In the second quarter, SCC sales were up 9%. Admixture sales increased 7% with North America up 15%. EMEA was up 8%.

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also continued to perform well growing 4%. And as Greg pointed out, VERIFI installed units, again, increased 40% in the second quarter with sales up 60%.

SBM's revenue was down 2% year-over-year, but Building Envelope sales were up 9%, including Stirling Lloyd and R.I.W. However, residential sales declined 21% due to our decision to reduce price promotions, shifting sales into July, as I mentioned. Specialty products declined 8% year-over-year due to the divestiture of Halex tack strip business and lower Halex promotional activity which, again, shifted business into the month of July.

On a regional basis for GCP in the quarter, North America revenues were up 5%. Sales excluding acquisitions increased 2%, primarily due to growth in our admixture business, which was partially offset by lower residential sales. EMEA revenue was flat in the quarter as growth in concrete admixtures was offset by a decline in Building Envelope due to a profit timing lower volumes, particularly in the Middle East. In Asia Pacific, revenues increased 7% due to growth in our Cement and Building Envelope businesses. Latin America revenue increased 5%, and over 20% excluding Venezuela, Mexico continued to be strong and Brazil grew about 7%.

Adjusted gross profit declined 4% to $113 million and margins declined 370 basis points to 37.2%. We captured the amount of price we anticipated in the quarter, about $4.5 million, but inflation and logistics costs were about $11 million. The increase was primarily due to a 10% sequential increase in average oil prices as well as emerging market foreign currency volatility.

The SBM business cover inflation with price overall. However, the revenue shift impacted margin mix. SCC was negatively impacted. Almost 70% of the total inflation was in the SCC business. In North America and Western Europe, SCC's price increases more than offset the inflation. However, Turkey, Argentina and Brazil, which represent approximately 10% of SCC sales, contributed more than 45% of SCC's inflation. Currencies for these countries, combined, moved 25% on average against the U.S. dollar, which contributed to year-over-year inflation of between 15% and 25% in these countries in the second quarter.

We've initiated significant double-digit price increases in these inflationary markets. In addition to price increases, we're also rationalizing our admixture position in certain low-profit countries, with an estimated revenue reduction of about 10% of SCC's annual sales. The 2018 revenue impact is estimated to be about $10 million with little or no impact on gross profit.

In conjunction with the rationalization, we've announced a restructuring and repositioning program targeted with annual savings of about $25 million, of which 70% will benefit the SCC business. We expect to realize $6 million to $8 million of savings in 2018 compared to our previous forecast. We expect to achieve the remaining $17 million to $19 million in savings in 2019, and we estimate total cost for the plan will be $30 million to $35 million. $20 million to $25 million of that cost is directly related to the restructuring actions, and $10 million of the cost will be directed to repositioning efforts.

GCP's adjusted EBIT declined 19% due to our segment's low operating income. Our interest expense of $66 million included $60 million pretax charge associated with our debt refinancing transaction. We expect the annualized earnings benefit of the lower interest rate on our new 5.5% senior notes to be approximately $0.25 a share. Our tax rate for the quarter was 29%. Adjusted EPS was $0.27 a share on a diluted share count of $72 million -- excuse me, 72 million shares.

Adjusted free cash flow was negative $9 million compared to positive $2 million versus last year's second quarter. The decrease was largely due to a $10 million accrued interest payment made in April as part of the redemption of our 9.5% senior notes, and $5 million transition toll tax related to the 2017 tax reform act. we'll not have an interest -- we will not have an interest payment for our new senior notes in the third quarter.

Looking at our revised 2018 guidance. We now expect sales of 5% to 8% growth. We have included in our forecast a $10 million reduction in SCC's revenue in 2018 as the results of our plan to rationalize low-profit admixture markets.

Our adjusted EBIT guidance is now $125 million to $135 million. We have included about $20 million of additional inflation in 2018 to account for the impact of second quarter results and our expectation for consistent inflation, partially offset by additional price actions and the restructuring initiatives I've just mentioned.

We expect our tax rate to remain between 28% and 31%, and we're now revising our adjusted EPS guidance range to $0.92 to $1.06 per share. And we now project, as a result, $25 million to $35 million in adjusted free cash flow.

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

Thank you, Dean. GCP's sales grew in the second quarter and our core markets remained healthy. Our SBM business is performing as we anticipated, given some project delays and the shift in the residential business in the quarter. We are taking actions to recapture our SCC margins, which were negatively impacted by the inflation and volatile foreign exchange rates we saw in the emerging markets. The actions include implementing additional price increases in these markets, initiating a restructuring and repositioning program targeting $25 million in annual savings, and focusing our resources on the core admixture markets and increasing penetration of VERIFI and our integrated In-Transit Management admixture system. This 3-point plan is designed to improve our SCC margins, reduce our overall cost structure, redeploy resources to higher margin opportunities and to lower the overall volatility of GCP's results going forward.

We want to thank you for joining our call, and now Dean and I would be happy to take your questions.

(Operator Instructions) The first question comes from Mike Harrison with Seaport Global Securities.

I was wondering if you can maybe give us a little bit more detail on how we should split up the $25 million of restructuring savings into different buckets? And can you talk at all about -- as you undertake some of these restructuring actions, talk about the tools or the analytical approach that you use to determine what actions you're going to take? Is there an EVA or ROIC-driven approach to those actions?

Yes. I mean, actually, it's -- in terms of the split of the money, the $25 million, as I said, about 70% of it will accrue to the SCC business. That's both in selling costs and factory admin as well as G&A that's allocated to that business. So each one of the lines on the P&L will benefit. Essentially, what we did was we resegmented all of our admixture businesses. We went down to the territory country and customer level. We went after those businesses that weren't generating the kind of returns that we expect in this business and we went through an assessment of how much resources we deploy in each one of those countries and to those customers, and we put the plans in place. They are already developed, approved by the board and being implemented to eliminate the costs associated with business. The cutoff point, frankly, was not in an ROI. We were looking at contribution margin which, for us, is defined as gross profit and then selling expenses. And we're also taking the G&A associated with that. So it was a very detailed resegmentation of the admixture business, which allowed us to take the $25 million of savings through the P&L. But also, as importantly for us, take those 25 to 30 countries where we have very nice margins, good positions and put resources against growing that business, so it's a twofold strategy.

Yes. And I think just to add to that comment, notably as I mentioned in my comments, about $10 million of revenue will be adjusted out as part of our updated guidance with little or no impact on gross profit. So I think that's just an indicator of the analysis -- the outcome of the analysis and the program that we're undertaking.

All right. And then question on...

One other point -- I'm sorry, one other point I would tell you. On that 25 to 30 countries, from the admixture standpoint, you can think in terms of us eliminating 45 to 50 countries. So you can see about the complication and simplification we're doing on the business. It does not impact cement, it does not impact SBM. Those businesses continue, but it's that type of complication and complexity we're taking out of the business. So sorry to interrupt, but I just wanted to follow up with that.

No, I appreciate that additional color. And then a question on pricing. Can you talk in a little bit more detail about how the contracts work in both the building materials and construction chemicals pieces? Are you able to get any more flexibility in this inflationary environment to be able to move prices as you see materials or logistic costs moving? Or are you kind of stuck with the contracted price, even if it moves 3 or 6 months later?

Look, it's a great question. And we've traditionally said it takes us a quarter or 2 to recapture our price. The fact of the matter is, in the second quarter, I mean, we have come out. We didn't quite get as much in the first, it took us some time, but I think Dean nailed it. We came in with about $4.5 million of price in the second quarter. What happened to us was, and especially in these emerging markets, this FX shift and the oil pass-through accelerated on us. Frankly, that is not a contract issue for us in those countries. We just need to go back in and put those prices in, and that's what we're doing as we roll into the third quarter. Where we have the contractual business in the admixture side, North America, the core European market, some of the mature markets in Asia Pacific, we did a pretty nice job of covering the inflation with price. In fact, in North America, we more than covered it. So it was not an issue, in this case, of the contractual obligations. It was more the speed with which the oil price changed. And typically, we see foreign exchange go the other way with oil. But in these countries, we got hit by both very quickly. Now that's the volatility issue we're talking about relieving.

(Operator Instructions) The next question comes from Chris Shaw with Monness, Crespi.

I guess the question I had in the SBM, you said things were, I guess, fairly on track through the first couple of months, but then you stopped promotion. I mean what was the reason for that? What was the market conditions that caused you to do that? I mean what -- I know it sounds like you're just pushing sales out to the third quarter, but like what's happening there that such a sort of, I guess, so much dramatic shift in sales can happen?

Yes. Chris, that's a great question. I'm glad to give you some color on it. What we essentially in -- historically, have done in the residential business has had promotional discounts that essentially reduced the prices. And with inflationary pressures, we decided to regain that price. And we made a decision in the second quarter to eliminate those promotional discounts in that business. What's happened then was rather than doing the buys that took place as they had those discounts in the prior year, they didn't buy in June, but they bought in July. We've seen no shift in our estimate for residential, so we picked up that margin. But it shifted, as Dean said, the res business was down 20...

21%

21% in the quarter. All of that shift came, frankly, in the latter part of the quarter. And we've seen a pickup -- I mean, we're through July now, we've seen it come back. So it was a promotional activity that we used. We decided that, that was another way to get price increases in that business or the best way to, and we eliminated those for the quarter.

Okay. And then I'd like to follow up, I guess, to something that you were just saying before about this sort of quick -- the quick rise in somewhat the raw materials in the second quarter. I thought that on the first conference -- first quarter conference call, you said you guys felt like you were ahead, caught up to -- or at least on top of the sort of raw material inflation with price. What happened in the quarter? I don't remember there being -- maybe there's some specific raw material that I'm not following, but that moved up in the quarter so quickly after seemingly being on top of it after the first quarter.

You're right, and we had put in and anticipated and put in pricing. In fact, we're about on our pricing plan for the operating plan for the full year. Two things happened. Oil did move 10% sequentially, which is the base of some of our raw materials. But the big driver for us was in Turkey, Argentina, Middle East, parts of India where you had these emerging markets, we had Brazil, a significant change in the FX rate in those specific countries. As Dean said, when you combine them up, they moved 25%. Usually, when that happens, it's the reverse of oil and we got them both. So we were buying raw materials, importing into those countries and getting the FX hit. So it was the specificity of that, ex that move, we would have been -- and when you look at our core markets, we did cover the inflation with price. So we thought we were on track that, that move on foreign exchange in those countries, we didn't anticipate.

And then I guess longer term in the SCC segment, what is sort of the targeted operating margin for that business?

Yes. I mean that's exactly the questions. So if we take the $25 million, $20 million of it accrues to that business. We picked up 250 to 300 basis points from where we are now, and then the opportunity is to shift that business to our core countries where we have better margins. Those countries, there's 25 to 30 of them where we have nice margins, good product lines. And in those businesses, we're focusing on VERIFI in addition to our admixture business. If you take that VERIFI business and add it to admixtures after depreciation, that part of the business gets SBM-type margins. So we expect to bring those SCC margins over time up. As we said, a couple of hundred basis points once we get the -- or more, once we get the $20 million back. So we took a hit here in those emerging markets, we're pricing ourselves to recover that hit and then we're focusing in the 25 to 30 markets where we have the position to improve the margins and taking the costs out.

The next question comes from Connor Cloetingh with KeyBanc Capital Markets.

So I was just wondering, I know at the end of 2017 and the beginning of 2018, you had some large projects that you're involved in. Anything similar to that, that gives you confidence in your back half outlook or going into '19 that you see on the horizon?

Yes. I mean we do have some really good project work. In fact, some of that shift took place. We've got some very nice projects in North America. We're finished -- we've got a major infrastructure project going on. And there are actually a couple of them going on in New York City, which you read about all the time. Those are in progress now and starting to ramp. We've got some good project work going on in Mexico. There's sort of in a transition from pouring slabs to building walls. So when they're pouring slabs, we do more, they'll come back and do some more waterproofing there. We picked up some nice work out in Asia Pacific with some of our new projects around shotcrete. We, actually, our pipeline on the SBM business is up about 10%. The project work is out there. The Middle East got pushed out. We have very good business going on in Qatar. You've read about what's going on there, those projects are getting finished, but they did get pressed out from us. That was some of the project delay we saw in the second quarter. We're shifting some of that projects in the third. So our project pipeline is pretty good. Actually, our SBM business, despite the fact that we had this disruption in the quarter, SBM business is pretty strong. We've just had res shift some margin.

Okay. Great. And then just a question on your acquisition strategy, is there still a good pipeline in the works there? Or any plans for share buybacks in the future?

Connor, we really like the pipeline that we're seeing and we're working that. So we haven't changed our strategy around capital deployment at all. We've got a good pipeline. We're continuing to work it. Our strategy is to buy those businesses that have the kind of margin profiles after we synergize and that fit into this structure. We're sticking with that. And we got a good pipeline and we're going to continue to pursue it, and we'll tell you about them when they get done.

Great. And then just one last one, just curious could you remind us how much of your SBM business is tied to residential?

Yes. That res business is about a little less than $100 million.

In the quarter.

It's a good business for us. And that business is solid this year, but we've got a lot of movement in terms of their quarterization, but it's a great question. It's a little less than $100 million.

Yes. In the quarter.

This concludes our question-and-answer session and the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.