OMNOVA Solutions' (OMN) CEO Kevin McMullen on Q1 2016 Results - Earnings Call Transcript

| About: OMNOVA Solutions (OMN)

OMNOVA Solutions Inc. (NYSE:OMN)

Q1 2016 Earnings Conference Call

April 6, 2016 09:00 ET

Executives

Kevin McMullen - Chairman & CEO

Paul DeSantis - SVP & CFO

Analysts

Roger Spitz - Bank of America

Michael Sison - KeyBanc

William Hoffman - RBC Capital Markets

Tom Spiro - Spiro Capital

Operator

Ladies and gentlemen, thank you for standing by, and welcome to OMNOVA Solutions First Quarter 2016 Earnings Discussion. At this time, all participants are in a listen-only mode. Later, will conduct a question-and-answer session, instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Chairman and CEO, Mr. Kevin McMullen. Please go ahead.

Kevin McMullen

Thank you, Brad, and good morning, everyone. Joining me as usual is Paul DeSantis, Senior Vice President and Chief Financial Officer.

In a moment, I'll review our encouraging first quarter results which reflect the hardwork we've been doing to improve company performance and position our business for sustainable long-term profitable growth. But first, I'd like to turn it over to Paul to make comments on forward-looking statements and to summarize our financial performance in the first quarter.

Paul DeSantis

Thanks, Kevin, and good morning, everyone. During this conference call, OMNOVA representatives may make forward-looking statements, as encouraged by the Private Securities Litigation Reform Act of 1995. All statements in this conference call and in subsequent discussions with the company's management, other than historical information are forward-looking statements. These statements represent management's current judgment on expectations for future results and other matters. A variety of risk factors highlighted in the company's Form 10-K and in our most recent earnings release could cause business conditions and the company's actual results to differ materially from those expected by the company or expressed in the company's forward-looking statements.

In addition, certain financial measures, referred to during this call, are non-GAAP financial measures. For an explanation and reconciliation of these non-GAAP measures, please see our most recent earnings release and investor presentations published periodically on the company's website.

Here is a quick snapshot of our first quarter. We earned an adjusted $0.04 per diluted share, well up from the adjusted loss of $0.01 than last year's first quarter. Margins expanded during the quarter with gross margin up year-over-year by more than 500 basis points, adjusted operating margins were up by 240 basis points driven by our cost reduction initiatives, improved mix and pricing. Trailing twelve month EBITDA reached $81.3 million, up $77.7 million at last year's first quarter-end.

Use of cash was favorable to last year by $15 million, as a result of the increased EBITDA and improved cash position, adjusted leverage was 3.8X compared to 4.2X at the end of last year's first quarter. Volume was up in several of our key specialty lines such as specialty coatings, laminates and films, and construction materials.

To bring you up-to-date on the many actions and initiatives that are driving this improvement, I will turn the call back over to Kevin.

Kevin McMullen

Thanks, Paul. We are pleased we are seeing tangible side of progress on the strategic re-positioning of OMNOVA that we began in 2014 which reached an important milestone in the first quarter of 2016 with $0.05 improvement in adjusted EPS highlighted by increased margins and cash flow.

It was particularly encouraging to achieve significant year-over-year improvement in profitability in what has historically been our slowest quarter of the year due to seasonality factors such as the holidays, year-end customer inventory adjustments in seasonality in the construction and refurbishment industry. While we still have work to do, we believe our improvements are building momentum. I would like to focus my remarks today on the progress we are making on two of our strategic priorities. As we have discussed one of those priorities is to expand margins and to generate greater cash in our performance materials business which includes a challenged North American paper market.

During the first quarter and through the third quarter in a row we were able to continue to expand margins and generate increased cash and performance materials year-over-year despite volume declines. This success is due to intense focus on picking up cost, realigning and right sizing our manufacturing footprint, developing current and new products and implementing pricing that reflects the value of our price an services and meeting our customer's needs. As you know we have significant steps to improve our cost based. The biggest actually has been a realignment of our manufacturing footprints to bring styrene butadiene capacity utilization North America from approximately 62% to greater than 90% today.

As part of this important initiative we ceased manufacturing at our Calhoun, Georgia facility at the end of first quarter and have transferred styrene butadiene production to our Green Bay, Wisconsin where we have a more modern cost competitive plant. This is beginning to deliver the positive benefits that we anticipated. In addition, we continue to receive the benefits of repurposing SB assets including closing our legacy oleochemical plant and transferring production to more modern and productive assets in Mogadore, Ohio which have been repurposed from SB latex to manufacturing products that will support our specialty business.

In February our lowest sold is rubber manufacturing operation and associated product lines in India. These products were not aligned with our go forward strategy, were not made in any other OMNOVA plants. The divestiture resulted in $2.2 million of lower sales year-over-year for the 2016 first quarter and will continue to impact the sales numbers for performance materials throughout this year. However, the India business was not a profitable contributor to the company. Importantly this move allows our team to place greater focus on those businesses that are strategic and which we have the ability to grow profit and cash.

As a result of these and other actions we now believe we have changed the trajectory in terms of the profitability and cash generation of performance materials as evidence by the third consecutive quarter of year-over-year profit growth. For the remainder of the year we expect to continue to see consistent profit increases as a result of our actions including additional cost favorability of the transfer of manufacturing to Green Bay, higher margins for pricing initiatives and the introduction of a new higher product for the carpet market, this new carpet latex representing more targeted approach to product development for the performance materials business.

I would now like to talk in depth about the strategic priority to accelerate growth in our specialty businesses. We consider this our number one priority. The results during the quarter indicate clear progress but we have more work to do. We have taken a hard look at what would be needed to ensure sustainable long-term profitable growth for the company. As a result, we have put in place and are pursuing an enhanced commercial excellence agenda with specific actions and reengineered processes designed to accelerate our profitable growth trajectory and reach our strategic goals.

I would like to take you through our actions in each of the three areas; first, selling. We have set up a new sales organization performance chemicals with a new goal of head of sales and sales leaders in each region including Asia-Pacific where we never before had a sales role at this high level. The people in these roles are proven sales leaders are employing new processes to drive results and excellence on a global sale. We have instituted key account management moving smaller customers to our inside sales team giving our top deal professionals more time to develop deeper relationships and identify more opportunities with larger customers that had extensive portfolios that are products getting addressed.

We are putting in place new processes the voice of the customer on a deeper level and to understand where and how their needs match with our unique capabilities. In doing so, we can better assess the likelihood of success and the impact if we are successful so as to more effectively target our efforts. Finally, but very important, we are creating greater alignment between our sales, marketing and technology teams. This is critical to ensuring that we are accelerating the speed at which we are developing and bringing to market technologies that our customers' needs but also have broad market applications while driving increased margins and profitability.

Secondly, the area of marketing; we have split our marketing organization into strategic marketing and product manager roles to better align talent and competencies to our business needs. This will allow us to gain greater focus on developing robust, strategic growth plans while at the same time accomplishing critical day-to-day product management tasks. We have added strategic marketing talent in our specialty businesses through our developing deeper more insightful marketing plans based on more thorough analysis of market size, growth characteristics, competitive landscape and most critically customer needs.

Our marketers are doing a better job of applying voice of the customer's findings from our sales team overlaying there thorough market analysis and working closely with our scientists to develop and bring new high value, high potential products and technologies to market faster. The third state of our commercial excellence is R&D or innovation where we have significantly increased the value of our new product portfolio. For example, we have narrowed our product development efforts while refocusing our higher margins and profit opportunities. We have reallocated resources to better support our specialty lines of business. We are ensuring a steady stream of new technologies and products in the pipeline which are focused on larger market opportunities for OMNOVA.

Our innovation efforts will have higher impact in return as we are more centered around developing platform technologies that have applicability in many applications and multi generation product plans. These new products will start coming to market over the next several quarters at margins accretive to overall company margins. We have several exciting new products at early launch stage all of which incorporate proprietary technologies from OMNOVA. For example our laminates and performance films business is ramping up new applications with market leading companies whose products go into large new construction and refurbishment markets including luxury vinyl tile which is the fastest growing flooring segment in North America.

We received initial orders of about a million dollars for these three applications in the first quarter. Together, they represent significant huge potential in a combined industrial market sizes several hundreds of millions in dollars. Another new product example is our water-based sun-crow [ph] hydrophobic technology which is a replacement chemistry solvent based silicone release coding used in construction materials. Our initial target market represented potential market size of tens of millions of dollars with a much broader serviceable market where our technology will allow us to gain a significant position.

And at the American Coating Show next week OMNOVA will be launching five new specially coated products. One is for zero-VOC direct-to-metal paints which furthers our strong global introduction of direct-to-metal coating resins in 2014 and 2015. Another new product is for commercial roof coatings offering excellent adhesions to difficult sub straits like polyurethane foam and supporting customer's efforts on energy conservation to obtain energy conservation certification such as ENERGY STAR for commercial buildings. The third coating product we launched provides best in class water resistance for using water proofing membrane coatings and the fourth new coating product is a time saving single component epoxy acrylic latex for garage floors replacing two part systems that are difficult and time consuming to install.

The fifth new introduction is for the floor care market. It is an advanced surface guard product for polished concrete. A flooring material used increasingly in commercial spaces. This product greatly reduces end-use customer makings, maintenance cost with new levels of durability and improved appearance. These five products join a growing lineup that have a strong potential to accelerate the growth rate of our specialty coatings business and significantly expand our served markets.

All of the products I just mentioned are coming to market at an ideal time as the construction industry continues its rebound and we prepare to enter the summer building and refurbishment season. For example, single family housing starts have been pending up and recently reached their highest level in 9 years. In addition the American Chemistry Council specialty market volume index for the first quarter points to particular strait in adhesives and construction chemicals while we are broadening our offering in both chemicals and engineered surfaces.

Overall we are very encouraged that we are beginning to see some positive traction as a result of the strategic actions we have taken over the last two years. We are seeing sustained profit growth, improving performance materials business. We have strengthened the capabilities of our commercials team, we have expanded margins from cost reductions, improved our product mix and taken placing actions and we continue to introduce value added products to expanding market place to accelerate growth in our specialty business.

We are making clear progress but realize there is more work to do. Our strengthened team is motivated and focused and we are on track to deliver a second year of significant adjusted earnings per share growth. We look forward to discussing our second quarter with you in June.

Thank you. And Paul and I are now ready to answer your questions and turn it over to the operator, Brad could you please open up the lines.

Question-and-Answer Session

Operator

Certainly thank you. [Operator Instructions] And we will go to the line of Roger Spitz from Bank of America. Please go ahead.

Roger Spitz

Thank you and good morning. Forgive me if you actually said this during the prepared remarks but could your have you given the fiscal Q1 2016 volume changes year-over-year in each of performance chemicals and engineering surfaces or if you have would you mind repeating them please?

Paul DeSantis

Sure so what we said was engineered surfaces volume and engineered surfaces for films and laminates was up slightly. If you look at the page from the financial statement coating fabrics was down, volume was down and both performance materials and it was down in the specialty chemicals. Performance materials volume was about where we expected it to be and in the specialty side of the business the primary driver of the decline was part of oil & gas business.

Roger Spitz

Okay. Thank you for that. The main thing was that you didn't give any particular percentage up or down.

Paul DeSantis

No, we did not. No in the earnings release we broke out an aggregate.

Roger Spitz

Right understood. In terms of specialty chemicals oil & gas what volumes do there in fiscal Q1 2016 and preferably how did that move? And is that quarter -- you're estate thinking that the turf for that sub-segment or sub-business?

Kevin McMullen

So just in context of our business we continue to diversify our business. We believe we are performing better than the underlying market. Our volumes were down kind of mid-single digit on a year-over-year basis. We think that's better than the underlying market as a result of the diversification we are doing both geographically as well as end markets served. Historically we have been pretty focused on the aspiration part of the market. We are diversifying our approach there and that is helping our performance better than the underlying market.

Roger Spitz

And if you only ask business preferable on an EBITDA basis in this quarter?

Kevin McMullen

Absolutely it has been throughout. It is a very good business for OMNOVA solutions.

Roger Spitz

Great and lastly can you give any guidance on the 2016 SG&A? We think about it on a clean basis which I think was $29 million this quarter. Is that a good run rate to think about for the rest of this year on a quarterly basis?

Paul DeSantis

Yes I mean SG&A, we have taken a lot of action to control SG&A and to bring it down and so I would expect SG&A to be relatively consistent quarter over quarter. If there are exceptions to that it would be things like bonus accruals or any kind of other issues but the underlying run rate on that business is not going to change too much from this quarter. We have the organization flushed out and placed right now.

Kevin McMullen

SG&A is down in the quarter on the year-over-year basis we have taken it. I think in addition to reducing overall SG&A I think there has been a lot of re-allocation of our SG&A to more focused resources on the area where we see the greatest opportunity to grow our specialty businesses. Both are reported in our mind to not only lowering our costs but refocusing those costs to areas we can drive growth.

Roger Spitz

Thank you for that and thank you very much.

Kevin McMullen

Thanks.

Operator

And our next question will come from the line of Michael Sison with KeyBanc. Please go ahead.

Michael Sison

Hey guys, couple of quick things, you have commented your latex operating rates are now above 90%, does that apply to performance materials and specialty chemicals or is that just a comment just for performance materials?

Kevin McMullen

So this is an SB latex comment which some of SB latex, over the bulk of SB latex goes into performance materials, some of it goes into specialty as well. But overall SB latex is at 90%.

Michael Sison

Okay. So can you gives us your thoughts what drives profitability up from here, obviously you have got your plan reasonably well utilized, I guess it could go up a little bit. And what else drives improved profitability from the 9% here that you achieved in the quarter?

Kevin McMullen

I think we will continue that. There is more contacts as a result of the plain closure that really happened starting our second quarter so we have seen the benefits of that in our income savings so we are going to see that as we go through the rest of the year. That's one, but on top of that certainly actions in growing our specialty business which will improve our mix which will improve overall profitability. The new products we talked about it's not an overnight sell. It will take time to sell in because new products and time will absolutely be agreed to our profitability and margins and will allow us to grow faster. And, the pricing actions that we have taken and we continue to look at will also give us increased profitability. I guess the last piece I would say is with some of these new introductions we have alluded to in engineered surfaces, its additional growth opportunities that we see in fact some new adjacent markets will help drive the improved profitability going forward.

Michael Sison

Okay. And then one quick one the specialty chemical side, the sales are down but you noted your profitability was up. Is that the impression that we are going to continue to see that, or maybe you can give us a bit of clarity of how the mix is really going to drive improving, you probably don't need sales to go up, you just need the changes in sales is going to drive the profitability improvement for that part of the business?

Paul DeSantis

Yes so that's a good question. So there was a pretty big mixed effect. We mentioned that coating was up good strong double digits and that's a pretty profitable business for us and so Kevin just mentioned we are launching five new products in coatings coming up at the coating show and these are products of our R&D, the revamped R&D process. We are targeting a creed of margins as we start to launch these products and part of what's happening is as we said before we were expecting a national decline in the paper side of the business. We are going to grow the non [ph], the coatings business, we're seeing that growth and those carry different margin profiles so clearly we are focused on growth primarily in our specialty businesses because that will take us where we think we need to get.

Michael Sison

Okay. Great, thank you.

Operator

And we will go to the line of William Hoffman with RBC Capital Markets.

William Hoffman

Yes good morning. I wonder if you talk a little bit more obviously the volumes that were provided in February and some of the tones obviously in U.S. as well as Europe, can you talk a little bit about what you see in subsequent months like anything starting to pick back up again as the markets come back, people get a little bit more confidence or they are pretty sluggish?

Paul DeSantis

Yes I think a quick answer to you would be we do see improvements. Couple of things, the first quarter is always seasonally our weakest so this starts in December; many companies are de-stocking at year end. The construction season obviously is in the low so on a sequential basis we definitely think there is volume and demand improving as the construction season starts up etcetera and the second quarter has 10 or 12 more days, more working days in it than the first quarter did. Chinese New Year behind us so all of those things point to things are improving.

I think one of the fundamental things is there was a fair amount of de-stocking at many businesses at year end and probably drifted into the beginning part of calendar year that I think is now starting to reverse so I think for those reasons North America feels like it is improving some, Europe feels like it, it is huge growth but it is unreasonably solid footing. Asia still has a lot of bumps in the road, it's still growing. The question is has it bottomed and started to accelerate its growth or is it going to be at a more moderate level? We are still trying to get a read on that. I think a lot of the press things you read that Asia's in a huge decline, we don't see it that way, we see it as not growing as fast as it once did. And obviously in China its huge market still, so even mid-single digit growth is a lot of volume growth on a big market so, we still think there is a lot of opportunity there.

William Hoffman

Great thanks and then just on SB latex, read a paper in Harvard Chemicals, obviously papers doing it a down, continued to decline here but with a capacity rationalization is views like it should be more steady, do you think there is any price recovery or is there risk of market share shifting on or anything like that recorded like what do you think the competitive dynamics are right now?

Kevin McMullen

Yes we do believe we can get price of that business. We believe value pricing is very important. We have been very focused on that with our customers in the first quarter we were able to get positive pricing in that business and we were encouraged by that. Obviously a lot of the business in paper and carpet is by contract and so as contracts come up that's the opportunity and so we had some contracts that came up in the first quarter where we were able to secure positive prices.

William Hoffman

And from a volume standpoint was there any share shifting or is it sort of stable at this point?

Kevin McMullen

I think it is reasonably stable. There is always some amount of turn we need to service but it is reasonably stable so we certainly have been focused and are very clear of our strategic focus of improving our cost position and improving our profitability in this business and we are able to do that and that continues to be our focus.

William Hoffman

Okay. Thanks and a quick question for Paul. Capital expenditure was like 27.5 which is still short of the target?

Paul DeSantis

Yes some where there, between 25 and 30.

William Hoffman

Okay. Perfect, thank you.

Operator

And we will go to the line of Laurence Alexander with Jefferies. Please go ahead.

Unidentified Analyst

Yes, hi, this is Nick Stefaros [ph] stepping in for Laurence, how are you guys doing today?

Paul DeSantis

Great, how are you?

Unidentified Analyst

So just really two quick questions, first one being what can we expect in terms of restructuring charges going forward and I was also wondering if you guys could elaborate on which end market specifically are you seeing any acceleration in?

Paul DeSantis

So I will take the restructuring charge so, we had $3.5 million. That was really two big pieces both related primarily to the closure of our Calhoun plant. That plant is closed, those costs are behind us, I would expect minimal restructuring charges on a go forward basis. We are through with the heavy lifting in that restructuring and so there maybe a little bit more but it will not be near the levels we have seen in the past.

Kevin McMullen

Yes I think in terms of markets accelerating we are very encouraged by the price we have and the businesses we have to go into construction and refurbishment coatings had a very strong quarter. Laminates and our films business were up on a year-to-year basis and are one of the new opportunities we talked about so, that's one area in particular we think in everything we read all the forecasts of analysts and so forth is that the construction market is in a pretty strong position. I think we will continue growth there and we would expect to grow share with our new products and our new technology will bring to market in a growing market which is a very good combination.

Unidentified Analyst

Okay. Thank you very much.

Kevin McMullen

Thanks.

Operator

And we will go to the line of Tom Spiro, I apologize I don't have a company name.

Tom Spiro

Tom Spiro, Spiro Capital, good morning.

Kevin McMullen

Good morning.

Paul DeSantis

Hey, Tom.

Tom Spiro

Kevin, I just wanted to know what your thoughts are with respect to carpet.

Kevin McMullen

Yes. So I think our deal is carpet was a very long and protracted cyclical decline following the housing bubble burst and the great recession. So from 2007 for the next seven years there were -- the market where carpets are declining in North America. We believe that is now stabilizing and there is modest growth in carpet. Going forward, I think residential carpet will be probably in the flattest area and commercial carpet will see some growth, 2% to 3%, something like that. So overall, modest growth in carpet going forward but very different story than in paper where we think it is structural. Carpet we think prolonged and cyclical and it is now starting to rebound and we will see modest growth going forward.

Tom Spiro

Thanks. On the specialty chemicals piece I think Kevin perhaps you or Paul noted early in the comments that the volumes there were down overall in specialty chemical and oil & gas volumes were down maybe mid-single digit and coating was up double-digit, doing double-digits. Given the role of size of oil & gas and coatings I was kind of curious is there something else in the specialty chemicals whose volume was declining something of significant piece of it?

Kevin McMullen

Yes there were different things going on during the quarter, some of which is timing related. First into the non-woven business, there was some softness in our non-woven business. We think that's largely timing. The whole dipper market on a global basis, there was some softness in Asia and that market during the quarter which we think is now starting to pick up again. There was some seasonality clearly in durable non-woven for construction materials where there is softness on a sequential basis that we are starting to see some volumes picking up there so there was some of that during the quarter but we take a lot of that was the timing.

Tom Spiro

Thank you, Paul a couple of questions. How much of our cash balance is in the U.S.?

Paul DeSantis

In the U.S. our cash balance, let me have that, in anticipation of you asking that question I actually wrote it down, so in the U.S. right now we have $3.5 million.

Tom Spiro

Do you anticipate picking to the revolver in the upcoming quarters?

Paul DeSantis

We tend to generate cash for the next three quarters for the year and so our expectations are that we will see that cash generation. We also are looking at ways to bring the cash back to the U.S.

Tom Spiro

Thanks and lastly, the quarter just ended, what was the difference in tension expense 2016:1 versus 2015:1?

Paul DeSantis

$600,000.

Tom Spiro

And for the year it is supposed to be four times of that, $28 million?

Paul DeSantis

Yes, somewhere in that range.

Tom Spiro

Okay. Thank you very much and good luck.

Kevin McMullen

Thank you.

Operator

And currently we have no further questions in the queue.

Kevin McMullen

Okay. I would like to thank everyone for joining us today and Brad if could give the replay instructions to everyone. Thanks for joining everyone and have a great day. We look forward to talking to you at the end of our second quarter. Thank you.

Operator

And a digitized telephone replay is scheduled from April 6, 2016 11:00 AM Eastern until April 27, 2016 at 11:59 Eastern. Also, an audio replay will be available on the OMNOVA solutions website www.omnova.com until 12:00 Eastern on April 27, 2016.

That concludes our conference for today, thanks for your participation and for using the AT&T teleconference service. You may now disconnect.

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