CLARCOR's (CLC) CEO Chris Conway on Q2 2016 Results - Earnings Call Transcript

| About: CLARCOR Inc. (CLC)

CLARCOR Incorporated (NYSE:CLC)

Q2 2016 Earnings Conference Call

June 16, 2016 11:00 AM ET

Executives

Tom Lawrence - IR, DVL Seigenthaler

Chris Conway - Chairman, President & CEO

David Fallon - CFO

George Manor - Corporate Controller

Analysts

Kevin Maczka - BB&T Capital Markets

Tim Mulrooney - William Blair

Richard Eastman - Robert W. Baird

Larry Pfeffer - Avondale Partners

Operator

Good morning, ladies and gentlemen and thank you for standing-by. Welcome to the CLARCOR Incorporated Second Quarter 2016 Earnings Conference Call. Today’s conference call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]

It is now my pleasure to turn the conference over to Mr. Tom Lawrence of DVL Seigenthaler. Please go ahead, Mr. Lawrence.

Tom Lawrence

Thank you. We appreciate your interest in joining us on CLARCOR’s conference call to discuss results for the second quarter of 2016. By now, everyone should have received a copy of the news release that was distributed yesterday. If anyone does need a copy, it is available on CLARCOR’s Web site at www.clarcor.com or you can call [Kathryn Berendt] [ph] at 615-244-1818, and she will send you a copy immediately.

Before I turn the call over to Chris Conway, CLARCOR’s Chairman, President & CEO, I’ll remind you that all statements made in the news release and during this conference call, other than statements of historical facts are forward-looking statements. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

The Company believes that its expectations are based on reasonable assumptions. However, these forward-looking statements involve known and unknown risks, uncertainties, and other important factors that could cause the Company’s actual results, performance or achievements, or industry results, to differ materially from the Company’s expectations of future results, performance, or achievements expressed or implied by these forward-looking statements. In addition, the Company’s past results of operations do not necessarily indicate its future results.

Finally, we want to let people know that the information statements made during the call are made as of the date of the call, June 16, 2016. Those listening to any replay should understand that the passage of time by itself will diminish the quality of the statements. Also the contents of the call are the property of the Company, and the replay or transmission of the call may be done only with the consent of CLARCOR.

It's now my pleasure to turn the call over to Chris Conway for his opening remarks.

Chris Conway

Thank you, Tom. Good morning and thank you for joining us today. With me are David Fallon, our Chief Financial Officer; and George Manor, our Corporate Controller. After a few opening remarks, I’ll turn it over to David Fallon to review our financial results and guidance in more detail. I’ll finish with a few additional remarks before we open up for questions.

We reported diluted earnings per share of $1.09 for the quarter after the close of trading yesterday. But as noted in the press release this included a one-time patent litigation award worth approximately $0.37 per share. David will discuss in more detail the various elements that contribute to our adjusted non-GAAP diluted earnings per share of $0.73 in the second quarter of 2016 compared with $0.74 in the second quarter of 2015. Market conditions in several of our markets remained challenging with our most significant headwinds coming in the oil and gas sector and the off-road ag engine filtration sector both of which are in cyclical troughs.

On the oil and gas side rig counts, a general indicator albeit not directly correlated to our natural gas market, continue to be down and could be for the next 12 to 18 months. One area of positive activity in the oil and gas market in the U.S. is in the liquefied natural gas infrastructure. With the gradual movement to permit and build LNG export facilities we see opportunities to supply filters to the pipelines that connect to these facilities, and in some of the applications within those facilities. While that is an opportunity we still recognize the need to take appropriate actions to right-size our oil and gas business and position ourselves to be stronger when these LNG opportunities solidify and when drilling picks up pace.

With respect to ag, we are seeing signs of stabilization but not necessarily of improvement. We expect the market to be stable for the rest of the year but visibility beyond that is challenging. Our experience in this area mirrors what you’re hearing from the large equipment players that we’re seeing what the rest of the market is seeing that is significantly lower equipment build and reduced inventories through the OE dealer networks. It’s obviously not all doom and gloom and several of our businesses performed well last quarter particularly HVAC and gas turbine.

As we’ve mentioned last quarter, we continue to execute our cost reduction efforts and the commercial strategies. This includes development and introduction of new products and continued penetration of new markets and customers. I’ll share some of these efforts later after David’s remarks. I’ll turn it over to him now to review more of our financial details. David?

David Fallon

Thank you, Chris. As a precursor to my comments I refer you to Pages 11 and 12 of our earnings release for reconciliations from GAAP to non-GAAP adjusted figures for the second quarters of 2015 and 2016. 2015 GAAP figures have been adjusted for the sale of J.L. Clark and 2016 GAAP figures have been adjusted for upfront cost associated with cost reduction initiatives and a $27.3 million patent litigation award received from 3M Company as disclosed in our first quarter 10-Q as a subsequent event pursuant to a dispute between 3M and TransWeb a company we purchased in 2010. Many of my comments today refer to these non-GAAP adjusted figures.

Our second quarter financial performance was relatively consistent with last year’s performance as adjusted diluted earnings per share of $0.73 declined $0.01 from last year’s second quarter on a $15 million or 4% decline in adjusted net sales and a 10 basis point improvement in adjusted operating margin. In general, the $15 million reduction in adjusted net sales after removing the impact of the J.L. Clark disposition was primarily driven by continued headwinds in our natural gas filtration business and continued challenges in our off-road fuel filtration business. Changes in foreign currency led by the British pound and the Chinese yuan negatively impacted net sales by $4 million. These year-over-year net sales declines were partially offset by higher HVAC and gas turbine filtration sales.

From a segment perspective, net sales in our engine mobile segment declined $7 million or 4% from last year’s second quarter. These lower sales were primarily the result of a $6 million decline in fuel filtration sales into the Ag and construction equipment markets. Although off-road fuel filtration sales declined 22% from last year’s second quarter these sales increased sequentially from the first quarter and have remained relatively flat on a quarterly basis from the third quarter of 2015 possibly indicating some current stability and the potential for continued stability for the remainder of the year. Nevertheless, despite easier second half comparables, we are projecting perhaps conservatively second half sales in this market to decline approximately 7% from last year’s second half, primarily as a result of limited, intermediate term visibility in this market.

As a result, we anticipate full year 2016 sales in this market to decline approximately 14% from full year 2015. Elsewhere in this reporting segment, heavy duty engine, filtration sales in our U.S. aftermarket declined 3% from the second quarter of 2015 primarily due to higher second quarter sales last year to Carquest as a result of initial channel fill. On a year-to-date basis, sales to Carquest are up slightly from the first 6 months of 2015 and we expect full year growth between 5% and 10%. Second quarter sales into our U.S. aftermarket excluding Carquest increased approximately 1% from last year’s second quarter as we’ve experienced low but stable growth in this market for the last 18 months. Net sales in our industrial environmental segment declined $8 million or 4% from last year’s second quarter including a $13 million or 19% reduction in natural gas filtration sales.

Similar to last quarter, lower sales in this market were primarily the result of a decline in capital vessels sales which have been negatively impacted in the U.S. from the significant reduction in shale extraction infrastructure projects. Capital vessels sales declined 36% from last year’s second quarter after declining 32% in the first quarter. Natural gas filtration aftermarket sales remained solid increasing 6% for the quarter and 8% year-to-date. However, due to continued uncertainty relating to the capital side of this business, we have once again reduced our sales outlook for this market. We now anticipate a 16% full year sales decline, a 4% or $12 million change from our previous expectations communicated at the end of the first quarter.

Partially offsetting lower second quarter natural gas filtration sales in our industrial environmental segment was a $6 million or 20% increase in the HVAC filtration sales. A significant portion of higher sales in this market relates to commercial products sold into the Middle East, but U.S. sales to commercial and industrial customers also increased 4% in the second quarter and 5% year-to-date primarily due to gains in domestic market share. Due to our first half sales performance and our expectations that this momentum will continue into the second half we are increasing our full year estimated sales in the HVAC filtration market by approximately $12 million now expecting full year sales growth of 14%.

As a quick update on our cost reduction program, we realized approximately $6 million of savings in the second quarter including approximately 4 million from last year's reduction in force, $1 million from lower discretionary selling and administrative expenses and $1 million from our purchasing initiative. This $6 million savings was equally split between cost of sales and selling and administrative expenses. We believe we're on track to realize savings in excess of $20 million from cost reductions in fiscal year 2016, similar to our comments at the end of the first quarter, we continue to evaluate other cost reduction initiatives that might impact cost structure beginning in 2015 or 2017 but we have no significant status update to share for these initiatives at this point.

We generated $156 million of cash from operations in the first half of 2016, $89 million higher than the first six months of 2015. This increase includes the $27 million patent litigation award, but the remaining additional $62 million was generated primarily from optimization initiatives across all working capital accounts, but notably inventory which declined over $20 million from year-end. We expect to generate approximately $210 million of cash from operations for the full year 2016 exclusive of the patent litigation award as cash management continues to be a core focus for the remainder of the year and beyond.

Finally, we maintained our previous 2016 diluted earnings per share and consolidated top-line guidance. However, we shifted $6 million of expected full year sales from industrial/environmental to engine/mobile. The $6 million increase in engine/mobile was precipitated by higher expected sales in several international markets and the $6 million reduction in industrial/environmental was driven by a $12 million decline in expected natural gas filtration sales and a $6 million decline in industrial liquids filtration sales offset by a $12 million increase in HVAC filtration sales.

This sales mix shift in industrial/environmental from two relatively high operating margin markets to a lower operating margin HVAC market produced the 0.3 percentage point reduction in expected industrial/environmental operating margin and the 0.2 percentage point reduction on a consolidated basis. From a quarterly pacing perspective, we anticipate third quarter net sales to be 5% to 10% lower than our second quarter primarily due to lower natural gas and gas turbine filtration sales.

As a result, we expect third quarter diluted earnings per share to be about 5% lower than our second quarter. Of course these third quarter expectations in light of our year-to-date results and our full year guidance suggests a robust fourth quarter. As a reminder, as it happens every four or five years our fourth quarter includes an additional or 14th week to accommodate our 5, 4, 4 closing calendar.

With that said I turn it back over to Chris.

Chris Conway

Thank you, David. We made continued progress on key initiatives this past quarter. We talked last time about the impact our CLARCOR management system has had on improving our operations and reducing costs. A close look at our cash flow results from this impact continues as we see further reduction in inventory, while emphasizing continuous improvement in customer service levels. New products and innovation continue to be a focus of investment even during challenging times. We have great examples of innovative new products being released in our industrial air business, our oil and gas business and our engine filtration business.

Many of these new products are the direct result of the synergies from our acquisitions and collaborations fostered by our internal organization efforts. In the first half of this year, our industrial air business has introduced numerous new products, these include a new modular baghouse which is the combination of our UAS business in the equipment space along with knowledge of baghouses from our BHA business which is part of the GE Air Filtration acquisition, a SMOG-HOG mist collector which uses PEACH media from our PECOFacet business and mist collection for hibachi tables, where we've seen double the number of orders compared to last year as well as the compact weld fume collector using our proprietary ProTura Nanofiber media along with an expanded relationship for weld fuming collection with a global welding process OEM.

These examples in our industrial air business represent a significant uptick in the pace of new product development and introduction, since we merged the BHA business we acquired from GE with our UAS equipment business.

In our oil and gas business, we have developed new products to solve critical gas and liquid coalescing and separating challenges of our customers. We are seeing increased sales of high flow filters for water treatment in oil and gas applications, and we introduced a PEACH element for high temperature applications such as those found in refinery operations. Combining CLARCOR's Nanofiber technology with our PEACH process has created products to help remove the iron sulphides which are commonly known as black powder in the gas fields in the Mid-East, notably in Saudi Arabia. And in South-East Asia, we are solving customers’ problems with removal of entrained mercury from natural gas sources.

In our engine business, we have introduced new products for fuel filtration that strip water from the fuel and include integrated sensors with advanced filter media inside the filters. These are for large over the road truck as well as for forklifts and off-road construction equipment. We have also leveraged PEACH coalescing technology from our PECOFacet business introduced a product called the closed crankcase ventilation filter which returns oil mist generated in the internal workings of the engine and returns that mist back into the loop system of the engine, rather than allowing it to be released to the outside air.

Our teams of engineers, scientists and operation specialists are hard at work on these and many other projects, aimed at improving growth and improving the operating margins. The work being done is with enthusiasm and dedication. I am excited about the energy I see and the cross fertilization happening within CLARCOR as we rollout the CLARCOR management system and share technologies and new product ideas across our multiple companies. This quarter's results come from the hard work of all our employees and I thank them on behalf of our customers and shareholders.

We will now open it up for questions.

Question-and-Answer Session

Operator

Thank you, Mr. Conway. [Operator Instructions] We will go first to Kevin Maczka with BB&T Capital Markets.

Kevin Maczka

First question on U.S. aftermarket, down three but plus one if we back out the Carquest, I guess the question is, that the freight environment is still fairly weak, what are you seeing there in that underlying rate? It doesn’t seem like it's changed much, but do you expect that to soften a bit going forward?

David Fallon

If you look at the trends that we are seeing in various statistics, notably the ATA truck tonnage, if you go back three months year-to-date or even a trailing 12 month figure, it seems to be fluctuating in that plus 2% to plus 3% range. I think there was an anomaly in February where it was up 9, but that truck tonnage has since come down. I think we see continued low growth in this market at least through the end of this year. As we always say visibility for us is pretty limited, much beyond just several weeks. But from conversations we have been having with customers and some of our larger distributors, I think the market anticipates at least on the filtration side relatively stable low single-digit growth going forward.

Kevin Maczka

Got it. And then on Carquest up 5 to 10 this year, can you talk about that a little bit more, is that a function of opening up some new opportunities with them, some further SKU additions or getting into the class five to six, what's that driving that 5 to 10?

Chris Conway

So what's driving it is, yes, we have added more SKUs compared to the starting program, and then there has also been some work done with additional store front activity experimental work with a limited product line in some of their other stores. But I would say the major part of it is probably the uptick in the SKUs that we are seeing.

Kevin Maczka

Got it. And finally from me on the LNG infrastructure opportunity that you mentioned, is there any way to frame kind of the timing of that, the potential size of that, anything at all that you are doing there currently or is this all kind of new greenfield opportunities?

Chris Conway

It's greenfield, we are working on trying to frame it a little bit better, but as you know it involves a long process of permitting and EPC work, so the timing of that at this point is a little bit hard to pin down. The way we are seeing it right now is coming in, in RFQs for some of the released projects that are out there. But at this point we don’t have a real good way to kind of frame it up for you.

Operator

We’ll go next to Tim Mulrooney with William Blair.

Tim Mulrooney

So looking at on the engine side first looking at your off-road fuel filtration sales, I think you said last quarter it was flat sequentially fourth quarter to first quarter, can you talk about what it was from the first quarter to second quarter?

David Fallon

Yes, there was certainly sequential growth from second quarter or from the first quarter to second quarter but -- and some of that growth is just related to seasonality, we have December in our first quarter in the holidays and sometimes weather impacts sales in the first quarter. So even though we show growth and I think it probably was up 7% 2Q versus 1Q, we don’t look at that as core fundamental growth, we look at that as more related to the seasonality. So going back to the third quarter of last year, quarterly sales if you adjust for seasonality are fundamentally flat, one quarter has been up a little bit and other quarter has been down but we’ve seen a real stability from 2Q this year to 3Q in 2015.

Tim Mulrooney

So then what’s your expectation I guess for the back-half of the year for this market, are you still expecting kind of flattish type of environment?

David Fallon

I would say relatively flat, now as I mentioned in our comments, if you look at the math and the numbers we are actually projecting a 7% decline in the second half of 2016 versus the second half of 2015, that is perhaps being conservative but due to the lack of visibility and the continued uncertainty in the Ag and construction equipment markets and also pursuant to some conversations we had with some of our larger customers if you look at the trend from 2Q to 3Q, we actually have taken that down just a bit.

Tim Mulrooney

Okay, I got you. And then how much did your TDC acquisition, how much did that contribute to sales in the quarter?

David Fallon

Yes, for the full year it’s about $5 million, in the second quarter, it was right around 4 million.

Tim Mulrooney

Okay. And then on the natural gas business switching gears a little bit and the new forecast is down 16% for the full year. I think that implies mid to high-teens declines in the second half of the year, is my math correct there?

David Fallon

It is right, and so year-to-date we’re down 16%, we have guided to down 16% for the full year so, yes, the second half is projected to be down 16% as well.

Tim Mulrooney

So, is it fair to say then that those LNG opportunities are being pushed out to a fiscal ’17 or later but not necessarily in the back half of this year?

Chris Conway

I would say, yes, and to the earlier question kind of trying to frame it at this point I wouldn’t really build much into our model for that until we get a little bit more information on what the, call it, pipeline of those opportunities represents.

Operator

[Operator Instructions] We’ll go next to Richard Eastman with Robert W Baird.

Richard Eastman

Chris or Dave I just wanted to spend a second to your -- on PECO though, the reduced sales outlook for PECO is that business pushed, does that 12 million of business remain in backlog or is that 12 million of business essentially what you had earlier expected to fall in the second half relative to the LNG opportunity?

David Fallon

I would say it’s a combination but most of that essentially are sales that we were anticipating based on a certain level of activity that just did not occur. And so I would not call it timing, meaning the expectation is not that a significant portion of this has been moved to the first quarter of 2017.

Richard Eastman

Okay, so it was not in backlog and we had hoped it would be in backlog, it is one of things that stepped out kind of real-time to us is our E&C kind of analyst has been flagging LNG project cancellations, I mean this is kind of real-time here in the last few months, I mean how does that factor into the visibility here, is that you know?

Chris Conway

I don’t think that’s driving them because we never really built a lot of…

Richard Eastman

Okay.

Chris Conway

…numbers around that effort, it really isn’t -- this is probably what you’re seeing in our numbers, is probably more our traditional North American type backlog of information and there have been a handful of projects that maybe have moved out a little bit, not necessarily LNG related but for the most part it's what David said it's just work that didn't show up that we were looking to see flow into the backlog numbers.

Richard Eastman

And then just a question on the engine/mobile side of the business it seems like maybe you could just give us a sense of how rest of the world engine/mobile performed in local currency, was it up mid single-digits or?

Chris Conway

So, overall engine/mobile in the second quarter declined 4% and that 4% decline was actually somewhat balanced between the U.S. and international. Now, of course included in that international business is export for the fuel filtration business, which of course was down rather significantly, if you strip that business out it actually was up low single-digits and if you look at it from a geographic perspective Europe was up about 5%, China was up 7% and some of our smaller markets also showed some growth including Australia which was up close to 20%. So, if you look at the performance in the second quarter I think it definitely was higher than our expectations. But suffice it to say we're not trusting the performance in the second quarter to continue through the end of the year. So, we have adjusted our second half expectations for those international sales somewhat but if you look at a trend rate from the second quarter sales and extend those to the second half of the year we definitely are expecting second half sales to trend below what we saw in the second quarter from an international perspective in engine/mobile.

Richard Eastman

Well, I mean China plus out was a nice surprise, I mean, but obviously that you're thinking China in the second half of this fiscal year will still be a negative number year-over-year?

Chris Conway

Yes.

Richard Eastman

Okay.

Chris Conway

And if you look year-to-date -- and China is very volatile. So, year-to-date China is relatively flat. So, we're coming off our first quarter where sales in China were down in the upper single-digits. So, what we saw in the second quarter could have been some tiny impact both from sales that would have been expected in the first quarter or due to the first fit nature we have a sense that some of that could have been a pull in from the third quarter.

Richard Eastman

And then maybe the new wrinkle in the quarter on the industrial side, the industrial liquid the air business softened, is that a new little wrinkle of concern here or I mean what does that business I mean that presumes that's like the polymer stuff and filtration and?

Chris Conway

Yes, that's the polymer side of our business and I think I mentioned maybe touched on it last quarter a little bit, it's, filter is the go into things like the carpet industry in the U.S. and that industry is off 25% to 30%. And so we've seen similar reduction in the sales now. Materially is it large that whole business -- it's out of our pure laser business which is really our smallest operating business. So, this is a piece of that and I guess what we see at this point is we don't see that recurring or coming back very soon. Because the trend what we're hearing the trend is really people moving away from because of sick house syndromes moving more towards hardwood floors and the carpet people are struggling because they're not seeing the kind of fiber generation sales that they used to.

Richard Eastman

And just maybe just one last question, Dave given the fourth quarter has an extra week in it from an accounting standpoint overall, I mean is 30 million a kind of a good estimate for the extra week? I mean what do you have in your plan for kind of that extra week? Does that [Multiple Speakers] the week because it's right at the end of the year?

David Fallon

Yes and it's really hard to do a mathematical, well actually it's really easy to do a mathematical explanation but that math may not be correct. I think in my comments at the end of my comments I suggested that the third quarter would be down 5% to 10% from the second quarter. So, that gives you a third quarter sales number around 345 million. And since we give full year guidance you can kind of plug the fourth quarter, so it's probably around 370 million. So, mathematically you're talking one week over 13 -- it's safe to say that that's worth 8% on a quarterly basis.

Operator

We will take our next question from Larry Pfeffer with Avondale Partners.

Larry Pfeffer

So on the HVAC business obviously things have been trending very nicely for you guys there with the extra absorption, are you going to close to double-digit margins in that business in the fourth quarter?

Chris Conway

Yes I think what we talked about in the past is that the long-term goal is to get closer to 10%. But we are probably still a good 12 to 24 months away from approaching that on a quarterly basis. But we could exit the fourth quarter certainly in that 7% to 8% range.

Larry Pfeffer

Okay. And just a remainder where were you towards the end of last year in that business?

Chris Conway

Yes. There is some volatility, we are still going through some restructuring but from a run rate perspective we were probably under 5%.

Larry Pfeffer

Okay, I appreciate that. And then just from a modeling standpoint incentive comp came in a little lighter than I anticipated this quarter, is this quarter's figure around 2 million a good run rate for the back half of the year?

Chris Conway

You are going to have to clarify incentive compensation?

Larry Pfeffer

Sorry, stock based comp.

Chris Conway

Okay, the comment in the earnings release essentially said that, stock compensation and other expenses were down $4 million from the second quarter of last year. About 2 million of that was stock compensation and it really was related to the accounting treatment of certain individuals that at a retirement age last year and so we had accelerated stock compensation in the second quarter of 2015 that was the primary driver of the year-over-year favorability.

Larry Pfeffer

Okay, so more of the timing issue, there isn’t any real change in the full year run rate?

Chris Conway

That’s correct.

Operator

With no other questions in queue at this time, Mr. Conway I’ll turn it back to you for closing remarks.

Chris Conway

All right, thank you very much for all your questions. I want to again reiterate thanks to all of our employees, who worked hard to deliver the results we saw this past quarter. And thank you on the call for your interest and your questions.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation. You may now disconnect.

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